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Analysts React To Section 956 Proposal

Some agree bill will benefit Puerto Rico, others unclear how much; could cost Puerto Rico Treasury half-a-billion in tax revenue on royalties now paid to parents


Algunos creen que el proyecto de ley beneficiará a Puerto Rico, otros no saben cuánto; podría costar al Tesoro de Puerto Rico medio billón de dólares


July 26, 2001
Copyright © 2001 CARIBBEAN BUSINESS. All Rights Reserved.

Gov. Sila Calderon’s proposed amendments to Internal Revenue Code Section 956 to provide a new federal tax incentive for manufacturing companies in Puerto Rico has been publicly embraced by representatives of companies and organizations on the island.

They are confident of the governor’s best intentions to create a more attractive tax environment for Sections 936 and 30A corporations prior to the expiration of the tax incentives under those to sections in 2005.

Las reformas propuestas por la Gobernadora Sila Calderon a la Sección 956 del Código de Ingresos para proveer un nuevo incentivo impositivo federal para las compañías manufactureras en Puerto Rico ha sido admitido públicamente por representantes de compañías y organizaciones de la isla.

Ellos son confidentes de las mejores intenciones de la gobernadora para crear un ámbito impositivo más atractivo para las Secciones 936 y 30A referidas a las corporaciones, antes de la expiración del incentivo impositivo de acuerdo con aquellas secciones en 2005.

On July 18, Gov. Calderon announced the filing of H.R. 2550 in the U.S. House of Representatives, with bipartisan support of Congressmen Philip Crane (R-Illinois), Charles Rangel (D-New York), and 26 additional congressmen. A similar bill should be introduced shortly in the U.S. Senate.

The Calderon administration proposal provides three key elements: no extension of Sections 936 or 30A, which expire in 2005; amendments to Sections 956 and 245 to allow controlled foreign corporations (CFCs) operating under Section 901 to repatriate up to 90% of their retain earnings tax free so long as it is invested in "U.S. property" or, alternatively, claim a deduction of up to 85% if distributed as dividends, respectively; and a safe harbor rule to allow the transfer of manufacturing intangibles to CFCs in Puerto Rico.

CARIBBEAN BUSINESS obtained reactions from several organizations’ leaders after they studied the bill. There appears to be consensus that the proposed amendment would benefit CFCs established in Puerto Rico and would provide a powerful incentive for them to remain operating in the island.

"The bill incorporates very good points, which the Puerto Rico Manufacturers Association (PRMA) agrees with," said Jorge Berlingeri, newly appointed executive vice president of the PRMA. "We were concerned with the elimination of Section 30A and its effect on those types of companies, which tend to be labor-intensive because they had a wage credit.

"This is the alternative for when Section 30A finalizes. I believe there is a good environment for the bill’s approval before the U.S. Congress, as long as Puerto Rico remains united. We need to remember that Puerto Rico has a lot of representation in Congress through the companies that are established on the island. The PRMA will also lobby in Washington, D.C. as an organization, as part of the government’s strategy," said Berlingeri.

Critics have charged that, as compared to the wage credit provisions of 30-A, which tied the incentive to the creation of jobs, the proposed Section 956 would provide a juicy tax exemption to companies without a commitment of job creation.

Puerto Rico Association of Economists president Carlos Soto also believes that the bill is well written in its effort to exempt CFCs from federal taxes on earnings to be repatriated to the U.S. Last week, the PRAE publicly abstained from supporting the measure without more information from the government

"This is a good first effort. Now the government should meet with the organizations and groups and evaluate in detail what this represents to the U.S. Congress. Have corporations been approached to attract them with this amendment? We need to know what is the government’s strategy and what data it has to substantiate and justify a project such as this," said Soto.

Other industry analysts complained that the language used in the proposed bill is confusing when it discusses tax exemptions. While the bill proposes that CFCs be allowed to repatriate up to 90% of its profits tax free from Puerto Rico or any U.S. possession to parent companies in the U.S. mainland, this would mean that the U.S. would levy 35% taxes on only 10% of the earnings repatriated, or 3.5% of total earnings.

Those CFCs with enough foreign tax credits could choose to benefit from the 85% dividend received deduction for dividends paid to U.S. shareholders. The U.S. Treasury would collect taxes on 15% of dividends distributed.

"Without committee reports the bill is very difficult to analyze. Those companies that filed under Section 936 benefited from income credits, and those that switched to CFCs could defer tax payment on earnings until dividends were distributed," said economist Jorge Freyre.

Freyre also warns against the impact the proposed transition rule on the transfer of manufacturing intangibles may have on Puerto Rico’s Treasury. "CFCs have been a bonanza for Puerto Rico’s Treasury because the rules on payment of royalties to parents are more stringent than they were under 936. Last year alone, taxes paid to Puerto Rico Treasury Dept. on royalties paid by CFC’s in Puerto Rico to their parent companies registered $550 million. At 10%, this means that CFCs must have repatriated at least $5 billion. The safe harbor rule [for certain transfers of licenses of intangible property to the CFC] ought to be looked at carefully, because Puerto Rico could lose these taxes if the intangibles are transferred to the island," said Freyre.

Senior economist Juan Lara, from Estudios Tecnicos, urged Gov. Calderon to not forget to strengthen the fundamentals of Puerto Rico’s industrial promotion program that were included in her economic platform.

"The proposed amendments have a substantial beneficial effect on Puerto Rico’s industrial promotion program. First, legislation would dispel the uncertainty that has characterized the industrial incentives climate in Puerto Rico since the mid-1990s. Second, the tax benefits are substantial and should prove attractive to capital intensive, high technology corporations.

"Fomento could then launch an aggressive round of new promotions. Most importantly, an improved outlook for industrial promotion would give Puerto Rico more time and resources to invest in strengthening the economic fundamentals: competitive costs of doing business, first-rate infrastructure, good quality of living, and a highly educated population proficient in technology," said Lara.

Even if Congress were to enact the proposal, change will not be evident immediately. The amendment could prompt companies already here to remain on the island. But attracting new corporations will require an aggressive industrial promotion program.

"This amendment to Section 956 will provoke long-term change. It normally takes a company three to four years to make a capital investment decision or move its facilities. But the amendment is sure to avoid the departure of those companies that are already here," said CPA Luis Torres Llompart, past president of the Puerto Rico Chamber of Commerce.

"Puerto Rico must decide what it will do with the remaining labor-intensive companies, which are not globally competitive. Companies in Puerto Rico that do not remain competitive in their industry will leave–with or without Section 956," said Torres-Llompart.

This Caribbean Business article appears courtesy of Casiano Communications.
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