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The San Juan Star

Section 956 Reform: Fact Or Fiction

By Ralph J. Sierra, Jr.

August 2, 2001
Copyright © 2001
The San Juan Star. All Rights Reserved.

Writing fiction - the weird practice of telling artful lies - can be quite bizarre when it affects the economic life of the almost 4 million U.S citizens residing in the Commonwealth of Puerto Rico. As Homer warned us many centuries ago, „Beware of "936 companies" bearing gifts.

The daily local press is replete with news covering the strong lobbying efforts being undertaken by the Governor of Puerto Rico, Hon. Sila Calderón, together with her colleagues, Resident Commissioner Aníbal Acevedo Vilá and Secretary of Industrial and Commercial Development Ramón Cantero Frau, and, more recently, local legislators, before the U.S. Congress to allow a Puerto Rico-based controlled foreign corporation (CFC) to invest its profits in the United States with a 90 percent exemption under Internal Revenue Code section 956 and facilitate the conversion of those companies operating in Puerto Rico under IRC sections 936 and 30A into CFCs. In so doing, they have induced many in the industrial, commercial and investment banking spheres in Puerto Rico to argue in their favor that approval of the pro—posed legislation will place Puerto Rico in a unique situation far outdistancing Singapore, Malaysia and Ireland, among others - for a CFC to establish itself.

Just this past July 18, H.R. 2550 was presented under circum—stances that oddly enough could presage the future of this bill. The bill to amend IRC section 956 (which upon first glance looks like a gold mine for the companies, and therefore of potential major benefit to Puerto Rico) was initially penciled in with what appeared to be No. 2520

This bill was later assigned No. 2550. H.R. 2550, The Economic Revitalization Act of 2001, is „To amend the Internal Revenue Cede of 1966 to provide an appropriate—ate and permanent tax structure for investments in the Commonwealth of Puerto Rico and the possessions of the United States, and for other purposes. On the other hand, H.R. 2520, The Abusive Tax Shelter Shutdown Act of 2001, is „To amend the Internal Revenue Code of 1986 to curb tax abuses by disallowing tax benefits claimed to arise from transactions without substantial economic substance, and for other purposes.

H.R. 2550 is an insult to the intelligence, honesty and integrity of the people of Puerto Rico, and makes it look like the representatives of the government of Puerto Rico were asleep at the wheel when the bill was being draft—ed. H.R. 2550 confers a 90 percent exemption from the dividend imputation consequence of IRC section 956 when the CFC makes stateside investments proscribed by that section. If the investment is made through loans or equity participation in an affiliate, H.R. 2550 would allow the investment to be made free of interest or the need to pay dividends.

When the CFC pays an actual dividend to its parent company, the full amount of the proscribed investment will qualify as previously taxed income, so that the net result is for full federal income tax to fall on only 10 percent of the amount invested stateside (that would be en effective tax cost of 3.5 percent under today's rates). In the alternative, the dividend from a CFC subsidiary would qualify for an 85 percent dividends received deduction.

Now that's a windfall that would really give Puerto Rice the Midas touch. And the program is being marketed to the Puerto Rico public on that basis (that is, the amendment, without going into details, will reap many benefits for the is1and) and the leaders of the community alluded to above are acting in a politically correct manner by backing the program to the maximum.

Unfortunately, they should read the other side of the coin as well. It is true that a CFC organized under the laws of the Commonwealth of Puerto Rico (or the other possessions of the United States) would allow its parent company to reap the benefits of the proposed amendment This being the case, how could anyone in Puerto Rico oppose the amendment (irrespective of the probabilities of approval)? But here is where the art of fiction comes alive, and the 956 Trojan Horse makes its presence. Not only would a CFC organized under the laws of the Commonwealth of Puerto Rico (or the other possessions of the United States) qua1ify for these benefits, but so would any CFC that is „engaged in the active conduct of a trade or business within the Commonwealth of Puerto Rico or a possession of the United States."

Thus rather than competing with Singapore, Malaysia and Ireland, and the others, Puerto Rico would more likely serve as a funnel or a laundry) for the earnings generated by these to-date more attractive places to have CFC operations. The mere opening of a branch in Puerto Rico (manned by one, two or three persons) by these other CFCs would be most deceptive for Puerto Rico's ambitions to find a reliable substitute to IRC sections 30A and 936 for furthering its own socioeconomic development

The art of drafting legislation can very well be like any other art - and to quote from a Russell Banks character, a small-time gangster named Jocko: „Yeah, well, artists are a lot like gangsters. They both know that the official version, the one everyone else believes, is a Lie."

The author is an attorney with Sierra Serapion.

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