Congress Passing Acevedo Positions In Tax Bill That Will Hurt Puerto Rico

October 8, 2004
Copyright © 2004 THE PUERTO RICO HERALD. All Rights Reserved.

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Congress Passing Acevedo Positions in Tax Bill That Will Hurt Puerto Rico

Two major tax provisions that will hurt Puerto Rico’s economy are expected to be enacted into law in a matter of days. The provisions curiously reflect positions taken by the territory’s official representative to the federal government, Anibal Acevedo Vila.

The U.S. House of Representatives passed the legislation late Thursday. The Senate is expected to pass soon, perhaps Sunday, October 10th. President Bush has indicated that he will sign the bill.

The new law would establish tax disadvantages to manufacturing in the Commonwealth by companies based in the States. It would overturn a history that dates to at least 1921 of laws that have provided tax advantages for companies based in the States to manufacture in the territory.

The provisions are included in a bill that is to reduce business taxes by some $150 billion. The legislation, which has been in the works for a year and a half, is said to be the biggest corporate tax cut bill in 20 years.

Acevedo, Puerto Rico’s Resident Commissioner in the U.S. and the "commonwealth" party’s candidate for governor, also tried to get the bill to include an even greater new tax incentive for manufacturers based in the States to operate in the Commonwealth. But he failed in his effort to obtain approval of a proposal that had previously been rejected by the chairmen of the Senate and House tax committees as well as by the U.S. Treasury Department and the White House.

Ironically, Acevedo took the positions that will hurt Puerto Rico’s economy in his failed effort to win the greater new tax incentive.

His proposal would have permanently exempted from federal income taxation 85-100 percent of profits that "controlled foreign corporation" ("CFC") subsidiaries in Puerto Rico of companies based in the States send to their parent companies. The proposal known as the Internal Revenue Code (IRC) Sec. 956 amendment was developed by Acevedo’s mentor, incumbent governor Sila Calderon. Based on a corporate income tax rate of 35 percent, an 85 percent exemption from taxation would have created a 5.25 percent tax rate for profits "repatriated" from Puerto Rico.

The Sec. 956 proposal would have replaced the primary federal tax incentive for companies based in the States to have territorial operations, IRC Sec. 936, effectively recreating it as it existed before it was reformed in 1993. Sec. 936 cuts the taxes on corporate income attributed to Puerto Rico by 40% but it expires at the end of next year. Before the 1993 reform, it effectively exempted from federal income taxation 100% of corporate income attributed to Puerto Rico.

One provision in the bill now expected to become law that is adverse to Puerto Rico’s economic interests would lower the corporate income tax rate on income from manufacturing in the States by nine percent, cutting it from 35 percent to 32 percent. The provision would leave the basic tax rate on income from manufacturing in Puerto Rico (as well as in foreign countries) at 35 percent.

The Senate Finance Committee passed a version of the bill October 1st, 2003. During the meeting, it rejected the 956 amendment for the second time. When this happened, Senator John F. Kerry, now the Democratic Party nominee for president of the U.S., proposed including manufacturing income from Puerto Rico in the 35 to 32 percent manufacturing tax cut. His amendment was accepted but Acevedo, a nominal national Democrat, fumed in reaction, "That’s not what we want!"

A year to the day later, however, Acevedo signed a letter requested by the Coca-Cola company supporting inclusion. The Kerry amendment was excluded, however, from a compromise version of the bill proposed three days later -- this past Monday -- by Acevedo’s House colleague, Ways and Means Committee Chairman William M. Thomas (R-CA). Thomas submitted the compromise to a "conference" committee of representatives of the House and Senate charged with working out differences between the House and Senate versions of the bill.

The next day, Senator Don Nickles (R-OK) asked the conference for the inclusion of manufacturing income from Puerto Rico in the tax cut in a package of 18 amendments. Nickles had been a strong critic of the 956 amendment because it would treat the Commonwealth and companies operating in it better than the States and companies operating in them. Consistent with this position, he contended that Puerto Rico and its companies should be treated no worse than the States and their companies.

Acevedo’s letter supported Nickles’ amendment. In it, Acevedo said that exclusion from the tax cut "could jeopardize local manufacturing . . . and create job losses in our manufacturing sector" even though he had not previously wanted inclusion.

Acevedo’s late letter failed, however, to make the strong arguments for inclusion, such as the following.

  • Without inclusion, domestic company manufacturing in Puerto Rico will be taxed more than manufacturing in both the States and foreign countries.???
  • The domestic manufacturing tax cut is being enacted to make manufacturing more competitive with foreign manufacturing and Puerto Rico is a part of the U.S. for Customs purposes.?????
  • The U.S. sets the terms for the Commonwealth’s foreign trade. ??

Contrary to what Acevedo’s letter stated, however, his chief aide said that the exclusion from the tax cut will NOT harm Puerto Rico’s economy because most manufacturing subsidiaries in Puerto Rico are CFCs. The Acevedo aide ignored several facts.

  • CFCs will repatriate income at some point and when they do the profits will be taxed at 35 percent versus the 32 percent that will apply to manufacturing income from the States.???????
  • Some 936 companies have not become CFCs – such as Coca-Cola.??
  • Some manufacturers that used the IRC sec. 30A tax credit for wages, capital investments, and local taxes in Puerto Rico rather than the Sec. 936 partial tax exemption also have not become CFCs.

Thomas declined Nickles’ amendments. Additionally, Senate Finance Committee Chairman Charles Grassley (R-IA) said that he preferred to take no action on Puerto Rico matters until the committee considered two studies that he had requested with the Senior Democrat on the committee, Max Baucus (D-MT).

The studies by the Congress’s General Accounting Office and its Joint Committee on Taxation are examining the treatment of Puerto Rico in tax and social program laws, how this compares with the treatment of the States and other territories, its relative positive and negative impacts on businesses and individuals in Puerto Rico, Puerto Rico’s economic needs and options for meeting any needs, and what companies based in the States did in reaction to the phase-out of Sec. 936 -- including the conversion of 936 companies to CFCs. The studies are expected to be completed later this year. The studies were requested in opposition to the Calderon/Acevedo 956 amendment.

Acevedo was not in Washington during the discussion. Participants said that they did not know of his last-minute paper conversion on the issue.

Acevedo’s aide also tried to downplay the importance of the defeat by saying that Acevedo’s tax priority was to obtain the extension of the higher amount of grants to Puerto Rico of federal taxes on rum produced in the territory and foreign countries that recently was enacted into law. The extension, however, was enacted before the conference discussion of whether to include manufacturing income from Puerto Rico in the manufacturing tax cut. Proposed by the Bush Administration, it had in fact been agreed to by both houses of the Congress long ago and was just awaiting final congressional passage of the package of tax provision extensions in which it had been included.

In any case, Acevedo’s aide did not explain why Acevedo would not have been able to work on the manufacturing tax cut at the same time he was working on the extension of the rum tax grant.

The other position taken by Acevedo that is bad for Puerto Rico’s economy that is in the expected law includes CFCs in the territory -- now most of the businesses that formerly used the 936 exemption -- in a one-time, one-year 85 percent tax cut on income taken out of CFC locations and reinvested in the States.

The proposal is somewhat similar to the Calderon/Acevedo 956 amendment in that it would lower the tax rate on repatriated CFC income to 5.25 percent. The fact that it is limited to a sole one-year period and is intended to not be extended makes it critically different, however.

As a one-year, one-time opportunity, it only provides a tax incentive -- a powerful one -- for disinvestment from CFC locations. By providing the 85 percent tax cut on a permanent basis, the 956 amendment would have provided an incentive for investment in Puerto Rico as well as for disinvestment.

When the Senate Finance Committee considered this proposal to encourage a massive repatriation of income kept by U.S. companies in foreign countries, Acevedo asked Sen. John Breaux (D-LA) to get Puerto Rico included.  Breaux got the amendment approved.  He later, however, endorsed Acevedo’s main rival for the governorship, former Governor Pedro Rossello (statehood/D), saying, among other points, that Rossello would be better for Puerto Rico’s economy.

It is unclear whether Acevedo: did not understand the critical difference between the proposals; thought that the one-year proposal would be a step towards a permanent 85 percent tax cut for money repatriated by CFCs in Puerto Rico; or was just acting to help some particular companies take investments out of the territory.

He claimed, however, that the provision would not harm Puerto Rico’s economy, citing views of aides to mentor Calderon and the Puerto Rico Bankers’ Association. He did not, though, explain why the provision would cause companies with money in Puerto Rico to keep it there while it would encourage companies with money in other CFC locations to reinvest the money in the States.

Top staff of the Congress' Joint Committee on Taxation, however, have confirmed that the provision will encourage disinvestment from the Commonwealth as well as from foreign CFC locations.

Acevedo’s position that the bill’s 85 percent tax cut for corporate assets sent from Puerto Rico to the States will not result in any disinvestment from Puerto Rico also contradicts his claim that the 956 amendment would have generated investment. As noted above, it was the lower tax rate for repatriations that was the 956 amendment’s investment incentive.

Acevedo also ignored the impact of the provision on the decision of companies whether to reinvest earnings in their Puerto Rico operations or to invest earnings in the States. The provision will, further, encourage companies to repatriate current earnings in addition to profits that have been retained in Puerto Rico. Doing so will enable them to avoid most of the federal income tax that is applied when earnings are repatriated.

The expected law is an especially great embarrassment for Acevedo because his priority in almost four years as resident commissioner -- and Calderon’s federal priority -- has been to obtain tax incentives for manufacturers based in the States to operate in Puerto Rico. Additionally, the two have criticized Rossello for an erosion of investment incentive advantages over the States during his previous tenure as governor. Their efforts -- which have included tens of millions of dollars in payments to lobbyists -- have only succeeded, however, in obtaining worse tax treatment for manufacturing than applies to the States.

Further, Acevedo and Calderon voluntarily and repeatedly gave up the opportunity that they inherited from Rossello to get the Sec. 30A tax incentive extended. Rossello had obtained support for extension from virtually all Democrats in the Congress and several Republicans on the tax committees of both houses of Congress as well as from the Treasury Department and the White House.

30A was not extended during his term of office, however, because of the opposition of Thomas’ predecessor as chairman of the House Ways and Means Committee. Thomas’s predecessor left office, however, at the beginning of 2001 as Acevedo and Calderon took office, clearing the way for the 30A extension.

Although Calderon and Acevedo were elected on a platform of obtaining the extension, they dropped the promise once in office. Instead, they sought the 956 amendment, which was rejected by almost all key federal officials as soon as they presented it.

Despite the rejections, however, they stuck with the proposal until this year. They also rejected several offers by congressional leaders to try to get 30A extended, the most recent as late as months ago.

The "Washington Update" appears weekly.

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