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PRIDCO: Holding Its Own

Multinational and local manufacturing companies have promised to invest $2.5 billion in their island operations and create 20,000 new jobs, thanks to some hard work by the Puerto Rico Industrial Development Co.

by Daniel R. Garza

June 8, 2000
Copyright © 2000 CARIBBEAN BUSINESS. All Rights Reserved.

Manufacturing is not the down and out industry many believe it is. In fact, there are some pleasant surprises in the performance of one of Puerto Rico’s largest private sector employer.

Manufacturing exports are at their highest levels, the Puerto Rico Industrial Development Co. (Pridco) expects a record-breaking year of job creation, and manufacturers are investing billions of dollars in Puerto Rico plants.

These are hardly the signs of an industry in decline. That’s because a growing number of companies are finding new ways to survive and thrive in anticipation of the elimination of the tax benefits of Section 936 of the U.S. Internal Revenue Code in 2005.

Among the most potent strategies companies are using is the renegotiation of tax rates under Puerto Rico’s 1998 Tax Incentives Act, reorganizing as foreign controlled corporations, and investing heavily to make operations more efficient and productive.

Since its enactment, 473 companies have applied to have their tax rates renegotiated under the 1998 law according the Puerto Rico Treasury Department (Hacienda). The law, which amended the 1987 Tax Incentive Law, slashed corporate income taxes from 9% to 14% to a range of 2% to 7% for manufacturers.

The 1998 tax law also eliminates "tollgate" taxes, which ranged from 5% to 10% under the 1987 law; gives labor-intensive industries, such as apparel, a maximum 4% income tax rate and in some cases as low as 2%; provides deductions of up to 200% for job training and research and development costs; a total exemption from property taxes during initial construction or establishment period, and during the first year of operations; and full expensing of investments in plants, parks, and equipment.

Under Section 901 of the Internal Revenue Code, U.S. companies can take a credit on their U.S. income tax returns for taxes paid to Puerto Rico. However, it’s not a replacement for 936, which allowed corporations operating in Puerto Rico to repatriate earnings to their stateside parents tax-free.

The jury is still out on whether 901 will provide enough federal tax benefits to keep companies interested in staying in Puerto Rico after 936 runs out in 2005. But judging from the levels of new investment they are committing to their Puerto Rico operations, it doesn’t appear they’re going anywhere anytime soon.

Since 1998, companies renegotiating tax rates have committed to invest $2.5 billion in their Puerto Rico operations and create 20,200 additional jobs according to the Treasury Department.

Some of the biggest commitments have come from Amgen Puerto Rico Inc.–$50 million in investment and 225 new jobs; Cutler-Hammer de Puerto Rico–$88 million and 804 jobs; Baxter Healthcare Corp. of Puerto Rico–$87.8 million and 666 jobs; Pharmacia & Upjohn Caribe Inc.–$162 million and 365 jobs; and Searle & Co.–$200 million and 720 jobs (see box).

Local corporate tax attorneys hired by multinational companies say the 1998 Tax Incentives Act has become a factor in preventing companies from leaving the island due to the phase out on Dec. 31, 2005 of Section 936, which allowed the tax free repatriation of earnings to the U.S. mainland.

"When a company has to consider alternatives, the economic kick-in of the flat tax has been successful in keeping companies here," said corporate tax lawyer Ralph Sierra.

Surprisingly, local companies benefiting from Puerto Rico Development Co. (Pridco) incentives have come on strong as job creators. Sixty-five companies have met 90% of their job commitments made since 1997. As a result companies such as Atlantic Pipe Corp., Café Yaucono, and Foam Pack Inc. among others have created nearly 10,000 new jobs.

Xavier Romeu, the Secretary of the Department of Economic Development & Commerce (DEDC) and the executive director of Pridco, expects a record-breaking fiscal year 2000.

"I was advised by my staff not to say it, but I set this goal at the beginning of my tenure," he said. "I looked at the numbers and told our employees and the press that we would break records."

The goal is to break the 23,737-job commitment mark set in 1972. It would be an impressive accomplishment because the 20,000 mark has only been broken four times since 1970. During the first nine months of fiscal 2000 (ending June 30) Pridco reported 14,849 job commitments.

The comparison may not be exactly on point. According to Romeu, 15% to 20% of the job commitments so far this fiscal year are in the service sector. Three decades ago, job commitments were all in the manufacturing sector, since Pridco (then Fomento) didn’t have a mandate to promote jobs in the service sector. Further, Pridco provided no information about when companies had to make good on their job commitments–whether it’s one, two, three years or more.

Romeu, who was appointed Pridco chief a year ago and DEDC secretary in January attributes much of his good fortune to his predecessors who authored the 1998 law and reorganized Pridco.

"When I arrived, I knew the company was going to benefit from the work of my predecessors," he said.

Romeu’s staff describes him as driven and very focused on his work. He is known to roust staffers out of bed in the middle of the night to have them take notes on ideas he wants implemented at work the next day.

Romeu’s ambition is, no doubt, an aspect of his character, but also a result of reality. He may have little time left at his post. With the Rossello administration scheduled to leave La Fortaleza in January, Romeu wants to leave his mark on the agency created by the legendary Teodoro Moscoso.

When he arrived at Pridco, the former executive director of the Puerto Rico Federal Affairs Administration immediately reorganized the agency’s administrative structure. The new structure now focuses more attention on strategic planning, marketing, and gives more autonomy to stateside Pridco offices, which are largely responsible for finding new business.

"Our [U.S. Mainland] offices were not fulfilling their potential because they were too dependent on the San Juan headquarters."

Romeu also believed that Pridco had almost ceased being an agency that served its primary customer–the manufacturing industry.

"We were not doing a service to the industry," he said. "But I think a new corporate culture is taking root."

Among the changes that he spearheaded was the fast tracking of environmental permits, which received high marks from industry executives.

Romeu believes the fast track permit process, the 1998 tax incentive law, a highly skilled work force, ties to the U.S., and vastly improved transportation system make Puerto Rico competitive with places like Ireland and Singapore.

"Puerto Rico does not have incentives problem, it has a marketing problem," he said. "If you sell it, they will come."

Beyond 936

One of Puerto Rico’s big selling points is the availability of certain tax advantages in a post-936 world.

As of mid-April, 45 multinational companies (former 936 companies) have reorganized as controlled foreign corporations (CFC), which are allowed to defer payments on U.S. taxes (see box).

"In order to defer the payment of U.S. taxes until earnings are repatriated to the states, they organize a corporation outside the U.S to carry on operations in Puerto Rico," said corporate tax attorney Fred Martinez.

Operating as a CFC is no where near the tax free benefits provided by Section 936, but it gives a multinational the opportunity to use money it would otherwise be paying in U.S. taxes to finance other operations."That’s why most of the 936 companies are converting to CFCs. They are using that structure to finance other businesses that are operating all over the world," said corporate tax attorney Melvin Rivera.

Many companies are reorganizing as CFCs also because they cannot benefit from 936 if they derive earnings from new products. "Companies that are going through large expansions are the ones that will most likely convert to CFCs," said Jose Ramon Cestero, a corporate tax attorney.

One of the big misconceptions held by elected officials and the media is that companies reorganize as CFCs under Section 901 of the Internal Revenue Code. A company does not have to be a CFC to take advantage of the federal tax credits outlined in 901.

"CFCs are not controlled by 901. All 901 does is give you a credit for the taxes you pay overseas, including Puerto Rico." said Sierra "If the foreign corporation be it French, German, or Puerto Rican pays a dividend back to the parent company in the U.S. you add to the dividend the amount of foreign taxes you paid to the foreign country when you earned that income and then you take the credit for that tax on your federal tax returns; 901 is a foreign tax credit provision, not a CFC provision."

Neither operating as a CFC or taking advantage of 901 tax credits can come close to the benefits of Section 936. The best bet is still an indefinite extension of Section 30A wage tax credits that would allow companies to introduce new lines of business.

Under Section 30A, companies operating under 936 can take up to a 40% tax credit on wages it pays to employees in Puerto Rico, but the credit can only apply to existing product lines. The credit expires along with 936 on Dec. 31, 2005.

Getting the wage credit extended indefinitely has been the subject of an intense lobbying campaign by Pridco. While the White House supports an extension, the Republican-controlled Congress opposes it.

Romeu has devised a "what’s good for Puerto Rico is good for your congressional district" strategy, which encompasses lobbying Congressional representatives whose districts are homes to corporations that have operations in Puerto Rico.

Romeu believes that wage tax credits are a lot easier to sell than the so-called "corporate welfare" embodied by 936. He drove home that message during a recent two-hour meeting with U.S. House of Representatives Speaker Dennis Hastert

"We’re beginning to convince key congressional representatives that wage based tax credits is where the future is," he said. "Puerto Rico is part of the U.S., but because of our geographic location we compete against lower cost jurisdictions and foreign nations and if 30A is not extended we will force U.S. jobs to leave U.S. soil."

Still most observers don’t expect 30A to get through Congress this year. If so, it will be up to a new Congress and a new President to decide if 30A should live.

In the meantime, Puerto Rico will have to continue to find new and creative ways to create new manufacturing jobs and attract new companies to the island. Contract manufacturing (CB May 25) is being touted as the island’s biggest opportunity to create new manufacturing jobs. In fact sources in Pridco say agency will likely unveil a contract manufacturing strategic plan by June 15.

"The 1998 law is a step in the right direction," Sierra said. "Companies have been able to get around most of the problems of operating in Puerto Rico, like high electricity costs, because of tax savings. As long as you have tax subsidies by means of 936 you can tolerate some of the cost inefficiencies."

This Caribbean Business article appears courtesy of Casiano Communications.
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