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Thursday, September 15, 2011

A Sensible and Appealing Proposal

The Puerto Rico economy will never fulfill its tremendous potential under the current territory status. The recent report issued by the White House Task Force made a similar point, asserting that “the long-term economic well-being of Puerto Rico would be dramatically improved by an early decision on the status question.” History shows that every former territory that becomes a state has experienced a substantial increase in business investment and economic activity and a major improvement in its standard of living.

So I am not one of those political leaders who argue, simplistically, that the Puerto Rico government should focus on economic issues to the exclusion of the status issue. The truth, as the Task Force recognized, is that the Island’s economic problems are largely a consequence of our status problem.

However, until the people of Puerto Rico express the desire for statehood, I will do everything within my power to strengthen the Island’s economy. Although my goal is that Puerto Rico will achieve the genuine political, social and economic equality that only statehood can deliver, it is my responsibility to be pragmatic and to work within the system as it currently exists, whatever its limitations.

Over the years, there have been a variety of tax incentives implemented or proposed at the federal level in an effort to encourage job-creating investment in Puerto Rico. For many years, U.S. corporations that had operations in Puerto Rico received a generous tax benefit under Section 936 of the Internal Revenue Code. In the mid-1990s, congressional leaders and non-partisan organizations argued that 936 did more to enrich companies than to create jobs in Puerto Rico, was easily subject to manipulation, and—overall—provided an economic benefit to Puerto Rico that was very small relative to its cost to the federal treasury. As a result, Congress repealed 936 in 1996.

Since 936’s repeal, local political and business leaders have urged Congress to enact a new tax incentive designed to help Puerto Rico’s fragile economy. One local proposal put forward would amend Section 243 of the Internal Revenue Code, which governs the federal tax treatment of dividends paid by U.S. subsidiaries to their U.S. corporate parents.

Currently, most U.S. firms that conduct business in Puerto Rico are organized as controlled foreign corporations (CFCs). A CFC’s earnings are not subject to any federal taxation until these earnings are distributed—repatriated—to its U.S. parent in the form of a dividend. If a CFC does repatriate its profits to its U.S. parent, those profits are subject to full federal taxation. By contrast, a domestic U.S. subsidiary can distribute its profits to its U.S. parent at favorable tax rates under Section 243. Many CFCs—in Puerto Rico and elsewhere—would like to repatriate so that their profits can be invested in the U.S., but do not do so because of the tax burden. As a result, billions of dollars in CFC profits that could otherwise be injected into the U.S. economy instead remain parked overseas.

Under the Section 243 proposal, CFCs in Puerto Rico would be able to repatriate their profits at the favorable tax rates now available to domestic U.S. subsidiaries. Supporters of this proposal say that it would encourage companies to invest in Puerto Rico—which helps the Island—and encourage those companies to repatriate their earnings—which helps the mainland U.S.

It is important to recognize that this proposal—or some variation of it—has already been considered and rejected by Congress on multiple occasions. The main critique of the proposal is that Section 243 is designed to prevent a corporate entity’s profits from being taxed twice: once at the subsidiary level and then again at the parent level. This would not be the case in Puerto Rico, however, because Island CFCs do not pay federal taxes on the income they earn in Puerto Rico. In other words, critics of the proposal say it would enable multinational firms to use Puerto Rico to avoid all federal taxation on their Island earnings.

Accordingly, it should come as little surprise that key Members of Congress from both political parties have expressed reservations about this proposal. It is clear that any proposal that we present to Congress must meet at least three criteria. It must have the potential to generate new investment and job creation on the Island, to incentivize the repatriation of capital to the United States, and it must contain provisions designed to prevent corporate evasion or absuse. Soon, Governor Fortuño and I will unveil a sensible and appealing proposal that is designed to seek better treatment for companies that do business in Puerto Rico and that has a meaningful chance of being approved by Congress.