Posted on 07/09/2006 8:06:22 PM PDT by 4Freedom
Critics of Section 936, while acknowledging that the incentive did help create new jobs in Puerto Rico, nonetheless assert that it was an "inefficient" mechanism for creating jobs. As evidence of Section 936's "inefficiency," they cite the fact that in recent years pharmaceutical employment on the island has increased "precisely when Section 936 benefits were being phased-out."
What these critics fail to recognize - but what the recent GAO report on Puerto Rico confirms - is that many companies operating in Puerto Rico in this post-936 era continue to benefit from a tax incentive somewhat equivalent to Section 936 but far less beneficial to the United States. That is why, even after the termination of Sections 936 and 30A, many companies (particularly the pharmaceuticals) continue to manufacture and increase their employment on the island operating as controlled foreign corporations.
There needs to be a better understanding of what Section 936 was, what its loss meant, what being a CFC is, and what its loss could mean!
As enacted by Congress in 1976, Section 936 was a very attractive incentive for mainland companies to establish operations in Puerto Rico (and other U.S. possessions) rather than elsewhere in the world. It provided a 100 percent federal tax credit for income generated by a "possessions corporation" manufacturing in Puerto Rico and repatriated to the U.S. mainland. That meant profits made in Puerto Rico could be brought home tax-free and invested in domestic operations. And of equal importance to Puerto Rico was the fact that Section 936 provided the same tax benefit for a company's earnings from income directly invested in a Puerto Rico financial institution or other qualified activity (the so-called 936 funds market).
By contrast, if a mainland company established manufacturing operations in Ireland, Singapore, Malaysia, or anyplace else in the world outside the United States and its possessions, the income generated could not be brought home tax-free but would be subject to a 35 percent corporate tax rate if repatriated to the mainland. Paying the tax could only be avoided (deferred) if the income generated from the controlled foreign corporation was kept offshore.
To federal authorities (the Treasury Department and the Congressional Joint Committee on Taxation) the "revenue costs" of Section 936 were measured, in effect, by calculating what tax a company would pay if it were not operating in Puerto Rico (i.e. getting a 100 percent tax credit) but were operating on the mainland where it would pay a $35 tax on $100 of income. In other words, federal authorities assumed that the U.S. Treasury was "losing" $35 in revenue for every $100 of income generated by a company operating in Puerto Rico.
Using this calculation, federal authorities by the early 1990s were estimating that the "revenue costs" of Section 936 to the U.S. Treasury were reaching $4 billion plus a year. The error in this revenue estimating calculation was the assumption that if a company was not manufacturing in Puerto Rico on a tax advantaged basis it would be doing the same manufacturing on the mainland, where its income would be subject to the full federal corporate tax. This, of course, was a completely wrong assumption with devastating consequences for continuation of Section 936.
In order to "raise revenue" to pay for tax relief for American (i.e. mainland, not Puerto Rican) small businesses, Congress in 1996 acted to repeal Section 936, phasing it out over a 10-year period. Also in the 1996 Act, Congress phased out the Section 30A wage credit and repealed outright the tax benefit for qualified investments on the island. In taking these combined actions, Congress estimated that it would "save" over a 10-year period $6 to $8 billion in "lost revenues" from the operations of Sections 936 and 30A.
Wrong! Why? Because the loss of Sections 936 and 30A companies did not move their Puerto Rico operations back to the United States where they would be fully taxable. Instead, most corporations restructured their Puerto Rico companies as controlled foreign corporations (CFCs) or moved their manufacturing to foreign countries where they could operate as CFCs.
Operating as CFCs, companies would pay no federal corporate income tax unless the income generated in Puerto Rico or from other offshore locations was repatriated to the U.S. mainland, when it would become fully taxable. It has been an historical fact that most companies operating as CFCs keep much of their income invested outside the United States thus avoiding (deferring) the payment of federal tax.
Several years ago, in an effort to encourage companies to repatriate their deferred earnings to the United States, Congress enacted a one-time incentive establishing a 5.25 percent (instead of 35 percent) federal tax on CFC income brought back to the mainland.
As a result, billions of dollars invested offshore were returned to the mainland and the U.S. Treasury benefited from the tax revenues collected. (Ironically, the 5.25 percent tax incentive was identical to the replacement incentive for the expiring Section 936 that had been proposed in 2001 by the Calderon administration but never acted on by Congress.)
Let me sum up the points I hoped to make in this article. First, the real "cost" of the Section 936 incentive was based on the erroneous assumption that absent the incentive companies would undertake the same manufacturing activities and pay the full rate of federal tax. This, of course, was not the case. Second, Puerto Rico has continued to enjoy the benefits of mainland manufacturing because companies have had the option, as a result of the island's fiscal autonomy, to re-organize as CFCs and to minimize their federal taxes. And, finally, without the ability of companies to organize as CFCs or to operate in some other uniquely tax-favored fashion, the likelihood of any significant continued growth in Puerto Rico's manufacturing base would appear to be remote.
Peter E. Holmes is former executive director of the Puerto Rico USA Foundation (PRUSA), a coalition of mainland manufacturing companies with plants in Puerto Rico. PRUSA, established in 1984, discontinued operations at the end of 2005 with the termination of Section 936 and 30A. Holmes continues as an independent consultant following Puerto Rico issues.
Time to close all of these Certified Foreign Corporation, tax scam, loopholes and offer all of these pharmaceutical companies tax incentives to relocate their operations back to the poorest areas of the mainland United States.
'PING!'
Do you have a link for this?
Thanks.
Just a note... last year (maybe the last few years), there was a tax amnesty in place - companies could repatriate their offshore dollars at only 5% tax rate. Companies like Dell and others having large overseas earnings, brought home BILLIONS of dollars.
Uh, OOPS on my part... this is mentioned later in the article.
The net result of that amnesty is we'll lose more jobs.
No, sorry no link.
ping
I agree Section 936 is a liability. If Puerto Rico were ever to become a state, this cozy arrangement would have to go.
"I agree Section 936 is a liability. If Puerto Rico were ever to become a state, this cozy arrangement would have to go."
That's a waste of U.S. Taxpayer's hard-earned dollars that's worth talking about, because it's the U.S. Taxpayers that are getting robbed.
I can understand why nobody in Puerto Rico wants to talk about it. Puerto Rico's doing the robbing.
LOL!
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