Ever since the first detailed outlines of a U.S. move to territorial taxation surfaced in 2005, many were surprised that the bed of roses made for multinationals would contain thorns. Properly disallowing U.S. deductions allocable to income free of U.S. tax and necessarily tougher base erosion protections meant the move could actually raise taxes on multinationals.
Well, the tax bill signed into law December 22, 2017, by President Trump disregarded the matching principle. It did, however, include some significant anti-base-erosion rules. While the provisions of the new law generally provide significant tax cuts for individuals and domestic businesses, the international provisions raise revenue. (See Figure 1.) True, much of that revenue comes from deemed repatriation of cash taxed at 15.5 percent and noncash assets taxed at 8 percent, which is really tax relief that raises revenue only inside the 10-year revenue window. But the minimum tax on foreign profits of U.S. multinationals (referred to as the global intangible low-taxed income tax) and the minimum tax on multinationals’ income in the United States (called the base erosion antiabuse tax) can take a considerable bite out of multinational after-tax profits. (See Figure 2.)
Although the details largely remained a mystery until the end, the general contours of the legislation’s anti-base-erosion measures were understood years in advance. And this caused a lot of heartburn for the government of Puerto Rico and members of the Puerto Rico Manufacturers Association. (See table.) Although Puerto Rico is part of the United States and its residents are U.S. citizens, for most income tax purposes the territory is considered a foreign jurisdiction. This has given it a tax-advantaged status relative to the rest of the United States. But under the widely anticipated international tax reforms, U.S.-headquartered operations in Puerto Rico will pay a lot more U.S. tax. That could result in the already economically troubled island suffering even more job losses on top of those lost since the expiration of generous U.S. tax benefits in 2006.
Company | Full-Time Employees in Puerto Rico |
|---|---|
Medtronic PLC | 4,015 |
Johnson & Johnson | 2,801 |
Pfizer Pharmaceutical LLC | 2,270 |
Amgen Manufacturing Ltd. | 1,800 |
Lily de Caribe Inc. | 1,600 |
Eaton Corp. | 1,500 |
General Electric Co. | 1,400 |
Baxter International Inc. | 1,285 |
St. Jude Medical P.R. LLC | 1,214 |
Stryker P.R. LTD | 1,094 |
Coca-Cola Puerto Rico Bottling | 981 |
AbbVie Ltd. | 971 |
Bristol-Myers Squibb Manufacturing Co. | 795 |
Becton Dickinson Caribe Ltd. | 780 |
Boston Scientific Corp. | 750 |
Zimmer Manufacturing BV | 545 |
Pepsi-Cola P.R. Distributing LLC | 500 |
Source: The Caribbean Business Book of Lists, 2017 edition. | |
In 2014 former House Ways and Means Committee Chair Dave Camp released his fully documented tax reform proposal. It included a new category of subpart F income called foreign base company intangible income. That foreign income (calculated as the amount of profit in excess of a normal return on tangible capital, similar to the rules for global intangible low-taxed income) would be subject to a 15 percent U.S. minimum tax if it were inadequately taxed by foreign governments. Worse still, that foreign income would be subject to a 25 percent U.S. tax if it were attributed to sales into the United States. Puerto Rico’s then-Gov. Alejandro García Padilla and then-Resident Commissioner (the island’s nonvoting representative in the U.S. House) Pedro Pierluisi lobbied hard for an exception to this rule, which would have given Puerto Rico a considerable competitive advantage over other tax havens and would no doubt have given the Puerto Rican economy a considerable boost. But, despite the island then being in its sixth year of recession (from which the mainland had already recovered), there was no special provision for it included in the Camp bill.
The success of the Republican Party in the 2016 U.S. elections raised the odds for passage of major tax legislation that would include territorial taxation. However, the simultaneous election in Puerto Rico of Ricardo Rosselló as governor and of Jenniffer González-Colón as resident commissioner muddled the message Puerto Rico was sending to Capitol Hill. Their predecessors — Padilla and Pierluisi — were members of the left-leaning Popular Democratic Party, which has historically favored retaining Puerto Rico’s commonwealth status for several reasons, not the least of which is the retention of favorable tax rules not available to businesses operating in the states. Rosselló and González-Colón, on the other hand, are members of the right-leaning New Progressive Party, which favors the island becoming a U.S. state.
From Bad to Worse
On June 30, 2016, President Obama signed the bipartisan Puerto Rico Oversight, Management, and Economic Stability Act to address Puerto Rico’s debt crisis. On May 3, 2017, Puerto Rico sought what is essentially bankruptcy relief in federal court. The Puerto Rican government and its agencies have accumulated about $74 billion in bond debt and $49 billion in unfunded pension obligations. In a two-week period in September 2017, category 5 hurricanes Irma and Maria laid waste to the island, and in November Rosselló requested $94.4 billion in aid from the federal government. The Chicago Tribune reported on December 25 that an engineering study conducted December 11 estimated that about 50 percent of the island’s 3.3 million people remain without power.
To be sure, both Rosselló and González-Colón opposed anti-base-erosion measures included in the various incarnations of what eventually would become the newly minted tax reform law. The governor took a more strident approach, demanding relief for Puerto Rico and threatening to mobilize the millions of voting Puerto Ricans who have migrated from Puerto Rico or are of Puerto Rican descent against those legislators, including Sen. Marco Rubio, R-Fla., who voted for the reform package. Consistent with views on statehood, Rosselló has often said he wants Puerto Rico treated like any other state. What he really wants (though it doesn’t often make it into his sound bites) is for Puerto Rico to be treated like a U.S. state when it comes to the anti-base-erosion rules. But unlike businesses in U.S. states, he doesn’t want Puerto Rico operations being subject to U.S. corporate tax, even at the new reduced rate of 21 percent. He also wants exemption from the deemed repatriation taxes if Puerto-Rico-based affiliates of U.S. companies invest unrepatriated funds in Puerto Rico.
González-Colón took a more conciliatory approach to the threat of lost tax advantages. She has a good relationship with House Speaker Paul D. Ryan, R-Wis., who arranged for her to work with Ways and Means Committee Chair Kevin Brady, R-Texas, on tax relief for Puerto Rico as part of the reform package. Along with Ways and Means member Carlos Curbelo, R-Fla., the goal was to get “opportunity zone” tax benefits included for Puerto Rico. That effort initially failed.
On December 15 Brady said it had been the intention of conferees to make Puerto Rico eligible for opportunity zone designation, but that the proposal was dropped because it violated the Byrd rule (although it was adopted by the full Senate on December 2 without violating the rule). As a result, Brady said he and Ryan decided to add the provision to the supplemental appropriations bill.
The House passed an emergency supplemental appropriations bill (H.R. 4667) on December 21 that designated $81 billion of disaster relief for damages resulting from hurricanes Harvey, Irma, and Maria, and the California wildfires. And, as promised, section 3004 of the reform package allows each census tract in Puerto Rico that is a low-income community to be designated as a qualified opportunity zone. The emergency supplemental appropriations bill has stalled in the Senate, where it cannot be acted on until January at the earliest.
Even if portions of Puerto Rico are automatically designated as opportunity zones, the benefits conferred are small beer compared with those that were available before the reform package went into effect, and so are unlikely to have any appreciable impact on the devastated Puerto Rican economy. “Empowerment zones” were first enacted after the 1992 Los Angeles riot as part of the Omnibus Reconciliation Act of 1993: They provide an array of benefits including employer wage credits, additional expensing of small business capital expenditures, and expanded eligibility of tax-exempt bond financing for 10 years. In 2009 the Joint Committee on Taxation reviewed economic studies on empowerment zones and found the results to be ambiguous, or that they gave scant evidence of a positive effect from the zone benefits.
If the empowerment zones did not work in the 50 states, it’s hard to see how they would work in Puerto Rico. The only benefit given to opportunity zones in the reform package is deferral and possible elimination of gain recognition if gains are invested in qualified investments within the designated zones. Even before bankruptcy and the widespread storm damage, Puerto Rico’s competitiveness was diluted by high electricity costs (because generators are fueled by petroleum), high shipping costs (because the Jones Act requires that U.S.-owned and U.S.-operated ships be used to transport between U.S. ports), and the costs of U.S. labor regulations, including the federal minimum wage.
Domestic Politics
In a December 20 Orlando Sentinel op-ed, Florida Republican Gov. Rick Scott claimed that more than 264,000 people have traveled from Puerto Rico to Florida since October 3. One study estimated that between 41,000 and 83,000 Puerto Ricans would migrate to Florida after Hurricane Maria (Edwin Meléndez and Jennifer Hinojosa, “Estimates of Post-Hurricane Maria Exodus From Puerto Rico,” Hunter College Center for Puerto Rican Studies (Oct. 2017)). That migration, plus widespread dissatisfaction within the Hispanic community with the federal government’s response in Puerto Rico, could affect Republicans in future elections in the nation’s largest swing state. But according to at least one unnamed source with ties to the GOP, Republicans aren’t worried about the domestic implications of lost tax incentives for Puerto Rico: “I think all the craziness that the governor had created saying that people are going to leave in droves is not flying on the Hill; let’s just say cooler heads are prevailing,” the source told Caribbean Business on December 14.