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Puerto Rico Treasury Secretary Warns Against Proposed FTC Regs

SEP. 30, 2020

Puerto Rico Treasury Secretary Warns Against Proposed FTC Regs

DATED SEP. 30, 2020
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September 30, 2020

The Honorable David J. Kautter
Assistant Secretary
Office of Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue NW
Washington, D.C. 20220

Re: Guidance Related to the Foreign Tax Credit; Clarification of Foreign-Derived Intangible Income [REG-101657-20]

Dear Assistant Secretary Kautter:

Reference is made to the Notice of proposed rulemaking REG-101657-20, published yesterday on the Internal Revenue Service (“IRS”) website, particularly in relation to new definitions with respect to foreign income taxes and taxes paid “in lieu of an income tax”. We have analyzed the proposed regulations and we are concerned of the potential economic impact these will have in their application to Puerto Rico.

As you may be aware, back in 2010, the Puerto Rico legislature enacted Act 154-2010 (“Act 154”), which imposed an excise tax on the purchase of products that are manufactured or services rendered on the island, and that are purchased by an entity that is an affiliate of the entity producing the products or rendering the services.

The Act 154 tax was designed so that, for purposes of the foreign tax credit rules of Section 901 of the Internal Revenue Code (“IRC”), it qualified to be treated as a tax paid or accrued “in lieu of an income tax” under Section 903 of the IRC. To achieve this result, Act 154 first provides for a “source rule” that requires the purchasing affiliate to treat a portion of the income derived from the sale of products produced in Puerto Rico as derived in Puerto Rico and subject to Puerto Rico income tax. However, the “source rule” does not apply if the sales of the entity operating in Puerto Rico exceeds $75 million and, if this is the case, then in lieu of being subject to Puerto Rico income tax under this rule, the affiliate is subject to the Act 154 tax.

The treatment of the Act 154 tax as a qualifying tax paid or accrued in lieu of an income tax under Section 903 of the IRC was addressed by the IRS in Notice 2011-29.1 To this day, the IRS has not revoked, modified or otherwise altered Notice 2011-29. Accordingly, U.S. corporations that pay the Act 154 tax have since relied on Notice 2011-29 in their treatment of the Act 154 tax as a creditable tax under Section 903.

The annual amount that Puerto Rico collects in connection with the Act 154 tax ranges between $1.8-2 billion, which represents over 25% of General Fund net revenues and enables over 78,000 direct/indirect jobs on the island. Ideally, any tax that would substitute the Act 154 tax would need to generate an amount of revenues that is similar to the aforementioned revenue amount to avoid any further aggravation to Puerto Rico's fiscal situation.

Our preliminary analysis of the proposed regulations shows the anticipated changes would largely hinder Puerto Rico's ability to come up with a substitute system that would generate sufficient amount of revenues to protect its current tax base under Act 154.

As currently drafted, the proposed regulations could result in serious disruption of the Act 154 tax program, which would deny our government the resources it needs to provide essential services, comply with PROMESA requirements, and meet its obligations under creditor agreements. As described above, potential changes on the creditability of Act 154 tax could severely impact the government's capacity to repay its restructured debt service and its ability to provide essential services to the people of Puerto Rico.

Moreover, the proposed regulations are in direct contravention with recently announced plans by President Trump to bolster pharmaceutical manufacturing in Puerto Rico and spark contrast with the goal to incentivize the relocation of pharmaceutical operations from China to the United States. If the administration truly believes in the concept of “China fired, Puerto Rico hired”, then it must begin by addressing the unfavorable conditions that would be present should the proposed regulations remain unaltered.

Based on the above, we respectfully request a meeting with your office in order to discuss the immediate and long-term effects the proposed regulations will have in Puerto Rico's future economic and fiscal outlook. We could also discuss alternatives to provide exceptions and/or transition rules in the proposed regulations that would permit Puerto Rico to address the impact of the proposed regulations in an orderly and planned manner. As always, we remain committed to helping the U.S. Treasury achieve its goals and we look forward to continuing working together with the federal government and Act 154 taxpayers in finding a solution for the benefit of all.

Should you have any questions or need any further information regarding the above, do not hesitate to contact me at your convenience.

Cordially,

Francisco Parés Alicea
Secretary
Department of Treasury
Puerto Rico

FOOTNOTES

1Notice 2011-29 was issued on March 30, 2011.

END FOOTNOTES

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