RANGEL: TREASURY MISREADS 1986 ACT'S CHANGES TO SECTION 936 CREDIT.

In an August 3 letter to Treasury, Rangel said he will ask the Joint Committee on Taxation to draft legislation clarifying the 1986 Tax Reform Act's changes to the cost-sharing option for corporations claiming the section 936 possessions tax credit. The clarification would produce at least $20 million per year in revenue, he said.

The draft legislation would make section 936 cost sharers subject to the section 482 cost-sharing regs in calculating their cost-sharing payment. However, the cost sharers would not be subject to a "buy in" requirement, added Rangel.

In 1986, Ways and Means sought to preserve the cost-sharing option and made "relatively minor modifications" to that option with an estimated revenue effect of only $20 million per year, said Rangel. Cost sharing is the method used by most of the more labor- intensive industries operating under section 936 in Puerto Rico, he added.

The recently proposed regulations under section 482, however, would produce revenue up to 10 times greater than originally intended, "forcing many legitimate cost sharers on to the profit split method, and reducing the benefits of those remaining on cost sharing," said Rangel.

Rangel requested that the IRS grant cost sharers another extension in which they may choose between the cost-sharing and profit-split method. He noted that the IRS has indicated it will allow to expire the current time extension for selecting between the cost-sharing and profit-split methods.

Any administrative decision to move forward with Treasury's approach "would create burdens for those taxpayers who provide a substantial number of jobs in Puerto Rico and for taxpayers who export a significant level of their production outside the United States and Puerto Rico," said Rangel.

The full text of Rangel's letter has been placed in The Tax Notes Microfiche Database and the Access Service as Doc 92-7713.

On a number of occasions over the past several years, I and other members of the Committee on Ways and Means have written to you to express our concern about Treasury's implementation of the Tax Reform Act of 1986 amendments to the cost sharing option for corporations claiming the possessions tax credit provided in Section 936 of the Internal Revenue Code. Our concerns appear to be confirmed by the recently proposed regulations under Section 482 implementing the changes made in the 1986 Act, which seem not to reflect the legislative intent to make relatively minor August 3, 1992, changes producing revenue of limited magnitude.

Cost sharing is the method utilized by most of the more labor intensive industries operating under section 936 in Puerto Rico. Recognizing this, the Committee on Ways and Means in 1986 sought to ensure the preservation of the cost sharing option and, therefore, made what was described by the Committee as only "relatively minor modifications" to that option with an estimated revenue effect of only $20 million per year. This revenue estimate has been confirmed to me by the Joint Committee on Taxation in a letter of October 5, 1990.

I am advised that the recently proposed regulations under section 482 are being interpreted by taxpayers as going beyond legislative intent, producing revenue up to ten times greater than originally intended; foreign many legitimate cost sharers on to the profit split method, and reducing the benefits of those remaining on cost sharing. These actions will likely curtail the possessions operations of Puerto Rico's most labor intensive industries which also generally have the lowest operating margins and thus, causing a loss of jobs.

I intend to request the Joint Committee staff to draft legislation to clarify the 1986 Act confirming the understanding of the legislation that was reached at the time of its approval by the Committee on Ways and Means. The legislation will provide that the "payment which would be required under section 482" shall mean the payment that would be required if the electing corporation were a foreign corporation that was subject to the section 482 cost sharing and was the owner of the manufacturing intangibles. The intent of this legislation is to make section 936 cost sharers subject to the section 482 cost sharing regulations in calculating their annual cost sharing payment. However, they will not be subject to a "buy in" requirement.

It is my understanding that this clarification will produce at least the $20 million per year of revenue estimated in 1986. I believe this clarification is consistent with the statutory language of the 1986 Act which treats the section 936 cost sharer as the owner of manufacturing intangibles. Since foreign corporations owning manufacturing intangibles are not required to make royalty payments, but are required to make cost sharing payments, I feel the proposal is a fair and reasonable reading of the 1986 statutory language.

As you know the IRS has indicated that it intends to allow the current time extension for selecting between the cost sharing and profit split methods to expire not withstanding that the cost sharing rules are far from settled. Clearly, any administrative decision to go forward with an approach which significantly alters the intent of the Congress in the 1986 Act is disturbing. It would create burdens for those taxpayers who provide a substantial number of jobs in Puerto Rico as well as taxpayers who export a significant level of their production outside the United States and Puerto Rico. Certainly any administrative action to foreclose the opportunity for making a decision between cost sharing and profit split methods before there is clarification either administratively in final regulations or legislatively is premature. A taxpayer should not be forced to make a decision until there is certainty over the consequences of the decision.

In order to resolve this matter in the least disruptive manner, I request that you have the Internal Revenue Service grant cost sharers an additional extension of time in which they may choose between the cost sharing and profit split method. If you conclude that legislation is necessary, I hope to receive your support and assistance in developing a proposal consistent with the understandings reached during the 1986 Act deliberations.

During the testimony before the Committee on Ways and Means on July 21, Assistant Secretary Goldberg reported on the study being undertaken by the Treasury on foreign income tax issues including section 936. Senator Lloyd Bentsen, as Chairman of the Senate Finance Committee, has requested the General Accounting Office to undertake a comprehensive study of section 936. Both studies are expected to be completed by mid-1993. Under the circumstances, I feel that it would be inadvisable to initiate any substantive legislative or regulatory changes to section 936 which cause a substantial loss of tax benefits before the results of these two studies become available.

Sincerely,