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Senate Committee Declines Calderon’s Proposed Tax Exemption for Companies in States but Senators Want to Replace Expiring Tax Credit
The U.S. Senate Committee on Finance this week declined to approve Governor Sila Calderon’s ("commonwealth"/no national party) proposal that profits that companies based in the States receive from U.S. territories be exempted from taxation.
But several members also indicated that they want to provide Puerto Rico with an industrial incentive to replace the expiring tax credit that companies in the States can take for income attributed to long-established territorial operations. And an even greater number said that they want to consider the issue in an expected reform of related provisions of the tax code later this year
The Committee also voted 12 to 6 to include profits from Puerto Rico in a proposal to reduce the tax on profits that companies in the States receive from foreign countries from 35% to 5.25% for one year. The overall rate cut proposal was rejected by the Committee, however, 11 to 10.
The decisions on the Puerto Rico proposals came as the Committee approved an economic stimulus bill that would provide $421 billion in tax cuts and aid to States and territories.
Calderon’s proposal failed to win inclusion after an intense lobbying effort on her part and by major national drug companies with operations in Puerto Rico. The companies have enjoyed the current tax credit for income from U.S. territories, Internal Revenue Code (IRC) Section 936.
The Calderon proposal and the inclusion of Puerto Rico in the 85% one year rate cut for "controlled foreign corporations" ("CFCs") were championed by Senator John Breaux (D-LA). Breaux was last Congress’ primary Senate sponsor of Calderon’s proposal to amend Sec. 956 and other provisions of the IRC.
He took over leadership on the proposal from former Senate Majority Leader Trent Lott (R-MS) after its first rejection this week. That came when Committee Chairman Charles Grassley (R-IA) declined the request of Lott, Calderon’s closest ally in the Senate, to include the proposal in his Chairman’s Mark (the bill that the Committee actually acted on).
Grassley’s rejection led to Democrat Breaux formally proposing the Calderon proposal as an amendment to the bill. Breaux, a close ally of the drug industry, has been a strong supporter of various proposals for tax benefits for companies from the States doing business in Puerto Rico.
Knowing that the senior ("Ranking") Democrat on the Committee, Max Baucus (MT) also opposed the Calderon proposal, Breaux initially offered the amendment "for discussion" purposes, acknowledging that it might not have enough support to pass. He said that he was doing so because the issue of Puerto Rico’s economy was "important . . . no area [of the country] . . . has more chronic unemployment or economic distress."
While impassioned, Breaux’s advocacy of replacing Sec. 936 was imprecise. He claimed Puerto Rico’s unemployment rate was 20% (vs. the actual 12%). More significant, he gave Committee members an inaccurate description of what the amendment would do in an advanced written explanation of it.
The explanation said that the amendment would alternatively "defer" taxes on 90% of the profits transferred to the States from territories or provide an 85% deduction of the profits from a company’s taxable income. The amendment did not, however, provide any time that the "deferred" taxes would ever be due. The IRC also contains no provision that would make such "deferred" taxes due.
In reality, Calderon’s proposal -- which Breaux was merely putting forward -- would exclude 90% of the profits from a company’s taxable income, in other words, permanently exempting it from taxation, rather than deferring the taxation. Calderon’s proposal would apply to CFCs in U.S. territories. The 35% federal corporate income tax is "deferred" until CFC profits are ‘repatriated’ to the States.
Breaux’s explanation also did not mention a provision of the Calderon proposal that she and lobbyists do not mention. It would enable companies to avoid paying tax on 100% of the profits by exempting "loans" of the profits from the IRC provision that ‘imputes’ (ascribes) interest income to entities making loans even if interest is not received.
The purpose of the IRC provision is to prevent tax evasive permanent transfers of assets masquerading as "loans."
Committee members got additional misleading information from drug company lobbyists. For example, the companies’ written submission said that it is long-standing federal policy not to apply any taxes to businesses and individuals in Puerto Rico. It called this the Commonwealth’s "fiscal autonomy." (Puerto Ricans pay taxes on income from the States and other taxes as the federal government determines. The Commonwealth’s "fiscal autonomy" is similar to that of the other territories and the States. It is the ability to enact local taxes.)
Additionally, the lobbyists Puerto Rico’s unemployment rate increased to more than double the national rate since Sec. 936 was sunsetted in 1996. (In fact, it has decreased from triple the national rate.)
They also said that Puerto Ricans would not otherwise benefit from the bill. (In fact, Puerto Rico would presumably receive some of the at least $20 billion in aid to States and territories. Puerto Ricans who pay payroll taxes and have three or more children could also benefit from the bill’s increase in the Child Tax Credit from $600 per child to $1,000. Puerto Ricans with substantial income from the States would also benefit from the bill’s cut in the taxation of dividends. Finally, Puerto Rico as a whole would benefit if the bill would accomplish its purpose of boosting the national economy. The national economic slowdown has been a major factor in Puerto Rico’s economic slowdown over the past couple of years.)
Breaux’s pitch was supported by Sen. Rick Santorum (R-PA) but it was opposed by the Chairman and Ranking Democrat of the Budget Committee, Sens. Don Nickles (R-OK) and Kent Conrad (D-ND) respectively. Nickles said that "there may be some merit" to providing additional economic assistance to Puerto Rico but the issue ought to be considered in an expected bill to reform ‘international’ provisions of the IRC.
He said he understood that the Sec. 956 amendment could cost the federal treasury more per job than Sec. 936, a cost he put at $100,000 per job. The purpose of Sec. 936 was to encourage companies in the States to make job-creating investments in U.S. territories. Tax loss costs of over $300,000 per year per job in some cases were the major reason for the repeal of Sec. 936.
Conrad additionally said that he had heard of ideas that could provide a "bigger bang for the buck" in terms of benefits to Puerto Rico than the Sec. 956 amendment. He expressed concern about the cost of the amendment and said that the issue should be fully reviewed before Congress acts on it.
Breaux reacted by saying that that he would not ask for a vote on the Calderon proposal (that he knew would lose) but that the overall issue of replacing Sec. 936 should be acted on and suggested a hearing during consideration of the international tax bill.
Santorum objected to considering Puerto Rico needs in an international context, noting it is a U.S. territory. He also said it was unfortunate that Puerto Rico lacked voting representation in the Congress.
Nickles also advocated a hearing.
The debate prompted Hatch, who had co-sponsored the Calderon proposal with Breaux in the last Congress, to say that Congress needed to replace Sec. 936 because it created a high unemployment problem in Puerto Rico by repealing the tax break. He noted he had supported Sec. 936.
Lott, noting that he had not always supported Sec. 936, agreed and said he supported the Sec. 956 amendment.
Nickles ended consideration of the Calderon proposal by saying the Congress should not approve a job-creation program that was too costly per job created.
The overall issue was raised again, however, when the Committee considered the proposal of Sen. Gordon Smith (R-OR) to cut the taxes on CFC income for one year only by 85%.
Breaux complained that the Committee "had just made a decision that it would not help Puerto Rico" in a similar manner. He said that it should not treat foreign citizens better than U.S. citizens.
Sen. Jay Rockefeller (D-WV) agreed with Breaux but supported Smith, saying that the Smith proposal would cause companies to ‘repatriate’ an estimated $135 billion.
Sen. Jim Bunning (R-KY) also supported Smith but noted that Sec. 936 had been repealed because of its excessive cost per job-affected in Puerto Rico. Santorum also supported Smith.
Breaux proposed adding profits from Puerto Rico to the Smith proposal. He presumably thought that this would be a major step toward the Calderon proposal although it would also give companies a significant incentive to take profits out of the territory during the one year window of the low tax rate.
Breaux’s amendment to Smith’s amendment caused Chairman Grassley to ask the Finance Committee’s staff to estimate the cost of adding Puerto Rico profits. They said it would increase the cost of the Smith proposal from $3.8 billion to $6 billion during the year.
The Breaux amendment to Smith’s amendment also caused Conrad to say that both proposals should be the subject of a hearing. He suggested that taxes on corporate income from the States and individuals should also be lowered to 5.25% if taxes on corporate profits from Puerto Rico and foreign countries are.
The Breaux amendment to add Puerto Rico profits was approved 11-6, with even opponents of Calderon’s Sec. 956 proposal, such as Conrad, voting in favor. The principal at issue was whether Puerto Rico should be treated as well as foreign countries. Additionally, members did not expect the Smith amendment to pass.
They were right. It was voted down 11-10.
The House Ways and Means Committee (and later the House) also acted on the economic stimulus legislation this week. Its bill would provide $550 billion in tax cuts.
There was no attempt to add Calderon’s proposal to the House bill by supporters such as Committee Ranking Democrat Charles Rangel (NY) or second-ranking Republican Phil Crane because they knew that Chairman William Thomas (R-CA) would not permit it.
The action in both committees very much reduces the chances of Calderon’s proposal ever being approved. But the action in the Senate committee demonstrated that there is substantial support for an economic incentive for Puerto Rico. Thomas favors taking some action, although not the Calderon proposal. The same is true of Senate Committee Chairman Grassley and Ranking Democrat Baucus. This is also reportedly the case with Senate Democratic Leader Tom Daschle, whom Calderon unsuccessfully lobbied this week.
Thomas, Baucus, and Daschle have all been open to the idea of extending the other expiring tax incentive for companies based in the States to do business in Puerto Rico, IRC Sec. 30A, or another means of providing justifiable assistance for job-creation in Puerto Rico. Sec. 30A gives companies a tax credit for wages and local taxes that they pay and capital investments that they make in Puerto Rico. Like Sec. 936, it expires at the end of 2005. It is the tax incentive that has been useful to the plants that have left Puerto Rico in recent years, attracted by low wages in foreign countries.
Another idea for assisting Puerto Rico’s economy is to give it Enterprise Zone economic benefits. Enterprise Zones are selected needy areas in the States.
Grassley has not been clear about his views on either idea but he has indicated that he is willing to consider ways of helping Puerto Rico’s economy other than pure tax exemption for corporate profits as Calderon has proposed.
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