Last month, the U.S Treasury Department informed Gov. Wanda Vázquez that the local government needs to work on a plan to eliminate Act 154 of 2010, or the Foreign Corporations & Partnerships Tax.
This tax was implemented by former Gov. Luis Fortuño’s administration in the midst of a fiscal crisis and as part of the economic reforms undertaken during that time.
Through this tax, the government hoped to finance the tax reform that was implemented in 2011 and provide the liquidity needed to address the large deficit of the time. The tax reform managed to reduce the tax rate to individuals and corporations and fed the private sector with $1 billion.
This, in combination with $7 billion in ARRA funds, were essential to the moderate economic upswing experimented between 2011 and 2012.
$1.8 Billion Gives Liquidity to the System
The new tax, which was controversial at the time due to the speed with which it was adopted and the repercussions on foreign corporations, allowed the government to access more revenue in order to finance the reform.
Over 50 companies had to start paying a 4 percent tax on their transactions between the parent company and its local affiliates.
The tax also allowed North American companies on the island to claim a 100 percent credit on monies paid to the government, which neutralized the consequences of the levies.
Act 154 of 2010 stipulated that the 4 percent tax would be gradually reduced until its elimination on 2016. However, from 2012 on, every government administration has modified the law in order to keep the tax steady at 4 percent.
This has, in turn, allowed the General Fund to generate close to $1.8 billion annually since 2011 and allowed the coffers to receive $16.2 billion globally, which have gone to the U.S. Treasury.
At its essence, the tax has provided the government and Puerto Rico’s economy with $16.2 billion over the last decade. This has been essential to avoiding fiscal bankruptcy.
The U.S. Treasury recently informed the local government that the tax on foreign companies must be eliminated and that they will provide Puerto Rico with some time to come up with a strategy. The only viable option is to turn the tax into a levy on foreign company’s revenues under the scope of the new tax law enacted by President Trump in 2017.
This would mean that 80 percent of taxes paid to the local Treasury would be credited to companies operating on the island. In turn, this would have a 20 percent net tax impact, far from the current 100 percent credit.
Challenges and Opportunities
At present, the elimination of the tax proves to be a monumental task due to the fiscal adjustments imposed under Promesa by the Oversight Board. Washington D.C.’s message is disheartening and the federal aid promised for the reconstruction of the island seems to be stuck.
Given this scenario, it is imperative that a creative solution is found that minimizes fiscal impact and doesn’t depend on incentives or outside mechanisms.