Puerto Rico will lose federal tax credits that support 18% of revenue

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Puerto Rico, already restructuring its billions in bond debt, now needs to look for an alternative to a tax that provided 17.6% of its net revenues in fiscal 2019.

U.S. Treasury Secretary Steve Mnuchin told Gov. Wanda Vázquez that the government would take steps to end the tax credit that supports Puerto Rico’s Act 154 tax on foreign corporations. Passed in 2010, Act 154 is a 4% excise tax on the revenues of foreign corporate subsidiaries based in Puerto Rico.

Act 154 revenues go to Puerto Rico’s General Fund, which will be used to pay general obligation and some other central government bonds, once the current stay on payments is lifted.

While Puerto Rico is part of the U.S., for tax purposes it is considered a foreign land.

In 2011 U.S. Treasury agreed to a tax credit for the Act 154 payments on a temporary basis. The credit has since been extended beyond its original sunset. On Tuesday Mnuchin said that the credit would have to be phased out, though he didn’t specify a deadline.

Observers have worried that the loss of the federal tax credit would lead corporations to remove their operations from Puerto Rico. Many of the “foreign corporations” affected by Act 154 are companies based in the U.S.

According to Puerto Rico, 10 corporations and partnerships paid 90% of all Act 154 taxes in fiscal year 2016. The law mainly affects corporations manufacturing pharmaceuticals and other high-tech products on the island.

Attorney John Mudd said that if Puerto Rico tried to continue the Law 154 tax after the federal tax credit was withdrawn, the subject companies would probably successfully challenge it in court.

There has been talk of substituting an income tax on the subsidiaries for the excise tax. Mudd said this would probably also be legally challenged, but would probably survive any such challenge.

If Puerto Rico were to put an income tax on the subsidiaries, the parent companies would have to pay another tax on the income in their federal taxes. However, under current federal tax law it would be 80% tax deductible.

Under the phase-out plan, the parent companies based in the 50 states with Puerto Rico subsidiaries would have increased tax bills. Under the new tax conditions, some may choose to move the subsidiary operations to other locations.

Vicente Feliciano, president of Advantage Business Consulting, was optimistic. “Puerto Rico needs to come up with a reasonable income tax structure that provides these companies with a competitive tax environment but maintaining the present level of tax revenues. Done carefully and with a transition period, it should not be a major issue.”

The Puerto Rico Oversight Board certified fiscal plan, based on a variety of factors excluding a federal decision to revoke tax credits, projected that Act 154 revenues would decline by 37% from fiscal year 2018 to fiscal year 2024.

Spokespeople for Puerto Rico’s local government didn’t respond to a request to respond to Mnuchin’s comments.

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