S. HRG. 114–462 

PUERTO RICO: ECONOMY, DEBT, AND OPTIONS 

FOR CONGRESS 

HEARING 

BEFORE THE 

COMMITTEE ON 

ENERGY AND NATURAL RESOURCES 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

OCTOBER 22, 2015 

( 

Printed for the use of the 

Committee on Energy and Natural Resources 

PUERTO RICO: ECONOMY, DEBT, AND OPTIONS FOR CONGRESS 

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98–944 2017

S. HRG. 114–462 

PUERTO RICO: ECONOMY, DEBT, AND OPTIONS 

FOR CONGRESS 

HEARING 

BEFORE THE 

COMMITTEE ON 

ENERGY AND NATURAL RESOURCES 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

OCTOBER 22, 2015 

( 

Printed for the use of the 

Committee on Energy and Natural Resources 

Available via the World Wide Web: http://www.fdsys.gov 

(II) 

COMMITTEE ON ENERGY AND NATURAL RESOURCES 

LISA MURKOWSKI, Alaska, Chairman 

JOHN BARRASSO, Wyoming 

JAMES E. RISCH, Idaho 

MIKE LEE, Utah 

JEFF FLAKE, Arizona 

STEVE DAINES, Montana 

BILL CASSIDY, Louisiana 

CORY GARDNER, Colorado 

ROB PORTMAN, Ohio 

JOHN HOEVEN, North Dakota 

LAMAR ALEXANDER, Tennessee 

SHELLEY MOORE CAPITO, West Virginia 

MARIA CANTWELL, Washington 

RON WYDEN, Oregon 

BERNARD SANDERS, Vermont 

DEBBIE STABENOW, Michigan 

AL FRANKEN, Minnesota 

JOE MANCHIN III, West Virginia 

MARTIN HEINRICH, New Mexico 

MAZIE K. HIRONO, Hawaii 

ANGUS S. KING, Jr., Maine 

ELIZABETH WARREN, Massachusetts 

Karen K. Billups, Staff Director 

Patrick J. McCormick III, Chief Counsel 

Isaac Edwards, Senior Counsel 

Angela Becker-Dippmann, Democratic Staff Director 

Sam E. Fowler, Democratic Chief Counsel 

Allen Stayman, Democratic Senior Professional Staff Member 

(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Murkowski, Hon. Lisa, Chairman and a U.S. Senator from Alaska ................... 1 

Cantwell, Hon. Maria. Ranking Member and a U.S. Senator from Washington .................................................................................................................... 2 

WITNESSES 

Weiss, Antonio, Counselor to the Secretary, U.S. Department of the Treasury 5 

Padilla, Hon. Alejandro J. Garcia, Governor of the Commonwealth of Puerto 

Rico ........................................................................................................................ 16

Pierluisi, Hon. Pedro, Resident Commissioner for Puerto Rico, U.S. House 

of Representatives ................................................................................................ 26 

Marxuach, Sergio, Policy Director, Center for a New Economy .......................... 35 

Fetter, Steven, President, Regulation UnFettered ............................................... 43 

ALPHABETICAL LISTING AND APPENDIX MATERIAL SUBMITTED 

Alliance for Free Association: 

Letter for the Record ........................................................................................ 389 

Baco, Luis: 

Statement for the Record ................................................................................. 394 

Cantwell, Hon. Maria: 

Opening Statement ........................................................................................... 2 

Competitiveness & Sustainable Economy Institute of Puerto Rico and the 

Puerto Rico Manufacturers Association: 

Letter for the Record ........................................................................................ 399 

Diaz, Jose Julio: 

Letter for the Record ........................................................................................ 403 

Fetter, Steven: 

Opening Statement ........................................................................................... 43 

Written Testimony ............................................................................................ 45 

Response to Question for the Record .............................................................. 388 

Hispanic Federation: 

Statement for the Record ................................................................................. 411 

Lopez, Franklin: 

Statement for the Record ................................................................................. 416 

Marxuach, Sergio: 

Opening Statement ........................................................................................... 35 

Written Testimony ............................................................................................ 38 

Responses to Questions for the Record ........................................................... 379 

Murkowski, Hon. Lisa: 

Opening Statement ........................................................................................... 1 

Padilla, Hon. Alejandro J. Garcia: 

Opening Statement ........................................................................................... 16 

Written Testimony ............................................................................................ 18 

Responses to Questions for the Record ........................................................... 71 

Pierluisi, Hon. Pedro: 

Opening Statement ........................................................................................... 26 

Written Testimony ............................................................................................ 28 

Puerto Rico Hospital Association: 

Statement for the Record ................................................................................. 420 

Rosselo ́, Ricardo: 

Forbes Op-Ed entitled ‘‘A New Path Forward for Puerto Rico’’ .................... 425 

Page

IV 

Santos (Ret.), Lt. Col. Armando: 

Statement for the Record ................................................................................. 428 

Weiss, Antonio: 

Opening Statement ........................................................................................... 5 

Written Testimony ............................................................................................ 7 

Responses to Questions for the Record ........................................................... 68 

(1) 

PUERTO RICO: ECONOMY, DEBT, AND 

OPTIONS FOR CONGRESS 

THURSDAY, OCTOBER 22, 2015 

U.S. SENATE, COMMITTEE ON ENERGY AND NATURAL RESOURCES, Washington, DC. 

The Committee met, pursuant to notice, at 10:07 a.m. in Room 

SD–366, Dirksen Senate Office Building, Hon. Lisa Murkowski, 

Chairman of the Committee, presiding. 

OPENING STATEMENT OF HON. LISA MURKOWSKI, 

U.S. SENATOR FROM ALASKA 

The CHAIRMAN. Good morning. The committee will come to order. 

Today we are here to look at the current state of Puerto Rico’s 

economy, its short-term liquidity issues, and options for Congress 

to address what has become a financial crisis for the island. 

In looking over the fiscal data that is available on Puerto Rico, 

I would like to reiterate Chairman Hatch’s remarks at his Finance 

Committee hearing on Puerto Rico last month. We do want to be 

helpful, but in order to be helpful, we need verifiable data. 

As an example, the FY 2016 budget approved by the Puerto Rico Legislature sets aside $1.5 billion for debt service costs, yet the 

Krueger Report states that the official FY 2015 $850 million surplus is ‘‘a far cry from interest and amortization costs of $2.8 billion.’’ The report further states that there is spending by entities 

other than the General Fund that is draining cash balances. That is a fairly significant gap of over $1 billion. With no independent audited financial report of Puerto Rico’s Government Development Bank—the island’s fiscal agent and financial adviser— 

since 2013 it leads to uncertainty over the true level of Puerto 

Rico’s financial situation. I would ask our witnesses this morning 

to share their views on the accuracy of the data that is available 

to us. 

What we do know is that a number of reports suggest that even 

with the emergency actions taken by the government of Puerto 

Rico, the government will run out of cash in November, just a few 

short weeks away. If the current course of action is continued, an 

even bigger cash crunch will take place in June 2016, with a negative cash balance of over $500 million. 

Barclays reports that the government may need to invade 

COFINA’s tax revenue in order to pay its general obligation debt 

over the next five years and even that might not be enough. In 

short, Puerto Rico’s short-term liquidity crunch is real, and action 

is needed. 

2 

A number of ideas have been floated to help address Puerto 

Rico’s fiscal challenges, both short-term and long-term. We are 

going to use today’s hearing to take a much closer look at what the 

reality on the ground is, what actions—both locally and at the Federal level—could have the most positive impact, and what structural reforms can be made to make for a more effective and efficient government. 

I also intend for this hearing to take a closer look at Puerto 

Rico’s Electric Power Authority (PREPA) and what is happening in 

Puerto Rico’s energy sector. In my opinion, energy and the economy 

cannot be separated. They are too intrinsically interlinked, and 

Puerto Rico’s economic health cannot be solved without also addressing its energy issues. 

I had a meeting just yesterday with some small-business owners 

in Puerto Rico. They tell me that some 30 percent of their business 

expenses go to energy costs. This is extraordinary. If one of the pillars for solving Puerto Rico’s long-term financial situation is private sector economic growth, that level of energy expense is simply 

not sustainable. As the various options are considered, we must 

keep that pillar in mind to ensure that any means implemented do 

not drive business away from the island or make it too difficult for 

them to remain in operation. 

With that, we have a very distinguished panel before us this 

morning. After Senator Cantwell’s remarks, I will introduce each of 

you, but we are very pleased to have the panel that we have. 

With that, I will turn to Senator Cantwell for her remarks this 

morning. 

STATEMENT OF HON. MARIA CANTWELL, U.S. SENATOR FROM 

WASHINGTON 

Senator CANTWELL. Thank you, Madam Chair, and thank you for 

holding this important hearing. I, too, look forward to the witnesses’ testimony this morning and working with you and other 

Members of the Senate on this issue. 

At the outset, I would note that many observers may be wondering why, exactly, the Senate Committee on Energy and Natural 

Resources is having a hearing on the Puerto Rico debt crisis. It is 

important to remember that, until the Senate reorganized its committee structure in 1977, this committee was actually known as the 

Committee on Interior and Insular Affairs. We have jurisdiction 

over measures relating generally to the insular provisions of the 

United States except those affecting their revenues and appropriations. 

So today, we retain jurisdiction over territorial possessions of the 

United States, including the former Trusteeship and matters related to the territory of Puerto Rico. 

It is because of our general responsibilities in oversight that the 

Energy Committee has a key role to play in convening a responsible discussion about economic solutions that Puerto Rico now 

faces. However, it is also clear that fashioning these solutions will 

require partnerships with other Senate committees—the Chair 

mentioned the Finance Committee hearing, which I attended, and 

the Judiciary Committee, along with many others in the Puerto 

Rican Government and the Administration. 

3 

The Finance Committee has convened a hearing on this topic to 

date. Today we will hear for the first time what the Administration 

would do to try to address the crisis more specifically, and I certainly look forward to that testimony. 

I would also like to make a few key points to put the current situation in context. First, it is very important to remember that 3.5 

million residents of Puerto Rico today are U.S. citizens and have 

been citizens since 1917. 

As we look at the ways that our U.S. economy has recovered, it 

is very important to understand that Puerto Rico has not rebounded. The continuing decline in productivity is felt there every 

day. Incomes are falling. Puerto Rico is already well below the 

poorest state, about $18,000 per person in Puerto Rico, about half 

the $37,000 in Mississippi. Tuition is up. Hospitals are closing. Everywhere, families are facing these challenges. 

Puerto Rico is currently experiencing one of the largest migrations in U.S. history, having lost about eight percent of their population, over 300,000 people, in the past ten years. These individuals 

are many of Puerto Rico’s most-skilled and highest-paid workers. 

This migration to the U.S. will continue, and I think it is one of 

the challenges we face. Debt has accumulated to an estimated $72 billion. In fact, the 

government and the electric utility have failed to make their required debt payments. I know, Madam Chair, you know a lot about 

high-cost utility costs, but the fact that these energy rates are at 

29 cents a kilowatt obviously presents an incredible challenge to 

any manufacturing in the future. Also, credit is either unavailable 

or prohibitively expensive, and cash reserves are expected to be exhausted in the coming weeks. 

It is clear that the current situation is not acceptable. It is clear 

that we do not want to see the situation unfold in which the government of Puerto Rico faces a binary choice of either paying teachers or reimbursing healthcare costs versus paying the debt, much 

of which has been bought up by Wall Street for pennies on the dollar, under the assumption that Congress would not act. 

I think it is very important that we meet our responsibilities 

here, that congressional authority over Puerto Rico and the territories that stems from the Territorial Clause of the Constitution— 

which, just to remind people, say Congress shall have the power to 

dispose and to make all necessary rules and regulations respecting 

territories—I think is very important. 

We have done this in the past. Congress has acted. The constitution of Puerto Rico was authorized and approved by Congress. The 

Organic Acts of Guam and the U.S. Virgin Islands are Federal statutes. All of these have been reported by the Senate committee, and 

so I think it is very important that we realize that we do have the 

power and authority to act here. 

It was first President Bush in 1992 who said that Federal agencies should ‘‘treat Puerto Rico administratively as if it were a 

state,’’ unless doing so otherwise would ‘‘increase or decrease Federal receipts or expenditures or seriously disrupt’’ Federal programs. 

I know there are a lot of ancillary debates here about how we 

help Puerto Rico, but we do have the ability to give them the key 

4 

tools to financial restructuring without doing another thing, without costing us anything. We have the ability to give them that 

power. 

If we are, in fact, to enact new laws in this area, we do need to 

have a partnership. Obviously, as I said, there are other committees that would have to be consulted in how we move forward on 

this issue. So I look forward to hearing from all the witnesses and 

the discussion about how we best move forward for Puerto Rico’s 

future. 

I should just note, getting through this financial crisis is one step 

of the process. Clearly I have a lot of questions in my own mind 

about a flat world and how an island economy can best proceed in 

the future, but we will save that discussion for another day and instead focus on how we give Puerto Rico the best tools possible to 

get through this financial crisis. 

I thank the Chair, and I look forward to the witnesses’ statements. 

The CHAIRMAN. Thank you, Senator Cantwell, I appreciate your 

comments this morning. 

With that, let us turn to our panel that has been assembled here 

this morning. We will lead off the panel this morning with Mr. Antonio Weiss. Mr. Weiss serves as the Counselor to the Secretary of 

the Treasury. He has been leading the Obama Administration’s efforts to provide technical assistance to Puerto Rico on financial 

matters. We appreciate you being here this morning and assume 

that you will fill us in on the details of the proposal by the Administration. 

Next we have the Honorable Governor Padilla. Governor Padilla 

has been Governor of Puerto Rico since 2013, and he has been head 

of the Popular Democratic Party since 2012. Governor Padilla, it is 

nice to have you back before the committee. Welcome. 

Next to the Governor we have Mr. Pedro Pierluisi. Mr. Pierluisi 

has been Puerto Rico’s Resident Commissioner in the U.S. House 

of Representatives since 2009. He is a member of the House Judiciary and Natural Resources Committee. Mr. Pierluisi has also been 

before the committee on several occasions, so we are pleased to 

have you back as well. Good morning. 

Next to Mr. Pierluisi we have Mr. Sergio Marxuach. I hope I am 

pronouncing that correctly. He is the Public Policy Director at the 

Center for a New Economy in Puerto Rico. He has previously 

served as Deputy Secretary of Commerce and Economic Development for the Government of Puerto Rico and as a Special Assistant 

in the Commonwealth’s Office of Management and Budget. Good 

morning. 

Finally we have Mr. Steven Fetter. Mr. Fetter is President of the 

advisory firm Regulation UnFettered. He served as Chair of the 

Michigan Public Service Commission. He has also been Group 

Head and Managing Director at Fitch Ratings with a focus on global energy issues. So we also welcome you before the committee. 

I will ask that each of you try to keep your comments this morning to about five minutes or less. Your full statements will be included as part of the record. 

I will alert you to the fact that we are scheduled to have one, 

if not two, votes commencing at 11 o’clock this morning, so my hope 

5 

would be that we would be able to get the testimony from each of 

you, and if we need to take a short break to run and do votes, we 

will do so. But hopefully we will be able to get all the comments 

in under that 11 o’clock time, and we will be able to proceed. There 

is a lot that is before the committee this morning, and we want to 

give you every opportunity. 

Mr. Weiss, if you would like to lead off. Welcome. 

STATEMENT OF ANTONIO WEISS, COUNSELOR TO THE 

SECRETARY, U.S. DEPARTMENT OF THE TREASURY 

Mr. WEISS. Chairman Murkowski, Ranking Member Cantwell, 

and members of the committee, thank you for inviting Treasury to 

participate in today’s hearing. We welcome the opportunity to have 

a constructive dialog with you and with your colleagues on this important and very urgent matter. The economic security and wellbeing of 3.5 million Americans living in the Commonwealth is at 

stake. I would also like to acknowledge our ongoing collaboration 

with Governor Garcia Padilla and Resident Commissioner Pierluisi, 

both of whom are here today. 

Through our daily contact with local leadership and frequent 

meetings with stakeholders in San Juan and Washington, I can tell 

you with total confidence that Puerto Rico’s fiscal crisis is escalating and it is very real, and that without Federal action, it could 

easily become a humanitarian crisis as well. 

Let me be clear: there is no substitute for legislative action. Administrative authorities are simply insufficient to put an end to the 

crisis. Without Federal action, this crisis will escalate and result in 

further economic contraction, outmigration, and suffering of American citizens in Puerto Rico. 

In the very near future, Puerto Rico will face impossible choices 

among providing essential public services, delivering promised pension benefits, and making payments on its debt. Now my written 

testimony describes the gravity of Puerto Rico’s fiscal challenges, 

but I would like to highlight a few of the more salient facts. 

First, Puerto Rico’s decline started before the U.S. financial crisis, but unlike the U.S. as a whole, the Commonwealth never recovered and remains in recession today. 

Second, these economic challenges have sparked the largest wave 

of outmigration from Puerto Rico since the 1950s, and that pace 

continues to accelerate. Eighty-four thousand Puerto Ricans left the 

island last year. 

Third, the Commonwealth has already run out of operating cash. 

Government services and debt payments have only continued because Puerto Rico is deploying unsustainable emergency liquidity 

actions, such as delaying tax refunds to its citizens and borrowing 

from workers’ compensation funds. But even with these steps, the 

Commonwealth projects it still will completely exhaust its liquidity 

before year end. 

Now the strain created from these actions is already evident. The 

pensions are underfunded severely, hospitals have reduced services—one has even closed—and invoices to small businesses are 

going unpaid. Against this backdrop, additional fiscal adjustment, 

while absolutely necessary, must be measured against its negative 

impact on Puerto Rico’s economy and people. 

6 

In our judgment, austerity alone is not a solution. Most fundamentally, the debt is unsustainable, and the market knows this, 

which is why Puerto Rico’s debt has traded for some time between 

30 and 70 cents on the dollar. 

Now there is plenty of blame to go around for the mistakes of 

the past, but we must now focus on the path forward. The Administration believes that Federal actions, executed alongside measures 

taken in the Commonwealth, are now required to allow Puerto Rico 

to address its fiscal crisis and for the economy to return to growth. 

We are presenting these policies as principles to the committee and 

stand ready to work with you on specific legislation. There are four 

interrelated elements to our plan. 

First, Puerto Rico needs tools to comprehensively restructure its 

financial liabilities. Congress should pass legislation already introduced that provides Chapter 9 protection to Puerto Rico’s municipalities and public corporations, but Congress should also authorize 

a broader legal framework that allows for a comprehensive restructuring of all of Puerto Rico’s outstanding debt. 

Second, Congress should require that Puerto Rico implement 

strong fiscal governance and oversight as part of any comprehensive legislative package. The oversight should provide sufficient 

safeguards to ensure Puerto Rico adheres to its recovery plan and 

fully implements proposed reforms, but care must also be taken to 

structure fiscal oversight in a way that respects Puerto Rico’s autonomy and unique heritage. 

Third, Congress must provide a long-term solution to Puerto 

Rico’s inadequate Medicaid treatment to raise the standard of care. 

We should also remove the Medicaid cap and increase support 

through the Federal Medicaid match. 

And finally, Congress must help Puerto Rico boost economic 

growth. The decade-long recession has taken its toll on Puerto 

Rico’s finances, its economy, and its people. To break this vicious 

cycle and help those hardest hit, Congress should extend the 

earned income tax credit (EITC) to citizens in Puerto Rico. The 

EITC is one of the strongest, most powerful policies for rewarding 

work and supporting economic growth. 

We look forward to a constructive, bipartisan dialog that identifies ways to execute the Administration’s proposals and provide 

Puerto Rico with the tools it needs to manage through this crisis 

and restore growth. 

You have kindly invited us today to discuss Puerto Rico’s economy, debt, and options for Congress. We believe this discussion is 

timely and the issue must be addressed. 

Thank you. 

[The prepared statement of Mr. Weiss follows:] 

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Insert offset folio 1 here 98944.001

EMBARGOED FOR DELIVERY 

Testimony of Antonio Weiss 

Counselor to the Secretary, U.S. Department of the Treasury 

Written Testimony 

Senate Committee on Energy and Natural Resources 

"Hearing on Puerto Rico: economy, debt, and options for Congress" 

October 22, 2015 

As Preparedfor Delivery 

Chairman Murkowski, Ranking Member Cantwell, and Members of the Committee: 

Thank you for the invitation to participate in today's hearing on Puerto Rico's economy, debt, 

and options for Congress moving forward. On behalf of the U.S. Department of the Treasury 

and the Obama Administration, we welcome the opportunity to have a constructive dialogue with 

you and your colleagues on this important and urgent matter. The well-being of3.5 million 

Americans living in the Commonwealth of Puerto Rico is at stake. 

I would also like to acknowledge our collaboration with Governor Alejandro Garcia Padilla and 

Resident Commissioner Pedro Pierluisi, both of whom are here today. 

We also appreciate the growing interest in this urgent issue by a wide range of Members of 

Congress on both sides of the aisle, and other Committees who have been engaged and have held 

hearings. 

But while growing bipartisan interest is appreciated, Congress will need to take action. The 

Commonwealth of Puerto Rico is in the midst of an economic and fiscal crisis, and, without 

federal action, the situation could become a humanitarian crisis as well. Puerto Rico's 

government is out of cash and running out of options. Over the past year, we have met regularly 

with key stakeholders, including members of Puerto Rico's legislature and local business and 

labor leaders. We also remain in daily contact with the officials managing Puerto Rico's fiscal 

response. The sense of crisis is escalating and very real. 

My testimony today will describe the magnitude of Puerto Rico's challenges and offer a 

comprehensive set of specific policies the Administration believes are needed to fix the problem. 

Let me be clear: there is no substitute for legislative action. No administrative authority can put 

an end to this crisis. A very wide gap exists between the proposals the Administration has put 

forth and any non-legislative alternatives. 

We remain deeply committed to doing what we can to help, but Congressional action is required 

to avert further crisis and put Puerto Rico's economy on a path toward sustainable growth. All 

stakeholders, including bondholders, need to contribute to the solution. Puerto Rico must also do 

its part by implementing a comprehensive fiscal plan. 

As the Administration has made clear, our policy proposals are not a bailout. On the contrary, 

they are the critical reforms we believe Puerto Rico requires to manage through this crisis. Only 
8 


Insert offset folio 2 here 98944.002

Congress can provide the tools Puerto Rico needs to restructure its debt, enhance its fiscal 

governance, fix its healthcare system, and help jumpstart its economy. 

Without action by Congress, the Commonwealth's crisis will escalate and result in further 

economic contraction, further outmigration, and further suffering of the American citizens in 

Puerto Rico. In the very near future, Puerto Rico will face impossible choices among providing 

essential public services, delivering promised pension benefits, and paying its debt. 

This Loultl Become a Humanitarian Crisis, Not .Just an Economic and Fiscal Crisis 

Puerto Rico was once referred to, and emulated, as a beacon for economic growth and 

democracy around the world. The Commonwealth has substantial strengths with a stable rule of 

law and currency as well as a highly-skilled workforce. For more than a century, Puerto Ricans 

have fought courageously to defend our nation. In 2014, the 65th Infantry Regiment, known as 

the Borinqueneers, was awarded the Congressional Gold Medal, and tens of thousands of Puerto 

Ricans proudly serve in our armed forces. 

Today, however, the Island is suffocating from a decade of economic decline and expanding 

deficits. Important efforts to increase revenues and reduce outlays have been insufficient to 

reverse the trend. As a result, Puerto Rico is experiencing a prolonged, downward spiral in 

economic performance, investment, employment and income flows, intensified by a sharp 

cutback in business and consumer lending. 

Puerto Rico's decline started before the U.S. financial crisis, but unlike the rest of our country, 

the Commonwealth never recovered and remains in recession today. Since 2006, Puerto Rico's 

economy has shrunk by more than 10 percent and has shed more than 250,000 jobs. More than 

45 percent of the Commonwealth's residents live in poverty- the highest poverty rate of any 

state or territory and its 11.6 percent unemployment rate is more than twice the national 

average. Median household income in Puerto Rico is less than $19,000, approximately one-third 

of the US. median. 

These economic challenges have sparked the largest wave of outmigration from Puerto Rico 

since the 1950's, and that pace continues to accelerate. More than 300,000 people have left 

Puerto Rico in the past decade; a record 84,000 people left in 2014. Citizens are leaving from 

across the socioeconomic spectrum. More than 40 percent leave for job-related reasons. They 

range from highly educated doctors, who are leaving at a rate of more than one a day, to young 

adults unable to find work in the local economy. As they depart, the population ages and the 

revenue base shrinks. Seniors already represent more than 23 percent of Puerto Rico's 

population, one of the highest in the United States, and the number of children under five years 

of age has decreased 37 percent to 187,000 since 2000. Only a return to growth can end this 

vicious cycle. 

The Commonwealth is already taking significant revenue and expense actions that, while 

necessary, are creating further economic headwinds. Nearly $2.0 billion in tax increases are 

reducing household income spending, and reductions in pay and benefits are having a 

2 
9 


Insert offset folio 3 here 98944.003

contractionary effect. The wholesale petroleum tax quintupled to $15.50 per barrel, and the sales 

tax recently increased to 11.5 percent, the highest in our nation. A strict fiscal sustainability law 

was enacted to reduce government expenses and cap public wages. Government spending, net of 

debt service, is now at its lowest level since 2005, both in nominal terms and as a share of Gross 

National Product. 

However, austerity alone is not a path to recovery. After ten years of recession, there are limits 

to the scale and pace of additional fiscal adjustment that can be achieved. 

Puerto Rico's Current Liquidity Situation 

Puerto Rico lost access to the traditional municipal bond market in February 2013 after ratings 

agencies downgraded its bond rating to below investment grade status. In March 2014, the 

Commonwealth raised $3.5 billion at an 8.5 percent yield entirely from hedge funds, but they too 

are no longer available as a sustainable funding source. Even short-term financing, such as tax 

revenue anticipation notes, has proved impossible to obtain on an affordable basis. 

Given the lack of market access, the Commonwealth ran out of the cash needed for normal 

operations earlier this year. Government services and debt payments have only continued 

because Puerto Rico is deploying onerous and unsustainable emergency liquidity actions. These 

measures include delaying payment of tax refunds to residents, borrowing from Puerto Rico's 

workers compensation funds, liquidating pension assets early to provide working capital, failing 

to pay certain appropriation debts, withholding monthly set aside funds for debt service, and 

stretching payment of accounts payables to vendors and other third parties. Despite these 

actions, the Commonwealth projects it will completely run out of emergency liquidity before 

year-end. 

The strain created from these actions is already evident For example, delays in healthcare 

reimbursements have forced many medical centers to close floors and eliminate specialized 

services, and at least one hospital shut down temporarily because of a failure to pay its bills. 

Puerto Rico's Federation of Mayors estimates that forty-five of Puerto Rico's seventy-eight 

municipalities will not have enough cash for payroll expenses as early as this November. Fuel 

services at six municipalities could be cutoff within weeks as welL Against this backdrop, any 

additional fiscal adjustment must be measured against its potentially adverse effects on the 

Puerto Rican economy and people. 

The central government's ongoing structural deficits also put Puerto Rico's pension systems at 

risk Monthly pension payments are the only source of steady income for many of the pension 

system's 163,000 retirees. An additional 167,000 workers, who represent nearly 20 percent of 

Puerto Rico's workforce, are also counting on the pension systems for future retirement income. 

For much of the past decade, while workers paid into the system, Puerto Rico failed to pay its 

annual required contributions. As a result, system administrators are currently being forced to 

sell pension assets to pay current benefits. Once those assets are depleted -likely by 2019 all 

3 
10 


Insert offset folio 4 here 98944.004

future pension benefits will need to be paid directly from the Commonwealth's General Fund. 

This will require an additional $700 million to $1 billion of outlays per year. 

Longer-term, absent policy changes, Puerto Rico projects it will confront a $28 billion budget 

shortfall over the next five years. The Commonwealth has identified additional tough revenue 

and expense measures to narrow that gap. However, full implementation of Puerto Rico's 

proposed actions, including the generation of economic grovvth, only reduces the estimated fiveyear fiscal deficit to $14 billion. The remaining $14 billion shortfall must be closed, in part, 

through the restructuring of Puerto Rico's large and complex debt burden. 

The Administration's Proposed Plan 

The Administration believes federal actions, executed alongside measures taken in the 

Commonwealth, are now required to allow Puerto Rico to address its fiscal crisis and restore 

economic growth. The Administration is presenting these concepts as principles and stands 

ready to work with Congress to advance comprehensive legislation that achieves our collective 

objective. 

There are four interrelated elements to the Administration's proposal: 

First, Congress should provide tools for Puerto Rico to comprehensively restructure its 

financial liabilities, Puerto Rico's debt load is unsustainable. Tax-supported debt service is 

projected to consume over 35 percent of government receipts in coming years. In contrast, debt 

service for the fifty states is, on average, only 5 percent of revenues. Additionally, total liabilities 

exceed 160 percent of GNP- a greater burden than can likely be supported by Puerto Rico even 

if economic growth resumes. The bond market also knows this, which is, in part, why Puerto 

Rico's uninsured debt trades between 30 and 70 cents on the dollar, and rating agencies have 

determined there is a high probability of default. 

For that reason, a central element of any Congressional response must include a fair and orderly 

restructuring mechanism built on the tested principles of the federal bankruptcy code. Puerto 

Rico does not have access to the federal bankruptcy courts to restructure its financial obligations. 

Puerto Rico's officials tried to address this shortfall on their own by passing a law to provide a 

bankruptcy-like process, but the United States Court of Appeals for the First Circuit held that 

federal law preempts the local legislation. Further, the Court held that only Congress may grant 

Puerto Rico access to bankruptcy protection. 

Puerto Rico's debt stock is highly complex. More than 20 creditor committees have already 

formed around Puerto Rico's 18 different debt issuers, each with its own competing interests. 

This will make it very difficult for Puerto Rico to negotiate a voluntary restructuring on a timely 

basis. A court-supervised process would help ensure fair treatment to all parties. Absent an 

orderly process, all stakeholders stand to lose in the face of continued deterioration of Puerto 

Rico's economic and financial conditions. 

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Bankruptcy is not a bailout. Allowing Puerto Rico to resolve its liabilities under the supervision 

of a bankruptcy court involves no federal financial assistance whatsoever. Instead, bankruptcy 

requires shared sacrifice from both Puerto Rico and its creditors. The alternative an untested 

and potentially disorderly process with numerous creditor lawsuits and years of litigationwould depress the local economy, increase costs, and make long-term recovery harder to 

achieve. 

Congress should move swiftly to pass pending legislation that provides Chapter 9 protection to 

Puerto Rico's municipalities in the same manner it already provides bankruptcy protection to 

municipalities in the fifty states. This legislation would cover approximately one-third of Puerto 

Rico's bonded debt. 

Congress should also authorize a broader legal framework that goes beyond the scope of Chapter 

9 to allow for a comprehensive restructuring of all of Puerto Rico's outstanding debt. The 

restructuring regime should be reserved exclusively for U.S. territories. As under current law, 

states would remain ineligible to file for bankruptcy under this or any other bankruptcy regime. 

The restructuring regime should provide the basic protections of bankruptcy: a stay on creditor 

collection actions, priority for new private short-term cash flow financing, and voting by creditor 

classes on any proposed restructuring. 

The restructuring regime should fairly balance the interests of Puerto Rico and all its creditors. It 

should safeguard Puerto Rico's capacity to fund its public pensions and pay retiree benefits. 

Such an approach would, among other things, provide breathing space for consensual 

negotiations and ensure the uninterrupted provision of essential public services. 

Second, Congress should require that Puerto Rico implement strong fiscal governance and 

oversight as part of a comprehensive legislative package. Puerto Rico's efforts have been 

hampered by a lack of fiscal oversight and transparency. Historically, Puerto Rico's budgets 

relied on unrealistic revenue estimates, and, as a result, annual budgets masked recurring 

structural deficits. Moreover, proposed revenue and expense measures have fallen short because 

Puerto Rico lacks important fiscal controls to ensure discipline. 

Consequently, independent and credible fiscal oversight is needed. Congress should enact that 

oversight as part of a comprehensive approach to the crisis. Care must be taken to structure the 

fiscal oversight in a way that respects Puerto Rico's autonomy. At the same time, the oversight 

should provide sufficient safeguards to ensure Puerto Rico adheres to its recovery plan and fully 

implements proposed reforms. This would help restore confidence among all stakeholders. 

Access to the broader restructuring regime should be conditioned on this oversight. The 

Administration is ready to work with Congress to identify the powers of this oversight body and 

its proposed membership. 

Any fiscal oversight should also work to improve Puerto Rico's fiscal accounting and reporting 

systems. While the historical inadequacies of Puerto Rico's financial systems are undeniable, 

there is little doubt about the realities of the current fiscal crisis. The Commonwealth recently 

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commissioned an independent and exhaustive forensic accounting of their financial books that 

for the first time revealed the true extent of Puerto Rico's fiscal crisis. This rigorous and 

thorough accounting is available on the website of the Government Development Bank. 

Congress should provide funding and authorization for technical assistance to help Puerto Rico 

make the critical investments needed to bring its accounting and disclosure practices into the 21'1 

century. This includes taking action to fund information technology upgrades, improve 

economic forecasting capabilities and provide Federal technical assistance around budgeting, 

cash management and spending controls. Agencies in Puerto Rico use different financial 

systems that are incompatible with one another, making it difficult to provide consistent, timely 

financial reporting and visibility into expenses. The funding amounts involved would be small, 

but the benefits would be great. 

Third, Congress must provide a long-term solution to Puerto Rico's inadequate Medicaid 

treatment. Given the current treatment of Puerto Rico and the other territories under federal 

law, the 3.5 million Americans in Puerto Rico do not have access to healthcare services 

considered standard in the rest of the nation. There are currently more than 1.6 million Medicaid 

enrollees in Puerto Rico's healthcare system, representing nearly half of the Commonwealth's 

population. Insufficient and unstable funding for Medicaid has contributed to Puerto Rico's 

fiscal challenges and endangered access to coverage. When one-time funds from the Affordable 

Care Act for Puerto Rico's Medicaid system are exhausted, as many as 600,000 Americans 

living in Puerto Rico could lose coverage. 

Puerto Rico's Medicaid program is fundamentally different from the Medicaid program that 

serves Americans in the 50 states and the District of Columbia. Medicaid funding in Puerto Rico 

is capped; U.S. citizens in Puerto Rico are offered fewer benefits; and the federal government 

contributes less on a per capita basis in Puerto Rico than in the states. 

As a result, Congress should reform Puerto Rico's Medicaid program to raise the standard of 

care and prevent Medicaid's unstable financing from exacerbating Puerto Rico's fiscal crisis. 

Americans in Puerto Rico should be provided with access to Medicaid and key healthcare 

services that better align with what people receive on the mainland. 

Congress should also remove the cap on Puerto Rico's Medicaid program and increase the 

Federal support Puerto Rico receives through the Federal Medicaid match, after a sufficient 

transition period. A transition period is required so Puerto Rico can develop the more robust 

infrastructure required to offer new benefits and strenf,>then its internal accountability, financial 

management, and program integrity controls to prevent fraud, waste, and abuse. Because the 

transition may take years, Congress should avoid a drop in coverage when one-time funds from 

the Affordable Care Act expire. 

Finally, Puerto Rico desperately needs measures to boost economic growth. The decadelong recession has taken its toll on Puerto Rico's finances, its economy, and its people. To break 

this vicious cycle and help those hardest hit, Congress should extend some of the most proven, 

bipartisan tools for stimulating growth and rewarding work to the citizens of Puerto Rico. 

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At forty percent, Puerto Rico has the lowest labor market participation in the United States and 

the territories- participation rates are about two-thirds the U.S. average. Low participation in 

the formal economy stunts economic growth and undermines Puerto Rico's economic reform. 

Puerto Rico does not currently have an Earned Income Tax Credit (EITC). A large body of 

economic research has found that the EITC is one of the strongest, most powerful policy tools 

for rewarding work and supporting economic growth. The existence of an EITC should also 

increase employment in the official sector relative to the informal economy by providing higher 

wages to workers who file taxes. As a result, Congress should grant Puerto Rico access to an 

ETTC. 

The EITC is a proven job creation policy that has long garnered broad bipartisan support in 

Washington. President Reagan proposed a major EITC expansion in his 1986 Tax Refonn Act, 

which he argued was "the best antipoverty, the best pro-family, the best job creation measure to 

come out of Congress'' Several studies demonstrate that the large expansions to the EITC 

enacted in the 1980s and 1990s induced more than half a million people to enter the labor force. 

Congress should also consider other proven measures, in addition to an EITC, that reward work 

and support growth, such as the Child Tax Credit 

Tlte Administration's Ongoing Engagement 

Although there is no substitute for legislative action, the Administration has been actively 

working for many months, within existing authorities, to help the residents of Puerto Rico. 

Treasury started monitoring Puerto Rico's fiscal situation several years ago. As the 

Commonwealth's financial challenges worsened, Secretary Lew intensified the Department's 

effort. He created a dedicated team within Treasury to evaluate Puerto Rico's fiscal outlook 

more closely and begin sharing our expertise with the officials that oversee the Commonwealth's 

economic policies. 

Since its formation, the team has visited Puerto Rico regularly to review Puerto Rico's financial 

data, offer our perspectives on how other entities have managed through similar crises, and 

recommend steps Puerto Rico could take to restore economic growth. We meet frequently with 

the Governor, members of Puerto Rico's legislature, and local business and labor leaders. We 

also remain in daily communication with the officials managing Puerto Rico's fiscal response. 

The National Economic Council and Treasury are also leading a broad, Administration-wide 

effort on Puerto Rico. This broader, Administration-wide effort includes the support of the 

White House Task Force on Puerto Rico, the Office of Management and Budget, the Department 

of Health and Human Services, the Department of Justice, and all other agencies needed to 

construct the legislative priorities proposed in this testimony. 

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The effort has three primary objectives. First, to ensure the Administration brings our full 

capabilities to bear, within the limit of our authorities, to guarantee Puerto Rico has access to all 

available federal programs. Second, to encourage federal agencies to pursue all possible 

administrative options for assistance. And, finally, it established the legislative priorities 

proposed today. 

The inter-agency effort has already produced results. These are some salient examples: 

• As part of our effort to ensure Puerto Rico has access to all available federal 

resources, the Department of Health and Human Services worked with the 

Administraci6n de Seguros de Salud (ASES) to implement an accelerated 

reimbursement timeline for eligible healthcare expenses. Rather than reimbursing 

ASES on a periodic basis, reimbursements now occur weekly, substantially 

reducing the friction between the time funds are outlaid and subsequently repaid. 

This helps to ease the burden on Puerto Rico as it manages through its limited 

liquidity. The Department of Health and Human Services also convened a 

working group between the Secretary's office and the Puerto Rico Healthcare 

Coalition to exchange information and identify any administrative flexibility that 

might exist. This working group is considering data proxies to improve Medicare 

payments to hospitals in Puerto Rico and adjustments to Medicare measures that 

would benefit high-poverty areas across the United States, including Puerto Rico. 

• The Department of Transportation (DOT) is working closely with Puerto Rico's 

Highways & Transportation Authority to spur infrastructure investment. As a 

result, the Federal Highway Administration identified more than $750 million in 

toll credits Puerto Rico can use to fund new and potentially existing infrastructure 

projects. DOT is also working with Puerto Rico to add PR-22 to the Presidential 

Dashboard and is accelerating the design of a congestion pricing system to improve 

traffic flow on PR-52. The Build America Transportation Infrastructure Center is 

also in conversation with Puerto Rico about lending its expertise on possible public 

private partnership opportunities. 

• The Department of Commerce, Jed by SelectUSA and through direct engagement 

from the Vice President of the United States, supported efforts to attract significant 

new investment to develop the Lufthansa Maintenance, Repair, and Overhaul 

facility in Aguadilla. Select USA continues to partner with Puerto Rico on a 

pipeline of potential investment deals to help attract jobs and boost economic 

growth on the Island. 

• The General Services Administration is helping create opportunities for local and 

small businesses by spending $85 million to construct a new FBI headquarters in 

San Juan. This will create both jobs and procurement opportunities for local 

businesses. As part of their Big Building Projects, the GSA also recently hosted a 

networking event for local contractors interested in being shortlisted for the FBI 

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project. Separately, the Department of Commerce's Economic Development 

Administration provided $800,000 to the Puerto Rico Trade and Export Company 

(PRTE) and the Puerto Rico Investment Development Corporation (PRIDCO) to 

host a Small and Medium Enterprises conference focused on business to business 

matching and procurement processes. 

• The Administration continues to partner with Puerto Rico to improve the structural 

competitiveness of its economy. Department of Agriculture is working with 

Puerto Rico to modernize and refonn the Island's Nutrition Assistance Program to 

help remove significant benefits cliffs that can potentially discourage individuals 

from seeking work in the formal economy. The Department of Justice recently 

signed a Memorandum of Understanding to help reduce violent crimes. And, the 

Department of Energy signed a Memorandum of Understanding to develop a 

long-term energy plan that will provide Puerto Rico with safe, reliable, and clean 

energy. The Department of Energy's efforts could help to lower electricity costs on 

the Island, which at twice the levels of the mainland, decrease the Commonwealth's 

competitiveness for business investment and raise costs faced by its residents. 

The Administration remains committed to supporting Puerto Rico as it addresses its fiscal crisis 

and seeks to restore economic growth. However, while these achievements represent tangible 

progress, they are insufficient to meet the magnitude of Puerto Rico's fiscal challenges. That is 

why Congressional action is essential to provide Puerto Rico with the tools it needs to manage 

through this crisis and restore growth. 

Conclusion 

There is plenty of blame to go around for the mistakes of the past. But we must now focus on 

the path forward. Puerto Rico can and will emerge from the current crisis and return to growth. 

The fundamental question is when and at what cost to its residents and economy. By 

implementing the Administration's four-part plan, Congress can help put Puerto Rico on the best 

path to a sustained recovery. 

If we do not act collectively and quickly, Puerto Rico will face a long, difficult, and uncertain 

process. The federal government will also pay a price if a comprehensive solution is not enacted. 

More residents of Puerto Rico would need to turn to federal safety nets including unemployment 

insurance, low-income housing grants, nutrition assistance grants, and temporary assistance for 

needy families, among other federal assistance programs. 

We look forward to a constructive, bipartisan dialogue to identify ways to execute the 

Administration's proposals and provide Puerto Rico with the tools it needs to manage through 

this crisis and restore growth. You have kindly invited us today to discuss Puerto Rico's 

economy, debt, and options for Congress. We believe this discussion is timely and the issue 

must be addressed. 

9 
16 

The CHAIRMAN. Thank you, Mr. Weiss. 

Governor Padilla, your comments, please? Thank you. 

STATEMENT OF HON. ALEJANDRO J. GARCIA PADILLA, 

GOVERNOR OF THE COMMONWEALTH OF PUERTO RICO 

Governor PADILLA. Thank you, Chairwoman Murkowski, for your 

leadership and for holding this hearing. I appreciate our collaboration and look forward to a bipartisan solution to this crisis, working with Ranking Member Cantwell, members of the committee, 

Congress, the Treasury, and the Resident Commissioner of Puerto 

Rico. 

We are facing a crisis in Puerto Rico, a crisis decades in the making. We did not create it, but we need to solve it. To address it, 

my administration has reduced expenses by 20 percent and increased revenues by another 20 percent in the last three years. 

Despite these efforts, by the end of this year, Puerto Rico may 

have to choose between paying its creditors and providing essential 

services to the island’s 3.5 million American citizens. Police and 

fire protection, healthcare, and social services are all in jeopardy. 

Puerto Rico is running out of cash and will soon exhaust the 

emergency measures we are using to keep the government operating. When faced with the prospect of either making payments on 

debt obligation or paying for essential services, Puerto Rico will 

have no choice but to default. With no bankruptcy options, creditors will sue, dragging us into complex and costly legal battles that 

will only aggravate the crisis. 

I urge you to read Dr. Anne Krueger’s report, which reinforces 

this reality. Her debt sustainability study, the first ever done by 

any administration in Puerto Rico, describes a vicious cycle of economic recession, public borrowing, and fiscal adjustment that 

began to accelerate in 2005 following congressional repeal of Section 936 of the Internal Revenue Code and the resulting downturn 

into our manufacturing base. 

From 2005 to 2012, Puerto Ricans shouldered the burden of a 

new sales tax, employee layoffs—thousands, a surtax on real property, and other expenditures and revenue measures while our debt 

burden nearly doubled from $39 billion to more than $70 billion. 

Upon taking office in 2013, I began to implement additional fiscal adjustment measures: reduce expenditures and froze collective 

bargaining agreements, reform our largest pension fund from defined benefits to defined contribution, and increased revenues. Most 

notably, throughout attrition, we now have 66 public employees per 

1,000 persons, lower than the U.S. average of 68, and have begun 

to reduce our debt, a historic first. 

Other actions my administration has taken are detailed in my 

written testimony. However, independent experts tell us, and we 

agree, that even if we implement all of the measures in my working group’s Fiscal and Economic Growth Plan, large financing gaps 

and unfunded pension obligations will persist. 

We have never asked Congress for a bailout, and we are not 

seeking one today. We ask for access to a legal framework to restructure our liabilities. We ask for fair treatment in Medicare and 

Medicaid funding, for reforms that stimulate labor force participation and job creation such as the earned income tax credit. We ask 

17 

for exemption of the Jones Act like that of the United States Virgin 

Islands, our closest neighbors. Treasury’s recommendations address 

many of my administration’s requests and are an essential step forward. 

Chairwoman and members of this committee, inaction is not an 

option. By moving forward on these measures now, you can help 

prevent the situation from getting worse. Your action will have a 

dramatic impact on the people of Puerto Rico and will have little 

or no effect on the serious national budget issues confronting Congress. 

Working—I am sorry—waiting will only allow the situation to 

grow worse, more expensive, and difficult for you to address down 

the road. Give us the tools, and we will finish the job. 

Thank you for your time and attention. 

[The prepared statement of Governor Padilla follows:] 

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Alejandro J. Garcia Padilla 

Governor of the Commonwealth of Puerto Rico 

Written Statement 

Senate Committee on Energy and Natural Resources 

Hearing on Puerto Rico: economy, debt, and options for Congress 

October 22, 2015 

Chairman Murkowski, Ranking Member Cantwell, and Members of the 

Committee: 

I want to thank the Committee for giving the Commonwealth of Puerto 

Rico ("Commonwealth" or "Puerto Rico") the opportunity to participate in this 

hearing. 

Introduction 

The plain and simple truth is that, notwithstanding the unprecedented 

emergency liquidity measures that Puerto Rico has implemented over the last 

year, the Government of Puerto Rico may run out of sufficient money to meet all 

of its obligations in the ordinary course before the end of the year and will 

inevitably have to choose between paying its creditors on time and providing 

essential government services to the island's 3.5 million American citizens. 

As many of you know, in early 2015 we commissioned a team of worldrenowned economists led by Dr. Anne Krueger, the former Chief Economist at 

the World Bank and First Deputy Managing Director of the International 

Monetary Fund (IMF), to undertake a comprehensive analysis of Puerto Rico's 

fiscal and economic challenges as well as a debt sustainability analysis, the first 

ever by any administration. 

Dr. Krueger's findings- detailed in a report often referred to as the 

"Krueger Report" - described that a number of economic shocks have contributed 

to Puerto Rico's economic stagnation and that, even with significant and painful 

reforms to reverse Puerto Rico's economic trends, large residual financing gaps 

would persist well into the next decade, implying a critical need for debt relief 

from a significant proportion of the principal and interest falling due in Puerto 

Rico in the next several years. 

After the release of the Krueger Report I constituted the Working Group 

for the Fiscal and Economic Recovery of Puerto Rico (often referred to as the 

"Working Group") and tasked it with developing the Fiscal and Economic 

Growth Plan for Puerto Rico. The Fiscal and Economic Growth Plan, which was 
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released on September 9, 2015, reviews the historical measures taken to increase 

taxes and reduce expenses; analyzes the current liquidity and fiscal position of 

Puerto Rico; recommends certain fiscal and economic reform and growth 

measures, including critical measures that require action by the U.S. Government; 

proposes to create a financial control board appointed by the governor upon the 

recommendation of a nationally recognized executive search firm or other 

independent third party; and identifies significant projected financing gaps (even 

assuming the implementation of the recommended fiscal reform and economic 

growth measures) that requires widespread debt relief. 

The bottom-line is that Puerto Rico faces a $28 billion funding gap over 

the next five (5) years, and serious action must be taken both by the Government 

of Puerto Rico and the U.S. Government to close that gap. But even if serious 

action is taken (notwithstanding all the implementation risks of doing so), Puerto 

Rico will still face a funding gap of approximately $14 billion over the next five 

(5) years, which will require substantial debt relief. 

Today, however, I would like to focus on three topics. First, and most 

critically, I will discuss the debt crisis that Puerto Rico faces right now, which, if 

not addressed, threatens 3. 5 million Americans with the disruption of essential 

government services. Second, I will address a misconception raised in the 

Finance Committee hearing on the Financial and Economic Challenges in Puerto 

Rico related to the availability of current and reliable financial information, which 

availability should not be used as a justification for failing to take action to solve 

this imminent crisis. Finally, I will provide an update regarding PREP A's 

ongoing restructuring efforts and the progress it has made and challenges it 

continues to face. 

Debt Crisis 

Based on current information, the Commonwealth will have a negative 

cash balance of$29.8 million in November 2015. The Commonwealth's 

illiquidity will only grow worse when a $355 million debt service payment on 

bonds of the Government Development Bank for Puerto Rico ("GDB") comes 

due on December 1, 2015. These GDB bonds are supported by a guarantee from 

the Commonwealth, and the GDB, which faces its own liquidity crisis, is not 

expected to be able to make the payment on its own based on current information. 

Accordingly, Puerto Rico's negative cash balance will swell to $205 million by 

year end. And by the end of Puerto Rico's current fiscal year (June 2016), Puerto 

Rico's cash balance will be further deteriorate to negative $512 million. These 

numbers are optimistic in that they assume the Commonwealth will be successful 

in implementing a number of"one-time" liquidity measures (such as continuing 

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to defer payments to suppliers (the past due amount of which already exceeds 

$1.6 billion) and $291 million of refunds due to taxpayers), measures that simply 

cannot be sustained without having a material adverse effect on the local 

economy. As we cannot pay debt service out of a negative cash balance, a default 

on some of our debt obligations is inevitable. 

I stress that, while these sums may seem small in comparison to Puerto 

Rico's overall indebtedness of $73 billion plus approximately $45 billion in 

unfunded pension liabilities (notwithstanding that we reformed our largest 

pension system from a defined benefit to a defined contribution plan), a negative 

cash balance poses an immediate and grave danger to the American citizens living 

in Puerto Rico. If Puerto Rico is unable to provide adequate assurance of future 

payment to its suppliers, service providers, and employees, the Commonwealth's 

ability to provide essential government services to its citizens will be put in severe 

jeopardy. Police and fire protection, medical services, social services and every 

other government service on which Puerto Rico's 3.5 million American citizens 

rely will be at risk. A disruption of essential government services will only 

exacerbate the massive outmigration of Puerto Ricans to the mainland, which last 

year reached almost 100,000 persons. The Government's cash crunch has already 

affected taxpayers, which will see their tax refunds delayed for almost a year, and 

individuals and businesses who provide essential services to the government, 

which have not been paid in months. This is and should be unacceptable. 

Additionally, while Puerto Rico has done everything in its power to avoid 

defaulting on its obligations (including reducing its public employee headcount to 

the 66 public employees per 1,000 persons, which is lower that the U.S. average), 

when faced with the prospect of either making payments on debt obligations or 

paying for essential public services, Puerto Rico will have no choice but to 

default. Nobody wants this, but it is a reality, and the consequences will be grave. 

With no insolvency regime in place, Puerto Rico's creditors will engage in a 

classic "race to the courthouse." The Government will be embroiled in countless 

complex and crippling legal battles that will further drain Puerto Rico of critical 

resources and prevent it from implementing many of the measures designed to 

achieve fiscal and economic sustainability. Much of this litigation is likely to be 

"intercreditor," that is, litigation between and among different groups of creditors 

seeking to establish the relative priority of their claims, which will have 

potentially devastating effects on Puerto Rico's access to its tax revenues and 

therefore on its ability to continue to provide essential services to its citizens. 

Notwithstanding this crisis, we have never asked Congress for a bailout, 

and we are not seeking one today. We ask for (i) access to a legal regime that 

would allow to restructure Puerto Rico's liabilities in an orderly manner; (ii) 

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equitable treatment in Medicaid and Medicare funding, incentives to grow Puerto 

Rico's economy; (iii) reforms that stimulate employment and labor force 

participation; and (iv) an exemption from the Jones Act (like that of the U.S. 

Virgin lslands). 1 

By taking action on these measures now, you can help prevent the 

situation from spiraling further out of control 2 Waiting will only allow the 

situation to grow worse and more expensive and difficult for Congress to address 

down the road. The window to take action to avert an imminent crisis is rapidly 

closing. The time is now. 

Financial Information 

It became apparent after the Finance Committee hearing that a 

misconception about the availability of reliable and up-to-date financial 

information regarding Puerto Rico's finances and its financial crisis is being used 

by some commentators as "justification" for not taking action to prevent this 

humanitarian crisis. The unavailability of reliable and up to date financial 

information is a "red herring" resulting from disinformation being propagated by 

1 Congress should not allow short-term distress investors who have amassed significant 

financial stakes speculating that Puerto Rico will be forced to default in the absence of a 

restructuring regime to drive national policy, particularly at the cost of the futures of 3.5 million 

Americans. While some of these investors have argued that extending bankruptcy protections 

would represent a bailout, it in fact does not require the expenditure of a single Federal tax dollar. 

Nor can distress investors suggest that providing a legal framework would be unfair because they 

purchased debt with the expectation that Chapter 9 would be unavailable. Instead, Congress 

already effectively dealt with this argument vvhen it adopted Chapter 9's predecessor provision and 

made it applicable to both future and existing obligations. Indeed, every purchaser of Puerto Rico 

bonds was well aware that Congress has the right and authority to make Chapter 9 available to 

Puerto Rico. 

2 The costs of not having access to a restructuring regime arc already weighing on the 

island. Specifically, despite reaching a consensual restructuring agreement with holders of nearly 

$4 billion of PREP A's debt, PREP A has been prevented from consummating the rcstmcturing 

transaction by 3 institutions that are holding out. With no debt-adjustment regime in place, 

PREP A has no mechanism by which to bind these hold-outs to the will of the majority. Failure to 

consummate this transaction will not only mean that PREP A is unable to restmcture its 

overwhelming debt burden, but will also prevent PREP A from going forward with plans to 

modernize its antiquated and unreliable infrastmcture, forcing millions of Americans to wonder 

whether they will have power each day -a fear to which I can personally attest. While the 

availability of a legal mechanism to adjust Puerto Rico's debts may seem theoretical, the 

consequences of not having such a framework in place are very real for PREP A, for PREP A's 

employees and for the 3.5 million Americans who depend on PREP A for electricity. There are 18 

other entities on the island facing this same issue. 

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those with vested interests in seeing Congress defer taking action so as to force 

Puerto Rico into a disorderly default. As you are no doubt aware, a number of 

institutions, many of whom have made a short-term bet on the outcome of Puerto 

Rico's dire financial situation, have literally spent millions of dollars on a 

coordinated lobbying campaign to propagate disinformation of this type. To be 

perfectly clear, in the last six months, Puerto Rico has been more transparent 

about its financial situation than at any point in its history, and it has engaged 

some of the best professionals in the world to provide up-to-date financial 

information to key stakeholders, all of which has been made publicly available. 

For example, over the last four months, Puerto Rico has commissionedand made publicly available- the Krueger Report, which includes a 

comprehensive and up-to-date debt sustainability analysis, the first ever 

commissioned by the Government, prepared by independent and internationally 

recognized experts. The Krueger Report is also unprecedented in presenting, for 

the first time, a consolidated long-term revenue and expense projection for the 

Commonwealth. In addition, at the request of our creditors, we commissioned a 

comprehensive liquidity analysis prepared by Conway MacKenzie (the "Conway 

Report"), the same financial management and consulting firm that the City of 

Detroit hired to assist it during its bankruptcy proceedings 3 As discussed above, 

the Conway Report concluded that Puerto Rico's liquidity is running extremely 

low and the Commonwealth will face a major cash crunch during the months of 

November and December of2015. We also published on our website the Puerto 

Rico Fiscal and Economic Growth Plan ("FEGP"), which contains our plan to 

stabilize our finances by increasing revenues and reducing expenses, and to grow 

our economy. Furthermore, note that the Puerto Rico Treasury Department 

publishes revenue results on a monthly basis. 

Both of the Krueger Report and the Conway Report were commissioned 

to provide independent third-party expert reports on the sustainability of the 

Commonwealth's debt, long-term revenue and expense projections and the 

current liquidity position of the Commonwealth. In addition, creditors and their 

advisors that are willing to sign confidentiality agreements may access additional 

material non-public information, including certain data supporting the reports that 

were released publicly. The fact that the Commonwealth has shared more 

detailed background information on the Krueger and Conway reports with 

creditors and advisors is standard practice in debt restructuring negotiations and 

should not be used to suggest the Commonwealth has not been forthcoming and 

3 All of the reports commissioned by Puerto Rieo and the GDB have been made public on 

GDB's website at http://www.bgfpr.com/. 

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transparent with respect to its current financial crisis. Finally, in the coming days, 

we will be issuing the Commonwealth Report, a quarterly document that provides 

updated information on all the various aspects of the Government finances, 

including up-to-date revenue, expense, debt, pension and litigation information, 

along with relevant risk factors and descriptions of recent material events. This 

too will be publicly available on the GDB website. In fact, during the past two 

years, the Commonwealth has sought to publish this report on a quarterly basis, 

which had previously been published only once a year or in connection with a 

public bond offering. 

The Government has kept the market updated with recent and relevant 

information, such as the Krueger Report, the FEGP, the Conway Report, monthly 

revenue and economic data, as well as May and June updates to the 

Commonwealth Report, among others. The issuance of our financial statements 

has taken longer than expected in large part due to the Government's fiscal 

condition, and the additional tests that our auditors are conducting regarding 

liquidity and other variables. Delays in the release of audited information is 

common in corporate and municipal distressed situations such as the one faced by 

Puerto Rico, as auditor demands become more searching and time-consuming. 

However, all the information necessary to make a proper evaluation of the 

Commonwealth's finances and liquidity position is public and has been vetted by 

third parties. 

In addition, as part of the FEGP, the Commonwealth is conducting an 

overhaul of its financial, accounting and payroll system in order to unify the 

patchwork of existing Governmental platforms, improve the Government's ability 

to monitor its fiscal situation on a real time basis and eliminate unnecessary 

delays in the preparation of financial information. Furthermore, the FEGP also 

requires the implementation of an ambitious 5-year plan to strengthen the 

Commonwealth's economic statistical systems and analysis by modernizing 

national accounts with an estimated investment of $3 million per year. Federal 

assistance in modernizing our financial systems would help improve the fiscal and 

economic decision making. 

Finally, as I mentioned earlier, the Puerto Rico legislature is considering 

legislation that provides for a control board (the "Board") to oversee the financial 

affairs of Puerto Rico's Government and each of its public corporations. The 

Board will be responsible for generating 5-year Commonwealth-wide budgets and 

certifying that the budgets of each public corporation conform to the 

Commonwealth budget. The Board will have broad information gathering powers 

and the ability to sanction public corporations and the Commonwealth itself for 

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non-compliance. Sanctions will include, automatic budget cuts, hiring freezes, 

approval requirements for large contracts and publication of a notice of noncompliance. To facilitate this process and ensure transparency across the 

Government, all Government entities will be required to conform their accounting 

systems to that of the Department of Treasury by no later than July 1, 2018, 

among other steps to simplify and coordinate financial practices and reporting. 

These steps necessarily take time, but the foundation for their implementation is 

being laid and the results will be greater transparency, accountability and controls 

across the Government. 

In short, any suggestion that Puerto Rico is not doing everything it can to 

provide up-to-date and accurate information to creditors, this Congress or the 

general public is simply not true. The breadth and depth of the fiscal and 

financial information published by the Commonwealth during the past six months 

is simply unprecedented. The situation is too dire to allow this fabricated 

misconception to delay immediate and necessary legislative action. 

As discussed above, while PREP A continues to face significant hurdles to 

implementing a consensual debt restructuring, namely, its inability to bind 

minority holdout creditors to the will of the majority without a restructuring 

regime in place, it has made significant progress in its efforts to do so, including 

reaching agreement on the terms of such a restructuring with the holders of nearly 

$4 billion of its debt. Like many other entities in Puerto Rico, however, a 

restructuring of its debt is only one piece, albeit a significant piece, of PREP A's 

turnaround efforts. In addition to its debt burden, PREP A suffers from an 

outdated rate structure, aging and technologically obsolete generating facilities 

and infrastructure, and significant operational inefficiencies. 

We have worked tirelessly to turnaround PREP A. In May 2014, I signed 

Act 57-2014 into law, pursuant to which an energy commission was established to 

exercise oversight over PREP A. The commission required PREP A to improve its 

services to the people and businesses of the Commonwealth, including by 

pursuing public-private partnerships to assist in the construction and operation of 

new generation facilities. Following the passage of Act 57-2014, PREP A 

initiated discussions with its key creditors and negotiated forbearance agreements 

in connection with which it retained a chief restructuring officer to implement 

operational reforms and lead its restructuring efforts. In addition to the more than 

$600 million in sinking fund payments that these agreements relieved PREP A 

from making, and the access they provided to various trust accounts during the 

forbearance period, PREP A's chief restructuring officer identified and 

7 
25 


Insert offset folio 17 here 98944.017

implemented steps to achieve between $245 and $390 million in annual 

operational savings and up to $260 million in one-time liquidity measures. The 

sources of these savings have ranged from day-to-day operational changes such as 

inventory tracking, purchasing controls, limiting cash payments and other 

industry-standard practices, to prevention of theft, enhanced collection efforts and 

a consolidation of PREP A's vendor relationships. PREP A is also actively 

examining its business to reduce and eliminate its operating deficit. Significantly, 

notwithstanding the cost cutting associated with these efficiencies, PREP A has 

managed to instill a culture of safety and accountability in its workforce during 

this time. 

These measures have enabled PREP A to continue to operate over the last 

18 months in spite of its severe liquidity crisis. Unfortunately, with no 

restructuring regime in place, PREP A's breathing room may soon be exhausted. 

In the first half of 2016 nearly $1.5 billion of debt will come due, an amount that 

PREP A will be likely unable repay. The consequences of a disorderly default of 

the island's only electricity provider could be catastrophic for the people of Puerto 

Rico. I urge you in the strongest of terms not to let that happen. 

Conclusion 

In conclusion, I thank the Committee for recognizing the urgency of these 

matters by holding this hearing, and for giving Puerto Rico the opportunity to 

participate. I look forward to working with all of the members of the Committee 

to ensure the health, safety and well-being of the 3.5 million Americans that call 

Puerto Rico home. And I urge you to maintain your focus on Puerto Rico's fiscal 

emergency; the future of3.5 million Americans depends on what you do next. 

8 
26 

The CHAIRMAN. Thank you, Governor. 

Mr. Pierluisi, welcome. 

STATEMENT OF HON. PEDRO PIERLUISI, RESIDENT COMMISSIONER FOR PUERTO RICO, U.S. HOUSE OF REPRESENTATIVES 

Mr. PIERLUISI. Chairman Murkowski, Ranking Member Cantwell, and members of the committee, for Puerto Rico to overcome 

its challenges, leaders in San Juan and Washington, D.C. must 

take swift and serious steps. The main economic problem in Puerto 

Rico is lack of growth. This is the result of low private investment, 

which is due to the lack of investor confidence in the economic and 

fiscal policies of the Puerto Rico government. 

The territory government has an outdated economic model that 

relies on government-owned enterprises, tax preferences, and subsidies. The government must streamline operations, expand publicprivate partnerships, and empower the private sector. 

There are no silver bullets or shortcuts. Progress requires smart, 

steadfast work. The Puerto Rico government must break its entrenched spending habits, which have not adjusted to changing economic and demographic realities. Our government must be a better 

steward of funds received from taxpayers and lenders, accounting 

for every dollar it spends. 

The local taxes require reform because it is complicated and unfair. Some taxpayers owe too little, while others owe too much, and 

the government does a poor job of collecting what it levies. 

With improved economic and fiscal policy, Puerto Rico can eliminate deficits and be in a better position to meet its obligations to 

creditors. In short, the Puerto Rico government must be transformed. We owe this to our constituents, no excuses. 

Let me turn to the Federal Government now. I am a proud 

American citizen, but I am also a Puerto Rican patriot. I have spoken forcefully about the need for the Puerto Rico government to 

chart a new path forward. The Federal Government should now 

speak with equal force about the need to correct its immoral and 

illogical policy toward Puerto Rico. 

Because Puerto Rico is a territory, it can be and is treated worse 

than the states under programs like Medicaid, Medicare, refundable tax credits, SSI, and Chapter 9 of the Bankruptcy Code. You 

cannot treat the people of Puerto Rico like second-class citizens and 

then profess to be surprised when we do not have a first-class economy, nor can you claim to be shocked that in the last decade over 

300,000 island residents have relocated to the States in search of 

equal opportunity. This was easily foreseeable, but only if your eyes 

are open. 

I join the Treasury Department, the National Economic Council, 

and HHS in urging Congress to enact a legislative package for 

Puerto Rico that contains provisions that give Puerto Rico more equitable treatment under spending and tax credit programs, and to 

grant Puerto Rico access to a fair and orderly legal process to restructure a meaningful portion of its debt. 

The package could also contain language authorizing Treasury to 

guarantee repayment of principal and interest on future Puerto 

Rico bonds. Puerto Rico is currently locked out of the capital marVerDate Nov 24 2008 13:17 Jun 21, 2017 Jkt 098944 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 C:\HEARINGS\98944\C98944.TXT C98944
27 

kets, and this provision would ensure that the government has the 

cash necessary to meet its immediate obligations. 

Finally, the package could provide for enhanced Federal oversight of the Puerto Rico government’s financial management practices with the goal of helping the territory to budget, spend, and 

tax in a more responsible and transparent fashion. I believe such 

assistance would be welcomed by citizens and creditors alike. 

While I am open to Federal oversight, I oppose Federal control. 

If Puerto Rico is better governed at the local level and receives fair 

treatment at the Federal level, we can overcome our challenges. My 

constituents already endured the indignity of not being able to vote 

for their national leaders. Further eroding democracy in Puerto 

Rico is not the answer. 

Finally, let me address the fundamental problem from which 

nearly all of Puerto Rico’s other problems emanate: our undemocratic and unequal political status. No Senator would accept territory status for their constituents, and I do not accept it for mine. 

Puerto Rico’s status is not an abstract or theoretical problem. It 

is a moral, social, and political wrong with the crushing practical 

consequences for the American citizens I represent. One day soon 

my constituents, including hundreds of thousands of military veterans, will have the same rights and responsibilities as your constituents. 

In 2012, there was a local referendum in Puerto Rico, and voters 

rejected territory status and expressed the preference for statehood. 

In 2017, it is very likely that voters in the territory will confirm 

their desire for statehood in the first Federally-sponsored vote in 

our history. The government of Puerto Rico will then use all appropriate means to petition Congress to enact legislation making the 

territory a state. 

For Puerto Rico to prosper, it must be treated equally, and to be 

treated equally, it must become a state. Until then, there is much 

the Puerto Rico government and the Federal Government can do to 

help the territory. 

There has been enough discussion. It is time for action. 

Thank you. 

[The prepared statement of Mr. Pierluisi follows:] 

28 


Insert offset folio 18 here 98944.018

The Hon. Pedro R. Pierluisi 

Written Testimony 

"Puerto Rico: Economy, Debt, and Options for Congress" 

Senate Committee on Energy and Natural Resources 

October 22, 2015 

Chairman Murkowski, Ranking Member Cantwell, and Members of the Committee: 

The Senate Committee on Finance held a hearing on the financial and economic challenges in Puerto 

Rico on September 29th, and 1 was a witness at that hearing. The House Committee on Natural 

Resources, Subcommittee on Indian, Insular and Alaska Native Affairs held a hearing on Puerto Rico's 

political status and economic outlook on June 24111, and I was a witness at that hearing. This 

Committee held a hearing on Puerto Rico's political status on August l, 2013, and l was a witness at 

that hearing. The accompanying footnote contains links to my written testimony at these three 

hearings, because each is relevant to the issues that the Committee is examining today. 1 

Rather than reiterating the specific points I made in these previous statements, I will use this 

opportunity to make three broad points about how local and federal policymakers can help resolve the 

economic, fiscal and demographic crisis in Puerto Rico. 

The Puerto Rico Government 

First, at the risk of stating the obvious, the government of Puerto Rico must do a far better job of 

actually governing the U.S. territory. Puerto Rico confronts a complex array of challenges that have 

accumulated over the course of many years, as a result of policy errors of both commission and 

omission. On balance, the actions taken by the current administration since January 2013 have made 

Puerto Rico's problems immeasurably worse. Puerto Rico's government is not regarded as credible, 

because it is not viewed as capable or consistent. Puerto Rico's challenges must be confronted with 

candor and competence; there are no shortcuts, silver bullets or gimmicks. In this effort, there is no 

substitute for good, effective, ethical leadership at the local level. In our democratic system, if such 

leadership is not being furnished, the remedy lies at the ballot box. Anyone who claims that Puerto 

Rico cannot govern itself, and requires unelected and unaccountable individuals from outside of Puerto 

Rico to administer the territory, underestimates the capacity of my constituents. 

As I detailed in my testimony before the Senate Finance Committee, the Puerto Rico government must 

elevate its performance. Most fundamentally, it needs to implement a comprehensive strategy to 

1 Sec September 29. 2015 Senate Finance Committee testimony here: June 24. 2015 House Subcommittee on Indian. Insular 

and Alaska Native Affairs Subcommittee testimony here; and August L 2013 Senate Energy and Natural Resources 

Committee testimony here. 
29 


Insert offset folio 19 here 98944.019

generate economic growth in the private sector by attracting job-creating investment from external and 

internal sources. To execute this strategy, the government must become more competitive in a range 

of areas, such as reducing bureaucracy, streamlining the permitting process, lowering the cost of 

electricity, improving infrastructure, and making the local tax code more simple and more fair. If my 

constituents cannot find decent employment that pays them a living wage, they will continue to 

relocate to the states in massive numbers, making it virtually impossible to achieve economic growth. 

(Since 2004, over 300,000 island residents have exercised their right as American citizens and moved 

to the U.S. mainland. Puerto Rico's population has declined by 9 percent, from 3.8 million to 3.5 

million, in this time period.) 

Additionally, in order to regain the trust of the Puerto Rico public and the investment community, the 

government must manage its public finances in a smart, disciplined and transparent way. The current 

administration has failed this test, and it is no excuse for local political leaders to insist that prior 

administrations failed it too. As 1 will explain in the following section, I believe there is an important 

oversight role that the federal government-namely, the Comptroller General of the United States, the 

chief executive officer of the Government Accountability Office (GAO), the investigative arm of 

Congress-can fulfill in this respect 2 

Finally, Puerto Rico has a sizeable and complicated debt burden-$72 billion spread across 

approximately 18 distinct bond-issuing public entities. However, if the Puerto Rico government takes 

serious steps to cut unnecessary spending, implement a fair tax system and collect the taxes it is owed, 

and execute a strategy focused on economic growth, the debt situation can be made far more 

manageable. It is also important to emphasize that the solvency of each bond issuer and the strength of 

the legal protections governing each class of bonds are different. The current administration's strategy 

is essentially to treat the territory's debt as if it were a single monolithic sum, which I believe is illadvised. Puerto Rico is a United States jurisdiction and, in the U.S., the facts and the law matter. Each 

credit should be considered on a case-by-case basis in light of its particular financial and legal 

attributes. In general, the current administration-steered by outside advisors to whom the 

administration has yielded far too much power-has used confrontational tactics that have created 

adversaries out of many creditors who should be allies of the government or, at least, should be more 

inclined to find common ground with the government. The current administration should interact in a 

more constructive manner with the institutions and individuals, hundreds of thousands of whom live 

and work in Puerto Rico, that have loaned the government money. Picking fights that you are unlikely 

to win, whether in a court of law or in the court of public opinion, is not a wise or winning strategy. 

This Congress is right to expect more from the government of Puerto Rico. More importantly, the 

people of Puerto Rico deserve-and they should demand-far better from their elected leaders. 

The Federal Government 

Second, while I am the first to offer constructive criticism of the Puerto Rico government, I will not 

silently accept such criticism from Members of Congress of either party unless that criticism is 

accompanied by a forthright acknowledgment that the federal government has shared responsibility for 

'The Comptroller General is appointed by tbc President with the advice and consent of the Senate to a 15-year tcnn. In the 

event of a vacancy. Congress establishes a bipartisan, bicameral commission to recommend individuals to 1he President. 

2 
30 


Insert offset folio 20 here 98944.020

this crisis. Instead of piously lecturing Puerto Rico about its shortcomings, Congress and the 

administration ought to correct the errors in their own policy towards the territory. Action in San Juan 

without corresponding action in Washington, D.C. will be insufficient, just as action in Washington, 

D.C. without accompanying action in San Juan will be inadequate. This is an American problem, not 

just a Puerto Rico problem, and it requires an American solution. 

Because Puerto Rico is a territory, the federal government has a license to treat the island worse than 

the states under federal programs. Congress does not have to use this license, but it does so with 

dismaying frequency. Puerto Rico is treated in discriminatory fashion, or excluded entirely from, 

programs like Medicaid, Medicare, the federally-subsidized health insurance exchanges established by 

the Affhrdable Care Act, Chapter 9 of the federal bankruptcy code, the earned income tax credit, the 

child tax credit, Supplemental Security Income (SSI), Temporary Assistance for Needy Families 

(T ANF), the Supplemental Nutrition Assistance Program (SNAP), and the Low Income Home Energy 

Assistance Program (LIHEAP). When it comes to programs within this Committee's jurisdiction, 

Puerto Rico is treated unfairly under the Land and Water Conservation Fund (LWCF), through which 

the federal government provides grants to states and territories to safet,>uard natural areas, preserve the 

habitat of endangered species, and provide outdoor recreational opportunities. 

l have introduced bills to eliminate or mitigate these various disparities, the cumulative impact of 

which has been devastating for Puerto Rico. I also recently filed legislation-H.R. 3725-that would 

authorize the U.S. Department of the Treasury to guarantee repayment of principal and interest on 

future bonds issued by government entities in Puerto Rico, but only if the Treasury Department first 

makes a determination that the government of Puerto Rico has demonstrated meaningful improvement 

in managing its public finances. The legislation is modeled on a 1975 federal law that authorized the 

Treasury Department to make short-term loans to New York City, which was unable to obtain loans 

from its customary sources. Because the Puerto Rico government has lost the trust of investors, the 

government is effectively locked out of the capital markets. My bill would ensure that the government 

has the liquid assets-cash-necessary to meet its short-term obligations, like providing essential 

services, paying workers and repaying loans. 

I urge Congress, acting on a bipartisan basis, to swiftly enact a legislative package that includes a 

number of the bills I have introduced to provide more equitable treatment for Pnerto Rico under federal 

spending and tax credit programs. Congressional action is essential, and absolutely justified. 

According to the U.S. Census Bureau's Consolidated Federal Funds Report, which was last published 

in Fiscal Year 2010, federal spending on both direct payments to individuals and grants is far higher in 

the 50 states than in Puerto Rico as a result of the territory's disparate treatment under federal 

programs. In the case of direct payments, federal spending per capita is $5,569 in the states, versus 

$3,465 in Puerto Rico. In the case of grants, federal spending per capita is $2,187 in the states, versus 

$1,695 in Puerto Rico3 Naturally, the gap is even wider when you compare federal spending per 

capita in the poorer states to federal spending per capita in Puerto Rico. 

Parenthetically, I have heard it suggested-including by a witness at the September 29111 Senate 

Finance Committee hearing-that residents of Puerto Rico do not pay federal taxes and therefore 

3 These statistics arc contained in Food and Nutrition Service, U.S. Department of Agriculture, ·'Examination of Cash 

Nutrition Assistance Program Benefits in Puerto Rico." at 6 J7, 2015). aYailable at 

3 
31 


Insert offset folio 21 here 98944.021

should receive less federal support than their counterparts in the states. This argument deserves careful 

scrutiny because the truth is more complex. Congress-acting on its own volition-has chosen to 

exempt most residents of Puerto Rico from paying federal taxes on income they earn in the territory. 

Nevertheless, in Fiscal Year 2014, the U.S. Internal Revenue Service collected nearly $3.6 billion in 

federal taxes from individuals and businesses in Puerto Rico, which is nearly as much as the IRS 

collected from several states4 Residents of Puerto Rico are required to pay federal taxes on any 

income that they earn in the states or in foreign countries, and employers and employees in the territory 

are responsible for all federal payroll taxes. Notably, nearly half of all individuals living in the states 

do not owe federal income taxes, and yet are treated equally under all federal programs. Finally, the 

reality is that federal law-through the application of refundable tax credits like the earned income tax 

credit and the child tax credit-provides a substantial benefit to working-class families in the states 

that it denies to working-class families in Puerto Rico. To illustrate, consider a married couple with 

two children living in a state that earns $25,000 a year, and then consider an identical family living in 

Puerto Rico. Both families owe the same federal payroll taxes. But the stateside family would receive 

over $6,000 in federal tax credits, for an income of over $30,000 after all federal taxes and credits. 

The Puerto Rico family, because it is ineligible for these credits, takes home less than $24,0005 This 

is a useful example to bear in mind when the supposed "tax advantages" of living in Puerto Rico are 

cited as a justification for treating residents of the territory unequally under federal programs. 

With respect to a potential legislative package, I recognize that there may be a desire on the part of 

certain Members of Congress of good faith to couple language that provides for better treatment of the 

territory under specific federal programs with language that provides for some degree of federal 

oversight of the Puerto Rico government's financial management practices. Although I do not believe 

equality for U.S. citizens should be conditioned in such a manner, I am open to this concept. However, 

as noted above, I would oppose any legislative provision that removes authority over taxing and 

spending decisions from Puerto Rico's elected leaders and places this authority in the hands of 

individuals who are not accountable to voters in the territory. Such a step would be perfectly legal, but 

profoundly unwise. Congress treats Puerto Rico poorly, and this is the principal reason why Puerto 

Rico's economic and fiscal performance has been consistently poor. The logical solution is also the 

moral solution: Congress should treat Puerto Rico equitably. If Puerto Rico receives fair treatment 

from the federal government and has more capable local leadership, I am confident we can overcome 

our challenges. My constituents already endure the indignity of not being able to vote for their 

president and commander-in-chief, U.S. senators, or voting members of the U.S. House. Further 

eroding democracy in the territory cannot be the answer. 

With respect to federal oversight (which I regard as potentially appropriate), as distinct from federal 

control (which I regard as inappropriate), let me make two points. First, on July 11, 2013, l testified at 

a hearing held by this Committee regarding S. 123 7, the Omnibus Territories Act. One provision in 

that bill as introduced-Section 8-would have required the U.S. Comptroller General to evaluate the 

annual estimates of revenues and expenditures of the five territory governments, including the 

2014 Internal Revenue Service Data Book, at page 12. available at https://www.irs.gmipub/irs-soi!l.+databk.pdf. In 

Year 2010, the Internal Revenue Service collected more federal taxes from individuals and businesses in Puerto Rico 

than in Vcnnont. Sec 20!0 Internal Revenue Service Data Book. at page 12. available at htlps://www.irs.gov/pub/irssoi/l Odatabk.pdf. 

5 This example 1s based on the federal mlcs for Tax Year 2013. 

4 
32 


Insert offset folio 22 here 98944.022

government of Puerto Rico, and to make recommendations for improving the process by which those 

estimates are developed. I testified in strong support of this provision, noting that the Puerto Rico 

government had a history of overestimating the amount of revenue that would be collected and 

underestimating the amount of expenditures that would be made in the coming fiscal year. I pointed 

out that when a government makes inaccurate budget projections, it has a negative cascading effectresulting in larger-than-expected deficits, excess borrowing, loss of market confidence, credit 

downgrades, higher interest payments, and the diminished ability to meet pension obligations and 

make other important investments. I expressed the view that GAO assistance could help the 

government of Puerto Rico better manage its finances 6 

Following that hearing, however, representatives of the Governor of Puerto Rico contacted the 

Committee and urged it to remove Puerto Rico from Section 8, making the argument that this 

provision would interfere with "the government of Puerto Rico's fiscal autonomy." (To clarify, under 

the U.S. Constitution, Congress has nearly absolute power over the territory of Puerto Rico. Over 

time, Congress has delegated to Puerto Rico about the same authority over local matters that the states 

possess. What Congress has given, Congress can take away or modify as it sees fit) When the 

Committee subsequently approved S. 1237, the bill contained a revised section that covered the four 

other territories, but not Puerto Rico7 It is fine for this Committee to criticize the Puerto Rico 

government for its poor budgeting practices, just as Members of the Senate Finance Committee 

recently did. But a dose of humility is in order. This Committee, by acceding to the Governor's selfinterested desire to shield Puerto Rico's budget forecasting from GAO scrutiny, has contributed to the 

problem it now complains about As part of any legislative package for Puerto Rico that Congress 

crafts, Congress could authorize the Comptroller General to evaluate the annual estimates of revenues 

and expenditures made by the Puerto Rico government and to make recommendations for how those 

estimates can be improved. lf the Governor again opposes such a provision, his objections should be 

duly noted and ignored. 

Second, I believe there is an additional role that the Comptroller General could fulfill in Puerto Rico, 

and a provision to this effect could be included in any forthcoming legislative package. Specifically, in 

1973, Congress enacted a law-Section 715 of Title 31 of the US. Code-requiring the Comptroller 

General to audit "the accounts and operations" of the District of Columbia government on an annual 

basis. Although this provision is still technically on the books, it has effectively been superseded by 

subsequent federal statutes, and the GAO no longer conducts such audits as a matter of practice. 

Under the law, the GAO was required to submit each audit report to the Mayor of the District of 

Columbia, the Council of the District of Columbia, and Congress. The audit report could include any 

recommendations that the GAO considered appropriate. Within 90 days of receiving the audit report, 

the Mayor was required to inform the Council and Congress of the measures the District of Columbia 

government was taking to comply with the GAO's recommendations. The law provided that the 

District of Columbia govemment had to make all relevant financial and other records available to the 

GAO, and to provide the GAO with the facilities to conduct the audit 

6 Sec hi tp:/ /www .energy .scnatc.gov/public/indcx .cfm/filcs/scrvc?Filc Jd~G 72238c6-3 20.J--19c0-82f9-d636 l.Jfc.Jac.J .pdf. 

S. 1237 was reported by the Conunittee on Ener!,>y and Natural Resources on April 8. 2014 and approved by the full 

Senate on June 18. 2014. The Committee converted Section 8 to Section 5 at its markup session on December 19, 2013. 

As noted, at the GoYemor's request the Committee amended this section to exclude Puerto Rico. 

5 
33 


Insert offset folio 23 here 98944.023

Although the District of Columbia and Puerto Rico are different in important respects, I believe this 

statute could serve as a suitable template for the territory. A legitimate criticism leveled against the 

Puerto Rico government by the Puerto Rico public, the investment community and federal officials is 

that the government is unable or unwilling to produce timely, accurate, audited financial statements 

that depict the true financial condition of the territory government, including its public corporations. A 

federal law tasking the Comptroller General with audit responsibilities for Puerto Rico could serve a 

valuable purpose for all stakeholders and help the territory government rebuild its damaged credibility. 

In summary, 1 am open to exploring different ways to fashion a legislative package that combines 

provisions to give Puerto Rico more equitable treatment under federal law with provisions to provide 

for enhanced oversight of the Puerto Rico government's financial management practices by the federal 

government. But I would oppose any provision that crosses the line from federal oversight to federal 

control. 

Puerto Rico's Political Status 

Third, the American public and their elected representatives must come to terms with a fundamental 

fact, which is that the main cause of Puerto Rico's multi-faceted problems is its undemocratic and 

unequal political status. As then-Chairman Wyden and then-Ranking Member Murkowski both 

recognized during their opening statements at this Committee's August I, 2013 heming, a clear 

majority of voters in Puerto Rico rejected this status in a locally-sponsored referendum in November 

20128 My constituents are now being governed under an arrangement to which they do not consent. 

Notwithstanding the mass exodus of Puerto Rico residents to the states, I still represent 3.5 million 

American citizens-more than 12 of the 22 Senators that serve on this Committee and more than 42 of 

the I 00 Senators that serve in this chamber. Not a single Senator would accept territory status for his 

or her constituents. So why should I accept territory status for my constituents? I do not accept it. To 

the contrary, I oppose it with every fiber of my being. Puerto Rico's status as a territory is not an 

abstract or theoretical problem. It is a moral, social and political wrong with crushing practical 

consequences for the men, women and children I represent. 

There will always be some people and politicians who assert, despite overwhelming evidence to the 

contrary, that Puerto Rico's consistent underpetformance relative to the 50 states over the course of 

many decades has nothing to do with the unequal treatment that Puerto Rico receives as a territory. 

There are even people and politicians who claim that Puerto Rico's status is an advantage rather than a 

disadvantage, though their voices have mostly gone silent in recent years. These people and politicians 

can always be counted on to find some reason why now is not the moment to address the issue of 

status. They are wrong on the merits, and they are on the wrong side of history. The time has come 

for my constituents to have equality in this union or to have independence outside of it. If Puerto Rico 

8 Sec opening statement of Chaimmn Wyden here C[T]herc is no disputing that a majority of the voters in Puerto Rico-54 

percent-have clearly expressed their opposition to continuing the current territorial status."). See opening statement of 

Ranking Member Murkowski here ("Now that the plebiscite has been held, it is clear to me that the majority of Puerto 

Ricans do not favor the current territorial status as cYidenccd by the first question on the ballot.'') 

6 
34 


Insert offset folio 24 here 98944.024

can be compared to a weak and fragile body, then territmy status is its depleted heart. Puerto Rico has 

the potential to be strong and stable, but it needs a powerful new heart. 

I look forward to the day when the U.S. citizens that reside in Puerto Rico, especially the hundreds of 

thousands of men and women who have served this nation in the armed forces, can vote for their 

national leaders and fully participate in debates over national policy that affect every aspect of their 

lives. I look forward to the day when Puerto Rico will be treated equally as a matter of right, and does 

not have to beg this Congress for fair treatment. I look forward to the day when my constituents have 

the exact same rights and responsibilities as your constituents-not better treatment, not worse 

treatment and not "special" treatment. 

That new day is just over the horizon. As noted, in a 2012 local referendum, Puerto Rico voters 

rejected territory status. In that same referendum, more voters expressed a preference for statehood 

than for any other status option. In 2017, it is likely that voters in the territory will confirm their desire 

for statehood in a federally-sponsored yes-or-no referendum on admission, pursuant to an historic 

law-P.L. 113-76-enacted by Congress in 2014 at my initiative. The government of Puerto Rico will 

then use any and all appropriate means to petition Congress to enact legislation making the territory a 

state. In the immediate term, there is much that the Puerto Rico government and the federal 

government can and should do to help the territory manage its economic, fiscal and demographic 

crisis. However, for Puerto Rico to truly prosper, it must be treated equally. And to be treated equally, 

the territory must become a state. 

7 
35 

The CHAIRMAN. Thank you, Commissioner. 

Mr. Marxuach, welcome. 

STATEMENT OF SERGIO MARXUACH, POLICY DIRECTOR, 

CENTER FOR A NEW ECONOMY 

Mr. MARXUACH. Good morning, Chairman Murkowski, Ranking 

Member Cantwell, and members of the U.S. Senate Committee on 

Energy and Natural Resources. I thank you for the opportunity to 

appear today before this committee to discuss Puerto Rico’s financial and economic challenges. 

Puerto Rico currently faces two distinct yet related crises. The 

first and most urgent arises out of the government’s weak financial 

situation. The second is the product of the chronic stagnation of its 

economy over the last ten years. 

Decades of fiscal and economic mismanagement have engendered 

an economy characterized by chronic primary deficits, high debt-toGNP ratios, low employment levels in the formal economy, a large 

informal economy encompassing both legal and illegal activities, 

significant government corruption and predatory rent-seeking behavior in both the public and private sectors, substantial tax evasion, a hollow productive base, and high levels of private consumption and indebtedness enabled by having access to a stronger currency than its economic fundamentals will warrant. In our opinion, 

the parallels with Greece are quite evident for all to see and none 

to misunderstand. 

Notwithstanding this dismal economic situation, the island man- aged to triple its public debt from $24 billion in 2000 to $72 billion 

in 2015. Indeed, during this period, Puerto Rico’s public indebtedness grew at a compound annual rate of 7.6 percent while its income measured by GNP grew at a nominal rate of only 3.6 percent. 

To be fair, for decades the borrowed money was put to good use: 

to finance the construction of public schools, hospitals, highways, 

and other essential infrastructure. The problem is that during the 

last 20 years or so, a large portion of the money borrowed by 

issuing long-term debt was used to finance budget deficits, operating expenses, and classic pork barrel spending. 

Given the magnitude and multiplicity of challenges facing Puerto 

Rico, it should be obvious that there are no quick fixes to solve the 

island’s fiscal and economic problems. Congress needs to implement 

a comprehensive program to remove some of the disadvantages imposed on Puerto Rico under the current political arrangement and 

eliminate some long-standing inequitable and discriminatory policies. The current situation simply does not allow for piecemeal action by Washington. A wide-ranging plan is needed. 

In the short-term, the most pressing issue is Puerto Rico’s deteriorating liquidity situation. If the cash-flow projections made by 

Conway MacKenzie are accurate, Puerto Rico will not have enough 

cash on hand to meet all its obligations as soon as December of this 

year. In that event, and the absence of either (1) access to an emergency liquidity facility, or (2) forbearance from bondholders, the 

probability of a disorderly default is quite high because the current 

administration has already stated its firm intention to keep essential government operations running, and Puerto Rico cannot avail 

itself of relief under Chapter 9 of the U.S. Bankruptcy Code. Given 

36 

the short time window, the policy options at the Federal level boil 

down to providing short-term financing to Puerto Rico to avoid a 

default or enacting legislation extending the application of Chapter 

9 to the island. 

Another significant problem on the fiscal side is the cost of the 

government health plan, which is one of the principal drivers of 

Puerto Rico’s non-interest expenditures. Providing Puerto Rico 

equal treatment under Federal healthcare programs such as Medicare, Medicaid, and the Affordable Care Act will provide the Commonwealth with some much-needed fiscal space and address a 

long-standing injustice inflicted on Puerto Ricans. For the truth of 

the matter is that Puerto Rican workers and employers pay the 

same payroll taxes as workers and employers in each of the 50 

states of the mainland, yet benefits to Puerto Rico are unfairly rationed by Federal legislation. 

On the economic growth side of the equation, we recommend extending the Federal earned income tax credit to Puerto Rico. The 

Federal EITC is the most effective anti-poverty program in the 

United States. It has been shown to promote savings. It helps poor 

families smooth out the effect of unexpected financial shocks and 

builds a strong sense of future orientation among recipients. Extending this program to Puerto Rico, which would provide a significant wage supplement to low-income Puerto Rican working families, could be expected to stimulate aggregate demand in the short 

run. 

Sustaining economic growth over the long-term, however, is a 

more complicated issue involving the interplay of many factors and 

variables, including the capability to accumulate and increase capital in all its forms: physical, financial, and human. 

The efficiency with which inputs are utilized in the production 

process, what economists refer to as total factor productivity, the 

degree of openness to the world, and the adaptable institutional 

structures that provide the right incentives to innovate and develop 

new technologies to reorganize production in order to exploit new 

opportunities. 

In this context, we recommend—we strongly recommend that any 

savings derived from a reduction in debt service be dedicated exclusively to develop and implement a new industrial policy for Puerto 

Rico based on a set of coherent horizontal policies such as reforming a complicated permitting and licensing system that stifles innovation; lowering energy and other costs of doing business in the island; substantially improving educational standards; discovering 

new sectorial opportunities through a process of dialog and consultation with key stakeholders in the private and civic spheres; 

and identifying spillovers, externalities, and other areas where 

Puerto Rican society could learn more. 

This new learning, in turn, would lead to new investment in research and development, increased productivity, identifying new 

areas of comparative advantage for Puerto Rican firms, higher economic growth, and the creation of high-quality jobs, which is what 

will in the end categorically terminate Puerto Rico’s economic stagnation. 

37 

We at the Center for a New Economy are currently working with 

experts from Columbia, Brown, MIT, and Brookings, among other 

institutions, to develop this medium- to long-term industrial policy. 

Finally, any new economic strategy for Puerto Rico, no matter 

how nuanced, sophisticated, or brilliantly conceived, is bound to fail 

if it ignores the fact that Puerto Rico has reached the limits of its 

development within the constraints imposed by its subordinate political status, which is both humiliating to Puerto Ricans and unworthy of a nation like the United States. 

In conclusion, Chairman Murkowski, I thank you and the committee for once again participating in this important public policy 

debate and look forward to answering any questions you may have. 

[The prepared statement of Mr. Marxuach follows:] 

38 


Insert offset folio 25 here 98944.025

TESTIMONY BEFORE THE UNITED STATES SENATE COMMITTEE ON ENERGY 

AND NATURAL RESOURCES PUBLIC HEARING ON PUERTO Rico's ECONOMY, 

DEBT, AND OPTIONS FOR CONGRESS 

Sergio M. Marxuach 

Policy Director 

Center for a New Economy 

October 22, 2015 

Washington, DC 
39 


Insert offset folio 26 here 98944.026

Good morning, Chairman Murkowski, Ranking Member Cantwell, and Members 

of the United States Senate Committee on Energy and Natural Resources. I thank you for 

the opportunity to appear today before this Committee to discuss Puerto Rico's financial 

and economic challenges. 

Puerto Rico currently faces two distinct, yet related, crises. The first, and most 

urgent, arises out of the government's weak financial situation. The second is the product 

of the chronic stagnation of its economy over the last ten years. 

Decades of fiscal and economic mismanagement have engendered an economy 

characterized by: (1) chronic primary deficits; (2) high debt-to-GNP ratios; (3) low 

employment levels in the formal economy; (4) a large informal economy, encompassing 

both legal and illegal activities; (5) significant government corruption and predatory rentseeking behavior in both the public and private sectors 1

; (6) substantial tax evasion; (7) a 

hollow productive base; and (8) high levels of private consumption and indebtedness 

enabled by having access to a stronger currency than its economic fundamentals would 

warrant. In our opinion, the parallels with Greece are quite evident for all to see and 

none to misunderstand. 

Notwithstanding this dismal economic situation, the island managed to triple its 

public debt from $24 billion in 2000 to $72 billion in 2015. Indeed, during this period 

Puerto Rico's public indebtedness grew at a compound annual rate of 7.6%, while its 

income (GNP) grew at a nominal rate of only 3 .6%. 2 

Given that Puerto Rico's indebtedness grew at an average annual rate two times 

faster than the growth rate of its GNP during the past fifteen years, it should not be 

surprising that Puerto Rico's public debt currently exceeds its GNP. To be fair, however, 

for decades the borrowed money was put to good use to finance the construction of 

public schools, hospitals, highways, and other essential infrastructure. The problem is 

that during the last twenty years or so, a large portion of the money borrowed by issuing 

long-term debt was used to finance budget deficits, operating expenses, and classic porkbarrel spending. 

In February 2014, the three principal rating agencies downgraded the 

Commonwealth's debt, as well as debt issued by several of its agencies and 

instrumentalities, to speculative or non-investment grade. 

The rating downgrades had a material adverse effect on the Commonwealth's 

finances because they essentially shutdown its access to the capital markets, at least at 

reasonable rates. This, at a time when the central government is still running a sizeable 

budget deficit, several of the Commonwealth's agencies and instrumentalities face 

1 "'Rent-seeking'' can be defined as the pursuit of uncompensated value from otber economic agents: in 

contrast witb profit seeking, where economic agents seek to create value through mutually beneficial 

economic activity. 2 In Puerto Rico. GNP, which measures income camcd by residents or by locally-owned production factors. 

is a more accurate measure of economic activity than GDP due to distortions induced by the transfer 

pricing pmctices of multinational companies operating in the island. For a technical analysis of the 

GNP/GDP gap in Puerto Rico see "Economic Growth" by Barry P. Bosworth and Susan M. Collins in The 

Economy of Puerto Rico: Restoring Growth, (Brookings Institution Press: Washington, DC. 2006), p. 17-

8l. 

2 
40 


Insert offset folio 27 here 98944.027

significant maturities in the near term, the economy is contracting at an estimated annual 

rate of 1.2%, liquidity is running extremely tight, and net outmigration has increased to 

levels not seen since the 1960s. 

Given the magnitude and multiplicity of challenges faced by Puerto Rico it should 

be obvious that there are no quick fixes to solve the island's fiscal and economic 

problems. Congress needs to implement a comprehensive program, remove some of the 

disadvantages imposed on Puerto Rico under the current political arrangement, and 

eliminate some long-standing inequitable and discriminatory policies. The current 

situation simply does not allow for piecemeal action by Washington, a wide-ranging plan 

is needed. 

In the short-term the most pressing issue is Puerto Rico's deteriorating liquidity 

situation. If the cash flow projections made by Conway MacKenzie are accurate, then 

Puerto llico will not have enough cash on hand to meet all its obligations as soon as 

December of this year3 

In that event, in the absence of either ( 1) access to an emergency liquidity facility 

or (2) forbearance from bondholders, the probability of a disorderly default is quite high, 

because the current administration has already stated its firm intention to keep essential 

government operations running and Puerto Rico cannot avail itself of relief under Chapter 

9 of the U.S. Bankruptcy Code. 

Given the short time window, the policy options at the federal level boil down to 

(I) providing short-term tlnancing to Puerto Rico to avoid a default or (2) enacting 

legislation extending the application of Chapter 9 to Puerto llico. 

With respect to Chapter 9, the first thing to notice is that Puerto Rico's debt is 

spread across of variety of debtors (18 issuers in total) representing a complex web of 

claims in an uncertain regulatory and legal framework. This situation makes it very 

difficult for creditors to work as a class because one set of creditors will worry that any 

relief they provide the island will simply make it easier for a different set of creditors to 

recover a larger amount of their claims. 

In game theory tenns, Puerto llico faces a game in which there are multiple 

players, which sometimes have common and sometimes-opposing interests, and not 

making a deal leaves everyone worse off. In this type of game the tina! outcome could be 

one of any number of possible "Nash equilibria", which would generate sub-optimal 

results for all parties involved. 

Congress could help Puerto Rico figure a way out of this conundrum by 

approving legislation to authorize the Puerto llican government to allow its distressed 

agencies, instrumentalities, and municipalities to file for bankruptcy under Chapter 9 of 

the U.S. Bankruptcy Code. 

However, while we support allowing Puerto llico to avail itself of Chapter 9 

procedures to adjust its debt and believe it would provide a helpful framework for 

addressing existing coordination and information failures, we also stress that it is by no 

means a complete or perfect solution to all of Puerto Rico's troubles. 

3 Conway MacKenzie. Commonl!'ea/th a_{ Puerto Rico Liquidi~y Update. August 25,2015. 

3 
41 


Insert offset folio 28 here 98944.028

Another significant problem on the fiscal side is the cost of the Government 

Health Plan, which is one of the principal drivers of Puerto Rico's non-interest 

expenditures 4 Providing Puerto Rico equal treatment under federal healthcare programs, 

such as Medicare, Medicaid, and the Affordable Care Act would provide the 

Commonwealth with some much-needed fiscal space and address a long-standing 

injustice inflicted on Puerto Ricans. For the truth of the matter is that Puerto Rican 

workers and employers pay the same payroll taxes as workers and employers in the 

mainland, yet benefits to Puerto Rico are unfairly rationed by federal legislation. 5 

On the economic growth side of the equation, we recommend extending the 

federal Earned Income Tax Credit ("EITC") program to Puerto Rico. The federal EITC is 

the most effective anti-poverty program in the United States. Recent research also shows 

that it encourages work, promotes savings, helps poor families smooth out the effect of 

unexpected financial shocks, and builds a strong sense of future orientation among 

recipients. 6 Extending this program to Puerto Rico, which would provide a significant 

wage supplement to low-income Puerto Rican working families, could be expected to 

stimulate aggregate demand in the short-run. 

Sustaining economic growth over the long-term, however, is a more complicated 

issue, involving the interplay of many factors and variables, including: the capability to 

accumulate and increase capital in all its forms-financial, physical and human; the 

efficiency with which inputs are utilized in the production process, what economists refer 

to as total factor productivity; the degree of openness to the world, which has become 

increasingly important as knowledge flows across national borders and foreign trade and 

investment influence the incentives to innovate, imitate, and use new technologies; and 

finally, adaptable institutional structures that provide the right incentives to innovate and 

develop new technologies, reorganize production in order to exploit new opportunities, 

and accumulate physical and human capital. 

In this context we strongly recommend that any savings derived from a reduction 

in debt service be dedicated exclusively to develop and implement a new industrial policy 

for Puerto Rico based on (1) a set of coherent horizontal policies such as reforming an 

unnecessarily complicated permitting and licensing system that stifles innovation, 

lowering energy and other costs of doing business in the island, and substantially 

improving educational standards; (2) discovering new sectorial opportunities through a 

process of dialogue and consultation with key stakeholders in the private and civic 

4 Commonwealth of Puerto Rico Quarterly Report, dated May 7. 2015. p. 20-21 and 37-40. 5 See United States Government Accountability Office, [/S'. Insular Areas: Multiple Factors Affect Federal 

Health Care Flmding, GA0-06-75. (October 2005), and Puerto Rico: Information on How Statehood 

Would Potentially Affect Selected Federal Programs and Revenue Sources, GA0-14-31, (March 2014). 6 Sec Brnce D. Meyer, "The Effects of the Earned Income Tax Credit and Recent Refonns" in Tax Policy 

and the F:conomy, Volume 24, Jeffrey R. Brown. ed .. (University of Chicago Press, 2010); Sara Sternberg 

Greene, The Broken Safetv Net: A Stuczv of Earned Income Tax Credit Recipients and a Proposal for 

Repair, New York University Law Review. Vol. 88. No.2, May 2013; V. Joseph Hotz, Charles H. Mullin. 

and Jolm Karl Scholz, Examining the Effect of the Earned Income Tax Credit on the Labor A.farket 

Participation of Families on Welfare. NBER Working Paper 11968, (National Bureau of Economic 

Research: Cambridge, MA, 2006); and Chuck Marr, Chye-Ching Huang, and Arloc Sherman, Earned 

Income Tax Credit Promotes Work, ~"ncourages Children at School, Research Finds, (Center on Budget 

and Policy Priorities: Washington, DC. 2014), among others. 

4 
42 


Insert offset folio 29 here 98944.029

spheres; and (3) "identifying spillovers, externalities, and other areas where [Puerto 

Rican] society could learn more." 7 

This new learning, in turn, would lead to: new investment in R & D, increased 

productivity, identifying new areas of comparative advantage for Puerto Rican firms, 

higher economic growth and the creation of high-quality jobs, which is what will 

categorically end Puerto Rico's economic stagnation. We at the Center for a New 

Economy are currently working with experts from Columbia, Brown, MIT, and 

Brookings, among other institutions, to develop this medium to long-term industrial 

policy. 

Finally, any new economic strategy for Puerto Rico, no matter how nuanced, 

sophisticated, or brilliantly conceived, is bound to fail if it ignores the fact that Puerto 

Rico has reached the limits of its development within the constraints imposed by its 

subordinate political status, which is both humiliating to Puerto Ricans and unworthy of 

the United States. 8 

In conclusion, Chainnan Murkowski, I thank you and the Committee once again 

for the opportunity to participate in this important public policy debate and look forward 

to answering any questions that you or Committee Members may deem appropriate to 

ask. 

Joseph E. Stiglitz and Bmce C. Greenwald, Creating a Learning Society: A New Approach to Growth, 

Development, ondSocial Progress, (Columbia University Press: New York, 2014), p. 489. 8 Neither a sovereign com1try nor a state of the unioiL Puerto Rico has no authority to negotiate 

international treaties, no access to emergency financing from multilateml institutions. no monetary policy 

instnnnents. limited fiscal policy tools, noJninal representation in Congress, and the U.S. Supreme Court 

has detennined it is constitutionally pennissible for Congress to discriminate against Puerto Rico in the 

application of federal programs as long as there exists a ''mtional basis" for doing so. 

5 
43 

The CHAIRMAN. Thank you, Mr. Marxuach. 

Mr. Fetter, welcome. 

STATEMENT OF STEVEN FETTER, PRESIDENT, REGULATION 

UNFETTERED 

Mr. FETTER. Thank you. Chairman Murkowski, Ranking Member 

Cantwell, and members of the committee, I appreciate the opportunity to testify on the fiscal issues affecting the Commonwealth of 

Puerto Rico. 

With my background as a utility regulator and utility bond rater, 

I have been asked to discuss Puerto Rico’s electric utility known as 

PREPA. 

I should say with the comments from my colleagues on the panel, 

the fiscal issues are extremely serious, but I believe, at least on the 

energy side, with a few changes it potentially has a brighter outlook, including the possibility of a consensual settlement agreement 

with investors short of a filing for bankruptcy. 

Initially, I wish to emphasize that I come at the PREPA issues 

with the hope that the ultimate resolution will create an environment in which investors will be willing to continue providing funds 

to the Commonwealth for the wide range of public services they 

now support and that that goes on well into the future. I believe 

the best way of achieving that is if stakeholders can reach a consensual settlement agreement under which necessary sacrifices can 

be shared across the board. 

This is consistent with the approach I took at the Michigan Commission, where I continually urged our staff and adversarial parties 

to attempt to reach agreement on points of difference through settlement because no matter how thorough a litigated case record is 

developed, the parties are always in a better position to weigh their 

areas of dispute and strike a fair balance as to how they wish them 

to be resolved. Basically, then, each party chooses the end result 

for themselves. 

Toward this ultimate goal, I offer the following thoughts: 

The new Energy Commission should expedite PREPA’s current 

base rate case as much as it possibly can, a point that I believe 

Congress could help emphasize. My understanding is that rate levels have long been inadequate to meet operating expenses and debt 

obligations, thus leading to PREPA’s financial crisis. 

Adding to the problem, when oil-reliant PREPA received a major 

positive break with oil prices plummeting down during the past 

year, those saved funds were immediately flowed back to customers 

rather than keeping rate levels the same and using the additional 

revenues to support operations and required investor payments. 

My back-of-the-envelope calculation puts those lost revenues during 

the past year as approaching $1 billion on a total base of $9 billion 

of debt at PREPA. 

I admit I am not sure if the Energy Commission had the authority to so direct these fuel savings, but my experience tells me that 

they could have done what I did at the Michigan Commission. I 

went to the Michigan legislature. Actually, your colleague, Senator 

Stabenow, was serving in the legislature at that time. 

I explained to policymakers why the law needed to be changed 

and why the public interest would be furthered if they did it immeVerDate Nov 24 2008 13:17 Jun 21, 2017 Jkt 098944 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 C:\HEARINGS\98944\C98944.TXT C98944
44 

diately. Such a proactive step would have helped PREPA respect 

the interests of debt investors while mitigating the financial pain 

its customers will likely have to face as this crisis proceeds. 

Similarly, PREPA should immediately endeavor to operate with 

substantially increased efficiencies, especially with regard to ratecollection practices. I think if I were serving at the commission or 

at PREPA, I would seek the advice of individuals and institutions 

that have faced similar difficulties in the past. 

For example, almost every U.S. utility regulator serves at 

NARUC, their longstanding national association, and utility executives belong to a range of electric and natural gas associations. I 

expect that any of these organizations would be willing to assist 

PREPA or the Energy Commission. 

And of course, relevant experience exists in utility consulting 

firms across the U.S. Expertise is there to be tapped, and I believe 

Congress could play a role in facilitating a connection between 

PREPA, the commission, and these experts. 

In addition, I understand that outside investors are willing to assist PREPA in a range of ways, from new investment aimed at 

asset modernization, all the way up to privatization. At this point, 

no option should be off the table. 

Finally, let me briefly discuss the potential for Chapter 9 bankruptcy filings being permitted for PREPA or other Commonwealth 

entities. At least with regard to the energy sector, the potential for 

a Chapter 9 filing was not a risk that investors considered at the 

time they decided they would lend money to PREPA. 

Undoubtedly, that means that if Chapter 9 were permitted for 

review of debt investors’ return of funds, there would be legal challenges to such an authorization that would go on for years. I think 

a consensual settlement agreement is potentially there and would 

be a far superior path. 

Finally, let me tell you just my concern about the Chapter 9. 

Debt investors lent money to the Commonwealth and its public 

agencies with the expectation that they would receive their funds 

back with interest. They are not equity holders or co-owners of 

PREPA, subject to the ups and downs of utility performance. Thus, 

in my mind, for any resolution of this crisis to succeed going forward, it must keep faith with the debt investment community because those are the individuals and institutions, along with possible future equity investors, that will be needed to support Puerto 

Rico’s continuing recovery well into the future. 

Thank you, Madam Chairman. 

[The prepared statement of Mr. Fetter follows:] 

45 


Insert offset folio 30 here 98944.030

U.S. SENATE COMMITTEE ON 

ENERGY & NATURAL RESOURCES 

HEARING ON PUERTO RICO: 

ECONOMY, DEBT, AND OPTIONS FOR CONGRESS 

Testimony of Steven M. Fetter 

President, Regulation UnFettered 

October 22, 2015 
46 


Insert offset folio 31 here 98944.031

Steven M. Fetter, President 

Regulation UnFettered 

Chairman Murkowski, Ranking Member Cantwell, and Members of the 

Committee: 

My name is Steven M. Fetter and I am President of an energy advisory 

firm called Regulation UnFettered. I appreciate the opportunity to testify on the 

economic issues affecting the Commonwealth of Puerto Rico. Based upon my 

past experience of serving as Chairman of the Michigan Public Service 

Commission and head of the utility credit ratings practice at Fitch Ratings, I will 

direct my comments toward the situation facing the Puerto Rico Electric Power 

Authority, known as PREP A, though I expect my views will have some relevance 

on other fiscal issues Puerto Rico is currently facing. 

Initially I wish to emphasize that I come at the PREP A issues with the 

hope that the ultimate resolution will create an environment in which investors will 

be willing to continue providing funds to the Commonwealth for the wide range of 

public services they now support well into the future. I believe the best way of 

achieving that is if stakeholders can reach a consensual settlement agreement 

under which necessary sacrifices can be shared. This is consistent with my 

approach at the Michigan Commission where I continually urged our Staff and 

adversarial parties to attempt to reach agreement on points of difference through 

settlement, because no matter how thorough a litigated case record is 

developed, the parties are always in a better position to weigh their areas of 

dispute and strike a fair balance as to how they wish them to be resolved. 

Simply put, through settlement, each party is able to dictate the type and extent 

of sacrifices they feel they can accept 

Toward this ultimate goal, I offer the following thoughts: 

The new Energy Commission should expedite PREP A's current base rate 

case as much as it possibly can, a point that I encourage Congress to emphasize 

to their counterparts in Puerto Rico as welL My understanding is that rate levels 

have been inadequate to meet operating expenses and debt obligations, thus 

leading to PREP A's financial crisis. Adding to the problem, when oil-reliant 

PREP A received a major positive break with oil prices plummeting down during 

the past year, those saved funds were flowed back to customers, rather than 

keeping rate levels the same and using the additional revenues to support 

operations and required investor payments. My back-of-the-envelope calculation 

puts those lost revenues during the past year as approaching one billion dollars. 

I admit, I'm not sure if the Energy Commission had the authority to so direct 

these fuel savings, but my experience tells me that they could have done what I 
47 


Insert offset folio 32 here 98944.032

did at the Michigan Commission: go to the Michigan Legislature- actually 

Senator Stabenow was in the legislature back then - and explain to the 

policymakers why the law needed to change, and that the public interest would 

be furthered if that change could be made immediately. Such a proactive step 

would have helped PREP A respect the interests of debt investors while 

mitigating the financial pain its customers will likely have to face as this crisis 

proceeds. 

Similarly, PREP A should immediately endeavor to operate with 

substantially increased efficiencies, especially with regard to rate collection 

practices. I think if I were serving at the Commission or in PREP A management, 

I would seek the advice of individuals and institutions that have faced similar 

difficulties in the past. For example, almost every US utility regulator serves in 

NARUC, their longstanding national association, and utility executives belong to 

a range of electric and natural gas associations - I expect any of those 

organizations would be willing to assist PREP A or the Energy Commission. And, 

of course, relevant experience exists in utility consulting firms across the United 

States. Expertise is there to be tapped, and I believe Congress could play a role 

in facilitating such interaction. 

In addition, I understand that outside investors are willing to assist PREP A 

in a range of ways: from new investment aimed at asset modernization all the 

way up to privatization. At this point, no option should be off the table. 

Let me briefly discuss the potential for Chapter 9 bankruptcy filings being 

permitted for PREP A or other Commonwealth entities, and caution Congress 

about becoming involved with the issue. Undoubtedly, legal challenges to such 

an authorization would go on for years with all the uncertainly that such a delay 

would engender. But, more importantly, if such proceedings were intended to 

take from debt investors, including insurers of such bond investors, more than 

they are willing to give, in my opinion the end result might be that the current 

crisis will morph into a Commonwealth catastrophe. 

Let me explain why: debt investors lent money to the Commonwealth and 

its public agencies with the expectation that they would receive their funds back 

with interest. They are not equity holders, or co-owners of PREP A, subject to 

making or losing a bunch of money depending upon the ups and downs of the 

utility's performance. Thus, in my mind, for any resolution of this crisis to 

succeed going forward, it must keep faith with the debt investment community, 

because those are the individuals and institutions, along with possible new equity 

investors, that will be needed to support Puerto Rico's continuing recovery well 

into the future. 

Thank you for your attention. 
48 

The CHAIRMAN. Thank you, Mr. Fetter, I appreciate your comments, and you gave some specific proposals there that I think will 

be good for the committee to look at. 

Let me begin my questioning first directed to you, Governor. 

Again, thank you for being here. 

As we have come to this hearing today, we have heard a great 

deal of discussion about the numbers and where Puerto Rico is and 

their clear inability to pay, but there has been a lot of concern 

about the fact that we have not seen the financial reports that 

have been hoped for. There have been a number of financial reports. You mentioned one, and several of you also mentioned the 

Krueger report. There is also the Conway MacKenzie report to the 

working group report, which I think is helpful. 

But there is concern, clearly, about the verifiability of Puerto 

Rico’s financial data, and this goes back to the fact that we have 

not seen a comprehensive independent audit since July 2013. I 

know that this was an issue that was raised before the Finance 

Committee as well. 

Can you tell the committee this morning whether or not there 

are plans to complete independent audits of the Government Development Bank for Fiscal Years 2014 and ’15 and then, of course, 

going into the future? What is the status of that? 

Governor PADILLA. Thank you, Chairwoman. 

It is a historical problem in Puerto Rico. We inherited such a 

mess there, too, and it was part of the different governments in the 

past to hide information to the market so they were able to have 

more access to the market. We have been dealing with that. Now 

we are just one audited financial statement behind. That should be 

released in the next weeks or months. 

The CHAIRMAN. Excuse me. Would that be ’14 or ’15 that would 

be—— 

Governor PADILLA. It will be ’14 and then ’15, but when I was 

sworn in, the delay was huge. We have been able to go forward and 

being now a little bit more accurate. The Conway MacKenzie and 

Krueger reports are part of that effort of the Commonwealth and 

my administration to bring you and to the world the right numbers 

about Puerto Rico through commission-independent experts to 

evaluate Puerto Rico numbers. 

So on the audited financial statement, it is a historical problem 

that we are just now getting up to date. But to supplement that 

lack of information, that is why we commissioned the same company that did the research in Detroit, this Conway MacKenzie, and 

the best one in the world from the IMF is the Krueger report. 

The CHAIRMAN. But what you are telling the committee is we 

should anticipate the 2014 independent audit sometime within the 

next several weeks? 

Governor PADILLA. Weeks or months, yes. I will tell you why. As 

you know, it is an independent contractor that is requesting every 

day information, so to put a burden on them to be faster, I need 

to ask them to address the issue in a more responsible way so you 

will have the better numbers. But, yes, we are putting a lot of pressure on them to accelerate that process. 

The CHAIRMAN. I think you understand the need and of 

course—— 

49 

Governor PADILLA. Of course. 

The CHAIRMAN.—concern for very clear numbers. 

Let me ask you, Mr. Weiss, given your close interaction with the 

Puerto Rico government over the last year, are you comfortable 

with the financial data that is available and has the Treasury Department considered sending a team from Treasury to help them 

produce some of these auditable financial statements? 

Mr. WEISS. Thank you for posing the question, Chairman Murkowski. 

An essential part of the plan that we are proposing, not covered 

in my oral testimony but contained in the written proposal, is that 

it is absolutely the case that Puerto Rico needs to make an investment in its financial reporting systems and cannot be in a position 

where audited financials are not released on a timely and transparent basis to all stakeholders. 

It is equally the case that we have analyzed all available data, 

including the Conway MacKenzie report and other analyses, and 

there can be no doubt—there can be no doubt in our judgment that 

there is a fiscal crisis and that it is imminent. There is a liquidity 

crisis as well as a long-run fiscal crisis. 

And this is why we have proposed not just a broader restructuring authority but also enhanced fiscal oversight, and as part of 

that fiscal oversight, an investment in IT infrastructure and also 

the authorizations, as you suggest, to allow Treasury and the other 

agencies within the Federal administration to provide real on-theground technical assistance to make sure that that IT infrastructure is built out quickly and effectively. 

The CHAIRMAN. So that technical assistance that you are speaking to will be a team from Treasury that will go to Puerto Rico to 

try to get a better handle on what we are talking about with the 

numbers? The reason I ask, you mentioned assisting with the system. You and I both know that that is going to cost money. You 

and I both know that there is a lot of uncertainty right now in 

terms of what is going on with just the budget and appropriations 

as we move forward. 

As we look at the proposals you have outlined, one of the concerns that has been expressed is that there does not appear to be 

any kind of an estimate as to what the overall cost may be, whether it is for the proposals that have been discussed with the EITC, 

removing the Medicaid cap, or, as you have just mentioned, assistance with helping build out what is very necessary, I would agree. 

But do we have any kind of an estimate out there in terms of the 

costs of the Administration’s proposals? 

Mr. WEISS. As to the cost of the build-out of the IT infrastructure, it is our judgment that the cost is low but that the benefits 

are great, and that, in fact, the technical assistance we could provide, not just out of Treasury but other agencies, would help to ensure that it is effective and quickly implemented. 

But I need to underline that there can be no doubt that there is 

a fiscal and liquidity crisis in Puerto Rico. The debt is consuming 

$3.5 billion to $4 billion annually out of a $10 billion budget. That 

is 35 to 40 percent of government receipts. This compares to figures 

more in the area of five to ten percent in states and municipalities. 

The debt trades at prices between 30 cents and 70 cents and has 

50 

traded there for the past two years since Puerto Rico lost access to 

traditional municipal bond investors. So the investment needs to be 

made, but it cannot be an excuse in our judgment for a failure to 

act. 

The CHAIRMAN. Okay. Mr. Weiss, I am well out of time but know 

that I am going to come back to you with this question in the next 

round to try to understand what it is that we are dealing with because, as I would agree, we have to work with Puerto Rico here. 

We must address this. 

We also recognize that we have issues as they relate to just dealing with the costs, so I am trying to get some kind of an understanding as to what we are dealing with with the Administration’s 

proposal and whether or not they have got a back-of-the-envelope 

number that we can be looking to. So know that I am going to be 

coming back to you. 

Mr. WEISS. Thank you. 

The CHAIRMAN. Senator Cantwell. 

Senator CANTWELL. Thank you, Madam Chair, and thank you to 

the panelists. 

I think having seen some of the discussion in the Finance Committee—at the end, it got kind of heated—I think it is safe to say 

that you all do not hang out together. [Laughter.] 

So if I could just get an answer to this question, a yes or no. 

Which of you support this Chapter 9 authority, creating Chapter 9 

authority for Puerto Rico? 

Governor PADILLA. Yes. 

Senator CANTWELL. Can we just go down the line? 

Governor PADILLA. I am sorry. 

Senator CANTWELL. Mr. Weiss? 

Mr. WEISS. Yes, Senator. 

Governor PADILLA. Yes. 

Mr. PIERLUISI. I support Chapter 9—giving access to Puerto Rico 

to Chapter 9. I introduced a bill for that purpose. 

Senator CANTWELL. Okay. 

Mr. MARXUACH. Yes, Senator, I support it. 

Mr. FETTER. No, I do not. 

Senator CANTWELL. Okay. Mr. Fetter, your testimony suggests 

that you believe that there are assets within the utility, and that 

is why you do not support Chapter 9, and you want to make sure 

that those assets—but in a bankruptcy, that is what the bankruptcy discussion is about. It is about what assets are there. 

So, Mr. Weiss, how is Puerto Rico—or the Governor—going to be 

constrained, and all the other sectors trying to reform in bankruptcy going to be constrained by this utility objection? 

Mr. WEISS. We need to be clear about bankruptcy as a whole. 

There are two aspects. One is Chapter 9, which has been introduced by Congressman Pierluisi in the House, and there is a companion bill in the Senate, and that would cover PREPA and the 

other public corporations and municipalities. That totals approximately one third of the total bonded debt in Puerto Rico. 

The Administration is absolutely in favor of moving forward with 

that legislation immediately. It would help not only finalize the 

PREPA negotiations, which are ongoing, but also cover the other 

municipalities in Puerto Rico, which are over-indebted. 

51 

At the same time, we are advocating for a broader bankruptcy 

that would cover the entire bonded debt of Puerto Rico. And the 

benefits of that are, first, litigation has been made at—various 

have mentioned litigation that provides a stay on litigation and 

necessary breathing space for the economy while it is in effect. Second, it provides a mechanism for assuring an agreement with each 

class of bondholders that is enforceable across the entire debt 

stock. And third, to the extent needed, it allows for senior financing, which can be brought in from the private sector and come out 

on a priority basis. 

It is our judgment that the time has come to address the entire 

debt stock of Puerto Rico and not just the Chapter 9 municipalities 

and public corporations. 

Senator CANTWELL. Mr. Fetter, you are definitely holding the 

utility area sacrosanct under this larger problem. What about what 

Mr. Weiss just said is not a process and procedure for making sure 

that this is—— 

Mr. FETTER. Senator, my—— 

Senator CANTWELL.—that your investors are going to have a fair 

day—in a horrible situation, no doubt—but they are going to have 

their fair day under this? 

Mr. FETTER. I guess I come at it a few different ways. It is a risk 

that they did not envision when they decided to make their investment. I believe with a commitment towards improved operations at 

PREPA and improved regulatory timeliness, a consensual settlement agreement can be reached. 

And so, to me, that is far superior than starting down a path of 

Chapter 9 restructuring, which, in the end, might be okay to investors or it might not be okay. So since it is that binary okay or not, 

my expectation is that they would raise legal objections at the outset, as opposed to working toward that settlement agreement that 

I think is possible. 

Senator CANTWELL. Mr. Marxuach. 

Mr. MARXUACH. I just want to make a quick remark. I disagree. 

I respectfully disagree with the remark that bondholders relied expressly on bankruptcy protection in order to make these investments. To my knowledge, looking at every prospectus that is out 

there, I do not think it was even highlighted, you know, when the 

debt was issued. The main driver for Puerto Rican bonds was the 

triple tax exemption they enjoyed under the U.S. Tax Code and in 

Puerto Rico, and that was really what drove people to invest in 

Puerto Rico. 

It will be very difficult, I think, for any investor to prove in a 

court that they relied expressly on a representation that bankruptcy was not an option. 

Senator CANTWELL. Okay. I see my time is expired. Thank you. 

The CHAIRMAN. Thank you, Senator Cantwell. 

Senator Barrasso. 

Senator BARRASSO. Thank you, Madam Chairman. 

Congressman Pierluisi, you mentioned in your written testimony 

that Puerto Rico is, I think you said, ‘‘treated in discriminatory 

fashion or excluded entirely’’ from various Federal programs, including Chapter 9 of the Federal Bankruptcy Code. As you know, 

there is a companion legislative proposal to your bill in the Senate 

52 

introduced by Senator Blumenthal to grant Chapter 9 Bankruptcy 

Code protection. 

I have concerns about families and retirees in my state and other 

states who were incentivized by Congress through the Tax Code to 

invest in the Puerto Rican bonds, including the Puerto Rico Electric 

Power Authority. I have heard there are many individuals who are 

invested in these bonds across the State of Wyoming. Some have 

investments in their 401(k)s, people who may not even know that 

their 401(k)s are invested in these bonds. Congress explicitly prohibited Puerto Rico from being able to access Chapter 9. Puerto 

Rico took advantage of the lower cost of capital by doing that. If 

access to Chapter 9 was granted and the rules under which investments in these bonds were made are retroactively changed, then 

the value would, I think, be negatively impacted. So my concern is 

people bought the bonds because they are tax-free, low-interest, 

Government bonds. So what happens when a retiree in Wyoming 

goes to their mailbox and opens their financial statement only to 

find their investment has been negatively impacted because Congress changed the rules of the game after the fact? What do I tell 

them? 

Mr. PIERLUISI. Okay. First of all, Congress has the power to 

change the bankruptcy laws at any time, and no lawyer worth his 

or her salt would advise a client that bankruptcy law cannot 

change. Puerto Rico for 45 years had access to Chapter 9. It did 

not use it then and did not need it then. For reasons that are not 

even expressed in the Congressional Record, it was left out. That 

is the story, the life of a territory. 

But I would also add that any investor would be in worse shape 

if, for any reason, the entity in which the investor invests has no 

legal structure, no legal remedy to handle its debt obligations. That 

is the situation in Puerto Rico right now. It is going to end up 

being chaos. You need a legal framework in which a Bankruptcy 

Court, a Federal Bankruptcy Court, oversees the reorganization of 

an entity that becomes insolvent. 

By the way, this is not like automatic. The law is clear. You need 

to show that you are insolvent. You need to show that you are not 

able to pay your debts when they become due. In addition, creditors 

have a participation in the process. So, if anything, I say it is much 

better to have Chapter 9 than not. And all we are asking is the 

same access as the states have. That is my answer. 

Senator BARRASSO. Thank you. 

Mr. Weiss, if this Chapter 9 status is granted, would that not 

cost Puerto Rico the confidence of investors in the future who are 

a key component of improving the economy of Puerto Rico? 

Mr. WEISS. Senator, thank you for the question. And it really 

leads to the point that Puerto Rico lost confidence of traditional investors two years ago when it lost its investment grade rating. And 

the only financing it has been able to complete since then has been 

one $3.5 billion financing at an 8.5 percent rate, which was put together entirely by hedge funds. 

More recently, it has also lost its interim financing. It is in a 

completely shutout situation from financial markets today and—— 

53 

Senator BARRASSO. So would granting Chapter 9 do anything to 

address the structural problems and practices that have led to the 

economic situation in Puerto Rico? 

Mr. WEISS. As we have said in our proposal, the Chapter 9, the 

broader version, which covers the entire debt stock of Puerto Rico, 

in our judgment, should be coupled with greater fiscal oversight 

provided by a body that appropriately represents the status and 

people of the Commonwealth, and investment in IT infrastructure 

around financial reporting. So we would do the two together. 

But we think the quickest way to restore confidence in Puerto 

Rico in financial markets is to go through a broader, comprehensive 

restructuring of the Commonwealth’s debt such that it emerges in 

a position where investors have confidence in the oversight and IT 

systems and that the level of debt itself, which today is totally 

unsustainable, better matches the size of the economy. 

Senator BARRASSO. Thank you, Madam Chairman. 

The CHAIRMAN. Thank you, Senator Barrasso. 

For the information of the committee members, a vote has just 

started. There will be two votes. So I think what we will do is go 

until 25 after, and then we will take a break. That way we can try 

to hit both votes at one time and then come back. 

At this time, we will go to Senator Heinrich. 

Senator HEINRICH. Commissioner Pierluisi, Mr. Fetter seemed to 

suggest that PREPA rates are not adequate, and that may be true 

from at least the narrow view of some investors. But as you know, 

PREPA rates are already far higher than mainland electric rates. 

If electric rates were higher in Puerto Rico, how would that impact the broader ability to attract additional business investment 

that is needed to grow out of the current situation? 

Mr. PIERLUISI. Excellent question. But of course that PREPA and 

our energy cost are crucial to Puerto Rico’s future. We need to 

grow. We need to grow our economy, and we are paying over 20 

cents per kilowatt hour for energy. PREPA needs to diversify its 

energy sources. To do so, it needs to attract private capital so we 

have new LNG plants in Puerto Rico. 

But in the current state of affairs in PREPA, it has become such 

a risk for the investment community that nobody would enter into 

a power purchase agreement with PREPA as matters are. That is 

why restructuring at PREPA, reorganizing PREPA under the protection of the Bankruptcy Code, should be an option. 

I am the first one, Senator, who supports consensual negotiations 

with creditors. PREPA has been doing that for more than a year. 

I have been saying that it has taken too long, but we should always 

have that option because it is good for the process. It encourages 

the parties to negotiate in good faith. It gives PREPA, yes, more 

leverage in the negotiation, but it is the right thing to do. 

And of course the solution cannot be raise rates. That cannot be 

the solution. That is going to harm our economy, and it is going 

to cause even more migration, and it is going to create more fiscal 

pressure. So you are absolutely right. 

Senator HEINRICH. With regard to Chapter 9, you believe that 

the certainty that that creates in the long run is better for the investment community than the status quo obviously? 

54 

Mr. PIERLUISI. Yes. Definitely, it is a tool we should have. I 

should say that in Puerto Rico I believe—I, for one—I believe we 

have 18 different entities issuing bonds in Puerto Rico. Some of 

those entities are in reasonable financial condition. Some definitely 

need to be reorganized. PREPA is one. The Water and Sewer Authority is probably the next candidate, and we should have this, 

too. We should definitely have this, too. 

Now, part of our debt, and I should make this point, is it has 

been issued by the central government and it has been guaranteed 

by our constitution; and Congress approved our constitution. I believe that that part of the debt, which is about $18 billion worth, 

is manageable, and we should pay every penny of it because it is 

our word. It is our constitution, and we should be a jurisdiction of 

law and order. 

So I want to clarify the record there. Even though I agree with 

having Chapter 9 as—I do not agree with the concept of restructuring or failing to pay all of our debt. We should honor our obligations to the extent we can, and we should have Chapter 9 available. 

Senator HEINRICH. Do you think there is a relationship between 

the uncertainty over Puerto Rico’s political status to the current 

economic crisis? What is the nexus there, Commissioner? 

Mr. PIERLUISI. A clear nexus. Let me give you just an example. 

And by the way, Chairman, you referred to the lack of estimates. 

Obviously, to the extent we start generating specific bills, we will 

score them. CBO will score them. 

But let me just give you one example. If you improve the treatment of Puerto Rico under the Medicaid program so that at least 

we can cover the people falling below the Federal poverty level— 

I am not even asking for Medicaid expansion—the Puerto Rico government would be receiving at the very least roughly about $1.5 

billion from the Federal Government that it is not receiving right 

now. 

That accomplishes two things. On the one hand, it helps us fiscally. We would not have the deficits that we are having. We would 

not have the liquidity problems we are having. On the other hand, 

we could cover this population, American citizens under the poverty level, as we should. So that is just one example. That is why 

this is tied to status. 

Why are we treated like that? Because we are a territory, and 

you have license to treat us differently. But I complained because, 

as American citizens, we should be treated equally. It has an impact on our fiscal health, and it definitely has an impact on our 

economy. 

Senator HEINRICH. Thank you, Madam Chair. 

Mr. FETTER. May I add some rebuttal? 

The CHAIRMAN. We are going to go to Senator Sanders just because we are running short of time here. 

Thank you, Senator. 

Senator SANDERS. Thank you, Madam Chair. 

I want to raise a couple of issues. First of all, let us be clear 

about the extent of the human tragedy currently taking place in 

Puerto Rico. As I understand it, since 2006, Puerto Rico has lost 

20 percent of its jobs. About 60 percent of Puerto Rico’s adult popuVerDate Nov 24 2008 13:17 Jun 21, 2017 Jkt 098944 PO 00000 Frm 00060 Fmt 6633 Sfmt 6633 C:\HEARINGS\98944\C98944.TXT C98944
55 

lation are either unemployed or have given up looking for work. 

Over the last five years alone, more than 150 public schools have 

been shut down, and the childhood poverty rate has shot up to 56 

percent. 

That is a human tragedy, and in my view, Wall Street should not 

be believing that they can get blood from a stone. When people are 

suffering and hurting, you cannot continue to squeeze them. 

I want to get back to that, but I want to say a word now on the 

energy situation. I have not heard one word—or maybe I missed 

it—on a phrase called ‘‘sustainable energy.’’ As I understand it, 

Puerto Rico today is producing its electricity 55 percent from oil, 

28 percent from natural gas, 16 percent from coal, 1 percent from 

renewables. 

Now, unless Puerto Rico’s advertising is incorrect, last I heard 

you were a sunny island. You are an island. There is wind. I do 

not understand why you are producing electricity from oil and why 

we are not investing significantly into sustainable energy. I know 

there are plans underway, but you have huge potential to lead this 

part of the world. 

All right. Let us get back to my friends on Wall Street here. Mr. 

Weiss, you indicated that the hedge funds, some of the vulture 

funds, are buying bonds at 30 to 70 percent. At a time when children in Puerto Rico are going hungry and schools are being shut 

down, why should the U.S. Government or why should these guys 

be getting back 100 percent on their investment when they are 

paying 30 to 70 percent on the dollar for these bonds? 

Mr. WEISS. Senator, as we have said, the debt is unsustainable, 

and the market knows this. The fact that the highest-rated, most 

senior debt trades at 70 cents is a clear indication that this is no 

surprise and you want—— 

Senator SANDERS. What are the interest rates? I do not have a 

lot of time. What are the interest rates now that these—— 

Mr. WEISS. A yield on the most highly priced security, debt security in Puerto Rico, is in excess of 11 percent. 

Senator SANDERS. Whoa. So they are getting 11 percent, or they 

want 11 percent? 

Mr. WEISS. They are receiving—— 

Senator SANDERS. They are receiving 11 percent—— 

Mr. WEISS.—11 percent. 

Senator SANDERS.—and children in Puerto Rico are going hungry. Somehow that equation does not make a lot of sense to me. 

I think this is an issue that has to be dealt with. 

So the first point that I would make, in any serious discussion 

about this issue, the goal cannot be simply to protect high interest 

rates going to vulture funds on Wall Street. They are going to have 

to sit down on the table and take a significant haircut. They made 

risky investments, and when you make a risky investment, you 

should not expect to get 100 percent back on your dollar. 

Mr. MARXUACH. Senator, may I make one point? That 11 percent 

is tax exempt. I just wanted to make that point. 

Senator SANDERS. All right. So I think let us put that on the 

table, and that has got to end. 

My own view is—and I indicated this to the Secretary of the 

Treasury, Mr. Weiss, I think the Secretary of the Treasury and you 

56 

should call a meeting with all of the players, including the players 

in Puerto Rico who are now suffering. Representatives of labor 

unions, when I hear labor reform, usually what that means to me 

is lower wages and longer hours, all right? But I would like to see 

all of the players sit down with the vulture funds and work out an 

agreement that is satisfactory to both sides. 

Now, in terms of transparency, I have heard, and I do not claim 

to be an expert on this, but that it is possible that some of the debt 

was incurred in an unconstitutional way, in violation of Puerto 

Rico’s constitution. 

Governor PADILLA. Yes. 

Senator SANDERS. Who wants to talk to that one? Yes, sir, Governor. 

Governor PADILLA. Yes, we need to audit that. 

Senator SANDERS. You think that that is a possibility that some 

of your debt was unconstitutional? 

Governor PADILLA. In those words, if that is a possibility, the answer is yes. 

Mr. PIERLUISI. And let me clarify that there is an Attorney General opinion in Puerto Rico providing some support for the interpretation that some of the debt could be issued outside the constitutional requirements. So it is a legal issue. But you might be right, 

and it is something that should be studied. 

Senator SANDERS. Should debt be repaid if, in fact, that debt was 

incurred in an unconstitutional way? 

Mr. MARXUACH. No. 

Senator SANDERS. Who said no? You both say no? Sir? 

Mr. MARXUACH. I said no, and in addition to the opinion from the 

Attorney General that Congressman Pierluisi mentioned, the constitution specifically says that to balance the budget, you are not 

allowed to issue debt. You are supposed to either—basically increase taxes. That is what the Puerto Rico constitution—— 

Senator SANDERS. And we presume that the investors understood 

that and were familiar with the constitution—— 

Mr. MARXUACH. Well, it was certainly disclosed in the financial 

statement. Whether or not they read it is a different question, and 

that is perhaps an issue to be investigated by the Banking Committee here in the Senate. 

Senator SANDERS. Okay. So what I am hearing, though, from several of you, that if these debts were incurred in a way that was unconstitutional, that perhaps this debt should not have to be repaid? 

Mr. PIERLUISI. Yes. And since the Senator raises the issue, or it 

has been raised, the issue of audits, let me say that Congress has 

the authority, this committee has jurisdiction to require GAO to do 

annual audits of the Puerto Rico government and financial transactions and issue recommendations. This committee had legislation 

before the committee providing for GAO to oversee or give guidelines and recommendations as to estimates, tax revenue, revenue 

estimates, expense estimates done by the territories. 

I testified before this committee, and I asked the committee to 

include Puerto Rico in that legislation. And for some reason you 

left Puerto Rico out, and you allowed GAO to advise the other territories but not Puerto Rico. And now, you tell me that our records 

or financial records are not the types that you would like to see. 

57 

So what I say is definitely Congress has authority to—it did with 

the District of Columbia, and you can do it in a way that respects 

Puerto Rico’s autonomy, and I think it should be done. And GAO 

could also—— 

Senator SANDERS. Thank you. 

Mr. PIERLUISI.—consider the issue—— 

Senator SANDERS. Okay. 

Mr. PIERLUISI.—the issue that was raised—— 

Senator SANDERS. My time is expired. 

The CHAIRMAN. We are going to try to get one more Member in. 

Senator Warren? 

Senator WARREN. Thank you, Madam Chair, and thank you all 

for being here. 

I want to see if I can try to pull this together. The people of 

Puerto Rico are in a really lousy position. They have been hit hard 

by ten years of recession, and now they are crushed by debt they 

cannot repay. Ordinarily a city in this kind of financial trouble 

would declare bankruptcy, a country would go to the IMF, and in 

either case they would work out a reasonable debt reduction and 

a repayment plan. 

Puerto Rico, by American law, cannot do either one of these, and 

that leaves the 3.5 million American citizens on the island at the 

mercy of the people who hold Puerto Rico’s debt. 

So who owns Puerto Rico’s debt? Many of these owners are socalled vulture funds that wait until a borrower is in trouble and 

then they buy the debt at a big discount so they can make a profit 

even if some of the debt does not get repaid. But the vulture funds 

do not want to negotiate. Instead, what do the vulture funds want? 

Well, they want Puerto Rico to raise taxes, cut healthcare, fire 

teachers, cut pensions, sell off $4 billion worth of government 

buildings, privatize public ports, close neighborhood schools, and 

cut support for the University of Puerto Rico, all so that these vulture funds can squeeze out more profits. 

Now, Mr. Marxuach, what would happen to the people of Puerto 

Rico and the economy of Puerto Rico if they did what the vulture 

funds are asking for? 

Mr. MARXUACH. Well, it is essentially another round of austerity 

that would be imposed on the people of Puerto Rico. We already 

have done pension reform. We have fired government employees. 

We have cut expenditures. We have raised taxes since 2009. So obviously what it will do to the economy is, you know, make the actual recession or contraction even more acute. 

Senator WARREN. Okay. 

Mr. MARXUACH. So I do not think it is part of the solution. 

Senator WARREN. So it will make things worse—— 

Mr. MARXUACH. Definitely. 

Senator WARREN.—in Puerto Rico? 

Mr. MARXUACH. In my opinion, it would. 

Senator WARREN. Worse for the people, worse for the future—— 

Mr. MARXUACH. Yes. 

Senator WARREN.—of this economy? 

Mr. Weiss, I understand that the Treasury Department’s position 

is that Congress should pass legislation so that Puerto Rico can 

force creditors to the negotiating table, the same way any American 

58 

city or any country can do. I believe that Congress should pass a 

law. I have cosponsored such a law, and I will fight for it. 

I also understand from your testimony that you have been working with other agencies to guarantee Puerto Rico has access to existing Federal programs. You have worked to encourage other 

agencies to pursue all administrative options. But I want to be 

clear on this point. Is it your position that Treasury itself has absolutely no power to help the people of Puerto Rico without congressional action? 

Mr. WEISS. Thank you for the question. 

The Administration has organized, led by the White House, an 

interagency effort, and we are part of that. There is a dedicated 

team at Treasury. There is also a dedicated team at HHS. We have 

been working closely with the Governor, with the legislative leadership. 

Senator WARREN. I am sorry. Just help me out a little bit on 

what ‘‘working with’’ means. I just want to understand what Treasury is doing to try to help out in these circumstances. 

Mr. WEISS. We have analyzed the finances of Puerto Rico. We are 

here to say today with no ambiguity that there is a liquidity crisis 

and that there is a fiscal crisis, and it is our strong belief that the 

most powerful way forward involves broader bankruptcy protection, 

as you stated, which would allow us to bring creditors to the table 

who would otherwise have no intention to enter into negotiations. 

Senator WARREN. Mr. Weiss, I will push on Congress to try to 

pass these bills, but frankly, I think Treasury needs to step up and 

show more leadership here. I agree with Treasury’s recommendations to Congress, but let us face it, in Washington sometimes 

things like this that sound good amount to just passing the buck. 

During the financial crisis when the banks were in trouble, 

Treasury did a lot more than just bail them out. Treasury stretched 

the limits of its authority to make sure that the banks stayed 

afloat. It helped broker deals between banks. It applied pressure to 

get parties to accept deals they may not have liked very much. It 

has done that in multiple other crises as well. 

Now the people of Puerto Rico are calling. They understand there 

is no bailout on the table for them, and they are not asking for one. 

After all, they are not a giant bank. But they are asking the Administration to do what it can to help broker deals, to stand up to 

the vulture funds that are pushing for a vision that is far at odds 

with the people of Puerto Rico and with all American citizens. 

Puerto Rico is not trying to protect its profitability. They just 

want to make sure that the families of Puerto Rico have a chance 

to build a future for themselves and their kids. I urge Treasury to 

be just as creative in coming up with solutions for Puerto Rico as 

it was when the big banks called for help. 

Mr. WEISS. Senator—— 

Senator WARREN. Thank you. 

Mr. WEISS. We—— 

The CHAIRMAN. I am sorry. We are going to have to adjourn. The 

vote is about to be closed, so we will stand adjourned for about ten 

minutes or until Members can get back. 

[Recess.] 

59 

The CHAIRMAN. I call this meeting back to order before the committee. We have got a little bit of a reprieve. The second vote is 

going to begin in about 10 or 15 minutes, so we will continue with 

the questioning and probably have to wrap it up by about five minutes after 12 p.m., or continue it, depending where we are in the 

process. 

With that, we will turn to Senator Hirono from Hawaii. 

Senator HIRONO. Thank you very much. 

Regarding Senator Warren’s line of questioning as to the Treasury being able to do more, I would share those sentiments because 

I think we need to do everything we can besides waiting for the 

legislation that would help Puerto Rico pass. That may take a 

while. I would like to echo her suggestion and her strong urging 

to Treasury that you be aggressive in doing what you can. 

In fact, I would like to ask Governor Padilla, do you think that 

Treasury is doing all it can to help Puerto Rico in this crisis situation? 

Governor PADILLA. Well, Senator, thank you for the question. 

And I want to be as comprehensive as you have been trying. 

Yesterday, Treasury and the White House put out a plan to 

make Puerto Rico, as you said, and it is a more comprehensive and 

ambitious one in my lifetime. I think that, since Kennedy, especially when Munoz was Governor, no one has addressed the issue 

as President Obama and Treasury yesterday. 

We can argue, for example, with HHS that they can fix Medicare 

right now, but what we cannot allow, Senator, is to let Puerto Rico 

struggle between the Hill and the White House with Congress arguing that the Administration should do more and the Administration arguing that we need to pass legislation. Maybe both are true, 

but Puerto Rico is in the middle. 

Senator HIRONO. Yes. My point is that it may take a while for 

Congress to act, considering what the circumstances and the environment here is. So short of Congress acting—and, yes, I totally 

agree that Congress should act on the bills that we have before us, 

but in the meantime, we would want to be assured that the Administration is doing everything it can to assist Puerto Rico. 

I have a question for Mr. Marxuach. 

Mr. MARXUACH. Yes. 

Senator HIRONO. In your testimony, you recommend that the extension of the earned income tax credit to Puerto Rican workers 

would be a very effective antipoverty program. It is that pretty 

much in the U.S. and all of the benefits of the earned income tax 

credit in promoting work, et cetera. 

So if implemented today—by the way, forgive me for not knowing, but would we have to pass legislation in order for Puerto Rico 

to qualify? Yes—— 

Mr. MARXUACH. Yes. 

Senator HIRONO.—that was yet another thing. 

Let us say that we did pass it, and if it passed, how long would 

it take? How soon would the benefits of the earned income tax 

credit accrue so that your economy and your debt situation could 

be improved? 

Mr. MARXUACH. Well, first of all, it depends when it is implemented, but assuming it is for the next—— 

60 

Senator HIRONO. Just say—— 

Mr. MARXUACH.—tax year, it would be pretty much immediate. 

I mean there are dozens of studies here in the United States that 

demonstrate that this type of refundable credit has a direct impact 

on consumption and on the welfare of the poorest families since 

they basically spend all their income. They have basically no 

money left over to save. So the impact in the short-term could be 

very significant, but as I mentioned in my testimony, it is only part 

of the solution. I mean it will help. You know, it is like a shot in 

the arm in the short-term, but we need to think also about the 

longer-term policies. 

Senator HIRONO. Did you want to add something, Governor? 

Governor PADILLA. Yes, Senator, just to make my point very 

clear on the previous question, there is no doubt that congressional 

action is needed, not to kick the can. If you want to kick the can 

a little bit, a few months, maybe a year, but to solve the problem, 

this is very simple. The ball is right now in Congress’s court. What 

we are asking is to throw the ball to our court. 

I want to solve the issue we began. We need to finish that job. 

Right now, the ball is in your court. Please, pass it to ours. We 

need to do the job. It is our problem. We need the tools to do our 

job. 

Senator HIRONO. I certainly get the sense of urgency that you 

have and that we all should share. 

Governor, in May 2014, you signed legislation that required the 

Puerto Rico Electric Power Authority (PREPA) to ensure that the 

electricity from fossil fuels be generated more efficiently. Have efficiency goals been met as a result of this legislation that you 

signed? 

Governor PADILLA. Let me give you just a little of background. 

When I was sworn in, we produced like 67 percent of our energy 

from oil. Now it is 54 percent, as Senator Sanders pointed out. 

When I was sworn in, energy was 31 cents per kilowatt hour; now 

it is 19. It is cheaper than in Hawaii or in the U.S. Virgin Islands. 

Puerto Rico is the offshore jurisdiction with cheaper energy than 

the United States. It is still high, 19 cents. 

But let me tell you why we got there. Did you know that a previous Governor took a loan addressing our GDP liquidity just to reduce the energy for the election period? That was amazing. That 

was incredible, and that was part of the problem. 

Yes, we are trying to add more renewables. We already signed 

for the building of 600 megawatts up to the amount of 3,200 

megawatts on renewables, but we need to finish the restructuring 

of PREPA that we already began or we are about to end successfully to allow the trust of the financial world to invest. But those 

are the right facts. Puerto Rico three years ago was at 31 cents per 

kilowatt. It is now at 19, and that is the reality of Puerto Rico. 

Senator HIRONO. Congratulations on that. 

Governor PADILLA. Thank you. 

Senator HIRONO. Hawaii, yes, we share certain common issues 

relating to reliance on fossil fuels. Thank you. 

Thank you, Madam Chair. 

The CHAIRMAN. Senator Wyden. 

61 

Senator WYDEN. Thank you, Madam Chair, and thank you, 

Madam Chair, for keeping this open as well. 

I want to see if for a moment I can take a bit of a longer view 

with respect to this challenge, and this really goes back to the days 

when I was the Chair of this committee and Senator Murkowski 

was Ranking Minority member. 

Let me direct this question if I might to you, Mr. Marxuach. To 

me, the central question if you are going to keep this from happening again, you have to resolve this issue of status. That, to me, 

is just basic. I see you are nodding your head yes, so let us kind 

of walk through a little bit of this. 

In November 2012, the Puerto Rican government held a local referendum on Puerto Rico’s political future. We noted, back again 

when I was Chair in August 2013, on that vote there was no dispute that a majority of the voters in Puerto Rico, 54 percent, clearly expressed their opposition to continuing the current territorial 

status. 

So at that hearing, I expressed my concern that the lack of resolution of Puerto Rico’s status not only distracts from addressing 

these huge challenges, it contributes to them. The President’s Task 

Force on Puerto Rico’s Status found that ‘‘identifying the most effective means of assisting the Puerto Rican economy depends on resolving the ultimate question,’’ which they called status. 

So it is still clear that, for Puerto Rico to get on top of these 

issues and really to achieve the full potential that all concerned are 

interested in, the issue has got to be resolved. Puerto Rico must either exercise full self-government as a sovereign nation or achieve 

equality among the States of the Union. Congress’s response to the 

2012 referendum, Congress responded to it by authorizing and allocating the funds for the first federally-sponsored status vote in 

Puerto Rico’s history. I am not sure that that has been fully appreciated, but the enactment of this law is, again, one of the important 

steps to get this resolved. It is my hope that the government of 

Puerto Rico will use this funding to conduct a federally-sponsored 

vote. 

A rejection of the current territory status by the voters of Puerto 

Rico leaves the Puerto Rico challenge with only two options: statehood under U.S. sovereignty or some form of separate national sovereignty. Once Puerto Rico does hold the vote, the Congress ought 

to respond in an appropriate fashion to implement the democratic 

desire of the U.S. citizens of Puerto Rico. So if you might, Mr. 

Marxuach, tell the committee a bit about how you see this question 

of political status, in effect, in suspended animation has harmed 

the economy of Puerto Rico. 

Mr. MARXUACH. Certainly, it has harmed the economy of a Puerto Rico. I am going to leave the political—— 

Senator WYDEN. I asked you about the economy. 

Mr. MARXUACH.—issue—yes. But economies are trained basically 

to deal with situations where they have to analyze and try to optimize a given event within certain restrictions. In the case of Puerto 

Rico, the restrictions have become overwhelming because precisely 

of this ambiguous status that we have that it is called Commonwealth. 

62 

You know, we are not a sovereign country. We are not a State 

of the Union. We have no authority to negotiate treaties, no access 

to emergency financing from multilateral institutions, no monetary 

policy instruments. We have limited fiscal policy tools, nominal representation in Congress, with all due deference to the commissioner 

here, and the U.S. Supreme Court has determined that it is constitutionally permissible to discriminate against Puerto Rico in the 

application of Federal programs as long as there exists a rational 

basis for doing so. So if you are trying to deal with an emergency 

or a crisis like the one we have now with no monetary tools, limited fiscal policy tools, and all these other political restrictions, it 

is almost an unsolvable problem. 

So yes, there are certain things we can do in the short-term to 

alleviate this situation, but eventually, if you are going to think alleviating to longer-term, you have to solve the underlying issue, 

which obviously is status. 

Senator WYDEN. Okay. I appreciate that point because I understand I missed some of the earlier discussion, and there was, as is 

the case in this committee, some fairly spirited debate. But what 

Mr. Marxuach has said—and I know it is not flashy and sensationalistic and will not drive this evening’s headlines, but the underlying question which I feel strongly about and Mr. Marxuach 

just confirmed, the underlying question is resolving the issue of 

status. If you do not resolve that issue, you are on a glide path for 

a threat that this could happen again, and no one wants to see 

that. 

I have to go back to the floor. I know one of the other witnesses 

wants to respond, I apologize for the discourtesy and perhaps—— 

Governor PADILLA. It is okay. I know you have a busy agenda. 

Senator WYDEN. Why do you not just go ahead? Please, if you 

could—— 

Governor PADILLA. Very briefly. 

Senator WYDEN. I apologize for—— 

Governor PADILLA. No, no, no, no. I appreciate your attention always to Puerto Rico, Senator. You are from Oregon, and we are 

glad that you are talking so much about us. 

First, this is a crisis that we need to solve now, and I want to 

highlight that. Second, we can address the issue of status. We need 

to address the issue of status, but we will not argue that the Illinois fiscal problems are due to an issue of status, or New York or 

Detroit or Orange County. We may say that statehood is a problem 

for Illinois, but we will not argue that. 

And I will urge the committee to take a look on the last report 

of Congress’s request from the GAO, information on how statehood 

will potentially affect Puerto Rico. 

Senator WYDEN. Let me do this if I might, because I will also be 

dealing with these issues, along with my colleague Senator Cantwell on the Finance Committee—— 

Governor PADILLA. I know. 

Senator WYDEN.—and there are a whole host of measures that 

come up there as well. Clearly, action needs to be taken to deal 

with a number of the challenges right away. But what happens in 

American politics and in American government is people always 

say, oh, let us respond here in the next 36 hours and we will call 

63 

it a day because we got it fixed. What Mr. Marxuach confirmed is 

essentially what I have been concerned about is that we could be 

back dealing with this again unless the issue of status is resolved. 

I look forward—— 

Governor PADILLA. Thank you. 

Senator WYDEN.—to working with all of you. 

Governor PADILLA. Thank you. 

The CHAIRMAN. Thank you, Senator Wyden. I think your point 

is certainly well taken. 

What we want to be able to do is not just address a short-term 

crisis. I think it is fair to say, whether it is a humanitarian crisis, 

as Mr. Weiss has used the terms, or financial crisis, fiscal crisis, 

we have a crisis. Several of the proposals I think that the Administration is proposing and I think that you, Governor Padilla, have 

put out on the table may deal with this in the short-term. 

But I absolutely concur with what Senator Wyden has said. We 

do not want to be back here as a committee or as a Congress several years from now in the same situation. We need to be looking 

to a longer-term solution. As probably one of the few—maybe I am 

the only one, I will have to check on it—Members of the Senate at 

least that was born in a territory, I pay keen attention to the situation in Puerto Rico and on the issue of status. 

Right now, what we are trying to do is figure out whether some 

of these short-term proposals are the fix that we need, and I think 

we have got a lot of work ahead of us. 

I also want to agree with what Senator Warren raised and what 

was reinforced by Senator Hirono, that what we are talking about 

here are proposals that the Administration has now put before 

Congress, and I think we all recognize that Congress sometimes, 

even in the midst of a crisis, takes a long while to work its magic, 

if you can describe it as magic. So everything that the Administration can be doing within its tool box needs to be pursued and considered. 

I do not know during the break, Mr. Weiss, if you had an opportunity to get a better handle on some of the numbers that I had 

asked you about in my questions, but I was able to get some information. Apparently, an energy analyst with the Height Securities 

report has provided a rough breakdown of the Administration’s proposal. The EITC, is estimated to cost about $1.5 billion in annual 

payments; the child tax credit, about $850 million; the FMAP to 

the Federal average would be about $2.8 billion; and the ballpark 

that is estimated again—and I am just giving you what I picked 

up over a Blackberry in the past half an hour or so, is about $5 

billion a year. 

If, in fact, we are in this ballpark, you need to understand that 

it is going to take Congress a while to work through some of these 

proposals. Attempting to identify an offset is something that we 

need to know that the Administration is going to be willing to work 

with us on because that will be a part of the hang-up here. 

That is a broad statement that leads to a response from you, Mr. 

Weiss, in terms of whether or not there are other administrative 

actions that you feel can be advanced at this point in time and if 

you feel that the proposal that you have laid out, that the AdminisVerDate Nov 24 2008 13:17 Jun 21, 2017 Jkt 098944 PO 00000 Frm 00069 Fmt 6633 Sfmt 6633 C:\HEARINGS\98944\C98944.TXT C98944
64 

tration has laid out, is somewhere in the ballpark of what this 

Height Securities report has advanced. 

Mr. WEISS. Thank you, Chairman Murkowski. And I would like 

to address the very fair comments made by Senators Hirono and 

Warren as well. 

Let me assure this committee that Treasury and the broader Administration will apply all of its efforts and all of our creativity and 

all of our resources to the resolution of this financial crisis, just as 

we have in past crises, and we will leave no stone unturned. And 

so we recognize that the Administration has a role to play alongside Congress in crafting these proposals and in making sure that 

Puerto Rico sees through this crisis and gets back on the path to 

growth. 

As to the costs of our proposals, I would like to highlight that 

bankruptcy involves no Federal funds. It costs nothing to the Federal Government. It is merely a means of bringing creditors to the 

table in order to achieve an orderly restructuring of liabilities. 

As to healthcare and the EITC, let me emphasize that we have 

introduced these two as principles, not as detailed legislation, and 

we would look forward to working with you and your staff and 

other Members of Congress as to how to bring this to reality in a 

fiscally responsible way. 

The CHAIRMAN. Okay. 

Mr. WEISS. We understand that this is a fiscally constrained environment, but at the same time, I need to highlight 1.6 million 

American citizens in Puerto Rico out of the 3.5 million population 

depend on Medicaid, and it is the lack of Medicaid that is also 

prompting some of them to leave the island. 

The CHAIRMAN. Understood. I do not mean to cut you off, but I 

am going to have to run to this vote because it is wrapping up also. 

I am also very cognizant of what this committee’s jurisdiction is, 

and as important as the Medicaid piece is, I know that other committees are going to be looking to address that. 

I wanted to ask a very quick question of Mr. Marxuach if I may 

because there has been a lot of discussion back and forth about the 

bondholders and gaining advantage and being paid 100 percent. Do 

you happen to have any idea what percent of the bondholders are 

actually Puerto Ricans? I have to imagine that they are not all outsiders who have no interest in what happens to Puerto Rico. 

Mr. MARXUACH. You are right about that. The number seems to 

change every week, I guess, but the latest figure we have here it 

is between 25 and 30 percent of all outstanding bonded debt is held 

by either Puerto Rico institutions or Puerto Rico investors. However, I have no way of verifying that. You know, this is a number 

that has been put out by some investment banks. But I personally 

do not have—I mean I cannot vouch for the validity of that, but 

that is the number that has been put out. 

Governor PADILLA. It is the same number that we have, Chairwoman. 

The CHAIRMAN. Mr. Pierluisi? 

Mr. PIERLUISI. And, Chairman, I would like to contribute. The 

best estimates that my office has obtained for the EITC, full application of EITC in Puerto Rico is roughly $500 million, so it is half 

65 

a billion dollars, not this number that you quoted from some other 

source. 

The CHAIRMAN. Well—— 

Mr. PIERLUISI. And child tax credit, full application of the child tax credit program, the number we have is roughly $150 million. 

And I agree with you, the challenge would be to identify an offset, 

but those are the best numbers I can provide you. 

The CHAIRMAN. I think part of what we are dealing with today, 

the Governor released his proposal, last week the Administration 

released their proposal. This is all new. It is out there on the table. 

There is a lot of assessment, a lot of analysis. There are going to 

be a lot of numbers going back and forth. 

This is why, at the end of the day, it really helps to understand 

what it is that we are dealing with, what are the true numbers, 

so whether it is what we have requested from the Governor and he 

has indicated we are going to see in the next couple weeks at least 

with the 2014 audited report, that is going to be important. It is 

going to be important that Treasury be able to rely on this. We 

need to have some keen understanding. I do not think that there 

is any disagreement that it is bad, but we also need to understand, 

again, if it is this bad, what are the costs that are associated—— 

Mr. MARXUACH. Madam Chairman—— 

The CHAIRMAN. Mr. Marxuach? 

Mr. MARXUACH.—if I may, in my extended written remarks that 

I submitted to the committee, I did take the time to look at the audits we do have from 2013 all the way back to 1998 and calculate 

what is called the primary balance for Puerto Rico. What that 

means in non-technical terms is how much money you have left before paying interest on your debt. And it is clear that at least, you 

know, during that period between 1998 and 2013, Puerto Rico ran 

a primary deficit. That is, we had a deficit before even paying the 

interest on our debt. 

So that essentially means that we are in a classic debt trap, 

what economists call a debt trap. You have to keep borrowing just 

to pay off the interest on outstanding debt. And when that game 

of financial musical chairs stops, you really cannot continue. And 

I think we have reached that point. 

I do not have the numbers for 2014, but I did take the effort to, 

as I said, calculate this primary deficit for Puerto Rico and it is 

submitted in the longer statement that I presented to the committee. 

The CHAIRMAN. We will all be looking at this, and it will not just 

be this committee, of course. It will be the other committees of jurisdiction: Judiciary and Finance. 

Again, I apologize that we are not able to give more time to this. 

Obviously, as I was speaking with Senator Cantwell, we could have 

continued this hearing well into the afternoon to probe deeper into 

it. 

But I appreciate all of you coming this morning and presenting 

the positions. We have much work to do. I think there is agreement 

that we must be working together to address the situation in Puerto Rico not only for the short-term, which is very precarious, but 

for the longer-term as well. There is so much material before the 

committee. 

66 

Thank you all, and we stand—— 

Mr. PIERLUISI. Thank you, Chairwoman. 

The CHAIRMAN.—adjourned. 

[Whereupon, at 12:06 p.m., the hearing was adjourned.] 

(67) 

APPENDIX MATERIAL SUBMITTED 

68 


Insert offset folio 37 here 98944.037

Ly.S Senate Committee on Energv and Xatural Resource8' 

Octo her 22, 2015 !fearing: Puerto Rico's Economy, Deht and Options jhr Congress 

Questions for the Record Submitted to Mr. Antonio Weiss 

Questions from Ranking Member Maria Cantwell 

Question 1: Would you please give the Committee more details on the consequences of 

Congressional inaction on legislation to stabilize Puerto Rico's financial conditions and 

ensure liquidity in the coming weeks. For example, I have heard reports of hospitals 

closing, and of electricity being cut off to critical facilities. Are these reports correct, and 

will there be risks to public safety in Puerto Rico in the coming months if Congress does 

not act? 

Answer: 

Deteriorating fiscal and economic conditions in Puerto Rico have increasingly complicated the 

delivery of core government services. Delays in health care reimbursements have forced many 

medical centers to close floors and eliminate specialized services, and, indeed, and at least one 

hospital shut down temporarily because of a failure to pay its bills. 

l recently joined Secretary Lew for a visit to San Juan. While there, we toured Eleanor 

Roosevelt Elementary School, where recent budget cuts have left the school unable to repair 

crumbling infrastructure and provide children with adequate school supplies. We then toured the 

Centro Medico de Puerto Rico, the primary medical center in Puerto Rico, where funding cuts, a 

lack of specialists, medication rationing and an influx of patients from other hospitals that have 

reduced services have made it difficult to treat patients. In the afternoon, we walked through 

Paseo de Diego, once a busy commercial area that has seen more than 80 percent of businesses 

close, and spoke to local stakeholders who shared their views on how the crisis has forced them 

to reduce services and close their businesses. 

Discussions at each stop focused on the real hardship already facing the residents of Puerto Rico 

as a result of this crisis, including escalating impacts on healthcare, legal and education services, 

and significant unemployment. 

The Administration believes this situation has already harmed the health, safety, and welfare of 

the 3.5 million Americans living in Puerto Rico. There is an urgent need for congressional 

action to address this crisis. 

In October, the Administration submitted a proposal to Congress that would establish an orderly 

process for Puerto Rico to restructure its debts, paired with independent fiscal oversight that 

respects Puerto Rico's self-governance. In addition, the Administration has proposed initiatives 

that improve health care policies and incentivize work to help solve Puerto Rico's longer-run 

challenges. 

Puerto Rico can and will emerge from the current crisis and return to growth, but only bipartisan 

action from Congress can provide Puerto Rico with the comprehensive tools needed to 

accomplish this. 
69 


Insert offset folio 38 here 98944.038

U.S. Senate Committee on Elwrgv and lv'atural Resource.v 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Option:s:JOr C'ongress 

Questions for the Record Submitred to Mr. Antonio Weiss 

Question 2: Is assigning oversight responsibilities to the Comptroller General as proposed 

by Resident Commissioner Pierluisi an approach you are open to? Or, do you have 

alternative recommendations for ensuring that structural reforms are implemented and 

effective? 

Answer: 

The Administration has been clear that any legislation to address the crisis in Puerto Rico must 

provide a workable, comprehensive restructuring authority and appropriate oversight that 

respects Puerto Rico's self-governance. In addition to these urgent tools to bring order to the 

current crisis, the Administration's proposal released last year would also address the longerterm issues facing Puerto Rico, such as rewarding work and supporting growth through a locallyadministered EITC and providing a long-term solution to Puerto Rico's historically inadequate 

Medicaid treatment. 

Question 3: Some members have expressed a concern that extending the full coverage of 

Chapter 9 of the Bankruptcy Code to Puerto Rico would unfairly impact average 

Americans who have pensions that are invested in Puerto Rico bonds. However, it is my 

understanding that pension funds have not held Puerto Rico debt since it was downgraded 

below investment grade because pension funds are required to sell such low-rated debt. 

Is that correct, or would extending Chapter 9 authority to Puerto Rico unfairly 

impact the pensions of average Americans? 

Answer: 

Any legislative solution must include restructuring tools for Puerto Rico that are comprehensive 

and workable. The legislation must allow the Commonwealth to restructure all of its liabilities 

and enable an orderly resolution to Puerto Rico's worsening crisis. The restructuring regime 

should fairly balance the interests of Puerto Rico and all its creditors. It should also safeguard 

Puerto Rico's capacity to fund its public pensions and pay retiree benefits. 

Monthly pension payments are the only source of steady income for many of the pension 

systems' 163,000 retirees. An additional 167,000 workers, who represent nearly 20 percent of 

Puerto Rico's workforce, are also counting on the pension systems for future retirement income. 

For much of the past decade, while workers paid into the system, Puerto Rico failed to pay its 

annual required contributions. As a result of this underfunding, pension system assets will likely 

be depleted by 2019, where all future pension benefits will then need to be paid directly from the 

Commonwealth's General Fund. This will require an additional $700 million to $1 billion of 

outlays per year. 

2 
70 


Insert offset folio 39 here 98944.039

[/.S. Senate Committee on Energy- and Satural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Deht and Optionsfi.Jr Congress 

Questions for the Record Submitted to Jfr. Antonio TVeiss 

Question 4: Some Members have raised concerns that the Administration, and Treasury 

specifically, could be using additional tools to respond to the crisis in Puerto Rico that 

would not require Congress to act. 

Would you describe the actions that Treasury has taken to date to assist Puerto 

Rico, beyond technical assistance, including any conversations with creditors 

regarding facilitating additional financing, acquisitions, or restructuring of Puerto 

Rico's debt? 

Answer: 

Treasury has a dedicated team devoted to evaluating Puerto Rico's fiscal outlook more closely 

and sharing our expertise with the local officials. The team has visited Puerto Rico regularly to 

review its financial data and offer our perspectives on how other entities have managed through 

similar crises. We meet frequently with the Governor, members of Puerto Rico's legislature, and 

local business and labor leaders. We also remain in daily communication with the officials 

managing Puerto Rico's fiscal response. 

The Administration remains committed to supporting Puerto Rico as its addresses its fiscal crisis 

and seeks to restore economic growth. However, Treasury has not identified any other 

administrative tools that it believes are sufficient to comprehensively address the crisis at hand. 

That is why Congressional action is essential to provide Puerto Rico with the tools it needs to 

manage through this crisis and restore growth. 

3 
71 


Insert offset folio 40 here 98944.040

U.S. Senate Committee on Energy and Natural Resources 

October 22,2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Governor Padilla 

Questions from Ranking Member Maria Cantwell 

Question 1: Would you please give the Committee more details on the consequences of 

Congressional inaction on legislation to stabilize Puerto Rico's financial conditions and 

ensure liquidity in the coming weeks. For example, I have heard reports of hospitals 

closing, and of electricity being cut off to critical facilities. Are these reports correct, and 

will there be risks to public safety in Puerto Rico in the coming months if Congress does 

not act? 

These reports are correct. Puerto Rico's insolvency is impacting essential public 

services on the island: suppliers are demanding that hospitals pay for medicine and other 

materials upon delivery; power at the Santa Rosa Hospital was temporarily suspended on 

because of past due utility bills; Puerto Rico's largest children's hospital has been forced 

to close down two wings and 40 rooms and reduce employees' hours and pay. Health 

services will continue to be under threat without a comprehensive restructuring authority 

that protects Puerto Rico from a disorderly default. 

Question 2: Is assigning oversight responsibilities to the Comptroller General similar to 

those assigned during the District of Columbia's financial crisis an approach you are 

open to? Or, do you have alternative recommendations for ensuring that structural 

reforms are implemented and effective? 

[Per email from Mr. Stayman dated May 19, 2016, the Committee requested that 

this question be dropped.] 

Question 3: What can the Federal government do to encourage PREP A's interest in and 

commitment to the adoption of new technologies, modernizing its equipment and making 

its operations more efficient? 

The first step is providing a bankruptcy regime that provides an orderly process to 

restructure PREP A's unsustainable debt burden. Once PREP A's balance sheet is 

restructured, credit support from the U.S. Government- e.g. Department of Energy 1703 

Program and/or USDA Rural Utilities Service program will be needed for PREP A to 

modernize its geriatric and fuel oil dependent infrastructure. 

Question 4: In 2011, the President's Task Force on Puerto Rico's Status found that "the 

calculation of Puerto Rico's GDP does not currently follow standards used for GDP for 

the rest of the United States," and that, "the current methodology has made it difficult to 

engage in short- and long-term economic planning that is critical for the Puerto Rican 

economy." The Task Force recommended that Puerto Rico Department of Economic 

Development and Commerce work with the U.S. Department of Commerce, Bureau of 

Economic Analysis (BEA), to update their statistical methods and develop their ability to 

produce accurate GDP data. 
72 


Insert offset folio 41 here 98944.041

U.S. Senate Committee on Energy and Natural Resom·ces 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Governor Padilla 

Would you please provide an update of these joint efforts and an estimate of when 

Puerto Rico expects to issue GDP figures based on statistical methods used by 

BEA and the rest of the U.S.? 

In September 2015, the Puerto Rico Planning Board ("PRPB") and the Puerto 

Rico Institute of Statistics ("PRIS") published the Road Map for the Modernization of 

Puerto Rico's National Accounting, a plan that describes a series of methodological 

milestones to implement the recommendations of the Task Force. At that time, the PRIS 

and the PRPB also initiated conversations with the BEAto secure technical assistance in 

order to execute the Road Map. 

Over the past few months, the PRIS and the PRPB have worked to implement the 

2016 milestones. In April, a high-level delegation from the BEA visited the 

Commonwealth to provide trainings on modern national accounting processes to the 

employees of the PRPB. As a result, the PRIS and the PRPB have taken stock of 

methodological improvements within the Commonwealth's reach. 

The Road Map also calls for the gradual implementation of several additional 

methodological changes needed to ensure Puerto Rico GDP statistics comply with current 

international guidelines, including: (i) the 2008 System of National Accounts of the 

United Nations adopted by the BEA for U.S. GDP statistics; (ii) reorganize Puerto Rico's 

current 5 national accounts into 7 accounts; (iii) develop a new forecasting model for 

Puerto Rico's national accounts; and (iv) publish full-set of quarterly national accounting 

statistics that is consistent with annual estimates. The PRPB and the PRIS have estimated 

that implementing the Road Map requires a $3 million annual investment over a 5-year 

period. The Commonwealth's Fiscal and Economic Growth Plan incorporated those costs 

as part of its financial projections and investments necessary to improve fiscal decisionmaking. 

As you know, Puerto Rico's exclusion from critical national datasets negatively 

impacts the quality and availability of statistical data about Puerto Rico. Congress should 

provide appropriate funding to include Puerto Rico in the 2017 U.S. Census of 

Governments, the National Agricultural Statistical Service surveys, and the Current 

Population Survey. Also, OMB and other appropriate federal agencies should conduct a 

comprehensive federal review of Puerto Rico's exclusion from other critical national 

datasets, such as the Job Opening Labor Turnover Survey, the American Time Use 

Survey, and the National Health Interview Survey. 

Question 5: Several reports have identified the poor quality and transparency of Puerto 

Rico financial information as a contributing factor in the current crisis. In fact, one report 

I received is that the majority of Puerto Rico's 84 agencies do not regularly report their 

basic financial information such as revenues, expenditures, and deficits to the local Office 

of Management and Budget. Please describe the current state of agency reporting 

2 
73 


Insert offset folio 42 here 98944.042

U.S. Senate Committee on Energy and Natural Resom·ces 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Governor Padilla 

requirements including significant problems with the quality and timeliness of the 

information they provide? 

What is the government's plan to improve the quality and transparency of 

financial data and what barriers exist to the full implementation of that plan? 

The Puerto Rico Office of Management and Budget ("PR-OMB") has direct 

access to the financial information of the agencies that receive appropriations from the 

general fund. These transactions are recorded in the Puerto Rico Integrated Financial 

Accounting System (PRIF AS). However, five departments-including education and 

health, which account for a considerable part of the Commonwealth's general fund 

disbursements-use a different version of the accounting system. This arrangement 

delays the recording of their transactions in PRIFAS, mostly due to interface problems 

between the different versions of the accounting systems. 

The delays in obtaining the necessary information to PRIF AS affects the decisionmaking process for policy stakeholders. PR-OMB and the Puerto Rico Department of 

Treasury are in the process of developing a single accounting system for all agencies. The 

new system will monitor expenditures on an integrated, timely and efficient manner. 

Question 6: The Krueger report recommended increasing the income tax rate for 

Controlled Foreign Corporations (CFCs) from 0 to 4 percent, up to 10 to 15 percent. The 

report estimated that this change would raise about $1 billion a year. However, the 

"Fiscal and Economic Growth Plan" does not include implementation of this 

recommendation. 

Why was this recommendation not adopted? 

Increasing the income tax for CFCs up to 10 to 15 percent would have an adverse 

effect on our capacity to attract investment and retain our industrial base. Although such 

an increase might boost revenues in the short te1m, these increases would be offset by 

larger and long-term declines in revenue as CFCs ship their operations and jobs overseas. 

For 2014, would you please provide a list of the major CFCs and for each: the 

approximate number of full-time employees these companies have in PR; their 

declared profits; and what they paid in corporate income taxes to Puerto Rico in 

FY 2014? 

Enclosed is a list of major CFCs in Puerto Rico that includes their respective fulltime employees. We are unable to provide declared profits and corporate tax payments 

for individual entities as such information is confidential under Puerto Rico law. Also 

enclosed, however, is a table that lists the amount of Act 154 companies as well as their 

total tax remittances for FYs 2011-14. 

3 
74 


Insert offset folio 43 here 98944.043

U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Governor Padilla 

Question 7: The Government of Puerto Rico has a program, under Act 22, to attract 

mainland investors to Puerto Rico through low tax rates. For example, one incentive is an 

exemption from the territorial tax on capital gains which was raised for long-term 

residents from 10 to 15 percent. I understand that the Government hired KPMG to make 

recommendations for reforms to Puerto Rico's tax system and that one of those 

recommendations was a repeal of this tax exemption. However, that recommendation was 

not adopted. 

Why was this recommendation not adopted? 

As explained in the enclosed "Commonwealth of Puerto Rico Tax Reform 

Assessment Project dated October 31, 2014 (the "KPMG Report"), KMPGwas tasked 

with preparing a holistic assessment of the Puerto Rican tax system. The Commonwealth 

commissioned the report in order to generate additional revenues and rationalize its tax 

system. KPMG developed alternative scenarios to create a simplified tax system that 

would provide additional revenues through a more streamlined and effective system. 

KPMG recommended that most existing tax expenditures be repealed or modified. The 

recommendations made by KPMG included lowering the individual income tax rate 

while making it applicable to a broader base, which would be offset by a 16% value 

added tax. The report included other recommendations that where not adopted, such as 

repealing preferential rates for capital income and the alternative minimum tax. 

With regards to Act 22, the KPMG Report failed to consider that the statute is a 

key element of the Commonwealth's economic development strategy. Continued 

outmigration coupled with the fiscal and economic crises have forced the Commonwealth 

to find new ways of attracting capital and diversifying its economy. Act 22 is part of a 

broader effort to transition into a knowledge services economy. And the Act has been 

essential in attracting capital to the island at a time of large deleveraging by the local 

banks and lack of access to the financial markets by the government. 

Based on the KPMG Report a proposed tax reform was introduced in the 

Legislative Assembly. The legislative process resulted in Act 72-2015, which was mainly 

intended to stabilize the Commonwealth's short-term liquidity needs and did not include 

a comprehensive tax reform. A broad tax reform that focuses on taxing consumption and 

incentivizes labor participation by rewarding work will be a critical part to the island's 

recovery. 

What are the government's estimates of the financial benefits to the insular 

economy of this program, and of the additional revenue that would be generated if 

these individuals paid the same capital gains tax rate, 15 percent, that is paid by 

longer-term residents? 

4 
75 


Insert offset folio 44 here 98944.044

U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Governor Padilla 

Most investment activities that would be subject to the 15% capital gains tax 

would not have been carried out in Puerto Rico without the incentives of Act 22. 1 The 

Department of Economic Development and Commerce published the enclosed 

"Act 20 & 22 Economic Impact Study" dated December 18, 2015 (the "DDEC Report"), 

which provides an overview of Acts 20 and 22. The DDEC Report concludes that Act 22 

has attracted more than $150 million in residential real estate and $650 million in 

commercial properties investments and $100 million in deposit inflows to Puerto Rico's 

banking system. Moreover, the DDEC Report estimates that activities related to Act 22 

have generated 2,483 direct jobs and 2,731 indirect and induced jobs. 

Question 8: The Government also has a program, under Law 20, to attract service 

providers from the States to Puerto Rico with tax exemptions and rate reductions with a 

corporate tax rate of 1-4 percent. I understand the local corporate tax rate has been raised 

from 30 to 39 percent. 

Please provide: 

1. The number of companies that participate in this program 

360 companies as of December 2015. 

2. The total amount of revenue they provided in 2014 

$896 million in gross income. 

3. The estimated number of direct jobs they have created. 

3,349 direct jobs. 

Act 20 is the backbone of our plan to convert Puerto Rico into a knowledge 

services hub. It was enacted to encourage the export of local services and promote the 

development of new businesses in Puerto Rico by attracting foreign capital. Act 20 also 

complements our strength as a high quality manufacturing location by attracting highvalue, knowledge-based industries by leveraging our position as a low-cost, high-skilled 

jurisdiction. 

When it was enacted in 2012 the economy had been contracting for over six 

years, the number of jobs los exceeded 125,000 and the prospects for a quick turnaround 

were minimal. Act 20 was modeled after Act 73-2008 and its predecessor industrial 

incentives laws that helped Puerto Rico become a manufacturing powerhouse. In fact, 

export services activities covered by Act 20 were eligible for incentives under Act 73 

from 2008 through 2012. During said period, the Commonwealth issued around 85 tax 

exemption decrees to companies providing services to foreign markets. 

1 Also note that individuals covered by a an Act 22 tax decree generate revenues bv paying Puerto Rico 

income tax on actiYe income (salaries and '':ages) and other taxes such as sales and usc and excise taxes. 

5 
76 


Insert offset folio 45 here 98944.045

U.S. Senate Committee on Energy and Natuml Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Governor Padilla 

Over 500 Act 20 applications have been received for the establishment of new 

export services operations in Puerto Rico, including the following industries: business 

process outsourcing, IT services, financial services, advertising and public relations 

services, engineering and architectural services, and research and development services. 

This has had a direct impact in the commercial real estate sector, the creation of direct 

and indirect jobs in the services industry, and the value of intangibles brought and 

developed in the island. Act 20 has attracted global companies like Infosys and 

Honeywell as well as helped local businesses export to foreign markets. 

I understand that KPMG recommended reforms to the Law 20 program. Would 

you briefly describe those recommendations and what action was taken on them? 

[Please see answer to Question 7 above.] 

Question 9: Puerto Rico's constitution provides that payments on bonds are guaranteed 

by the government and will be made from any available revenue before any other 

expenditure of the government. The Governor has said that the government's debts are 

"unpayable". 

Would you clarify whether the Governor is saying that these constitutionally 

guaranteed bonds will not be paid? 

According to Article VI, Section 8 of the Commonwealth's Constitution, the 

general obligation (GO) debt is afforded priority over other debt of the Commonwealth 

central government. Debt issued by other entities in Puerto Rico may or may not be 

impacted by this priority provision because such debt may be supported by other sources 

of revenue besides the central government. It should be noted that each provision of the 

Commonwealth's Constitution, like the U.S. Constitution, is subject in all cases to the 

right and obligation of the government to exercise its constitutional powers in order to 

defend and protect the security, health, education and welfare of the residents of Puerto 

Rico. In the event Puerto Rico's economic situation continues to worsens, it is unlikely 

that the Commonwealth will be able to honor all of its obligations as they become dueincluding debt service payments for GO bonded debt. As such, the responsibility of the 

Commonwealth to carry out this obligation will be given preference over even GO debt 

obligations. 

What amount of the $72 billion in debt is covered by the constitutional guarantee? 

Approximately $17 billion of bonded debt is GO or Commonwealth guaranteed. 

**** 

Enclosures 

6 
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Commonwealth of Puerto Rico 

Tax Reform Assessment Project 

Unified Tax Code of Puerto Rico: 

Tax Policy Implementation Options 

General Explanation of Principal Options 

October 31, 2014 
78 


Insert offset folio 47 here 98944.047

2.1 Revise Consumption Tax ........................................................................................ 1 

2.2 Excise Taxes 

2.3 Revise Individual Income Tax 

2.4 Revise Domestic Business Tax Structure 

..... 13 

. 17 

.............................. 30 

2.5 Revise Allocation of Business Tax Incentives ......................... . . ...................... 49 

2.6 Property Tax ............................................. . 

2. 7 Penalties .................... . 

2.8 Transition .... 

.. 59 

62 

·············· 65 

KPMG's role is limited to the services and deliverables articulated in the Contract for Professional 

Services dated March 18, 2014 as subsequently amended (the "Engagement Contract"). It is 

understood that any actions taken by the Government of the Commonwealth of Puerto Rico 

related to these services and deliverables may involve numerous factors that are outside of the 

Contract's scope. KPMG's services and deliverables cannot take such factors into account and, 

therefore, recommendations for such actions are not implied and should not be inferred from 

these services and deliverables. Further, while such deliverables may include analyses of certain 

legislative initiatives, no service described in the Engagement Contract and/or subsequent 

amendments will involve advising the Department regarding lobbying or other public policy 

advocacy activities related to legislation or regulation, including evaluating the likelihood of 

enactment of any proposed initiative or providing advice to the Department as to methodologies 

to ensure enactment. KPMG cannot undertake any role in connection with the Contract services 

that could be deemed lobbying, public policy advocacy, or impair the independence of KPMG as 

an auditor for the Department of the Treasury such as drafting legislation and engaging in 

implementation assistance. 
79 


Insert offset folio 48 here 98944.048

Overview 

This document addresses principal options with respect to changes to the existing consumption 

(sales and excise) taxes, individual income tax, business taxation, property tax and penalties. The 

discussion of the first three topics is organized as follows: Current Law; Reasons for Change; 

Description of Options; Analysis; and Revenue Effect The latter two topics are discussed more 

summarily. The "Description of Options" section for each tax generally sets forth a single option. 

In each case there are many other options that could be considered to achieve different revenue, 

distributional or economic goals. In general, those alternatives are discussed and quantified in 

the "Revenue Effect" section relating to each tax. 

2.1 Revise Tax to Provide a Goods and Services Tax (GST) 

A 6% sales tax is levied on every sale of a taxable item in Puerto Rico. 1 Further, a use tax is 

levied, at the same rate, on the use, storage, or consumption of a taxable item in Puerto Rico 

(collectively, the "IVU") 2 

The 78 municipalities also levy sales and use tax at the rate of 1% on the same tax base and with 

the same limitations- effectively bringing the sales and use tax rate to 7% 3 The municipalities 

also have the right to levy the tax on food. 

The sales tax is levied on all tangible personal property other than: 

Money; 

Certain vehicles and vessels; 

Certain petroleum products; and 

Electricity and water. 4 

The tax also is levied on all services and admission fees other than: 

Services rendered to a person in business (with the exception of certain defined services 

including bank charges, cleaning and laundry services, certain leasing of motor vehicles, 

telecommunication services, waste pickup services, security services, and certain repair 

and maintenance services); 

Services provided by the Government of Puerto Rico; 

Defined professional services and certain tax return services; 

Educational services; 

Certain financial services (including insurance services); 

1 PRIRC § 4020.01. 

2 PRIRC § 4020.02. 

3 PRIRC § 6080.14. 

'

1 PRIRC § 4010.01(gg). 
80 


Insert offset folio 49 here 98944.049

Healthcare services; and 

Services rendered by businesses with a turnover of less than US$50,000. 5 

There are a number of sales and use tax exemptions, which can be based on: 

The nature of the good or service being supplied; or 

The person by whom, or to whom, the good or service is being supplied. 6 

Key exemptions based on the nature of the good or services being supplied include: 

Taxable items sold for use or consumption outside of Puerto Rico; 

Taxable items introduced to Puerto Rico for a temporary period; 

Promotional material; 

Admission to school athletic events; 

Food and prescription drugs; 

Equipment for the disabled; 

Leasing of real property; 

Child care and elderly care services; 

Funeral services; 

Solar electric equipment; 

Certain healthcare equipment; 

Uniforms, materials and textbooks; and 

Items introduced into Puerto Rico as a result of transfer of a residence. 

Key exemptions based on the person by whom, or to whom, the good or service is being supplied 

include: 

Manufacturing plants on the purchase or raw material or equipment; 

Government agencies on the purchase of taxable items; 

Sales made by churches; and 

Certain sales made by manufacturers or wholesalers. 

A merchant may be relieved of the requirement to withhold tax on sales to merchants holding an 

Eligible Reseller Certificate7 

A manufacturing plant or eligible reseller may request an Exemption Certificate or an Eligible 

Reseller Certificate exempting it from the payment of the sales and use tax in respect of the 

purchase of items for sales to persons who may acquire the goods exempt from tax for sale as 

a non-taxable items, where the manufacturing plant or eligible reseller makes 80% of their sales 

to such persons8 

Any merchant who acquires goods for resale may request a Reseller Certificate, which will 

identify the reseller as able to claim a credit. A registered merchant holding a Reseller Certificate 

5 PRIRC § 4010.01(nn). 

6 PRIRC § 4030 01 to PRIRC § 4030.21. 7 PRIRC § 4020.07(d). 8 PRIRC § 4030.02. 
81 


Insert offset folio 50 here 98944.050

can claim a credit for sales tax paid on purchases of taxable items for resale9 This credit is limited 

to 75% of the tax liability reflected in the return. The Secretary has the authority to prescribe by 

regulation an increase or decrease in the percentage of credit that may be claimed. 

Where a credit exceeds the tax payable in a particular month, the credit may be carried forward 

until used in full. If the merchant can demonstrate that, due to the nature of the merchant's 

business, the credit will never be used, the Secretary may authorize a refund of the accumulated 

credits. 

Various other credits are available for items such as bad debts, merchandise returns, and 

purchases of products manufactured in Puerto Rico. 

Merchants are required to file monthly sales and use tax returns and make payments by the 

twentieth of the month following the month in which the transactions occurred. Further, Use Tax 

Returns on Importations are required to be filed by the tenth of the month following the month 

in which the importation took place. 10 

Merchants are required to file a single state return by entity. However, merchants are also 

required to file separate municipality returns by location. 

Sales and use taxes constituted 7.1 o/o of internal tax revenues in Puerto Rico. Excise taxes 

constituted 11.9% of internal tax revenues. In comparison, globally, all consumption taxes 

(including excise taxes) account for almost 31 o/o of revenue collected by OECD governments. 11 

GST type taxes typically account for 20% of total revenue. This indicates that Puerto Rico's 

current consumption tax regime taxes a narrower base than the global benchmark and that the 

tax system is more reliant on income and corporate taxes. Moreover, there are inefficiencies 

within the system that result in unrealized revenue and there is evidence of a large underground 

economy in Puerto Rico with sales tax evasion affecting all aspects of society. 

This evasion appears to be driven, in part, by the complexity of the current IVU and, in part, by 

the impression that the cost of compliance is greater than cost of evading, particularly due to 

reporting obligations in multiple municipalities. Further, the decentralized administration of the 

tax hampers decision making and gives rise to differences in interpretation of the tax base. 

The current sales and use tax base is relatively broad. Nonetheless, currently excluded goods 

and services and exemptions increase the complexity of the tax regime and cost of administration 

by raising inevitable issues associated with determining whether a particular good or service is 

exempt. The exclusions and exemptions narrow the base of the consumption tax, foregoing 

revenue and creating the potential for distortion of economic decisions based on the operation 

of the tax. 

The existing system often taxes business inputs even though the acquired goods are for business 

purposes. The inappropriate taxation of business inputs may result in the distortion of production 

decisions. The cascading of the tax through the supply chain increases the effective tax rate on 

consumers. 

9 PRIRC § 4050.04. 10 PRI RC § 4041.02 and PRIRC § 4042.03. 

OECD {2012), Consumption Tax Trends 2012: VAT!GST and Excise Rates, Trends and Administrative Issues, OECD PubliShing, 

p. 11. 
82 


Insert offset folio 51 here 98944.051

A credit system for goods acquired for resale requires the carrying forward of credits, which can 

create cashflow burdens. Further, the discretionary power in the Secretary to refund tax where 

merchants can demonstrate they will be in a regular refund position creates uncertainty. 

The existing system is overly burdensome for taxpayers. It is estimated that the sales tax 

compliance rate is in the neighborhood of 56%, an obviously unacceptable number. While the 

elimination of the requirement to file sales and use tax returns by location rather than by entity 

has simplified the compliance process to a certain extent, the requirement to file separate 

municipality returns and use tax returns for imports imposes significant compliance costs. The 

inconsistency between the municipalities in the administration of the tax, combined with a lack 

of information sharing between the municipalities and Department of Treasury, hampers decision 

making and gives rise to differences in interpretation of legislation. For example, there are 

inconsistencies in determining the point in time a merchant is considered to have commenced 

trading upon first sale, first payment of payroll, or upon laying the first stone of the 

establishment. 

The existing consumption tax structure could be replaced by a broad-based single rate Goods 

and Services Tax ("GST") with regressivity relief accomplished through direct transfer payments. 

Financial services, residential housing, water and electricity would be exempt. Certain goods and 

services subject to excise tax could also be exempt. (See excise tax discussion below.) 

Businesses below a certain level of receipts, for example $75,000, would not be required to 

register. Regressivity relief would be calculated to assure that households below a specified 

income level would not incur any additional tax burden under the new system. All consumption 

taxes would be collected and administered at the Commonwealth level and proceeds distributed 

to the municipalities from a dedicated fund pursuant to a revenue sharing formula 

GST, also known as Value Added Tax ("VAT"), is recognized as the most efficient consumption 

tax both in terms of revenue for governments and neutrality towards domestic and international 

trade. It is the most common consumption tax utilized today. Over 150 countries and 33 of the 

34 OECD countries have implemented some form of GST. 12 Its recognized capacity to raise 

revenue in a neutral and transparent manner has contributed to its virtually universal adoption. 

A broad based GST with a single rate minimizes compliance cost and, from an economic 

perspective, is the best policy choice. 13 From an efficiency perspective, a moderate GST rate 

with a broad base and few exemptions is preferable to a higher rate with exemptions. 

The move to a GST would lead to enhanced compliance and revenue when compared to current 

law. The tax rate would be a function both of revenue needs and the desirability of using 

consumption tax revenues to reduce the tax burden in other areas, particularly the individual 

income tax, or to replace revenues lost through repeal of existing provisions, such as the Patente 

Nacional. 

12 OECD (2012), Consumption Tax Trends 2012: VAT!GST and Excrse Rates, Trends and Admmistrative Issues, OECD PubliShing, p. 

28. 

OECD (2012), Consumption Tax Trends 2012: VAT/GST and Excise Rates, Trends and Admimstrative fssues, OECD Publishmg, p. 

73. 
83 


Insert offset folio 52 here 98944.052

The key features of the GST system would be: 

A single rate; 

GST on goods and services and on importation; 

GST relief for exported goods and services; 

Limited exemptions (i.e., financial services, residential accommodation, water, electricity 

and perhaps certain goods and services subject to excise tax)); 

Low compliance costs for businesses and government; 

Neutrality between businesses; and 

Transparency in respect of its administration. 

GST has a significant number of benefits over single stage consumption taxes. GST is charged 

at each leg of the supply chain, with a credit provided where the item has been purchased for 

business purposes, until the item is purchased by the final consumer who bears the ultimate 

burden of the tax. As GST is collected at various stages along the supply chain, rather than at a 

single stage, it is a more robust tax when it comes to revenue protection. This permits a lower 

rate, which in turn reduces the incentive for evasion. 

Further, a GST is a relatively self-enforcing tax. A GST has formal invoicing requirements. In the 

absence of a valid invoice, a purchaser is unable to claim a tax credit. This creates an incentive 

for a purchaser to request an invoice. These invoices create an auditable paper trail. Also, due to 

the invoice-credit nature of the tax, transactions should appear on both the supplier's and the 

purchaser's tax returns, therefore providing better opportunities to detect evasion. Further, the 

tax authorities have a record of a taxpayer's purchases through the credit mechanism. This 

enables tax authorities to estimate what a reasonable level of sales should be. This is particularly 

useful at the retail level where there may not be a purchaser claiming a credit that would allow 

the matching of transactions. 

Finally, GST is more conducive to growth than direct taxes because it is a business neutral tax 

that does not distort economic choices. 14 By definition, a GST exempts from taxation the normal 

rate of return on an investment, thus eliminating the "tax wedge" in investment decisions. A 

broad based GST applied at a single rate is economically efficient because it does not distort 

consumer spending and saving choices or the allocation of capital. In addition, because exports 

are not taxed, but imports are, a GST system does not discriminate between foreign and 

domestic products. 

2.1.4.1 Exemptions 

This topic is discussed in detail in Appendix E. 

Exemptions increase the cost of collection (administration costs for the government and 

compliance costs for businesses). There are frequent disputes over which goods and services 

are included in the tax base. Exemptions also create political pressure for other 

businesses/industries requesting exemption. 

Jens Arnold, Bert Brys, and Laura Vart1a, "Tax and Economic Growth," OECD Econom1cs 

pp. 42-45. Jul. 11.2008, ECONVKP 12008)28, p. 18. 
84 


Insert offset folio 53 here 98944.053

Exemptions may also affect business decisions. Under a GST, suppliers making exempt supplies 

cannot claim credits or refunds for GST paid on their purchases. This creates an incentive to 

self-supply or vertically integrate rather than incur GST charged by third party suppliers. 

Finally, a business that makes both exempt and taxable supplies may need to make complex 

calculations to determine how much GST it has paid on its purchases related to taxable supplies 

and can therefore be claimed as a credit or refund. 

Consequently, any exemptions that are adopted should be carefully considered from a policy 

perspective and what they are intended to achieve. Ebrill et al 15 state "Exemptions are abhorrent 

to both the logic and the function of a VAT" as they narrow the tax base, result in taxation of 

business inputs, distort business decisions and result in tax cascades. 

The majority of the currently existing exemptions would be eliminated. Food, education, 

healthcare, water, electricity and items currently subject only to excise tax are likely to be the 

most sensitive areas from a political and public relations perspective. 

Rather than providing exemptions for food, education, and healthcare, regressivity issues related 

to the GST should be addressed by cash transfer payments to a defined class of taxpayers to 

eliminate the tax burden associated with the purchase of these necessities. Exemptions relieve 

all purchasers from the burden of the tax and therefore can be costly from a revenue perspective. 

Indeed, uniform application of the tax across all income levels should provide sufficient revenue 

to finance regressivity relief to the lowest income levels. 

New Zealand is a good example. The evidence available at the time of introduction suggested 

that while the bottom 20% of households allocated between 23% and 29% of their budgets to 

food, the top two deciles spent between 7% and 10% of their budgets on food. However, overall, 

upper income households spent twice as much as low-income households. Of every NZ$100 

spent on food in New Zealand, the least well off spent NZ$6.50, whereas the most wealthy spent 

NZ$12. Thus, taxing all food made revenue available to redistribute and supplement the income 

of the poor. 16 

Some jurisdictions exempt healthcare and education to ensure there is no competitive distortion 

between education or healthcare provided by the public and private sectors. While such 

exemptions can effectively result in subsidizing those sectors, they create significant 

administrative difficulties in determining which goods or services should fall within the 

exemption. 

The treatment of water and electricity is a special case in Puerto Rico. The pre-tax cost of both 

of these commodities is already extremely high and subjecting them to an additional GST tax 

would impose unacceptable additional costs on consumers. As both are supplied by government 

authorities and are not in competition with the private sector, the exemption of these types of 

supplies is manageable. 

Similarly, there are a number of goods and services that are currently subject to excise taxes but 

not IVU. The receipts from a number of those taxes are dedicated to particular uses and in four 

cases are pledged to secure revenue bonds. If the threshold decision is made to eliminate double 

taxation of these items the question arises as to whether that should occur by subjecting them 

to GST and reducing the excise tax or exempting them from GST and keeping the current excise 

Ebnll et al, The Modern VAT. International Fund, 2001. 16 lan D1ckson and Oav1d White, Insights the New Zeafand Goods and Services Tax Model, Work1ng Paper Senes, 

Work Paper No. 60, V1ctona Apr. 2008, p 6. 
85 


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tax. In the case of excise taxes that are pledged to secure revenue bonds the least burdensome 

alternative could be to exempt those goods and services from excise tax. 

2.1.4.2 Regressivity Relief 

The practical and political key to acceptance of a broad based GST is the provision of adequate 

relief from the regressive nature of the tax. "Adequate" is not a self-defining term. The 

appropriate level of relief is a policy decision that is informed by a desired distribution of the tax 

burden. But no matter the ultimate outcome, it is generally agreed that certain levels of household 

income (a policy decision determined by elected officials) should not bear tax on their purchase 

of necessities (also a policy decision determined by elected officials). 

As an empirical matter, to the extent data exist by household income levels on consumption of 

specific items (such as food, housing, medicine, education), it is possible to mitigate the 

consumption tax burden rather precisely by a cash payment to the taxpayer. The cash payment 

can either be a payment based on taxes paid on actual amounts spent by the taxpayer or can be 

calculated in bands using average consumption by income level. The distribution goals can be 

attained by adjusting the payment to those households. Using a precise calculation requires an 

extensive system to monitor (both from a technology and manual operational perspective). 

The question then arises as to how the relief is to be delivered and what systems exist to ensure 

that it is being delivered only to those entitled to receive it. The delivery system can be 

accomplished using one or some combination of the following: 

Direct disbursement to households; 

Tax Credits; and 

Electronic Benefit Transfer System. 

Historically, payments have been in the form of checks or warrants. This system is more 

expensive than other options. The distribution of checks requires a mailing address which is 

problematic for some people in the lower socioeconomic strata. If a mailing address is not 

practical, it requires the taxpayer to physically go to a government location to obtain the check. 

Furthermore, the lower socioeconomic strata tend to be disproportionately underserved by the 

banking system, which results in high fees paid to check cashing establishments. Thus this 

disbursement option tends to be costly to administer, inconvenient to the taxpayer and may 

provide a lower net benefit to the taxpayer. 

A second option to deliver the regressivity payments is to provide a tax credit. This can be done 

either by using the income tax system or at point of sale for sales taxes. Using the income tax 

as a basis for the payments is generally done on an annual basis. The delay in relief for most 

recipients would require them to pay the tax and wait for up to a year for reimbursement. The 

same delay would occur if the credit were refundable. Thus, this method would not provide timely 

relief. While this option could be cost efficient for the Commonwealth, it will be 

counterproductive for the intended purpose of the regressivity payment system. 
86 


Insert offset folio 55 here 98944.055

Recently, payments have migrated to an electronic funds transfer. In the case of government 

disbursements, payroll and other disbursements are increasing done via ACH payments or direct 

deposit. In the case of benefit payments, the disbursements are increasing using an Electronic 

Benefit Transfer system or EBT Card. The EBT cards are less costly to administer (prepare, 

distribute and account for), provide timely benefits through online management and provide 

increased ability to track, control and potentially monitor usage. An electronic benefit system can 

also increase and standardize customer service by reducing the taxpayers need to interact with 

the limited operating hours of government operations in a finite number of locations. The EBT 

Cards and potential increased customer service hours assist the taxpayers by limiting the 

interference with their workplace requirements. 

The above analysis indicates that the best option for the regressivity payment system is an 

electronic benefit system. The Puerto Rico Department of the Family currently administers an 

EBT system to issue health, human and social cash benefits to eligible participants via a 

magnetically encoded payment card. Key programs included in the EBT system are: Nutritional 

Assistance Program (NAP), Temporary Assistance for Needy Families (TANF), child support and 

child welfare payments, and other human and social programs. A recipient may have one EBT 

card, with multiple benefit types, or accounts, associated to an EBT card depending on program 

type and eligibility. 

Eligible recipients use their EBT card to make purchases at approximately 6,000 certified 

participating retailers in Puerto Rico. Cash benefits may be used to purchase items at a 

participating retailer, as well as to obtain cash-back or make a cash withdrawal from a participating 

ATM machine. 

Once eligibility and level of benefits are determined, information is transferred to the 

Commonwealth's EBT contractor and an account is established in the recipient's name, and 

benefits are deposited electronically in the account on a specified frequency each month. A debit 

card, similar to a bank issued debit or credit card, is issued and a personal identification 

number (PIN) is assigned or chosen by the recipient to give access to the account. 

The Puerto Rico NAP program provides for up to 25% of the benefits in cash that can be legally 

spent at any retailer and the remaining benefits must be spent for the purchase of food in certified 

retailers. Puerto Rico has approximately 670,000 families (approximately 1,300,000 recipients) 

receiving benefits totaling approximately $133,000,000 in monthly benefits in EBT card 

payments. The two primary EBT cards in Puerto Rico are the Family Card (NAP and T ANF 

accounts) and the Unica Card (child support and other programs). Each health and social program 

has a unique account on the EBT card. A recipient eligible for more than one program may have 

multiple program accounts on the same EBT card. Programs may have different allowable costs, 

program requirements or compliance accordingly to federal and/or local laws. 

The Department of the Family contracts with the Government Development Bank (GOB) and 

EVERTEK to administer the EBT system. The GOB is responsible for batch processing, account 

settlements and reconciliations, reporting, a 24 hour-7 day a week customer service help desk 

for beneficiaries (assistance from EVERTEK) and maintains a web-portal with account information 

for beneficiaries. EVERTEK is the ATM provider and handles the electronic transfers for individual 

accounts on the EBT cards. 
87 


Insert offset folio 56 here 98944.056

Hacienda is positioned to deliver regressivity relief by leveraging the existing contracts and 

Memorandums of Understanding (MOUs) with the GDB and EVERTEK. Regressivity relief is an 

extension of existing government assistance programs. The GDB began conducting a financial 

analysis of the cost to issue payments via check, ACH and electronic benefits. There may be cost 

efficiencies through the creation of a government card, which could include regressivity relief 

payments as well as tax refunds, if applicable. 

States such as Georgia, Oklahoma, South Carolina, New York and Connecticut have implemented 

an electronic benefit system for government payments, including tax refunds. 

Because of the scale and scope of the project, Hacienda should undertake a robust Enterprise 

Architecture project. The Enterprise Architecture will enable Hacienda to expand the current EBT 

system to fit the specific requirements, benefits and outcomes for regressivity relief payments 

to eligible participants. Enterprise Architecture helps reduce and manage the complexities of a 

transformational project that will link the tax administration business processes and organizational 

alignment with information technology system requirements and security to effectively and 

efficiently deploy a regressivity relief electronic benefit system. 

There are four key reference models in the KPMG Enterprise Reference Architecture (KERA) to 

address the architectural domains at a strategic level: 

1. Capability Model The Capability Model is the business and application domain 

reference model which provides the foundation for Hacienda stakeholders to gain 

understanding of the business-centric view of the organization, goals and processes. Also 

the Capability Model facilitates prioritization of business or system capabilities specific to 

initiatives and prioritized scope for transformations 

2. Software Services Model - The Software Services Model is the application domain 

reference model that provides a set of software functions to be aligned with models in 

other architecture domains. Also, it assists in determining the functional scope of 

information systems needed for identifying the current EBT system software, legacy 

system gap assessment, application portfolio rationalization assessment and potential 

vendor software fit-gap assessment 

3. Conceptual Data Model -The Conceptual Data Model is the data domain model that 

describes the data to be shared by business processes (across departments, agencies or 

other entities) and facilitates the semantic interoperability requirements between 

organizations and supporting IT system 

4. Deployment Model - The Deployment Model is the technology and security domain 

reference model that outlines the software, security zones, components and services 

KERA has been applied and deployed successfully on engagements to accelerate the planning, 

design and delivery of a transformation initiative. The KERA toolkit focuses on mitigating potential 

challenges using four elements: 

Scoring - Scoring focuses on client specific assessments. Tasks include reviewing 

high-level functional requirements (as outlined in a tax administration deliverable), IT 
88 


Insert offset folio 57 here 98944.057

fit-gap {legacy IT and other Department solutions) and an application portfolio 

rationalization. 

Modeling- Modeling focuses on the client specific blueprints. Tasks include reviewing 

targeting operating models (as outlined in tax administration deliverables), business and 

systems architecture, elaborating business and system requirements. 

Prioritizing - Prioritizing focuses on client specific roadmaps. Tasks include reviewing 

client strategic plans, prioritized list of business and technology requirements and 

associated business cases. 

Costing - Costing focuses on client specific transformation estimates. Tasks include 

initial scoping estimates and release specific funding estimates. 

Benefits 

Implementing KERA allows Hacienda to take one step closer to fulfilling the goals of Tax Reform: 

designing a more equitable tax system for all Puerto Ricans. Additionally, the Treasury will be 

equipped with a state of the art delivery system that includes: 

Integrated set of reusable tools, reference models and methods and courseware to 

support the design, planning, budgeting and implementation of a large tax design 

transformation 

Rigorous approach to the address complexities and challenges associated with IT-enabled 

transformations 

Business process mapping to prioritize requirements 

Leverages existing target operating model (TOM) elements within the Tax Administration 

work stream deliverables as a foundation for requirements 

Enables key stakeholders ability to provide emergency relief, if needed 

Policy and Implementation Decisions: 

Ultimately the rate and delivery vehicle for regressivity relief must be made by the 

Commonwealth's leadership. Decisions must be made regarding the regressivity payment 

frequency and whether the new system will be directly linked with existing EBT cards for 

alternate programs. Legal opinions regarding the ability to tax necessities will be required and 

potential support from other Federal agencies should be assessed. A policy decision concerning 

the extent or level of regressivity relief (income level and eligibility requirements) must be 

reached. Finally, eligibility and compliance monitoring systems must be created and 

implemented. 

2.1.4.3 Non-taxation of Business inputs 

Under the current IVU business inputs are often taxed where goods are not acquired for resale. 

A consumption tax should not tax business inputs or intermediate business transactions. The 

taxation of business inputs can result in the distortion of production decisions (potentially creating 

an incentive for vertical integration) and the cascading of the tax through the supply chain 

increasing the effective tax rate imposed on consumers. 

From an operational perspective, the GST will be very similar to the current IVU with credits being 

provided for business acquisitions. The two key differences will be: 
89 


Insert offset folio 58 here 98944.058

A full credit will be given for all goods or services acquired for business purposes rather 

than only for goods acquired for resale or manufacturing; and 

Excess credits will be refunded rather than be carried forward. 

A poor refund system can do significant harm to taxpayer acceptance of the tax and voluntary 

compliance. Failure to refund excess credits timely undermines the core principal of a GST -

intermediate transactions between firms should not bear a GST cost. 17 It will also undermine the 

neutrality of the tax as business decisions will be influenced by the GST cash flow costs they 

may face. Therefore, it will be essential to ensure robust processes are in place to facilitate timely 

issuance of refunds. 

2.1.4.4 Municipalities 

The current structure with respect to municipalities is unnecessarily complex. However, the 

municipalities rely extensively on the revenue from this source. Consequently, any changes to 

the existing system have to accommodate that reality. One option is to centralize collection of 

the GST at the Commonwealth level and create a dedicated fund of some portion of the receipts 

to be distributed according to a pre-determined revenue sharing formula. 

The revenue and distributional effects of a GST depend upon a number of principal factors: the 

tax base, tax rate, amount of regressivity relief and the compliance rate. The first set of tables 

below show the results of a 16% and 14% GST with exemptions for financial services, residential 

housing, water, electricity, fuel and hotel occupancy, appropriate regressivity relief, a small 

business registration level of $75,000 and a compliance rate of 75%. The second set of tables 

show the distributional effects of the two different tax rates. 

(Loss'of Revenue frorr) !VU) ($1,150) 

'Ibid 

taw. G"sm, 7sm. ebm~l•m~" 

l$1;150) 
90 


Insert offset folio 59 here 98944.059

Distribution of GST Burden (14% GST) 

Distribution of GST Burden (16% GST) 
91 


Insert offset folio 60 here 98944.060

The final table shows the revenue effect of exempting food, medicine, medical services and 

education from the GST base. 

tax all,gOofis,~nt:FserVICe$ Sxcep(water, 

electricity, fuel and (\otet occupat\Cy. ($75K SBEJ . . ... 

2.2 Excise Taxes 

Excise tax receipts (excluding Law 154) for the fiscal year ending June 30, 2014 were $1.38 

Billion, of which $919 Million was committed to the General Fund. 

The provisions of Subtitle C of the Puerto Rico Internal Revenue Code of 2011 govern the 

imposition and administration of the excise tax regime in Puerto Rico, which also includes certain 

taxes on gambling and the levying of license fees on certain wholesalers and retailers, Subtitle C 

levies an excise tax on the sale, consumption, use, transfer or acquisition in, or the introduction 

into, Puerto Rico of the following articles 18: 

Locally manufactured and imported cement; 

Sugar; 

Plastic products; 

Introduction or manufacture of cigarettes; 

Gasoline; 

Aviation fuel; 

Gas oil; 

Diesel oil; 

Crude oil; 

Unfinished oils, oil byproducts, and any other hydrocarbon mixtures (excluding natural 

gas); and 

Motor vehicles. 

The tax is only paid once and the rates are specific to the particular article. 

18 PRI RC § 3020.01. 
92 


Insert offset folio 61 here 98944.061

The rates are as follows: 19 

--"·~~----~--~-~~~~-~------~-

6 cents for each hundredweight or fraction 

thereof. 

14 cents on each pound or fraction thereof. 

6.6 cents of the taxable price in Puerto Rico on 

specified plastic products that do not meet certain 

standards. 

$16.15 on every 100 cigarettes or fraction thereof 

($17 from July 1, 2015). 

16 cents on each gallon or fraction thereof. 

3 cents on each gallon or fraction thereof. 

4 cents on each gallon or fraction thereof. 

8 cents on each gallon or fraction thereof. 

$9.25 per barrel or fraction thereof (subject to an 

annual inflation adjustment). 

$750 to 40% of the taxable price of the vehicle 

depending on the value and age of the vehicle. 

17% of the taxable price of the vehicle. 

20% of the taxable price of the vehicle. 

10% of the taxable price of the vehicle. 

6.6% of the taxable price of the vehicle. 

7% on the suggest retail price or cost respectively. 

$1.00 per pound of chewing tobacco or fraction 

thereof. $3.02 per pound of snuff or fraction thereof. 

The sections setting out the rates of excise tax also include a number of exemptions (e.g., certain 

ambulances, cigarettes for export and certain types of fuel when acquired by certain businesses 

are exempt). 

19 PRI RC § 3020.02 to § 3020 09 
93 


Insert offset folio 62 here 98944.062

Excise tax is required to be reported as follows: 20 

Every importer is required to submit an excise tax statement on all articles introduced 

from abroad at the time of the payment of the excise taxes; 

Bonded dealers introducing vehicles, vessels or heavy equipment need to file an excise 

tax statement no later than 10 days following the taking of possession of those vehicles; 

For merchandise introduced by mail or air carriers, the excise tax statement must be filed 

no later than five days following the taking of possession of the merchandise; 

Merchants who introduce taxable items subject to use tax must include the excise tax 

information in the monthly use tax filing, where those merchants have given the required 

deposit; and 

A bonded importer or manufacturer of articles subject to excise tax should file a monthly 

return no later than the 1Oth day of the month following the date of the introduction or 

manufacture of such articles. 

A number of exemptions or reliefs exist (subject to certain conditions), including: 21 

A refund on a portion of the excise tax paid on certain vehicles powered by alternative or 

combined energy; 

Articles in transit, for export or returned to Puerto Rico; 

Vehicles for public transportation; 

Vehicles acquired or introduced by consular officers and employees; 

Specially modified vehicles acquired by handicapped persons; 

Certain vehicles acquired by churches; 

Vehicles acquired for donation to the Puerto Rican Police and Municipal Governments for 

police related work; 

Raw materials and certain equipment acquired for manufacturing processes; 

Limited amounts of cigarettes for travelers and cigarettes sold to foreign flagged ships; 

Articles sold in air and maritime terminal stores to persons leaving Puerto Rico; 

Certain vehicles for non-profit charitable institutions; 

Articles acquired by government agencies for official use; 

The introduction of vehicles by persons in government service who have been transferred 

to Puerto Rico; 

Contaminated gasoline or diesel oil; 

A refund of 11 cents for each gallon of gasoline which has been used in sea and air travel 

between Puerto Rico and foreign destinations; and 

Ships used to provide towing or bunkering services. 

Subtitle C also levies a tax of 10% on certain gambling winnings obtained in banks and 20% on 

all winnings from pools, betting against the bank, daily doubles, and subscription funds or from 

any other betting transactions legally authorized on the racetracks of Puerto Rico. 22 

20 PRIRC § 3020.10. 

21 PRIRC § 3030.03 to§ 3030.21. 

PRIRC § 3040.02. 
94 


Insert offset folio 63 here 98944.063

Further, this Subtitle levies a five cent tax on each betting slip, 15 cents on each daily double, 

exact, betting against the bank and any other bet legally authorized, and 25 cents on each bet on 

a game of checkers made at a horse racing agency. 23 

Finally, this Subtitle levies annual license fees on wholesalers and retailers of goods subject to 

excise taxes, arms dealers, alcohol retailers, certain coin operated machines, operators of 

free-port stores, and on sea, air and land carrier business. 

A room tax of 9 or 11 percent is levied on hotel rooms depending upon whether there is a 

"casino" associated with the hotel. 

The following table shows receipts and uses of the excise and room taxes. 

Excise and Room Taxes Revenues for the year ended June 30,2014 

Tobacco Products 

Petroleulll Produc:\s Uet Fuel) 

MotorVetm:los 

Hon~os R;>r:!-lcS 

lnsurdncePronmuns 

Cen1ent 

SlotMuchmes 

Other Exc1se T axos ~ ma111!y PVC Products 

Sugilfi>ndCo!!oe 

Petroleum Products 

Gasolino 

DieselandGas01I 

30.376 00 

4,04200 0.00 

392.04300 000 

16,35400 000 

112.64200 000 

71600 000 

2Hl1000 000 

3/18900 10200 

000 8.33300 

000 255.59000 

4.04200 

392,0.13 00 

16,35400 

42.64200 

716.00 

21,91000 

3.68100 

8.333 00 

255,59000 

Special Fund or Public Corporation Name 

Office ot $P.rv1ces to Forrner Governors anct 5 Public Corp 

AgnculttrraiD<cvoloprnontFund 

AgnculhJr,11 Development Fund 

PR Highw;>y Atlthon!y\Pied~Jed fm Revomw Bo11tls) 

0 00 156,018 00 15GD18 00 PR HJ!)hway Atlthon\y(Pioduf;,d for RcvontJO Bonds) 

__ 0_0_0 _ 10210 00 10,210 00 PR Hlt~hway .4uthori!y\PJod(JeiJ tor Revenue Bondsl 

Totdl Exc1se Taxes 918.846 00 <160.719 00 1.379,565 00 

RoornTaxos __ o_oo__ G5.G42 oo 

-7S~=;;._~ 

Only alcohol and tobacco are subject to the current IVU/IVA regime. All the goods and services 

listed above would be subject to the GST if it is implemented as described in the preceding 

section. Thus, those goods and services currently exempt from the IVA/IVU regime would be 

subjected to a significantly higher tax burden than exists under current law. Moreover, the 

proceeds of seven taxes are dedicated to particular uses. And the proceeds from four secure 

debt obligations. 

The question arises as to whether it is necessary or appropriate to subject any or all of these 

goods or services to both excise tax and GST. If double tax is to be avoided, it should be 

accomplished, if possible, by reducing the excise tax rather than exempting the item from the 

GST. Thus, the automobile excise tax could be replaced by the GST. However, as noted below, 

2

3 PRIRC § 3040.03. 24 PRIRC § 3050.01 to§ 3050.04. 
95 


Insert offset folio 64 here 98944.064

due to the complications associated with renegotiating existing debt security arrangements, 

double tax on fuel and hotel rooms could be eliminated by exempting those items from GST. 

The extent to which any or all of these items should be subjected to both GST and Excise tax is 

a political question. However, implementing a decision to avoid double taxation raises structural 

issues, particularly with respect to dedicated funds. Ideally, to maintain the symmetry of the GST 

base and avoid the problems with exemptions that have been identified in the GST discussion, 

all the goods and services listed above would be subject to GST and the excise tax reduced in an 

amount sufficient to maintain the current tax burden. If that were done, an annual dedicated 

appropriation from the general fund would be necessary to assure sufficient liquidity to service 

the debt obligations of the Highway Fund and Tourist Commission. The need to assure funding 

tor the other designated recipients could be re-examined. However, it may be too burdensome 

to renegotiate security arrangements, in which case double tax relief will have to occur through 

GST exemption. 

The need to continue funding tor the other designated recipients could be re-examined. 

Assuming that only tobacco and alcohol will be subject to both GST and excise tax, the aggregate 

revenue raised by those two items will increase due to their inclusion in the GST base. With 

respect to vehicles, the aggregate revenue will not change materially but it will come from the 

GST rather than the excise tax. 

2.3 Revise Individual Income Tax to 

Income Taxpayers and lower Rates 

Tax Base, Reduce Number of 

Individual residents of Puerto Rico are subject to Puerto Rico income tax on their worldwide 

income. A resident individual's income tax liability includes: (1) the regular tax on "net income"; 

(2) the amount of tax paid at preferential rates on certain items of income; and (3) the alternative 

minimum tax. Net income means "gross income" reduced by certain exemptions, deductions, 

and income subject to preferential tax rates25 Individuals must calculate "adjusted gross 

income" to determine the amount of certain deductions and exemptions allowed in computing 

net income. Individuals may reduce their tax liability by certain tax credits. 

2.3.1.1 Gross Income 

Gross income means all income, gains, or profits from whatever source received or derived, other 

than certain items specifically excluded from gross income26 Items of gross income include: 

compensation for personal services, interest, dividends, capital gains, trade or business income, 

and income from certain pensions or annuities27 

Items excluded from gross income include: life insurance; gifts and inheritances; compensation 

for injuries or sickness; income from discharge of certain debts; child support payments; federal 

PRIRC § 1031.05. 26 PRIRC § 1031.01. 

PRIRC § 1031.011al 
96 


Insert offset folio 65 here 98944.065

social security payments; certain death benefits; and net long-term capital gain from the sale of 

certain new construction property. 28 

Over 40 categories of income are exempted from gross income. Key exemptions include: interest 

on certain debt obligations; certain amounts paid by an employer under a flexible benefits plan; 

employer contributions to health insurance plans; dividends received from certain organizations; 

lottery prizes; income from pensions or annuities; unemployment compensation; distributions 

from nondeductible individual retirement accounts; and gain from the sale or exchange of a 

principal residence or qualified property by certain individuals. 29 One particularly noteworthy 

series of exemptions are those provided by Law 22 which was enacted to entice high net worth 

individuals to relocate to Puerto Rico. It provides a total exemption from Puerto Rico income tax 

for all passive income realized or accrued after such individuals become residents of Puerto Rico. 

As of June, 2014, 288 exemption decrees had been issued under Law 22. 

2.3.1.2 Adjusted Gross Income 

Adjusted gross income is determined by subtracting certain "above-the-line" deductions from 

gross income (after exemptions). 30 These deductions primarily are for business and investment 

related expenses, as well as for alimony payments31 

2.3.1.3 Deductions from Adjusted Gross Income 

In determining net taxable income, the Code also allows numerous "below-the-line" deductions 

from adjusted gross income. Key deductions available to individuals not engaged in a trade or 

business include: home mortgage interest; charitable contributions; interest on student loans; 

contributions to certain retirement or pension accounts; medical expenses above a certain 

threshold; contributions to an education or health savings account; and casualty losses on a 

principal residence not covered by insurance. 32 Additional deductions are available for individuals 

engaged in a trade or business. 

If an individual taxpayer has $20,000 or more of income subject to preferential tax rates 

(discussed below), below-the-line deductions are disallowed to the extent allocable to income 

subject to preferential tax rates. 33 

The Code generally also allows a personal exemption deduction of $3,500 ($7,000 for married 

taxpayers filing joint returns), and a $2,500 dependent exemption deduction with respect to 

certain minor and elderly dependents34 

2.3.1.4 Regular Tax on Net Income 

Regular income tax for resident individuals is determined by applying the tax rate schedule to net 

taxable income. The tax rate schedule is broken into five incorne tax brackets. The brackets for 

taxable years beginning in 2014 are: 35 

28 42 PRI RC § 1 031.01(b). The exclusion for new construction property is found in Acts 132-2010 and 216-2011, as 

amended. 

'" PRI RC § 1031.02. 30 PRIRC § 103103. 

31 1d. 32 PRIRC § 1033.15. 

33 PRI RC § 1033.20. 34 PRIRC § 1033.13. 

35 PRIRC § 1021 01(a)(4). 
97 


Insert offset folio 66 here 98944.066

Net Taxable Income Tax 

Not over $12,000 

0% 

Over $12,000 but not over $26,000 

7% of the excess over $12,000 

Over $26,000 but not over $42,750 

$980 plus 14% of the excess over $26,000 

Over $42,750 but not over $62,750 

$3,325 plus 25% of the excess over $42,750 

Over $62,750 

$8,325 plus 33% of the excess over $62,750 

2.3.1.5 Income Subject to Preferential Tax Rates 

The Code provides special preferential tax rates-or allows individuals to elect special tax ratesfor certain items of income. Some of the special tax rates include: 

2.3.1.6 

10% rate on long-term capital gains36; 

10% (or 17%) rate on interest from deposits in certain types of accounts37 ; 

10% rate on eligible dividend distributions from certain corporations38; and 

20% rate on distributions from certain retirement accounts 39 

Alternative Minimum Tax 

Certain resident individuals are subject to an alternative minimum tax equal to the excess of the 

tax on alternative minimum net taxable income over their regular tax liability40 Very generally, 

alternative minimum net taxable income is computed in the same way as net taxable income, 

except that certain exemptions and deductions from gross income are disallowed. 41 

2.3.1.7 Tax Credits 

An individual may reduce his or her tax liability by available tax credits. The laws of Puerto Rico 

provide numerous refundable and nonrefundable tax credits. Tax credits are allowed for, amongst 

other things, investments in certain industries (e.g., film or tourism) or qualified investment 

funds_"2 investments in certain housing and development projects,"3 and the purchase of a new 

or existing home. 44 Additional credits are available for individuals engaged in a trade or business. 45 

3o PRI RC § 1023.02. 

37 PRI RC § 1023.04. 

38 PRI RC § 1023.06. 

39 PRI RC § 1023 09. 40 PRIRC § 1021.02. 

41 ld. 

See, e.g., Acts 78-1993, 225-1995, 3-1987, 46-2000, and 27-2011. 

'"See, Acts 98-2011, 212-2002, and 140-2001 

PRI RC 1052 03 and .04. 45 PRI RC § 1052 02(b). 
98 


Insert offset folio 67 here 98944.067

2.3.1.8 Filing Obligations 

The following categories of individuals must file Puerto Rico income tax returns: (1) every 

individual resident of Puerto Rico who is an individual or married taxpayer and has gross income 

(after exemptions) over $5,000; (2) every individual nonresident of Puerto Rico for all or part of 

the year who is a citizen of the United States and who has Puerto Rico source gross income 

(after exemptions) in excess of $5,000, unless the tax on the income has been fully paid at 

source; (31 every alien individual nonresident of Puerto Rico who has taxable Puerto Rico source 

gross income for the taxable year, unless the tax on the income has been fully paid at source; 

and (4) every individual whose alternative minimum net taxable income is $150,000 or more 46 

The computation of individual income tax liability is inordinately difficult due primarily to the 

existence of exclusions, credits and preferential rates for certain forms of income as well as the 

need to calculate alternative minimum taxable income. While the base of the individual income 

tax contains relatively few itemized deductions, the special rates, exemptions and credits reduce 

potential revenue and produce an uneven distribution of the tax burden. One effect of these 

special provisions is to tax wage income more heavily than capital income, thus creating 

horizontal inequity. 

These special provisions are called tax expenditures. Tax expenditures are "revenue losses 

attributable to provisions of the.. tax laws which allow a special exclusion, exemption, or 

deduction from gross income or which provide a special credit, a preferential rate of tax, or a 

deferral of tax liability. Special income tax provisions are referred to as tax expenditures because 

in many cases they are substantively analogous to direct outlay programs, and the two can be 

considered as alternative means of accomplishing similar budget policy objectives .... Tax 

expenditures are similar to ... direct spending programs that are available as entitlements to those 

who meet the statutory criteria established for the programs. 47 " 

Tax expenditures affect the amount and distribution of the tax base. They also alter economic or 

social behavior. Thus it is important to understand who they affect, how much they cost and how 

they operate in order to assess their effect. Once identified, the tax expenditure can be analyzed 

as a direct spending program. Those eligible for the program can be identified and, if sufficient 

data exist, the cost of the provision can be compared to its benefits. 

Economic efficiency, spending and/or rate reductions, and/or increased revenues could occur 

through the repeal or reduction of tax expenditures. But one must be clear about how much can 

realistically be accomplished by that form of base broadening. The largest individual tax 

expenditures are retirement savings incentives, the home mortgage interest deduction, interest 

exclusions and capital income rate preferences. 

Apart from the political constituency that supports each of those items, one must recognize that 

many of them are spending programs that cannot be cut off without real economic consequences 

that must be analyzed and addressed. A number of the existing tax expenditures could be 

redesigned to provide benefits in a more rational way: for example, converting them to 

[refundable] credits that phase out as incomes rise. 

46 PRIRC §106.01. 

Joint Committee on Taxat1on, KRr:<nr·n,rln Information on Tax Expenditure Analysis and Historical Survey of Tax 

Expenditure Estimates, JCX·15·11 28, 2011). 
99 


Insert offset folio 68 here 98944.068

Appendix A contains estimates of the static revenue loss attributable to most individual income 

tax expenditure provisions of the Puerto Rican tax code. It also shows the percent of the tax 

benefit enjoyed by taxpayers taxed at the highest marginal tax rate as well as the number of 

taxpayers claiming the benefits. Due to data limitations, it does not contain an estimate for the 

loss attributable to the provisions dealing with employer provided health insurance benefits, nor 

does it contain an estimate for the loss attributable to the provisions that provide a fair market 

value basis increase for property that is transferred at death and permit the deferral of gain on 

like kind exchanges. 

Significant structural and compliance simplification, horizontal equity and revenue can be attained 

by the elimination or modification of existing tax preferences. With exception of the preferences 

relating to retirement benefits, health benefits, mortgage interest and charitable contributions 

every tax expenditure listed in Appendix A could be repealed. The home mortgage interest and 

charitable contribution deductions could be modified to achieve a more rational subsidy structure. 

For example, the former could be redesigned as a tax credit, the benefit of which would phase 

out as income increases. The benefit of the latter could be restricted principally to contributions 

to Puerto Rican charities. The retirement benefit provisions could be modified to make 

distributions fully taxable. Law 22 could be repealed. 

The revenue obtained by modifying or eliminating tax preferences could be used to eliminate 

income tax liability for a significant number of households as well lower existing tax rates. 

The analysis below assumes, as an example, exemption levels of $35,000 for singles taxpayers 

and $70,000 for married couples filing jointly. 

The rate structure for single filers would be 15% for income above $35,000, 20% for income 

above $125,000 and 30% for income above $200,000. For married couples filing jointly the rates 

would be 15% for income above $70,000, 20% for income above $125,000 and 30% for income 

above $200,000. 

One initial observation is important The elimination of the tax expenditures described below 

(except to the extent they are refundable credits under existing law) will have no impact on those 

individuals who do not have income tax liability under the tax structure described above. The 

distributional consequences of the hypothetical tax changes are described in the Revenue Effect 

section below. 

2.3.4.1 Credits 

As detailed in Appendix A many of the existing tax credits are utilized by a limited number of 

taxpayers and none have been subjected to a cost-benefit analysis. By design, these credits (as 

well as many of the special rates, deductions, exemptions and exclusions) distort the tax base, 

create horizontal inequity and promote economic inefficiency. The burden of proof for retention 

of any of them should be a demonstration that the value of the intended tangible benefit exceeds 

the revenue cost 
100 


Insert offset folio 69 here 98944.069

2.3.4.2 Deductions 

The charitable contribution deduction could be re-examined. The rationale for special tax 

provisions for charitable giving is to encourage that activity. However, like any other tax 

expenditure the existence of the provision creates a revenue loss that must be offset. Moreover, 

as an analytic matter it is a government subsidy program pursuant to which the expenditure of 

government funds is determined by private individuals. Some question whether those who do 

not choose to make charitable contributions should bear the economic burden of the choices 

made by others. That is a political decision. 

Assuming a charitable contribution deduction is retained, the deduction could be limited to 

contributions to Puerto Rican charities or other external charities designated by the Secretary as 

having significant charitable activities in Puerto Rico. There is no apparent reason for Puerto Rican 

taxpayers to be subsidizing charitable activity that has no discernible benefit to Puerto Rico. 

If the charitable contribution deduction were limited as suggested a statutory structure to 

determine eligible Puerto Rican entities would have to be enacted and an administrative 

procedure created. The exempt organization provisions of the U.S. Internal Revenue Code 

provide one model. 

The home mortgage interest deduction is a prime example of a tax expenditure. A tax on 

economic income does not allow the deduction of expenses that produce non-taxed income. 

Home mortgage interest is an expense related to exempt income- the imputed rental value of 

the home it finances. Thus, it is a tax expenditure. When analyzed as a government spending 

program, the deduction is available only to those who own their homes, not to those who rent. 

Thus, it encourages homeownership. But while it is available to all taxpayers who have mortgages 

on their homes, the deduction is of no value to those without income tax liability and the value 

of the deduction increases as the taxpayer's tax bracket increases. When translated into a 

government program to subsidize housing, it is a program that provides greater government 

subsidies to high income taxpayers than to lower income taxpayers and provides no subsidy at 

all for homeowners who do not have tax liability. 

There is a fear that total elimination of the subsidy would adversely affect housing prices and the 

housing market. However, if the subsidy is to be retained it could be redesigned to direct the 

benefits to those who most need it. In the first instance the benefit could be redesigned as a tax 

credit to assure that the benefit does not increase as income becomes higher. Because the 

subsidy is arguably not necessary for higher income individuals, it could be phased out as 

incomes increase. Finally, if the subsidy is to be provided to the lowest income categories, it 

could be made refundable. 
101 


Insert offset folio 70 here 98944.070

The following is a hypothetical nonrefundable credit designed to meet the foregoing objectives: 

~ I il!!i ~·~· 

Not over $125,000 Smaller of (a) 15 % of mortgage interest expense 

and lbl $5,250 

Over $125,000, but not over $140,000 Smaller of (a) 12 % of mortgage interest expense 

and (b) $4,200 

Over $140,000, but not over $155,000 Smaller of (a) 9 % of mortgage interest expense 

and (b) $3,150 

Over $155,000, but not over $170,000 Smaller of (a) 6 % of mortgage interest expense 

and (b) $2,100 

Over $170,000, but not over $185,000 Smaller of (a) 3 % of mortgage interest expense 

and (b) $1,050 

Over $185,000 $0 

The table below shows the value of a home mortgage interest subsidy under (a) current law, (b) 

current structure of the deduction and the tax rates and exemption levels described above, and 

(c) as a tax credit under the rates and exemption levels described above. 

2.3.4.3 Social Security 

Social security receipts constitute economic income. While sometimes described as 

"insurance", social security is in fact a transfer payment that has not been actuarially determined. 

The increased exemption levels in the income tax option provide tax exemption for social security 

payments received by approximately 80 percent of filers. As to the balance, a 20 percent 

exclusion recognizes that some portion of a social security payment has been "financed" by tax 

payments that could be viewed as creating a "basis" in the amounts received. 
102 


Insert offset folio 71 here 98944.071

2.3.4.4 Preferential Rates for Capital income 

An income tax does not distinguish between wage and capital income. The preferential treatment 

of capital income creates horizontal inequity and requires disproportionate taxation of wage 

income to achieve revenue goals. 

The traditional rationalization for preferential treatment of capital income is that it encourages 

saving because it increases the after tax rate of return on investment as compared to labor. While 

it is true that the after tax rate of return on investment is increased relative to wage income it is 

by no means clear that the preferential rate in fact induces increased investment. Moreover, even 

if that were demonstrable as a general proposition, it questionable whether, with the exception 

of the exclusion for interest on Puerto Rican debt obligations and certain bank accounts, the 

existing capital income preferences have any material positive effect on the Puerto Rican 

economy. Other than those exceptions, the existing capital income preferences are not targeted 

to investments in Puerto Rico. Thus, Puerto Rican wage earners are subsidizing capital 

investments that have no relationship to the Puerto Rican economy. Preferential rates for 

dividends and capital gain on the sale of corporate stock are also rationalized as alleviating the 

burden of "double" taxation of corporate income. Options regarding elimination of "double" 

taxation of corporate income (and the need for a tax preference for dividends and capital gain) 

are discussed below. 

2.3.4.5 Step up in Basis 

The failure to tax unrealized appreciation in property held at death is one of the most glaring 

omissions from a comprehensive income tax base, producing horizontal inequity, inefficient 

resource allocation and substantial revenue loss. Step-up induces individuals to hold property 

until death. It creates an artificial impediment to sales that would normally occur and therefore 

distorts normal capital flows. 

Horizontal inequity is illustrated by this simple example: A and B are siblings. Each bought stock 

X for $100,000. It is now worth $3 million and each has decided to sell. A meets Bin the street 

outside their broker's office just after A has executed her trade and before B is going to do the 

same thing. A car hits them and both die. Assuming a 20-percent income tax rate, A's heirs 

receive $2,420,000. B's heirs get the stock with a new basis of $3 million and can sell the next 

day and pocket the entire $3 million. That is an indefensible result. If B borrowed money using 

the stock as collateral, B had the use of the appreciation during his life and the debt can be repaid 

from the tax free proceeds of the sale of the stock after B's death. That is also indefensible. 

There are two polar ways that such unrealized appreciation can be included in the income tax 

base. The first is by providing that the basis of such property carries over to the transferee (the 

current rule with respect to property transferred by gift). The second is by treating death as an 

income tax realization and recognition event. The optional system adopts the latter principle, but 

provides an election to defer recognition of the realized gain until the sale of illiquid assets and 

provides a carryover basis for property transferred to a spouse. 

The fundamental rule is that death is an income tax realization and recognition event with respect 

to any marketable property held by a decedent/donor that is transferred to any beneficiary other 

than a spouse or public charity. The transfer of non-marketable property at death to any 

beneficiary other than a spouse or public charity will be an income tax realization event and the 

gain calculated, but, at the election of the recipient of the property, the tax would not be due 

("recognized") until the property is sold. Interest at a market rate, payable annually, would be 
103 


Insert offset folio 72 here 98944.072

charged on the deferred tax liability to assure that the present value of the deferred tax is equal 

to the tax that would be paid if death were a recognition event. 

All lifetime transfers, other than those to a spouse or a public charity, will be income tax 

recognition events, subject to appropriate loss limitation rules. Property transferred to a spouse 

or public charity would receive a carryover basis with a special rule for split interest transfers. 

Principal residences transferred at death would be exempt from the realization regime and would 

receive a date of death value, as would tangible personal property other than collectibles. No 

other property would be exempt from this system. Anti-avoidance rules would be enacted to 

deter the creation of non-marketable interests to defer recognition. 

The tangible personal property exclusion is based on the premise that most of such property is 

not appreciated in value and in any event it is not likely that cost basis records exist. Including 

"collectibles" in the regime provides a boundary for the exclusion, although it admittedly 

introduces identification issues. The principal residence exclusion is based on a combination of 

pragmatism and administrative convenience. Experience in administering existing law with 

respect to collecting the tax on gain realized on lifetime sales of residences indicates that this is 

an area in which compliance can best be described as shoddy. One does not generally want to 

reward shoddy compliance with tax exemption, but in this instance it may be appropriate. 

The proposed realization/recognition regime proceeds from the premise that to the extent 

possible all income tax accounts should be closed upon a taxpayer's death. The deferral election 

for non-marketable property addresses liquidity concerns posed by those assets. The exemption 

for property transferred to a spouse is sirnply an extension of the principle that the spousal unit 

is treated as a single unit for tax purposes so that such transfers are "non-events" for tax 

purposes. Exempting transfers to public charities preserves current law with respect to the 

transfer of appreciated property to such entities. 

2.3.4.6 Preferential Rates for Retirement Plan Distributions 

The tax structure for retirement benefits is substantively a consumption tax, i.e., the tax base is 

reduced by the retirement contribution (saving). The two principal methods are (1) an immediate 

deduction for retirement savings with full inclusion of distributions or (2) no deduction for 

contributions but no inclusion of distributions. If tax rates rernain the same those two models are 

economic equivalents. 

By definition, in both of these structures, the normal rate of return on the retirement contribution 

is tax free (the well-recognized "immediate deduction-yield exemption" equivalence). The 

existing Puerto Rican system departs from the conceptual consumption tax model-and actually 

creates a tax subsidy for retirement benefits - due to the fact that distributions from qualified 

plans enjoy preferential rates and exclusions. There is no policy justification for this additional 

subsidy. Distributions should be fully taxed as ordinary income. 

The following tables show the revenue and distributional effects of the income tax base changes 

described above at exemption levels of $35,000 for singles/$70,000 for married couples filing 

jointly and at two different rate schedules. The effective rate of tax at various income levels is 

also shown. 
104 


Insert offset folio 73 here 98944.073

MITII!tJ!l\'tatli~Cil!lmil!< 

Sing!<> 1\llartl\111 

m a >~;'ill a SS\!121! 11!1\1> :!!ll!ll!li 1!f% ti!lii!l!OO i!ow. t2li·l!llo :!1!1ll>l >liOO aw. ,.lloo 31111'. 

Ull;!!ll!i>lal!! ratll!!!iili!lmile , 

\!!!till !'llatri!i<t ' m" o ,, l<Clo o ali·~.ll1 ~!!;'%\ ~ll-~llll lilt%' • 

2,5'11111l ll:l!'!li ,~llci!U!I ill&% 

.. ~~~~~ '311!!11 l\!21111 '311% 

L!'S$ t~!lri $~1 ,sOd 

Gieat.er than $21,'800, l~ss~han $33,00() 

Greater than.$3:>,0\)0, tess thai\$50,ooo 

Great~.r;\1ian ~so,ooo, le~.tl\an $69,500 

Greater th".n $69,500; less thllh $84,200 

Greater th:•h $84.~oo, lessihan$100;ooo 

dreat~rJI)an $tog;ooo, le'ss.tt>ari 11>140,000 

Greaterlhan $140,QOQ, ie5s. than $2oil,ooo 

Greater\han $30();0QO 

Total 

The following four tables show the combined revenue and distributional consequences of the 

GST and Individual Income Tax changes combined at two different rate schedules. The first two 

tables present the results at the 14% GST rate and the second two tables present the results at 

the 16% GST rate. 
105 


Insert offset folio 74 here 98944.074

14%GST 
106 


Insert offset folio 75 here 98944.075

IGG<!!!l)< tl;l\< rate S~l!\l!dti!l!l 

S!nli!" 1\lia]t<ell ~am !l .. ;m a ~!<ll2i5 l!l\\\1, ii\lt1ifll!li $lic!l!! !!lil5+4ltilll!!il!llf )!}llc~OO ll!!!JQ 

>l!!lil !\!Q.!!(l ,~m;: il:lt.!l!l 

14% GST 
107 


Insert offset folio 76 here 98944.076

16%GST 

!rm'd!iiieit!l)(;dfal(e ~fie!\!!ile 

li!ii!lli!ll l\llartrte!! ~ Q ><~!:li l\1 Sli¥~1i!li ~;;!Jiii :r:IJIJ!mia!l ~ii\Jl!i 

!!ll!i"'i!o'l!!!l!!$!1 ~li!IJiiili!!!o'!!o'!lli 

~~ !!o'llll "~Si!ll ~S!i¥ 
108 


Insert offset folio 77 here 98944.077

2.4 

16% GST 

Revise Domestic Business income Taxation to the CCloronr:~tP Tax 

Base, Reduce the Number of Corporate Taxpayers and Rationalize 

Flow-Through Taxation Regimes 

Domestic Business Taxation 

Choice of Entity 

Business owners have broad flexibility to conduct business activities in Puerto Rico through 

numerous forms of legal entities. Individual business owners also may conduct their activities as 

sole proprietorships, which do not involve a separate legal entity. Under current law, the taxation 

of income earned by a business typically depends on the type of entity through which the 

business is conducted. For income tax purposes, Puerto Rico business entities generally are 

taxed either: {1) as regular corporations; {2) as pass-through entities; or {3) pursuant to a special 

tax regime. Some business entities may elect the manner in which they are taxed. 
109 


Insert offset folio 78 here 98944.078

2.4.1.1 Corporations 

Regular corporations are subject to two levels of taxation. The income of a regular corporation is 

taxed at the corporate level when the income is earned, and the shareholders of a regular 

corporation are taxed on dividend distributions of the corporation's after-tax income. The 

shareholders also are subject to tax on gain from the sale of stock in a regular corporation. 

Business trusts generally are treated as regular corporations for income tax purposes. 

2.4.1.2 Pass-Through Entities 

The Puerto Rican tax rules contain a number of different regimes relating to business entity 

taxation that generally provide for only one level of tax to be incurred with respect to earnings. 

Certain of the regimes provide "pass-through" treatment so that owners of the entity are taxed 

by reference to the income and losses of the entity. 

Entities legally formed as partnerships generally are taxed on a pass-through basis under rules 

similar to the U.S. federal income tax rules applicable to partnerships. Limited liability companies 

(" LLCs") generally are treated as corporations for Puerto Rico income tax purposes, unless the 

LLC elects to be treated as a partnership or corporation of individuals or the LLC elected to be 

treated as a partnership for U.S. federal income tax purposes. This rule applies regardless of 

whether an LLC has a single member or multiple members. Unlike U.S. law, Puerto Rico does 

not treat a single member LLC as an entity disregarded as separate from its owner for income 

tax purposes. 

A corporation or partnership that meets certain eligibility requirements may elect to be treated 

as a corporation of individuals, a special entity that is taxed under a simplified pass-through 

regime 

A professional corporation generally is taxed as a regular corporation, unless it elects to be taxed 

as a corporation of individuals. 

A Special Employee-Owned Corporation ("SEOC") is a corporation for legal purposes that is 

taxed based on a blend of cooperative and pass-through principles. 

2.4.1.3 Special Entities 

The Code provides for several additional types of entities that generally are not taxed at the entity 

level. An entity that qualifies as a real estate investment trust ("REIT") or registered investment 

company ("RIC") is exempt from tax in Puerto Rico so long as it distributes at least 90 percent 

of its earnings on an annual basis. REIT and RIC shareholders generally are subject to tax on 

distributed earnings. 

The Code also provides an exemption or reduced rate of taxation for income earned by an 

International Banking Entity or International Financial Entity. 

The availability of multiple forms of legal entities with varying tax treatments creates undue 

complexity and distorts taxpayer behavior. In most cases, there is no compelling reason to tax a 

business's income on a pass-through versus entity-level basis solely by reference to the legal 

form through which the business is conducted. Indeed, as discussed in below, efficiency and 

simplification generally are best served by allowing most domestic businesses to be taxed 
110 


Insert offset folio 79 here 98944.079

primarily at the individual level via a pass through regime, regardless of the legal form of the 

business. Certain business entities, however, always should be taxed as corporations. 

One option to reduce complexity and encourage pass-through taxation is to allow most business 

entities to elect to be treated as pass-through entities for income tax purposes, regardless of 

whether the business was formed as a corporation, a partnership, or an LLC. Similar to the U.S. 

entity classification rules (commonly referred to as the "check-the-box" rules), any business 

entity that is not treated as a "per se" corporation for income tax purposes (an "eligible business 

entity") may elect to be taxed as a pass-through entity. An eligible business entity that satisfies 

the requirements to be treated as a corporation of individuals may elect to be taxed either as a 

corporation of individuals or a regular partnership. An eligible business entity that does not elect 

to be taxed as a pass-through entity generally will be taxed as a regular corporation. Consistent 

with current law, a business entity with a single owner that does not choose to be taxed as a 

corporation is respected as a separate tax entity, 100% of whose items of income, deduction, 

credit and loss flow-through to its owner (rather than being disregarded as separate from its 

owner, as is the case under the U.S. "check-the-box" rules). Thus, a single member LLC, for 

example, may be taxed either as a corporation or a pass-through entity. 

Certain business entities automatically will be classified as per se corporations for income tax 

purposes. These entities may not elect to be taxed on a pass-through basis. Per se corporations 

could include publicly traded corporations, banks, insurance companies, and business entities 

with, for example, more than 200 owners. 

Allowing eligible business entities to elect to be treated as pass-through entities for income tax 

purposes will reduce complexity in many cases and further the goal of increasing the number of 

domestic business entities that are taxed on a pass-through basis, thus allowing a more accurate 

measurement of income at the individual level. It is anticipated that many eligible business 

entities that currently are taxed as corporations will elect to be taxed either as corporations of 

individuals or partnerships. As discussed in below, transition rules will be needed to allow 

business entities to convert from corporate to pass-through status in a tax efficient manner. 

Corporations 

A regular corporation is subject to Puerto Rico income tax as an entity separate from its 

shareholders. A regular corporation's income generally is subject to two levels of taxation: the 

income is taxed at the corporate level when earned and is taxed again at the shareholder level 

when distributed as dividends. This section provides a general overview of corporate level 

taxation. 
111 


Insert offset folio 80 here 98944.080

2.4.5.1 Gross Income less Exclusions and Exemptions 

The gross income of corporations includes all gains, compensation for services performed, 

income from sales and dealings in properties, rent, interest, dividends, partnership profits, 

transactions in securities, and any other gains, profits, and income derived from any source 

whatsoever.). 

The Code provides numerous exclusions and exemptions from gross income for items such as 

interest on certain obligations (e.g., obligations issued by the government of Puerto Rico), 

dividends received from certain corporations (e.g., dividends from limited dividends corporations), 

and income from the conduct of certain activities (e.g., rents from the lease of property in the 

Historic Zone). In addition, corporations may qualify for various tax incentives designed to 

stimulate economic development and reduce unemployment. Corporations qualifying for such 

incentives may obtain certain relief from Puerto Rico income, property, and municipal taxes. The 

income that is exempted under such tax incentives laws is excluded from gross income when 

determining the Puerto Rico corporate income tax liability. 

There also are certain transactions in which the gain realized is not recognized for tax purposes 

and, therefore, is excluded from gross income. In general, the reason for not recognizing such 

gains is that the underlying transaction is not considered sufficient to break the continuity of the 

investment. Such is the case, for example, with certain exchanges of like kind property, certain 

involuntary conversions, certain corporate reorganizations, transfers to a corporation controlled 

by the transferor, property received by a corporation in a complete liquidation of its controlled 

subsidiary, securities exchanged for securities of the same corporation, and certain transfers of 

qualified securities to an employee stock ownership plan. 

2.4.5.2 Net Taxable Income 

The net taxable income of a corporation is determined by reducing gross income less exclusions 

and exemptions by allowable business deductions. Expenses incurred during the taxable year by 

a corporation that are directly connected to its business activities are generally deductible 

provided they are ordinary, necessary, reasonable, and not in violation of public policy. In general, 

the rules for the deductibility of the business expenses of a corporation closely follow the rules 

applicable under the U.S. Internal Revenue Code. Examples of allowable deductions include 

dividends received from certain Puerto Rico corporations, business debts that become worthless, 

contributions to pension or other qualified retirement funds, and charitable contributions. 

The Code also limits the ability of corporations to deduct certain expenses that might otherwise 

qualify as a business expense. For example, life insurance premiums paid by a corporation on the 

life of an officer, employee, or person financially interested in the trade or business of the 

corporation, when the corporation is directly or indirectly the beneficiary of the policy, are not 

deductible. In addition, corporations are only allowed to deduct capital losses to the extent of 

capital gains, with a five-year carryover of the excess capital losses. 

A corporation's net operating loss for a taxable year may be carried forward to offset up to 90% 

of the corporation's liability in a subsequent year48 If a corporation acquires, by reorganization or 

by the liquidation of a controlled corporation, substantially all the assets and liabilities of the 

acquired corporation, the net operating loss of the acquired corporation may only be used to 

48 Net operat1ng losses 1ncurred 1n tax years 

forward 12 years. Net operating losses 

forward 1 0 years. 
112 


Insert offset folio 81 here 98944.081

reduce the net income of the acquiring corporation derived from the same commercial activity or 

trade or business that generated the loss. Also, if a corporation undergoes a change in ownership, 

the use of its net operating loss in subsequent years may be limited. 

Capital expenditures are included as part of the basis of an acquired or improved asset 

Depending on the asset and the circumstances involved, such capital expenditures will be 

depreciated, amortized, or depleted pursuant to the applicable depreciation, amortization, or 

depletion rules, or included as part of the basis until the asset is sold or disposed of. 

2.4.5.3 Corporate Tax Rates including Patente Nacional 

Income tax liability is generally determined by applying the corresponding Puerto Rico income 

tax rate to net taxable income. The regular tax rate for corporations is 20%. Corporations also are 

subject to a graduated surtax on net taxable income in excess of $25,000, with rates ranging 

from 5% to 19%. In addition to the regular tax and surtax, corporations are subject to an alternate 

minimum tax in certain situations when the regular tax liability is less than the alternative 

minimum tax liability. For taxable years commencing after December 31, 2012, a portion of tax 

liability of certain Puerto Rico corporations having gross revenues above certain amounts is based 

on gross revenues. This is the Patente Nacional. 

In addition, certain items of income are taxed at special rates, and the tax on such items must be 

computed separately and added to the incorne tax on the net taxable income not subject to 

special rates. For example, net long-term capital gains may be taxed at the flat tax rate of 20%. 49 

In addition, dividends paid to non-Puerto Rico corporations that are not engaged in a trade or 

business in Puerto Rico from Puerto Rico earnings are generally subject to a flat 10% tax. 

Non-Puerto Rico corporations or partnerships operating in Puerto Rico thus may be subject to a 

1 Oo/o branch profit tax and the withdrawal from doing business in Puerto Rico by a non-Puerto 

Rico corporation is considered a taxable event. 

An accumulated earnings penalty tax may be imposed if a corporation is determined to have been 

formed or used to prevent the imposition of income tax on its shareholders by accumulating 

corporate earnings instead of distributing such earnings to the shareholders. 

Individual shareholders of a non-exempt Puerto Rican corporation are taxed at 15% on dividends 

received from the corporation, and Puerto Rican resident individuals are taxed at 15% on capital 

gains from sales of stock in such corporations. 50 

2.4.5.4 Tax Credits 

The income tax liability that is finally due is determined by deducting allowable tax credits from 

the income tax determined in the manner described above. The Code and various incentive Acts 

provide numerous tax credits for investments in certain activities (e.g., tourism, agriculture, and 

waste disposal and treatment). 

49 Act 77-2014, Passed July 1, 2014, increased the 50 Act 77-2014 increased the Individual dividend and 10% to 15%. 
113 


Insert offset folio 82 here 98944.082

A classical corporate tax system (such as the current system), in which tax is collected 

independently at the individual and corporate levels, will almost always lead to distortions and to 

a higher aggregate tax burden on domestic business activity than a pass through or integrated 

regime. The rate, base, and structure of the corporate tax system also interacts with the individual 

tax system both in terms of rule complexity as well as overall tax burden. The current corporate 

tax regime is neither necessary nor appropriate for most non-publicly traded businesses. There 

were 42,740 corporate tax returns filed in 2011. Of that number, 38,838 reported net income of 

$60,000 or less. Equity, efficiency and simplification are best served by allowing businesses with 

relatively small numbers of owners to be taxed primarily at the individual level via a pass-through 

regime, particularly when the entity has little taxable income (see discussion of existing regimes 

and suggested changes below). Where the equity of a business is publicly-traded (there currently 

are six publicly traded corporations), or where the investors are not Puerto Rican resident 

individuals, it is preferable to collect a tax at the corporate level. 

Without regard to the number of entities to which it applies, the current corporate tax regime 

contains alternative minimum taxes, multiple rates, and numerous exemptions, credits, and 

exclusions that create complexity, distort economic choices, and produce horizontal inequities. 

Unless justified on a cost-benefit basis, elimination of these provisions (listed in Appendix B) 

would materially simplify the system and reduce economic distortions. 

Certain corporations also are subject to the Patente Nacional, the corporate tax that is determined 

on the basis of gross receipts. The stated purpose of this alternative minimum tax is to assure 

that businesses with significant revenues in Puerto Rico make an appropriate tax contribution to 

the general revenues. However, an unapportioned gross receipts tax has the potential to subject 

high volume, low margin businesses to tax liabilities that far exceed the amounts that would be 

due if the tax base was income. Indeed, it is possible for entities with no taxable income to be 

responsible for significant tax payments on the basis of their gross receipts. The Patente Nacional 

is not the appropriate tool to achieve the desired revenue objective 

The objective of domestic corporate tax reform is to create, within specified revenue goals, a 

simple, transparent, and equitable system that will raise sufficient revenue and encourage 

economic activity in the Commonwealth. 

2.4.7.1 Conform Individual and Corporate Tax Rates 

The highest corporate income tax rate (including the surtax) currently is higher than the highest 

individual income tax rate. Conforming the corporate tax rate to the highest individual tax rate 

would reduce distortions that arise when the rates are different. Further distortions would be 

eliminated by taxing dividends received from Puerto Rican corporations and gain on the sale of 

stock in a Puerto Rican corporation at ordinary rates. The preferential treatment of dividends and 

gains on sales of stock is usually justified as a means to alleviate the burden that results from 

imposing tax at both the corporate and shareholder level. These rules, however, are imperfect, 

create opportunities for tax avoidance, and increase complexity (in part by the adoption of 

additional rules to try and combat the tax avoidance that the preferential treatment created in the 

first place). By making pass-through taxation available to virtually all small business, the inequities 

of full taxation at both the corporate and shareholder level can be avoided in the vast majority of 

cases. In the case of publicly-traded corporations (at least those with a single class of stock and 

no undue concentration of ownership), consideration should be given to fully or partially forgiving 
114 


Insert offset folio 83 here 98944.083

the shareholder level tax-although in order to maintain the integrity of the system, losses on 

sale of such stock would have to become non-deductible. 

2.4.7.2 Repeal Certain Tax Preferences 

The Code and various incentive Acts provide numerous tax preferences to corporations. A list of 

corporate tax expenditures is attached as Appendix B. The cost of many of these preferences 

does not appear to justify the benefits, and the multitude of preferences creates undue 

complexity and distorts economic decisions. Further, many of the tax preferences are claimed by 

only a small number of taxpayers. 

2.4.7.3 Repeal the Patente Nacional and Audit Inbound Companies Suspected of 

Transfer Pricing Abuse and Other forms of Base Erosion 

There is wide consensus that the Patente Nacional should be repealed. The Patente Nacional is, 

in economic terms, a consumption tax. The revenue lost by repeal can be replaced by revenue 

from the economically equivalent GST described above. Further, inbound companies suspected 

of transfer pricing and base erosion abuse should be identified and audited and, if necessary, 

robust transfer pricing and base erosion rules enacted. 

2.4.7.4 Repeal or limit the Alternative Minimum Tax 

The corporate alternative minimum tax(" AMT") regime adds additional complexity and taxpayer 

burden to an already complex regime. Depending on the extent to which corporate tax 

preferences are reduced or eliminated, consideration should be given to repealing or limiting the 

scope of the AMT. 

2.4.7.5 Repeal the Accumulated Earnings Tax 

If corporate and individual tax rates are conformed, the accumulated earnings tax would no longer 

serve a meaningful purpose and therefore could be repealed. 

2.4.8.1 Conform Individual and Corporate Tax Rates 

One principal objective of reform is to reduce the number of taxpayers subject to the corporate 

tax regime. Increasing the number of businesses subject to a single layer of tax simplifies the 

business tax system, enhances economic efficiency, and reduces distortions in business decision 

making (e.g., whether to engage in debt or equity financing, how and when to make distributions, 

and how to organize business activity). It also could have salutary enforcement and compliance 

consequences. 

When the individual income tax rate is equal to or less than the corporate tax rate, there is an 

incentive for business owners to choose pass-through taxation rather than corporation taxation 

to avoid two layers of taxation on business earnings. This is particularly true when corporate 

dividend distributions are taxed at ordinary individual tax rates. Eliminating the graduated 

corporate tax rates and setting the rate at the highest individual rate should create an economic 

(mathematical) incentive for every eligible business entity to elect pass-through taxation because 

of the graduated rate structure of the latter as compared to the flat rate of the former. As 

discussed below, transition rules should be adopted to allow business entities to convert from 

corporate to pass-through taxation with minimal or no tax cost. Although a pass-through entity is 
115 


Insert offset folio 84 here 98944.084

not itself a taxpayer, in order to aid in collection, consideration should be given to requiring 

withholding to be done at the entity level. 

Where the equity of a business is publicly traded, it is generally preferable to collect a final tax at 

the corporate level due to the complexity of allocating income and providing pass-through 

information statements to a large and frequently changing population of shareholders. In these 

circumstances, there is little or no potential for using a corporation to avoid or defer the imposition 

of Puerto Rican tax at shareholder level and thus, in theory, there is no need for further tax at the 

shareholder level on distributions or sales of corporate stock. Significant rule complexity can 

arise, however, from an attempt to define the boundaries where such treatment does not 

facilitate avoidance and to deal with situations where a corporation may cross those boundaries 

as its ownership changes. These considerations are what generally make most "integrated" 

corporate tax regimes relatively complex. Given the small number of corporations that would not 

be eligible to either elect pass-through taxation under the proposed entity classification rules or 

obtain negotiated incentives under Law 73 (see below), it is unclear whether there would be 

material benefit from adopting an integrated regime. Rather, the most straightforward approach 

may be to conform the individual and corporate tax rates, thus giving eligible business entities a 

strong incentive to choose a pass-through regime and to continue to alleviate the potential over 

taxation of inbound investment via negotiated decrees. Note, however, that the considerations 

may differ depending on the ultimate resolution of issues relating to Law 154 (see below). 

For publicly-traded companies where flow-through taxation is impractical, it may be possible to 

mitigate the avoidance possibilities of providing shareholder level relief from taxation of dividends 

and capital gains. This is particularly true if shareholders are denied a deduction for loss on the 

sale of publicly-traded stock (while this may seem unfair, it is just as appropriate to ensure that 

deductions are not claimed at both the corporate and shareholder level as it is to try and prevent 

gains from being taxed at both levels). Shareholder level relief should be limited, however, to 

shareholders of publicly-traded corporations that have only a single class of stock, no more than, 

e.g. 10 percent of which is owned by any single shareholder (taking into account related party 

attribution). 

2.4.8.2 Repeal Certain Tax Preferences 

Appendix B lists all of the current corporate tax expenditures. The Appendix also lists the number 

of entities taking advantage of each preference item for the 2011 tax year, as well as the static 

revenue loss attributable to each item, to the extent data was available. One striking aspect of 

the list is the limited number of entities taking advantage of many of these preferences, indicating 

that repeal would in essence terminate limited special interest provisions that have not, to our 

knowledge, been subjected to any cost benefit analysis. As discussed below in the economic 

analysis section, repeal of the tax preferences would produce sufficient revenue to partially 

finance the corporate rate cut described below. 

2.4.8.3 Repeal the Patente Nacional 

The Patente Nacional apparently was enacted to address the perceived opportunity under 

existing law for domestic subsidiaries of U.S. parent corporations that do not have tax decrees 

under Law 73 to manipulate inter-company charges to reduce their Puerto Rican source income 

to reduce or eliminate Puerto Rican tax liability. The Patente Nacional was intended to ensure 

that inbound businesses with significant Puerto Rico revenues make an appropriate economic 

contribution to the Commonwealth. A gross receipts tax, however, is not the optimal means to 

address this concern. A more appropriate solution is to create robust transfer pricing and base 

erosion rules to ensure that income that is attributable to Puerto Rico is properly calculated and 
116 


Insert offset folio 85 here 98944.085

taxed. Further, to our knowledge, none of the inbound companies that the Patente Nacional was 

intended to target has been audited to examine whether it has engaged in transfer pricing abuse 

or other forms of base erosion. A comprehensive audit of these companies should be conducted, 

and, to the extent that abuse is detected, an appropriate legislative or regulatory response can 

be implemented. 

The imposition of a GST in place of the Patente Nacional also could offset the lost revenues from 

repeal and would in many respects collect tax from a similar base. 

2.4.8.4 Repeal or limit the Alternative Minimum Tax 

The purpose of the AMT is to ensure that a corporation cannot eliminate its income tax liability 

through the excessive use of certain corporate tax preference items. The AMT regime 

significantly increases complexity and taxpayer burdens. The benefits of maintaining the AMT 

regime must be weighed against these costs. To the extent corporate tax reform includes the 

repeal or reduction of corporate tax preference items-thereby reducing the incremental 

difference between net income for regular tax purposes and alternative minimum net income for 

AMT purposes-further consideration should be given to whether the incremental revenues 

justify the continued existence of the AMT regime. An alternative to repealing the corporate AMT 

regime in its entirety is to limit the scope of the regime to only large businesses with gross 

revenues above a certain threshold (e.g., $5 million). 

2.4.8.5 Repeal the Accumulated Earnings Tax 

As discussed above, when the individual tax rate is equal or close to the corporate tax rate, 

individual business owners generally prefer pass-through taxation. Thus, if corporate and 

individual tax rates are conformed, it is unlikely that individual business owners will elect 

corporate taxation over pass-through taxation solely for the purpose of avoiding current 

shareholder level taxation on the business's earnings. Accordingly, the accumulated earnings tax 

no longer would be needed to prevent the abuse for which it was enacted. 

Pass-Through Entities 

The Puerto Rican tax rules contain a number of different regimes relating to business entity 

taxation that generally provide for only one level of tax to be incurred with respect to earnings. 

Certain of the regimes provide "pass-through" treatment so that owners of the entity are taxed 

by reference to the income and losses of the entity. Others provide for an exemption from tax at 

the entity level so long as certain requirements are met, including the distribution of a baseline 

portion of annual earnings. Other regimes go even further, reducing or eliminating both 

entity-level and shareholder-level taxes with respect to specifically described earnings. 

2.4.9.1 Pass-Through Entities 

With limited exceptions, prior to the enactment of the 2011 Puerto Rico Income Tax Act !the 

"2011 Act"), entities legally formed as partnerships were taxed as corporations. Following the 

2011 Act, entities legally formed as partnerships generally are taxed on a flow-through basis 

under rules similar to the U.S. federal income tax rules applicable to partnerships. However, 

losses with respect to such partnerships can be used only to offset income from other 

pass-through entities (i.e., other partnerships, corporations of individuals, and special 
117 


Insert offset folio 86 here 98944.086

partnerships) and cannot offset income from other sources. A partner generally is subject to 

withholding ("remittances") by the partnership with respect to its allocable share of partnership 

income. 

From a tax perspective, a conversion from corporation to partnership status is treated as a 

liquidation of the corporation followed by the formation of a partnership; the liquidation often is 

taxable. However, the 2011 Act generally treated these deemed liquidations as tax-free during a 

transition period, with the entity generally becoming subject to special rules, such as the 

recapture of certain items, deemed distribution of accumulated earnings and profits, and a 

1 0-year built-in gain recognition period during which a corporate level tax would apply. 

Although some of the operative tax rules for partnerships are similar to the operative rules for 

corporations of individuals, as a general matter, the partnership rules are more complex than the 

rules for corporations of individuals (described below). The partnership rules, however, allow for 

more flexible economic arrangements than the corporation of individuals rules. In addition, the 

partnership rules impose no requirements relating to earning Puerto Rican source income to 

qualify for taxation as a partnership. 

Although an entity legally formed as a limited liability company ("LLC") generally is subject to tax 

as a corporation, it can elect to be taxable as a partnership or a corporation of individuals. With 

limited exceptions, however, an LLC must be taxed under the partnership rules if it is treated as 

a partnership or a "disregarded entity" under the laws of a foreign jurisdiction (such as the U.S. 

"check-the-box" regulations). If an LLC elects partnership status at a time after its formation, the 

transition from corporation to partnership status for tax purposes gives rise to a deemed 

liquidation of the corporation; this liquidation can be taxable for current conversions. An LLC with 

a single owner is regarded as a separate entity for Puerto Rican tax purposes. 

A corporation of individuals is a corporation or a partnership that elects to be treated as a 

corporation of individuals and that meets certain eligibility requirements. The eligibility 

requirements are similar, but not identical, to the eligibility requirements for "S corporations" 

under U.S. law. Among other things, a corporation of individuals must: (1) be organized under the 

laws of Puerto Rico, a U.S. state, or the District of Columbia; (2) be engaged in the active conduct 

of a trade or business solely in Puerto Rico; (3) have no more than 75 shareholders; and (4) have 

only shareholders that are individuals, estates, and certain kinds of trusts. In addition, only 10 

percent of gross receipts of a corporation of individuals can be derived from passive activities or 

from sources outside of Puerto Rico. These eligibility requirements limit the businesses that can 

use the corporation of individual's regime. 

A corporation of individuals is taxed on a flow-through basis so that income and losses generally 

flow through and are taxed only at the owner level. As in the case of partnerships and special 

partnerships, losses of a corporation of individuals can only be used to offset income from other 

pass-through entities. In addition, an owner of a corporation of individuals is subject to 

withholding by the corporation with respect to his or her share of corporate income. There also 

are taxes that can apply as a result of a corporation's conversion to corporation of individuals 

status (such as certain recapture taxes and a 10-year built-in gain recognition period during which 

a corporate-level tax would apply). 
118 


Insert offset folio 87 here 98944.087

Rules relating to" special partnerships" were made applicable to qualifying local law partnerships, 

LLCs, and corporations for taxable years beginning after December 31, 1984. In order to qualify 

as a special partnership, an electing entity must derive at least 70 percent of its gross income for 

each taxable year from sources within Puerto Rico and from certain defined activities (such as 

construction, land, substantial rehabilitation of buildings, sale or rental of buildings, manufacturing 

generating substantial employment, tourism, agriculture, exports, films, infrastructure, and green 

energy). 

A special partnership is taxed as a pass-through entity. Like a partnership or a corporation of 

individuals, its income and losses flow through and are taxed at the owner level. The rules relating 

to the taxation of special partnerships evolved significantly over the years. Although the special 

partnership rules currently are similar in some respects to those applicable to partnerships, there 

are some differences between the regimes. For example, to address certain aggressive tax 

planning that took place in the past regarding partners' use of losses, the special partnership 

rules provide that liabilities of a special partnership do not increase a partner's basis in its 

partnership interest. In addition, for a period, flow-through losses could not reduce a partner's 

net income by more than 50 percent, although this limitation is no longer applicable. Partners of 

special partnerships are subject to withholding with respect to their shares of partnership income; 

however, the withholding rates applicable to foreign partners not otherwise engaged in a trade 

or business in Puerto Rico can be lower than under the partnership rules. 

As a result of the 2011 Act, no special partnership elections have been allowed for taxable years 

beginning after December 31, 2010. However, special partnerships in existence at that time were 

grandfathered. There are procedures pursuant to which special partnerships currently can convert 

into partnerships in transactions that are exempt from immediate tax. 

The tax regime relating to Special Employee-Owned Corporations ("SEOCs") was introduced in 

1990 to promote certain labor incentives for manufacturing entities that were operating in Puerto 

Rico following the repeal of section 936 of the U.S. Internal Revenue Code (relating to the 

possessions tax credit). Although a SEOC legally is a corporation, the taxation of such entities is 

a blend of cooperative and flow-through principles. For example, a SEOC takes into account 

various deductions and credits on its information tax return and then passes certain items through 

to its members. A SEOC may have regular members (employees of the SEOC), special members 

(customers), and corporate members. Regular members must control the SEOC's management. 

We are not aware of any studies addressing whether the SEOC rules have achieved their 

intended objectives. 

2.4.9.2 Single-level of Tax for Certain Investment Entities 

The Puerto Rican Code has provided special tax rules for real estate investment trusts ("REITs") 

since 2000. The REIT provisions generally follow the U.S. tax model, with numerous 

requirements relating to shareholder dilution, property ownership and operation, and required 

distributions. Property ownership must be focused in Puerto Rico by virtue of a requirement that 

75 percent of gross income be derived from, among other sources, rents from real property 

located in Puerto Rico and interest on obligations secured by mortgages on real property located 
119 


Insert offset folio 88 here 98944.088

in Puerto Rico. A REIT is exempt from entity level tax in Puerto Rico so long as it distributes at 

least 90 percent of its earnings on an annual basis. REIT shareholders generally are subject to tax 

at a rate of 10 percent on distributed earnings, which tax is withheld at the source. 

Anecdotal evidence indicates that the REIT regime may not be operating as it originally was 

intended. The regime apparently was directed at encouraging Puerto Rican entrepreneurs to 

invest in local real estate through such entities. Because of the dilution requirements patterned 

after U.S. rules, however, the target audience has not found the regime attractive, as these 

parties are used to taking larger ownership stakes in real estate investments. As a result, of the 

few REITs that have been formed in Puerto Rico, most (and possibly all) have been formed by 

U.S. entrepreneurs. 

Provisions relating to registered investment companies(" RICs") initially were adopted as part of 

the Puerto Rico Income Tax Act of 1954. These rules have been amended over the years, most 

recently as part of the 2011 Act. As with REITs, a RIC will incur no tax at the entity level as long 

as at least 90 percent of its earnings are distributed annually. RIC shareholders generally are 

subject to tax at a rate of 10 percent on distributed earnings, which tax is withheld at the source. 

Exempt dividends and dividends from industrial development income are excludible from income. 

In 2013, the Puerto Rican rules were altered fairly significantly in an attempt to promote economic 

activity and public interest in Puerto Rico. Dividends from a U.S. RIC now generally are taxed at 

ordinary income rates for Puerto Rican residents, creating a disincentive for Puerto Rican 

residents to invest in U.S. RICs. In addition, effective for taxable years beginning after December 

31, 2013, a RIC qualifying under the Puerto Rico Investment Companies Act of 2013 and 

satisfying certain additional rules may qualify as an "exempt investment trust." The "eligible 

sources" of income for an exempt investment trust generally must relate to the promotion of 

economic activity and public interest in Puerto Rico or the raising of Puerto Rican capital. A 

qualifying exempt investment trust is subject to more favorable rules in that the trust is exempt 

from tax regardless of its level of distributions, and eligible shareholders are completely exempt 

from Puerto Rican tax on eligible distributions. An exempt investment trust also may elect to be 

taxed as a partnership, and members will be exempt from tax on income allocated by such 

entities. 

2.4.9.3 Exempt or Reduced-Reduced Rate Income at Entity level 

The regime for International Banking Entities ("IBEs") has been in place since 1989 and 

apparently was intended to encourage banking activities in Puerto Rico for clients outside of 

Puerto Rico and for capital deposits used outside of Puerto Rico. An IBE is entitled to an income 

tax exemption for net income generated by its qualifying activities. If the I BE operates as a branch 

or unit of a bank, the tax exemption is limited to 20 percent of the total net income of the bank. 

No income tax withholding applies to dividends paid from income generated by the qualifying 

activities. 

An IBE was required to apply for IBE status. Once IBE status was granted, the IBE became 

subject to the applicable rules provided under Act 52. After September 25, 2012, no new 

applications have been accepted for IBE status; however, renewals of IBE licenses could still be 

processed and existing licenses remained in effect. Although existing IBEs can apply to be 
120 


Insert offset folio 89 here 98944.089

International Financial Entities ("IFEs"), described below, the IBE rules are generally more 

favorable than the IFE rules. 

Since September 25, 2012, a separate regime for IFEs has been in effect An IFE is subject to 

rules that are similar to the rules applicable to IBEs, except that tax at a rate of 4 percent is 

applicable to net income from qualifying activities (subject to the same 20 percent limitation for 

IFEs operated by a bank). Income tax withholding applies to dividends at a rate of 6 percent on 

dividends paid from income generated by the qualifying activities. Upon approval of the licensing 

request, the IFE operates under a tax exemption decree that provides for the !FE's tax treatment 

The tax exemption decree is effective for a period of 15 years, with two possible renewal 

extensions of 15 years each. The tax rate for the last possible 15-year period can range from 4 

percent to 10 percent No exemption decrees (other than renewals) can be issued for IFEs after 

December31, 2019. 

Two alternative sets of considerations should be taken into account in analyzing reform efforts 

with respect to pass-through entities. The first set involves an analysis of largely duplicative 

regimes and a determination of whether certain regimes may be eliminated or combined. The 

second set relates to encouraging a large segment of the business community currently 

operating in corporate form to convert to taxation under a pass-through regime. More specifically, 

as part of the effort to transition more businesses to a pass-through regime, certain adjustments 

relevant to the operation of the pass-through regimes may be considered to (1) make such 

regimes accessible to such a broad group of taxpayers, and (2) prevent abuse by taxpayers 

operating under such regimes. 

2.4.10.1 Consolidating Duplicative Regimes 

Regimes relating to the taxation of entities that are largely duplicative, with only slight 

differences, force taxpayers to expend effort in making choices that may have de minimis 

consequences. Also, if taxpayers can choose between different entity regimes that are designed 

to promote the same policies and activities, they often will choose the one that results in the 

lowest tax, possibly resulting in a loss to government revenues. 

From the tax administrator's perspective, significant resources must be expended in developing 

and maintaining rules and procedures necessary to properly administer alternative regimes. In 

addition, training audit teams to enforce such duplicative regimes consumes scarce resources 

that could be deployed more efficiently elsewhere. 

As new regimes are created, it is useful to analyze whether existing regimes continue to be 

necessary to promote the policies that originally justified such regimes. It also can be productive 

to periodically evaluate specific regimes to determine the extent to which the regimes are being 

used and are promoting the policies that are intended. Periodic accumulation of data and statistics 

with respect to the various regimes can be useful in undertaking these analyses to corroborate 

the effectiveness of current regimes that are intended to promote distinct policies. 

As is readily apparent from the description of current law, there is significant overlap between a 

number of the regimes that are currently in place for subjecting business income to one level of 

tax. In certain situations, regimes have been left in place when new regimes were adopted that 

provide similar tax treatment For example, the regime for special partnerships was retained after 
121 


Insert offset folio 90 here 98944.090

the more broad-based regime for partnerships was enacted in 2011. Similarly, the regime for 

IBEs was left in place after the modified regime for IFEs was adopted. In both situations, only 

grandfathered entities continue to be taxed under the prior regimes; no new entities can elect 

special partnership or IBE status. Thus, a different set of rules can apply to similarly situated 

businesses. 

There is less of an overlap between certain other regimes. For example, although partnerships 

and corporations of individuals provide similar pass-through treatment for their owners, the 

corporation of individuals rules offer the benefit of simplicity for businesses with simple capital 

structures (provided those businesses can meet the requirements regarding the type and source 

of income). By contrast, the operative tax rules applicable to partnerships are more complex, but 

provide for more flexible economic arrangements. Thus, differences in businesses and capital 

needs provide justification for retaining simple corporation of individuals rules as well as more 

complex partnership tax rules. 

Some of the other regimes, as currently structured, appear to be underutilized. For example, 

there are very few REITs. Also, most (if not all) existing RICs are operating under longstanding 

rules; however, the new exempt interest trusts, which are intended to promote economic activity 

and public interest in Puerto Rico, have been in effect for only a relatively short period thus far. 

2.4.11.1 Consolidating Duplicative Regimes and Eliminating Unnecessary Regimes 

It appears that entities currently operating under the special partnership regime could operate 

under the 2011 Act partnership regime with minimal disruption. Accordingly, consideration 

should be given to eliminating the rules for special partnerships and allowing such entities to 

convert to partnerships on a tax efficient basis. 

Given the lack of studies regarding SEOCs, it is not clear whether the objectives of the SEOC 

regime are being achieved or whether the regime could be eliminated without negatively 

affecting the level of Puerto Rican manufacturing activities. It may be prudent to have a study 

conducted to determine whether the economic benefits of the regime justify its continued 

existence. If these special tax rules are not encouraging the stated goals, such entities might be 

converted to partnerships with little disruption. 

If anecdotal evidence regarding the limited use of REITs is accurate, consideration could be given 

to eliminating the REIT regime and allowing existing REITs to remain subject to the REIT rules 

for a transition period. Thereafter, tax efficient conversion to partnership status could be 

permitted for such entities. 
122 


Insert offset folio 91 here 98944.091

Usage of the new exempt investment trusts should be monitored, and if after some reasonable 

time it appears that the economic benefits in Puerto Rico sought through the promotion of such 

entities will not be realized, the regime for these entities should be eliminated. 

The IBE rules could be repealed and IBEs could be allowed a short grace period to request 

licenses for treatment as IFEs. Such entities would become subject to the !FE regime upon the 

issuance of a tax exemption decree. 

2.4.12.1 Consolidating Duplicative Regimes and Eliminating Unnecessary Regimes 

There would seem to be little justification for retaining the separate special partnership and 

partnership regimes that exist under current law. Although certain foreign investors may incur a 

higher tax burden with respect to their existing investments under the partnership regime than 

under the grandfathered special partnership rules due to differences in withholding amounts, the 

elimination of the special partnership rules would seem to present little threat to the level of 

future investment by those investors. Furthermore, providing a benefit to parties by reference to 

historical ownership of certain entities does not promote a level playing with respect to such 

property investment. 

The transition to the 2011 Act partnership regime seemingly would be simple for grandfathered 

special partnerships that were formed as partnerships or LLCs under the relevant jurisdictional 

law. Because juridical corporations cannot be taxed as partnerships under existing law, however, 

some accommodation would have to be made for special partnerships that are legally formed as 

corporations. If non-traded corporations generally are allowed to elect taxation as a partnership, 

no further adjustment to the rules would be required. If not, transition rules could provide that a 

special partnership could elect to be taxed as a partnership without any immediate tax on the 

conversion and without generating recapture of specified items from the period it was a special 

partnership, notwithstanding its legal status as a corporation. 

Special partnerships that become partnerships no longer would be subject to the requirement 

that at least 70 percent of their gross income be derived from within Puerto Rico and be from 

certain specified business activities. Under current law, grandfathered special partnerships that 

have difficulty meeting this requirement can convert to partnership status anyway; thus, not 

imposing this requirement in the future should not have a significant impact on Puerto Rican 

economic activity. 

The SEOC rules are complicated, and it is not readily apparent that the regime is well designed 

to accomplish its intended purpose of promoting labor incentives for manufacturing taking place 

in Puerto Rico. Depending on the outcome of the study suggested above, it may make sense to 

repeal the SEOC rules and allow existing SEOCs to convert to partnerships without triggering 

any immediate tax and without being subject to recapture. 
123 


Insert offset folio 92 here 98944.092

Given what apparently is limited use of REITs by Puerto Rican entrepreneurs fourteen years after 

adoption of the original legislation, it appears that such a regime may not be useful in an economic 

environment like Puerto Rico's. While immediate elimination of the rules could impose an undue 

hardship on the limited real estate concerns that are operating under this regime, the adoption 

of transition rules that would allow the parties investing in such entities to properly reap a 

justifiable portion of the anticipated benefits without continuing those benefits in perpetuity may 

be appropriate. There is precedent in the United States in relation to the taxation of publicly traded 

partnerships for grandfathering the current tax treatment of entities for 10 years prior to transition 

to taxation as a corporation. Given the generally passive nature of REITs, providing for tax efficient 

conversion to partnership status following termination of REIT status could be appropriate. 

Rules relating to the taxation of exempt investment trusts were adopted with the intent of 

encouraging economic development in Puerto Rico. Given the significant limitations on the 

permissible activities and investments of such entities, it is not clear that the exempt investment 

trust regime will be successful in achieving its goals. Accordingly, this regime should be 

monitored, and if usage of the entity indicates that the desired goals are not being achieved, the 

regime should be eliminated. 

The IBE regime is applicable only to grandfathered entities and is intended to encourage the 

same activities as the current IFE regime. There would seem to be little justification for retaining 

the IBE regime under these circumstances. IBEs do not operate under tax exemption decrees 

and have no vested right with regard to their current treatment. In transitioning existing IBEs to 

IFEs, IBEs should submit to an expedited IFE licensing process. Prior qualification as an IBE could 

be a favorable, heavily weighted, factor in granting an IFE license, so as to ease concerns that 

ultimate conversion may be improbable. Although current IBEs may complain about losing a tax 

status that is more favorable than that accorded to IFEs, it is valid to question whether taxpayers 

who were fortunate enough to operate under the prior regime should continue to benefit from a 

lower tax rate than their competitors indefinitely. 

2.4.12.2 Accounting for Broader Usage of Pass-Through Entities 

In considering whether to allow entities currently operating under the corporate tax system to 

transition into a pass-through tax regime, it will be important to evaluate the pass-through 

regimes that will be made available for conversion and whether the current regimes are well 

designed to accommodate the businesses that would be the subject of the conversions. 

As an initial matter, it is important to recognize that over 90 percent of corporations operating in 

Puerto Rico have less than $60,000 of annual income. It is likely that the individuals running these 

businesses lack the sophistication and resources to operate under a tax regime with a high 

degree of complexity. While pass-through taxation generally is thought to be beneficial, due to 

the avoidance of a second level of tax, any variance from a basic capital structure and 

cash-funding of asset acquisitions and operations can introduce significant complexity to the tax 

reporting exercise for such entity. To the extent possible, the promotion of a straight-forward 

pass-through reporting regime for the relatively simple businesses would seem important. 
124 


Insert offset folio 93 here 98944.093

Of equal importance, if a materially broader group of taxpayers will be given access to one or 

more pass-through regimes, there should be a heightened sensitivity to opportunities for abuse 

that might be facilitated through such regimes. While many of the parties who would convert to 

a pass-through regime will operate simple businesses and will not be inclined toward (or possess 

the sophistication to engage in) such abusive transactions, it should be assumed that this will not 

be the case for all who are encouraged to operate under such a regime. 

A corporation of individuals is a relatively simple tax regime that presents little opportunity for 

abuse. The regime requires that the entity have only one class of stock. With such a simple capital 

structure, income allocations must be pro rata and thus are quite straightforward. The inability to 

undertake non-pro rata allocations also provides some limit on the opportunities for abuse. The 

inability to include liabilities in shareholder basis (for purposes of sheltering losses and 

distributions) also is a significant limitation on abuse potential. 

Given the simplicity and limited opportunity for abuse inherent in the corporation of individuals, 

it seems that this regime should be made available and encouraged for many of those who would 

convert. The current rules provide that a corporation of individuals will terminate if the corporation 

has gross receipts other than from the conduct of a trade or business in Puerto Rico in excess of 

ten percent for the taxable year. Not only does the rule restrict activities to Puerto Rico, but it 

also necessitates the earning of a high level of gross income that is trade or business income 

rather than passive investment income. The rule, while arguably encouraging economic activity 

in Puerto Rico, provides a barrier to usage for some. The importance of making such a simple tax 

regirne available to a broader constituency arguably should outweigh the reasons originally 

supporting the imposition of this limitation. Accordingly, consideration should be given to 

eliminating this limitation. In connection with the elimination of this limitation, steps should be 

taken to ensure that the corporation of individuals could not be used by individuals to avoid the 

limitation on deductibility of investment expenses under section 1 033.02(a). Requiring that such 

expenses must be "separately stated" and allocated to the owners as separate items subject to 

the limitation would seem to provide adequate protection. Further, there is no compelling reason 

to limit the availability of corporation of individual's status to entities with 75 or less owners. 

Under this option, any eligible business entity with 200 or less owners may elect to be taxed as 

a corporation of individuals, so long as the entity satisfies the other applicable requirements. 

In addition, given a target audience of taxpayers who may be relatively unsophisticated, there is 

a risk that numerous taxpayers will make "footfault" errors that cause disqualification as a 

corporation of individuals. A relief provision currently exists for excusing "inadvertent 

terminations" with the approval of the Secretary of the Treasury. However, in recognition that 

many of the mistakes will be "innocent" and cause no real compromise of the tax system, 

consideration should be given to implementing expedited procedures for correcting such errors 

and retroactively reinstating corporation of individual's status. 

Business entities with more sophisticated capital structures or a shareholder base in excess of, 

e.g., 200 persons will not qualify as a corporation of individuals. If such businesses operating as 

corporations are allowed to convert to pass-through status, a partnership will be the most rational 

regime for these entities. 

As noted above, partnerships are very flexible entities. Allocations of income and loss can be very 

flexible, non-recognition treatment generally is provided in connection with the contribution and 

distribution of assets, and partners are entitled to include their share of liabilities in the basis of 

their partnership interests. With such flexibility comes a heightened potential for abuse, and 

encouraging additional businesses to operate as partnerships could open the door to such 
125 


Insert offset folio 94 here 98944.094

abusive transactions. In this regard, many of the abusive transactions that have occurred in Puerto 

Rico in the past apparently have involved the use of allocated liabilities in the adjusted basis of 

partnership interests. Rules should be adopted to prevent the re-emergence of such abusive 

transactions. 

Currently, the rules relating to special partnerships prevent partners from including partnership 

liabilities in the basis of their partnership interests. This rule has the benefit of simplicity, although 

some would view such a rule as improperly denying tax benefits to parties who take on true risk 

with respect to debt financed transactions through guarantees, indemnification arrangements, 

etc. The "at-risk" rules under the U.S. Internal Revenue Code try to strike a balance in this regard 

these rules generally permit taxpayers to claim benefits in the form of tax losses only to the 

extent that taxpayers truly are bearing risk of loss with respect to the expenditures that generate 

the losses. This regime illustrates a potentially more fair, albeit more complicated, option and 

should be considered. The U.S. at-risk regime includes certain rules that provide favorable 

treatment for" qualified nonrecourse financing" relating to certain nonrecourse debt attributable 

to real estate. Given the nonrecourse nature of the debt, partners who share in such debt do not 

truly undertake risk with respect to such debt. If the desire is to provide credit only for debt with 

respect to which a partner is truly at-risk, the rules relating to qualified nonrecourse financing 

should not be adopted. 

2.4.12.3 Transition from Corporate to Pass-Through Regime 

As previously described, it would be more efficient for many of the businesses currently 

operating under tax rules applicable to corporations to instead operate under a pass-through 

regime. In order to promote transition to the more efficient model of taxation, consideration 

should be given to permitting many of the entities that currently are taxable as corporations to 

convert with minimal or no tax cost to taxation under a pass-through regime. 

In analyzing the parameters of entity transition rules, a number of factors must be taken into 

account. First, it is necessary to determine what entities within the pass-through regime would 

be available for conversion from taxation as a corporation. Once a decision is made with respect 

to the available entities, consideration must be given to the tax cost of the conversion. Issues 

related to the future taxation of converted entities also must be considered in light of decisions 

relating to the chosen taxation of the conversion transaction. Finally, if favorable transition rules 

are adopted relating to entity conversions, the duration of such transition relief must be 

determined. 

With respect to the entities available for conversion, it seems that any entity that would not be 

taxable as a per se corporation under the entity classification rules discussed above should be 

permitted to efficiently convert into either (1) a corporation of individuals (if requirements for 

qualification can be satisfied), or (2) a partnership. Corporations that could qualify as a corporation 

of individuals should be strongly encouraged to convert to such an entity. The rules for operating 

under this regime are much simpler and generally will accommodate the needs of smaller 

businesses with simple capital structures. In addition, transition issues and the potential for 

abuse with respect to such entities generally are more straightforward. Other non-per se entities 

should be permitted to convert to the partnership tax regime. 

There is precedent in the Puerto Rican tax system for permitting favorable transition from 

corporate to pass-through treatment. Most recently, as part of the 2011 Act, a partnership or LLC 

that was subject to tax as a corporation was permitted to become taxable as a partnership 

effective as of the first day of the entity's taxable year beginning after January 1, 2011. Under 

these rules, on the last day of the taxable year beginning prior to January 1, 2011, the partnership 
126 


Insert offset folio 95 here 98944.095

or LLC that was taxable as a corporation was treated as transferring its assets and liabilities to its 

partners or members in liquidation of the partnership or LLC, and immediately thereafter the 

partner or member contributed the distributed assets and liabilities to an entity that was treated 

as a partnership for tax purposes. The transition provision stated that, except for limited 

situations, no gain or loss would be recognized in connection with the distribution by the entity 

taxable as a corporation, and the contribution transaction would be analyzed under the general 

non-recognition provision applicable to partnerships. The exceptions where gain or income could 

be recognized paralleled the rules that apply when a corporation converts to a corporation of 

individuals. Specifically, upon conversion, the partnership or LLC that was taxable as a corporation 

was required to: (1) recapture LIFO benefits; (2) recapture benefits of flexible or accelerated 

depreciation; (3) recognize deferred income under long-term contracts; (4) recognize deferred 

income from installment sales; and (5) treat earnings and profits as if they were currently 

distributed. In addition, a corporate tax would be imposed on the entity treated as a partnership 

with respect to built-in gain as of the date of conversion if recognized within a 1 0-year period 

following conversion. 

A similar approach could be taken with respect to entity conversions under the new regime, 

although in the interest of encouraging more taxpayers to convert into a more rational tax regime 

for their businesses, consideration may be given to forgoing the deemed distribution of earnings 

and profits and 1 0-year built-in gain period. The other recapture and recognition provisions relate 

to tax-advantaged elections or alternatives that the corporation affirmatively took advantage of, 

and it seems more rational to recapture or recognize those amounts in all events. 

In many situations, the total adjusted basis of the stock held by shareholders will be higher than 

the adjusted basis of the assets held by the corporation. In those situations, by electing to convert 

to a corporation of individuals or partnership on a largely tax-free basis, shareholders could realize 

some detriment, as they would lose the adjusted basis in their stock, and the adjusted basis in 

the corporation of individuals stock or partnership interests would be determined by reference to 

the bases of the assets that were deemed distributed to these persons (each holder would 

succeed to a proportionate part of the basis of each distributed asset based on a ratio determined 

as the value of the holder's equity interest over the total value of all outstanding equity interests, 

and the basis of such holder's interest in the corporation of individuals or partnership would equal 

to total basis of the portion of the assets deemed contributed by such holder.) This appears to 

have been the construct for conversions from a partnership or LLC taxed as a corporation to 

taxation as a partnership in 2011, and in that context, the parties still had to account for the 

deemed distribution of earnings and the 10-year built-in gain recognition period. In addition, 

parties wishing to convert to a corporation of individuals still would have the option to convert 

under the existing regime, in which case the shareholders would preserve their stock basis, but 

at the cost of the deemed distribution of earnings and 1 0-year built-in gain recognition period. 

The adoption of a conversion mechanic that equates inside asset basis and outside basis in equity 

interests will facilitate rational reporting on a going forward basis with respect to the converted 

entities, particularly those that are partnerships. The partnership tax regime generally operates 

on the assumption that inside asset basis should equal outside equity interest basis. 

The economic rights of partners generally will be accounted for by reference to "capital 

accounts." In general, a partner's ultimate rights upon liquidation of a partnership should equal 

the partner's initial capital account in a partnership, increased by "book" income allocations and 

the value of property contributions, and reduced by "book" loss allocations and the value of 

property distributions. Under the proposed regime for partnerships, following conversion, initial 

capital accounts for each partner would be set at the amount that the partner would be entitled 
127 


Insert offset folio 96 here 98944.096

to receive if the partnership sold its assets for fair market value on the date of conversion and 

liquidated. Each partner would have a share of adjusted basis in the partnership assets equal to 

such partner's adjusted basis in its partnership interest The difference between a partner's 

capital account and its share of inside basis would be taken into account under principles similar 

to the principles relating to contributed property under section 1 071.04(c) of the Puerto Rican 

Code. Each partner would have a proportionate share of built-in gain or loss in each asset 

determined by reference to the partner's built-in gain or loss in its partnership interest Following 

these rules, if all partnership assets are sold, and the partnership liquidates, distributing cash to 

each partner consistent with such partner's economic share, the partner should recognize no 

gain in connection with the liquidating distribution. This result is consistent with a properly 

operating partnership tax regime. 

With respect to the corporation of individual's regime, the allocation regime should be more 

straightforward. The concept of "capital accounts" is not relevant in the context of corporations 

of individuals. Instead, given the "single class of stock" capital structure, all allocations of income 

and loss are simply made on a pro rata basis. 

Finally, a decision must be made regarding the period during which conversions may be 

accomplished on the tax-favored basis. When entities previously were allowed to convert in 

connection with the 2011 Act, the relevant entities were provided with a one-time opportunity to 

convert as of the entity's first taxable year beginning after January 1, 2011. Anecdotal evidence 

indicates that many entities that could have benefited from such an election failed to take 

advantage of this option. In order to provide a greater opportunity to educate the relevant 

constituency of the presence of the conversion option and the benefits that might be obtained, 

consideration should be given to a longer period of e.g. three years when entities may take 

advantage of this conversion option. 

Beyond the initial transition period, any non-per se entity taxable as a corporation could be allowed 

to convert to pass-through status for Puerto Rican tax purposes. After a reasonable transition 

period during which favorable conversion conditions are permitted, however, the more traditional 

tax treatment would apply, including recognition of gain upon the deemed liquidation of the entity 

taxable as a corporation (except for certain controlled subsidiary liquidations. 

2.5 Rationalize Allocation of Incentives for Inbound Business Taxation 

2.5.1.1 In General 

The taxation of income of nonresident aliens, foreign corporations, and foreign partnerships 

("foreign persons") generally depends on the source of the income and whether the foreign 

person is engaged in the conduct of a trade or business in Puerto Rico. A foreign person that is 

not engaged in a trade or business in Puerto Rico is subject to Puerto Rico income tax only on 

certain items of Puerto Rico source income. A foreign person that is engaged in the conduct of 

a trade or business in Puerto Rico is subject to Puerto Rico income tax on all income effectively 

connected with that trade or business (" ECI "). If a foreign person is engaged in a trade or 

business in Puerto Rico at any time during a taxable year, all Puerto Rico source income and gains 

received by the person during the year are treated as ECI. Non-Puerto Rico source income is 

treated as ECI only if the income consists of a certain type of income, the foreign person has an 

office or other fixed place of business in Puerto Rico, and the income is attributable to that office 

or fixed place of business. A branch profits tax is imposed on the withdrawal of assets from 
128 


Insert offset folio 97 here 98944.097

Puerto Rican operations in order to equalize the treatment of foreign corporations that do 

business directly in Puerto Rico and those which operate through a Puerto Rican subsidiary. 

2.5.1.2 law 73 and law 135 

Inbound investment in Puerto Rico has long been encouraged by tax subsidies. The Economic 

Incentives for the Development of Puerto Rico Act ("Law 73") became effective on July 1, 2008. 

Law 73 replaced the Tax Incentives Act of 1998 ("Law 135"), which continues to apply to a 

number of decrees that were issued prior to 2008. While there are some differences between 

the two Laws, the substantive parameters are generally the same. Because Law 73 governs 

current grants, this discussion will focus on Law 73. 

Under Law 73, exemption decrees are issued to qualifying businesses by the Office of Industrial 

Tax Exemption. The Puerto Rico Industrial Development Company ("PRIDCO") is responsible for 

the promotion of the incentives program. 

Law 73 provides reduced tax rates on net industrial development income of exempt businesses 

and reduced withholding tax rates on payments made by exempt businesses (generally 4% and 

12%, respectively, or alternatively, 8% and 2%, respectively), as well as additional deductions 

for acquiring, constructing, or remodeling certain buildings, structures, machinery and equipment, 

and tax credits for purchases of Puerto Rico manufactured products, for special eligible 

investments, for investment in energy producing machinery and equipment, for reduction of 

energy costs, and for investment in strategic projects. Dividends or profit distributions by an 

exempt business of industrial development income to its shareholders or partners are not subject 

to tax. In addition, the Law provides a 90% exemption from property taxes, 100% exemption 

from municipal license taxes during the first 3 semesters of operations and at least 60% 

thereafter, and 100% exemption from excise taxes and sales and use taxes with respect to the 

acquisition of raw materials and certain machinery and equipment used in exempt activities. The 

length of the exemption period generally is 15 years and generally may be extended for an 

additional 10 years. Businesses eligible for the exemption include manufacturing and service 

units, owners of properties used by exempt businesses, research operations, energy suppliers, 

recyclers, value added activities related with the Las Americas Port and various other ports, 

software developers, renewable energy equipment assemblers, certain specified strategic 

projects, the construction of social interest housing and the planning and development of self 

sustainable housing projects, and repair, maintenance and overhaul of aircraft. 

2.5.1.3 law20 

Law 20, the "Export Services Act," enacted in 2012, is the latest business incentive measure. It 

is intended to encourage local businesses to expand their operations in Puerto Rico and foreign 

businesses to move their operations to Puerto Rico, by providing preferential tax treatment to 

businesses that export certain services from Puerto Rico to customers around the world. Eligible 

businesses must obtain an exemption decree to receive benefits under Act 20. 

To be eligible for benefits under Law 20, a business must have an office or bona fide 

establishment located in Puerto Rico that carries out, or may carry out, "Eligible Services" that 

are either "Export Services" or "Promoter Services." 

Eligible Services (to the extent provided for export) include: research and development; 

advertising and public relations; economic, environmental, technological, scientific, managerial, 

marketing, human resources, computer, and auditing consulting services; consulting services for 

any trade or business; commercial arts and graphic services; drafting of construction plans and 
129 


Insert offset folio 98 here 98944.098

engineering, architectural, and project management services; professional services such as legal, 

tax, and accounting services; centralized management services that include, but are not limited 

to strategic location, planning, and budgetary services carried out at the headquarters or similar 

regional offices of an entity engaged in rendering such services; electronic data processing 

centers; computer program development; voice and data telecommunications between persons 

located outside Puerto Rico; call centers; shared service centers that include, but are not limited 

to accounting, finance, tax, auditing, marketing, engineering, quality control, human resources, 

communications, electronic data processing, and other centralized management services; 

storage and distribution centers of companies engaged in the business of transportation of items 

and products that belong to third parties, known as "hubs"; educational and training services; 

hospital and laboratory services; investment banking and other financial services insofar as these 

services are provided to foreigners; and any other service designated by the Secretary of the 

Department of Economic Development and Commerce of Puerto Rico. 

An Eligible Service is considered a service provided for export (i.e., an Export Service) if such 

service is rendered for the benefit of a person or entity that is not a resident of Puerto Rico and 

the service does not have a connection with Puerto Rico. 

Certain services that have a connection with Puerto Rico (and thus fail to qualify as Export 

Services) may qualify as Eligible Services if they constitute Promoter Services. Promoter Services 

are services provided to non-resident persons related to the establishment of a new business in 

Puerto Rico. 

To receive benefits under Law 20, a Puerto Rico service provider must apply for and receive a 

tax exemption decree from the Department of Economic Development and Commerce of Puerto 

Rico. A tax exemption decree constitutes a binding contract between the service provider and 

the Government of Puerto Rico, and benefits are guaranteed for the term of the decree 

regardless of a subsequent change in law. The decree will have a term of 20 years, with a possible 

10 year extension. 

The tax benefits under Law 20 include: 

1) 4% fixed income tax rate on net income derived by an Eligible Business from Export 

Services; 

2) 3% fixed income tax rate on net income derived by an Eligible Business from Export 

Services if more than 90% of the Eligible Business's income is derived from Export 

Services and the Export Services are considered "Strategic Services" under the Act; 

3) 100% exemption from Puerto Rico income tax on dividend distributions received by 

shareholders or members of an Eligible Business that holds an exemption decree; and 

4) 100% exemption from personal and real property taxes during first five years of 

operations for personal and real property used by an Eligible Business that provides 

services related to corporate headquarters, call centers, or shared service centers. After 

the first five years, a 90% exemption applies for the remaining term of the decree. 
130 


Insert offset folio 99 here 98944.099

2.5.1.4 law 154 

Law 154, enacted on October 25, 2010, materially affects the tax burden borne by inbound 

investors. Law 154 modified the Puerto Rico Internal Revenue Code to expand the circumstances 

in which a foreign person may be treated as engaged in a trade or business in Puerto Rico and 

to treat certain income derived by foreign persons as Puerto Rico source ECI, and thus subject 

to Puerto Rico income tax. Law 154 applies only to foreign persons who engage in high volumes 

of transactions with related parties engaged in business within Puerto Rico. As a result, there is 

a very high overlap between those multinational groups whose Puerto Rican subsidiaries have 

been granted decrees under Law 73 and those who are subject to Law 154. 

Prior to the enactment of Law 154, an office or other fixed place of business of a Puerto Rico 

person was attributed to a foreign person only if the Puerto Rico person had the authority to 

negotiate contracts in the name of the foreign person, the Puerto Rico person regularly exercised 

that authority or maintained an inventory of merchandise from which it regularly filled orders on 

behalf of the foreign person, and the Puerto Rico person was not a general commission agent, 

broker, or other independent agent acting in the ordinary course of its business. Law 154 

expanded this rule to attribute the office or fixed place of business of a Puerto Rico resident to a 

related foreign person if the related parties engage in certain types of transactions (the "Related 

Party Attribution Rule"). If the Related Party Attribution Rule applies, a portion of the foreign 

person's income is treated as Puerto Rico source ECI, and thus subject to Puerto Rico income 

tax (the "Source Rule"). Law 154 also adopted an excise tax (the "Excise Tax") that is imposed 

on certain foreign persons in lieu of the income tax that the foreign persons would pay under the 

Source Rule. 

Two features of the law are very important to understanding its history and its function. As an 

initial matter, the decrees granted pursuant to Law 73 severely restricted Puerto Rico's ability to 

collect revenues directly from the operating Puerto Rican subsidiaries of multinational 

corporations. By taxing the Puerto Rican source income (as redefined) of related parties dealing 

with those subsidiaries, the decrees were circumvented and Puerto Rico was able to tax income 

related to the activities governed by the decrees without violating their terms. In addition, the 

regime has had the benefit of generally allowing U.S. groups to claim a credit against their U.S. 

taxes for the amounts paid under Law 154, while still benefitting from indefinite deferral of the 

U.S. tax on the income reported by the Puerto Rican subsidiary. As a result, the impact of the tax 

on the worldwide effective tax rate of the group is substantially less than it would be in the case 

of a tax imposed directly on the Puerto Rican subsidiary. 

2.5.1.4.2.1 Related Party Attribution Rule 

The Related Party Attribution Rule applies in situations where a foreign person (a "Foreign 

Purchaser") purchases goods from a related 51 company that manufactures property or performs 

services in Puerto Rico (the "Seller"). and, for the taxable year or any of the three preceding 

taxable years, one of the following requirements is satisfied: 

51 Corporations are related for this purpose if they are members of the same controlled 

are members of the same control rf one corporatiOn owns, directly or at 

voting power and value of stock the other corporatron, or a common 

percent of the total voting power and value of the stock of each rmnm"ticm 
131 


Insert offset folio 100 here 98944.100

1) The Seller's total gross receipts from the sale to the Foreign Purchaser of personal 

property manufactured or produced in Puerto Rico, or from the performance of services 

in Puerto Rico for or on behalf of the Foreign Purchaser, accounted for at least 1 Oo/o of 

Seller's gross receipts; 

2) The Foreign Purchaser's purchases of personal property manufactured or produced in 

Puerto Rico by the Seller, or services performed in Puerto Rico by the Seller, accounted 

for at least 10% of the total costs of the Foreign Purchaser's purchases of property or 

services; 

3) The Foreign Purchaser earns commissions with respect to property manufactured or 

produced in Puerto Rico by the Seller, or services performed in Puerto Rico by the Seller, 

and such commissions account for at least 1 Oo/o of the amount of the Foreign Purchaser's 

commissions or other tees from similar transactions; or 

4) The Foreign Purchaser facilitates the Seller's sale of personal property manufactured or 

produced in Puerto Rico, or the performance of services in Puerto Rico, and, together 

with the transactions in the first three categories, the facilitated transactions account tor 

at least 1 Oo/o of the gross receipts of the Seller or at least 1 Oo/o of the gross receipts of 

the Foreign Purchaser. 

Law 154 provides an anti-abuse rule that disregards any transaction, or series of transactions, if 

one of the principal purposes of the transaction or series of transactions is the avoidance of the 

Related Party Attribution Rule. 

2.5.1.4.2.2 Source Rule 

If a Foreign Purchaser satisfies the Related Party Attribution Rule and otherwise maintains an 

office or other fixed place of business in Puerto Rico, or is treated as maintaining an office or 

fixed place of business in Puerto Rico apart from the Related Party Attribution Rule, a portion of 

the Foreign Purchaser's income is treated as income from Puerto Rico sources. If a Foreign 

Purchaser that is not otherwise engaged in a trade or business in Puerto Rico has income that is 

treated as Puerto Rico source income under the Source Rule, the Foreign Purchaser is treated 

as engaged in a trade or business in Puerto Rico and the Puerto Rico source income is treated 

as ECI (and thus subject to Puerto Rico income tax). 

The Source Rule applies if the Seller's gross receipts from sales to the Foreign Purchaser of 

personal property manufactured or produced in Puerto Rico, and services performed for or on 

behalf of the Foreign Purchaser in Puerto Rico, does not exceed $75,000,000 for any of the three 

preceding taxable years. If the Seller's gross receipts exceed $75,000,000 for any of the three 

preceding years, the Foreign Purchaser is subject to the Excise Tax in lieu of the income tax that 

the Foreign Purchaser would owe on any income treated as Puerto Rico source income under 

the Source Rule. 

The portion of a Foreign Purchaser's income that is treated as Puerto Rico source income under 

the Source Rule is determined by multiplying the total amount of the Foreign Purchaser's income 

by a fraction based on four equal factors: property, payroll, sales, and purchases (the 

"Apportionment Formula"). The numerator of the Apportionment Formula is the sum of four 

fractions: (1) the value of real or tangible personal property owned and used by the Foreign 

Purchaser in Puerto Rico over the value of the Foreign Purchaser's total worldwide real and 

tangible personal property; (2) the amount the Foreign Purchaser paid or accrued in Puerto Rico 

for compensation over the Foreign Purchaser's total worldwide compensation expense; (3) the 
132 


Insert offset folio 101 here 98944.101

Foreign Purchaser's sales in Puerto Rico over the Foreign Purchaser's total worldwide sales; and 

(4) the Foreign Purchaser's purchases of property in Puerto Rico over the Foreign Purchaser's 

total worldwide purchases of property. The denominator of the Apportionment Formula is four. 

If a Foreign Purchaser believes the Apportionment Formula has operated or will operate to 

subject a greater portion of its income to taxation than is reasonably attributable to business or 

sources within Puerto Rico, the Foreign Purchaser may file an objection to the application of the 

Apportionment Formula and propose an alternative method of apportionment that it believes to 

be proper under the circumstances. 

If a Foreign Purchaser subject to the Source Rule is unwilling or unable to provide sufficient 

documentation to support its computation of the Apportionment Formula, and the Foreign 

Purchaser does not file a timely objection to the use of the Apportionment Formula, 50 percent 

of the Foreign Purchaser's gains, profits, and income from the sale or exchange without Puerto 

Rico of personal property manufactured or produced in whole or in part within Puerto Rico will 

be treated as ECI. 

The Related Party Attribution Rule and Source Rule apply to income accruing after December 31, 

2010. 

2.5. 1.4.2.3 Excise Tax 

The Excise Tax is imposed on the value of certain personal property and services acquired by a 

foreign person from a related Puerto Rico entity with gross receipts of at least $75,000,000 if the 

foreign person has, or is treated as having, an office or fixed place of business in Puerto Rico 

under the Related Party Attribution Rule or through an agent, and the related party transactions 

exceed a certain threshold. Similar to the Related Party Attribution Rule, the Excise Tax only 

applies if Foreign Purchaser acquires personal property manufactured or produced in Puerto Rico 

and services performed in Puerto Rico from a member of the same controlled group, or where 

one person provides distribution or facilitation services for another member of the same 

controlled group, that during any of the three preceding taxable years account for: 

1) At least 10% of the Seller's total gross receipts from the sale of personal property 

manufactured or produced in Puerto Rico, or from the performance of services in Puerto 

Rico; 

2) At least 10% of the total cost of the Foreign Purchaser's acquisitions of personal property 

and services; 

3) At least 10% of the total amount of the Foreign Purchaser's commissions or other fees; 

or 

4) In the case of transactions facilitated by the Foreign Purchaser. such transactions, 

together with the transactions in the first three categories, account for at least 10% of 

the total gross receipts of the Seller or at least 10% of the total gross receipts of the 

Foreign Purchaser from facilitation services. 

If the aforementioned requirements are satisfied, the Excise Tax is imposed at a 4% rate on the 

value of the tangible property manufactured in whole or in part in Puerto Rico and the services 

performed in Puerto Rico in connection with the manufacture or production of tangible property 

that the Foreign Purchaser acquires from Seller. The Excise Tax provides an anti-abuse rule that 

disregards any transaction, or series of transactions, if one of the principal purposes of the 

transaction or series of transactions is the avoidance of the Excise Tax. 
133 


Insert offset folio 102 here 98944.102

The Excise Tax liability is imposed on the Foreign Purchaser but is collected and remitted by the 

Seller. A Foreign Purchaser that is subject to the Excise Tax is allowed a credit for taxes paid to 

any U.S. state on the acquisition of tangible property manufactured or produced in Puerto Rico, 

or services performed in Puerto Rico by certain persons in connection with the manufacture or 

production of tangible property. 

As originally enacted, the Excise Tax rate was scheduled to be phased out and eliminated after 

2016. In 2013, the Excise Tax was extended at a 4% rate through 2017. 

2.5.2.1 In General 

It is generally believed that in the absence of the benefits granted under statutes such as Law 

73 and Law 20, existing foreign investors would reduce or eliminate their business activities in 

Puerto Rico and the procurement of new inbound investment would be severely hampered. 

Given the direct revenue contribution, as well as the significant economic contribution made by 

these companies, that would be an unacceptable result. Thus, this project assumes that Puerto 

Rico must maintain a robust incentives program in order to maintain and attract inbound 

investment. However, certain subsidy programs, such as Law 20, can be strengthened to ensure 

that they achieve their stated objectives. Additionally, further study is needed to evaluate 

whether the optimal design features of the current subsidy programs may be improved or may 

lie outside the tax area. 

2.5.2.2 law 154 

Although there is to some extent a sense of dissatisfaction with Law 154, in-depth conversations 

with companies currently benefitting under Law 73 and 154 that are also subject to Law 154 

suggest a general acceptance of the current regime. Like any taxpayers, the companies would 

prefer a lower tax burden, and there is a measure of concern relating to the issues discussed 

below. Nonetheless, the companies did not suggest a wholesale replacement or reworking of 

the Law 154 regime. Rather there was a measure of consensus that if similar amounts of revenue 

are to be raised from the constituency affected by Law 154, it would be best to do so by 

extending the existing regime. 

The Related Party Attribution Rule, Source Rule, and Excise Tax are without doubt a very complex 

set of rules. Although the Tax Reform Committee that was convened in 2010 believed that the 

Related Party Attribution Rule and Source Rule would be simpler to implement than a combined 

reporting system that treated a Puerto Rico manufacturer and its related foreign affiliates as a 

single unitary business subject to tax in Puerto Rico, the Tax Reform Committee recognized that 

the Related Party Attribution Rule and Source Rule also could be difficult to administer. 

Accordingly, the legislature adopted the temporary Excise Tax to apply in certain cases in lieu of 

the income tax that otherwise would be owed under the Source Rule. 

The Statement of Motives to Law 154 explains that "It] he benefits in the administration and 

oversight of an excise tax such as this one are particularly significant in the use of high volume 

manufacturers." Thus, while the simpler Excise Tax applies to certain Puerto Rico manufacturers 

or service providers with gross receipts from related-party transactions in excess of $75,000,000, 

the more complex Related Party Attribution Rule and Source Rule apply to Puerto Rico entities 
134 


Insert offset folio 103 here 98944.103

with gross receipts below that threshold. Further, all taxpayers will be subject to the more 

complex rules when the Excise Tax expires after 2017. 

The Related Party Attribution Rule and Source Rule were intended to constitute permanent 

changes to the Code. The Excise Tax, on the other hand, was intended to be a temporary 

provision. The Statement of Motives to Law 154 explains that the "temporary excise tax as an 

alternative to the Income Source Rule would be in effect exclusively for a six (6) year period and 

would gradually drop during this period of time in order to facilitate the implantation of the fiscal 

responsibility measures of this Administration." In 2013, however, the Excise Tax was extended 

at a flat 4 o/o rate through 2017. 

The United States generally allows a U.S. corporation to elect to claim a credit against its U.S. 

income tax liability for income, war profits, and excess profits taxes paid or accrued during the 

taxable year to any foreign country. Puerto Rico generally is treated as a foreign country for 

purposes of the U.S. Internal Revenue Code. Accordingly, a U.S. corporation generally is eligible 

to claim a credit against its U.S. income tax liability for income taxes paid to the government of 

Puerto Rico. 

The United States also allows a credit for any tax paid to a foreign country in lieu of a tax on 

income, war profits, or excess profits. The Excise Tax was enacted with the expectation that it 

would be treated as a creditable tax for U.S. tax purpose because the excise tax is imposed in 

lieu of the income tax that a Foreign Purchaser otherwise would be required to pay pursuant to 

the Source Rule. Some taxpayers and practitioners have expressed uncertainty, however, as to 

whether the Excise Tax is a creditable tax for U.S. tax purposes. 

Following the enactment of Law 154, U.S. taxpayers asked the U.S. Internal Revenue Service 

and Treasury Department to issue a ruling regarding the creditability of the new Excise Tax. On 

April 18, 2011 the U.S. Internal Revenue Service issued Notice 2011-29, 52 stating that: 

The IRS and the Treasury Department are evaluating the Excise Tax. The provisions of the 

Excise Tax are novel. The determination of the creditability of the Excise Tax requires the 

resolution of a number of legal and factual issues. Pending the resolution of these issues, the 

IRS will not challenge a taxpayer's position that the Excise Tax is a tax in lieu of an income 

tax under section 903. This notice is effective for Excise Tax paid or accrued on or after 

January 1, 2011. Any change in the foreign tax credit treatment of the Excise Tax after 

resolution of the pending issues will be prospective, and will apply to Excise Tax paid or 

accrued after the date that further guidance is issued. 

Although this was a taxpayer-favorable Notice, the Notice did not eliminate taxpayer uncertainty 

because the Notice can be revoked prospectively at any time. 

5' 2011-161.R.B. 663. 
135 


Insert offset folio 104 here 98944.104

Some taxpayers and practitioners also have raised concerns regarding the constitutionality of 

Law 154. Specifically, these parties have questioned whether the law violates the so-called 

"Dormant Commerce Clause" of the U.S. Constitution. Very generally, the "Commerce Clause" 

of the U.S. Constitution provides that the U.S. Congress shall have the power "to regulate 

Commerce with foreign Nations, and among the several States, and with the Indian Tribes. " 53 In 

addition to this affirmative grant of authority, the U.S. Supreme Court has long held that the 

Commerce Clause, by negative implication, forbids the states from enacting laws that 

discriminate against or unduly burden interstate commerce. 54 This negative implication is known 

as the Dormant Commerce Clause. The U.S. Court of Appeals for the First Circuit has held on 

two occasions that Puerto Rico "is subject to the constraints of the dormant Commerce Clause 

doctrine in the same fashion as the states." 55 Although modeled on state income taxes which 

employ worldwide apportionment fractions to impose tax on amounts of income that may be 

greater than what is reported by in-state affiliates on their separate books, a critical difference 

between Law 154 and such regimes is that Law 154 does not attempt to collect the tax from the 

Puerto Rican affiliate, but rather from the non-Puerto Rican (frequently U.S.) affiliate through an 

imputation of nexus. This distinguishes Law 154 from regimes that have been previously held to 

be constitutional, and thus creates at least some measure of uncertainty in this regard as well. 

Law 154 was quickly enacted with little input from taxpayers or tax practitioners. In addition to 

objections to the substance of Law 154, many taxpayers and their representatives criticized the 

government for failing to involve them in the legislative process and to provide them with an 

opportunity to review the law and provide their comments and concerns before the law was 

enacted. The Legislative Assembly is aware of these criticisms and has solicited the comments 

and concerns of interested parties in developing a replacement for Law 154. 

2.5.3.1 Examine and Rationalize Existing Incentives 

The current incentives structure should be examined to determine whether, on a prospective 

basis, there are more efficient alternatives to encourage the desired investment activity. Further, 

all incentive programs should be subject to periodic rigorous cost-benefit review. 

2.5.3.2 Amend law 20 to Require a Certain Threshold of Specific Puerto Rico 

Economic Activity as a Condition of Awarding Grants 

Consideration should be given to amending Law 20 to condition the receipt of benefits under the 

Law on a certain minimum threshold of activity in Puerto Rico, based either on number of 

employees, payroll expense, or property owned in Puerto Rico. 

5..1 Article I, Section 8, Clause 3. 54 13 L.Ed. 996{1852). 

C1r. 1992); see also Antilles Cement Corporation v. Fortuna, 670 F.3d 
136 


Insert offset folio 105 here 98944.105

2.5.3.3 Extend Law 154 Excise Tax 

Consideration should be given to a short extension (e.g., five years or less) of the Law 154 excise 

tax. 

2.5.4.1 Examine and Rationalize Existinglncentivizes 

As noted above, this project assumes that Puerto Rico must continue to grant benefits under 

statutes such as Law 73 and Law 20 to maintain and encourage inbound investment. A broad 

based low rate tax regime (such as that of Ireland) would not attract material amounts of 

investment and would reduce the revenue collected from domestic corporate business activity. 

Thus, as a practical matter, negotiation of individual arrangements with existing and inbound 

investors appears to be the most promising way to attract and maintain inbound investment. 

However, if the tax system is chosen as the delivery mechanism for these incentives, the 

structure of the incentive programs must be carefully designed to assure that the benefits are 

targeted. Moreover, the arrangements negotiated by PRIDCO should be subjected to regular, 

rigorous cost benefit analysis and the incentives adjusted if necessary. 

2.5.4.2 Amend law 20 to Require a Certain Threshold of Specific Puerto Rico 

Economic Activity as a Condition of Awarding Grants 

A company should not be entitled to benefits under Law 20 unless the company makes a certain 

minimum contribution to the Puerto Rico economy. The efficacy and objectives of Law 20 would 

be improved by requiring companies that receive benefits under Law 20 to maintain a minimum 

threshold of either employees, payroll expense, or business property in Puerto Rico. 

2.5.4.3 Extend Law 154 Excise Tax 

The Commonwealth needs the revenue from Law 154 (estimated at approximately $2 billion for 

FY 2015), and the inbound sector appears to be the most viable source to obtain the bulk of that 

revenue. Although the major inbound companies initially objected to the enactment of Law 154 

-in particular the lack of transparency in connection with the legislation that brought it into being, 

those companies now seek certainty, predictability, and sustainability of the Puerto Rican laws 

that determine their Puerto Rican tax burden rather than attempting to rewrite past history. While 

in an ideal world it would be preferable from a tax policy standpoint to replace Law 154 with a 

simpler regime, the majority of the maJOr inbound companies were unable to identify an 

alternative regime that they would find preferable to Law 154 (based on the assumption that 

Puerto Rico will continue to impose a similar tax burden on inbound companies regardless 

whether Law 154 is continued or repealed). Further, none of the major inbound companies 

indicated that an extension of Law 154, in and of itself, would cause them to revisit their 

investments in Puerto Rico. Accordingly, a short extension (no more than five years) of the Law 

154 excise tax appears to be the best option for the Commonwealth to meet its short-term 

revenue needs. 

In connection with the process, possible responses of the U.S. federal government acting 

through its Treasury Department and Internal Revenue Service were considered. For both 

political and tax policy reasons, it seems likely that the federal government would be more 

accepting of a short-term extension of the Law 154 excise tax, as compared to a permanent or 

long-term extension of the excise tax. There is reason to believe the latter action would be much 

more likely to cause the U.S. Treasury Department to revisit the 2011 Notice. 
137 


Insert offset folio 106 here 98944.106

2.5.4.4 Elimination of Branch Profits Tax 

The options to amend the taxation of Puerto Rican corporations generally do not do away with 

withholding taxes on dividends paid to foreign shareholders. The retention of the taxation of 

dividends in general (including withholding) is to prevent the use of corporations in creating 

artificial losses or otherwise avoiding taxes properly collected at the shareholder level. In the case 

of branch operations of a foreign corporation, these considerations are not relevant. Therefore, 

in connection with the changes to the taxation of domestic corporations (and in particular making 

flow-through taxation more generally available) consideration should be given to eliminating the 

branch profits tax. 

2.6 Property Tax 

Property taxes are the primary source of funding for the municipalities of Puerto Rico. Property 

tax receipts were $979, 398 000 in FY 2012-13 of which $631.7 million was attributable to real 

property taxes and $347.69 million was attributable to personal property taxes. 

Puerto Rico imposes property tax on real property located in Puerto Rico and personal property 

located in Puerto Rico that is used in a trade or business. Property taxes are imposed by the 

Municipal Property Tax Act of 1991 ("MPTA"), 56 and taxes are collected by the Municipal 

Revenue Collection Center (commonly known by its Spanish acronym as "CRIM"). Property 

taxes are partly imposed by the government of the Commonwealth and partly by each 

municipality, but all property taxes are collected by the CRIM based on a single combined rate. 

The Commonwealth levies a tax on all non-exempt real and personal property located in Puerto 

Rico equal to 1.03% of the assessed value of the property. 5

7 The municipalities generally are 

authorized to levy a tax of up to 4 o/o of the appraised value of all personal property and up to 6% 

of the appraised value of all real property. 58 The municipalities also have limited authority to 

assess additional property tax. 59 The combined tax rate for real property generally ranges from 

8%-10% and the combined tax rate for personal property generally ranges from 6%-8%60 

2.6.1.1 Taxable Property 

All personal property and real property located in Puerto Rico is presumed to be taxable unless 

an exemption applies 61 

2.6.1.2 Real Property 

Real property includes land, subsoil, and all structures, objects, machinery, and devices attached 

to a building or fixed on the ground in a permanent manner. 62 

56 Codified at 21 LPRA § 5001 et. seq. 57 21 LPRA § 5002. 

58 21 LPRA § 5001. 

59 21 LPRA § 5002. 

60 See Rios-Mendez and Alemar-Escabi, 7320 T.M., Business Operations in Puerto Rico, Part IV.G.2. 01 21 LPRA § 5061 

oz 21 LPRA § 5061. 
138 


Insert offset folio 107 here 98944.107

2.6.1.3 Personal Property 

Personal property generally includes all property other than real property. 63 The MPTA specifically 

provides that personal property includes: machinery, containers, instruments, and other devices 

not attached to a building or land in a permanent nature; livestock; money; bonds, stock, and 

other financial instruments; and copyrights, trademarks, franchises, and concessions64 

2.6.1.4 Exemptions 

The MPTA expressly exempts numerous categories of property from personal and real property 

tax65 Exempt property includes: household personal property strictly for personal use; certain 

intangible property such as bank accounts; the first $15,000 of the value of real property resided 

in by its owner; property of the United States or the Commonwealth of Puerto Rico; property 

held by municipalities for public use; stock, bonds, promissory notes, and other securities or 

debts issued by Puerto Rico entities or certain foreign entities; property owned by nonprofit 

organizations and hospitals; motor vehicles subject to the payment of license plates; livestock 

and the structures and equipment for raising them; certain watercraft; real property located in 

historic zones; renewable energy equipment; and property of international banking institutions. 66 

2.6.1.5 Assessment and Collection 

Personal property is assessed based on the book value of the property as of January 1 of each 

year. 67 Book value means the cost of acquisition or production of the personal property adjusted 

for depreciation, obsolescence, or other factors as reflected in the accounting books and records 

in accordance with generally accepted accounting principles68 If book value does not reasonably 

reflect fair market value the personal property may be assessed based on fair market value69 

Every person that is engaged in a trade or business and owns personal property used in that 

trade or business as of January 1 must file a personal property tax return for that taxable year. 70 

Persons that own only exempt personal property on January 1 generally do not need to file a 

property tax return71 Every for-profit corporation with sales over $3,000,000 must submit 

certified financial statements with its property tax return and have the return reviewed by a 

CPA72 Effective December 25, 2013, the return of these corporations also must include certain 

supplemental information. 73 

The personal property tax return is due on May 15 immediately following the January 1 

assessment date74 For taxable years commencing after December 31, 2013, the self-assessed 

63/d. 

64fd. 

65 See generally 21 LPRA § § 5002, 5003, 5151. 

66Jd. 

67 21 LPRA § 5204. 68 21 LPRA § 5202(g). 

co 21 LPRA § 5204. 

' 0 21 LPRA § 5203(a). 71 21 LPRA § 5203(b). 

n21 LPRA § 5203(c). 73 21 LPRA § 5203( c), modified by Act No. 163-2013. 

"21 LPRA § 5205(a). 
139 


Insert offset folio 108 here 98944.108

tax on personal property must be paid through four equal estimated payments due on August 15 

and November 15 of the current year, and February 15 and March 15 of the following year75 

Real property is assessed according to its status and condition as of January 1 of each year.76 

The Commonwealth has not conducted a real property reassessment since 1958. As a result, all 

real property taxes are based on the assessed valuation of real property in fiscal year 1957-58n 

New construction also is assessed based on what the value of the property would have been in 

1958. Accordingly, the overall assessed valuation of real property for taxation purposes is 

substantially lower than the actual fair market value. Real property taxes must be paid in two 

equal installments by July 1 and January 1 immediately following the assessment dates78 No tax 

return is required to report and pay real property tax. 

A primary objective of property tax reform is to create an efficient and equitable revenue stream 

that will enable each municipality to "stand on its own bottom." 

Many object to the personal property tax in general, but more specifically the inclusion in the tax 

base of business inventories. The real property tax base is significantly undervalued. It has been 

suggested that the real property tax base be revalued and the revenue from such a revaluation 

(and possible rate revision) be used to eliminate the personal property tax and perhaps augment 

general revenues. Indeed the New York Federal Reserve has noted that Puerto Rico, in 

comparison with states in the United State, has "a notably low reliance on property taxes." 79 

The current system has multiple deficiencies when compared to international best practices. 

Options to improve the system include repeal of the personal property tax, updating and 

maintaining real property values at current fair market value, creating systems to capture new 

construction and improvements, consideration of differential rates for different property uses, 

creating a modern system for recording property transfers, consideration of a real property 

transfer tax, devising a system for allocating property tax receipts and a systematic examination 

of the current structure for administering the tax. 

If the scope of the engagement is expanded, subsequent reports will quantify the economic and 

distributional effects of the options described above as well transition options to implement the 

new regime most efficiently. 

75 21 LPRA § 5205(h) 

76 21 LPRA § 5068. 77 See Commonwealth of Puerto Rico, Financial Information and Operating Data Report (Oct. 18, 2013), available at 

79 [Fed Report, p.16]. 
140 


Insert offset folio 109 here 98944.109

2.7 Penalties 

The current Puerto Rico Tax Code80 has an extensive set of provisions that provides for penalties, 

additions to tax, and surcharges for various acts, omissions, and violations of the Puerto Rico tax 

laws. These penalties and additions to tax apply to any taxes, license fees, or levies with respect 

to the income taxes; estate and gift taxes; excise taxes; sales and use taxes, and alcohol 

beverage taxesB1 Most of these penalties and additions to tax are found in Subtitle F, 

Administrative Provisions, Procedures, Interests, Penalties, and Additions to Taxes. There are 

civil penalties that result in monetary fines and also loss of tax benefits, 82 and there are criminal 

penalties (misdemeanor and felony) that can result in monetary fines and imprisonment. The 

more frequent penalties that are associated with income taxes, estate and gift, excise taxes, and 

sales and use tax are highlighted below. 

With respect to income taxes, the failure to file penalty is 5% for the first 30-day period and 10 

percent for each 30-day period or fraction thereof not to exceed 25 percent; 83 the failure to timely 

pay penalty is 5% if made during the 30-60 day period after due date and 1 Oo/o if made after 60 

days;84 the accuracy-related penalties for negligence, substantial undervaluation of income, 

substantial overvaluation of property, substantial overvaluation of contributions to pension plans, 

and transactions lacking financial substance are 20% of the deficiency but increased to 40% for 

grossly overvalued property or contributions to pension plans;85 and the failure to pay estimated 

tax for both individuals and corporations (and partnerships) is 1 Oo/o for each due and unpaid 

installment. 86 Any deficiency as a result of fraud with intent to evade taxes is subject to a penalty 

of 100% of the assessed amount 87 

With respect to estate and gift tax, the failure to file required returns and failure to timely pay are 

subject to the same penalties discussed above. However, the accuracy-related provisions contain 

a penalty not to exceed double the deficiency for an undervaluation of property included in an 

estate as a gift for less than its value88 

With respect to excise taxes, the failure to file required returns and failure to tirnely pay as 

discussed above would be applicable. In addition, the Secretary of the Treasury of Puerto Rico 

(Secretary) may administratively impose a fine not greater than $20,000 for each violation of the 

excise tax provisions based on the magnitude of the violation. No penalty is to exceed $2,000 

unless it involves fraud, tort, or systemic evasion. However, for repeat offenders, an additional 

penalty of 50 to 100% of the tax rnay be imposed89 In addition, any person who fails to file 

required excise statements and monthly returns is subject to a $100 penalty for each failure. 90 

80 All sectron references rn thrs memorandum refer to Title 11 of the Puerto Rico Tax Law unless otherwise denoted 81 Section 6010.01. 82 Section 1052.01 (g) 1 0-year denial period for fraudulently claiming the Earned Income Credit 83 Section 6030.11. 81 Section 6030.02. 

ss Section 6030.03. 86 Section 6030.09 for individuals and Section 6030.10 for corporations and partnerships. 87 Section 6030.03(b). 88 Section 6030.03(c). 89 Section 6042.01. 

oo Section 6042.15. 
141 


Insert offset folio 110 here 98944.110

With respect to sales and use tax provisions there are also substantial penalties. The failure by a 

merchant that is required to register is subject to a penalty of up to $1 0,000; selling or transferring 

a registration without authorization is subject to a penalty of $5,000; providing false information 

is subject to a penalty of $5,000; forgery of a registration certificate or knowing use of a fraudulent 

registration is subject to a $10,000 penalty. 91 The failure to remit the sales and use tax timely and 

in the required manner is subject to a penalty of not less than 25% and not more than 50% of 

the unremitted amount with a 100% penalty for repeat offenders92 Any person required to file 

the monthly sales and use tax return timely and in the manner required is subject to the greater 

of $100 or 10 percent of the tax liability on the tax return (failure to file electronically when 

required is considered a failure.) 93 Any merchant that fails to keep documents is subject to a 

penalty of up to $20,000 for each violation. 94 

With respect to real property taxes, there is an addition to tax of 5% if payment is made after 30 

days but within 60 days from the due date, the penalty is increased to 10% for a delay of more 

than 60 days95 Any owner of property that willfully fails to report assets that have not been 

appraised for the levy of taxes to the Collection Center is subject to a misdemeanor and a fine of 

$500 and/or imprisonment for six months96 

With respect to personal property tax, if there is a delay in making a timely payment, there is a 

surcharge of 5% for a payment after 30 days but before 60 days, 10% penalty for a payment 

made after 60 days but before 90 days, and 15% for a payment after 90 days. In addition, if there 

is a failure to file the return timely, there is a penalty of 5% if the delay is not more than 30 days 

and an additional 5% per for each 30-day period or fraction thereof not to exceed 25%. In case 

of a deficiency, there is a 10% penalty for negligence or intentional disregard of the rules or 

regulations, and a 100% penalty if due to fraud. The interest on delinquent taxes is 10%. 97 

The interest rate for tax due on nonpayment and deficiencies is 10%98 while the interest paid to 

the taxpayer on a credit or refund is 6%. 99 Thus, although not a penalty, the interest rate at 10 

percent may be an incentive for taxpayers to make their tax payments on time. 

Section 6030.02 provides for additions to tax for failure to pay. In general, there is no penalty if 

the payment is made within 30 days of the required payment date; 5% if the payment is made 

after 30 days but before 60 days, and 10% if made after 60 days. Although the date for payment 

may be extended, there is no general reasonable cause exception for failure to pay. However, 

there is a special rule for excise taxes and sales and use taxes. Section 6030.07 provides that the 

Secretary may release a taxpayer from the surcharges and interest established in section 6030.02 

at his or her judgment and discretion. Also, the Secretary may fix a new date for payment under 

four stated conditions. 100 The conditions appear to be very limited. Moreover, there does not 

91 Section 6043.03. 92 Section 6043.04. 93 Section 6043.05. 91 Section 6043.06. 

ns 21 L.P.R.A. §5091. 

96 21 L.P.R.A. §5069. 9' 21 L.P.R.A. §5221. 98 Sections 6030.01 and 6030.02. 99 Section 6025.03. 100 1) Wl1en, within six (6) months of the effectiveness of a new 

written consultation to the Secretary concerning a construction such legal or 

of the matter involved, and the Secretary takes over ninety (90) days 

at hrs/her office to issue hrs/her answer. 
142 


Insert offset folio 111 here 98944.111

appear to be a clear reason why this exception should only be applied to excise and sales and 

use taxes and not the other taxes. 

Although interest continues to accrue on the nonpayment of tax after the 60th day, no additional 

penalty for failure pay apples. Perhaps, the penalty should continue to apply until it reaches a 

maximum, e.g., 5% per month or fraction thereof until it reaches a maximum of 25%. 

Section 6030.03 provides for accuracy-related penalties on deficiencies for negligence or 

intentional disregard for rules and regulations, substantial undervaluation of income taxes, a 

substantial incorrect valuation of property; substantial overvaluation of contributions to certain 

pension plans, absence of financial substance in transaction, and estate tax incorrect valuation of 

a gift. The penalty is 20% of the deficiency except it is increased to 40% for gross valuation 

errors. Except for the negligence or disregard for rules and regulations, the penalty applies 

mechanical. There does not appear to be a reasonable cause exception for this penalty. Section 

6030.08 provides a limited exception from penalties that would not apply in many cases. 156 

Thus, it appears that a taxpayer who in good faith relied on a well-reasoned opinion from a 

qualified tax adviser with respect to a complex or complicated transaction would be subject to 

this penalty if the mechanical test applied. 

If there is no reasonable cause relief for accuracy-related penalties, a taxpayer may be reluctant 

to file an amended return correcting an error because it would result in an automatic penalty. 

Consideration could be given to permitting a "qualified amended return". If a taxpayer files a 

qualified amended return (a return reporting an increased tax liability), before the taxpayer is 

contacted by the taxing authority for an examination for that year, the amount reported on the 

amended return will be deemed to have been reported on the original return and the taxpayer 

would not be subject to the penalty under section 6030.03 with respect to this increased amount. 

Section 6030.09 provides that if taxes are not paid within 10 days of notice and demand after 

completing bankruptcy or receivership proceedings, interest shall accrue. A surcharge of 5% will 

if payment is after 30 days but before 60 days and 10% for over 60 days. This provision appears 

to be duplicative of section 6030.02. 

The Code provides for various exceptions from penalties and surcharges if the taxpayer meets 

certain standards equating reasonable cause. The term "reasonable cause" is used with respect 

to section 6041.14 (failure to furnish information statement to recipient of income); section 

6041.11 (failure to file certain information statements and statements of brokers or stockbrokers); 

section 6041.12 (failure to deposit taxes withheld); section 6041.13 (failure to furnish reports to 

special employee-owned corporation members; section 6042.15 (failure to file excise tax 

statement and monthly return); and section 6043.05 (failure to file monthly sales and use tax 

return); and section 6043.06 (failure to violating other provisions of sales and use tax). 

The Code also uses the term "reasonable cause and not from willful carelessness" or 

"reasonable cause and not due to willing carelessness" for section 6030.11 (penalty for failure 

121 When with new items or taxable items that are new in the market of Puerto Rico, which create a 

reasonable in terms of their taxable status. classification. or extent pursuant to the laws 1n effect, insofar as. 

131 When the taxpayer files a well-grounded, wntten allegation concerning his/her status as exempt from 

taxes, and the Secretary, by reason of the legal takes rnore than ninety (901 days the 

date of of such consultation in his/her office to 

141 When the clearly and definitely leads a submits a written 

consultation concermng a contentious issue that until any regulations or 

promulgation. 
143 


Insert offset folio 112 here 98944.112

to file tax returns); section 6041.09 (individual failure to pay estimated tax; and section 6041.10 

(corporation failure to pay estimated tax). 

Section 6071.03 provides for administrative sanctions and monetary penalties for Specialists (tax 

return preparers) for violations such as failure to keep a copy of the return, furnish a copy to the 

taxpayer, failure to sign the return. However, the penalties are waived if "just cause is proven." 

The use of these different standards to establish an exception from a penalty is confusing. A 

single standard should be considered. 

Section 6071.03(a)(5) provides that when an underpayment of tax can be attributed to a deliberate 

act of a Specialist (tax return preparer), a fine of $1,000 can be imposed on the Specialist for each 

tax return or refund claim but is limited to $25,000 per year. The $25,000 annual limitation is the 

sarne as for a Specialist that acted negligently. For a deliberate act, the annual limitation be 

increased to a significantly higher. 

Section 6071.02(a)(7) provides that the Specialist is required to include the registration number 

on the prepared return. However, there is no penalty for failure to include the registration number. 

The monetary penalties under section 6071 (a)(3) for failure to sign the return could be modified 

to include failure to provide a registration number. 

2.8 Transition 

2.8.1.1 Cash Flow 

Maintaining adequate cash flow is critical. Once alternatives are selected cash flow alternatives 

must be modeled. These considerations will affect the form and timing of transition relief 

2.8.1.2 Time to Implement 

A number of proposed changes will take time to implement. Failure to allow sufficient time to 

implement changes may jeopardize the project. In particular, moving to a GST may require from 

18 months to two years to implement. In the interim, the revenue base must be maintained. 

Once decisions are taken as to the contours of the Governor's proposals appropriate timing and 

revenue options can be explored. 

2.8.1.3 Protecting Economic Expectations 

Fundamental fairness requires that tax changes protect the consequences of economic decisions 

that have been made in reliance on existing law. Thus, effective dates and phase-in provisions 

have to be considered carefully. 

2.8.1.4 Public Education 

A robust and comprehensive public education effort should commence as soon as practicable, 

particularly with respect to the introduction of a GST. The New Zealand program could be a 

template for the scope of a similar program in Puerto Rico. 
144 


Insert offset folio 113 here 98944.113

Commonwealth of Puerto Rico 

Tax Reform Assessment Project 

Unified Tax Code of Puerto Rico: 

Tax Policy Implementation Options 

Appendix 

October 31, 2014 
145 


Insert offset folio 114 here 98944.114

Table of Contents 

Appendix A: Individual Tax Expenditures ................................................ , ........................ 1 

Appendix B: Business Tax Expenditures ...................................................................... 10 

Appendix C: Options for Goods and Services Tax ......................................................... 20 

Appendix D: Goods and Services Tax Special Cases ................................................... 109 

Appendix E: Goods and Services Tax Exemptions ........... ,, ......................................... 141 

KPMG's role Is limited to the services and deliverable$ articulated in the Contract for Professional Services 

dated March 10, 2014 as subsequently amended (the "Engagement Contract"). It is understood that any 

actions taken by the Government ot the Commonwealth of Puerto Rico related to these services an!l 

deliverables may involve numerous factors that are outside of tho Contract's scope. KPMG's services and 

doliverables cannot take such factors into account and, therefore, recommendations for such actions are 

not implied and should not be inferred from these services and deliverables. Further. while such 

deliverables may include analyses of certain legislative initiatives, no service described in the Engagement 

Contract and/or subsequent amendments will involve advising the Department regarding lobbying or other 

public policy advocacy activities related to legislation or regulation, including evaluating the likelihood of 

enactment of any proposed initiative or providing advice to the Department as to methodologies to ensure 

enactment. KPMG cannot undertake any role in connection with the Contract services that could be 

deemed lobbying, public policy advocacy, or i111pair the independence of KPMG as an auditor for the 

Department of the Treasury such as drafting legislation and engaging in implementation assistance. 
146 


Insert offset folio 115 here 98944.115

Appendix A: Individual Tax Expenditures 
147 


Insert offset folio 116 here 98944.116

Appendix A: Estimates of Individual Tax Expenditures 

This. document provides estimates of individual income tax revenue losses attributable to 

provisions of the Puerto Rico tax laws that allow an exclusion, exemption or deduction from gross 

income, or provide a special credit or preferential rate of tax. These estimates attempt to 

measure reductions in personal income tax !lability stemming from tax provisions that provide 

tax benefits {relative to a normative income tax law) to a particular group of taxpayers. Items that 

provide less favorable tax treatment, which can be viewed as negative tax expenditures, are 

excluded from those estimates. 

The estimates contained in Table 1 below are based on (11 actual income tax returns of 1,053,703 

taxpayers who filed tax returns (Form 481.0 or Form 482.01 for the 2012 calendar year and (2) the 

most current tax rate schedule. 

The magnitude of a tax expenditure is the difference between tax liability under current law and 

tho tax liability that would result in the absence of the tax benefits of a particular provision (e.g., 

exclusion from measure of gross Income). The estimates in Table 1 below use a methodology 

that serves as a proxy for re-computation of each individual taxpayer's tax liability in the absence 

of a given provision. It does not consider tho effect of a provision on the computation of tho 

alternative minimum tax, Its effect on possible credit limitations, or any other indirect effects on 

tax liability. 

Additionally, the estimates assume no change In taxpayer behavior in response to changes to the 

current tax regime. For example, while eliminating a deduction to one type of business activity 

may induce taxpayers to engage in such activity less frequently (thereby making the tax 

expenditure estimate an overestimation), the estimates below assume no such reduction in the 

activity generating the deduction. 

Estimation Methodology 

Tax Expenditure Estimates Related to Credits 

Since credits provide a dollar for dollar reduction In tax liability, tax expenditure was estimated 

simply as the aggregate of all credits claimed by all taxpayers on Form 481.0, Part 1, Line 13, 

Form 402.0, Part 3, Line 23, or Form 482.0, Schedule B, Part II. 

Tax Expenditure Estimatos Related to Items Excluded or Exomr>ted from the 

Measure of Gross Income 

Tax expenditures on excluded and exempted items were each estimated using the same 

methodology. Tho excluded or exempted amount reported on Schedule IE of the taxpayer's 

return was added to net taxable income reported on the return to arrive at a modified taxable 

income measure. Based on the taxpayer's modified taxable income, a marginal tax rate was 

assigned to the taxpayer using tile 2013 tax rate schedule. The tax expenditure.was thereafter 

estimated to be the amount claimed, multiplied by the marginal tax rate calculated. 
148 


Insert offset folio 117 here 98944.117

Tax Expenditure Estimates Rolatod to Deductions from Gross Income 

The deduction reported on Schedule A of the taxpayer's return was added to net taxable income 

reported on the return to arrive at a modified taxable. income measure. Based on the taxpayer's 

modified taxable income, a marginal tax rate was assigned to the taxpayer using the 2013 tax 

rate schedule. The tax expenditure was thereafter estimated to be tile amount of the deduction, 

multiplied by the marginal tax rate calculated. 

Tax Expenditure Estimates Related to Prefemntlal Rate Items 

The measure of income taxed at specified rates reported on Schedule A2 Individual of the 

taxpayer's return was added to Net Taxable Income at regular rates {Line 10, Column A of 

Schedule A2) to arrive at modified net taxable income taxable at regular rates. Based on this 

modified net taxable income measure, a marginal tax rate was assigned to the taxpayer using 

the 2013 tax rate schedule. The. tax expenditure was thereafter estimated to be the amount 

claimed, multiplied by the marginal tax rate minus the preferential rate. 

Table 1: lndlvlduallncome Tax Expenditure Table 

Items In red could be reJlealed 

Items in blue could be modified 

Item Expenditure Percent of Tax Number of 

Benefit Enjoyed Claimants 

By Taxpayers 

Taxed At Highest 

Marginal Tax Rate 

Exclusion of employment No Data 

provided health insurance 

Individually purchased health No Data 

insurance 

Basis step-up at death No Data 

Uke-kind exchanges No Data 

CREDITS 

Credit for Investment In film $798,838 98.!% Industry development 10 

Credit attributable to losses or for $19,224 N/A 4 

investment in Cnpitallnvestment 
149 


Insert offset folio 118 here 98944.118

Fund, Tourism or other funds, or 

direct Investments 

Credit for payments of 

Membership Certificates by 

Ordinary and Extraordinary $419 35.8% 3 

Members of Employees-Owned 

Special 

credit for the purchase of tax $76,388,886 credits 98.11% 405 

Credit for Investment in housing $287,071 93.61% 7 Infrastructure 

Credit for investment In the 

construction or rehabilitation of 

$85,000 rental housing projects for low or 100.00% 2 

moderate Income families 

Credit for construction Investment $3,690,201 90.98% 32 In urban centers 

Credit for merchants affected by $373,636 urban centers revitalization 100.00% 9 

Credit to Investors who acquire an 

exempt business that Is In the $14,183 65,95% 6 

process of closing Its operations In 

Puerto Rico 

Credit for purchases of products 

manufactured In Puerto ruco and $0 N/A N/A 

Puerto Rican agricultural products 

Credit for contributions to Santa $77,000 100.00% 1 Cat~llna's Palace Patronage 

Credit for the estillllfshment of an 

eligible conservation easement or $0 N/A N/A 

donation of eligible land 

Exemption for persons that operate $117,095 as bookseller 99.82% 2 

Credit for Investment Act 73·2008 $1,224,956 99.80% 8 
150 


Insert offset folio 119 here 98944.119

credit for Investment Act 83-2010 $398,270 98.43% 8 

Credit for alternate basic tax from $2,300,671 95.69% 108 previous taxable years 

Credits carried from previous years $1i1,015,046 57.58% 155 

Other credits not Included on the $5,202,666 92.86% 252 preceding lines 

DEDUCTIONS 

Allowable deduction for mortgage $278,554,515 62.50% 239,845 interest 

Casualty loss on your principal See Note 1 N/A N/A residence 

Medical expenses $6,987,818 42.52% 17,731 

Charitable contributions $22,588,652 73.30% 56,197 

loss of personal property as a $544,369 29.21% 1,968 result of certain casualties 

Contributions to governmental $56,428,128 36.72% 173,071 pension or retirement systems 

Total contributions to Individual $18,906,891 84.58% 17,774 retirement accounts 

Total ~:otltrlbutlons to health 

savings accounts with a high annual $12,107 69.92% 227 

deductible medical plan 

EducDtlonal Contribution Account $797,485 89.60% 3,674 

Totallnterestllald on students $6,350,331 63.08% 26,542 loans 

EXCLUSIONS FROM INCOME 

Compensation for Injuries or $6,930,160 60.03% 1,785 sickness 

Ilene fils from federal social $130,731,918 security for old-age and survivors 31.79% 60,126 
151 


Insert offset folio 120 here 98944.120

Income derived from discharge of 

$1,501,713 75.82% 308 debts 

IVU loto prizes $207,292 86.34% 44 

Meal and \ravel expenses paid to 

Certain Volunteers up to $1,500 $17,906 36.80% 46 

under Act 261-2004 

Other exclusions $4,729,903 60.33% 1,753 

EXEMPTIONS FROM INCOME 

Fringe benefits paid by the 

ClllJ)Ioyer In relation to a cafeteria $209,035 43.85% 263 

plan 

Obligations from the United States 986 

Govemment, nny of Its states, $7,400,575 93.44% 

territories or political subdivisions 

Obligations from the Government 

$39,155,077 95.49% 2,126 of Puerto Rico 

Securities m1der Agricultural loans 

$873,445 82.36% 379 Act 

Certain Mortgages $8,910,858 89.22% 1,642 

Obligations secured or guaranteed 

under the Servicemen's $79,619 82.21% 25 

1\ead]ustment Act of 1944 

Securities Issued by cooperative $78,694 79.08% 248 associations up to $5,000 

Deposits In Puerto Rico Interest 

bearing accounts up to $2,000 $4,467,606 66.73% 24,214 

($4,000 for married filing jointly) 

Obligations Issued by the 

Consef'vatlon Trust, Housing and 

$147 0.00% 2 Human Development Trust and San 

Juan Monuments Patronage 

limited dividends corporations $1,893,505 85.97% 855 
152 


Insert offset folio 121 here 98944.121

Cooperative associations $1,485,144 74.12% 3,131 

International Insurer or Holding 

Company of the International $217,517 86.30% 168 

Insurer 

Expenses of priests or ministers $150,117 19.92% 117 

llecapture of bad debts, prior $10,592 0.00% 7 

taxes, surcharges and other Items 

Stipends received by certain 

physicians during the lnternshh> $2,710,003 43.79% 495 

period 

Prizes from the Lottery of Puerto $4,852,671 92.90% 401 

lllco and the Additional lottery 

Income from pensions or annuities, $137,388,225 18.46% 84,027 

up to the apt>llcable limitation 

Christmas Bonus, Summer Bonus 

$127,086 28.41% 2,166 and Medicine Bonus 

Gain from the sale or exchange of 

principal residence by certain $8,674,939 87.08% 642 

Individuals 

Certain Income related to the 

operation of an employee's owned $31,519 26.43% 3<1 

special corporation 

Cost of living allowance (COLA) $6,633,382 70.60% 6,646 

Unemployment compensation $701,893 45.13% 2,249 

Compensation received from active 

$960,610 military service In a combat zone 33.16% 291 

Income received or earned In 

relation to the celebration of sports $7,098 0.03% 10 

games organized by International 

associations 

Compensation received by an $755,946 eligible Investigator or scientist 

94.54% 57 
153 


Insert offset folio 122 here 98944.122

Compei\satlon received by an 

eligible Investigator or scientist In $152,969 91.74% 20 

the District under Act 214-2004 

Rents from the Historic Zone $773,172 76.32% 101 

Compensation to citizens and 

aliens nonresidents of Puerto 1\lco $60,950 99.84% 6 

for the production of film projects 

Remuneration received by 

employees of foreign governments $465,765 95.59% 29 

or International organizations 

Income from buildings rented to 

the Government of Puerto lllco for $2,842,883 70.64% 1,439 public hospitals, health or 

convalescent homes 

Income derived by the taxpayer 

from the resale of personal $127,160 67,55% 17 

property or services which 

acquisition was subject to tax 

Accumulated Gain In Nonquallf!ed $1,113,573 86.58% 97 Options 

Distributions of Amounts 

Previously Notified as Deemed $7,028,034 98.68% 50 Eligible Distributions under Section 

1023.06 

Distributions from Non Deductible $2,698,698 85.02% 274 Individual Retirement Accounts 

Special Compensation Paid dtle to a 

Liquidation or Close of Businesses $24,573,971 89.10% 1,167 under Article 10 of Act No, 80 of 

May30, 1976 

Distributions of Dividends or in 

Liquidation from Exempt $30,205,021 99.24% 91 

Businesses 

Salaries from Overtime during $1,259,858 76.90% 576 Emergency Situations 
154 


Insert offset folio 123 here 98944.123

Income from copyrights up to $38,424 72.91.% 27 

$10,000 under Act 516-2004 

Income received by designers and 

translators up to $6,000 under Act $7,378 10.85% 17 

516·2004 

Distributable share on exempt $19,489,785 99,01% 116 

Income from flow-through entitles 

Other exemptions $37,934,015 83,38% 5,892 

PREFERENTIAL RATE ITEMS 

Net long Term Capital Gnin at 10% $66,304,818 99.51% 2,562 

Eligible Distribution of Dividends at $40,874,647 98.5405% 6,163 10% 

Distributions from Qualified $3,797,274 105.7357% 935 

Hetlrement Plans at 20% 

Distributions from Q\lallfled $3,196,794 93.9605% 597. 

1\ctlrement Plans at 10% 

Interest on Deposits from Fln~nclal $3,260.447 96,2749% 1,210 Institutions at 10% 

Note 1: There appear to have been data entry issues related to this particular deduction on the 

Short Form. The entries are duplicates of the charitable contributions deductions according to 

the data provided by personnel at the Commonwealth's Treasury Department. 
155 


Insert offset folio 124 here 98944.124

Appendix 8: Business Tax Expenditures 
156 


Insert offset folio 125 here 98944.125

Appendix B: Business Tax Expenditures 

Item Total Regular Exempt Number of 

Expenditure Corporations Corps And Claimants 

Other 

Business 

Entities 

ACT80F1987 

INCENTIVES 

Total reduction 

Special Deduction· $140,193 $140,193 10 Payroll 

Special Deduction· HR $0 $0 0 Training 

Special Deduction· $0 $0 0 R&D Expanse 

Special DeductionInvestment on $345,492 $345,492 2 buildings, structure, 

M&E 

ACT 135·1997 

Total reduction 

Special Deduction- $9,755,962 $9,756,962 127 Payroll 

Spacial Deduction· HR $1,296,309 $1,296,309 21 Training 

Special Deduction- $8,596,386 $8,596,386 5 R&D Expense 

Special Deduction· 

Investment on $102,981,067 $102,981,067 88 

buildings, structure, 

M&E 

Spacial credits granted $3,348,016 $3,348,016 4 

Credit for products $1,946,366 $1,946,366 17 manufactured in 

Puerto Rico 

Credit for losses of $842 $842 1 United States parent 

company 

Credit for taxes $13,300,000 $13,300,000 1 withheld on royalty 

payments 

Credit for donation of $0 $0 0 an eligible 

conservation 
157 


Insert offset folio 126 here 98944.126

easement or donation 

of eligible land 

Credit for construction $5,581,202 $5,581,202 1 Investment in urban 

centers 

Credit for merchants $0 $0 0 affected by urban 

centers revitalization 

Credit for purchases of 

products $40,546,667 $40,546,667 54 manufactured in 

Puerto Rico 

Credit for investment 

in research and $6,979,314 $6,979,314 8 

development 

Credit for investment 

in machinery and $0 $0 0 

equipment 

Credit to reduce the $23,730,060 $23,730,060 100 cost of electric power 

Credit for investment $0 $0 0 in strategic projects 

Credit for industrial $0 $0 .0 investment 

Credit tor acquisition 

or manufacture and $16,836 $16,836 2 installation of electrical 

solar equipment 

Other applicable $18,376,813 $18,376,813 17 

credits 

ACT20·2012 

Total reduction 

ACT73·200S 

Total reduction 

Special Deductions $10,170,000 $10,170,000 3 

Credit for purchases of 

products $1,318.456 $1,318,456 3 

manufactured in 

Puerto Rico 

Credit for job creation $0 $0 0 

Credit for investment $1,998,523 $1,998,523 1 in research and 

development 

Credit for investment $0 $0 0 in machinery and 

equiP!nent 
158 


Insert offset folio 127 here 98944.127

Credit to reduce the $467,639 $467,639 5 

cost of electric power 

Credit for intellectual $0 $0 0 

orooerty transfer 

Credit for investment $0 $0 0 

in strategic projects 

Credit for industrial $23,916 $23,916 1 

investment 

Credit for donation of 

an eligible $7,993 $7,993 1 conservation 

easement or donation 

of eligible land 

Credit for construction $0 $0 0 investment in urban 

centers 

Credit for merchants $0 $0 0 affected by urban 

centers revitali~alion 

Credit for acquisition 

or manufacture and $0 $0 0 

installation of electrical 

solar equipment 

Other applicable $0 $0 0 

credits 

ACT 83·2010 

Total reduction 

Credit for purchases of 

products $0 $0 0 

manufactured in 

Puerto Rico 

Credit tor job creation $0 $0 0 

Credit for investment $0 $0 0 in research and 

development 

Credit for the transfer $0 $0 0 

of intellectual property 

Credit tor donation of 

an eligible $0 $0 0 conservation 

easement or donation 

of eligible land 

Credit for construction $0 $0 0 investment in urban 

centers 

Other applicable $0 $0 0 

credits 

ACT27·2010 
159 


Insert offset folio 128 here 98944.128

Total reduction 

SCHEDULE L PARTIALLY 

EXEMPT INCOME 

Total reduction 

CREDITS 

Credit for increase in $111,642 $71,913 $39,729 5 investment 

Credit attributable to 

losses or for investment $2,526,277 $1.781,611 $744,666 4 in Capital Investment, 

Tourism or other funds 

Credit for investment on 

Film Industry $286,568 $286,568 N/A 12 

Development 

Credit for investment in $570,690 $570,690 N/A 4 Housing Infrastructure 

Credit for investment in 

the Construction or 

Rehabilitation of Rental $23,603 $23,603 N/A 1 Housing Projects for 

Low or Moderate 

Income Families 

Credit to investors in an 

exempt business that is 

in the process of closing $2,939 $2,939 N/A 2. 

its operations In Puerto 

Rico 

Credit for purchases of 

products manufactured 

in Puerto Rico and $2,917,510 $2,820,683 $96,827 16 

Puerto Rican agricultural 

products 

Credit for contributions 

to Santa Catalina's $9,793 $9,793 N/A 1 

Palace Patronage 

Credit for the 

establishment of an 

eligible conservation $0 $0 $0 0 

easement or donation of 

eligible land 

Credit for construction 

investment In urban $1,825,534 $982,521 $843013 4 

centers 

Credit for merchants 

affected by urban $10,518 $10,518 $0 2 

centers revitalization 

Exemption for parsons $3,649 $3,649 N/A 2 that operate as publisher 
160 


Insert offset folio 129 here 98944.129

Exemption for persons $0 $0 N/A 0 that operate as printer 

Exemption for persons 

that operate as $533 $533 N/A 1 

bookseller 

Credit tor investment $725,743 $725,743 N/A 5 Act73-2008 

Credit for investment $140,229 $140,229 N/A 1 Act 83-2010 

Credit for the 2006 $2,790.484 $1,289,278 $1,501,206 44 Extraordinary Tax 

Credit for additional tax 

on gross income paid in N/A N/A N/A case of financial 

business 

Other credits not 

included on the $7,028,757 $6,684,245 $344,512 69 

preceding lines 

DEDUCTIONS 

Dividends received from $63,562,029 $63,562,029 144 domestic corporations 

Accelerated depreciation N/A N/A 

Charitable contributions $6,325,832 $6,325,832 5,788 

Contributions to pension $23,385,047 $23,385,047 895 or other qualified plans 

Bad debts. N/A N/A 

EXCLUSIONS FROM 

INCOME 

Plantation insurance $0 

Income derived from $637,923 $637,923 9 discharge of debts 

IVU Loto prizes $21 $21 1 

Other exclusions $321,350 $321,350 17 

EXEMPTIONS FROM 

INCOME 

Interest earned from 

obligations from the 

United States $26,328,544 $26,328,544 98 Government, any of its 

states, territories or 

political subdivisions 

Interest earned from 

obligations from the $103,855,658 $103,855,658 221 Commonwealth of 

Puerto Rico 
161 


Insert offset folio 130 here 98944.130

Interest earned "trorn $36,801 $36,801 securities under 5 

Agricultural loans Act 

Interest earned from $237.359 $237,359 25 certain Mortgages 

Interest earned from 

obligations secured or 

guaranteed under the $0 $0 

Servicemen's 

Readjustment Act of 

1944 

Interest earned from 

securities issued by $0 $0 

cooperative associations 

up to$5,000 

Interest earned from 

obligations issued by the 

Conservation Trust, $0 $0 Housing and Human 

Development Trust and 

San Juan Monuments 

Patronage 

Interest earned from 

loans granted by a $0 $0 

commercial bank to an 

emplqvees 

Interest earned from 

loans granted by a 

commercial bank in 

Puerto Rico for $0 $0 acquisition and payment 

of membership 

certificates in an 

employees owned 

special corporation 

Interest earned from 

loans granted by a 

commercial bank in 

Puerto Rico for the $0 $0 

purchase or investment 

in preferred stocks of an 

employees owned 

special corporation 

Interest earned from 

loans for the $14,728 $14,728 establishment or 

expansion of small and 1 

medium businesses up 

to $250,000 
162 


Insert offset folio 131 here 98944.131

Interest earned from 

loans ior the $3,066 $3,066 

capitalization of small 1 

and medium businesses 

up to $260,000 

Dividends from $16,819 $16,819 industrial development 8 income derived from 

certain interests 

Dividends irom limited $47,972 $47,972 7 dividends corporations 

Dividends from $351 $351 2 cooperative associations 

Dividends from 

international Insurer or $0 $0 

Holding Company of the 

International Insurer 

Recapture of bad debts, $307,952 $307,952 prior taxes, surcharges 2 

and other items 

Income from news $0 $0 agencies or unions 

Certain income related 

to the operation of an $0 $0 

employees owned 

special corporation 

Income received or 

earned in relation to the 

celebration of sports $299,146 $299,146 games organized by 1 

international 

associations or 

federations 

Income derived by the $1,267,051 $1,267,051 International insurer or 

Holding Company of the 1 

International Insurer 

Rents from the Historic $521,618 $521,618 12 Zone 

Income from $31,132,576 $31,132,576 International Banking 7 

Entities 

Income from vessels 

owners associations and $0 $0 

mutual protection and 

indemnity 

Income from buildings $27,836 $27,836 

ranted to the 3 

Commonwealth of 
163 


Insert offset folio 132 here 98944.132

Puerto Rico for public 

hospitals or schools, or 

health homes 

Income derived by the 

taxpayer from the resale 

of personal property or 

seNices which $0 $0 acquisition was subject 

to tax under Section 

3070.01 or Section 2101 

of the Internal Revenue 

Code of 1994 

Distributions of 

Amounts Previously $0 $0 Notified as Deemed 

Eligible Distributions 

under Section 1023.06{i) 

Distributions of 

Dividends and Benefits 

from Industrial 

Development Income of $1,395,789 $1,395,789 2 Exempt Businesses and 

In Liquidation under Act 

73-2008 and Act 135-

1997 

Rent of residential $437,841 ' property under Act 132- $437,841 45 

2010 

Other exemptions $17,261,128 $17,261,128 88 

PREFERENTIAL RATE 

ITEMS 

Preferential treatment of $8,139,392 $8,139,392 168 capital gains 

Interest subject to $195,224 $195,224 5 preferential rate 

Other income subject to $420,844 $420,844 6 preferential rate 

Income subject to 

preferential rates from N/A partnerships and special 

partnerships 

Income subject to the 

4% tax rate from tile 

operations of an N/A international financial 

entity that operates as a 

banking unit 
164 


Insert offset folio 133 here 98944.133

Note 1: There appear to have been data entry issues related to this particular deduction on the 

Short Form. The entries are duplicates of the charitable contributions deductions according to the 

data provided by personnel at the Commonwealth's Treasury Department. 
165 


Insert offset folio 134 here 98944.134

Appendix C: Options for Goods and Services Tax 
166 


Insert offset folio 135 here 98944.135

Appendix C: Goods and Services Tax 

a. General Description of a Goods and Services Tax 

This document outlines the form a Goods and Services Tax !"GST"l in Puerto Rico could take. 

This first section sets out how a GST generally operates. It is introduces and defines key GST 

concepts and terminology that is used in the following sections. 

The second section sets out how the main operating provisions of the GST law could be 

structured. 

The third section examines how each of the main operating provisions could be drafted based on 

leading practices derived from four comparable jurisdictions- New Zealand, Singapore, Malaysia 

and Ireland. In addition to these comparable jurisdictions, the International Monetary Fund VAT 

Act- Commonwealth of New Vatopia was reviewed. 

The document does not address special cases such as grouping related parties for registration 

purposes, the treatment of branches, agents, sales of going concerns, loyalty programs, 

vouchers, gambling, non-resident GST refunds, electronic services. supplied by a non-resident, 

and domestic reverse charge. Special cases are addressed in Appendix D. 

Further, it does not address the administrative powers of the tax authority with respect to debt 

collection, disputes, wlings, audits, and penalties and any rules in respect of language 

requirements, currency and documentation retention. These powers and rules are generally not 

GST specific and the existing Puerto Rico administrative provisions could be leveraged. 

1.1 Operation of a GST 

GST, also known as a Value Added Tax ("VAT"), is the most common general consumption tax 

in the world and is recognized as the most efficient consumption tax both in terms of revenue 

and economic neutrality. Over 150 countries l:)nd 33 of the 34 OECD countries have implemented 

some form of VAT where it generally accounts for one fifth of tax revenue. 1 The recognized 

capacity to raise revenue in a neutral and transparent manner has contributed to the spread of 

GST around the world. 

The key features of a GST include: 

iol It is a tax on final consumption; 

n It is not a tax on business - GST does not generally result in a cost to a business -

businesses effectively act as collection agents. A credit is provided for tax incurred on 

business inputs; 

t1 GST is a multi-stage, transaction based tax that is levied at each stage of the supply chain, 

including imports; and 

1 OECD (2012), Consumption Tm<Tronds 2012: VAT/GST and £xcisa Ratlls, Tmnris and Admlnislf8llv8 /ssuos, OECO Publishing, p. 

20. 
167 


Insert offset folio 136 here 98944.136

'~ It is a broad based tax that applies to most goods and services. 

A GST system seeks to tax the value added at each stage in the supply chain. There are a number 

of methods that can be used to calculate the value added at any particular stage in a supply chain 

and levy the tax (including the addition, subtraction and invoice-credit methods). The addition and 

subtraction methods are not very common (only Japan uses a certain version of subtraction 

method) and do not represent practical options for Puerto Rico. These methods are not 

discussed. 

The invoice-credit method is the most common method and the only practical option if a GST is 

to be considered in Puerto Rico. 

The OECD describes the invoice-credit method as follows: 

" ... each trader charges VAT at the specific rate on eac/1 sale and passes to the puichaser an 

invoice showing the amount of tax thus charged. The purchaser is in turn able to credit such 

payment of input tax against tile output charged on his sales, remitting the balance to the tax 

authorities and receiving refunds when there are excess credits. This method is based on 

invoices that could, In principle, be cross-checked to pick up any overstatement of credit 

entitlement. By linking tile tax credit on the purchaser's inputs to the tax paid by the purchaser 

the invoice-credit method is designed to discourage fraud. "2 

This right to deduction through the supply chain until the final consumer, where no credit Is 

allowed, results in a business neutral tax, the burden of wh!ch lies on the final consumer {i.e .. 

avoiding the issue of the taxation of business input that arises under an SUTl. 

The operation of an Invoice-credit GST is illustrated as follows: 

GSY ch~rged by 

Bu$ln0&9 on ea<:h$lo ttensacUon 

(Oulpul !O<) 

loss 

<J$T paid by Suslno" 

oo each purclmse ttansactlon 

(Input lox) 

Equals . 

<JST rofundable by 

lhe Govemmonl 

'OECD (2012), Consumption Tox Trends 2012: VAT/GST ond t!xcfso Flotos. Trends •nd Adminlslfatlve lssuos. OECD Publishing, p 

32. 
168 


Insert offset folio 137 here 98944.137

The invoice-credit method tends to be preferred over other methods of value added taxation for 

the following reasons: 

H The tax is levied on a transaction by transaction basis allowing the application of different 

rates, where required; and 

P The use of an invoice for evidencing the charging of the GST and the right to dedliCt 

creates a good audit trail. 

An example of the invoice-credit method applied to a supply chain is as follows (assuming a 10% 

GST): 

Overseas Vendor 

GSTReturn 

Salo • $250 + 25 GST 

l<ev Prfncip/es and Terminology 

$25~ GST on sales 

• $20- GST on purchases 

$5 -payable to Gov! 

Govt revenue 

$10 

$10 

$5 

$26 

GST laws generally levy the tax on supplies of goods and services made in the jurisdiction for 

consideration in the course or furtherance of a taxable activity carried on by a taxable person. 

The above statement introduces a number pf GST specific terms and concepts: 

,, Supply; 

H Consideralion; 

Taxable Activity; 
169 


Insert offset folio 138 here 98944.138

m Taxable Person; 

~1 Goods and services; and 

"' Made in the jurisdiction. 

Each of specific terms is discussed in detail In the third section of this document. However, a 

brief overview of each term is discussed below. 

Supply- the term "supply" defines a transaction that is captured in a GST. It is often broader in 

concept than a "sale" to ensure that the tax captures every economic transaction, subject to 

limited exceptions. For example, many jurisdictions deem certain actions that would not normally 

be considered to be a sale as a supply for GST purposes to maintain the neutrality of the tax -

e.g., goods provided free of charge to employees are deemed to be a supply for GST purposes 

and are subject to the tax. 

Consideration - consideration generally refers to something of value that is provided in return 

for goods and services. However, as with the definition of supply, many jurisdictions will deem 

consideration to be provided in respect of certain supplies to maintain the neutrality of the tax. 

The example noted above of the deemed supply of goods that are provided free of charge to 

employees would generally require a provision deeming that the supply was for consideration in 

order to bring the activity within the scope of the tax. 

Taxable Activity - a taxable activity is similar to the term "business" - e.g., tho activity of 

traders, producers or service suppliers. However the term is often broader than what is 

traditionally thought of as a business to include s~tch things as certain government activities. 

There is generally no requirement that the activity be carried on with the intention of making a 

profit. However, employment, hobbies and private recreational pursuits are often excluded. 

Taxable Person· the term "taxable person" describes a person who is carrying on an activity 

that falls within tha GST regime, rather than the term "taxpayer." The distinction is generally 

made to avoid any confusion with the person who bears the ultimate economic incidence of the 

tax, which is the person receiving the taxable sale.3 

Goods and services -a supply for GST purposes will either be a supply of goods or a supply of 

services. The distinction between the two is important because the nature of the transaction may 

influence where the supply should be taxed (I.e., within Puerto Rico or outside Puerto Rico), 

when the supply should be accounted for, and who Is liable to collect the GST. 

Made In the jurisdiction- GST laws include various "place of supply" rules that help determine 

whether a supply is made in the jurisdiction and should be subject to the tax. 

Additional principles and terms that should be noted are as follows: 

Taxable supply- a supply subject to GST, whether it be it at the standard or zero rate. 

Zero·rated supply -a supply subject to GST at a notional Oo/o (discussed in more detail below). 

"David Williams, Tsx L•wDesign and Drsfting, ChepW 6VolueAdded Tax, Volume 1; International Monetary Fund, 1996, p. 12. 
170 


Insert offset folio 139 here 98944.139

Exempt supply-a supply that falls within the scope of the GST law but is exempt from the tax 

(discussed in mora detail below). 

Outside scope - a supply that falls outside the scope ot the GST law and is effectively ignored 

for GST purposes. 

Input tax- GST that is paid by the recipient of a supply. 

Output tax- GST that is charged by the supplier of a supply. 

Tax Invoice- a formal document issued under the GST law evidencing the supply. 

Accounting for the tax -generally the supplier is required to collect and remit the GST to the 

government. However, in certain circumstances, the recipient is required to account for the tax 

-e.g., where the supplier is a non-resident with no presence in the jurisdiction. 

Time of supply- the time of supply refers to when the transaction should be accounted for in 

the GST return. 

Input tax credits· Generally, GST incurred by a taxable person can be claimed as a credit if the 

supply that was subject to GST was acquired for the purpose of making taxable or zero-rated 

supplies. Where the supply was acquired for making exempt supplies, the GST cannot be claimed 

as a credit. 

The concepts of zero-rating and exemption are extremely important and are discussed in more 

detail below. 

Zero-rating 

Where a supply of a good or service is zero-rated, no GST is charged on the sale or provision of 

that service. However, the person making that supply is able to recover the GST it has incurred 

on its purchases related to the making of that zero-rated supply (contrast this with exempt 

supplies below). 

Zero-rating relieves the entire supply chain from tax if zero-rating is at the final stage of the chain 

- see diagram below. 

Zero-rating is often used for exported goods and services to ensure that foreign customers do 

not bear the burden of domestic consumption tax. 
171 


Insert offset folio 140 here 98944.140

Manufacturer GSTrelurn -

Exemption 

Sata-$100+ 10GST 

-

-

Export Safe- $260 + 0 

GST 

....------ Govt rave1me 

$10- GST on sales 

-* .. -" -~ $10 

$10- payable to Govt 

$20-GST on sates 

- $10- GST on purchases 

~ $10 

---

$10- pa~able to Govt 

$0 - GSTon sales 

- $20- GST on purchases ~- ($20) 

$20-refund from Go_'!!__ ---- $() 

Where a supply of a good or service is exempt from GST, no GST is charged on the sale or 

provision of that good or service. However, the person making that supply is unable to recover 

the GST it has incurred on Its purchases related to the making of that exempt supply (contrast 

this with zero-rating above). 

Exemptions are usually implemented for social reasons (e.g., healthcare and education} or 

because they are difficult to tax (e.g., financial services). 
172 


Insert offset folio 141 here 98944.141

Exemptions have the following impact on the supply chain and the collection of the tax: 

Ovameas Vendor 

Who!o•olor/ 

lmpmlar 

RetaUar 

$20 - GST on snlas 

--<lST rotmo'- :.~.~~_:-.~~IJl<ltt GST 

$10- payable to Go"! 

Snl• • $2lill • 0 GST 

Go\1 revenue 

$1Q 

$10 

In summary, when examining the GST treatment of a supply, the following questions should be 

asked: 

1. Is there a supply for consideration 7 

2. Is the supply made by a taxable person? 

3. Is the supply made within the GST jurisdiction? 

4. Is the supply exempt or zero-rated 7 

5. Who is liable to account of the tax and when? 

6. Can the GST be recovered? 

The following sections set out how the main operating provisions of the GST law could be 

structured and how each of the main operating provisions could be drafted based on leading 

practices. 

b. Outline of Goods and Services Tax Legislation 

This section sets out how a GST law could be structured in Puerto Rico. It sets out the main 

operating provisions of a GST. It does not set out rules tor special cases, which address such 

things as the grouping of related parties for registration purposes and the treatment of branches, 

agents, sales of going concerns, loyalty programs, vouchers, gambling, non-resident GST 

refunds, electronic services supplied by a non-resident, and domestic reverse charge. 

In addition, it does not set out the administrative powers of the tax authority with respect to debt 

collection, disputes, rulings, audits, and penalties and any rules in respect of language 
173 


Insert offset folio 142 here 98944.142

requirements, currency and documentation retention. These powers and rules are generally not 

GST specific and the existing Puerto Rico administrative provisions could be leveraged. 

2.A Interpretation/General Definitions 

This chapter Will set out the definitions of certain terms. 

The following principal GST terms will be defined in separate sections: 

i. "Taxable Person" 

ii. "Taxable Activity" 

iii. "Supply" 

2.8 Imposition of the Tax 

i. Imposition of the Tax-This section will be the main charging provision of the taw and will 

set out when GST should be charged on a supply (i.e .. supplies made in Puerto Rico) and 

who Is Hable to account for tho tax. 

ii. Place of supply- This section will set out the rules for determining when a supply is 

deemed to be made in Puerto Rico for the purpose of the imposition of the tax. 

ill. Time of supply- This section will set out the rules for determining when the supply is 

deemed to take place and the period in which tho supply should be reported and GST 

accounted tor. 

lv. Imported Services/Reverse charge - This section will set out the rules lor supplies of 

services made by non-residents and where the recipient of the supply should account for 

the tax. 

v. Value of the supply- This section will set out the rules for determining tho value of a 

supply upon which the GST should be charged. It will also include rules for transactions 

between related parties and the supply. 

vi. Imported goods- This section will set out the rules for levying GST on the importation of 

goods and the interaction with the Customs rules and related relief provisions. 

vii. Value of imported goods-This section will set out the valuation rules for goods imported 

into Puerto Rico, consistent with the customs rules. 

viii. Zero-rated supplies -This section will provide the rules for zero-rating goods and services 

and which categories of goods and services are zero-rated. 

ix. Exempt supplies- This section will list which categories of goods and services are GST 

exempt. 
174 


Insert offset folio 143 here 98944.143

2.C Registration 

i. Registration - This section will set out who is req~!lred to be registered and who can 

voluntarily register, including the rules in respect of calculating a taxable person's turnover 

for registration threshold determination, and exceptions to the registration requirement. 

ii. Cessation of requirement to be registered and cancellation of registration -This section 

will set out the rules for when a taxpayer will cease being required to be registered and 

the cancellation of a GST registration, including notification rules and effective dates. 

2.0 Calculation of Tax Payable, Tax Periods, and Tax Returns 

Taxable periods -This section will set out the rules for the periods the GST return must 

cover. 

ii. Filing of returns and payment of the tax - This section Will set out the rules for when a 

return must be filed and payment of any tax due should be made. 

iii. Accounting basis-The section will set out the rules for when taxable persons are able to 

complete returns on a cash basis versus an accrual basis, including the conditions required 

to be met for each type of accounting basis. 

iv. Calculation of tax payable-This section will set out the rules for calculating the tax payable 

for a particular period, including offsetting Input tax against output tax. 

v. Input tax deductions/credit rules - This section will set out the rules for determining 

whether an input tax credit may be claimed in respect of GST incurred on expenses by 

the taxable person, including deemed input tax deductions for such things as insurance 

payments and secondhand goods. 

vi. Adjustment and apportionment rules -This section will set out the rules for apportioning 

input tax credits between taxable and non-taxable activities and where adjustments are 

required to be made to account for private or non-taxable use, 

vii. Bad Debts This section will set out the rules for recovering output tax previously 

accounted for on a supply but the recipient never paid tor that supply. 

viii. Refund of excess tax This section will set out the ntles relating to the payment of 

refunds where input tax exceeds output tax for a particular period. 

ix. Tax invoices, credit notes and debit notes -This section will set out the rules for when a 

tax invoice, credit note or debit nota should be issued, including the form such documents 

must take. 
175 


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c. Goods and Services Tax Design Leading Practices 

The following section sets out the leading practices for designing a GST. 

The OECD International VAT/GST Guidelines describe basic neutrality principles that should apply 

to a GST: 

"' The burden of value added taxes should not lie on taxable businesses except where 

explicitly provided for in legislation. 

"' Business in similar situations carrying out similar transactions should be subject to similar 

levels of taxation. 

~· VAT rules should be framed in such a way that they are not the primary influence on 

business decisions. 

These principles have been followed when outlining the possible structure of a GST for Puerto 

Rico. 

In drafting these leading practices, we have reviewed four comparable jurisdictions, as follows: 

m New Zealand- Goods and Services Tax Act 1985 ("NZ GST Act"); 

lil Singapore- Goods and Services Tax Act 1993 {"Singapore GST Act"); 

t~~ Malaysia ·Goods and Services Tax Act 2014 ("Malaysia GST Act"}; and 

m Ireland· Value-Added Tax Consolidation Act 2010 ("Irish VAT Act"). 

In addition, we reviewed the International Monetary Fund model VAT Act- Commonwealth of 

New Vatopia {"IMF Model Law"). 

New Zealand was chosen as a comparative regime as it is widely regarded as having the gold 

standard of consumption tax regimes, with the following key features: 

rn One single rate; 

m GST on goods and services and on importation; 

m Limited exemptions; 

m Low compliance costs for businesses and government; 

" Neutrality between businesses; 

& Transparency in respect of its administration. 

Singapore and Ireland were chosen as they are considered competitors to Puerto Rico from a 

global inbound investment perspective. Further, Ireland is based on the older European model of 

a VAT/GST and provides a contrast against how newer consumption tax regimes have been 

implemented. 

Malaysia was chosen as it is the most recent GST law to have been introduced. 
176 


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The IMF Model Law was chosen as it has setved as a guide for the implementation of a 

consumption tax regime in many countries and it is a broad based tax with few exemptions with 

a structure based on the more modern VAT/GST structures. 

Below, we set out a proposed structure of a GST law and the leading practice approach tor each 

of the relevant operational provisions. 

3.A Interpretation/General Definitions 

3.A.1 Taxable Person 

Overview of Concept 

In VAT/GST regimes the term "taxable person" is used to describe a person who is carrying on 

an activity that falls within the VAT/GST regime, rather than the term "taxpayer." The distinction 

is generally made to avoid any confusion with the person who bears the ultimate economic 

incidence of the tax, which is the person receiving the taxable sale. 4 This is driven from the nature 

of a VAT/GST being a consumption tax with the suppliers of goods and services upon which the 

tax is charged merely collecting that tax lor and on behalf of the government. 

The concept of taxable person can be compared to the concept of "merchant" used under Puerto 

Rico's current SUT. 5 

In a broad based GST system, the term "taxable person" generally includes all persons 

irrespective of their residency, establishment or incorporation. A narrow base GST system would 

generally define a taxable person as only those which are established or incorporated within the 

GST jurisdiction; for example Mexico. 

Leading Practice 

The definition of "Taxable person" should be drafted to include the following: 

~~ Any person registered or r\'lquired to be registered under the GST Jaw. 

The definition of "Person" should be drafted to include the following: 

M A state, a local authority, board, natural person, trust, company, and partnership; 

M Exclude the US Federal Government and its instrumentalities. 

Discussion 

The GST legislation in Singapore and Malaysia state that a person is a taxable person for GST 

purposes where it is required to be registered under the GST Act. 6 

•David Williams, Tnx Lnw Doslgn and Drafting, Chapter 6 Value Addod Tax, Volume 1: International Monetary Fund, 1996, ibid. 

'PRIRC § 4010.01111]. 

'Singapore GST Act, § 8(2]; Malaysia GST Act, § 2. 
177 


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The IMF Model Law also defines "taxable parson" as a parson who is registered or Is required 

to register under the law. 7 

The New Zealand GST Act does not have the concept of taxable person but uses the term 

"registered person" for someone who is registered or required to be registered under the Act6

• 

Singapore and Malaysia do not define the term "Person," however New Zealand defines person 

as company, an unincorporated body, a public authority and a local authority. The IMF has a similar 

definition that includes the state, a local authority, board, natural person, trust, company, and 

partnership.9 

All the above jurisdictions utilize the term "taxable person" or "registered parson" in the main 

charging provision to require the levying of the tax. This is generally done by requiring tax to be 

charged where a supply is made by the taxable or registered person within the jurisdiction, in the 

course or furtherance of a business or taxable activity. Tho imposition of GST and taxable activity 

are discussed under their respective sections in more detail below. 

Ireland takes a slightly different and more convoluted approach, defining "taxable person" as a 

person who independently carries on a business. 10 This term is utilized within the main charging 

provision to levy the tax on any supply made by such a person. Ireland then has an additional 

term called an "an accountable person", which is effectively equivalent to a registered person to 

require tho collection and returning of the tax. 11 

Leading practice would be to adopt tl.1e more certain and simple appro(lch of New Zealand and the IMF. ··. , , . ·. , . ·· ... ··· . . .. . . ·. . . .. ·. . . . . .. · .. 

Most of the comparable jurisdictions include governments and their bodies either explicitly or 

implicitly in tho definition of "taxable person," however this is often limited to whether such 

public bodies are in competition with the private sector. This ensures broad based taxation and 

avoids any distortion arising where the private and public sector could be in competition. 

Where governments and their bodies are included with tho GST regime, it is often necessary to 

specifically include their activities within the definition of taxable activity and deem the provision 

of certain public goods and services to be a supply for GST purposes. We discuss these issues 

under "Taxable Activity" below. The issue of determining whether a public body is in competition 

with the private sector is also a complex issue and we discuss this under the "Taxable Activity" 

section below. 

Given Puerto Rico is part of the United States, the constitutionality of including tho federal 

government, state governments, and their instrumentalities should be addressed. Under the 

Supremacy Clause and the doctrine of sovereign immunity, the federal government and Its 

' IMF Modal VAT lew, § 6. 8 New Zealand GST Act, S 2{11. 

'IMF Model Lew, § 2. 

IOitish VAT Act, § 2{1). 

"Irish VAT Act.§ 6. 
178 


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instrumentalities are immune from state and local taxation. 12 Consequently, the federal 

government and its instrumentalities must be excluded from the definition of "person." While 

many states currently exempt state governments, their agencies, municipalities, and their 

political subdivisions, there is no constitutional prohibition against state taxation of these bodies. 

Consequently, in order to achieve a broad based taxation model and avoid any economic 

distortion where the private sector may be in competition with the state, state governments, 

municipalities, and their political subdivisions these bodies should be included within the 

definition of "person." 

This leading practice approach would be similar to the current definition of "person" under the 

current Puerto Rico SUT regime, which already includes the government, its political 

subdivisions, municipalities, state agencies, bureaus or departments and public corporations. 13 

The U.S. federal government and its instrumentalities are also excluded from the definition of 

person, since "state" means any U.S. state, the District of Columbia or a U.S, possession. 14 

It should be noted that the inclusion of such government bodies within the regime will not result 

in those bodies ultimately bearing a tax burden as the burden is ultimately born by the and 

consumer. It merely simplifies the operation of the tax through reducing the number of 

exemptions and exceptions. 

3.A.2 Taxable Activity 

Overview of Concept 

The concept of "taxable activity" is a central term in a GST system as only goods or services 

supplied within the course or furtherance of a taxable activity will be subject to the tax. The 

concept of taxable activity can be related to the concept of "in business" under the current SUT. 16 

VAT/GST jurisdictions use different terms for this concept, including economic activity or 

business, however the objective of this concept is consistent across most jurisdictions- that any 

transactions made in the course of a business and not of a personal nature should be included 

within this term. A key difference between GST and income tax is that GST does not require 

there to be any intention to make a profit. 

Leading Practice 

The definition ol "Taxable activity" should be drafted to include the following: 

tl Any activity: 

o Carried on continuously or regularly; 

o Whether or not for pro lit; 

"McCulloch v. Mmylnnd, 17 U.S. 316 {1819). 

"PR/IlC § 4010.0Hbb). 

"PRtRC § 4010.01(0). 

"PRIRC § 401 0.0111>). 
179 


Insert offset folio 148 here 98944.148

o Involving the supply of goods and services; 

o For consideration; 

o By any person (which includes public bodies). 

ru The commencement and ending of a taxable activity. 

Iii Any activity of public bodies that qualify as taxable person. 

It is recommended that the definition excludes hobbies and activities of employees. 

Discussion 

New Zealand defines "taxable activity" as "any activity which is carried on continuously or 

regularly by any person, whether or not for a pecuniary profit, and involves or is intended to 

involve, in whole or in part, the supply of goods and services to any other person for a 

consideration; and includes any such activity carried on in the form of a business, trade, 

manufacture, profession, vocation, association, or club." 16 The NZ GST Act explicitly includes in 

this definition the activities of any public authority or any local authority. The NZ GST Act also 

clarifies that anything done in connection With the beginning or ending of a taxable activity is 

treated as "taxable activity." Expressly excluded from the term are private recreational pursuits 

or hobbies and employment. 

The IMF Model Law has a similar definition as the NZ GST Act. However, the law explicitly 

excludes any activity to the extent that the activity involves the making of exempt supplies. 17 

Further the exclusion of employment is under the definition of supply, rather than under the 

definition of taxable activity. 

Singapore uses the term "business" rather than "taxable activity." The term "business" is 

defined as including any trade, profession or vocation. 18 The following is also deemed to be the 

carrying of business: the provision by any club, association, society, management corporation or 

organization (for a subscription or other consideration) of the facilities or advantages available to 

its members or subsidiary proprietors, as the case may be; and the admission, for a consideration, 

of persons to any premises. 19 

However, any organization which has objects in the public domain and carries on activities which 

are political, religious, philanthropic or patriotic in nature, cannot be considered as carrying on a 

business, as it only receives subscriptions from its members without providing any services to 

the members in return.20 

Finally, while the Singapore GST Act recognizes that acts done in connection with the termination 

of a business are treated as being done in the course of that business, it does not address acts 

,. Naw ZGaland GST Acl, § 6(1). 

"IMF Modo! Law, S 6(2). 

" Singapore GST Aot, § 3(1 ). 

" Singapore GST Acl, § 3!21. 

"Singaporo GST Act, S 3(3). 
180 


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dona in connection with the beginning of business. 21 However, a person can register for GST in 

Singapore if he or she intends to make supplies in the course of furtherance of a business. 

Malaysia adopted the same definition of "business" and "deemed business" as Singapora.22 

However, the Malaysian GST Act does not exclude from the definition of business subscriptions 

received by political, religious, philanthropic organizations. In addition, the Malaysian GST Act 

explicitly states that the commencement and termination of a business is treated as being done 

in the course of the business. 23 

Ireland also uses the term "business" which is defined as any activity, whatever the purpose or 

results of that activity, and includes any activity of producers, traders or persons supplying 

services, including mining and agricultural activities and activities of the professions, and the 

exploitation of tangible or intangible property for the purposes of obtaining income there from on 

a continuing basis.24 

The GST law should provide a precise definition of "taxable activity." A precise definition of 

"taxable activity" will promote efficiency, certainty, and effectiveness of the tax. 

Common elements of the definition of a taxable activity or business across all of the comparative 

jurisdictions are as follows: 

~ An activity that is carried out continuously or regularly- excluding one-time transactions; 

~ Whether or not for profit. 

Key differences include whether the definition includes the requirement that the activity must 

involve a supply of goods or services for consideration. New Zealand and the IMF adopt such a 

definition, while the other comparable jurisdictions general imply that there would be 

consideration for a supply though the use of such terms such as trade or commerce. 

Certain jurisdictions explicitly exclude the following within the definition of taxable activity: 

M Hobbies or recreational activities; 

"' Employment (whether expressly or through the operation of other sections of the 

legislation). 

While others practically exclude such activities through either stating the activity must be carried 

on independently (implying that employment is not included) or through the use of the terms 

trade or professions (implying that hobbies and recreational activities are excluded). 

For certainty and simplicity, leading practice would be to adopt a similar approach to New Zealand 

and the IMF. 

" Singapors GST Aot, § 3(~). 

" Malaysia GST law, § 3(1) and 312). 

" Malaysia GST law, § 3(3), 

"Irish VAT Act,§ 2(11, 
181 


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As discussed above in relation to the definition of "Taxable person," the inclusion of public bodies 

within the scope of a GST is a complex and controversial issue. 

The approach adopted by the comparative jurisdictions of taxing public bodies varies significantly, 

and we summarize these approaches below: 

111 New Zealand- includes public bodies within the definition of "person" (as discussed 

above) and "taxable activity". Within the definition of "supply", New Zealand deems most 

government fees to be consideration for a supply of goods or services. 

m Singapore - treats public bodies as falling within the regime through a special provision 

that deems any supplies made by the government in course of businass, except certain 

excluded supplies, to be subject to GST. 

Ill Ireland and Malaysia - Exclude supplies made by public bodies unless they are in 

competition with the private sector. 

m !MF- Includes the public bodies within the definition of taxable person. 

The inclusion of public bodies within the scope of the GST regime promotes neutrality and 

reduces complexity in the application of the law and helps eliminate any distortion of competition 

between the public and private sector. It should be noted that the inclusion of such government 

bodies within the regime will not result in those bodies ultimately bearing a tax burden as the 

burden is ultimately born by the end consumer. It merely simplifies the operation of the tax 

through reducing the number of exemptions and exceptions. 

A common approach globally is to treat those goods and services provided by the public sector 

that are in competition with private businesses as subject to GST in order to ensure there is a 

level playing field with the private sector. Those goods and services provided by the public sector 

in a non-commercial context are generally considered to be outside the scope of GST- see the 

below diagram: 

Transport!Haellh/Educatlon - Subject !o GSTGovernment 

Driver license Mtvlcas - Not subject to GST 

However, there are a number of challenges with this approach. Firstly, one of the biggest issues 

faced is how to determine whether a public body is in competition with the private sector and 

therefore should be taxable. Secondly, for those public bodies providing non-commercial 

services, input tax recovery in respect of GST incurred on their purchases is denied. This can lead 

to self supply bias and a distortion of production decisions where public bodies are required to 

minimize costs. See diagram below for Illustration. 
182 


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Government 

Vendor 

IThelpdesk 

services 

$100+$10 

GST 

Government 

Driver license services 

-no GST (GST on costs not recoverable) 

In the above example, the $10 becomes a cash cost to that government department. impacting 

its budget. 

Where public bodies provide both taxable and non-taxable services, input tax apportionment 

issues can arise. similar to those discussed below in respect of financial services. In the diagram 

below, the IT helpdesk services are used by the government in the delivery of the transport 

services (subject to GST) and in the delivery of the driver license services (not subject to GST). 

The $10 GST charged by the services provider may only be recovered to the extent they are 

applied to the provision of transport services. Calculating this recovery percentage can result in 

significant compliance issues. Please refer to sections 3.0.5 and 3.0.6 for a more detailed 

discussion on input tax recovery and apportionment issues. 

Government 

Vendor 

IT helpdesk 

services 

$100 + $10 

GST 

DriVer license 

seNices -no GST (GST on 

costs not 

Government 

Transport services 

- GSTohargad (GST 

recoverablro)'-----'------, 
183 


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Input tax credits for GST on purchases can eliminate this self supply bias and any distortion of 

input choices - effectively deeming all supplies made by public bodies as zero-rated for GST 

purposes {other than those competing with the private sector). However the issue of determining 

whether the public body is in competition with the private sector remains. This is illustrated in 

the following diagram: 

$100+$10 

GST 

Government 

Agency 1 

Driver lloonse services 

-zero-rated (GST on 

Government 

Vendor 

IT ho!pdesk 

services 

$100 + $10 

GST 

Government 

Agonoy2 

Transport services 

- GSTchsrged (OST on 

costs raoovorable) 

Alternatively, supplies of goods and services made to government bodies not in competition with 

the private sector can be treated as zero-rated. However, this can create additional complications 

for suppliers with respect to the requirement to Identify whether the particular government body 

is eligible to receive zero-rated supplies or whether it should be treated as a taxable person as it 

is in competition with the private sector. This is illustrated In the diagram below: 

$100 + $0 

GST 

Government 

Agency 1 

Government 

Vendor 

$100 +$10 

GST 

Government 

Agonoy2 

Transport services 

- GST charged (GST on 
184 


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Further issues are created in respect of those suppliers that primarily contract with government 

entities perpetually being in a GST refund position, with the associated cash flow impact this has 

and Issues where full refunds of GST are not paid in favor of a carry forward mechanism. 

Another approach, as adopted in Naw Zealand, is to treat the public sector as fully taxable In 

respect of all of its activities where there is consideration for the goods or services supplied. This 

eliminates the issues associated with determining whether the supplies made by the public 

sector are in competition with the private sector and any apportionment issues associated with 

claiming input tax credits. See diagram below: 

$10D + $10 

GST 

Oovornmant 

Agency 1 

Otlver Jleense aef\lloos - GST charged (GST 

on cost$ roooverablii~) 

~~ 

Government Vendor 

IT holpdO$k 

service-s 

$100+ $10 

GST 

O{)vernment 

Agenoy2 

Transport oervloos 

- GST charged (GST 

The recommendation made by Copenhagen Economics when considering reform of the VAT 

treatment in the public sector is a full taxation model because it is a future proof model that can 

deal with any changes in how public and private sector entities compete, promotes a broader 

base and has lower compliance costs than those associated with the other options.26 

Such a model would deem all supplies of goods and services by a public body to be subject to 

GST irrespective of whether they are in competition with the private sector. Further, to eliminate 

any issues associated with apportionment of input tax credits, public bodies would be deemed 

to be fully taxable and entitled to recover 100% of VAT incurred on their purchases. 

We consider such an approach constitutes a leading practice in the case of Puerto Rico. As such, 

the definition of taxable activity should include the activities of public bodies in Puerto Rico. 

However, the treatment of water and electricity is a special case in Puerto Rico. The pre-tax cost 

of both of these commodities is already extremely high and subjecting them to an additional GST 

tax would impose unacceptable additional costs on consumers. As such, a full taxation model 

may not be appropriate in Puerto Rico in respect of these sectors. As both are supplied by 

"Copenhagen Economics. VAT in tho Publkl Sector and Exemptions In the Public Interest. final report for TAXUD/2011/DE/334, 10 

January 2013. 
185 


Insert offset folio 154 here 98944.154

government authorities and are not in competition with the private sector, such an approach is 

manageable. 

Notwithstanding the discussion above and as discussed under Section 3.A.1, due to 

constitutional issues, activities of the U.S. government and its Instrumentalities cannot perform 

a "taxable activity" for GST purposes. 

3.A.3 Supply 

Overview of Concept 

This section addresses the definition of supply. A GST is generally designed to bring within its 

scope every economic transaction subject to limited exceptions. 26 GST laws usually refer to 

transactions subject to GST as "supplies." 27 The concept of supply can be related to sales of 

taxable items under the current SUT.20 GST laws usually divide supplies into "supplies of goods" 

and "supplies of services." Similarly, the current SUT law divides "taxable items" into tangible 

personal property, taxable services, and adrnlssion fees and combined transactions. 29 

Similar to the current SUT, defining "supply of goods" and "supply services" is important 

because the nature of the transaction may influence the place of supply rules, the time of the 

supply, and the person liable to collect the GST. 

Leading Practice 

The definition of "Goods" should be drafted to include the following: 

1n All movable and immovable property (personal and real property); 

111 Utilities such as water and electricity; and 

n Excludes money, 

The definition of "Supply of Goods" should be drafted to include the following: 

., Transfer of the right to dispose of a good as owner. 

t• A transfer or provision of thermal or electrical energy, heat, gas, refrigeration, air 

conditioning, or water. 

The definition should also include any deemed supplies of goods In accordance with Puerto Rico's 

commercial laws and economic realities. 

The definition of "Services" should be drafted to include the following: 

H Anything that is not goods or money. 

The definition of "Supply of services" should be drafted to include the following: 

"David Williams, TnxLaw Design snrf oralllng, Chapw 6 Value Added Tax, Volume 1; lnteroalionel Monetary Fund, 1996. 

"David Williams, Tok Law Design snd Orslling, Chapter 6 Volue Added Tax, Volume 1; International Monetary Fund, 1996, p. 6. 

"See e.g .. PRIRC § 4010.01(11). 

"PAIRC § 4010.01(aa) .. 
186 


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'' Anything that is not a supply of goods. 

The definition should also include any deemed supplies of goods in accordance with Puerto Rico's 

commercial laws and economic realities. 

Dlsousslon 

Definition of "goods" 

In New Zealand, the GST Act defines "goods" as including all kinds of personal or real property; 

but not chooses in action (i.e., a right to use), money, or a product transmitted by a non-resident 

to a resident by means of a wire, cable, radio, optical or other electromagnetic system, or by 

means of a similar technical system.30 

The Malaysian GST Act defines goods as any kind of movable and immovable property, but 

excludes money except a bank note or coin before it becomes legal tender or a collector's 

piece.31 

The IMF Model Law defines "goods" as "all kinds of corporeal movable or immovable property, 

thermal or electrical energy, heat, gas, refrigeration, air conditioning, and water, but does not 

include money." 32 

The Irish VAT Act defines "goods" as all moveable and immovable objects {other than things In 

action or money). 33 

The SingaporE) GST Act simply defines "goods" as not including money but provides greater 

guidance in under the definition of "supply of goods", discussed below.34 Singapore includes the 

supply of utilities as a supply of goods in the supply of goods definition. · 

The GST law should define what is considered a "good" for GST purposes. 

The common factors across the comparable jurisdictions in relation to tho definition of "goods" 

include: 

"' All movable and immovable property (personal and real property); 

"' The exclusion of money. 

In addition, leading practice demonstrates that the definition should include utilities such as water 

and electricity as this removes any complications arising from determining the place of supply of 

such transactions. 

"'New Zealand GST Aot. § 2. 3' M•layslo GST Act. § 2. 

"' IMF Modellaw, S 2. 

"'Irish VAT Act, § 2(1). 

"' Singapore GST Act. § ?(1 ). 
187 


Insert offset folio 156 here 98944.156

Such a leading practice definition of goods goes beyond the current Puerto Rico definition of 

"tangible personal property," which does not include automobiles, intangibles. gasoline, 

electricity, and watar.36 

Definition of "supply of goods" 

New Zealand does not provide a separate definition for supply of goods. However, the general 

definition of "supply" includes all forms of supply. 36 New Zealand has an extensive list of what 

it is deemed to be a supply of goods, including, goods retained upon deregistrationY 

In Singapore, the GST Act defines "supply" to include all forms of supply, but not anything done 

otherwise than for consideration. Moreover, the GST Act provides a non-exhaustive list of 

transactions that qualify as a "supply of goods. " 38 This list states, among other things, that the 

transfer for the whole property in goods is a supply of goods but a transfer of any undivided share 

or of the possession of the goods is a supply of services. 

The Malaysian GST Act's definition of "supply" includes all forms of supply.39 The first schedule 

of the GST Act provides a list of transactions that are classified as a "supply of goods." The list 

includes, amongst other things, the transfer of the whole property in movable goods, the transfer 

of land, the supply of utilities, and the transfer of business assets.40 

The IMF Model Law defines a supply of goods as a transfer of the right to dispose of tangible 

property as owner, including an agreement of sale and purchase; a transfer or provision of thermal 

or electric~! energy, heat, gas, refrigeration, air conditioning, or water, is a supply of goods; or a 

supply of goods for goods or services is a supply of goods.41 Similar to New Zealand, the Modal 

Law also includes a list of certain deemed supplies, such as for lay-bye agreements. However, 

in contrast to most of the other comparable jurisdictions, the leasing of a good is treated as a 

supply of goods. 

Ireland focuses its definition on the transfer of ownership of the goods.42 

Other than New Zealand, the definitions adopted by the other comparable jurisdictions focus on 

the transfer of ownership. Such an approach results in the hiring, renting, or leasing of goods 

being deemed to be a supply of services. This is the more common approach across the globe. 

For clarity and certainty, leading practice would be adopting a more prescriptive approach, such 

as that adopted by the IMF. Inclusion of the various utilities in the IMF definition removes any 

uncertainty that may arise from determining whether a person using electricity acquires the right 

to dispose of the electricity as owner. In addition, similar to New Zealand and the IMF, the 

definition of supply of goods should also include any deemed supplies of goods based on Puerto 

"PRIRC § 4010.01(gg). 

"' NZ GST Act, § 5{1]. 31 Now Zealand GST Act, § 2. 

"Singapore GST Acl, § 10(2) 

"' Malaysia GST Acl, ! 4. 

"Malaysia GST Acl, First Schedule. 

" IMF Model Lew, §4. 

"Irish VAT Acl, § 19. 
188 


Insert offset folio 157 here 98944.157

Rico's commercial laws and economic realities and to facilitate the operation and neutrality of the 

law (e.g., deemed supply of assets retained upon deregistration where input tax has previously 

been claimed). 

Definition of "services" and "supply of services" 

The NZ GST Act defines "services" as anything that is not "goods" or "money."43 However, 

New Zealand has an extensive list of what it deems to be a supply of services, which includes 

gambling and vouchers. New Zealand also deems many payments to public bodies to be in 

consideration for a supply of goods or services. 

Singapore, although not defining "services," defines "supply of services" as anything which is 

not a supply of goods but is done for consideration (including the granting, assignment or 

surrender of any right).44 The Second Schedule of the Singapore GST Act includes the transfer of 

the possession of goods as a supply of services. 

In Malaysia, "services" means anything done or to be done including the granting, assignment 

or surrender of any right or the making available of any facility or benefit but excludes supply of 

goods or money.'5 The First Schedule of the GST law provides a list of transactions that are 

considered a "supply of services" and includes, amongst other things, the transfer of possession 

of a movable property, leasing or tenancy of land, and treatment or process.46 

The IMF Model Law also defines services as anything that is not goods or moneyY In addition, 

the definition of "supply of services" provides a non-exhaustive list of what is considered 

supplies of services; e.g., making available any facility or advantage; or refraining from or 

tolerating any activity. 48 

Ireland does not define "services" but defines "supply of services" as the performance or 

omission of any act or the toleration of any situation other than the supply of goods. Various other 

deeming rules exist to treat certain supplies of goods as supplies of services.49 However, such a 

prescriptive approach to the definition of services adds complexity and as such, is not 

recommended. 

There is a balance to be struck between having a general definition of "services" and "supply of 

services" and being prescriptive in the definition with various deeming provisions to help 

maintain the neutrality of the tax. The comparable jurisdictions differ significantly in respect of 

their approaches. 

"Now Zealand GST Act, § 2. 

"Singapore GST Act, § 10!21lbl. 

"Malaysia GST Act, § 2. 

"Malsysla GST Act, First Schedule. 

"IMF, Modo! Law, § 1. 

"IMF Modal Law, § 4. 

"Irish VAT Act, § 26. 
189 


Insert offset folio 158 here 98944.158

Ultimately, the definition adopted will be specific to the business and economic environment in 

Puerto Rico. However, as a starting point, the definition of "services" and "supply of services" 

should be as follows: 

"Services"- anything that is not goods or money. 

"Supply of services" anything that is not a supply of goods. 

The definition of supply should also Include any deemed supplies of services based on Puerto 

Rico's commercial laws and economic realities and that maintain the neutrality of the tax. 

Such a leading practice definition departs from the current definition of "taxable services" under 

the sur. While the sur definition includes any service rendered to any person, it does not 

include, amongst other, intangibles, professional services, and services by the Government of 

Puerto Rico, educational services, insurance services, and healthcare services. 60 

3.B Imposition of the Tax 

3.8.1 Imposition of the Tm< 

Overview of Concept 

This is the main charging provision of the law. It sets out what types of transactions are subject 

to GST, the territorial scope of the GST and who is required to charge the tax. 

Puerto Rico currently has two charging provisions: one for sales tax and another one for the 

compensatory use tax. 61 

Loading Practloo 

The main Charging provision should be drafted to Include the following: 

GSr shall be levied on the taxable supply of goods and services made in Puerto Rico by 

a taxable parson in the course of a taxable activity. 

J,, GST shall be levied upon the importation of goods into Puerto Rico. 

n GST charged on a supply must be accounted for by the taxable person making the supply 

~,, GST levied upon the importation of the goods is the liability of the importer. 

Discussion 

Each jurisdiction has a main charging provision which achieves the same results. However, the 

wording of this charging provision and how it interacts with related sections of the law varies 

significantly from one jurisdiction to another. 

New Zealand's main charging provision states that GST shall be charged on the supply of goods 

and services in New Zealand by a registered person, in the course or furtherance of a taxable 

«PRII:\C § 4010.01(nn). 

"PRIRC § 402M1 ond PRIRC § 4020.01. 
190 


Insert offset folio 159 here 98944.159

activity carried on by that person.62 The charging of GST on the importation of goods into New 

Zealand is addressed under a separate section.63 Taxable activity and registered person are 

defined in the Interpretation Part of the Act. The liability to pay GST is also provided for in a 

different section. 64 

In contrast, Singapore's main charging provision includes most of the key concepts and rules 

within the same provision.65 It states that GST shall be charged on the supply of goods and 

services in Singapore and the importation of goods into Singapore where it is taxable supply 

made by a taxable person in the course or furtherance of a business carried on by him. Further 

the section also states that the tax charged is the liability of the person making the supply. 

As discussed above, the term taxable person and business are effectively equivalent to the New 

Zealand terms of registered person and taxable activity. Therefore the key difference between 

the two jurisdictions is Singapore's inclusion of the importation GST charging provision within the 

main charging provision. 

The IMF, in section 9 of Model Law, and Malaysia, in section 9 of the Malaysia GST Act, adopt a 

very similar approach to Singapore. 

The Irish VAT Act's main charging states that a supply for consideration of goods or services 

made by a taxable person acting in that capacity where the supply is made in Ireland, is subject 

to VAT. In addition, the charging provision includes the levying of VAT upon the importation of 

goods.66 

The Singaporean approach is preferred over the New Zealand approach as it includes the 

provision charging GST on the importation of the goods within the main charging provision. 

Further, this approach olearly s(;lts out who is liable to account for the tax compared to the New 

Zealand approach which sets out this rule following the calculation of the tax payable in a 

particular period. 

3.B.2 Place of supply 

Overview of Conce1>t 

The place of supply rules determine whether a supply of goods or services Is deemed to be made 

within Puerto Rico and therefore, whether the supply is subject to the charging provision. These 

" New Zealand GST Acl, § 0. "N•w Zealand GST Acl, § 12 . 

.. New Zealand GST Acl, § 20. 

"'Singapore GST Act, §s 7 and 0. 

"'Irish VAT Aol, § 3. 
191 


Insert offset folio 160 here 98944.160

rules are conceptually similar to the rules for determining the source of the income generated by 

the sale of taxable items under the current SUT. 67 

One of the biggest issues in respect of the place of supply concept is the GST treatment of cross 

border transactions. This is the current focus of international discussions and the area which has 

seen the most recent development. 

There is widespread consensus that the destination principle (that goods and services should be 

subject to tax in the country of destination or where they are consumed - following the core 

principle that GST is a tax on consumption} is preferable to the origin principal from both a 

theoretical and practical standpoint. 66The destination principle preserves the intended neutrality 

of the tax with respect to international trade. 

Cross border transactions involving goods is a fairly straight forward issue - imports should be 

subject to GST and exports should be zero-rated. This Is in line with the destination principle and 

ensures that imported goods are placed on a level playing field with domestically produced goods 

and exporters are not competitively disadvantaged on the world market with local GST either 

being charged to foreign purchasers or being an embedded cost on the supply chain. We refer 

to the Zero-rating section (3.8.8) for a discussion of the effect that zero-rating has on the supply 

chain. 

The GST treatment of the cross-border trade in seNices is more complex as there are no border 

controls such as those which facilitate the efficient taxation of goods. Further, actual 

consumption or use of services is often difficult to tracksoproxies are often used to determine 

the place of supply of sewices. . . . . . . ·. .·. . . 

While most jurisdictions apply the destination principle in respect of the application of GST, subtle 

variances in each jurisdiction's rules can result in double taxation, non-taxation, and uncertainties 

for businesses and tax authorities. Such uncertainties and inconsistent treatment can result in 

distortions of consumer and business consumption decisions in respect of cross border 

transactions. This prompted the OECD to develop international VAT/GST guidelines to provide 

guidance to governments on apply VAT to cross border trade. 5

9 

In addition to the general VAT neutrality guidelines mentioned above, the OECD Guidelines also 

set out GST principles for international trade. These key principles have been taken into account 

when determining the leading practice for the GST place of supply rules and zero-rating rules 

discussed below. 

To effectively manage the neutrality of the tax, the place supply rules are interdependent with 

the importation of goods, zero-rating and the imported services rules. 

"PR!RC § 4020.03. 

'"OECD (20121. Consumption Tax Trends 2012: VAT/GST snd Excise Ratss, Trends and Adminislrativelssuss, OECD Publishing, p. 

34. 

"0ECD lntetMtional VAT/GST Guidalines. 
192 


Insert offset folio 161 here 98944.161

leading Praotlco 

The place of supply rules should be drafted to include the following: 

m Place of supply of goods: 

o Where the goods are located at the time of supply. 

m Place of supply of services: 

o If the supplier is established in Puerto Rico, the place of the supply is in Puerto 

Rico; 

o If the supplier is not established in Puerto Rico, the place is outside Puerto Rico 

unless the services are physically performed in Puerto Rico. 

Where necessary, the GST law should include specific place of supply rules for deemed supplies. 

Discussion 

New Zealand has adopted vary broad place of supply rules from a jurisdictional perspective. In 

practice however, these rules do not impose GST on a greater range of supplies In comparison 

to other jurisdictions. However, it can result in the requirement to treat certain supplies as zerorated where other jurisdictions would treat such supplies as out of scope, thus resulting in a 

reporting obligation in respect of those supplies. 

New Zealand includes its place of supply rules in its main charging provision. 60 The primary rule 

is based on the residency of the supplier- goods and services are deemed to be supplied in New 

Zealand if the supplier is resident in New Zealand (with zero-rating rules applying to maintain the 

destination principle) and deemed to be supplied outside New Zealand if the supplier is nonresident in New Zealand. However, this primary rule has a number of exceptions to ensure the 

destination principal is maintained. 

If the supplier is a non-resident, a supply of goods is deemed to be supplied in New Zealand if 

the goods are in New Zealand at the time of supply (earlier of invoice issuance or payment). A 

supply of services is deemed to be supplied in New Zealand by a non-resident if the services are 

physically performed in New Zealand by a person who is in New Zealand at the time the services 

are performed. In order to avoid the unnecessary registration of non-residents, where goods and 

services are deemed to be supplied in New Zealand but are supplied to a person who can claim 

a credit for any GST charged, the supply is deemed to be made outside of New Zealand. 

Finally, New Zealand also has a reverse charge rule for services not performed in New Zealand 

that are received by a taxable person that is unable to claim a full input tax credit. In such cases 

the services are deemed to be made in New Zealand and the recipient is required to account for 

the GST (refer to section 3.B.4 below for a discussion on reverse charge). 

New Zealand also has specific rules in relation to telecommunications suppliers. 

"'New Zealand GST Aol, § 8. 
193 


Insert offset folio 162 here 98944.162

Singapore focuses on the transport of goods for determining the place of supply. 6

' A supply of 

goods is treated as being supplied in Singapore if the supply does not involve their removal to or 

from Singapore. Further, if the supply involves the removal of the goods from Singapore, then 

the goods are deemed to be supplied in Singapore (potentially subject to zero-rating as an export). 

If the supply involves the removal of the goods to Singapore, the supply Is deemed to be outside 

of Singapore. 

In respect of supplies of services, services are treated as supplied in Singapore if the supplier 

belongs in Singapore and are not treated as supplied in Singapore if the supplier belongs outside 

of Singapore. The "belongs" test is similar to the New Zealand residence test focusing on the 

supplier's presence in the country. 

Malaysia has adopted similar rules as Singapore in section 12 of the Malaysian GST Act. 

The key difference between the New Zealand approach and the Malaysian and Singaporean 

approaches relates to the treatment of services. While all three countries tax a supply of services 

by a business established in the jurisdiction (with zero-rating rating rules applying for certain 

exported services), only New Zealand taxes services physically performed in the country by a 

non-resident, potentially resulting in a non-resident being required to register for GST in New 

Zealand. Malaysia and Singapore do, to a certain extent tax services physically performed in their 

respective countries by non-established entities through their reverse charge regimes (we 

discuss the reverse charge regimes in section 3.8.4 below). However, many services can escape 

the tax nat. As such the New Zealand approach is preferred. 

The IMF Model Law adopts the approach of the EU that was in place prior to 2010.62 While the 

place of supply rules for goods remain unchanged, the EU substantially changed the place of 

supply rules for services to have more of a destination principle focused VAT. Given a destination 

principle is regarded as leading practice, we do not consider the IMF Model VAT Law place of 

supply rules to be an appropriate comparable and do not discuss these rules in detail. 

The place of supply rules as implemented by Ireland are as follows. 

A supply of goods is deemed to take place where the goods are made available to the supplier. 

If the supply of the goods involves transportation of those goods, then the place of supply is 

deemed to take place where the transport begins.63 

The Irish VAT Act also provides specific rules for the supply of electricity, water and similar 

utilities; being where the supply is received. 64 

Supplies of services in a business to business transaction are deemed to take place where the 

customer is located. 65 However, various exceptions to this general rule include: 

"Singapore GST Act. § 13. 

"'IMF Model law, § 12. 

"'Irish VAT Act.§ 29·30. 

"'hish VAT Act,§ 31. 

"l1ish VAT Act, § 33 • 34. 
194 


Insert offset folio 163 here 98944.163

m Supplies connected with immovable property- where the property is located. 

m Passenger transport- where the transport takes place. 

m Admission to certain cultural, artistic and sporting activities- where the event takes place. 

fil Restaurant and catering services- where the services are physically carried out. 

fi' Restaurant and catering services onboard ships, aircraft and trains - the place of 

departure. 

~J Short term hiring of means of transport (less than 30 days) -where the means of transport 

is collected. 

Supplies of services in a business to consumer transaction are deemed to take place where the 

supplier is located. However, various exceptions to this general rule also exist, including: 

oo Services provided by an intermediary- taxed where the main transaction takes place. 

•• Supplies connected with immovable property where the property is located. 

Ill Valuation of, or work on, tangible personal property - where the services are physically 

delivered. 

Ill Passenger transport- where the transport takes place. 

0 Transport of goods- where the transport takes place. 

~• Ancillary services to the transport of goods- where the service are physically performed. 

m Any service related to certain cultural, artistic and sporting activities - where the event 

takes place. 

m Restaurant and catering services- where the services are physically carried out. 

m Restaurant and catering services onboard ships, aircraft and trains - the place of 

departure. 

r1 Short term hiring of means of transport (less than 30 days)- where the means of transport 

is collected. 

Ill Long term hiring of means of transport (more than 30 days) ~ where the customer is 

located. 

m Electronically supplied services, radio and television broadcasting services and 

telecommunication services - the location of the customer (post 2015), 

r-1 Advertising, consulting and legal services, financial services, transferring trademarks, 

patents and similar rights- where the customer is located. 

Ill Restraint of trade- where the customer is located. 

l!i Supply of staff- where the customer is located. 

" Hiring of moveable tangible property (other than means of transport) - where the 

customer is located. 
195 


Insert offset folio 164 here 98944.164

There are various other place of supply rules and use and enjoyment rules that override the 

above.66 

The prescriptive nature of the Irish place of supply rules, while effectively achieving a destination 

principle VAT system (with certain exceptions) create barriers to compliance due to their 

complexity. 

For this reason. and the reason discussed above in respect of the Malaysian and Singaporean 

rules, adopting place of supply rules similar to the New Zealand model constitute leading practice. 

The GST law should, where necessary, provide specific place of supply rules for deemed 

transactions. In addition, special taxation provisions should be created for telecommunication, 

broadcasting and electronic supplies services provided to final consumers in Puerto Rico by nonresidents in order to ensure that the destination principle is maintained. Because the latter 

constitute specific transactions, the specific taxation rules for these transactions should be 

addressed outside the main taxing provisions as a Special Case. 

3.B.3 Time of Supply 

Overview of concept 

The time of supply rules primarily determine when VAT should be accounted for in respect of a 

supply (i.e., the period/return in which the transaction should be reported). However, it also sets 

a reference point for when a tax invoice should be issued {e.g. within 21 days of the time of 

supply) and can be used as a reference point for determining the place of supply (e.g., the place 

of supply of goods is where they are located at the time of supply). 

leading Practice 

The time of supply rules should be drafted to include the following: 

u The time of supply is the earlier of: 

o The issuance of any invoice; 

o The receipt of any payment; or 

o The delivery of making available of the goods or the completion of the 

performance of the services. 

ra For continuous supplies, the time ot supply should be deemed to occur when each 

successive payment Is made or becomes due or when an in invoice relating to that 

payment is issued. 

Specific time of supply rules should be drafted for such supplies as gambling, vouchers. imported 

goods, imported services and should be addressed under their respective provisions. 

"Irish VAT Act, S 31l. 
196 


Insert offset folio 165 here 98944.165

Discussion 

New Zealand takes a very simplistic approach with its basic time of supply rule. 61 The time of 

supply is the earlier of the issuance of an invoice or the receipt of any payment. This basic rule is 

modified in the case of supplies between associated persons to ensure that the liability to 

account for GST is not artificially deferred. In such cases, the time of supply is deemed to be as 

follows where no invoice or payment has been made: 

11t For supplies of goods: 

o If the goods are to be removed, at the time of the removal. 

o If the goods are not to be removed, at the time they are made available to the 

recipient. 

1\i For supplies of services: 

o The time the services are performed. o For related party imported services, the end of the taxable period that is 2 months 

alter the first balance date of the recipient following the performance of the 

services. 

Special rules also exist for layaway arrangements (when title is transferred), lotteries, casinos, 

vending machines, supplies by government authorities, major construction, hire purchase 

agreements and vouchers. Further, where goods or services are supplied under an agreement 

which provides for periodic payments, the time of supply is triggered at the point when each 

successive payment is made or becomes due or when an in invoice relating to that payment is 

issued. 

Singapore has the same general time of supply rule as New Zealand - earlier of invoice or 

payment- but it is modified to state "to the extent that the supply is covered by the invoice or 

consideration. " 00 However, Singapore's exception to this rule, which is drafted in the same 

manner as New Zealand's, does not apply to associated persons but applies to specific supplies 

that are listed in the legislation, including: 

m A supply of goods consisting of the grant, assignment or surrender of any interest or right 

over land; 

1\l Where a taxpayer has applied to the Comptroller to apply this exception to the general 

time of supply rules; and 

Ill A supply by an agent that is deemed to be made by him as principal under a specific 

provision of the law. 

The Singaporean law then provides specific rules for the following: 

M When input tax may be claimed- general rule; 

m Calculation of turnover threshold for registration purposes- general rule; 

" New Zealand GST Act, § 9. 

"Singopote GSTAot, § 11. 
197 


Insert offset folio 166 here 98944.166

r.i Disposal of assets of a business for no consideration - at the time the goods are 

transferred or disposed of; 

r• Business assets used for private purposes for no consideration - the last day of the 

accounting period in which the goods were used for private purposes; 

"' Where goods are provided on a trial basis- at the end of 12 months following the goods 

removal if no invoice or payment has been issued or received; 

"' Where goods or services are made available to a non-registered person prior to the seller's 

registration but Invoiced after registration - there is a choice on how to treat the 

transaction; 

~<~ Where the parties are associated persons and no invoice has been issued or consideration 

paid -at the end of 12 months after the goods have been removed; 

•• Financial services paid on installments -treated as wholly taking place at the time when 

the invoice for the first installment is issued or paid; and 

~~ Where a person deregisters from GST after the goods are made available or removed or 

the services are performed and issues an invoice/receives payment after deregistrationthe time of supply is the day immediately before deregistration (this is included in the 

definition of supply in the New Zealand law). 

The Comptroller may also alter the time of supply at the request of the taxable person. The GST 

regulations provide certain exceptions to the associated parsons' time of the supply rule, and 

rules around continuous supplies of services where payments are made periodically. 

Malaysia takes a mora complex approach to the general time of supply rule. 69 For goods the time 

of supply is as follows: 

m At the time of the removal of the goods if the goods are to be removed; 

Ill At the time when the goods aro made available to the recipient if the goods are not to be 

removed; 

rn Where goods are provided on a trial basis- the time when it because certain that a taxable 

supply has taken place or 12 months after removed, whichever is earlier. 

For the supply of services, the time of supply is when the services are performed. 

Notwithstanding the above rules, if a tax invoice Is issued or payment is made prior to the above 

tax point being triggered, then the invoice or payment will trigger the time of supply to the extent 

the payment or invoice covers the supply. However, if a tax invoice is issued within 21 days of 

the time of supply determined under the basic rule, the date tho tax invoice is issued becomes 

tho tax point. 

The Director General may also alter the time of supply at the request of the taxable person. 

,. Malaysia GST Law, § 11. 
198 


Insert offset folio 167 here 98944.167

Malaysia also has specific rules as follows: 

m Disposal of assets of a business - at the time the goods are transferred or disposed of; 

and 

m Business assets used for priv11te purposes- at the time when the goods were used for 

private purposes. 

The regulations provide further rules for periodic supplies/payments by installment. 

The time of supply rules under the IMF Model VAT Law effectively takes elements from a number 

of jurisdictions. 70 

The primary rule is that the time of supply is the earlier of: 

w The delivery or making available of the goods or the completion of the performance of the 

services; 

~'~ The issuance of an invoice; or 

h!l The receipt of any payment. 

Specific rules are provided for: 

m The supply of goods under a credit agreement - at the time tho agreement is entered 

into; 

m The supply of goods under a lay-bye agreement- at the time the goods are delivered to 

the purchaser; 

Iii The making available of goods for private or employee use - at the time the goods are 

applied to that use; 

fjl The deemed supply of repossessed goods by the debtor to the creditor- at the time of 

repossession; 

m The deemed supply of services under a cancelled lay-bye agreement - when the seller 

obtains the right to retain any amounts paid by the purchaser; 

m Supplies made through vending or other coin operated machines - when tho money is 

removed from the machine; 

u Goods under a rental agreement or supplies under an agreement which provides for 

periodic payments -when each payment is due or received; 

lll For major construction work or utilities where payments are due periodically -the earlier 

of the when the payment is due, made or when an invoice is issued; and 

~~ Tokens, vouchers, forfeiture of deposits. deemed supply of good on hand at 

deregistration. 

"IMF Model Law, § 10. 
199 


Insert offset folio 168 here 98944.168

The Irish time of supply rules are as follows: 71 

u For B2B transactions, the date of the issuance of the invoice or when the invoice should 

have been issued; 

r1 For B2C continuous. supplies of telecommunication, gas and electricity, when a statement 

of account is issued; 

'' For all other B2C supplies, when the goods or services are supplied: and 

'' For advance payments, if the goods or services are yet to be supplied, then the time of 

supply is triggered at the time of payment to the extent payment has been received. If 

received after the supply of the goods or services but before Invoice, then the time of 

supply is triggered at the time of payment for the full value of the supply. 

Various other specific time of supply rules are provided, similar the various specific rules noted 

for the other jurisdictions.12 

Given the greater risk of fraud in Puerto Rico, it is likely the New Zealand and Singapore approach 

ol relying solely on the issuance of an Invoice or receipt of any payment to trigger the time of 

supply could create greater opportunities to artificially defer tax liability. Further, the complexities 

of the Irish and Malaysian rules do not promote the principle of simplicity, As such, we consider 

the better approach would be the IMF Model Law. 

The GST law should also, where required, provide specific time of supply rules for deemed 

supplies if not addressed under Special Cases. 

3.B.4 Imported Servicos!Revorso charue 

Ove.rvlew of Concept 

In order to effectively maintain the neutrality of a GST and minimize the compliance obligations 

placed on non-residents that do not have any presence in the jurisdiction, many jurisdictions adopt 

an imported services or reverse charge regime. Such a regime generally deems services acquired 

by residents from overseas. to be self-supplied by the resident recipient with the recipient being 

required to account for GST on that transaction (akin to a use tax), 

An example of how the reverse charge operates is noted in the diagram below (assuming a 10% 

GST rate with no recovery for the recipient of the supply): 

"Irish VAT Act, I 74. 

"Irish VAT Act, § 70. 
200 


Insert offset folio 169 here 98944.169

~ Overseas Vendor 

AcoounUng setvlces 

~entofthe supply 

$10-GST reverse charge 

~--~ 

$10- payable to Govt 

Govt revenue 

$10 

$10 

Such a regime relieves any potential distortion in the economic decision of a resident of whether 

to purchase domestic services or services from overseas and creates a level playing field for 

domestic and international supplies. preserving the neutrality of the tax. 

Leading Practice 

The imported services/reverse charge rules should be drafted to include the following: 

f1l Where services are supplied by a non-resident to a person in Puerto Rico, that are not 

otherwise deemed to be supplied in Puerto Rico under the place of supply rules, the 

supply should be deemed to be supplied in Puerto Rico by the recipient of the supply. 

M The provision should not apply if the recipient is able to claim a full input tax credit in 

respect of the service received. 

Discussion 

New Zealand includes its reverse charge regime under the place of supply provision. 73 It states 

that where a supply Is made by a non-resident and it is not deemed to be supplied in New Zealand 

under any other place of supply rules, that the supply is deemed to be made in New Zealand. A 

provision within the definition of supply then deems this transaction to be made by the recipient, 

therefore requiring the recipient to account for tax on the transaction. However, these provisions 

only apply where the recipient is not in a position to claim full input tax credits for any GST 

charged. If the recipient can claim full input tax credits, then the reverse charge would simply be 

an accounting exercise creating an additional compliance burden with no benefit to the revenue 

authority. 

Singapore imposes a reverse charge regime under a discrete section that includes not only the 

deeming of the supply to be made in Singapore by the taxable person but also sets out the time 

of supply and valuation rules.74 Technically this section also applies Irrespective of the input tax 

recovery position of the recipient. This is in contrast to the New Zealand approach which includes 

valuation and time of supply in relation to such transactions under those respective sections. We 

do note that Singapore is yet to enforce this reverse charge provision. 

13 NZ GST Act, § 9{4Bl. 

"Singapore GST Aot, § 14. 
201 


Insert offset folio 170 here 98944.170

Malaysia adopts a similar approach to Singapore.76 

The IMF Modal Law takes a completely different approach by including the importation of 

services within the main charging provision of the Ad6 and then defining the importation of 

services within the definitions section. 77 However, similar to New Zealand, there is no 

requirement to account for the reverse charge where a full input tax credit may be claimed. 

Unusually, the IMF Model Law then requires an import of services declaration to be made to the 

Commissioner and pay the tax within 20 days of the end of the taxable period in whicl1 the service 

were imported.10 

Ireland addresses imported services througl1 the place of supply and the liability rules. 79 Whore 

a supply of services is deemed to be made In Ireland and the supplier is not VAT registered nor 

has an establishment in Ireland, the liability to account for the tax falls on the recipient. This rule 

applies irrespective of whether the recipient can claim a full input tax credit in respect of the 

transaction. 

To meet the neutrality objective of a GST and promote the destination principle, leading practice 

would be to adopt a reverse charge regime for imported services. It is recommended that a 

combination of the New Zealand and Singaporean approach be adopted - the Singaporean 

approach of including the importation of services provisions in a separate section but not requiring 

tho reverse charge to be accounted for when a full input tax credit may be claimed by the recipient 

for simplicity purposes. 

3.8.5 Value of the Supply 

Overview of concept 

The rules governing the value of the supply determines the taxable base upon which the VAT 

rata will be applied. 

Leading Practioo 

It is recommended that the valuation rules be drafted to include the following; 

~~~ The value of the supply is, with/without the addition of tax charged (depending on tho 

commercial laws of Puerto Rico), equal to the consideration for the supply. For imported 

services, the value should be, without the addition of tax charged, equal to the 

consideration for the supply. 

~~ The value of supplies of services between related parties below the open market value 

shoulcl be the open market value unless the recipient can claim an input tax credit tor any 

tax charged. 

"Malaysia GST Act,§ 13. 

"IMF Model Law, § 9. 

"IMF Model Law,§ 2. 

"IMf Modollaw, § 19. 

"Irish VAT Act, § 12 ond 34. 
202 


Insert offset folio 171 here 98944.171

>l It the consideration is not in money, it is the open market value of the consideration. 

~'~ The value of the supply should include any other taxes, duties or levies (or similar 

charges). 

Specific valuation rules should be adopted for deemed supplies, specific transaction, or special 

cases that are not adequately dealt with in the general valuation provisions. 

Discussion 

The general rule under the New Zealand law is that the value of the supply of goods and services 

shall be, with the addition of tax charged, equal to the consideration for the supply. If the 

consideration is in money, it is the amount of money payable. If the consideration is not in money, 

it is the open market value of the consideration.00 An exception to this tax inclusive valuation of 

the supplies is in respect of imported services subject to the reverse charge regime. In such 

cases the value is treated as the consideration for the supply before the addition of tax. 

If a supply is between associated persons and is made for no consideration, or consideration that 

is less than the open market value of the supply, then the supply is treated as the open market 

value, unless the recipient could claim an input tax credit tor any tax charged. 

There are a number of rules that are specific to the New Zealand regime which are not relevant 

here and, as such, are not discussed. However, relevant specific valuation rules include the 

following: 

Ill Imported services subject to the reverse charge where those services are supplied 

between related parties; 

l1l Credit contracts to exclude any interest component; 

m Long term residential accommodation in a commercial establishment; 

rn Fringe benefits provided to employees; 

m Deemed sale of business assets upon deregistration; 

01 Deemed supply of services following the cancellation of a lay-by sale; 

"' Supplies by government bodies; 

" Betting, gambling and casinos; and 

ti Certain cross border intra- group company transactions. 

The New Zealand valuation provision also addresses mixed supplies -where the consideration 

relates to both taxable and non-taxable supplies. In such cases, the consideration should be 

apportioned to the relevant parts of the supply: 

The Singapore GST Act adopts the same general valuation rules as New Zealand. 01 Further 

Singapore has a similar associated person rule for when there is no consideration or the 

., New Zealand GST Act, § 10. 

"Singapore GST Act, § 17 and Third Schedule. 
203 


Insert offset folio 172 here 98944.172

consideration is less than open market value however, the uplift to open market value is at the 

discretion of the Comptroller. 

Singapore has specific rules to address the valuation of the following: 

lll Valuation rules for tl1e disposal or business assets or the deemed disposal of business 

assets upon ceasing to be a taxable person; 

w Provision of food and beverages or hotel accommodation lor similar) to employees; 

l'il The inclusion of other taxes or duties in the taxable base; 

lll Leasing of residential premises; and 

"' Used motor vehicles. 

Malaysia has a similar general valuation rule as New Zealand and Singapore, with the exception 

of the treatment of supplies made for no consideration. In such cases tl1e value is deemed to be 

the open market value irrespective of the relationship between the parties. 62 

Malaysia also provides the Director General the power to deem a sale to be at open market retail 

value where the goods are sold by a registered person to non-registered persons for resale. 03 

Malaysia provides a similar. valuation rule as New Zealand for gambling. 

The IMF Model Law is similar to New Zealand. 

The IMF Model Law provides a number of special valuation rules, as follows: 

"' Credit agreements to exclude any interest component; 

a Value of the deemed supply upon repossession of goods; 

!il Deemed supply of services following the cancellation of a lay by sale; 

~"~ Vouchers; 

!il Betting; 

1!1 Deemed supply where a part of the transfer of a going concern is acquired for non· 

business use; 

m Deemed sale of business assets upon deregistration. 

The Irish valuation rule states the amount on which tax is chargeable is the total consideration 

which the person supplying goods or services becomes entitled to receive, including all taxes, 

commissions, costs and charges, but not including value-added tax chargeable in respect of that 

supply. 84 

"Malaysia GST Act, § 16. 83 Malaysia GST Aol, Schedule 3. subparagteph 6. 

"Irish VAT Act. § 37. 
204 


Insert offset folio 173 here 98944.173

Where tho consideration does not consist of or does not consist wholly of an amount of money, 

the amount on which tax is chargeable shall be the total amount of money which might 

reasonably be expected to be charged if the consideration consisted entirely of an amount of 

money equal to the open market price. 

The Commissioner has a discretion to determine the value of a transaction, based on the open 

market value of the supply, to ensure the correct amount ot VAT is paid.35 

Specific valuation rules are provided tor such things as vouchers, reverse charge, and nonbusiness use of immovable goods. 

The approach to the valuation rules by each jurisdiction is very similar. However, Ireland treats 

the consideration as VAT exclusive while the other jurisdictions treat the consideration as GST 

inclusive. The ultimate decision on whether to veat the consideration as being GST inclusive or 

exclusive for the purposes of the GST valuation rules wilt depend on the commercial or consumer 

laws of Puerto. Rico. However, for imported services, the consideration should be deemed to be 

GST exclusive. 

In any event, the valuation for GST purposes should include any other taxes, duties, levies paid 

on that supply because GST is not an alternative to those taxes and the value of the supply 

including those taxes represents the real value of the final consumption of the good or service. 06 

The use of the open market value uplift should be limited and prescriptive, similar to the New 

Zealand approach, rather than be discretionary such as in Ireland and Singapore In order to provide 

certainty within the tax system. 

Specific valuation rules should be adopted for deemed supplies, specific transactions or special 

cases that are not adequately dealt with in the general valuation provisions. 

3.8.6 lnworted Goods 

Overview of Concept 

A key concept of GST is the levying of the tax on Imported goods. As mentioned above In respect 

of the place of supply rules, this is consistent with the destination principle and ensures that 

imported goods are placed on a level playing field with domestically produced goods. 

Key challenges that will need to be addressed relate to the importation of goods into Puerto Rico 

from the United States given Puerto Rico's relationship with the United States. 

Leading Practice 

The levying of GST upon the importation of goods should be Included within the main charging 

provision, as discussed above. 

"Irish VAT Aot, § 30. 

"D•vld Williams, TBK Law Dsslon and Drafting. Chapter 6 Value Added Tax, Volume 1; International MonelaiY Fund, 1996, p. 45. 
205 


Insert offset folio 174 here 98944.174

However, this specific section should address the time at which a good is considered to be 

imported (e.g., when the goods are cleared by customs) and any import GST suspension or relief 

regimes. 

The provision should provide relief for certain importations by contract or toll manufacturing 

operations and in respect of the temporary importation of goods. 

For taxable persons in good standing, a GST deferral regime should be available to allow those 

taxable persons to self account for import GST in their GST returns, relieving them of any cash 

flow burden that may arise from having to pay the GST to release the goods at the border and 

the subsequent claiming of a credit in the later return. 

Discussion 

As discussed above ln respect of the imposition of the tax, New Zealand has a separate section 

that imposes GST on upon importation (other than fine metals).m This is in contrast to the other 

comparable jurisdictions, which include the importation of goods within their respective main 

charging provision. 

The charging provision refers to the Customs Laws to determine when goods are considered to 

be imported into New Zealand. As such, any relief provisions under the Customs Laws (e.g., 

temporary importation) also apply to the GST. 

Within this section, Nelf>'. Zealand also sets out various rules In respect of when GST should not 

be applied upon importation, including: 

~ Goods Intended solely for the use of an organization, visiting force, expedition or other 

body approved by New Zealand Customs that may be established or temporarily based in 

New Zealand under a government or international agreement; and 

!'l Goods intended for the use of a person temporarily resident in New Zealand for the 

purposes of serving as a member of any of the above organizations. 

The section also sets out the value of the imported goods for the purposes of levying the GST. 

Further, reliefs are provided for reimported goods (where the importer is the same person as the 

exporter and the goods were not treated as a zero-rated exported supply). 

Various provisions are included to address the refund of GST for goods re-exported from the 

country where the importer was not entitled to an Input tax credit and the goods were of the 

wrong specification or were faulty. 

Additional exemptions are provided for certain specified items under the New Zealand Tariff 

including: 

t• Certain gifts; 

" New Zealand GST Act, § 12. 
206 


Insert offset folio 175 here 98944.175

Personal baggage and effects (subject to certain limits); and 

Limited amounts of alcohol and tobacco, 

Singapore imposes GST on importation in the main charging section of the act e!!ectively treating 

GST as if it were a customs duty and all goods imported into Singapore are dutiable, Exemption 

from import GST for investment precious metals is separately provided for. 

Singapore provides discretion to the Minister to issue orders granting relief from import GST ior 

such things as re-imported goods, temporary imported goods, and goods related to an 

international agreement or arrangement In addition, similar to the New Zealand law, Singapore 

defers to the customs legislation lor the levying of GST unless there is contrary intention noted 

in the GST law. 

The Singapore GST Act also provides the Minister \/\lith the power to issue regulations relieving 

or deferring the levying or payment of GST where goods are imported by any taxable person in 

the course of that persons business.00 

Such sch~>mes include:00 

The exemption olthe importation of petroleum products where imported lor the business 

of the taxable person; 

Exemption of imports by persons approved under the Major Exporter Scheme and 

approved third party logistics company scheme (this is a scheme available to taxable 

persons \Niu:re the majority of their supplies are exports or supplies of international 

services); 

Approved import suspension scheme (for taxable persons in the aerospace industry}; 

Import Goods and Services Tax Deferment Scheme (allows taxable persons to self 

account for import GST In their tax return); 

Approved contract manufacturer scheme {where the taxable person carries out work on 

goods under contract with an overseas person); and 

Approved refiner scheme (who imports investment precious metals and make supplies 

of refining or supplying such metals). 

Malaysia is similar to Singapore in that the charging provision for the levying of GST on 

importation is in the main charging Malaysia has a number of special very 

similar to a number of Singaporean regimes. 

The !MF Model Law also has the levying ol VAT on importation in the main charging provision. 91 

The exemption from import VAT is covered by section 17, referring to Schedule Ill. which 

essentially states that import VAT is not payable if the goods are not dutiable. Further, if the 

'"Malaysia GST Act. § 9. 

" IMF MQdot l~w. ~ 9, 
207 


Insert offset folio 176 here 98944.176

supply of the goods within the country would be zero,rated or exempt, then no import VAT should 

apply. 

The IMF Model Law also includes a section providing the Commissioner of Customs with the 

obligation to collect the VAT and requires the importer to provide the Commissioner with an 

import declaration. 

Ireland levies VAT upon the importation of 

the following exemptions or reliefs from import VAT:93 

Import into free trade zone; 

Imports into customs warehouse; 

Ireland includes 

Inward proc<Ossing arrangements (similar to the contract and toll manufacturing schemes 

in Malaysia and Singaporel; 

Temporary importation arrangement; 

Transit arrangement; 

A regime similar to <:'"'""""''"'" scheme; and 

A deferred payment scheme, 

All comparable jurisdictions levy GST on the import of goods within the territory. This is in line 

with th>:i current SUT regime, under which use tax must be paid upon importation of goods into 

Puerto Rico before the person takes possession of the goods. 94 

Amongst the comparable jurisdictions, only New Zealand does not include the levying of GST 

upon importation within the main charging provision. For clarity purposes, the leading practice 

would be to follow Singapore, Malaysia, th>:i IMF, and Ireland in this respect. 

The section should also address the paint in time that a good is considered to be imported {e.g., 

when the goods are cleared by customs) and any import GST suspension or refief regimes. For 

this purpose the comparable jurisdictions generally refer to the customs laws. 

Given Puerto Rico's economy, special consideration should be given to regimes related to 

contract or toll manufacturing operations and the temporary importation of goods, which would 

eliminate the levying ol impart GST in certain prescribed situations. For example, the importation 

of raw materials for processing into final goods toot are to be exported from Puerto Rico, 

For taxable persons in good standing, a GST deferral regime should be avaHable to allow those 

taxable persons to self account for import GST in their GST retums, relieving them of any cash 

flow burden that may arise from having to pay the GST lo release the goods at the border and 

the subsequent claiming of a credit in the later return. 

•t l<i$~ \/AT Act§ 3, 

"'Irish VAT Act, Ss 63 to 00. 

"'1'1\i!lC s 4!14UKlla), 
208 


Insert offset folio 177 here 98944.177

In this regard, the special schemes in Singapore, Malaysia, and lreland should be considered and 

adapted to Puerto Rico's needs. 

Like the existing rule collection of sales tax on sales by mall order,95 the GST law should also 

address separately the specific case of mail order deliveries private individuals from the U.S, 

Overview of Corlcept 

It is common to have separate valuation rules for lila importation of goods that refer to the 

customs valuation rules, This mduoos an administrative complexities that would arise if the 

valuation GST purposes is different than for customs purposes but the GST is levied and 

collected using the same mechanism as for the collection of duties. Further, such valuation rules 

assist in determining the taxable base for GST purposes where there is no reference transaction. 

The valuation rules for levying the GST on the importation of goods i!'llo Puerto Rico should be 

based on the customs valuation rules, plus any duties or levies payable upon importation, 

Discuaion 

The New Zealand charging section for levying GST on imported goods also sets out the value of 

!he imported goods for the purposes of levying the GST. The valuation provisions refer to the 

customs valuation rules plus anv other duties or levies payable upon imlnnt·t,ti<w• 

The IMF, Ireland, Singapore, and Malaysia have separate valuation sections. 97 Ali sections refer 

to the valuation prescribed under the customs laws and operate in the same manner as New 

Zealand. 

Overview of Concept 

Where a supply of a good or service is zero-rated, no GST is charged on the sale or provision of 

that service. However, the person making that supply is able to recover tile GST has incurred 

on its purchases related to the making ol that zero-rated supply !comrast this with exempt 

supplies below), 

The main issue with zer<Hating, is that the entire suppli' chain is relieved from tax if zero-rating 

is at the final stage of the as illustrated it' the diagram below. As such, zero-rating is more 

costly to the government in terms of revenue foregone, Further, zero-rating requires mora 

controls to ensure rsfunds claimed by taxable persons making zero-rated supplies are valid. 

il2!21, 

Maloysia GST AM, 'i !5. IMf Model low,,§ 14, ,lri•h VAT A¢!, S 54. 
209 


Insert offset folio 178 here 98944.178

Zero-rating has the following impact on the supply chain and the collection ol the tax: 

A few countries zero rate some domestic supplies lor social and political reasons: sales of food, 

medicines, books, children clothes and shoos !UK, Ireland) to completely remove the tax burden 

from the supply chain. This is widely viewed as inappropriate, because it amounts to a subsidy 

of the activity or transaction treated in this way and zero-rating is costly in terms ol government 

revenue forgone as tax is relieved from the entire supply chain. II would usually be better to 

identify the policy reason for the subsidy and address it through a direct 

leading Practice 

Zero-rating should be limited to exported goods and services where the effective consumption 

takes place outside of the GST jurisdiction, maintaining the destination principle of GST. As such, 

to the extent !11e services supplied to non·residents relate to real or moveable personal property 

in Puerto Rioo, GST should be charged, 

For the reasons explained under 3A 1 supplies to the U.S. Federal Government and its 

instrumentalities should also be zero-rated. 

In addition, to avoid double taxation in respect of fuel and hotel rooms and an additional tax 

burden baing placed on consumers, given those supplies are subject to excise tax and the excise 

tax is unable to be adjusted due to debt obligations, such supplies should be zero·ra!ed, 
210 


Insert offset folio 179 here 98944.179

Discussion 

Exported goods; 

Duty free goods travelers; 

Supply of a boat or aircraft leaving New Zealand under its own power; 

Goods not situated in New Zealand at the time of supply and the goods are subsequently 

imported by the recipient and subject to import GST; 

Goods used for the provision of zero-rated repair, renovation, modification services and 

those goods are consumed or affixed to the goods that are the subject of the zero-rated 

repair, renovation, modification services (e.g., good used the repair of ships or aircraft 

temporarily in New Zealand); 

Goods for the use on a pleasure craft temporarily imported into New Zealand related to 

the operation of the craft; 

Consumable stores supplied for use on ships or aircraft leaving New Zealand; 

Sale of a taxable activity; 

Supply of land for the use in a taxable activity; 

Supply of any new fine metal after its refining; and 

Supply of tools to a nmHesident that are to be used in New Zealand for the purpose of 

manufacturing goods solely for export 

Various rules are listed that restrict the application of zero-rating in certain circumstances to 

mitigate evasion opportunities, 

New Zealand zero-rates the following types of services: '

00 

International transport of passengers or goods, including anciHary services such as the 

loading and unloading of goods, insurance related to such transport; 

Services supplied directly in connection with land or moveable personal property situated 

outside New Zealand; 

Services supplied overseas postal organizations for the delivery of mail in New Zealand 

Which originated from overseas; 

Services supplied directly in connection with temporarily imported goods; 

Services physically performed outside New Zealand or the arranging of services "'"·'"'r'"ll" 

performed outside New Zealand; 

'' New Zealand GST Act ~ 

"" N&w Zo•land GST Act § 11 A_ 
211 


Insert offset folio 180 here 98944.180

Services supplied to a non-resident who is outside New Zealand at the time the services 

are performed and the services are net supplied directly in connection with land or 

moveable personal property in New Zealand; 

Supply of information to a non-residant where the services are supplied directly in 

connection with moveable personal property in New Zealand; 

Services supplied to a non-resident which are directly in connection with goods to be 

exported; 

Services supplied to a norHesident which are directly in connection with tools that are to 

be used solely to produce goods to be exported; 

Services related to imported goods under warranty to the extent the services are provided 

under the warranty and supplied to a warrantor who is a non-resident; and 

Certain telecommunication services supplied to a non-resident telecommunications 

supplier. 

Singap,ore zero-rates the following types of 

Exported goods; 

Use as stores or fuel on aircraft or ship (including retail as merchandise to persons carried 

on a ship or aircraft}; 

For installation on a ship or ship under construction; 

For use in the maintenance or operation of a ship; 

Supply of tools to a non-resident that are to be used in Singapore for the purpose of 

manufacturing goods for that norHesioont; and 

Certain supplies to approved marine customers, 

Singapore zero-rates international services which include the fnl''"'"'"'"' 

International transport of passengers or goods, ancillary services such as the 

loading and unloading ol goods, insurance related to such transport; 

The letting on hire of any means o! transport lor use in a place outside Singapore which 

is exported by the lessor to such a place or are outside Singapore; 

Services supplied directly in connection with land or goods situated outside Singapore; 

Services supplied to a non-resident which are directly in connection with goods to be 

exported; 

Prescribed financial services supplied in connection with goods for export outside 

Singapore or for the removal of goods from a place outside Singapore to another place 

outside Singapore; 

'" Sing• pore GST Act, § 21 !6). {8A). 

101 Sin!japore GST Act § 21. 
212 


Insert offset folio 181 here 98944.181

'" Cultural, artistic, sporting, educational. entertainment, exhibition, convention (and ancillary 

services! wholly performed outside Singapore: 

Services supplied to a person who belongs outside Singapore and which directly benefit 

a person who belongs outside Singapore at the time the services are performed including 

computer server co-location services to equipment owned by the non-resident; 

Services supplied in connection with the handling of ships or aircraft the handling or 

storage of goods carried on any ship or aircraft; 

Pilot age, salvage; or towage services performed in relation to ships or aircraft; 

Services comprising the surveying of any ship or aircraft; 

The supply of any ship or aircraft and certain parts; 

Prescribed services comprising the repair. maintenance or broking or management of any 

ship or aircraft;. 

Prescribed services relation to telecommunication; 

Services supplied to a trust where the services and the person supplying the service 

satisfy the conditions as may be prescribed; 

Prescribed services in connection with the provision of an electronic system relating to 

the import or goods or export of goods out of Singapore; 

Supply of advertising services >vhere the advertising is substantially made outside 

Singapore; 

Air and sea containers and certain services related to air and sea containers; 

Services supplied to a noo·resklenl which are directly in connection with toots that are to 

be used solely to produce goods to be eXPorted; and 

Grant or assignment of lease, tenancy or license to occupy land where the supply Is to a 

non-resident and It is an approved warehouse. 

The IMF Model Law is very similar to New Zealand zero-rating provisions. 

Ireland zero-rates an extensive list of goods including the fnl!nwino· 

Export of goods; 

Certain food items; 

Books; 

Medicines and certain medical equipment; and 

Children's' clothing. 

VAT relief for exported services, as found in the other jurisdictions, is addressed through the 

place of supply rules, treating the supplies as outside of the scope of Irish VAT to maintain the 

'"'ltish VAT Act Sch•dulo 2. 
213 


Insert offset folio 182 here 98944.182

destination principle rather than treating as within the scope o! VAT and zero-rating the 

transaction {see section 3.9.2). 

At the time of drafting, the Malaysian regulations governing zero-rating were only available in the 

local language. 

are not exhaustive but are the principal and most relevant supplies that are zeroZenrrating should be limited to exported goods and services where a local consumption tax 

should r1ot be imposed on foreign purchasers where the effective consumption takes place 

outside of the GST jurisdiction, maintaining destination principle of GST. Please refer to 

section 4.2.2.4 in the deliverable entitled Analysis of Current StrucliJre and Optional Tax 

Strategfes (Sept. 9, 2014l and Appendix E for the policy discussion around the implementation 

of multiple rates exemptions in a GST regime and why a broad based system is preferred. 

The described leading practice GST constitutes one of the biggest from the current 

applicable SUT regime, which provides a vast list of exempt transactions.104 However, when 

addressing concerns ol reducing existing exemptions and thus effectively broadening the scope 

of !he GST, the following points should be reminded: 

Certain key exemptions remain under the leading practice GST in the form of GST 

exemptions (see section 3.8.9); 

Business inputs will be relieved based on the input tax credit system (see section 3.0.5!; 

The regressMty resulting lmm eliminating key exemptions may be addressed via other 

means {see section 4.2.2.4 the deliverable entitled Analysis of Current Structure and 

Optional Tax Strategies (Sept. 2014ll: 

Export transactions will remain untaxed as explained above; and 

Key import transactions remain untaxed under special import provisions (see section 

3.8.6). 

Overview of Concept 

Where a supply of a good or service is exempt from GST, no GST is charged on the sala or 

provision of that good service. However, the person making that supply is unable to recover 

the GST has incurred on purchases related to the making of that exempt supply (contrast 

this wilh zero·rating above). 

Exemptions are usually implemented for reasons (e.g., healthcare and education) or 

because they are difficult to tax (e.g., financial services), Please reler to section 4.2.2.4 in !he 

deliverable entitled Analysis of Current Structure and Optional Tax Strategies !Sept. 9, 2014) and 
214 


Insert offset folio 183 here 98944.183

Appendix E for the policy discussion around the implementation ol multiple rates or exemptions 

in a GST regime and why a broad based system is preferred. 

Exemptions have the following impact on the supply chain and the collection of the tax: 

$10 

Where an exempt supply occurs further up the supply chain, lax cascading can occur, resulting 

in a higher effective tax rate at the end of the supply chain or creating incentives for vertical 

integration. Tax cascades arise when a supplier of exempt goods or services cannot recover the 

GST incurred on its purchases. That GST then becomes part of the cost of providing the services 

or producing the goods. Where a business that makes taxable supplies acquires these goods or 

services with this imbedded GST, and then charges GST on its supplies, there is effectively a tax 

on tax resulling in a higher effective tax rate. See diagram below: 
215 


Insert offset folio 184 here 98944.184

In the above example, the tax rate is 10%. However, the effective tax rate 14%. 

Further challenges with exemptions include: 

Suppliers making exempt .supplies can have an incentive to self supply or vertically 

integrate as GST charged by third parties is not racoverable; 

Entitias making taxable and exempt supplies are required to track and apportion the GST 

charged on business inputs to ensure only GST related to taxable supplies that entity 

makes is recovered gives rise to higher compliance costs. This is di!licuit to achieve 

accurately and disputes can arise between the taxpayers and tax authority regarding the 

methods used to apportion input tax credits; 

Provides the opportunity lor exemption creep due to political pressures from related 

industries that may not be subject tile exemption; and 

There are often issues with defining what should come within the scope of the exemption 

and what should not be included the interpretation ot those definitions. 

Exemptions should be carefully considered from a policy perspective and what they are intended 

to achieve. Ebrill et al 105 state "Exemptions are abhorrent to both the logic and the function oi a 

VAT" as they narrow the tax base, result in taxation ol business inputs, distort business 

decisions, and result in tax cascades. 

However, should no other options be available to reduce the regressivity of a VAT, exemption is 

a better option, economically and administratively, than zero rating or reduced rates for the goods 

and services that require for some tax concession. Exemptions can be less costly to the 

government in terms of revenue generation as those businesses making exempt supplies are 

still baing taxed on their inputs. Further. exemption is simpler than tho reduced rate alternative, 

and politically, it is an easier sell to tho general public. 105 

That said, exempting financial services and real estate are generally considered unavoidable. 

These areas are discussed below. 

Financial Services 

Financial services transactions generally include the provision of loans, taking of deposits, and 

trading in securities (e.g., shares) among other related services" 

Financial services are almost universally exempt under GST systems around the world due to the 

challenges associated with identifying the base upon wi1ich the lax should be levied - the value 

of financial intermediation usually included in the interest rate spread and is difficult to 

determine on a transaction by transaction basis. Extracting the value of the service element from 

this spread is problematic. Aside from the valuation issues, GST is generally a tax on consumption 

of goods and services whereas returns on savings are to compensate for the time value of money 

'" E!:lrill at at TlleModl!lm VAT, ln!,rMtionol 

'" Tuao Minh la, Val"" Added TJ!JXJ!JIIQ/!: MfiCI!snisms, ""''rmoM>'Oil<CY 
216 


Insert offset folio 185 here 98944.185

and therefore should not be included in the consumption tax base until those savings are applied 

to purchases of goods or services. The taxation of the time value of money would effectively 

result in double taxation. In order to prese!Ve the neutrality of a GST, there should not be a 

difference the treatment of current versus deferred expenditure. 

Such challenges do not exist where there are specific fees or commissions charged for services 

such as safe keeping services, debt collection, investment advisory services, etc. and these are 

generally treated as subject to GST. The problem becomes apparent with deposit and loan tvpe 

transactions. 

A number of options for the taxation of financial services to tax the margin of a financial 

intermediary (without taxing pure interest} and to eliminate the tax cascading effects have been 

considered around the world, including the Cash-Flow Approach, 101 addition method {tax on 

wages and profits), 100 zero-rating of 626 financial services, 100 and allowing financial 

intermediaries to claim input tax <:redits on a prescribed recovery percentage. 110 

The discussion of such options lor taxation are beyond the scope of this paper as the complexities 

associated with such regimes for the taxation of financial services would create significant 

challenges with the implementation of a GST in Puerto Rico, 

Although exempting financial services will depart from the objective of implementing a broad 

based GST system in Puerto Rico, such an exemption is current leading practice from a GST 

perspective, 

Exported financial se!Vices should be zem·rated consistent with international practice and to 

ensure that Puerto Rican financial service industry is not competitively disadvantaged. 

Real Estate 

Tile application of GST to the real estate sector needs to be considered in the context of the 

following: 

Residential real estate; 

Commercial real estate; and 

Construction. 

Nearly all jurisdictions exempt the renting or leasing of residential real estate. However, some 

choose to tax the sale of new residential real estate, 

It is sometimes asserted that residential housing should be treated favorably because it is an 

essential part of household consumption and that favorable treatment would address the 

POOdar & r,xslloo of Fl'noncmJ Smvlc<lo Utulm ll Vslue ·Ad-Tax: Applying the C•slri'IDw ApprOilC/1, 

Joomol. Vo160 No,l!March 19lm p,p, 1!9·112. 

'"Hisi<J<io I•M$11 VAT !rootment <>! lirnmcial•ervloas. 1{1f! New L0ak'ntd GST tte~tma~t of ti:nancla~ se~, 

1H1 Sl:ngJ)lp(llra GST tnta1.m-0nt of Hrutooia~ -S~iCfUL 
217 


Insert offset folio 186 here 98944.186

regressivity issues that would otherwise arise if residential housing is subject to GST. 111 From a 

practical standpoint, the exemption of residential is generally driven by the fact that the 

taxation of owner-occupied housing Is inherently challenging with a requirement calculate an 

imputed rental value, not to mention the compliance/administratfve burden perspective with all 

owner-occupiers required to register and account for GST. While rental and leasing 

contracts are easier lo tax as they are traded in the marketplace and therefore the taxable base 

is easy to determine, a difference in the GST treatment between owner· occupied housing and 

residential rental or leasing will distort consumers choices between buying a renting. Thus, 

residential real estate is generally exempt 

The treatment of commercial real estate varies from being exempt, taxable or exempt with the 

option to tax. 

The treatment of construction services materials also varies in some jurisdictions depending on 

what the construction services relate to or tile types of materials. This can cause significant 

compliance and administrative issues from a definitional perspective. 

Le~ding Practice 

The following supplies should be treated as exempt from GST: 

Financial services !other than zer<:Hated financial services!; 

Supply by any non-profit body of any donated goods and services; 

The supply of residential accommodation by way of lease or otherwise; 

of any fine metal (other than a supply of fine metal that is zero-rated!; 

Supply of water and electricity. 

Olsoossion 

New Zealand exempts the following 

Financial services (other than zero-rated financial services); 

Supply by any non-profit body of any donated goods and services; 

The supply of residential ao:::ommodatfon by way ollease or otherwise; and 

Supply of any fine metal (other than a supply of fine metal that is zero-rated). 

Singapore exempts the following 

Financial services; 

'' Investment precious metals; and 

Residential property. 

m Alan A. Tail. \laluo Addod r,x, lnlemolk')tltil Pti!!CtfCrnmd Problems. !nt<~mational Mon•M'i' l'un;:!. 1988, 

"' Now Zealand GST Act § 14. 

"' Singap<J<e GST Act § 22, Pouth SCh, l'•<t 
218 


Insert offset folio 187 here 98944.187

The IMF Modal Law exempts the following 

Financial services; 

Prescription drugs and medical services: 

Education services; 

Accommodation in a dwelling; and 

Supply ol goods or services by the State or not for profit where the consideration for the 

goods and services is nominal in amount or not intended to recover the cost of such 

goods or services. 

Ireland has an extensive list of exemptions that include the 

Financial services; 

Welfare; 

Insurance; 

Education and training; 

Betting and lotteries; 

Medical Services; 

Postal services; and 

Letting of immovable property. 

At the tin1e of drafting, the Malaysian regulations governing exemptions were only available in 

the local language. 

To facilitate the implementation of a leading practice GST system with a broad base and limited 

exemptions, leading practice would be to exempt the following services: 

Financial services (other than zero-rated financial services) as discussed above, the 

exemption should be limited to financial services that are not based on a specific fees or 

commission; 

Supply by any non-profit bedy of any donated goods and services- because these goocls 

or services likely contain an imbedded GST cost; 

The supply of residential accommedation by way of lease or otherwise; and 

Supply of any line metal {other than a supply of fine metal that is zero-rated)- investment 

metals are generally considered a form financial services. 

The treatment ol water and electricity is a special case in Puerto Rico. The pre-tax cost of both 

of these commodities is already extremely high and subjecting them an additional GST tax 

would impose unacceptable additional costs on consumers. As such, a full taxation model may 

"' IMf Mod•l § 18, SCh. II. 

VAT Act schedt~e 1. 
219 


Insert offset folio 188 here 98944.188

not be appropriate in Puerto Rico in respect of these sectors. As both are supplied by government 

authorities and are not competition with the private sector, such an approach is manageable. 

Regressivlty issues associated with a GST in respect of basic food items,. healthcare, and 

aducatiotl for consideration shollld be dealt with via transfer payments. We refer lo Appendix 

the policy discussion around the implementation of multiple rates or exemptions a GST 

regime, why a broad based system is preferred, and exemptions relating to basic food items, 

education, and health care should be avoided. 

3.C.1 Reclist1·atlc•n 

Overview of Coneept 

regliStl·ath)n is similar to the current requirement for merchants to register in the Merchants' 

jurisdictions set a monetary annual threshold, whereby 

hw•inc'""''" that under this threshold do not need to for This not only means 

that those businesses are relieved from the obligation to remit GST to the government 

but those businesses are also unable to claim credits for GST incurred on their business inputs. 

reoristr·ati()n threshold will affect the revenue base of the tax !La., a higher registration 

lhn.,.,h,nlrl will result in fewer taxpayers). 

GST thresholds from jurisdiction to jurisdiction. Thresholds 

a ofthe Ac.<'1•nm~lic a country. Som\'1 countries have a corno~uativelv 

number of small om:messt•s 

businesses or contribute little to the colfection of 

administratively therefore exp.;msive-to coHect tax !rom such 

GST compliance costs tend to be (i.e., small businesses to 

more on compliance than larger The setting of a high •""~~r..nrrl mll·i""'""' 

these issues. 

Another advantage of 

there is less of a strain 

taxpayer knowledge 

thn'"'""',; particularly at the introduction of the tax, is that 

"rl'"'"'''""'"'''''"' resources during a time when there is limited 

Overall, the main reason lor excluding small businesses a registration threshold is that 

the costs o! tax administration and""''"'''"" ""'"'"'''l"''"" '""' rlio"'"''"',.lr'"'"'''"' GST revenues 

"""'"'''""'rl from the activity oi those The level threshold is tradebetween minimizing compliance and administration costs and losing GST revenue. 

Setting the threshold is important decision. The !irst VAT in Ghana failed, in 

due to the threshold set too low. The second, and succasslul, '""'~! .. ,.,,,"+"'''"'' 

VAT in Ghana, avoided !his problem setting a higher threshold the retail sector. In 1999 
220 


Insert offset folio 189 here 98944.189

threshold reoistraN<m rate tor the VAT was 200 million cedi 1$80,000), up from 25 million cedi 

{$15,000) in 

Some countries have different registration thresholds for suppliers of 

services {e.g., France) and others allow registration for 

the registration threshold. different registration thrAst1n!rls 

residents versus norrresidents. 

In summary, the advantages of adopting a low registration threshold includes: 

No artificial discrimination between taxpayers based on a threshold level: 

It enables to collect revenues at full potential; and 

There is no possibility to avoid taxation by artificially splitting of businesses. 

However, as noted, this can give rise to a higher compliance burden on small businesses when 

introducing a new tax and a higher compliance cost for small businesses and tax administration 

that is disproportionate to the GST revenues. 

The advantages of allowing voluntary registration for businesses falling below the registration 

threshold include: 

Enabling small businesses to recover GST on their inputs, potentially allowing them to 

become more competitive by reducing the price point of their goods or services without 

affecting their profit margin; 

Small businesses exporting goods will be able to recover GST on their inputs ensuring 

there is no embedded GST cascading through the system and indirectly imposed on 

foreign customers; and 

It can help avoid any distortionary effects arising from businesses operating just below 

the threshold. 120 

However. a voluntary registration program is not without its challenges. can result in an 

increased burden on the tax administration arising !rom a higher number of registered taxpayer 

to manage and give rise to uncertainty in respect of the potential number of voluntary registrants 

on implementation, thus making resource planning difficult 

Leading Practice 

During the implementation stage, a relatively high registration threshold should be sat to limit the 

number of GST registered businesses to a manageable number. There is anecdotal evidence that 

upon the implementation of the IVU in Puerto Rico, tile number o! taxpayers that would register 

was grossly underestimated, which put a significant strain on Hacienda. A high registration 

threshold would help avoid this issue. 

fro.<n G!l8M, Th• Wo~d B•n~. f'REM NolM PubliC Soot<>•, Osesmll<lr 2001 Numner 61. 

Mon•t•'Y F"mt 2001. 
221 


Insert offset folio 190 here 98944.190

The registration threshold should be gradually reduced, as required over the two years following 

the implementation of the GST to the optimal level for Puerto Rico. This would enable a gradual 

implementation of GST that businesses and consumers get progressively used to the 

new tax. 

Voluntary registration should be permitted and anti-avoidance provisions should be introduced to 

avoid artificial splitting of businesses to avoid GST registration obligations. Safeguards should be 

put in place to ensure those taxable persons voluntarily registering tor GST are carrying on bona 

fide taxable activiti<;~s. A requirement, similar to that if a business voluntarily registers 

it must remain registered for a certain period, may help deter frivolous registrations. 

There should be no difference in the threshold level between suppliers of goods or services to 

promote simplicity and there shoufd be no different in treatment between resident and non· 

resident taxpayers to promote neutrality. 

the registration threshold calculation shoufd exclude exempt supplies. 

Discussion 

New Zealand requires any person carrying on a taxable activity to register for GST at the end of 

any month where the total value of their supplies made New Zealand exceeds NZ$60,000 in 

that month and the previous 11 months or is expected to exceed that arnount in the next 11 

months. 121 Exceptions are provided where there is no expectation that the supplies will exceed 

that amount in the following 12 months or where the exceeding of the threshold was due to the 

ending or substantial reduction in size of the taxable activity. or the replacement of any plant or 

capital asset. 

Where a person does become liable, that person is required to apply for registration within 21 

days. 

Voluntary registration is possible where a person is carrying on, or intends to carry on, a taxable 

activity but has not breached the registration threshold and any person purporting to charge tax 

on a supply is also deemed be a registered parson. 

New Zealand also allows the registratiOn of non-residents where that person would be eligible to 

register if carrying on its business in New Zealand for the purposes of input tax recovery. 122 

Singapore takes a similar approach to New Zealand but refers to quarters rather than months and 

the annual threshold is SG$1 mliUon. Singapore also includes a provision that prevents the 

artificial splitting of taxable activities such that a taxable person falls below the registration 

threshold. 

"' N..w Zealand (lSi Act. § 51. 

"'New Zealand GST Act§ !MB. 
222 


Insert offset folio 191 here 98944.191

Where a person becomes liable to be registered in Singapore, that person is required to apply for 

registration within 30 days. 

As with New Zealand, a person can voluntarily register GST in Singapore. However, where a 

person voluntarily registers for GST in Singapore, that person must remain registered for at least 

two years. 

Malaysia is similar to Singapore and New Zeatand. ~ However, imported services are excluded 

from the turnover threshold calculation. The registration threshold is RM500,000 and where a 

person becomes liable to be registered the person must apply fm registration within 

28 days. Voluntary registration is also permissible. Malaysia also contains a rule to prevent the 

artificial splitting of businesses to avoid breaching the turnover threshold. 

The IMF is also similar. However, the taw includes specific rules tor auctioneers, promoters of 

public entertainmet1t and the display of registration certificates. 124 

Ireland is similar. However a different threshold applies for those businesses supplying goods as 

opposed to services !EUR75,000 and EUR37,500 respectively! and !here is no threshold for non· 

residents making supplies in Ireland. 

The threshold calculation all cases excludes exempt supplies. JurisdictiMs achieve this 

through various mechanisms (e.g., excluding exempt supplies from the definition of taxable 

activity or using the term taxable supplies for calculating the registration threshold), 

In most cases, the value of imported services is included in the calculation o! lhe registration 

threshOld. However, Malaysia requires businesses to account imported services even where 

businesses are not registered, while other jurisdictions only require registered businesses 

to account for the reverse charge on imported services, 

II is important to determine when a taxable person ceases to be required to be registered and 

th" cons.,quences of deregistration. 

I.Mding Practiee 

Deregistration should be permitted where the tax authority is satisfied that the taxable person's 

value of taxable supplies is, or is not expected to exceed the turnover threshold, or where the 

taxable person ceases carrying on a taxable activity. 

Rules should be includ"d to deem goods on hand at the time of registration to be supplied and 

GST should be accounted the lesser of cost or open market value of those assets. 

"' Mai®Y11i8 llST Aot, §s 19 t<:> :24,. 

'" lMF Mooel t•w, ; 2!l•nd 21. 
223 


Insert offset folio 192 here 98944.192

Retrospective deregistration should be provided for where a person been registered in error. 

New Zealand deems a person to caa$e being Hable to be registered where at any time the 

Commissioner satisfied that the value of that persons taxable supplies in the next 12 months 

will be below the registration threshold, A person that satisfies this requirement may cancel the 

registration effective on the last day of the taxable period in which the Commissioner was 

satisfied, 125 

A person that ceases carrying on all taxable activities must notify the commissioner within 21 

days. 

commissioner also cancel the registration where he is satisfied that the person is not 

carrying on a taxable activity, 

The Singapcre, Malaysian anciiMF cancellation rules are similar to New Zealand's, However, !or 

Slngapcre and Malaysia the notification period is 30 days rather than 21 days. 

A key aspect of deregislration applicable to all jurisdictions is that the assets on hand upon 

deregistration are deemed to be supplied at the lime of deregistralion. Jmisdictions often include 

this rule in the definition of supply {with associated valuation and time of supply rules). The 

valuation rules can require the deemed supply to be accounted for on the lesser o! open market 

value or the original cost of the asset or simply open market value. 

Ireland has similar deregiatration rules, '~ 6 but, it does not deem goods on hand at deregistralion 

to be Instead It requires an adjustment to the previous input tax claimed. Such a 

more complex to administer than the deemed supply rules adoptoo by the other 

furisdictions. As such, deregistration rules similar to New Zealand, Singapore, Malaysia and the 

IMF constitute leading practice, 

3.0 Calcufation of Tax 

Overview of Concept 

taxable period is the period of time respect of which a return is required to be tiled to 

repor1 the tax position of a taxable person. Consequently, !he taxable pGriod is closely related the 

payment and refund of GST, The length of the taxable period is generally a policy decision that 

needs to oo made raking into account administration and compliance burdens and cash flow 

issues. The approach of jurisdictions varies from monthly, bi-monthly, quarterly, or annual taxable 

periods. 

"' N<>w Zoolomd GST law !l 52. 

'"ltish VAT Aot, §l!S~!ld Rsgula!i<>n l9f31. 
224 


Insert offset folio 193 here 98944.193

leading Practice 

The taxable period provision should be drafted to include the following: 

TI1e taxable period for taxable persons whose taxable supplies over a consecutive 12 

months period are equal or above a c~main dollar value threshold shall be the calendar 

month. 

The taxable period for taxable persons whose taxable supplies over a consecutive 12 

months period are below the dollar value threshold shall be the calendar quarter. 

Taxable persons subject to the calendar quarter taxable period should be allowed to apply 

for authorization to use the calendar month as taxable period. 

Discussion 

New Zealand allows monthly, two-monthly, and six monthly periods, The 2·month period is the 

standard taxable period. 127 A taxable person may apply for the six monthly period where, in a 12· 

month period, the taxable person makes {or is likely to make) taxable supplies of less than NZD 

500,000. 11liA person whose taxable supplies are (or are likely to bel more than NZD24 million in 

a 12·month period must adopta monthly taxable all other cases, a person can choose 

between a monthly or bi·monthly taxable period. A person's taxable periods must align with their 

balance date for income tax purposes. The period will usually end at the end of the relevant 

calendar month. 

Singapore requires the filing of GST returns every month, quarter, or half a year, or any frequency 

approved by the tax The default filing frequency is quarterly. Taxable parsons are 

assigned prescribed accounting periods according to their financial year-end at the point of GST 

registration. Taxable persons may request a change in their filing frequency. However, filing of a 

return every half a year is available only to taxable persons whose annual value of taxable supplies 

less than SGD1 million on a retrosp!!ctive or prospective basis. 

Malaysia allows two taxable periods: monthly and quarterly, '~ 1 

to taxable persons whose taxable supplies in a 12-rnonth period are MYR 5 million or more. 

Taxable persons with annual taxable supplies of less than MYR 6 million are subject to the 

quarterly taxable period but can request to file monthly returns. 

In the IMF Model Law, the taxable period is the calendar month, but the Minister may by 

regulations authorize different tax periods for types or taxable persons. 1a

2 

Ireland has a two·montllly tiling frequency, but smaller taxable persons may apply to adopt a fourmonthly filing period where their annual liability between EUR3,001 and EUR14,400. If a 

taxable person's annual liability is below EUR3,000, a taxable person can apply to file on six· 

"' Now Z&aiand GST Act. !i !5{11, 

'"Now z.,.land GST Acl, § 

""Now Zealand GST Act, § 15!4), 

"" Slllll'IPO"' GST Act § 4 H1\and G ST !logo1a1iono, rogul•tloo 52. 

'" Malayola VAT Aot § 41l 

'"" IMF Modol Acl .• •11. 23. 
225 


Insert offset folio 194 here 98944.194

moqthly basis, '

33 A kay diff'€lrem::e between Ireland and the other comparable jurisdictions is that 

the thresholds for filing frequency focus on GST liability rather than gross receipts, 

In order to ensure the elliciency and eflecthteness of the GST, the taxable period should be short 

A common approach is to use a calendar month taxable period, The monthly taxable period is 

also used under the current sales and use tax regime and will thus not result in a change for 

businessas,134 However, because a shorter taxable period could increase the administrative 

burden on small businesses compared to revenues collectod advisable to allow smaller 

taxable persons to adopt longer taxable periods such as tw<rmonthly or calendar quarter, 

TM difference between taxable parsons subject to the monthly and quarterly taxable period 

should be determined based on the value of taxable supplies made over 12 months period. 

Consequemly, the monthly taxable period would apply to taxabla.persons who estimate that over 

the next 12 months their taxable supplies will be above a certain dollar value threshold, The 

quarterly taxable period would thus apply to those taxable parsons with taxable supplies below 

the threshold. In addition, taxable persons subject to the quarterly taxable period should be 

allowed to file a request to the Commissioner to be allowed to be subject to the monthly taxable 

period, 

An alternative option to alleviate cash flow burdens on the tax administnation would be to adopt 

a similar approach as Ireland, basing the taxable period on net VAT liability, but making the longer 

taxable periods mandatory rather than optional for those taxable persons frequently in a refund 

position. Such an approach is not leading practice and can result in significant cash flow burdens 

on taxpayers such as exporters, 

Overview of ConC-ept 

Under a GST, taxable persons am required to provide information to tax authority at regular 

inte!ll!lls. The information is provided through the filing at a "GST HJ!Ufrt The GST law 

regulations should describe what information taxable persons must provide and the 

deadline for filing GST ratums. In addition, GST laws generally prescribe when payment of the 

tax is due, 

The main consideration relates to providing Sllfficient time following the end of the taxable period 

to gather the required information and calculate the GST liability. 

leadingl'ractiee 

The filing of returns and payment of tax provision should be drafted to !he following: 

Every taxable person should be required to file a GST return and pay any GST by the 28th 

of the month following the and of the taxable period. 

"' fr\sh VAT Aot, ~ 

• 4041.02. 
226 


Insert offset folio 195 here 98944.195

GST return should be submitted electronically, 

The provision or regulatkm should also set out what information is required to be included in the 

GSTretum. 

Discussion 

New Zealand requires taxable persons to file their GST returns on or before the 28th day of the 

month following the end of the taxable period unless the month following the end of the taxable 

period December, which case the deadline is January 15, or Aprl!, for which the deadline is 

May 7. This is to provide the taxable person with extra time given the December holidays and 

the March end o! financial year obligations. TI1e tax authority has the discretiorr to change the 

due date for the ratum lor non·profits and in special circumstances, 136 GST returns can either be 

filed in paper or electronic format 

In Singapore, returns {and payments) are due within one month of the end of the prescribed 

accounting periods; e.g., lor the prescribed accounting period from January to March, ending on 

March 31, the filing (and payment! due data is April The due data for the prescribed 

accounting period from April to June, ending on June 30. is July 31, and so on. 121 Returns must 

be filed "l"'"''''ni''"lll" ,~ 

In Malaysia, every return for each taxable period is required to be submitted to the tax authority 

no later than the last day o! the month following the end of the taxable period. 1w Electronic filing 

is encouraged but not mandatory, 

In the IMF Model Law, taxable parsons are required to file a tax return for each tax period with 

the Commission within 21 days alter the end of the period, whether or not tax is payable in 

respect of that The return should be filed the manner prescribed by the 

Commissioner. 

Ireland requires a retum to be filed within 19 days of the end of the taxable period.141 

In all jmisdictions, the deadline for payment of VAT/GST the same as the deadline for the !lUng 

of the returrl, All jurisdictions reviewed, other than Ireland, have a deadline close to, at the 

and of the month following the end of the taxable period. 

Overview of Concept 

GST laws generally have two distinct methods of accounting: accruals (or and cash {or 

payments) accounting. Most jurisdictions adopt the accrual basis of accounting. Any supplies in 

'"'Now Zllill!an<l GST Act. § 16. 

""Now Zealand GST Act, !i 100l, 

'" Singapor~ GST Ao1. § 41(1) aoo GST RegulatiOn$, r"!!ulallon SZ, 

§ 42 and GST Rogl<loli011s, rogulatioo 53, 

S41!4), 

24(1). 
227 


Insert offset folio 196 here 98944.196

respect oi vvhich the time of supply has been triggeroo within the taxable should be included in 

the tax retum, irrespective of payment Cash accounting, or payments basis accounting, requires 

only those supplies in respect of which payments have been made or received within the taxable 

period to be accounted for the tax return. In addition, because GST is only accounted lor when 

payment is received, there is no need lor a bad debt relief mechanism (see section 3.0.7!. 

However, the cash accounting system delays the moment when GST is creditable to the time 

when vendors are paid. 

Leading Practice 

The accounting basis provision should be drafted to include the following: 

All taxable persons must account for GST according to the accrual basis. 

Taxable persons whose taxable supplies over a consecutive 12 months period are below 

a certain dollar value threshold may opt to account for GST under a cash basis. 

Discussion 

The NZ GST Act provides three types of accounting methods: the invoice (or accruals) basis, the 

payments (or cash) basis, and the hybrid basis. The invoice basis is the default method. 

The payments basis is mandatory for non-residents who are registered solely for the recovery of 

input tax, and resident non-profit entities. Any other taxable person that makes taxable supplies 

of NZD 2 million or less within any 12 month period may request to be on a payments basis. 143 

New Zealand also has a hybrid basis (essentially a combination ol payments and invoice basis) 

where, the registered person must account for output tax on an invoice basis, but claim input tax 

credits lor purchases and expenses using the payments basis. 

Singapore requires all taxable persons to account for output and input tax line with the time of 

supply rules {accruals basis). In addition, taxable persons whose annual taxable supplies do not 

exceed SGD million can opt to account for VAT on a cash basis. 14• 

Malaysian GST Act also requires all taxable persons to account lor GST on an accrual basis. 145 

However. the Director General may, upon appiicatton in writing and subject to the prescribed 

conditions. approve the registered person to account lor the tax on a payment basis. 

The lMF Model Law does not contain any specific provision regarding the accounting basis. 

Therefore, output and input VAT must be accounted in fine with the time of supply wles. 

"' New Zealand GST Acl, § 19. 

'~' New Ze•lan<l GST Act. § 19A. 

'" Singapo!e GST Act, § 41 •nll GST i1@1)ul•!ion®, ragulolioo 67 to 76, 

'" Moll!ysia VAT Act §37{1), 
228 


Insert offset folio 197 here 98944.197

Ireland is to the above jurisdictions in that the accrual basis is the default acoounting basis 

and payments basis is permitted if the taxable less than EUR 1 million or it makes 

90% or more of its supplies to non-registered parsons. 

Leading practice is to have the accrual basis of accounting as the delault accounting basis and to 

provide an option for cash accounting where a taxable person's turnover is less than a specified 

threshold. 

Ov&TIIIew of Concept 

GST payable lor a particular taxable period should correspond to the output tax attributable to a 

taxable period tass any input tax attributable to a taxable period, oonsistent with the acoountlng 

basis adopted by the taxable person. Including a provision relating to the calculation of tax payable 

provides clear guidance to !M tax authority and taxable persons on how the tax liability or refund 

should be computed lor any given tax return, 

Leading Practice 

The calculation of tax payable provision should be drafted to include the following: 

Tax payable for a taxable period by a taxable person under the GST law amounts to any 

output tax attributable to taxable period less any input tax attributable to the taxable 

period,. subject to the specific input tax deduction rules. 

Where during a taxable period the amount of deductible 

amount of output tax, the excess input tax amount shall be 

In accordance with the refund of excess tax rules. 

This section should also state which periods output tax and input tax are attributable. 

Discussion 

The New Zealand GST Act Includes a tax calculation section that determines how the tax payable 

or refund for a particular taxable period should be calculated, 147 

The section states that amount of tax payable corresponds to the amount of output tax 

accounted in the taxable pli1riod less the amount of input tax deductible in !he taxable period. 

Further, where the amount of input attributable to the period exceeds the amount of output 

attributable to the period, the amount is required to be refunded by the Commissioner. 

New Zealand also includes input tax deductibility rules 

separately In section 3.0,5 below. 

'"Irish VAT Ac~ g llO. 

"' N<!w Zoolamd CST Aut, § 201 ll. 

this section. TI1ese are analyzed 
229 


Insert offset folio 198 here 98944.198

Ireland adopts a similar approach to New Zealand. 

Singapore takes a similar approach but includes the input tax daductibilily rules in a separate 

section. 149 However, the tax calculation provision also details the apportionment and adjustment 

m!es,.100 while in New Zealand these are addressed under a separate section. 

Malaysia adopts a slightly differe\nt approach to the other j(Jrisdictions. While it also has a single 

provision governing the computation of the tax position of the taxable person similar to 

Singapore, it has separate provisions addressing what input tax may be deducted. Unlike 

Singapore and slmitar to New Zealand, the adjustment and apportionment rules are dealt with in 

a separate provision. In addition, Malaysia includes specific refund rules under this provision !hat 

govern when a refund is paid or when a refund should be carried forward or applied for another 

purpose. 

For simplicity, leading practice would be to adopt an approach similar to the IMF, 152 which 

efleotively is a combination of the approaches from all of the comparable jurisdictions. This 

includes having separate for: 

The calculation of the tax liability; 

The input tax deductibility rules; 

The "'"'"""nr1m1"m and adjustment rules; and 

The refund rules. 

The separate provisions relating to input tax deductibility, apportionment and adjustments, refund 

rules are addressed below. 

Overview of Concept 

Input tax is generally defined as any GST paid to a supplier. In principle, any input tax incurred by 

a taxable person should be deductible or creditable against any output lax liability provided the 

supplies are used in a taxable activity carried on by the taxable person, This deductibility feature 

of a GST facilitates the staged collection process of a GST while ensuring GST does not become 

an absolute cost to businesses and shif1ing economic burden of the tax onto the consumer. 

Specific rules are required to ensure the correct amount of input tax is deductible by a taxable 

person. 

'"Irish I/ AT Act, § 59(2!. 

"' Sl~gopOte GST Ae!, § 

'"'Sifl!IBpom GST Act,§ 1ll!4J, 

• 38. 
230 


Insert offset folio 199 here 98944.199

Leading Practlee 

The input tax deductions/crecHt rules should be drafted to include the following: 

A taxable person should be allowed to deduct 

o the total amount of input tax incurred on 

0 

as "rl<i iti<•n:>l 

'""'""'""'m"''"' and bad debt rules; 

supplies paid during a taxable 

o any amount that is deemed output tax under the adjustment and 

apportionment n.Jies. 

Input tax should only be deductible if the goods and services purchased are used by the 

taxable person for making taxable supplies or SLtpplies that would be taxable if made in 

Puerto Rico. 

Deemed input tax credits for certain industries such as secondhand goods dealers and 

certain insurance company payouts. 

Input tax credits for goods and services acquired by government entities. 

Input tax credits for goods and services acquired by non-profit bodies for activities other 

than those related to exempt supplies. 

input tax shoold only be deductible provided that the taxable person holds a valid tax 

invoice, credit, debit nola, or import document. 

To promote a broad based, neutral GST system there should be no ,,,,.,,.,,r;~,., of goods or 

services in respect of which input tax recovery is denied. 

Dlscusl!!un 

New Zealand defines "input tax" as GST imposed on goods and services acquired by a person 

under the GST Act, GST imposed at import, and a tax fraction of the purchase price of second 

hand goods. 153 

In genera!, input tax can be deducted only to the extent to which the goods or services acquired 

are used for, or available for use in making taxable supplies, 154 which is determined at the time 

ol acquisition. In addition to this general rul&, New Zealand provides a number of specific rules 

for input tax deductions, including the following: 

Tax invoice, debit or credit note must ba l1eld (unless certain exceptions apply); 

Timing of input tax credits in respect ol output tax accounted for under the reverse charge 

regime; 

Import GST; 

'"'New Z«~IMd GST A<lt, § 3AII). 

'" New Z<>Biand GST Act, ! 20130). 
231 


Insert offset folio 200 here 98944.200

Input tax credits for goods and services acquired by charities; 

insurance payments; 

Amounts calculated under the adjustment and apportionment rules; 

Bad debts; and 

Non-resident recovery. 

In addition, input tax incmred In relation to entertainment expenses is only deductible to the 

extent permitted under the income tax law. 

tax more narrowly than most other 

incurred on supplies of goods 

a taxable where the goods 

uuruu'"'"' of business. 5 Further, 

tax is to the extent the good or service am 

the GST Act states that taxable are entitled 

to the extent the Input tax is 

by the taxable person in course of 

taxable supplies; 

supplies outside ""''"'"~"'"'that would have been taxable supplies if rnada In Singapore; 

supplies of goods made while the goods are under customs control; and 

lor which no output tax Is chargeable under the various schemes in the 

Input tax deduction is disallowed for any of 

lees, medical and accident insurance premiums, medica! extlerlse,s. 

transaction involving betting, sweepstakes, lotteries, fruit m""~'~''n"" 

any 

require that any claim for input tax credit to be supported by a tax invoice 

Under the Malaysian GST Act. a taxable person is allowed to deduct tax for GST incurred in 

the course of taxable and supplies made outside which would have 

been taxable il In addition, lor importation of goods, only GST which bas 

actually been paid on can be cfaimed, 

Input tax is 

t!1e 

ue<uutmut<~ where the following conditions are met 

is a taxable person; 

the goods or services are acquired for business purpose; 

'"'Singapore GST Ar,1, ! !9(4), 

,,. Singopore GST Act, § 20. 

"' Singapor& OST R6gulations, r"!Julatioo 25. 

'"' Singapom GST Reg11la~oos, regulation 61, 

"' Maloysia GST Act, § 3!!. 
232 


Insert offset folio 201 here 98944.201

the goods are acquired for the purpose of making taxable SIJpplies; 

there must be a valid tax invoice; 

the invoice is issued under the name of the claimant. and 

the goods and services acquired are not subject to any input tax restrictions. 100 

The GST Act denies an input tax deduction for incurred on certain types of expenses such 

as private motorcars and certain employee benefits. 

The IMF law also 

to input tax allocation 

is allowed an input tax deduction 

situations such as gambling and 

tax deduction is granted if the taxable holds a tax invoice, tax debit or tax 

note, or a bill of entry customs However, the Commissioner may allow 

input tax deduction whsre an invoice is if the Commissioner satisfied that !1) the 

taxable parson took all ;easonable steps to acquire a tax invoice, !21 the failure to a tax 

invoice was not the fault of the taxable person, and (3) the input tax amount is correct 

Taxable parsons era not allowed to deduct input tax incurred in relation to the following 

purchases: vehicles, entertainment, and fees or subscriptions paid for 

memberships. 

'"".'"';""n However, Ireland has more restrictions in terms of what cannot 

including: 

Limited deduction on or hire of motor cars; 

Any business entertainment; 

Accommodation (except lor qualifying hotel conferences); 

Food and drink; 

Petrol (VAT on diesel is claimable); 

Employee personal services (e.g,, 

Because 

attention 

tax deduction is the cornerstone of any neutral. efficient. and fair GST law, spacial 

be paid to the drafting of the input tax deduction/credit rules. 

"" Malilysla, GST Guida !or lnpll! Tax Ctedit nt 33, 

Malaysia, GST lnpu!Tax Ct•dit, at 1 L 

'"' IMf Mo;:lo!law,i 27l1l!a!. . 

"'' !Mf Modal Law,!i 21!1l. 

"' IMF Mod(!! low, § 27!2). 

"" IMF Moo<!~ law, § 27!31. 

'"'IMF Model law, § 2S!21. 

'" l!iSo VAT Aot §§59~-
233 


Insert offset folio 202 here 98944.202

""'"..,"""'h'l" jurisdictions adopt a similar input tax should be deductible 

tax incurred paid on imports are used by taxable to carry out 

supplies. Differences arise in respect of specific disallowances or rules 

tax credits an insurance payout in New Zealand, the of 

or goods services acquired by charities). 

,..,,., .. ,nn!v adopted approach will ensure that input tax 

taxable person. 

it is to address such 

or usee, 

the adjustment and apportionment rules {see 

section 3.0.6). 

In order 

that lhe 

section 3.0.9). 

the provision should also state that 

person holds a valid tax invoice, credit note, 

tax deduction for 

prir1ci11•les of neutrality, 

to maintain the "''"'"'li•••l" 

should be same manner as any other 

However .• in order to ensure that the GST does not impact the 

such government bodies should be entitled to input tax credits 

ac<ru~>nulJH<~ regardless of their activity. 

Overview of Concept 

The rules for allowing tax deduction few difficulties for taxable 

the purposes 

be an approach 

""'"u~''""''Y taxable However, the law should address two issues. 

law must the where a taxable person makes both taxable and exempt supplies. 

Second, the GST law must address private non-business usa o! goods and services. 

Apportionment rules 

Given that the premise for input tax recovery is that the taxable person uses the goods and 

services purchased to carry out taxable taxable persons making both taxable and 

exempt supplies should be entitled to a recovery of tax to the extent the and 

services are to the taxable the taxable business. the GST 

law must right deduct tax lo the extent the goods and services are applied to 

the making o! exempt supplies. 
234 


Insert offset folio 203 here 98944.203

This requires a careful review of the total input tax paid by a taxable person to apportion the input 

tax into three <:categories: 

Input tax exclusively incurred for making taxable supplies !fully recoverable}; 

Input tax incurred for making exclusively exempt supplies {non-recoverable}; and 

Input tax incurred for making both taxable and exempt !Partially recoverable}, 

The apportionment rules address the third category. 

Adjulltment rules 

In addition to apportionment, adjustment rules are used to address situations such as follows: 

Goods and services acquired lor use in the taxable activity but subsequently used for a 

non-business purpose; 

Goods acquired for a non-business purpose but subsequently used in a taxable activity; 

and 

Post sales adjustments to the purchase price. including discounts, 

l.eeding l'l'actite 

The apportionment rules should be drafted to include the following: 

Where a taxable person carries out taxable and exempt supplies, input tax should be 

deductible as follows: 

0 incurred exclusively to carry out taxable supplies should be fully 

dedu•c\ible; 

excluswely to carry out exempt supplies should not be 

tax should be deductible based on the 1n11nwmn 

input = residual input tax • total 

GSTJ during taxable period I total supplies !excluding 

The above rule should not apply where exempt supplies do not exceed a specified dollar 

value threshold in a month and a certain percentage threshold of the total value of total 

supplies made in that period, 

Supplies considered as incidental financial supplies should not be subject to the above 

rules. 

Where a taxable person is in the business of carrying out exempt supplies the incidental 

financial supplies rule should not apply. 

The adjustment rules should be drafted to include the following: 

Where the usa ol goods and services of a certain dollar value threshold changes within a 

certain timeframe alter the end of the taxable period, the taxable person is required to 

make the following adjustments: 
235 


Insert offset folio 204 here 98944.204

o over-deducted 

taxable 

Any short claimed 

tax retum for the 

tax should be !or as output tax in the tax return 

which the change use takes 

tax should be accounted for as ,c~,;ttirm<>l tax in the 

period in which the change of use takes 

An adjustment should not be required where the change of use of the goods and services 

purchased is below a certain percentage threshold. 

No adjustment should be required where the goods or services are lost or unintentionally 

destroyed. 

vVhere a registered person issues a credit note in accordance with the tax invoice, tax 

credit note, and tax debit note rules. the additional tax specified in the tax credit note is 

deemed to be output tax for the registered recipient of the credit note and additional input 

tax for the supplier. 

Where a registered person issues a debit note accordance with the tax invoice,. tax 

credit note, and tax debit note rules, the additional tax specified in the tax debit note is 

deemed to be input tax for the registered recipient of the debit note and additional output 

tax for the supplier. 

In addition, the adjustment rule should also address the situation where a taxable person does 

not report input tax in the correct taxable period. 

Discussion 

Apportionment wtss 

New Zealand applies a minimum threshold for apportionment where goods and services are 

acquired for both the making of taxable and exempt this provision, registered 

persons are not required to apportion a deduction lor input tax if in an "adjustment period" 

(generally a 12-month period} they make both taxable and exempt supplies and have reasonable 

grounds to belteve that the total value of their exempt supplies will not be more than the lesser 

of: NZD 90,000; and 5% of the total consideration for all their taxable and exempt supplies for 

the adjustment period, Above this threshold, apportionment is required, and is calculated by 

multiplying the full input tax deduction by the percentage intended use. Ill!! 

"Percentage intended use" for a registered person. means the extent to which the goods or 

services are intended to be usced by the person for making ta.xable supplies, estimated at the 

time of acquisition and expressed as a percentage of total use. to the New Zealand 

tax authority, the method lor determining the extent of intended taxable use will largely depend 

on the nature of the goods and services in question !e.g,, for a car the logbook of the previous 

car may be used). New Zealand has a numbar of specific rules relating to such thing as: 

Apportionment for suppliers of financial sarvicces; and 

'"'New Zealand GST Act ! 20f3fll. 

,,. New lealan<l GST 1\et, § 20t3H). 

New Ze$il!Od GST Act § 21 GO)(b). 
236 


Insert offset folio 205 here 98944.205

" Use of certain assets. 

Singapore also applies a de minimis rule whereby, if during an accounting period the exempt 

supplies do not exceed both an average of SGD40,000 per month and 5% ol taxable and exempt 

supplies, no apportionment of input tax is required. 171 In addition, the Singapore GST Act provides 

that where a taxable person supplies incidental exempt supplies (e,g., deposit of money, 

exchange of currency, issue of own shares or debt securities, loan, assignment of trade 

derivatives, issue of units, and purchase of bondsl a taxable person is not reQ\iired to apportion 

the input tax incurred. m This rule does not apply !f the taxable person's main activity involves 

these transactions {e.g,. financial institution). 

Where the foregoing rules cannot be applied, input tax is deductible on and imports that 

can be identified as used or to be used exclusively in making taxable Input tax paid on 

supplies and imports used exclusively in making exempt supplies or in carrying on any activity 

other than making taxable supplies is not deductible. Any input tax ("residual input tax") used for 

both taxable and exempt supplies must be apportioned according to use basad on the following 

formula: 173 

Residual input tax recoverable = residual input tax * value of taxable supplies I (value of 

taxable + value of exempt supplies) 

Like New Zealand and Singapore, Malaysia applies a de rninimis rule when thG total value of 

exempt supplies does not exceed an average of AM5,000 per month and does not exceed 5% 

of the total value of total supplies made in that period.114 

Similar to Singapore, Malaysia also excludes from any apportionment obligation incidental 

financial supplies such as deposit of money, of currency, holding of bonds, transfer ol 

securities, loan, holding of any unit and These supplies will not be considered as 

incidental i! the taxable person is considered to be in the business of making exempt supplies. 

The GST Act provides a list of persons falling in this category !e.g., banks, moneylenders, and 

credit card companies). 

In Malaysia, where the foregoing rules cannot be input tax on supplies and imports thai 

can be identified as used or to be used exclusively in making taxable supplies is deductible. Input 

tax paid on supplies and imports used exclusively making exempt supplies or carrying any 

activity other than making taxable supplies is not deductible. Any input tax !#resklt1al input tax") 

used for both taxable and exempt supplies must be apportioned according to use based on the 

following formula;176 

mgulation 29, 

ragulo!h>O 33. 

""Soo <;~,g., lntomal Rewnue Aolhority Sinli'!POI&, IRAS <~·Tax Gtiid"- GST: l'lo!li;ll E.xsmpti<ln ood tnpul Tax RiiC<WSIJ' (Doc. 31, 

2013). 

114 M•l•vsia, GST Guide for lnpuiTax Credit, ot2!. 

"'M•loysio. GST Guide f<J< lnpul Tox Credit o111. 1" Malays~$, GST Guido for lnplll T ox C«1dit. ot 23. 
237 


Insert offset folio 206 here 98944.206

Residual input tax recoverable total value of taxable supplies (excluding GSTJ I total value 

of all supplies (excluding GST} • residual input GST 

The IMF Model Law also provides for a de minimis rule that applies where the proportion of 

taxable supplies of total supplies (including exempt supplies) is more than 90% during the 

preceding Unlike Malaysia and Singapore, the IMF Model Law does not address 

incidental exempt supplies. Where the de minimis rule does not apply, input tax on supplies and 

imports that can be identified as used or to be used exclusively in making taxable supplies is 

deductible. Input tax paid on supplies and imports used exclusively making exempt supplies 

or in carrying any activity other than making taxable supplies is not deductible. Any input tax 

("residual input tax"l used for both taxable and exempt supplies must be apportioned according 

to use based on the following formula: 178 

Residual input tax recoverable =total residual input tax • total amount of taxable supplies 

made by the taxable person during the preceding financial year I total amount of supplies 

made by the taxable parson during the preceding !immcial year 

In Ireland, where a taxable person carries out both taxable and exempt transactions. the taxable 

person is entitled to deduct a proportion oi tax which correctly reflects the extent to which the 

goods and services are used for the purposes of that person's taxable supplies or activities and 

has due regard to the range of that person's total supplies and activities, In practice, Ireland allows 

the use of any apportionment method to the extent the apportionment correctly reflects the use 

to which the goods and services are put and also reflects the range of the taxable person's 

activities. 

In order promote neutrality, fairness, and certainty of the tax, the GST law should contain an 

apportionment provision addressing the special case of taxable persons carrying on beth taxable 

and exempt supplies. 

Based on the comparative jurisdictions, it reccmmended for fairness, and flexibility 

purposes that the GST law contains a de minimis provision. Such a provision should relieve the 

taxable person from any apportionment obligation where the taxable person only performs a 

certain dollar value threshold of exempt supplies and under a certain percentage of exempt 

supplies ol total supplies. For this purpose the dollar value threshold should be based on a 

calendar month and the percentage threshold on a taxable period basis. 

Referring to the previous financial year. as does the IMF Model Law, would increase the 

complexity of the law and require an end of year adjustment to reflect the reality of the supplies 

performed during the current financial year. 

The GST law should also provide that incidental financial transactions do not fall within the 

apportionment rules. For this purpose, the GST law may include a list of supplies that qualify as 

"'IMF Mod$! § 2llM). 

"'JMF Model taw. §. 28\3). 

"'Irish VAT At:l. ~ 61. 
238 


Insert offset folio 207 here 98944.207

"incidental." The GST law should further clarify that where a taxable person is in the business of 

carrying out exempt supplies, the incidental financial transactions rule does not apply .. 

Finally, the GST law should clearly state that, where a taxable person performs taxable and 

exempt supplies and the above de minimis rules are not applicable, input tax !or the purpose of 

carrying out taxable supplies is deductible, but input tax incurred lor carrying out exempt supplies 

is not deductible. Any residual input tax should be apportioned according to the following formula: 

Residual input tax deductible "' residual input tax " taxable supplies during taxable 

period/total supplies during taxable period 

Adjustment Rules 

In New Zealand, after the initial claim of input tax deduction based on the intended usa of the 

goods or services, a review of the actual use of the asset must be carried out every ''adjustment 

period'' (generally every 12 months). If the value of the goods and services (excluding GSTJ is 

more than NZD 5,000 and the de minimis rule described above did not apply to the acquisition, 

then at the end of an adjustment period the registered person must carry out an input tax 

adjustment if the "percentage actual use" of the asset differs from the "percentage intended 

use" by more than 10 percentagE! points and the adjustment amounts to more than NZD 

The formula which must be applied in each "adjustment petiod" for calculatrng the required input 

tax adjustment is as follows; full input tax deduction "percentage difference.161 if the adjustment 

is positive and the asset has actually been used for taxable purposes more than originally 

estimated, then adjustment is allowed as an additional input tax deduction. 1821f the adjustment is 

negative and the asset has actually been used for taxable purposes less than originally estimated, 

then the adjustment is a positive amount of output tax. 1m 

The "first adjustment period" is defined as the period starting on the date of acquisition of the 

good or service and ending, at the election, on the person's first balance date following 

the date of acquisition or the person's first balance date that falls at least12 months alter the 

date of acquisition. 1()4After the first adjustment period, each "subsequent adjustment period" is 

the 12-month period following the previous adjustrnent period. goods and services other 

than !and, adjustments do not have to be made indefinitely, If the value of the goods and servi<..""es 

\exclusive of GSTJ is: 100 

between NZD 5,000 and NZD 10,000, there are only two adjustment periods; 

between NZD 10,000 and NZD 500,000, there are five adjustment periods; and 

greater than NZD 500,000, there are ten adjustment periods. 

,,. New Z•oland GST ,Aot 21 (2), 

NewZo•lood r,.~.r Act, 'l21D. 

""New Zaaland GS'T Ae!, !: 21 D\31. 

"'' New Zoalond GST Act § 21 013), 

"' N<~w Zoo!and GST Aot, § 21G(21(ol. 

'"' NewZaolond GST Act,§ 21GI2)!bl. 

"' New Zooi•O<l GST Act, § 2lGI41!ol, 
239 


Insert offset folio 208 here 98944.208

For a supply of land, there is no limit to the number of adjustment periods, '

87A final adjustment 

must be calculated upcn disposal or deemed disposal of an asset in the course of a taxable 

activity, where the original supply of tile asset was subject to an input tax apportionment lllll 

Similar to New Zealand, in Singapore a taxable parson, wllo has deducted input tax that has been 

attributed to taxable supplies because the intended use of the goods or services vvas for the 

making either taxable supplies or both taxable and exempt supplies, is required to adjust his input 

tax deduction when he subsequently uses or forms an intention to use the goods or services 

concemad to maka (a greater propcrtion ofl exempt supplies. 1MOn the other hand, the tax 

authority must allow a daduction for input tax previously denied to a taxable person if the taxable 

person subsequently uses or forms an intention to use the goods or services concerned to make 

(a greater proportion of) taxable suppfies. 19a 

Singapore requires partially exempt persons to perform of their input tax deducted 

during a period of five years commencing on the first day of the accounting period in which the 

input tax was claimed. 19'Where the de minimis rule described above, in respect of 

apportionment, does not apply in a certain accounting period, but does over the relevant live year 

period, taxable persons can deduct the input tax not previously claimed, Conversely, if they pass 

the de minimis rule in any prescribed accounting period, but fail the rule at the Gnd of the relevant 

Hve year period, they are required to adjust the input tax previously deducted. 

The Malaysian adjustment regulations are not available in English. 

The IMF Mode! Law does not contain a special provision regarding the change of use ol goods 

and services purchased. 

Ireland adopts a similar adjustment regime as New Zealand and Singapcre. The differences 

between the Irish regime and those regimes are not material. 192 

The common theme among the comparable jurisdictions is that, after the initial apportionment, 

ongoing adjustments are required based on actual use. The extent and duration of the 

adjustments and when those adjustments should be made vary from jurisdiction to jurisdiction. 

For a GST to be neutral and fair, tl1e GST law should provide special rules where the use of goods 

and services changes following the initial apportionment of input tax credits. However, for 

efficiency and simplicity purposes, !he rule should only apply to goods and services of a certain 

dollar value threshold where the use changes within a pre-determined time period. 

However, taxable persons should not be required to make any adius!ment of the input tax 

deducted where the change in use is not above a certain percentage. For simp!fcity purposes, it 

'"'New z,.!!lnd GST Ac1, § 2Hll~). 

""New Zealand GST Ao! .• § 21 F. 

"" Sirlll"POr@ GST R"llul•lioos, mgof•ll<1<l 37. 

"'' SingopO<e GST R"llufotiO!ls, mgu!!ltioo 3R 

Singapom GST 11"l:lolotioos. ragulatioo 36. 

'*Irish VAT Act§ 64, 
240 


Insert offset folio 209 here 98944.209

is recommended that no adjustme11t is required where the goods or services subject to the 

adjustment provisions are lost or unintentionally destroyed. 

The GST law should also address this section, adjustments resulting due the issuance of tax 

credit notes or tax debll notes. Please refer to section 3.D.9 regarding credit notes and debit 

notes. 

Overview of Concll:pt 

Given that GST is generally accounted for prior to payment being received under the accrual basis 

of accounting, situations frequently occur where GST is the tax authority but payment for 

the underlying supply is never received by the taxable person from the recipient of the supply, 

giving to a bad debt. In such cases, requiring the taxable person to pay the GST on the supply 

conflicts with the intended busiMss neutrality of the tax and principle thai GST should be 

levied on the consideration for supply. 

As such, where a bad debt arises and GST has already been accounted for by the taxable person, 

the taxable person should be permitted to claim a credit for the GST to the extent of the nonpayment for the supply. 

The bad debt provision should be drafted to include the following: 

debl shOuld be defined as any debt relating to a supply of goods or services that is 

not recovered within a certain timeframe from !he time of supply or where the customer 

has become insolvent. 

The Sllpplier should send a credit note to the customer to inform him that the debt 

qualifies as bad debt under the GST law. 

Suppliers should be allowed to deduct input tax equal to the GST portion ol bad debts 

alter sending the credit note. 

Any amount recovered after the bad debt relief is applied considered as a taxable supply 

and the supplier must account outpllt. tax on the amount recovered. 

Discussion 

In New Zealand, a supplier is entitled to a deduction from outpllt tax in the case ol a bad debt 

that the supplier has ofL 1

"'The deductible amount is the portion of GST charged on the 

supply, calculated from the ratio of the amount written otl as a bad debt to the total consideration 

for the supply. '

9411 the written-off debt is wholly or partly recovered by the registered person, 

that amount of the deduction which has claimed, calculated from the ratio of 

the amount of the bad debt recovered to tile bad debt written oft is deemed to be the tax charged 

"' N~wZ<>alamiGSI Aot, i 20i3!Gl. 

"' New Zo~laod GST Ael, s 26. 
241 


Insert offset folio 210 here 98944.210

in relation to a taxable supply made during the taxable period in which the bad debt is wholly or 

partly recovered, 100 

Singapore allows suppliers who have attempted to collect a GST debt, but are unable to r<:~cover 

the money after 12 months, to apply for bad debt relief and receive a refund ofthe GST previously 

accounted tor and paid provided they took reasonable steps to recover the debts, 

In addition, Singapore also has rules that apply to the recipient of the supply, A taxable person 

who fails to pay his supplier the consideration for the supply of any goods or services, and who 

has credited the input tax to which the consideration which he failed to pay relates, is required 

to repay such amount to the Comptroller in the prescribed accounting period. Should he 

subsequently make payment to his supplier, the taxable person is allowed to credit the same 

amount of input tax in the prescribed accounting period in which he makes the "'"""'"'' 

Malaysia, the GST portion ot the bad debt can ba reclaimed provided that the claimant has not 

received any payment after 6 months of date of supply or the debtor has bacome insolvent before 

the period of 6 months has elapsed, and the tax authority is satisfied that all reasonable efforts 

have been made by tha claimant to recover the debt. 100 The refund of the GST portion of the bad 

debt is done through an adjustment to the input tax in any taxable period. Any payment recovered 

by the taxable person after the adjustment is deemed to be a taxable suppfy. 111!l 

Under the IMF Model Law, a taxable person is allowed an input tax deduction for the VAT portion 

of a bad debt 200 An input tax deduction is only granted for made to non-taxable persons 

or where a credit note has been issued to a taxable person. Any recovered by the 

taxable person after the adjustment is deemed to be a taxable 

Ireland permits a deduction in respect of the VAT on a bad debt when all reasonable steps to 

recover the bad debt have been undertaken but no consideration has been received. 2ro Where 

a credit for a bad debt is claimed, a credit note must be issued by the supplier. 

All comparable jurisdictions provide a relief for bad debts, Differences arise in respect o! what 

qualifies as a bad debt. and the requirement to issue a credit note. All jurisdictions require the 

repayment of any input tax claimed in respect of a bad debt to the extent that the debt is 

subsequently recovered. 

We suggest that the supplier should be allowed to claim an input tax deduction equal to the GST 

portion of the bad debt. Should the suppHer recover any amount treated as bad debt after 

deducting the input tax, the GST amount relating to the recovered amount should be considered 

'"New Zealand GST Aot, § 2612). 

'"Sin{!llpo">GST Al>!, § 191121. 

"' Si!ijjapore GST Aol, § 19!12A). 

,. Moi~~YSia GST Aot. § 58{1),, 

i 58!31. 

''" IMf Law, ! 30(!>), 

IMF law, ! 3014), 

m Irish VAT flegtliation 
242 


Insert offset folio 211 here 98944.211

as output tax. The approach of Ireland and ihe IMF of issuing a credit note for a bad debt creates 

a good paper trail and should be considered leading practice. Further, this will require the 

customer to apply the general rules relating to credit notes and !hus correct the input tax originally 

deducted with no payment having been made {see 3.D.6 and 3.DJ31. 

Overview of Concept 

As discussed above in section 3.0.4 in respect ot the calculation of tax payable, where during a 

taxable period the amount of cleductible input tax exceeds the attributable output tax, the excess 

input tax amount should be refunded to the taxable person in accordanca with the refund of 

excess tax rules. 

Given that GST intended to be a business neutral tax, taxable parsons should be entitled to a 

refund of tha excess input tax. Thus. provisions that address the refunding of any excess GST 

era required. 

Providing rules in resp<Jct of the refund of GST also promotes certainty for taxable persons. 

leading Prastlce 

The refund provision should be drafted to include the following; 

Where during a taxable period the amount of input tax exc'Seds the amount of output tax, 

the excess of input tax should be refunded to the taxable person. 

Payment of the refundable amount should be made by the tax authority within a certain 

number of working days after the retum was rec-eived by the tax authority, 

The Secretary should have the power to withhold any refundable amount to offset against 

unpaid taxes, any amount under investigation, where there are outstanding returns, 

Discussion 

The New Zealand GST Act allows the tax authority to apply any excess of input tax to other tax 

debts owed by the registered the registered person has no other tax debts and the 

Commissioner is satisfied that the amount ot the GST refund is correct, then the tax authority 

must pay the relund within 15 vvorking days of receiving the registered person's return where 

the registered person a New Zealand resident. 

The Commissioner can withhold any relund where the amount refundable is under investigation 

or where there are outstanding returns. 

In Singapore, the tax authority must refund any excess input tax within a period equivalent to the 

prescribed taxable period after lhe return to which the payment relates is received by the t<~x 

a registered whose presc<ibed taxable period on a quarterly 

New Zo•IMd GST Aet, § 41l. 

"" Sing•!}oro GSl Act, § 1~!t•J; "''"~flora GST Roguls~ono. toguiatino 63. 
243 


Insert offset folio 212 here 98944.212

basis will gat a refund within 3 months from the date the return was submitted. In addition, the 

tax authority is entitled to over the whole or any part of an input tax credit to a subsequent 

period. 

As with New Zealand, a GST refund may be withheld and applietl against other L!npaid taxes. 

In Malaysia, if the amount of input tax exceeds the amount of output tax in a tax<.~ble period, the 

belance will be refum:!ed. 207 The refund will be made within 14 working days alter the return to 

which the refund relates is received in the case of online submission and 28 days after 

the return to whicll the refund relates is received in the case of manual submission. However, 

any refundable amount may be held over to be credited to any following or subsequent taxable 

period either on the taxable person's request or on any direction given by the tax authority. 200 

The tax authority may also withhold any refund paymant to offset unpaid taxes. 210 

Under tile IMF Mode! law, excess input tax must first be carried forward and the taxable person 

must be in a refund position lor three consecutive taxable periods before the taxable person can 

claim the refund.~11 The refund must be made within 2 months of the being made, 

Ireland similar to the above regimes but requires the filing of a separate refund claim for the 

r&fund to be issued. 212 

Granting a relund of excess tax is considemd business friendly and promotes the neutrality and 

fairness of the tax. The GST Jaw should thus authorize refunds !or taxable persons who are in a 

refund position during a given taxable period. 

refund should be paid out within a short timeframe after receipt ol the return. This will reduce 

any cash flow impact on businesses that are in regular refund position. The taxable person should 

not be required lo file a separate claim for the issuance of the refund in order to promote 

simplicity and efficiency. However. lhe tax authority should have the power to retain a refund 

where an or audit is commenced or where the taxable person has outstanding 

returns. Further, where a taxable person has other tax debts, the refur1d should lirst be applied 

in satisfaction ol those debts prior to issuance. 

Ovenlew of Concept 

A lax invoice is a document issued by a taxable person who makes a taxable supply that records 

the detaifs of the supply and amount of GST charged. 

~ 

GST AA:t, § 38l3i. 

"" Mataysio, GST Gul~ lor lnpot T•x cre<l1~ at 3'1. 

* Moloysia GST kt § 38!41. 

4!i 

IMF Model VAT low <>I NIIW Vatopio, an. 45. 

"' l!ish VAT law, reg<J!ali<>n 36. 
244 


Insert offset folio 213 here 98944.213

Credit notes and debit notes are documents that evidence the adjustment of the value of a 

previously made supply following the issuance ol a tax invoice. 

In an irwolc<rbased GST system, these documents create a valuable audit trail for enforcement 

purposes. Further, without holding a valid tax invoice, purchasers are generally unable to claim 

credits for any input tax incurred on their expenses. This provides a valuable control within the 

supply chain, creating an element of self enforcement 

Consequently, GST laws generally outline the situations where these document must be issued 

and what form they should taka. 

Leading Practice 

The tax invoice provision should be drafted to include the following; 

Registered persons should be required to issue a tax invoice for taxable supplies within a 

specified number of days after the delivery or making available of the goods or the 

completion of the performance ol the services, 

A "tax invoice" should contain at least the following information: 

o The "tax invoice" listed on nrr>rll'""''r 

o Name, and GST number 

o address and GST number (if reg!isH~re•::lJ 

the value of the supply is greater 

0 

0 

0 

0 

0 

0 

of supply, type ol goods or services, and 

(excluding GSTI; and 

A registered person is required to issue a tax credit note or tax debit nota when: 

o there is a in the consideration due on a supply; or 

o when the is cancelled. 

Registered persons should be required to issue a tax credit note or tax debit note within 

a specified number of days after the change in the consideration due on a supply occurs, 

in case of bad debts. or when the supply is cancelled. 

A "tax credit note" or "tax debit nota" should contain at least the folfowing information: 

o the words "credit note" or "debit note" in a prominent 

o the address, and GST registration number of the '"~""'t•Rn>ti person making 

0 address and GST Registration ol the recipient of the supply (if 

o the date on which the credit or 

o Sequential number of credit 

o the value of the supply shown on the tax the correct amotmt of the value 

of the the difference between those two amounts, and the tax charged 

that to that difference; 
245 


Insert offset folio 214 here 98944.214

brief explanation of the circumstances giving rise to the issuing of the credit or 

note; and o the number and date of the original tax invoice. 

A tax invoice, tex credit note, or tax debit note may be issued in electronic form provided 

the registered person can ascertain the authenticity of origin. the integrity of oontent. and 

the legibility of the document 

Diseunion 

Tax Invoice 

In New Zealand, a registered person who makes a taxable supply of more than NZD 50 must 

provide the purchaser with a tax invoice if the purchaser requests oneL 213The tax invoice must 

then be issued within 28 days of the Under New Zealand law there is a difference 

between an "invoice, " 211lwl1ich triggers time of supply and is simply any document which notifies 

an obligation to make payment and a "tax invoice, " 111lwhich is an invoice that meets certain 

requirements and allows a registered person to claim an input tax credit 

Tax invoices must contain the i11formation set out below, 

In New Zealand, a valid tax invoice must contain the following information: 217 

the words "tax invoice" in a prominent place; 

the name and registration number of the supplier; 

the date it was issued; 

a description of the goods and services 

the consideration lor the supply; 

the name and address of the recipient; 

the quantity or volume of the goods and services supplied; and 

either the total amour1t of the GST charged, the price before GST and the price with GST. 

or if the GST charged is a fraction of the price, the price and a statement that it includes 

GST. 

Tax invoices may be issued in paper or electronic form. There is no prescribed format In addition 

to tax invoices, there are special types of tax invoices in the following situations: 

the consideration lor the supply does not exceed NZD 1,000 (and is not a zero-rated 

supply)-this Is referred to as a "simplified tax invoice;" 

"'Now Zoolom;! GST Act, § 24. 

'" N~w Ze~lond GST Aot § 24(1). 

'" New Za.!fand GSI Act, § 2. 

"'New Zool•mHlST Act, § 24. 

"' N•w Z""lond GST Act, ! 24{31, 
246 


Insert offset folio 215 here 98944.215

ii thee supply is of second-hand goods- this is referred to as a "second4land goods tax 

invoice," a buyer-created tax invoice; and 

shared tax invoices for groups. 

Singapore requires a registered taxable person rooking a taxable supply to a taxable person to 

provide the latter with a tax invoice. 218 The tax invoice must be issued within 30 days of the time 

of supply, As with New Zealand, no tax invoice needs to be issued for zero-rated supplies, exempt 

supplies, or deemed supplies. There is also no need to issue tax invoices to non·GST registered 

persons. 

However, unlike New Zealand, the Singapore GST Act requires a receipt to be issued for every 

taxable supply made, unless a tax invoice has already bean issued. at least a 

recaipt must be issued to a non-GST registered person. Tax invoices may be issued in paper or 

electronic form. There is no prescribed format 

In Singapore, a valid tax invoice must contain the following information:2w 

the words "tax invoice" in a prominent place; 

an identifying number; 

the date of issue of the invoice; 

the name. address and registration number of the supplier; 

the name and address of the person to whom the goods or services are supplied; 

a description su!ficient to identify the goods or services supplied and the type of supply; 

for each description, the quantity of the goods or the extent of the services and the 

amount payable, excluding tax; 

any cash discount offered; 

the total amount payable excluding tax, the rate of tax and the total tax r:h;;lrafmhls shown 

as a separate amount; and 

the total amount payable including the total tax chargeable. 

ln addition, Singapore has the following types of special types of invofces: 

nself-billing" arrangement in which the customer may issue a tax invoice on behalf of his 

supplier and forward a copy of the tax invoice to the supplier;221 and 

"simplified invoices" when the amount payable on the tax invoice, including the tax, does 

not exceed SGD 1,000. 

"' Singap"'e GST Act, § 41 11): Slngap<>te GST 1\~~l•tioos, rogulotion 10. 

H4: 

GST R~ulotioos, t0!j1J!Qtion 11. 

""'""""'"ns. togulation 10(41. 

"' Singopore GST Regulations, regulotioo 13 
247 


Insert offset folio 216 here 98944.216

In Malaysia, every registered person who makes taxable supply of goods and services is required 

to issue a tax invoice.213Tax invoices must be issued within 21 days from the time of 

supply,224However, no tax invoice needs to be issued for zero-rated supplies, deemed supplies, 

or supplies under a special scheme under the GST Act Tax invoices may be issued in paper or 

electronic form. There is no prescribed format 

In Malaysia, a valid tax invoice must contain the following intormation;215 

the words "tax invoice" a prominent place; 

the tax invoic& serial number; 

the date o! issuance of the tax invok~&; 

the name, address, and identlfication number of the supplier; 

the name and address to whom goods or services are supplied; 

a description sufficient to identify the goods or services supplied; 

for each description, distinguish the type of supply for zero rete; standard rate and 

exempt, the quantity of the gcoos or the extent of the services supplied and the amount 

payable. excluding tax; 

any discount offered; 

the total amount payable excluding tax, the rate of tax and the total tax chargeable to be 

shown separately; 

the total amount payable inclusive of the total tax chargeebla; and 

any amcunt disclosed must be expressed in Malaysian Ringgit 

Jn addition, Malaysia has the following types of special types of invoices: 

self-billed invoice; 

simplified invoices; and 

invoice or statement of sales by auctioneeL 

Under the IMF Model law, a taxable person is required to issue a tax invoice for taxable supplies 

to another taxable person. 226 If 60 days after the date of supply the recipient does not receive a 

tax invoice, the recipient may request the supplier to issue such an invoice. m No tax invoice 

must be issued if the total consideration for the taxable supply is in cash and does not exceed a 

certain amount 22e The IMF Model VAT Law does not address the format under which invoices 

should be issued. 

'" M~l&ysill GST Act, § 33. 

Mal•y•ill GST G\Jide, Tsx fnvoioo ond l'l&eO<<i Kaoping !0/lAFTI, ~~ 3. 

"*Malays!• GST Act, SohoduioiV, 

tl< IMf Modoll!lw, ! 32. 

IMF Modal taw, § 32!51. 

"•IMF Modal tow, § 32!2), 
248 


Insert offset folio 217 here 98944.217

Under the IMF Model law, a valid tax invoice must contain the following information: 2

w 

the words 'tax invoice' a prominent place; 

the name, address, and VAT registration number of the registered person making the 

supply; 

for a supply to a regist<~red recipient the name, address, and VAT registration number of 

the recipient of the supply; 

ll the individualized serial number and the date on which the tax invoice is issLled; 

a description of the goods or services supplied; 

tht:~ quantity or volume of the goods or services and 

the total amount of the tax charged, the consideration for the 

consideration including tax, 

and the 

In ireland, a taxable person who makes a taxable supply to another taxable person, a public body, 

or a person carrying on an exempted activity is required to issue a tax invoice, A simplified invoice 

may be issued if the amount of the invoice is not greater than €100, or when commercial, 

technical or administrative practices in a particular business sector mak<~ it difficult to comply 

with general invoicing requirements. The invoice must be issued within 15 days of the time of 

supply.23o 

The VAT invoice issued must show: 

the date ot issue of the invoice; 

a sequential number, based on one or more series, which uniqualy identifies the invoice; 

the full name, address and the registration number of the person who supplied the goods 

or smvices to which the invoice relates; 

the full name and address of the person to whom the goods or services were supplied; 

in the case of a reverse charge an indication that a reverse charge applies; 

the quantity and nature of the goods supplied or the extent and nature of the services 

rendered; 

the date on which the goods or services were supplied or, in the r.ase of early payment 

prior to the completion ot the supply, the date on which the payment on account was 

made, in so tar as that date differs from the date of issue of the invoice; 

• ' in respect of the goods or services supplied: 

the unite price exclusive of VAT; 

o any discounts or price reductions not included in the unit price; and 

"" SlngapO<e GST Regulalioo•. re9Qio!i0n 11. 

"'Irish VAT Act,§§ 00 .. 73. 
249 


Insert offset folio 218 here 98944.218

the consideration exclusive of VAT. 

in respect of the goods or services supplied, other than reverse charge supplies: 

the consideration exclusive of tax for each rate (including zero·rate) of VAT; and 

o the rate of VAT chargeable. 

the VAT payable in respect of the supply. 

Tax invoices may be issued in paper or electronic form (Ireland provides specific rules tor issuing 

invoices in electronic formal). 

In addition. Ireland has special types of invoices including for: 

self·billed invoice; 

simplified invoices; and 

margin scheme. 

AU comparable Jurisdictions require the issuance ol an invoice. In most cases, formal tax invoices 

are only required where supplies are made to registered persons. However, due to the risk of 

fraud and evasion in Puerto Rico, tax invoices should be issued for all taxable supplies, 

irrespective of the nature of the recipient of the supply. As with all the comparable jurisdictions, 

prescriptive requirements for the content of a tax invoice should be included within the 

legislation. The only simplification should be for supplies of a value not greater than $1 ,000, in 

which case the invoice should not be required to contain the name, address and GST number !if 

registered} ol the recipient to whom the supply is made. This exception should address most 

retail sales and thus reduce the compliance burden. 

The GST leading practice approach departs from the current SUT system, under which a 

merchant is responsible to issue any receipt, invoice, ticket, or other evidence of sale. 

However, the current SUT does not provide for invoicing requirements as the invoice does not 

constitute the principal mechanism to combat tax fraud and avoidance. Rather, the SUT puts an 

emphasis on the importance of exemption certificates such as the reseller certificates. Due to 

th.;~ input tax deduction mechanism (see 3<0,5), the requirement to issue valid tax invoices should 

create a more reliable paper trail of all transactions subject to GST and ensure to a certain extent 

that the tax is self-enforced by all taxable persons. 

Tax Credit Note and TllX Debit Note 

In New Zealand, where a tax Invoice shows an incorrect GST amount, the supplier must issue a 

credit or debit note to the recipient 232 A credit or debit note must be issued when: 

a supply of goods and services has ba<.Jn cancelled; 

the nature of that supply of goods and services has been fundamentally varied or altered; 

" 11'RIRC ! 4\lOOOSibl. 

'" New Z<!l<lland GST Act. § 25, 
250 


Insert offset folio 219 here 98944.219

" the previously agreed consideration for the! supply of goods and services has been 

alterecl(whether clue to the offer of a discount or otherwise); or 

And 

the goods and services or part of those goods and services supplied have been returned 

to the supplier. 

the supplier has provided a tax invoice in relation to that supply and as a result of any one 

or more of the above events: 

o the amount shown on the tax invoice as GST charged on that supply is incorrect; 

or 

o the has submitted a return in relation to the taxable period for which 

output tax on that supply is attributable and, as a result of any one or more of the 

above events, has accounted for an incorrect amount of output tax on that supply. 

Fm a registered recipient that adjustment must be made if the price has decreased and the 

recipient has been issued with a credit note, but is optional if the price has increased and the 

recipient has been issued with a debit note, 23"The tax authority retains discretion to determine 

that a credit or debit note need not be issued, or need not contain any of the requirements in 

circumstances where it is impracticable, 

A valid tax credit note or tax debit note must contain the following informatfon:234 

the words "credit note'' or ''debit note" in a prominent place; 

the name and registration number of the supplier; 

the date it was issued; 

the name and address of the recipient; 

the amount of consideration for that supply contained in the tax invoice, the correct 

amount of consideration, the difference between those tw<o amounts, and the tax charged 

in respect of that supply; and 

a brief explanation of the circumstances giving rise to the issuing of the credit or debit 

note. 

The Singapore GST Act does not define the situations when a credit note to be used except 

where there is a change in the rate of GST and the supplier has to issue the tax invoice to reflect 

the new rata.1

• 5 In practice, the Singapore tax authority recognizes that a credit note should be 

issued when:2a

6 

""K. Holmt~s, New Z<Ytlam:J- Cmpo1~1e Tm<atioo s<>o. 13., Cou~t<y Anolys"s IBFO, 

'"' Now Zeal•n<l GST Act, § 25!3!. 

"'Singapore GST 11111lulalioos, 1egulatloo 12. 

'"D. Kaur, Sin!J')poro • CDJpora1& Texiitioo sw. 13 .• C<Ju!\lry AMI,•11os lllfO. 
251 


Insert offset folio 220 here 98944.220

correcting a genuine mistake (e,g,, goods invoiced as standard-rated which should have 

been exempt or zero rated); 

the supply did not take place; 

charges are partly or fully waived before/after delivery of the goods; 

goods or services are accepted, but terms of the contract are not fully mel (e.g., substandard goods are accepted by the customer at a reduced price); 

goods are returned or services are not accepted; or 

goods and services are suppli<~d lor an unconfirmed consideration. 

The GST Act does not address tax debit notes. 

In credit notes should contain the number and date of the original tax invoice to which 

the cr<~dilnote retates, in addition to the following particulars: 

th<~ date of Issue; 

the name, address and GST registration number of the supplier; 

tht~ customer's name and address; 

the reason for the credit- for example, "returned goods;" 

a description sufficient to Identify the goods and services for which credit is being 

allow<~d; 

the quantity and amount credited for each description; 

the total amount credited, excluding tax; 

the rate and amount of tax credited; and 

the total amount credited, including tax. 

In Malaysia, the GST Act provides the requirement for the issuance of credit and debit notes in 

respect of a The consideration lor a particular supply can only be altered by means ol 

a credit or debit note. ~1here there is any such change in the consideration, the person making 

or reooiving the supply, as the case may be, shall within twenty-one days (21 days)after any such 

change or ev<~nts_, or \'Vithin such longer period as the Director General may allow, issue a credit 

not<~ or debit note. 239 The issuance of credit and debit notes by the registered person occurs 

when there is a change in the consid<~ration due on a supply including a change in the rate ol tax 

or a change the descriptions of the zero-rated or exempt supply or a cancellation of the supply. 

In Malaysia, a valid tax credit or debit note must contain the following information:240 

"" Mot•ysia GST Acl, § 35_ 

""Moi~VlliU GST Aot, 9 35. 

'"' Melaysio GST Guioo, Tax lnv<lic" aod R~oord Ke•lli"9 lO!lAFT!, a! 24. 

""Malaysia GST Guida, 1 ox lnv<>ioo •m:l Rooord !<:o•!)iog lORAH), at 26. 
252 


Insert offset folio 221 here 98944.221

,,, the words "credit note" or "debit note" in a prominent place; 

the serial number; 

the date of issuance; 

the name, address, and identification number ol the supplier; 

the name and address to whom goods or services are :>UIJPnea; 

the reasons for its issue; 

description of the goods and services; 

the quantity and amount for each 

the total amo\mt payable excluding tax, 

the rate of tax and the total tax chargeable; and 

the number and date of the original tax invoice. 

Under the IMF Model Law, a valid credit or debit note must be issued when the amount shown 

as tax charged the tax invoice exceeds the tax pwperly chargeable in respect of the 

Only where a issues a tax credit note to rectify the output lax charged to a recipient the 

additional tax specified in the tax credit note is treated as output tax payable by the recipient in 

respect ol a taxable supply made by the recipient in the tax period in which the tax credit note is 

received. 2421n addition, a taxable person is required to issue a debit note where the tax properly 

chargeable in respect of the supply exceeds the amount shown as tax charged in a tax invoice~ 243 

Where a registered person issues a tax debit note to rectify the output tax charged to a registered 

recipient, the additional tax specified in the tax debit note is deemed to be input tax payable by 

the registered recipient in the tax period in which the tax debit nota is received. 244 

Under the IMF Model Law, a valid tax invoice must contain the following information:445 

the name, address. and VAT registration number of the registered person making the 

supply; 

the name, address, and VAT registration number of the recipient of !he supply; 

the date on which the credit or debit note is issued; 

the value of the supply shown on the tax invoice, the correct amount of the value of the 

supply, the difference between those twc amounts, and the tax charged that relates to 

that difference; 

"'' IMF M<XIell~w. § 33ill, 

'" IMF M<XIollaw, § 21!('7l. 

,., IMF Mod$1law, s 33(3). 

""IMF Mooal Low, !i 2Sifi), 

'" IMF Mooollaw, Sched"la IV, 
253 


Insert offset folio 222 here 98944.222

a brief explanation of the circumstances giving rise to the issuing ol the credit debit 

note; and 

information sufficient to identify the taxable supply to which credit or debit note relates, 

The Irish VAT Act requires taxable persons to issue credit and debit notes when, after issuance 

of an invoice, the consideration stated in the invoice Is increased or reduced, or a discount is 

allowed, 246 Where there is any such change in the consideration, the person making or receiving 

the supply, as the case may be, shall within fifteen (15 days) alter any such change or events 

issue a credit note or debit note. In Ireland a debit note is considered as an additional invoice and 

thus follows the same invoicing requirements. Tl1e credit note must show: 

" the date of issue of the note; 

a number, which uniquely identifies the note; 

the full name, address and VAT registration number of the person issuing the note; 

the full name, address and VAT registration number of the person to whom the note is 

being issued; 

ln the case ol a supply to a person who is registered for value"added tax in another EU 

Member State, the person's VAT identification number in that Member State; 

the reason why the note is being issued and a cross.reference to the invoice which was 

issued for the supply in respect of which the consideration was reduced; 

the amount of the consideration, exclusive of tax, in respeot of which the note is being 

issued; and 

the rate or rates of tax in force when the related invoice was issued and the amount of 

tax at each rate as appropriate to the consideration shown on the note {other than where 

the reverse charge applied on the transaction). 

In order to avoid fraud, GST adjustments relating to post sale adjustments should only be 

permitted where a valid tax credit note or tax debit note is issued. The GST law should thus 

indicate clearly in which situations registered persons are required to issue tax credit notes and 

tax debit notes. For simplicity purposes, tax credit and debit notes should be issued when there 

is a change in the consideration due on a supply or when the supply is canoelled, For efficiency 

and certainty purposes, the GST law should require registered person to isstJe a tax credit note 

or tax debit note within a certain timelrame after the changed occurred. 

"'Irish VAl Aet, !! 66-73, 
254 


Insert offset folio 223 here 98944.223

Appendix D: Goods and Services Tax Special Cases 
255 


Insert offset folio 224 here 98944.224

Appendix D: Goods and Services Tax Special Cases 

1 Special Cases 

1.A.1 Grouping 

Overview of concept 

Under a GST, each person canying on a taxable activity is required to register for GST and comply 

with the GST law. However, some countries allow closely related entities to form a GST gro~1p 

whereby all members of a GST Group will be considered as a single taxable person for GST 

purposes. This mechanism is generally designed to reduce the compliance burden by requiring 

the group as a whole to file a single return rather than having each entity file a separate return. 

Where a GST group is formed, one entity designated as the group's representative files returns 

on behalf of the group that includes all transactions made and received by group members. In 

addition, because all members of a GST group are considered to constitute a single taxable 

person, transactions between GST group members are ignored lor GST purposes. This has a 

consequential beneficial affect of removing any cash flow burden that may arise from accounting 

for GST on such supplies. 241 

Caution is required to be exercised when drafting rules in respect of to ensure the 

operation of the GST is not adversely allected. Specifically, input tax credits incurred by a group 

member related to the making of exempt supplies to another group member should not be 

recoverable based on the taxable supplies made by the group as a whole. This issue is addressed 

in different ways by jurisdictions having implemented a GST grouping provision and are discussed 

below. 

leading Practice 

The GST law should include a GST provision, which should include the following: 

established in Puerto Rico may apply to the authority to 

form a GST group that 

o there is an element of common control between members !based on existing commercial and income tax ,..,.,,,,.,, .. t,,\. 

each member make 

should be the calculation 

supplies f1ncldental exempt supplies 

percentage~. 

If all the conditions a 

o one member of the group be designated as 

o all transactions between group members should be 

GST. 

AU members of a GST 

Where a member ol 

should be excluded from the 

which the requirement ceased to 

"'lmp.roving VA T/GST- D"signing a Simp/a a.fld Fl8Ud·Proof T~~ System, at 17 .1.4. l!lfO 120!4). 

in 
256 


Insert offset folio 225 here 98944.225

Discussion 

In New Zealand, GST grouping is permitted provided that (1) all companies are registered parsons 

for GST purposes; {2) there is a 00% common ownership among the members of the GST group; 

(3) all companies make collectively taxable supplies to non-group members that amount to at 

least 7 5% of their total supplies made to non-group members; \4) group members account for 

GST on the same basis !payments or invoioo), and {5) group members have the same taxable 

Individuals, partnerships, trusts, and non-resident entities may join a GST group where 

certain control tests are satisfied. Where a GST group is formed, one company must be 

nominated as the "representative member" of the group. It is the <epresentative member which 

is deemed to carry on all the taxable activities of the group members, and make and receive all 

supplies made by and to group members. Each individual member is deemed not to carry on that 

taxable activity o< individually make or receive supplies for GST purposes. The representative 

member is responsible tor filing GST returns and paying GST to the tax autrlority. However, each 

group member remains jointly and severally liable for the GST liability of the group, 

In Singapore, GST Grouping is also permitted provided there is an element o! common control 

over the members of the GST registration is available to two or more taxable 

persons, each ol whom must possess at least ooe of the following attributes: 

• the taxable person is resident in Singapore or has a business establishment in 

person has an annual turnover of SGD 1 million or more; 

has issued shares which are fisted on a securities exchange or outside :-,m,aa!10T•F>: 

" the taxable person is a a body corporate that satisfies the conditions 

above; or 

• the taxable person is finanwd by an entity that satisfies the conditions above. 

addition, the taxable person must meet at !east one of the following control requirements: (1} 

one taxable person controls each of the other taxable persons, (2] one person (whether a body 

corporate or an individual) controls all of the taxable persons; or l3l two or more individuals 

carrying on a business in partnership control all of the taxable 

Furthermore, similar to New Zealand, the tax authority also requires each member of the 

proposed group to be individually registered for GST and can refuse an appliootion for the 

protection of revenue, 

in contrast to New Zealand, the above requirements are more restrictive and there is no threshold 

requirement in respect of taxable versus exempt supplies. Nonetheless, the effects of GST 

grouping are the same as New Zealand. 

m Nsw loaland GST Aol, i 55, 

""Singap<>r<> GST Act, § 30; Sln!IJI!m'<! GST Rogula!lons, r"lJuletion 4, 

""Singaporo GST Act, S 30; Sin!IJI!J<}fo GST Regu!ati<ms, f"lJlllatioo 4. 
257 


Insert offset folio 226 here 98944.226

The Malaysian GST Act allows group registrntion lor two or more companies provided the 

following conditions are met:~ ' 

• 

• 

indrvidually GST registered before they can register as a group 

and 

have power over the other companies within the group 

and Singapore). 

Generally, a company is deemed to have control over another company if the first company holds 

or indirectly, through subsidiaries, more than 50% of the issued share capital of the 

second mentioned company. A company is deemed to be a subsidiary of another company if that 

company holds more than 50% of the share capital of the first mentioned company. 

In contrast to New Zealand and Singapore, individuals or partnerships are not eligible to be a 

member of a group. However, companies controlled by individuals or partnerships may register 

as a group. Again, in contrast to New Zealand and Singapore, foreign companies which are not 

established in Malaysia cannot become members of a group. However, for the purpose ol 

eligibility for group registration, their subsidiaries or registered branches in Malaysia can be 

considered as members of a group,262 

The consequences of GST 

The IMF Model law does not include any specific provisions for groups. 

Ireland also permits the formation of a VAT group by two or more persons closely bound by 

financial, economic and organizationallinks. ~ Companies are treated as being "closely linked" 

il one owns 50 percent or more of the share capital of the other, or one owns 50 percent or more 

ol the power of another, or one has power to appoint 50 percent or more of the board of 

the other. Similar to Malaysia, only Irish established entities may be members of a group. 

Unlike in the other comparable jurisdictions, the Irish tax authority may deem a person to be a 

member of a VAT group and also has authority to cancel the registration ol such groups. 

The effects of VAT grouping in Ireland are the same as the other comparable jurisdictions. 

However, the VAT group provisions do not apply in the case ot the supply of immovable goods 

by a group member to another group member. 

Based on comparable jurisdictions, it is leading practice to include GST grouping provisions within 

the GST law to help ease the compliance burden for closely related entities. Common 

characteristics of GST grouping provisions include: 

Moloyslo GST Act, § Malaysia GST G<Jida, GSI Registratioo <lo•i<io ~DAAH), at I 7, 

'" Moloyslo GST Guide, (lST A~glotration Guido !DRAfT), ol ! 7. 

"''ltish VAT Acl, § 16. 

'" 0. Maher. lr<>lood · Volue A<id<ld Ta¥. TopiO!ll Aoolys"slSFD. 

'"'iris~ VAT Act § IS. 
258 


Insert offset folio 227 here 98944.227

• There is an element of common control between members; 

• A representative appointed to file GST returns on behalf of the group; 

• All members of the group remain jointly and severally liable tor the payment of 

GST· 

• lntr~-group IJ"'IJU';"'"' and 

• All supplies to and by group """'"'h'""~ to be made to and by the 

group as a whole. 

Differences arise in respect ol how jurisdictions approach the following: 

• Definition of common centro!; 

• Whether group are and 

• Whether group are 

In the case ol Puerto Rico, the definition of oommon control should follow existing oommercial 

and income tax concepts to ensure consistency, 

In respect of allowing non-resident entities to be group members, there are contrasting 

approaches between the comparable jurisdictions. While New Zealand and Singapore authorize, 

to a certain extent non-residents as members of GST groups, such an option is not available in 

Malaysia and Ireland. In the context of creating a simple and easily administrable GST, only 

authorizing established entities to be members of a GST group would be the preferable approach. 

In order to address the potential over-deductibility of input tax that might arise from the forming 

of a GST group where exempt supplies are disregarded by virtue of the grouping provisions, the 

comparable jurisdictions have taken different approaches. 

New Zealand imposes certain threshoids for carrying on taxable supplies therefore restricting 

entities that make signilicant exempt supplies from joining GST groups. Malaysia takes a more 

strict approach with only permitting GST grouping tor members who make 100% taxable 

supplies. Ireland and Singapore have no restrictions. As such in Ireland, VAT grouping is 

commonly used to mitigate VAT costs arising from a group member making exempt supplies 

\e.g., !he finance or insurance industry). 

Puerto Rico should follow the Malaysian approach with GST grouping only being permitted for 

taxable parsons who make 100% taxable supplies (rather than the New Zealand approach which 

would require complex threshold computations), regardless of their status (i.e., corporat.ions, 

individuals, partnerships, branches) which are established Puerto Rico in order to avoid any 

GST tax planning opportunities. 

The GST law should also state that where a taxable person no longer meets t11e common control 

requirement, !he taxable person should be excluded from the GST group. However, the taxable 

person should remain jointly and severally liable for any GST payable during the taxable periods 

in which it was a member. 
259 


Insert offset folio 228 here 98944.228

1.A.2 Branches and divisions 

Overview ofconcept 

Branches and divisions are not separate legal persons from their head offices. As such, GST 

regimes generally treat branches and divisions and their head offices as single taxable persons. 

Consequently, any transactions between head offices and branches are disregarded for GST 

purposes. 

However, some countries allow or require branches and divisions to be regarded as separate 

taxable persons lor two reasons: 

• Allowing separate GST registrations for a head ollice and a branch can address 

,.,nrnnlii""'"" concerns where the head office and the branch oparate accounting 

and in practice, despite the fact that they one are 

rrnln~rlAf'l and as two distinct establishments. such cases, the filing 

return may be overly burdensome for the taxable person. 

Leading Practice 

The GST law should include a provision regarding branches and divisions, which should include 

the following: 

Where a taxable 

taxable person is 

person If: 

a taxable 

to apply 

its taxable activity In branches or divisions, the 

taxable 

its in branches or divisions should be 

or division to be registered as a separate taxable 

o The branch or division has an independent of and 

o The branch or can be by the nature of 

the activities carried on or the location the branch or division. 

Where a taxable person carries out taxable activities both inside and outside Puerto Rico 

through branches or divisions: 

o Each head office, branch, or division established overseas should be treated as a 

o or divisions established in Puerto Rico should be 

treated as a single person. 

Discussion 

New Zealand allows taxable persons carrying out their activity branches or divisions to apply 

for any such branches or divisions to be registered as separate taxable persons where those 

branches or divisions have an independent system of accounting and can be separately identified 

by reference to the nature ot the activities carried on or by the location of the branch or division. 256 

'"'New Zooland GST Act § 66. 
260 


Insert offset folio 229 here 98944.229

In addition, the GST Act treats the offshore branch or head office of a company and its head 

office or branch in New Zealand as separate persons to ensure there is no avoidance of any GST 

liabilities arising from cross border transactions, as described in the Overview of Concept section 

•n'l:orlseqw>nt!y, transactions between a resident head office and a norHesident branch 

will be treated as subject to the GST regime. 

Singapora> does not have any special provisions with regard to the treatment of transactions 

betw~n a branch and its head office for GST. Consequently, where a branch has transactions 

with an oVGrseas head office, the branch and the head office are considered as the same legal 

entity and thus there is no supply for GST purposas.256 However, similar to New Zealand, an 

application can be made to register each division separately where (1) it is likely to cause real 

difficulty for the taxable person to submit a single return in respect of all the divisions; (2) each 

division maintains an independent system of accounting; and (3) each division is separately 

identifiable by reference to the natura of the activities carries on by or the location of the 

division. 200 

Malaysia takes a similar approach to Singapore and New Zealand authorizing the separate 

registration of branches and divisions under similar conditions.2ll0 In addition, lor a separate 

branch or division registration, Malaysia requires that the taxable person and all the branches or 

divisions make wholly taxable supplies; the taxable person is not a member of a GST group; and 

each branch or division has the same taxable period, Once registered, all branches and divisions 

must charge and account for GST even though an individual branch or division may not have a 

turnover that exceeds RM500,000 (i.e., the registration threshold), 

Under the IMF Model law, where a taxable person carries out its taxable activity in branches or 

divisions, the taxable parson is deemed to be a single Consequently, transactions 

between head offices and branches are not subject to VAT. The law also authorizes taxable 

parsons to apply for a separate registration lor branches and divisions where the branch or 

division maintains an independent system of accounting and can be separately identified by the 

nature of its activities or its location (similar to New Zealand).2 ~ 

The Irish VAT Act does not contain any specific provision regarding branches and divisions. 

However, under EU VAT case law, and in contrast to New Zeatand, supplies of services between 

branches and head offices must be disregarded, even in cross border situations, because the 

transaction is within the same legal However, this does not apply to cross border 

supplies ol services where a branch is a member ol a VAT group. 264 

All comparable jurisdictions, except Ireland, contain special provisions regarding the separate 

registration of branches and divisions under certain circumstances. However, New Zealand is the 

T ~X Systom, Ill 

theEutl"'""o U•'lioo, Ca"" C-210/()4 I'Cfi. Sqnl: ~ 

Etfrcpean Un~on, Cas~ C·7/13, Skdmiirt AmeriCa CorpOtstlon, 
261 


Insert offset folio 230 here 98944.230

only jurisdiction which deems cross border trensactions between a head office and a branch to 

be a supply for GST purposes. 

The GST Law may, similar to the IMF, clarify that where a business operates its taxable activity 

in branches or divisions, such branches or divisions should be considered carrying out the activity 

as a single taxable person. Consequently, all transactions between a head ollice, division. or 

branch will be disregarded for GST purposes. Such an approach provides certainty. 

Based on the comparable jurisdictions, it is leading practice to allow a separate lor 

branches or divisions where the branch or division maintains an independent system of 

accounting and can be separately identified by the nature of its activities or its location. Additional 

conditions such as those imposed by the Malaysian GST Act may be included, but is likely to add 

complexity to a provision deemed to provide flexibility to the law. 

Finally, the GST law, should similar to New Zealand, deem cross·border transactions between 

head offices and branches to be supplies between two separate taxable persons for GST 

purposes. This provision will aid in maintaining the neutrality of the tax and mitigate avoidance 

opportunities. 

1.A.3 Groups of persons/unincorporated bodies/partnerships 

Overview of concept 

Groups of persons, unincorporated bodies, and partnerships are often considered "pass-through 

entities" for income tax purposes, whereby partners or members of these entities are directly 

liable for tax. Applying the same principles for GST purposes may result in administrative and 

compliance complexities because each partner would be required to register for GST and special 

wle.s would be required for the artificial .splitting of the supply between partners and the issuance 

of invoices. Con.sequen!ly, GST laws generally introduce a mechanism that recognizes these 

entities a.s single taxable persons for GST This will treat these entities as making or 

receiving all relevant supplies rather than supplies being made to or by each partner. 

Leading Practlce 

The GST law should include a provision regarding groups of persons, unincorporated bodies, and 

partnerships, which should include the following: 

"""'""''"hin carries on taxable 

"'"'""''"'''" is required to register 

members of the body are deemed to be made by or to the bcdy 

individlual members, 
262 


Insert offset folio 231 here 98944.231

Discussion 

group of persons, unincorporated body, or partnership are jointly and 

tax 

in which he or she 

group of person, 

Under the New Zealand GST Act, a "person" inchJdes a company, an unincorporated body of 

persons, a public authority, or a local author!ty.z66 Consequently, any unincorporated body 

subject to the general registration rules. 261 Where an unincorporated body of persons, including 

a partnership, joint ventura or trustees of a trust, carrying on a taxable activity is registered for 

GST, the individual members of the unincorporated body are not themselves Hable (or able) to 

register in respect oi that taxable AU supplies made or received in respect of the 

taxable activity carried on by the body are deemed to be made by or to the body and not the 

individual members. Changes in membership do not havl'! any effect for the purposes of the GST 

Act Each member o! the unincorporated body is jointly and severally liable for the GST of the 

body for taxable periods in which they were members. even if they are no longer a member of 

the body.2111l 

Singapore, Malaysia and the IMF adopt a similar approach to New Zealand.2?(1 

Ireland does not separately address the case ol groups of persons, unincorporated bodies. and 

partnerships, which are thus subject to the general rules. 

All comparable jurisdictions, except Ireland, adopt a specific provision regarding groups of 

persons, unincorporated bodies, and partnerships. New Zealand's approach, which is followed 

by Singapore, Malaysia, and the IMF, thus constitutes leading practice. Consequently. the GST 

law should provide for the following in respect of groups of persons. unincorporated bodies, and 

partnerships: 

• unincorporated bodies, and partnerships register for inriiHirifo H>l members; 

members of the body are deemed to be made by and to 

members; 

• where it taxable activity; 

• 

• 

and "'"'m"""'" for taxes a member to notify the tax authority where it is no a member of the 

""N"w Zealand GST kl. § 2. 

'"See Supra 3.C, 

"' N"w Zealand GST ll<lt. § 57(21" 

"'' New Z<lllillnd GSI kt § 57(3). 

" 0 Si"!!"l>"'" GST Act§ 31 and 32, Molaysio GST Aol, S 28, IMF Mooel L~w. o 57. 
263 


Insert offset folio 232 here 98944.232

1.A.4 Agents 

Overview of concept 

Where a supply of goods or services involves an agency relationship, generally the supply is made 

by to the principal and not the agent GST rules generally follow this principal. However, there 

may be situations where the agent does not reveal that there is an agency or declines to reveal 

the Identity of the principal (e.g., undisclosed The general operation of the GST rules 

whereby the supplier is required to issue an invoice to the customer would disrupt 

this commercial arrangement As such, where an agent is acting in its own name but for and on 

behalf of a principal, many GST jurisdictions deem a buy/sal! transaction to occur between the 

agent and the principal for GST purposes and GST purposes only. 

leading Practice 

The GST law should include a provision regarding agents, which should include the following: 

Discussion 

are 

be 

through an undisclosed 

as a supply to the agent 

on behalf of a and not the 

acting in its own as a supply by the 

In New Zealand, where a person (the "agent") is authorized by another person {the "principal") 

to act, represent and/or enter into legally binding agreements with third parties on behalf of the 

principal, any supplies made by the agent pursuant to the agency relationship are deemed to be 

made by the principal and not the 

However, a principal and their agent can agree in writing that a supply via the agent can be treated 

as two supplies - a supply oi goods and services by the principal to the agent and a supply by 

the agent to the recipient. 

Even in the event of no SL!Ch agreement, an agent can issue a tax invoice for the supply as if 

made the supply and can request a supplier to issue a tax invoice to the agent as i! received 

the supply. In such cases, tax invoices cannot also be issued by and to the principal. 

Similarfy, where a registered person makes a taxable supply of goods or services to an agent, 

that supply is deemed to be made to the principal for GST purposes and not the agent 274 

273N"w l""land GST Act, § ll!lHl and m, m New Zoalaml GST Aol, § 00!21. 
264 


Insert offset folio 233 here 98944.233

Singapore has a similar approach to New Zealand. A supply of goods or services thmugh an agent 

who acts in his own name can be treated both as a supply to the agent and as a supply by the 

Malaysia is also similar to New Zealand in that when goods or services are supplied or by the 

agent acting on behalf of a principal, the will be deemed as made to or by the principal 

and not the 

However, where goods or services are supplied through an agent acting in his own name, the 

supply is treated as a supply to the agent and as a supply by the agent 211 

The !MF adopts a similar approach to New Zealand in relation to invoicing but does not have a 

provision for deeming a supply to occur to and by the 

Ireland takes a similar approach to agents as Malaysia where the agent is acting in its own name, 

Where an agent acts in an undisclosed capacity (Le,, in its own name, but on behalf of a principal), 

any sales of goods and/or services through him are deemed to constitute a supply of those goods 

and services to and simultaneously by the 

Where an agent is a disclosed agent {Le<, in the name and on behalf of the principal), any supply 

of goods or service takes place directly between the principal and the third party, 

All comparable include specific provisions transactions performed through 

agents, Differences arise in respect of whether the legislation includes a provision confirming 

whether a supply through a disclosed agent is made to or by the principal {New Zealand and 

Malaysia), a provision deeming a buy/sell to occur where the supply is made through an 

undisclosed agent (Ireland and Malaysia), a provision providing the option for a deemed buy/sell 

!New Zealand and Singapore), and a provision allowing agents to issue invoices in their own name 

even in the absence of a buy/sell !New Zealand and the IMF), 

For clarity purposes the GST law should state that where a supply is made through a disclosed 

agent the supply made to or by the principal and not the agent The GST law should also state 

that where supplies are made through an undisclosed agent there should be two distinct 

supplies: one by the agent and the other one to the agent Such an approach preferable as 

avoids any difficulties for the third party to identify the principal where the principal's name is not 

disclosed for the purposes of issuing GST compliant invcices, 

1.A.5 Going concerns 

Overview of concept 

Normally, the sale of the assets of a GST registered business should be subject to GST (unless 

an exemption or zero rate applies), However, when aU assets constituting a business are 
265 


Insert offset folio 234 here 98944.234

transferred and that business is to be carried on by the purchaser, the cash flow burden arising 

from the purchaser having to pre finance the GST in respect ol the purchase while awaiting the 

processing of an input tax claim can be unduly burdensome. Consequently, many jurisdictions 

provide a relief mechanism the case of a transfer of a business as a going concern for GST 

purposes (TOGC}, where specific conditions are met. 

Leading Practice 

The GST law should include a provision regarding the GST treatment of a transfer of a business 

as a going concern, which should include the following: 

The transfer of a 

A maybe 

that part of the business should 

reclist•ere<i person; and 

agree in writing thai the supply is a going 

Discussion 

In New Zealand, "going concern" is defined as a supply of a taxable activity, or of a part of a 

taxable activity where tl1at part is capable of separate operation, where all of the goods and 

services that are necessary for the continued opemtion of that taxable activity, or that part of a 

taxable activity, are supplied to the recipient; and the supplier carries on, or is to carry on, that 

taxable activity or that part of a taxable activity up to the time of its transfer to the recipient 2130 

The supply of a "going·concem" is explicitly treated as a taxable supply, but is zero· rated for GST 

purposes if:281 

• the 

supply 

and the GST registered recipient agree, in writing, that the supply is to be a 

• the 

activity, or 

concern by 

concern; and 

GST registered 

of a taxable activity, 

recipient 

intend that the 

capable of being 

is of a taxable 

on as a going 

Singapore also provides a special rule lor TOGC, but takes a different approach to that of New 

Zealand. A transfer of a going concem is neither a supply of goods nor a supply of services, thus 

taking the transfer outside of the scope ol the tax. input tax incurred in relation to the 

TOGC remains deductible for both transferor and transferee. 00 The transferee who receives such 

a transfer of assets shall ba deemed to have incurred input tax on the value of the assets supplied 

him, and to have deducted such deemed input tax from any output tax due from him on the 

day the supply made. l11is is to facilitate any subsequent change of use adjustments. 

§ 2, 

SlHlllml. 

Services !Excluded Transactions) Order. 

Revenue Authority of Singapore, E·Tax Guide~ Transfer But~iness as a Going Concern. p. 6. 
266 


Insert offset folio 235 here 98944.235

In order lor a supply to qualify as TOGC, tile following conditions must be met: 

• the of assets is made in relation to a transfer of the business or part thereof to 

the traJ·<~f,~r"'"'' 

• the assets to be transferred must be intended for use on 

the same kind of business as the transferor. For the transferor a 

rental business should continue with the transferred tenancies and not terminate them 

so as to put the immovable to another use; 

• in the case where only ol business is transferred, that part must be capable of 

being operated inrll<>r"""'lAn,tflr 

" the business or part must be a going concem at the time of the transfer; 

• the transferee must be a GST registered taxable person at the time of the transfer; and 

• both the transferor and transferee must maintain sufficient records on the transferred 

assets. 

Singapore also has additional requirements where the transferee is a member of a GST group. 

Malaysia takes a simifar approach to Singapore.2

MUnder the Malaysian GST Act, the transfer of 

a business can be considered as a transfer of going concern if: 

mu><:t<.rnr is a taxable person; 

1ra1nsfere,e is a taxable person or will be a taxable person after the transfer of 

• the of the business must be acc:on1o<ll'liE1d transfar of business assets that 

will be used on the same kind of "'"""'''"'" • lf is transferred, then part of the business must be able to 

The IMF takes a similar approach to New Zealand as the transfer of a business as a going concern 

is also a zero-rated transaction. 265 There is a transfer of going concem where: 200 

and services nAit~AF:~alrv 

or taxable activity 

• the carries or activity up to the time its 

operation of that taxable activity 

to the tr<>•~"t'~"'"' and 

that taxable activity or that part of a taxable 

transferee. 

In Ireland. similar to Singapore and Malaysia, the transfer of ownership of goods and intangible 

assets such as goodwill, in connection with the transfer ot a business or part thereof to another 

person is deemed not to be a supply of current legislation does not expressly state 

that it is necessary that the business be sold as a going concern. it states that the transferred 

assets should constitute an undertaking, or part ol an undertaking, capable of being operated on 

an independent basis. 

AU comparable jurisdictions include a 

in the Overview of Concept section 

TOGC provision for the reasons discussed above 
267 


Insert offset folio 236 here 98944.236

While New Zealand and the IMF consider a TOGC as a zero-rated transaction, Singapore, 

Malaysia, and Ireland consider the transfer of a going concern to be out of scope of GST 

However, the ultimate effacl is the same lor all jurisdictions. 

The GST law should identify what types of transactions qualify as going concerns. All comparable 

jurisdictions take similar approaches with regard to the conditions that should be met to treat the 

transfer of a business as a TOGC. Therefore, based on the comparable jurisdictions a transfer ol 

a business should be treated as a TOGC and subject to GST relief where the following conditions 

are met: 

• 

• 

that part of the business should be 

person; and 

agree in writing that the supply is a going concern. 

The New Zealand approach of electing lo treat this type of transaction as zero-rated is preferred, 

rather than making it a mandatory treatment, as determining whether all requirements for such 

treatment are met can be problematic. For certainty purposes, it is advisable that the parties 

agree in advance that the transfer qualifies as a going concern. 

1.A.6 Vouchers 

Overview of concept 

Vouchers, stamps, coupons, tokens and similar items ("vouchers"! are generally instruments 

which give the holder a right to goods or services, or to receive a discount m rebate in relation to 

a supply of goods or services. :ws 

Vouchers create unique 

two transactions: 

from a GST perspective as a voucher is generally involved In 

could be free or for consideration!; 

goods or services. 

The question that arises from a GST perspective is whether to tax the issuance of the voucher 

or the redemption of the voucher. In order to provide certainty and ensure there is no double 

laxation or non-taxation, special rules arE! generally required for the GST treatment of vouchers. 

Further, issues can arise in respect of how the value of the transaction should be determined. 

For example, vouchers ma')' be sold for less than their redemption value or they may be sc!d 

through a supply chain involving many parties with each party making a profit on their respective 

sales. Finally, vouchers could be issued for a specific gcod or service or for multiple types of 

COUNCIL DIRECTIVE •moooing Diroc!iv() ~000{112/!iC"" lll" common system ol v•loo added tax, •• regardsllle 

10l!if2!l12 Oll)<lgo 2. 
268 


Insert offset folio 237 here 98944.237

goods or services that may have dillerent GST treatments, therefore creating issues with 

determining the correct treatment the voucher is to be taxed upon issuance, 

Leading Practice 

The GST law should include a provision regarding the GST treatment of vouchers, which should 

include the following: 

1'/'\,'\<:itit>"Ahrm ShOUld not be 

or services the received voucher, 

is less than, or equal to, the face value ot the voucher, stamp, 

the consideration received lor th<> issuance of the voucher, stamp, 

exceeds the lace value of the or token: 

be applicable at the time of the stamp, 

or token; 

amount should correspond to the difference between the 

cotlSkier;aticm received and the face value of the voucher, stamp, coupon, or 

and services should be required to include in the valuation of the 

supplied the value of the voucher, stamp, coupon, or token 

The above leading practice addresses the basic application of the GST law to the issuance and 

redemption ol vouchers. The treatment of vouchers is an extremely complex area from a GST 

perspective. During the drafting of the GST law, special attention should be given to the following 

more complex matters: 

• 

• 

• 

Discussion 

made to the current European 

In New Zealand, the issue or sale of a token, stamp, or voucher is treated as a supply of goods 

and services, other than those issued for no consideraUon, 200 

To prevent a double imposition ol GST, the following are not treated as a supply of goods and 

services:2ll1 

• goodsand 

voucher; 

supplied pursuant to the redemption of the token, stamp or 

'""Pmpoo•llor o COUNCIL DIRECTIVE amending Di...,!iv• 2006,'1 12/EC oo tho common system of V$luo ~dd•d lox, as l"ilold•tl>o 

tteatment of V>O!X:he:rs 

""Now z...,l•nd GST Act. § 6(11 El, 

'

91N;w; Z<J®Ilmd GST Act, ! 6111EAl•nd (1lF), 
269 


Insert offset folio 238 here 98944.238

• the r~>r•i<>t."r"ti person to another registered 

or sells the stamp, or voucher the first 

who actually the and 

stamp, or 

However, if the voucher has a lace value and it is not practical for the supplier to treat the issue 

sale of the token, stamp, or voucher as a taxable supply, then the supplier may treat the 

redemption ol the voucher as the supply of goods and services, rather than the issue of the 

voucher!a' 

A situation where it may be impractical to treat the supply of the voucher as a taxabie supply 

includes one in which the supplier of the voucher and the supplier of the underlying goods or 

services may be different. If the issuer of the voucher and the supplier of the goods and se!Vices 

upon redemption of the voucher are different persons, then the issuer and the supplier must 

agree to this GST treatment.Z00 

This elective GST treatment cannot apply to the extent that the consideration received for the 

supply is more than the face value ol the tokens, stamps or vouchers. 

Singapore takes a different approach and differentiates between vouchers 

(MF!Vl and vouchers (Non·MRVJ. 2:!14 However, the Singapore GST law does 

not use these terms, rather they are terms that have been adopted by the tax administration to 

assist with the application of the GST rules to vouchers. 

Section 35A of the Singapore GST Act provides the Minister with the authority to set rules 

to the taxation of vouchers via the regulations. 

Where any voucher is supplied by an issuer for consideration that is equal to or less than the 

value of the voucher, the suppty of the voucher is disregarded for GST purposes!~5 Where the 

consideration exceeds the value of the voucher. GST is payable on that excess.200 

For vouchers that are wholly redeemed on a single occasion, GST may be accounted for (at the 

option o! the taxable person) on the value of the voucher or the amount of the consideration 

received for the voucher {where the consideration received is less than the value of the voucher). 

If the consideration received for the voucher was equal to., or more than, the value of the voucher, 

GST must be accounted for on the value of the voucher. 297 

For vouchers that are partially redeemed on more than one occasion, the value of the supply on 

each such occasion is as follows: 200 

where the consideration received by the issuer lor the voucher was less than the value 
270 


Insert offset folio 239 here 98944.239

of the the following at of the taxable 

o the of value of the redeemed on occasion; or 

o the amount of that co11si!:!Braticm that is proportional to the value of the voucher 

being redeemed on 

where the consideration received 

!han the value of the voucher, the 

on that occasion. 

to or more 

redeemed 

There are also specific rules for accounting for GST on unredeemed vouchers.m 

Taxable persoos can elect to be subiect to different rules, upon approval of the Comptroller, to 

account lor GST at the time the voucher is issued, :roo The Comptroller has fairly broad powers in 

determining what conditions need to be met in order to be subject to these different rules, 

The Singapore Tax authority has interpreted these rules as fo!lows.301 

Sale ofvoucher 

Types of goods and/or 

services that can be 

redeemed 

GST Treatment 

Examples 

{bJ When voucher is redeemed 

GST has to be accounted for 

on value of the 

redeemed and/or 

l•$Slngapor<! GST AoQUiotioos, flegulatioo 930. 

JOOsiogapore (lST Regulolioos, Regulation OOE, 

Non·Multi·Redemption 

Voucher ("Non·MIW"l 

Need ool be sold for a 

consideret.ion 

Sale of voucher and redemption 

of goods and/or services is 

treated as a single supply. 

lal When vouc~1er is sold 

GST is to be accounted 

for at the earlier ol 

when the 

received or 

invoice is issued. 

(bl When voucher is 

redeemed 

No further GST is 

accountable unless 

additional is 

received. 

is received, 

accountable on 

' 01 1nlond ll"""nuo Authority of Singapore, IRAS eT!>X Guido, GSl 'fr<~•tmelll <>f Vouchers, 31 Deoombor 2013, •t p. 1, 
271 


Insert offset folio 240 here 98944.240

Singapore also has speclfic rules addressing the supply of vouchers by inte:rmediaries and how 

to acoount for the: margin made by the intermediary on the resale of those vouchers.302 

The Malaysian law is drafted a simpler manner in respect of the treatment of vouchers. It 

simply states that where a right to receive goods or services for a monetaty value stated on any 

token, stamp (other than postage stamp) or voucher is granted for a consideration, the 

consideration shall be disregarded except to the extent, if any, it exceeds the rncnetary value. 

The tax authority's application of this rule differentiates between rncnetary and non-monetary 

vouchers. Monetary vouchers are those vouchers with a face value while non-monetary vouchers 

are vouchers that entitle the bearer to a specific good or service mentioned in the vouchec304 

GST is only chargeable on the issue ol a monetary voucher to the extent the consideration for 

the voucher exceeds the value o! the voucher. GST is payable when the voucher is redeemed 

for goods or services. 

For non-monetary vouchers, if the non-monetary voucher is issued for consideration, GST is 

applicable at the lime of the supply. However, if the issuance of vcucher is lor no consideration, 

there is a distinction between >'llhether the voucher relates to goods or services. If the vcucher 

relates to services, GST is only applicable when the voucher is redeemed. If the voucher relates 

to goods, then the Malaysian gift rules apply- only if the value of the goods to which the voucher 

relates is more than RM500 is the issuance of the voucher subject to GST.30• 

The IMF Model Law was foHowed by the Malaysian law. The wording of the principal provision 

governing the treatment o! vouchers is the same.306However, this does not apply to prepaid 

phone cards. 

If the issuance of a voucher results in a taxable supply, the supply takes place when the voucher 

is issued.3<l7 The valuation of the taxable supply is in this case equal to the amount by which the 

consideration exceeds the monetary value of the voucher. :MJe Where a vcucher is issued without 

consideration, the supplier ol goods or services is required to include the value of voucher in the 

value of goods and services supplied when the voucher is redeemoo.3

1l9 

In Ireland, the sale ol vouchers or telephone cards, and similar items !other than vouchers or 

telephone cards sold to and by taxable persons with a view to their re·sale) is not liable to tax 

except where, and to the extent that, thee oonsideration paid exceeds the redeemable value.316 

Where a taxable person supplies a coupcn, stamp, telephone card, token, or voucher, which has 

a redeemable value, to a taxable person with a view to resale, and the supplier promises to 

:Ml1Sing•porG GST !lsgul•~ons, Regulation 93F. 

3<>3 Malay$lso GST Law, Third Schedui•. §3 

""Mo!oys!a, GST Tox Guide on A<>loillng,, •t 25. 

"~ Mal•ysl•. GST Tax Guido oo fl•tailiog, o! 28. 

""'IMF Modol Law, §4!19), 

"''IMF Modal law, ; 10(11!. 

""IMF Modo! Law. ~ 13{10). 

""IMF Model Law,§ 13!11!. 

'" Irish VA 1' Act, § 43. 
272 


Insert offset folio 241 here 98944.241

subsequently accept that coupon, stamp, telephone card, token or voucher at its redeemable 

value in full or part payment of the price of goods or services, the supply is treated as a taxable 

sale, When such coupon, stamp, telephone card, token voucher is used in payment or part 

payment of lhe price of goods or services, its redeemable value disregarded for tax calculation 

such, where vouchers are issued through a multi·stage supply chain, vouchers 

are taxed on issuance. 

Finally, where a supplier sells a vouchecr to a buyer at a discount and promises to subsequently 

accept that voucher at its face value in full or part payment of the price of goods purchased by a 

customer who was not the buyer of the voucher, and who does not normaUy know the actual 

price at which the voucher was sold by the supplier, consideration represented by the 

voucher shall, subject to regulations ()! any), be the sum actually received by the supplier on the 

sale of the voucher. 

The GST treatment of vouchers is a complex area. It is therefore necessary for the GST law to 

provide simple and clear rules regarding vouchers in order to avoid any double or non·taxation of 

the transaction. The comparable jurisdictions take various approaches towards vouchers and, as 

such, a leading practice cannot be readily determined. 

New Zealand's approach departs largely from the approach of the other jurisdictions as vouchers 

are subject to GST upon issue. This approach can be impractical and therefore New Zealand 

includes an exception to this rule such as situations when the issuer of the voucher is not the 

supplier of the goods or services. 

All other juriadictions identify !at least to a certain ;:;xtentl that the moment of redemption should 

be the time of supply, This approach should be preferred as it avoids the impracticalities of the 

New Zealand approach, Singapore and Malaysia consider the type of voucher (i.e., MRV or nonMRV and Monetary or non-Monetary) to determine the tax treatment While this approach takes 

into consideration various business models, it adds complexity to the GST law, which should be 

avoided when introducing a new type of laK The IMF and, to a lesser degree, the Irish approach 

constitute a simpler approach with regards to vouchers: ( 1) vouchers are subject to GST at the 

moment of redemption regardless of their nature; and (2) only to the extent that the consideration 

received exceeds the monetary value of the voucher GST is applicable at the moment of sale on 

the differential amount This approach first avoids any discussion regarding the specific type of 

voucher and any issues regarding whether the issuer of the voucher is also the supplier of goods 

and services. It also covers situations in which the issuer of a voucher receives consideration for 

the issuance of the voucher. 

1.A.7 Gambling 

Overview of concept 

Gambling constitutes a specific challenge fO!' the design of a GST law as it is necessary to 

determine if there is a supply in the first instance and, if there is a supply, when the supply 

'" Irish VAT Act, ! 43. 
273 


Insert offset folio 242 here 98944.242

takes places for GST purposes and on what value the GST should be levied. Due to these 

complexilles, historically, gamblfng fell into the exempt supplies category. However, many of 

the more modern GST regimes have developed mechanisms to effectively bring gambling 

within the scope of GST. 

Leading Practice 

The GST law should include a provision regarding the GST treatment of gambling activities, which 

should include the following: 

of any amount by a sweepstakes, 

gaming machines, or chance be a services by the 

operating the betting, sweepstakes, lotteries, gaming mAr:hi•n"'" or games of 

Dls~;usslon 

In New Zealand, payments in relation to the following are treated as payments for a supply of 

services by the person organizing the gambling or racing or sports betting, participation 

in gambHng or prize competitions, and casino garnbfing. 

Where there is a deemed supply by a racing board, the time of supply is deemed to occur when 

and to the extent that any amount of money is dealt with by the board, 313 For gambling or prize 

competitions, other than casino gambling, the time of supply occurs when the draw is made.31• 

However, this rule does not apply to an instant game played by way of a machine (i.e., slot 

machines). In that case, the time of supply is deemed to occur when tile ooin token is taken 

from tile machine by the For casino gambling, the time of supply occurs at the time 

ot tile "casino oount 

The value of the supply of services for racing betting or sports betting is the amount received by 

the New Zealand Racing Board plus the return of bets laid off by the New Zealand Racing Board 

less the sum of refunds and winning services for equalizer 

''' Naw ZO<lland GST Act, § 5\lll t" i11 Cl. 

'" New Za~Jaod GST Aot, § 9l2lldl. 

"' New Z••IMd GST Act, § lll2!1al, 

"'New leland GST Aot, § 9!2l!fl. 

,.. N•w Z<ral3nd GST Act, § 912Hgl. 

>» N•w l""!aml GST Act, § 1 0(1 2). 
274 


Insert offset folio 243 here 98944.243

betting is the amount received by racing club. For gambling and prize competitions, other than 

casino gambling, the value of the supply is the total consideration paid in money by a recipient to 

participate in gambling to a supplier less the total amount of prizes paid in money by the 

It the gambling is in a casino venue, then the value is the amount of money paid to 

the casino for a chip, as commission, or to otherwise participate in gambling less any amount 

paid out by the casino as winnings. 3'1> 

Singapore includes a separate section for betting, sweepstakes, lotteries and gaming under the 

Special Cases part of the legislation. This section states that the Minister may, by regulations, 

make provisions modifying the GST rules for transactions involvirlg betting, sweepstakes, 

lotteries, fruit machines or gaming. 310 

Part XIII of the Singapore GST regulations addresses betting and gaming, The Singapore GST 

regulations state that where any person pays an amount in money to partk:ipate in any transaction 

involving betting, sweepstakes, lotteries, fruit machines or games of chance, the amount of 

money so paid shall be treated as consideration for a supply of services to him.321 

For any gambling supply made outside of a casino, the tax base is equal to the amollllt paid for 

participating the gambling transaction less any amount ol money to any person 

participating successfully in the """m"''"u. 

In respect of casinos, a casino operator shall be treated as having made a taxable supply of 

services when a person pays an amount in money to a casino operator as a bet received and 

accepted by the casino operator as a wager on any game where the casino operator is a party to 

a wager; or to participate in any game where the casino operator is not a party to a wager but the 

game is conducted by on the premises of the casino 

Casino supplies are deemed to be made at the end of the prescribed taxable pariocl in respect ol 

which the net win from that supply is included in determining the gross gaming revenue of the 

casino 

The tax base is calculated based on the same principles as lor gambling supplies made outside 

of a casino. In addition. the regulation provides special rules for complementary chips or coupons 

given by the casino operator and bad debts resulting !rom gambling supplies. Further, any casino 

loss maybe carried forward and offset against the supplies made in a subsequent period (i.e., 

where amounts paid out exceed amounts receivad). 325 
275 


Insert offset folio 244 here 98944.244

Finally, the GST Act provides that any betting, sweepstake, and lottery duties must be included 

in the value the gambling '""'n'" ••• 

Malaysia adopts a similar position as New Zealand and Singapore in determining the value of the 

betting and gaming supplies. According to the Third Scl1edule of the GST Act, the value of taxable 

supplies of services made by a person licensed under any written law involving betting 

sweepstakes, lotteries, gaming machines or games of chance must be the ameunt received by 

the supplier less any winnings paid out to the betting participants. 

The GST Regulations provide further details on the time of supply o! gambling and similar 

activities:327 

• 

• Where isa 

when the race is 

• Where there is a when l'nli'<>t'tir.n 

the or 

• there is a day of the taxable 

services lottery and a game of 

is at the time the numbers are 

services involving sweepstakes, the time of supply is at the time 

place. 

of servces by gaming machine, the time of 

from the macl1ine, or at the time when tra11sactkm 

casino betting, the time of supply is on the last 

takes place. 

Under the IMF Model Law, the placing of a bet by a person with another person operating a 

game of chance is a deemed to be a supply of servces by the person operating the game of 

chance,329 The time of supply for games of chance is subject to the general rules: i.e., earliest of 

performance of service, date of invoice, or peyment329 However, if the supply tor consideration 

In money is received by the supplier by means of a machine, meter, or other device operated by 

coin, note, or token, the time ol supply occurs when the coin, note, or token is taken frorn the 

machine, meter, or other device by or on behalf of the value of a supply of games 

of chance is the amount received in respect of the bet, reduced by an amount equal to the tax 

fraction multiplied by the amount received in respect of the bet 331 Unlike the other jurisdictions 

discussed above with value the supply as being net of any payments made to winning gamblers 

or participants, the IMF Model Law allows a specific input tax deduction lor payments as a prize 

or winnings.332 

Ireland departs !rom the approach followed by all the other comparable jurisdictions and exempts 

gambling and lotteries. 333 

Based on the comparable jurisdictions, leading practice is to tax gambling transactions, Therefore, 

the Irish approach should be excluded. Specific valuation rules and time of supply rules should 

RGguloti<>oo, R0gulotip" 13, 

"•IMF Mode! t•w, !4{91. 

"' IMF Modo! Law, !10\ll. 

""IMF Modal §11)(:7). 

IMF Modell.aw, !13(151, 

""'IMF Mod$1 l..aw, § ?:ftdl. 

""' Iris!\ VAT Act, Schml<~lo 1. 
276 


Insert offset folio 245 here 98944.245

be adopted to reduce the compliance burden associated with calculating GST on a per supply 

basis. 

1.A.8 Non-resident GST refunds 

Overview of concept 

There may be situations where non-residant taxable persons who are not GST registered, nor are 

required to be GST registered, in a jurisdiction incur GST in that jurisdiction. Such GST costs can 

arise in a number of ways, including: 

Countries adopt various approaches to address such GST incurred by foreign entities, including: 

The general rationale for allowing non-residant businesses to recover GST incurred on costs is 

that GST should not be a cost to business; it is a tax on final consumption. 

Many jurisdictions that allow GST refunds to non-resident businesses often place certain 

!imitations on those refunds. For refunds may not be permitted unless the business's 

country of residence also provides refunds to non-resident business or refunds may not be 

permitted in respect of goods or services consumed in the country, such as food and 

accommodation. 

rise to non-residents GST is that ol purchases made by tourists. 

Many jurisdictions allow tourists to recover GST incurred on purchases made in the jurisdiction 

provided the purchases are removed from the country ·when the tourist leaves the country, The 

rationale behind such an is that GST should only apply to goods or services consumed 

in the GST jurisdiction. If a tourist purchases a souvenir take back to their home country, 

consumption of that good arguably occurs in the tourist's home country, 

leading Practice 

The GST law should include a provision regarding non-resident GST Refunds, which should 

include the following: 
277 


Insert offset folio 246 here 98944.246

a 

calendar 

amount of that 

value threshold r<'ltllinr!Art to the within a prescribed number of days inllmN;nn the GST return was filed, 

The GST law should also provide a refund ol GST for tourists visl!ing Puerto Rico who purchase 

goods in Puerto Rico during their stay which they subsequently take back to their home countries. 

Dioousslon 

Refunds for nolt·resident businesses 

In New Zealand, a non-rasident can voluntarily ragistar lor GST even where the no!Hesident does 

make taxable supplies in New Zealand.:~."' A non-residant may only register it the following 

conditions are met 

• tax in its country or carries out an 

'"'''''"t"""'li if the activity was carried out in New 

• The non-resident does not carry on or intend to carry on a taxable activity in New 

Zealand; 

• The non-resident does not can reasonably foresee will be 

received and 

• The is not and not intend to become a member of a group of 

companies that carries on a taxable activity in New Zealand. 

GST is refunded within 90 worl<ing days ot receiving the registered parson's retum,335 

"" Now li'<lllland GST Acl. § 541!. 

'" N<1w Z<lllf~nct GST Acl, § 46. 
278 


Insert offset folio 247 here 98944.247

In order to facilitate the claiming of a refund under the law, special rules are included in the 

section addressing the calculation of tax p<Jyable to allow the nrnHesident to claim GST that has 

been incurred despite the fact this it is not making supplies subject to New Zealand GST.a-'l!l 

'v'<''<'V'"''"· Singapore and the IMF do not have general norwesident relund rules. Singapore has a 

limited refund rule for GST incurred on the importation of goods, subject to certain conditions. :m 

Ireland has a simplified regime for non-resident business to claim VAT incurred in Ireland. This 

regime does not involve the non-resident registering for VAT but allows the non-resident to file a 

refund claim by supplying certain required supporting documentation.33s The VAT incurred must 

relate to the business carried on by the non-resident and the non-resident must not be making 

supplies of goods or services in Ireland. 

In order to promote fairness and neutrality olthe tax, the GST law should allow non-residents to 

reCOIIer input GST where is incurred for the purposes of its business activity, that activity 

would be taxable if carried on in Puerto Rico. For Puerto Rico, the New Zealand approach of 

requiring the non·resident to register lor GST is preferable over the simplified approach of Ireland, 

in order to reduce the opportunity for fraud. 

Tourist refunds 

All comparable jurisdictions, except New Zealand, allow to a certain extent a refund of GST paid 

by tourists on purchases of goods made in the jurisdiction during their stay, which they bring 

back to their jurisdictions. 

In order to maintain Puerto R.ico's "'""'""m'v"'""'"" in the tourism sector, GST refunds for 

purchased by tourists thai are Puerto Rico upon the tourist's departure 

provided. 

1 .B General 

1.8.1 Document retention 

Overview of concept 

In order to facilitate the efficient assessment and enforcement of the tax by the tax authorities, 

the GST law should prescribe document retention rules. The provision should describe what type 

of documents should be retained, for how long, where and in what format {e.g .• electronic or 

hard copyl. Special rules should be included in the GST law as documents supporting GST 

positions taken can differ from those documents used for income tax assessment purposes. For 

example, there may be certain GST specific regimes, or transactions with a greater GST risk that 

require specific types of documents to be maintained (e.g., import documentation, 

documentation relating to transfers of going concerns, GST invoices and adjustment notes), 
279 


Insert offset folio 248 here 98944.248

Consideration should be given to the complfance burden and associated costs placed on taxable 

persons with regard to record storage and this should be balanced against the tax risk, as well as 

the statute of limitations relating to lax reassessments. 

The rvles should also address tax authority access to the records. 

Leading Practice 

The document retention rules shovld be drafted to inclvde the following; 

0 

0 

0 

o Business and 

Books, bank "t"''"m'<>nl<tl 

mvst be retained for a certain defined 

period to which relate. The 

other tax and accounting in Puerto Rico. 

and 

purchase registers. 

from the end of the 

be consistent with 

Records be kept in a foreign upon tax authority approval or subject to 

certain as ae<:esl!ibillitv. 

the 

the 

electronic format provided that there are controls to Y"''"'"' """' 

origin of the documents and maintain the integrity of 

taxable person must able to produce any requested records to the lax authority 

within a reasonable tim,"'f'"'"'''"' 

Discussion 

Under the New Zealand GST Act, a GST registered person must keep records that are sufficient 

to enable ready ascertainment by the tax authority of that person's liability to tax for a period of 

at least seven years after the end of the taxable period to which they re!ate.339 

The law provides a non·exclusive list of records that should be kept, including books of account 

recording receipts or payment or income or expenditure, vouchers, bank statements, invoices, 

tax invoices, credit notes, debit notes, receipts, and such other documents necessary to verify 

the entries in the books of account 3M! 

Those records should contain at least {1l a record of all goods and services supplied by or to that 

registered person allowing the Commissioner to identify the goods and services, and the 

suppliers or the their agents; !2l the charts and codes of account, the accounting instruction 

manuals, and the system and program documentation; and (3) any list required to be 

prepared under the GST Act 

The New Zealand GST Act also includes special record keeping rules in relation to certain supplies 

of land, and powers for tl1e Commissioner to extend the record keeping period for an additional 

three years if the taxpayer is under audit or will likely be under audit 

"'New z.,lond GST Act, $ 75!3). 

"'" Now z,.!ao<l GST Acl, § 
280 


Insert offset folio 249 here 98944.249

The records must be maintained in New Zealand unless the registered person has been 

authorized by the Commissioner to keep the records outside of New Zealand.341 

In every taxable person is required to keep the following records for a period of five 

years from the end of the prescribed accounting period to which the record relates: (1) business 

and accounting records; {21 copies of all tax invoices and receipts issued by the taxable person; 

(3) tax invoices received by the taxable person; 14) documentation relating to importations and 

exportations by the taxable person; and (51 all credit notes, debit notes or other documents which 

evidence an increase or decrease in consideration that are received, and copies of ali such 

documents issued by the taxable The records can be in electronic format 

In Malaysia, every taxable person is required to keep full and true records of all transactions which 

may affect his liability to tax including (1) all records of goods and services supplied by or to that 

taxable person including tax invoices, invoices, receipts, debit notes, credit notes, and export 

declaration forms; (2) all records of importation ol goods; and (3! all other records required by the 

tax authority. 343 The records must be kept in Malaysia, unless record storage outside ol Malaysia 

has been approved, and must be kept for a period of seven years. 344 The records can be kept in 

elemronic format provided that the original document was an electronic document345 

Under the IMF Model law, every taxable person is required to maintain in the jurisdiction !1) 

original tax invoices, tax credit notes, and tax debit notes received by the person; (2) a copy ol all 

tax invoices, tax credit notes, and tax debit notes issued by the person; (3) customs 

documentation relating to imports and exports by the person; {4) accounting records relating to 

taxable activities carried on in the jurisdiction; and (5) any other records prescribed by 

Records must be retained for six years after the end of the taxable period to which 

they relate.347 The law defines records as accounting records, accounts, books, 

computer-stored information, or any other 

The Irish VAT Act provides that every taxable person must in accordance with regulations, keep 

full and true records of all transactions which affect or may aflect his liability to tax and 

entitlement to deductibility ior a period of six years from the date of the last transaction to which 

they refer. 349 

The basic records to be maintained by businesses (large and small) are essentially the same and, 

in brief. include invoices, credit notes,. debit notes, receipts, books, bank statements or other 
281 


Insert offset folio 250 here 98944.250

documentation that relates to the supply of goods or services, importation or intra·community 

acquisition of goods. 

The irish VAT Acl is much more prescriptive than the other jurisdictions and also includes specific 

record keeping rules for certain types at transactions that have a special treatment under the Irish 

VAT Actaau 

All comparable jurisdictions include a spacific provision detailing the recordkeeping requirements 

for GST purposes. The common theme of these rules is that ali records that enable the tax 

authority to validate the tax position taken by the taxable person must be kept lor a certain period, 

varying between five and seven years. 

Based on the comparable jurisdictions. it is leading practice to include spedfic record keeping 

rules in the GST law which will facilitate the inclusion of GST specific record keeping rules relating 

to GST specific regimes, where required. Taxable persons should be required to keep all invoices, 

credit and debit notes relating to input and output transactions. In addition, taxable persons 

should also keep customs documentation relating to import and export transactions performed. 

Finally, taxable persons should be required to maintain accounting records. 

The length of time records should be maintained should be in line with other tax and accounting 

rules in Puerto Rico. 

In order to minimize compliance costs, taxable persons should be permitted to maintain records 

electronically and in a foreign jurlsdiclion, subject to the tax authority's approval or guidelines. 

1.8.2 Currency 

Overview of concept 

Transactions with non-resident businesses may occur in foreign currencies. Exchange rate 

variations may thus creat<~ valuation distortions between the value of the supply at the time of 

supply and when the supply is reported. 

Further, where domestic mmsactions between businesses are conducted ln a foreign currency, 

if the supplier (JSes a different exchange rate to that of the purchaser, there can be a variance 

between the output tax reported by the supplier and the input tax claimed by the purchaser, 

potentially resulting in a cost to the government. 

GST laws thus generally include a provision dearing with foreign currency transactions. 

Leading Practice 
282 


Insert offset folio 251 here 98944.251

The currency rule should be drafted as a separate provision and incltlde the following: 

All under the GST law should be expressed in US dollars with the exchange 

rate at the time of used for currency conversion. 

A power for the tax to other currency conversion methods that may 

ease the administrative of the taxable person. 

Discussion 

In New Zealand, for transactions under the NZ GST Act, all amounts of money must be expressed 

in New Zealand dollars. 351 As such, GST invoices are required to be issued in New Zealand dollars, 

thus ensuring thai the output tax reported by the supplier is the same as the input tax claimed 

by the purchaser. The exchange rate should be the prevailing rate at the time of supply. 

In Singapore, where e value is expressed in a currency other than dollars, it must be 

converted into Singapore dollars at the prevailing selling rate at the time of The 

rnmn.tmu,, can also publish rates of exchange that may be used or determine other acc:eoted 

methods lor currency conversion. The use of alternative methods is generally subject to 

Comptroller approvaL 

Malaysia adopts a similar approach to Singapore. 353 The use of the following exchange rates 

corresponding to the time of supply is acceptable: 

exchange rates {buying, selling or 

• goods, conversion of foreign be at the 

by Customs which are updated every 

Under the IMF Model Law, aU amounts of money are to be expressed in the local lf 

an amcunt is expressed in a foreign currency, the amounts must be converted at the exchange 

rate determined in the customs act for imports and at the exchange rate applying at the time the 

amount is taken into account under the Act effectively the time of suppJy_:me 

Ireland requires that the amount of VAT included on a tax invcice must be expressed in Euros.357 

Where a currency other than Euro used, it must be converted into Euro, The exchange rate to 

be used must be:300 

• The latest selling rate recorded by the Central Bank of Ireland or the European Central 

Bank for the in at the time becomes due, il no agreement has 

been reached with as to the the excl1ange rate; 

• If there is an with the Revenue a method to be used in determining the 

exchange rate, exchange rate under that method. 
283 


Insert offset folio 252 here 98944.252

All comparable jurisdictions include a specilic provision in respect of currency conversion in order 

to provide certainty in respect of how foreign currencies are to be converted and to ensure there 

are no mismatches between what output tax is paid by a supplier and what input tax is claimed 

by a purchaser, Given the cQmpliance burden associated with monitoring foreign exchange rates. 

some jurisdictions allow the use of methods other than dally exchange rates !e.g,, mid-month or 

month end rates, rates to be renewed every three months). These concessions are usually 

provided as an administrative relief and not included under the law, other than providing the tax 

authority with the power to prescribe other methods. 

The location of the currency provision within the law also varies with some jurisdictions including 

the provision with the valuation sections (Singapere, Malaysia and Ireland) and others having a 

separate currency provision (New Zealand and the IMF). 

Leading practice would be to include a currency pmvision to avoid the issues discussed above. 

For simplicity it should be included as a separate provision, similar to the IMF and New Zealand 

law, Ali amounts under the GST law should be expressed it1 US dollars with the exchange rate 

applicable at the time of supply used for currency conversion. The section should also include a 

power lor the tax authority to determine other currency conversion methods that may ease the 

administrative burden of the taxable person. 

1 .B.3 Language 

Overview of concept 

In order to facilitate the administration of the tax, GST laws generally provide that records must 

be maintained in the local language. Some jurisdictions allow records to be maintained in another 

language provided that a translation can be made readily available upon the request of the tax 

authority. Such a provision is especially important for non-resident taxable persons that may not 

use the language commonly spoken in lhe GST jurisdiction in their day to day accounting system. 

Leading Practice 

The language provision should be drafted to include the following: 

Records should be maintained in 

Taxable to permission to maintain records in a 

language other 

Discussion 

In New Zealand, the Tax Administration Act requires that records to be kept English. However, 

the tax autherity may approve records to be kept in a foreign language upon request. 

Singapore and Ireland do not include any specific requirement regarding language their 

legislation. 
284 


Insert offset folio 253 here 98944.253

In Malaysia, all records regarding the supply of goods and services must be kept in Bahasa 

Malaysia or in the English langlJage.300 

The IMF Model Law states that where records are not kept in the national language, the 

Commissioner may require the person keeping the record to provide, at that person's expense, 

a translation into the national language by a translator approved by the CommissioneL,61 

The Malaysian approach to require record keeping in a specific language should not be followed 

as it may bo impractical for non-residents, especially those only registered lor GST refund 

pmposes. The IMF and New Zealand provide the leading practice in respect of language 

requirements, with the IMF being less stringent than New Zealand by not requiring the taxable 

person to obtain prior approval to keep the records in another language but by requiring a 

translation of the documents upon the tax authority's request 

In order to provide some control over the languages that are acceptable for record keeping, the 

taw should require the records be maintained In Spanish or English language. Should a taxable 

person wish to maintain records in another language, the taxable person should apply to the tax 

authority lor such permission. Approval of such applications should be dependent upon the 

language and whether the tax authority is satisfied that translated documents could be provided 

by the taxable person in a timely manner. 

1.8.4 Additional issues to consider 

Enactment of the tax and supplies spanning rate and rule changes 

The enactment of the tax and supplies spanning rate or rule changes may affect agreements or 

contracts that span the enactment, rate, or rule change. GST laws may change over lime to adapt 

to the revenue needs of the govemment or to address soclaf issues, The changes generally 

involve rate increases or decrease, or changes in the treatment ol particular types oi supplies 

(e.g., change the treatment lrom taxable to exempt or vice versa}. Therefore, GST laws generally 

provide for specific rules dealing with the transition period between old and new rules, 

Secondhand goods 

Taxable persons selling secondhand goods are required to charge GST their sales like any other 

taxable person. However, where they acquire those secondhand goods !rom non-registered 

persons, GST is likely to be imbedded in the cost of that acquisition as a result of the GST that 

was paid by the non-registered person on the initial acquisition of the good. In order to prevent 

GST being levied twice on the same good, jurisdictions adopt dille rem approaches. One approach 

is to apply a margin scheme lor such dealers in secondhand goods so that only the margin is 

subject to GST. Another approach is to allow a notional input tax credit on the acquisition of the 

second hand goeds from non-registered persons. The GST law should include rules governing 

sales and purchases of second hand goods. 

""M•lay$io GST Act § 36(2Hbl, 

1MF Model law, § 63, 
285 


Insert offset folio 254 here 98944.254

Domestic Reverse Charge 

Some countries apply the reverse charge mechanism on certain limited domestic transactions 

either to a110id additional administrative burden on taxable persons (e.g., cash flow burden arising 

from h!gh value domestic transactions) or to combat tax fraud and evasion (e.g., in industries 

where refund fraud is more likely). Introducing a domestic reverse charge results in the recipient 

of the supply accounting for both the input and output tax on the transaction, therefore 

eliminating any cash flow burden arising from the transaction for the parties involved and any risk 

of a fraudulent refund payment being made by the tax authority. Consideration should be given 

as to whether any industries in Puerto Rico would warrant such treatment. 

Agents for non-resident principals 

Many jurisdictions have specific rules around agents being liable for the GST payment and 

compliance obligations of non-resident principals. Some jurisdictions require the appointment of 

a fiscal representative at the time of the registration of the non-resident, while others include a 

deeming provision within the law whiol1 states that an agent carrying on an activity for and on 

behalf of a non-resident is liable for the non-resident's GST obligations. Consideration should be 

given as to whether Puerto Rico should adopt a similar approach. 

Electronically supplied services by non-residents 

"Electronically supplied services" (ESSl are generally services that are: 

• Delivered over the Internet or an electronic network {in other words reliant on the 

Internet or similar network for its provision); 

• Heavily on information techn<>int1v 

is automated, involving 

information technology does not have viability!. 

iin other words the service 

""'"'"~nttnn and in the absence of 

F'"'mr>l"~~ of ESS include digital books, downlceded music and videos, webhosting, online 

storage, software, apps, etc. 

Most GST jurisdictions do not tax services supplied by an overseas supplier to an end customer 

over the internet ii the supplier has no presence in that jurisdiction. However, there are special 

rules in the EU, Switzerland, Norway, Iceland, South Africa. and Ghana that require the providers 

of electronically supplied services to account for GST on sales to private consumers and nontaxable entities (e.g. public schools! in these territories {collectively B2C supplies), regardless of 

the absenca ol any local presence. B2B supplies are generally not subj<:~ct to these special rules. 

The rationale behind this approach is that creates a level playing fisk! for domestic suppliers ol 

such services and non-resident suppliers given that the consumer can generally obtain such 

services from anywhere in the world with ~<>lative ease. Puerto Rico should consider the 

application of such a regime. 
286 


Insert offset folio 255 here 98944.255

Appendix E: Goods and Services Tax Exemptions 
287 


Insert offset folio 256 here 98944.256

Appendix E: GST Systems and Exemptions 

A universally applicable broad basad fiat rate GST will be regressive. There are two ways to 

redress ragressivity. The first, adopted by most modem regimes, is through transfer payments 

select taxpayers to mitigate the impact of the tax on "nececssities," The second, used 

principaUy by early adopters, is to provide exemptions or special rates designated goods or 

services. Best practice indicates exemptions should be kept to a minimum to reduce the 

complexity of the administration of the tax 

This paper focuses on the issues associated with GST exemptions noted in our deliverable 

entitled "Analysis of Current Tax Structure and Optional Tax Strategies." it provides examples 

of some of the challenges faced by GST regimes that have chosen to usa exemptions to address 

regressillity. 

Overview 

A single rate, broad based system is prelerred because: 

• It towers cost of coltection (administration costs for the government and compliance costs 

for businesses).There are no disputes over which rates should apply to which goods and 

services nor is there any incentive to fraudulently apply an incorrect rate. Further, 

accounting processes are simplified bacause only one rate is required to be tracked. 

• A single rate avoids exemption creep and creating political vulnerability from businesses 

requesting to benefit from a lower rate. 

• It eliminates the potential disruption of consumer choices that may arise where multiple 

rates may create an incentive to purchase lower rated goods and services. 

• It minimizes the si!uations where suppliers will be making exempt supplies and therefore 

have an incentive to self-supply or vertically integrate because GST charged by third 

parties is net recoverable. 

• It reduces the number of entities that will be making both taxable and exempt supplies 

requiring them to track and apportion the GST charged on business inputs to ensure only 

GST related to taxable supplies is recovered. This apportionment is difficult to achieve 

accurately and disputes can arise between the taxpayers and ta)( authority regarding the 

methods used to apportion input tax credits. 

In 2007, Copenhagen Economics undertook a study on the application of reduced VAT rates in 

tile European Union. 362The study found empirical evidence indicating that compliance costs 

associated with lower VAT rates can be sizeable. It further found that differences in VAT rates 

between similar products may give rise to a substantial number of administrative and legal 

conflicts about the proper classification of specific goods. 

Co~)etl!laglm Economics, ~"!w:!y .:Nl r&duced cl,<\ T applied !O goods ami services #1 lii!J Member States of !Ill! 

Eut(){)IM)n Union, 21 Juno 
288 


Insert offset folio 257 here 98944.257

Collection costs are dillicult to estimate and data is hard to come by. However, one clear 

implication of the evidence from developed economies is that !he collection costs associated 

with GST are to be significantly affected by the design of the tax.~113 A broad based, single 

rate tax with a high registration threshold and few exemptions wili have relatively low collection 

costs. 

Evidence from New Zealand has shovvn that while precise administrative costs of GST may be 

difficult to ascertain, those costs are lowered if a broad based, low rate version of the tax is 

introduced. New Zealand's GST has had one major policy review since its enactment in 1986, 

which produced no recommended structural change. The Inland Revenue Department, 

responsible for most of the legislative work on GST. has the time of just 1ll2 professional policy 

staff dedicated to GST oot of a total tax policy complement of 45. The key point is the New 

Zealand GST regime has been low cost from an administrative perspoctive. This is generally 

attributed to the twin policy pillars of comprehensive coverage and a single domestic rate.3

6!1 

The study also observed that due to the substantial economic consequences of activities being 

classified with different VAT rates, businesses and tax authorities are constantly disputing 

borderline cases. In Sweden, such disputes constitute roughly 1/5 of all cases referred to their 

tax tribunal, and consuming. conservatively estimated, real resources in the public and private 

sector of almost US$100 million (Swedish Government, 2005),300 

The Study also found that even very detailed guidance on the appropriate VAT rates to be applied 

on each potential food-like product will not prevent a large number of borderline cases being 

disputed between businesses and tax authorities because having different VAT treatments for 

goods and services can create considerable incentives for traders to obtain a lower rate for a 

specific good or service. :!66 

Ultimately, the found that the income distributional effects of differentiated VAT rates are 

modest particularly countries with a equal distribution of income, relative to the 

resulting compliance costs and distortions consumer choice. For countries with lass 

comprehensive transfer systems and more unequal distribution of the ellects are 

The 

However, in botl1 cases the that more targeted systems and 

compliance costs could be costs to society.367 

stressed the need to consider alternatives to lower VAT rates to ""''"H~nli<>h 

Targeted subsidies may have smaller mechanical revenue loss 
289 


Insert offset folio 258 here 98944.258

Mechanical revenue loss arises where GST revenue foregone does not contribute to reaching 

the desired goal (e.g., GST exemption for food in order to improve the income distribution 

resulted in mechanical revenue loss because high income households will also benefit from lower 

GST).369 

Exemptions and reduced rates can rGsult in significant mechanical rewnue loss. in New Zealand, 

the evidence available at the time suggested that while the bottom 20% ol households allocated 

between 23% and 29% of their budgets to food, the top two deciles spent between 7% and 

10% oi their budgets on food, However, overall, upper income households spent tvvice as much 

as low-income households. 01 every NZ$100 spent on food in New Zealand, the least well off 

spent NZ$6J:i0, whereas the most wan off spent NZ$12. Taxing all food thus made revenue 

available to redistribute and supplement the income of the poor via other means, 370 

The OECD arrived at the same conclusions in Its bi..annual analysis of consumption taxes.371 The 

OECD observes that while most countries implement reduced rates and exemptions in order to 

alleviate the tax burden on low"'income households, the benefits are greater for the better of! 

resulting in tax expenditure producing a result that is unlikely to be in line with the original 

intention. 

Givan Puerto Rico's current administrative capabilities, a single rate, broad based system would 

be the best option, 

Specfflc Country Experience · Food 

Food exemptions create significant issues in determining whether particular food items fall within 

the exemption. Further, extensive tax authority guidance is required to help with this 

classification of food. Even with such guidance, there are often significant economic incentives 

for taxable persons to push the boundaries of those exemptions and dispute borderline case.s. 

Also, the exemption of certain food items results in foregone rewnue that could be redistributed 

more effectively. Some of the issues faced by some jurisdictions that have chosen to exempt 

food are discussed below. 

In UK, basic food products for human consumption are zero rated and Her Majesty's Revenue 

and Customs (" HMRC") provides complex guidance detailing all the exceptions to zero·rating in 

the VAT law. 

There are a number of exclusions from this treatment including: 

'~'" Copenhagen Ecooomlcs, Study 011 tedul!lld VAT appJi&d to goods and saNicos in the Member Stales of the 

Euro{)(lafl Union, 21 June 2007 at p, 6 

"" lan Dickson am:l Dlfvid White, Tax Design Insights from the New Ztilekmd Goods and Slillvices Twr Mode£ 

Working Paper Series, Work Paper No. 60, \lleloria University of Welliilgton, Apr. p. 6. 

OECD, Cor~sumption Tax Tnnls VAT/GST aml Excise Rates .• Trends and Mminisl1atirn1 
290 


Insert offset folio 259 here 98944.259

Cold items taken away may be zeroorated in certain circumstances while certain hot 

food items taken away are standard rated. 

Confectionery is standard rated. 

A supply of food in the course of catering is standard rated, 

Certain beverages are standard rated. 

With these exclusions come a number of classification and interpretation issues: 

• Hot vs. Cold takeaway food items 

In the UK, cold items taken away may be zero-rated in certain circumstances while certain 

hot food items taken away are standard rated. Disputes have arisen in respect of why food 

items may be hot when taken away (i.e" are they sold for consumption whilst 

hot or are they sold hot lor another reason(!. 

One dispute related to the sale of het bagels which HMRC sought to tax at the standard 

VAT rate. However, the taxable person successfully argued that the reason why the bagels 

were hot when taken away was that they needed to oo toasted to create a crunchy interior 

rather than for consumption whilst hot a

72 

Another dispute related to heated ciabatta. HMRC argued that the purpose of heating the 

ciabatta was for the customer to consume the food hot and therefore it should be standard 

rated. However, the UK VAT Tribunal agreed with the taxable person's argument that the 

ciabatta was heated to maintain optimum freshness and to create appeallng aroma in the 

shop, The taxable person further argued that it had no interest in, nor control over, the 

temperature at which the customer chose to consume the product. 

• Conl6ctio/llilry vs. Basic Foodstuffs 

ln the UK, conlectionary is standard rated while basic foodstuffs are zero·rated. There have 

been many disputes of the classification of conlectionary resulting a number of complex 

tests developed by the courts. 

The courts have found that confectionery is generally held as being any food normally eaten 

with the lingers and made by a cooking proc.ess (other than baking) which contains a 

substantial amount of sugar or sweetening Further, the courts consider the view 

of the purchaser, appearance, size, ingredients. manufacturing process, taste, texture, 

packaging and marketing are relevant 314 

These types of tests can obviously be very subjective, giving rise to further disputes as to 

classification of certain food products. 

17018) (WC 29Jl8L 
291 


Insert offset folio 260 here 98944.260

• Catering 

The treatment of the supply of food in the course of catering has also been the subject of 

many disputes, 

A supply of food and drink in the course of catering is standard rated, is 

characterized as a supply involving a significant element of service or the supply of food is 

for 'on premises' consumption. 

Many of the disputes have centered around what should be considered a "significant 

element of service." 

Disputes have also arisen in respect of whether the food supplied for "on premises" 

consumption. HMRC considers premises to be the areas controlled by the retailer or areas 

that have been specifically provided for the customer to consume the food purchased, 

Similar disputes have arisen in other countries, for example, where seats were provided by 

the European equivalent of a food twck vendor -does this constitute "on premises" 

consumption? 

• Drinks 

The classification of beverages is particularly complex in the UK. Beverages are generally 

standard rated, with the following exceptions: 

• Tea, mate, herbal teas and similar products, and preparations and extracts thereof; 

" Cocoa, coffee and chicory and other roasted coffee substitutes, and preparations and 

extracts thereof; and 

• Milk and preparations and extracts thereof. 

Disputes have not only arisen in respect of whether a beverage falls within one of these 

exceptions but also whether a drink is a beverage or not 

In respect of the former, the VAT tribunal found that as the drink contained over 50% milk 

extracts, the drink was able to be zero-rat<'!d, even though it did not appear to be a milk 

based drink, 375 

In respect of the latter, complex tests have been developed through case law to determine 

whether a drink is a beverage, 

The court found in Bioconcepts that notwithstanding the Oxford English Dictionary 

definition of "beverage" meaning drink, it not used in the sense of meaning all drinkable 

liquids. Its meaning in ordinary usage covers drinks that are commonly consumed. This 

concept of what is a commonly consumed beverage was characterized by the courts as: 

1, A liquid tllat is commonly consumed; and a liquid that 

""'Rivelfa IVKHid(VTD 163821 ffVC29J75), 
292 


Insert offset folio 261 here 98944.261

2. Increase bodily liquid levels; 

3. To slake the thirst; 

4. To fortify, or; 

5. To give pleasure 

These five points \Wre adopted by HMRC as being the key factors in determining whether 

a product is a beverage. They were placed in HMRC gt.Jidance through Public Notice 

701/14/02 Food (May 2002). Subsequent cases have cited the "Beverage Test" within the 

decision. 

Each of these five points gives rise to its own complexities and interpretation. An example 

is in respect o! increasing bodily fluids. In the case of Uni!ver Beslloods UK Ltd the tribunal 

found that the high sugar content of "Vie Shots" had the effect ol slowing the rate of 

absorption of the product Vle Shots were therefore not considered suitable lor quick 

hydration of body fluid levels. 

Some of the tests am quite subjective, the fortify and pleasure points. In respect 

of the fortify point, in the case of Ocean Grown UK Ltd, it was noted that to consider 

whether or not a beverage is it is important to look at how the customer 

perceives the product and what the marketing literature aays; it was felt that scientific 

research is irrelevant 

In Australia. basic food products are GST tree. Australia has very comprehensive guidance on 

food, including an SS page list of specific food items and their treatment Further. they have a 

dedicated Food Classification Working Party to address GST and food Issues. 

Where a certain food itern is not specifically listed, a taxable person needs to work through a 

complex flow chart to determine whether the food should be subject to GST. This flow·chan 

includes 12 steps, each giving rise to !heir own definitional issues. 

Not only can disputes arise in respect of the classification of food, as noted in the examples, 

but they can also arise where exempted foods are sold with other products. Such a dispute arose 

in Australia in respect of a supplier of exempt food who included promotional items with the 

food, such as radios and alarm clocks. Even though the promotion items were mark€1d as "free." 

the court held that the amount paid for the exempt food and the promotion item needed to be 

apportioned between the exempt food and the taxable promotional item. 51" 

Where food classification disputes arise, complex analyses of the products are often required. 

Another Australian case considered whether a mini ciabatte was a cracker. 371 The judge went 

through the following analysis: 

" the ingredients of Mini Ciabatte are substantially the aame as those of a cracker; 
293 


Insert offset folio 262 here 98944.262

• the ratio of ingredients in Mini Ciabatte and crackers are substantially the same; 

• the manufacturing processes are largely the same for Mini Ciabatte and crackers; 

• both Mini Ciabatte and crackers can be produced using yeast and can include 

fermentation stages; 

• the percentage of sugar as an ingrediant of Mini Ciabatte is within the range specified 

for crackers; 

• to the extent that the Italian origin of Mini Ciabatte is relevant, the evidence points 

towards the product being a cracker; 

• Mini Ciabatte and crackers are put to the same use; 

Mini Ciabatte and crackers are in supermarkets as comparable products; 

• while the market Mini as Italian flat bread, the treat it 

and sell it as a cracker or in the of crackers and 

• the moisture content of dry flat bread Ciabatte is quite low and similar to 

crackers; 

• Mini Ciabatte has an elongated ceil structure similar to that of a cracker; 

• both Mini Ciabatte and crackers have a gluten network; 

• the percentage of protein of Mini Ciabatte is within the range specified for crackers; 

" Mini Ciabatte's appearance (size, weight, docking, saltiness and thinness! is like that of 

a cracker; 

• Mini Ciabatte snaps or cracks like a cracker; and 

• Mini Ciabatte's long shelf life points to it falling into lha biscuit/cracker category. 

The case was appealed. The taxable person emphasized in the that the Mini Ciabatte was 

not a cracker on the basis that the water and yeast content of the mini ciabatte is outside the 

range ot those for crackers. 

in Ireland, basic food products are also generally zero-rated. However, certain items are 

specifically excluded from the zero rate (taxable at standard or reduced rate!. 

In 2007, Ireland had defined 2,500 subgroups of goods and services in order to implement a 

three-tier VAT with standard !21.5 parcent), reduced !13.5 and zero rates. Food 

alone had 89 such that nuts are zero rated, while are standard rated, cold 

pizza is :;:em warm pizza is reduced rated in a take-away. 

Ireland, again, has similar classification issues as lhe UK. The Irish authorities some 

interesting guidance on the classification of bakery products and food supplements. 

The products such as cakes, biscuits, bagels and croissants, 

based is liable to VAT at the reduced rate of 13.5%. However, 

bread that meets a certain ingredient definition is !labia to VAT at tl1e zero rate. The •nnrrA<1'"'1! 

definition of bread is specific and although products, such as bread, onion and 

!anne! bread are as bread, these do not conform to the ingredient 

definition of bread and do not therefore for !he zero rate of 

tl1<1 Member Sf:i;tes of the 
294 


Insert offset folio 263 here 98944.263

In respect of food supplements, the z<:~ro rate applies to the following substances, whether they 

are marketed as food supplements or not, provided they are formulated to make good the 

potential shortfall from the nutrition required for a normal, healthy diet: 

" Vitamins and minerals in solid form, such as capsules, tablets, piUs or lozenges, intended 

for oral consumption without further preparation; 

• Vitamins and minerals in Uquid form intended for oral consumption without further 

preparation, but not including beverages such as high vitamin drinks; and 

• Fish oils for oral consumption, 

The following substances do not benefit from the zero rate, even illabe!ed and marketed as food 

supplements: 

• Substances marketed specifioally to improve sporting or physical performance, e,g., 

ergogenic aids; 

• Substances marketed specifically for the purpose of bodily sculpture or weight reduction, 

e.g., slimming aids; 

• Substances that. although consisting in whole or in part of ingredients regarded as food 

supplements, are marketed for use other than for h\Jmim consumption, such as, 

liniments, ointments and rubs. 

• Substances in the form of bars or sweets or any other fom1 similar to confectionery; 

• Beverages of any kind {including water!, concentrates, crystals, essences, extracts, 

powders or other products for the preparation of beverages, unless they come within the 

scope of certain exceptions. 

Specific Country Experience- Education 

As with food, GST exemptions for education can give rise to disputes relating to the 

interpretations of the application of the exemptions resulting in significant administration costs 

the government. Some of the issues faced by jurisdictions that have chosen to exempt 

education are described below. 

In Australia, education is zero-rated !GST..free in Australian terminology), along with associated 

field trips, course materials and certain boarding accommodation. Education includes: 

al a pre-school course; or 

b) a primary course; or 

c) a secondary course; or 

dl a tertiary comse; or 

el a special education course; or 

fl an adult and community education course; or 

g) an English language course for overseas students; or 
295 


Insert offset folio 264 here 98944.264

hl a first aid or life.-saving course; or 

a professional or trade course; or 

a tertiary residential college course. 

The Australian Tax Office has issued a number of rulings to help taxpayers navigate the 

complexities around determining whether an education related service falls within the GST relief. 

Three of the rulings governing primary, secondary, tertiary and spacial education amount to 73 

pages o! examples of what is, and what is not, subjact to GST. 

For example, an amenities fee paid by students a university used for plant and equipment, 

buildings, lockers, childcare and parking facilities is not subject to GST while payments for using 

such facilities, such as parking, are subject to GST. However, at another college, students pay a 

$20 amenities fee but are given a photocopy card to the value of $20. This amenities' fee is 

subjoct to GST. 

While Australia treats education as not subject to GST, the Australian Bureau of Statistics found 

that in 2009·10, while the wealthiest 20% of households spent 2.3% of their annual expenditure 

on primary and secondary school fees, the poorest 20% spent only 0.35%. This suggests that 

the taxation ol education is not as regressive as one might think as wealthier households spend 

more of their income on education than poorer ones. 

The European Union (EUl VAT Directive provides that member states shall exempt the provision 

ol children's or young education, school or university education, vocational training or 

retraining, including the supply of services and of goods closely related thereto. Such goods and 

services need to be supplied by educational bodies governed by public law. In addition, tuition 

given privately by teachers and covering school or university education is also VAT exempt. 

The provision has given rise to many disputes with regards the scope of the VAT exemption. 

In Germany, for example, the tax authority considered that research activities performed by public 

sector higher education establishments fell into the provision of the VAT exemption lor 

education. The Court of Justice ol the European Union (ECJ) however held that only closely 

related activities to university education may fall under the VAT exemption. As making the 

research activity subject to VAT would not increase the cost ol education, and because research 

activities performed by universities are not essential to the provision of education, the 

ECJ held that research activities performed by universities are subject to VAT. 

Another dispute concerned what "school or university education" means. The ECJ held that the 

phrase is not limited only to education which leads to examinations for the purpose of obtaining 

qualifications or which provides training for the purpose of carrying out a professional or trade 

activity, but includes other activities which are taught schools or universities in order to develop 

''" C-287100, Commission v. Germany (Jun. 20, 2002!. 
296 


Insert offset folio 265 here 98944.265

pupils or stutients' knowledge and skills, provided that those activities are not purely 

recreational. :llll 

In the UK, a prlvate individual argued that the golf tuition he gave in his capacity as a director of 

a company must be exempt from VAT because the same tuition was exempt when he provided 

it as a partner in a partnership. The tribunal held that the VAT exemption is not applicable because 

the individual was not a body governed by public law or a body with similar objects having 

education as its aim.3st 

A golf club also argued that "green fees" should fall within the VAT exemption for education 

services. The issue is currently referred to the ECJ, which has to decide whether the VAT 

exemption requires that the scope of the exemption lor services closely linked to sport education 

restricted to membership fees. In such a case, "green fees," which mer~:Jiy constitute 

additional revenue for the club should not fall within the scope of the VAT exemption. 383 

Specific Country Experience- Httalthcsre 

Healthcare exemptions face similar issues. Primarily in respect of what types of hea!thcare 

should be exempt and classification issues relating to whether a particular type of service falls 

within the exemption. 

Defining the categories of exempt healthcare can be problematic. For example, should only 

services provided by registered health professionals {i.e., doctors and nurses) be exempt or 

should the exemption be extended to include all services intended to protect/maintain/restore 

the health of individuals. It the latter, should acupuncture be included but hypnotherapists, yoga 

and homeopathy be excluded? 

In lerms ol medication, should only prescription drugs be exempt from GST or should certain 

"over the counter" drugs also be excluded? How should over the counter drugs be treated where 

they are prescribed by a doctor? 

These types of issues create political pressure for exemption creep. 

Even once a set of exempt categories has been determined, as with other exemptions, issues 

can arise in respect of whether a particular good or service falls within an exemption, For 

example, in Australia, "appropriate" dental treatment is not subject to GST. In order to help with 

interpreting the term "appropriate treatment", the Australian Tax Office has issued a ruling. An 

extract from this ruling is reproduced below to illustrate the complexity of such "'"~'mr1ttn:n!':: 

"Appropriate treatment" also includes medical treatment of a preventativ$ nature, 

for example, a periodic oral examination where there is no evidence of an ailment 

prior to attendance. However, tiJis does not extend to tho supply of services and 

UKUT272 

Goods ar\d servic<~s tax: goods and services supplied by dentists {2() February 
297 


Insert offset folio 266 here 98944.266

goods in relation to customized mouth guards. Whilst a Cl.ISiomized mouth guard 

is a device that may prevent or reduce damage sustained to the mouth and teeth 

in the event of an it is not considered to be 'treatment' that is performed 

on a patient. 

43. To be GST-free, the dental profession must accept that the service is 

necessary and acceptable treatment, taking into account the patient's individual 

circumstances. 

44. Services provided in assessing a patient for insurance or litigation purposes, 

that is, medico-legal services, are not 'necessary for the appropriate treatment' of 

the patient and are not GST-free. 

45. Services which are predominamly for the improvement of the appearance of 

the patient are also not 'necessary for the appropriate treatment' of the patient 

and therefore, are not GST.free. 

46. Services tllat are intended to improva the health of the patient but which also 

comprise a 'cosmetic' component, for example, raconstruction of a badly 

damaged tooth, are 'necessary for the appropriate treatment' of tile patient and 

are therefore, GST-free. 

The EU VAT Directive provides that Member States should exempt the following services: 

• hospital and medical care and closely related activities undertaken by bodies governed 

by public law or, under social conditions comparable with those applicable to bodies 

governed by public law, by hospitals, centers lor medical treatment or diagnosis and 

other duly recognized establishments of a similar nature; 

• the provision of medical care in the exercise of the medical and paramedical professions 

as defined by the Member State concerned; 

• the proviskln of medical care in the exercise of the medic<~! and paramedical professions 

as defined by the Member State concerned; 

• the supply ol human organs, blood and milk. 

These provisions have been implemented in the 28 member states in various ways and 

resulted in abundant case law from both national courts as well as the ECJ. 

The ECJ held that tile VAT examption applies to medical seNices consisting of: 

• conducting medical examinations of individuals for employers or insurance companies, 

• the taking of blood or other bodily samples to test for the presence of viruses, infections 

or other diseases on behalf of employers or insurers, or 

• certification of medical fitness, for example, as to fitness to travel. 
298 


Insert offset folio 267 here 98944.267

However, the VAT exemption does not apply to the following services: 

• giving certificates as to a person's medical condition lor purposes such as entitlement 

to a war pension, 

• medical examinations conducted with a view to the preparation of an expert medical 

report regarding issues of liability and the quantification ol damages for individuals 

contemplating personal injury litigation, 

• the preparation of medical reports following examinations referred to the previous 

indent and medical reports based on medical notes without conducting a medical 

examination, 

• medical examinations conducted with a view to the preparation of expert medical 

reports regarding professional medical negligence for individuals contemplating 

litigation, 

• The preparation of medical reports following examinations referred to in the previous 

incident and medical reports based on medical notes without conducting a medical 

examination. 

determining which services were subject to the VAT exemption and which should be taxable, 

the ECJ observed that only medical services effected lor a purpose o! protecting, including 

maintaining or restoring, human health should benefit from the exemption. The fact that other 

services whose aim is not to protect human health should be taxable does not increase the cost 

of healthcare.300 

The ECJ also heid that supplies of dental prostheses made by an intermediary who does not have 

the status of dentist or dental technician are net covered by the However, the 

same supply would be exempt performed by a dentist or dental technician. 

A Danish taxpayer argued that the VAT exemption applies to the collection, transportation, 

analysis and storage of umbilical cord blood for possible future therapeutic use, wi1en those 

services are supplied by a private stem cell bank which is olficiaily authorized to handle stem 

cells from such blood. As stem cells are collected only to ensure that a particular resource will 

be available for medical treatment in the uncertain event that treatment becomes necessary but 

not, as such, to diagnose, treat or cure diseases or health disorders, the ECJ held that activities 

consisting the dispatch of a kit for collecting blood !rom the umbilical cord of newborn children 

and in the testing and processing ol that blood and. where appropriate, in the storage of stem 

cells are not VAT 

However. the ECJ held also that the removal of joint cartilage cells from biopsy cartilage material 

taken from a human being and their subsequent multiplication, with view to reimplantation for 
299 


Insert offset folio 268 here 98944.268

therapeutic purpcses, constitute the "provision of medical care," regardless of whether the cells 

obtained from the cell multiplication are intended for reimplantation in the donor or in another 

person.300 

An Austrian court held that the services of practitioners of "mental suggestion" do not qualify for 

the exemption lor medical care because practitioners of "mental suggestion" treat patients 

during individual therapeutic sessions by means of hypnosis and mental suggestion, and are not 

designated as paramedical IJ"'";''"'""'' 

According to a Swedish court, medical advice given by a certified nurse by telephone is not 

covered by the exemption for medical care because the nurse's advice is not based on physical 

examination of the patient and the nurse does not actually treat the n~'""''n •·· 

The Swedish tax authority considered that cosmetic and plastic surgery constituted medical care 

that is exempt from VAT and thus denied a taxpayer the input VAT recovery right on purchases 

made for this activity. The ECJ held that cosmetic and plastic surgery should be VAT exempt if 

those services are intended to diagnose, treat or cme diseases or health disorders to protect, 

maintain or restore human health, The subjective understanding of the person who undergoes 

plastic surgery or a cosmetic treatment has of it is not in itself decisive in order to determine 

·whether that intervention has a therapeutic purpose. It is also not sufficient that the surgery is 

performed by a qualified medical practitioner.''"' 

A Dutch court observed that independent aMsthesia assistants, who assist anesthesiologists 

during surgery in hospitals and clinics provide services that an essential part of the medical 

treatment of the patient Therefore, the services provided by the independent anesthesia 

assistants should be VAT 

The UK tax authority considered that prescription glasses ordered through an online ordering 

procedure are subject to VAT as they constitute a distinct supply to the eye eX!lm provided by a 

different optician or optometrist The UK tribunal held that the supplies in question should be 

exempt because neutrality requires online suppliers be treated the same as brick and mortar 

suppliers of the same product:l!!3 

AdminiWalive Court !Hi:lgsta lorvaltningsdomstolenL 9 Feb, 2011, Case 5772·10, Other Domestic 

PFC Clinic !Mar, 21, 20131. 

olll;:>peal !Getechtshofl of H(ll'!oganbooch, 4 Oct. 2013, Case 13!00538, Other Dornootic Case lew 

303F'rMcslnti<m Eyewear v, HM RGvtmue and C~stoms, TC02759, 120131 UKfTI 357 (TCl. 
300 


Insert offset folio 269 here 98944.269
301 


Insert offset folio 270 here 98944.270

Act 20-2012: Tax Incentives to Promote Export Services in 

Puerto Rico .................................................................................... 10 

Act 22-2012: Individual Investors Act, ..................................... 11 

Economic Impact Methodology .............................................. 13 

Quantitative Data ....................................................................... 14 

Act 20 Statistics .... . ............ 15 

Act 22 Statistics ............................................................................. 15 

Data processing ..... . ....... 16 

GNP and Economic Growth ..... . ... 17 

General Fund Net Revenues ..................................................... 17 

Recent Fiscal Events .................................................................... 18 

labor Markets ............................................................................... 19 

Occupation by Industry .......................................................... 19 

Construction Industry .................................................................. 20 

Gross Domestic Investment ....................................................... 22 

Employment in Professional and Technical Services ............ 23 

GDP by Sector ...................................................................... 25 

Summing up .................................................................................. 27 

Profile of Grantees ...................................................................... 27 

Employment .................................................................................. 29 

Investment.... . ....... 33 

Potential Income and Taxes ...................................................... 33 

Other Fiscal Revenues .... " '"" "" "" .... 34 
302 


Insert offset folio 271 here 98944.271

Grantee's Profile .......................................................................... 39 

Act 22 Economic Impact ..................................................... .41 

Qualitative Data .......................................................................... 44 

Other Economic Effects ............................................................. 45 

limitations ..................................................................................... 48 

Theoretical Approach ................................................................. 48 

Proxies of the Potential Base... . . .................................... .49 

Forecasts of the Act 20 Potential Base .................................... 50 

Description of the Data.. . ................ 50 

Imputation of NAICS to EHglb!e Activities ................................ 50 

Timespan of the Data.. . ....... 51 

Forecasting Method .................................................................... 51 

Forecasts of the Act 22 Potential Base..... . .............. 52 

Description of the Data ............................. , ................................ 52 

Timespan of the Data.. . ..... 52 

Forecasting Method ...... , ............................................................. 52 

Decree Estimates: The Static and Dynamic 

Scenarios for the Dynamic Capture Rate ....................... 54 

General Assumptions ........ , ......................................................... 56 

The Trimmed Mean .............................................. , ....................... 56 

Act 20 ............................................................................................. 5? 

Act 22 ............................................................................................. 63 

Act 20 ............................................................................................. 64 

Act 22.. .. . ......... 67 
303 


Insert offset folio 272 here 98944.272

The DDEC Approach ....................................................... 72 

Act 20 Assumptions .......................................................... 72 

Act 22 Assumptions .......................................................... 72 

Limitations with the DDEC Approach- Act 20 .............. 72 

LimitaHons with the DDEC Approach - Act 22 .............. 73 

*The information provided is based on DDEC's CRM database of Act 

22 Applications and Annual Reports. Data reflects all decrees 

approved as of 11/02/2015. It is important to note that database is 

se!f-repor1ed and hence subject to inherent limitations in terms of 

potential human errors. 
304 


Insert offset folio 273 here 98944.273

During the past 25 years manufacturing 

employment in Puerto Rico has seen a 

consistent decline. During the same period, 

professional services employment increased 

almost continuously. This evidences Puerto 

Rico's transition to a service economy, even 

though manufacturing output, due to its high 

productivity gains, has remained the main 

contributor to Puerto Rico's GNP. 

The economy's state calls for a wide ranging 

set of actions that w111 generate investment, 

stimulate productive activity and provide the 

basis for development of an advanced 

services sector with export potentiaL Both 

law 20 and law 22 address these needs by 

stimulating local production beyond 

domestic demand. In this respect, both 

incentive programs wH! contribute to a more 

robust service sector and thus, higher exports. 

This report highlights Act 20 and Act 22 

performance. particularly by providing a 

summary profile of current program 

beneficiaries along with detailed 

descriptions of their impact in the economy 

and potential impacts in a 10 year timeframe. 

The findings evidence the importance of 

maintaining both acts, since their positive 

effects are maximized when both laws are 

combined. Both pieces of legislation will 

continue to foster the development of Puerto 

Rico's service economy, increase the share 

of service export as a share of total exports, 

and ultimately run a service trade surplus of 

high-skill and high-paying services. 

Currently Act 22 has added over $266 million 

in acquired real estate, and by 2020 grantees 

will have demanded dose to $1,000 mil!ion in 

real estate investments. These investments 

will provide an injection of capital to the 

local construction industry. Moreover, the 

total value of individual expenditures of Act 

22 grantees wil! reach over $830 million by 

2024. Individual expenditures will provide for 

a wider tax base in Puerto Rico's economy. 

Similarly, Act 20 has generated new 

economic activity by exporting services and 

increasing Puerto Rico's participation in the 

global economy. This law has provided the 

greatest opportunity for technology transfer 

and spillover effects in the local economy. 

The analysis performed for this report shows 

that dose to 20% of Act 20 decree holders 

are local companies and more than 33% 

export to destinations beyond the U.S. 

market. In terms of the current economic 

impact a total of 7.033 direct. indirect and 

induced jobs are generated by the incentive 

program. !t is estimated that by 2024 dose to 

50.000 direct employment opportunities wm 

be created. The study reveals that jobs 

created under this program have a salary 

above the Island's average employee 

compensation. Finally by 2024 Act 20 

companies would have accumulated over 

$38.5 billion in gross revenue and paid over 

$800 miiHon in corporate income taxes. 
305 


Insert offset folio 274 here 98944.274
306 


Insert offset folio 275 here 98944.275

Since the end of World War It Puerto Rico has 

consistently maintained an economic 

development strategy which retains at its 

core, the attraction of foreign capital or 

foreign direct investment (FDI), with the aim 

of creating new economic activity. Such a 

strategy has been almost exclusively focused 

on new productive capacity in the form of 

capital-intensive manufacturing facilities. 

However, Puerto Rico's factor endowments 

have migrated from a traditional 

maquiladora {low-skilL labor surplus type of 

economy 1to a high-skill post-industrial service 

economy. The pool of highly educated 

resources has allowed for the development 

of a domestic service provider class that has 

fueled the shift to a post-industrial economy2. 

These new service based ventures have 

been mainly dependent on internal demand. 

Hence, due to the decline in manufacturing 

activity and the increase in local service 

providers, Puerto Rico's service economy has 

maintained a trend which could eventually 

catch up with the traditional manufacturing 

economy in terms of its impact on the 

aggregate economy. 

At the US level most states employ local 

policy tools to attract external investment. 

Puerto Rico, benefiting from its fiscal 

autonomy has employed fiscal policy tools to 

attract foreign capital and develop new 

economic activity. The main actors in this 

new scenario are fiscal policies that promote 

trade in services. Both Act 20 and Act 22 

support movement in this direction. 

The Department of Economic Development 

& Commerce (DDEC. for its Spanish 

acronym) is the agency responsible for Act 

20 of 2012, known as the Law to Promote the 

Export of Sentices, as amended, and Act 22 

of 2012, known as the Law to Encourage the 

Transfer of Individual investors to Puerto Rico, 

as amended. Utl!izing both laws. since 2013, 

one of the DDEC's main economic 

development strategies has focused on 

making Puerto Rico a top destination for 

business as wei! as an attractive location for 

establishing residence, for both high-profile 

individuals and companies. 

Act 20-2012 seeks to provide the appropriate 

environment and opportunities to make 

Puerto Rico a center of international services, 

by encouraging local service providers to 

expand their business and services to clients 

located outside the Island, and persuading 

foreign service providers to relocate their 

operations to Puerto Rico. Act 22-2012 

focuses on drawing new residents to Puerto 

Rico by providing a 100% exemption from 

Puerto Rico income taxes on all passive 

income realized or accrued after such 

individuals become bona fide residents of 

Puerto Rico. 

Currently few policy tools have the 

advantages to combine a scheme similar to 

the previous FDI era, particularly with our 

current economic profile. That is, the ability to 

create a series of incentives that- when 

combined- allows creating new economic 

activity by moving beyond domestic 

demand and satisfying increasing 

intemational demand for Puerto Rican 

products and services. At the same time that 

it attracts new productive capacity into the 
307 


Insert offset folio 276 here 98944.276

local economy, strengthens local 

economic activity in Puerto Rico. The Island's 

challenge is to maximize the spillover effects 

from both, the export of services and the law 

22 decree holders (grantees). 

Such policies have the effect to boost the 

competitiveness of firms established in Puerto 

Rico, vis~6~vis other U.S and international 

jurisdictions. These policies alone are not 

sufficient to pull Puerto Rico out of its recent 

economic malaise. yet, these measures, 

combined with adequate policy 

interventions that guarantee higher spillover 

effects (internal linkages) have a great 

potential to bootstrap economic 

development within a smalL open and 

export oriented economy. Both pieces of 

legislation wll! continue to foster the 

development of Puerto Rico's service 

economy, increase the share of service 

export as a share of total exports, and 

ultimately run a service trade surplus of highskill and high-paying services. 

The effects of these policy tools cannot be 

observed individually. To maximize the 

potential of both laws, they must operate 

together. That is, the best scenario for these 

laws to operate is to use Act 22 as an 

incentive to import new capital and 

knowhow into the economy, and Act 20 as 

an export vehicle for both local and newly 

formed enterprises in the Island. 

The newness of such instruments and their 

recent implementation means that any 

analysis of their impacts may well be 

premature. since it usually takes five or more 

years for substantial effects to be observed in 

the economy. Nevertheless, this report has 

been able to highlight several direct effects 

of these incentives, which are expected to 

continue increasing during the next few 

years. To measure the impact of these laws 

on Puerto Rico's economy. the DDEC 

commissioned Estudios Tecnicos, Inc. to carry 

out an economic impact study 

Moreover DDEC uses other policy tools which 

seek to complement the incentives offered 

by Act 20/22. These other laws provide tax 

incentives to promote the !ntemationa! 

Financial Entities ("IFEs") (Act 273-2012). and 

the International Insurers and Reinsurers Act, 

which establishes the legal basis for the 

International Insurance Center of Puerto Rico 

{Act 399-2004). Through Act 399, insurance 

companies can export and import insurance 

and services related to the insurance industry. 

While Act 273 seeks to make Puerto Rico an 

intemational banking and financial center 

by providing tax incentives for banking and 

financial services provided to clients outside 

of Puerto Rico. Law 73 of 2008 is the 

legislation that provides a wide range of 

incentives mainly related to manufacturing, 

but provided an initial basis for a transition 

from manufacturing to a service economy. 

This document describes the methodology 

used to pursue the economic impact of tax 

incentive laws, the legal and economic 

background, data gathering procedures, 

economic impact analysis, economic 

impact forecasts and recommendations. 
308 


Insert offset folio 277 here 98944.277
309 


Insert offset folio 278 here 98944.278

During 2012, two laws were enacted to 

promote the transfer of investors to Puerto 

Rico and to incentivize export of services 

from the Island. These laws have been known 

as Act 20 and Act 22. Even though both 

policy tools are administered by the DDEC 

and have been promoted together, their 

core tenets vary substantially. 

This law applies to companies established in 

Puerto Rico that export services to 

jurisdictions outside the Island. Act 20-2012 

arises from an analysis which demonstrated 

the comparative advantage of Puerto Rico 

in foreign markets. The Island's competitive 

edge is particularly strong in the provision of 

advanced services such as: information 

technology and communications, project 

management financial services and 

business support services, among others. 

This initiative provides substantial tax 

incentives for businesses that wish to establish 

or expand their operations by exporting 

services from Puerto Rico. Companies that 

hold an Act 20 decree will benefit from: 

4% fixed income tax rate on export 

service activities. 

3% fixed income tax rate ln the case of 

services considered strategic and over 

ninety percent (90%) of a!! gross income 

of the entity that carries out the eligible 

business and its affiliated entitles is 

derived from the provision of services for 

export. 

100% tax exemption on distributions from 

eaming and profits. 

90% tax exemption from real and 

personal property taxes related to 

property used in eligible activities, 

Businesses who perform centralized 

management services, shared services 

and cal! centers benefit from 100% 

exemption. 

60% tax exemption on municipal taxes 

(90% tax exemption if business operates 

within the municipalities of Vieques and 

Cu!ebra). 

No federal taxes on Puerto Rico source 

income 

To obtain a decree under Act 20, a person 

who has established or proposes to establish 

an eligible business in Puerto Rico, may 

request the benefits by filing the 

corresponding duly sworn application with 

the DDEC's Office of Industrial Tax Exemption 

(OITE). 

The following are the activities eligible to 

receive benefits under the Act: 

Research and development 

Advertising and public relations 

Consulting services 

Creative industries 

Production of blueprints, architectural 

and engineering services, and project 

management 

Professional services such as legal, tax 

and accounting services 

Centralized management services 

Centers for electronic data processing 

Development of licensable computer 

software 

Voice and data telecommunications 

between persons located outside of 

Puerto Rico 

Call centers 

Shared services centers 

Storage and distribution centers 

Educational and training services 

10 
310 


Insert offset folio 279 here 98944.279

Hospital and laboratory services 

Investment banking and other financial 

services 

Promoter services 

Commercial and mercantile distribution 

of products manufactured in Puerto Rico 

for jurisdictions outside Puerto Rico 

Assembly, bottling and packaging 

operations of products for export 

Marketing centers 

Trading companies 

In terms of the effective period of the 

incentives, the law provides that once the 

service provider is officially granted the 

decree, tax rates will be secured for the 20 

year term, irrespective of any changes in the 

applicable Puerto Rico tax laws. The decree 

may be eligible for a ten year extension. 

To maintain accountability with respect to 

the performance of the program. most 

decree holders will annually file a report no 

later than thirty 130) days after the filing of the 

corresponding income tax return. This report 

shall contain data that shows compliance 

with the conditions set out in the decree for 

the immediately preceding taxable year, 

including average employment generated 

by the services covered by the decree and 

other performance measures. 

Act 22, as amended, provides significant 

incentives to individuals who decide to 

relocate to Puerto Rico, and establish their 

residence here. So far the incentives have 

attracted new capital investments in the real 

estate and financial sectors. although there 

have been investments in other sectors. 

This Act applies to individuals, who have not 

been residents of Puerto Rico for the 6 year 

period 3 prior to January, 2012. To benefit 

from the law. the individual needs to 

become a bona fide Puerto Rico resident. 

for the purposes of the law, a resident of 

Puerto Rico means a person who is present 

for at least 183 days during any tax year4• All 

program participants from December 1 >t, 

2015 and onwards wiH be required to acquire 

a residential property and a bank account in 

Puerto Ricos. 

Tax exemptions include: 

100% tax exemption on interest and 

dividend income received by Resident 

Individual Investors during the Exemption 

Period. The exemption applies to all 

sources of such income. 

In the case of tong-term capita! gains, the 

Act provides for either a full Puerto Rico 

income tax exemption or a reduced tax 

rate of 5%, depending on meeting 

certain requirements 

No federal taxes on Puerto Rico source 

income 

In order to benefit from the incentives 

provided in this Act, every Resident Individual 

Investor must request from the Secretary of 

Economic Development the issuance of a 

tax exemption decree pursuant to this Act, 

by filing a duly swom application before OITE. 

Once the individual is officially granted the 

incentives. such benefits become an 

agreement between the Govemment of 

Puerto Rico and the individual. The maximum 

of residence for the resident 

Per an amendment introduced in .l\ct 187-2015. 

11 
311 


Insert offset folio 280 here 98944.280

term for the agreement ends in December, 

2035. 

Also, since the December 20 J 4 amendment, 

every resident individual investor who holds a 

decree granted under this Act, shall file an 

annual report not later than April 15 of each 

year6. During 2013, the annual report was 

The report's methodology uses a multivariate 

approach, which essentially entails the use of 

various research methods (including primary 

and secondary research) to gather data and 

validate results. An additional test for quality 

control identifies outliers and estimates 

margin of errors. 

Data was initially gathered from DDEC's 

database system {which wi!! be described 

below), data was then validated with DDEC 

personnel, and also measured against 

individual data points, gathered from 

interviews with Act 20/22 service providers 

and other key industry informants 7• Yet. the 

main information source of the report relied 

on empirical evidence gathered from 

annual reports and decree applications. 

To capture the complete spectrum of Act 

20!22 information, ETI developed a hybrid 

approach which combined data from 

annual reports s (being the most accurate 

A thirty (30) day extension may be granted. 

Annual 10ports are conside1ed more accurate data 

year. 

required as a condition in the decree, all 

decrees awarded prior to the enactment of 

this requirement, are not obliged to file the 

report. To assess the program's performance, 

annual reports contain data that reflects 

compliance with the conditions set out in the 

decree for the taxable year immediately 

preceding the date of filing. 

source of information) and complemented 

that data with information provided by 

decree holders (grantees) in the application 

form9• Hence, for all approved decrees with 

no annual reports, the information was 

obtained from the application form. In order 

to create a unified database of DDEC's 

app!lcations and annual reports, information 

was validated, merged and standardized. 

Generally, applications will offer a wider set 

of data points, since applicants are required 

to provide financial, legal and operational 

information about their businesses and 

investments before a decree is granted. 

!tis important to note that not all fields under 

the annual report can be complemented 

with the applications. In some instances both 

data objects do not coincide. Therefore, 

some of the analyses in the report utilize the 

hybrid approach, and other will depend on 

the tendencies reflected in the applications 

or annual reports exclusively. This condition is 

12 
312 


Insert offset folio 281 here 98944.281

particularly relevant for Act 22 for which 

reports vary substantially from applications. 

To estimate the economic impact ET! 

developed a series of econometric tools that 

gauge employment, fiscal revenues, 

investment and consumer spending. As will 

be explained in each section of the report, 

every Act has its own set of procedures to 

determine the economic impact in Puerto 

Rico's economy. This is particularly important, 

since both laws are usually perceived as 

similar policy tools. However, in economic 

terms both Acts utilize different incentives 

and thus. produce different impacts in the 

economy. 

The methodology employed for Act 20 

follows the procedures used for an economic 

incentive program which targets businesses 

established in Puerto Rico and which plan to 

export se!Vices to other jurisdictions, 

including the U.S. This diverges from Act 22 

which is focused on attracting foreign 

individual investors IO and the diaspore, into 

the local economy. 

There are several ways to measure the 

economic impact of export activif!es, yet, 

most of the analysis will focus on a few 

economic variables which have tangible 

effects in the economy such as sales volume, 

value added per GOP, wealth creation in the 

form of property values, personal income 

and job creation. AI! these measures (if 

positive) serve as proxies for improvements in 

the economy's well-being. Nonetheless, 

these estimates cannot be equated with a 

cost-benefit analysis 11 , which will require a 

different methodological approach and its 

inconsequential for these type of incentive 

program. !t is important to note that these 

measures are overlapping. Thus, when 

determining the aggregate economic 

impact, measures cannot be simply added. 

On the other hand the methodology used 

for determining the impact of foreign 

investment usually incorporates the 

economic literature of Foreign Direct 

Investment (FDI). This type of analysis centers 

on econometric tools at the aggregate 

national level with no particular 

consideration to individual investment efforts, 

which is the focus of Act 22. Thus. the 

methodology employed in this report 

combines the concept of FDI with a 

particular focus on individual private 

investments. The studies developed around 

individual private investment, such as those 12 

regarding the US EB-5 Visa program 13 are 

13 
313 


Insert offset folio 282 here 98944.282

particularly relevant. It is important to note 

that several decree holders (grantees) have 

combined their incentives from Act 22, with 

those from Act 20, by moving their business 

operations to Puerto Rico. Yet, the 

methodology employed has standardized 

the data to guarantee that economic values 

are not double counted when these 

circumstances are present. 

Variables such as employment, investment 

(mostly real estate), consumer spending and 

fiscal revenuesl4, will be used to assess the 

overall impact in the economy. For salaried 

workers employed by the investors, a salary 

characteristic of their respective 

occupations (lf available) wHI be imputed. 

Household spending for investors and their 

hired employees will also be estimated so as 

to determine consumption-based taxes and 

their spending~side impact upon the 

economy. It is important to point out that the 

economic impact of these investors goes 

To understand the sources of data available, 

interviews were conducted with personnel 

from the DDEC OITE and the agency's 

information technology consultants. 

Currently, the DDEC has three sets of data 

related to Act 20 and Act 22 beneficiaries: 

Applications - AI! beneficiaries are 

required to submit an application 

requesting a decree that contains the 

most information. However. data must be 

analyzed as proposed or potential 

tax 

beyond mere household spending, as these 

investors purchase vehicles. properties, other 

durable goods. and generate indirect 

economic activity as a result of these 

purchases. Whenever possible, these 

spending pattems will be taken into account 

in the estimation and forecasting analysis. 

Economic multipliers will be used to 

determine direct, indirect. and induced 

employment produced by Act 20 businesses. 

These estimates will have an aggregate 

impact on GNP that can be determined 

using a labor input-share analysis upon the 

relevant industries. Additionally, population 

forecasts will be used to determine potential 

employment in the following years, as well as 

economic impact derived from their 

expectations. 

A detailed description of the econometric 

methodology employed in the estimates will 

be explained in the Forecasts section 

impacts estimated with no specific 

timeframe. 

Decrees- Is the agreement between the 

Commonwealth and the Act 20/Act22 

beneficiary. Per DDEC's database, 

information is limited, but contains 

accurate data on the actual number of 

beneficiaries per program. 

Annual reports - An annual report 

constitutes the most accurate 

representation of recent economic 

activity of program beneficiaries; 

completeness. accuracy and uniformity 

of data was enhanced for the purposes 

of this report. Both Acts have different 

-Estimates of the tax revenue generated from personal 

irtcome. and sales taxes 

14 
314 


Insert offset folio 283 here 98944.283

requirements in terms of annual reports. 

Act 20 requires annual reports to be filed 

30 days after the tax retum filing date. On 

the other hand, Act 22 reporting 

requirements will vary depending on the 

date of issuance of the decree. Act 22 

decrees granted before mid-20 13 are 

not required to submit annual reports. 

Data was gathered using DDEC's web based 

system call CRM {a Customer Relationship 

Management tool created on Microsoft 

Dynamics). This platform is used by grantees 

to submit decree applications and also to 

submit their annual reports. Simultaneously, 

DDEC personnel use this too! to manage and 

monitor both programs. Estudlos Tecnicos' 

team was granted access to the system. so 

as to gather the necessary data to assess the 

economic impact of both programs. 

Additional efforts have been made to obtain 

data filed prior to the establishment of the 

platform. It is important to note that a 

migration process was undertaken at the 

DDEC prior to the development of CRM. This 

process transferred most of the information 

from hardcopy files into the web-based 

system. As described in the addendum some 

of the limitations inherent to the data are 

intrinsically related to this process. Thus, a 

great deal of emphasis was placed on 

obtaining high-quality data and developing 

adequate control measures. 

As of November 2nd, 2015, there were 360 

Act 20 decrees approvedl5, Out of the total 

approved decrees only 160 decrees had the 

responsibility to file an Annual Report due to 

their business' commencement of operation 

date. A total of 129 had submitted annual 

reports (complete) by the time of this report. 

To bridge the gap between available 

information from annual reports and the total 

number of decrees, data was also gathered 

from decree applications. The methodology 

further explains this procedure. 

As of November 2, 2015, there were 574 Act 

22 decrees approved. 16 According to 

DDEC' s database, only 133 reports were 

presented for taxable year 2014. 11 The 

difference between decrees and annual 

reports is partially attributed to grantees 

which did not had the obligation to file due 

to amendments to the enabling Act and the 

time allowed in the decree to forma!!y 

17 This amount excludes any canceled and Incomplete 

15 
315 


Insert offset folio 284 here 98944.284

establish residence in Puerto Rico. 

Furthermore. annual reports were adjusted to 

guarantee that decree holders with spouses 

were not double counted if both family 

members were decree holders. Also, reports 

were adjusted for decree holders which had 

both Act 20 and 22, and thus could have a 

potential double counting in the operational 

business analysis. 

Regarding applications, there are several 

pending cases which are in transit to 

approved decrees. For instance, around 159 

applications have been filed but are not yet 

approved, and another l01 applications are 

in process in CRM, but have not been 

properly filed. 

To develop a uniform data set. information 

from applications. decrees and annual 

reports was generated using CRM. Reports 

(applications. decrees and annual reports) 

obtained from CRM provided all data. as 

self~reported by the grantee. These individual 

files were consolidated in order to gather the 

greatest amount of information for each 

case, using the decree/case number. used 

as the unique identifier. 

Application forms and annual reports 

template capture multiple data fields. Yet, a 

set of data points which are relevant for 

assessing the economic impact of both laws 

was selected. During the data merge, some 

fields were included or excluded to 

guarantee consistency and/or minimize 

duplication. For instance, individuals under 

Act 22, whose spouses are also decree 

holders, and who have businesses with Act 20 

decrees. 

A preliminary analysis of CRM data 

demonstrated various limitations mostly due 

to incomplete data and lack of uniformity. 

For instance: 

Data is self-reported and thus cleanup 

was required. 

The forms, and systems used to capture 

the data have changed over the years, 

thus subject to submission date, different 

data fields are included. 

Since there are no required fields in the 

application and annual report templates, 

some information is missing in CRM. 

Data related to the service type, as well 

as other fields, required a standardization 

procedure. Partially due to the fact that 

the system does not provide a set of 

altematives to choose from. 

The report includes a section solely 

dedicated to the information gathered from 

applications and reports and how to 

develop adequate performance measures. 

16 
316 


Insert offset folio 285 here 98944.285

With the exception of 2012, Puerto Rico 

hasn't registered positive economic growth 

since 2006. Given the fiscal situation, public 

spending is expected to see substantial 

declines in the coming years. The recession 

has begun to impact personal consumption, 

In October of 20 15 general fund revenues 

were 99.7% of estimated revenues. Even with 

the positive news regarding revenues the 

Department of the Treasury has revised its 

2015 revenue estimate down by $354 million. 

which for the first time since 2009 declined in 

2014 (-2.6%). Estudios Tecnlcos has projected 

negative growth until the end of the decade. 

The Island currently faces reductions in 

Medicare and Affordable Care Act funds 

which could force the reduction of health 

benefits for many of the Island's elderly and 

low income residents. 

Revenues were higher in the first quarter of 

fiscal 2016, yet October reflected a 7.3% 

decline in revenue. The increase in the sales 

tax that went into effect on July 1st is 

expected to bring in an additional $Llll.7 

million in revenue to the General Fund. 

17 
317 


Insert offset folio 286 here 98944.286

To address short-term liquidity problems, 

emergency cuts and self-financing measures 

had to be enacted. The greatest of these is a 

$400 ml!lion internal Tax Revenue 

Anticipation Notes (TRANs) issue, which will 

be purchased by SINOT, ACAA and the State 

Insurance Fund. 

Other measures include delays on tax refund 

payments and payments to suppliers, 

reorganization of government agencies and 

restructuring their payment and serviceproviding processes, and 

privatization/suspension of AMA routes, 

including reducing Sunday services. For 

Net Migration since 2010 reached over 

200,000 people in 2014. According to the 

Cumulative Estimates of the Components of 

Populations Change, approximately 218,137 

people migrated from Puerto Rico during the 

period from April l, 2010 to July 1, 2014; 

55,092 of which migrated during July 1, 2013 

additional liquidity, an agreement is in 

process for the Retirement fund to pay their 

part of the retirement pensions owed in July 

and October directly, instead of these being 

paid by the General Fund 

Even with these measures the necessary 

liquidity needed for the first half of fiscal 2016 

was not acquired. This has increased the risk 

of additional emergency measures being 

taken to address the lack of liquidity. These 

measures could have adverse effects on 

economic activity as they contemplate a fu!! 

or partial government shutdown, a reduction 

of the working day for public employees, or 

default of further instruments. 

to July L 2014. The local population 

decreased 1.2% annually since 2010, 

reaching 3.548,397 inhabitants in 2014 

177.392 persons fewer than the baseline 

Census estimate (3.725.789). The population 

estimates for 2012 and 2013 were also revised 

downward, to 3.642.281 and 3.595.839 

persons, respectively. 

Population 

3.808,610 

3.725.789 3.686.771 3.642.281 3.595.839 3,548.397 

2000 2010 2011 2012 2013 2014 

Sources: Census Bureau. Population. Population Census 2000 and 2010; Current population survey; Population 

18 
318 


Insert offset folio 287 here 98944.287

Labor markets continue to downsize with the 

cumulative net loss of jobs reaching 137,894 

employees between 2007 and 20 i 5. 

Although salaried non-farm employment has 

increased since June on a year over year 

-07.892 

-137)394 

Pvb!ie 

Source: PR nercactm,ent 

basis, the cumulative loss of jobs reached 

67,892 in the public sector and 69.647 in the 

private sector. Of the private employment 

losses, approximately 50% of the 

accumulated losses were from 

manufacturing employees. 

(Employment) 

-69.647 

Manufocturing 

Statistics, non-farm employment (adjusted 

Current Employment 

-<-until september 

Of particular importance is the employment 

in the technical services industry as many 

investors that take advantage of laws 20 & 22 

belong to these occupations. Employment in 

this industry has increased between 2012 and 

2014 by 6.4%, from 26,990 fo 28,720, This 

increase could be reasonably attributed to 

the passage of Acts 20 & 22, since there few 

other policy measures specifically targeting 

these sectors. This is an impressive growth rate 

given the fact that total salaried non-farm 

has been declining as presented in the 

previous section. 

Office and administrative support has 

registered an increase. in 20l41t represented 

32.7% of employment in the technical 

services industry up from 31.5% in 2012. 

Architecture and engineering, and business 

and financial operations have also slightly 

increased and represent the second and 

third occupation respectively. 

19 
319 


Insert offset folio 288 here 98944.288

Office8ndAdministralivE' 

Support, 31.5% 

11.1% 

" Architecture and 

Engin<>cring 12.2% 

Occup,Jtional Ernploynwnt S~Jrw:y, US Depc1rtrnent of Labor SciE'nce,2..'i% 

Manilgemf'nt, 6.2% 

Offla'iJnd 

Admimstrative 

Support, 32.7%", 

Legal,6.8% 

Business and Financial 

Operations, 12.9% 

Co~1putN and M8thematical, 

~~.Architecture and 

Engmeering, 13.3% 

llfe, Physical, and SociJIScience, 

Source: Occup;:1tional Employment Survev, US Department of Labor 

Construction activity has remained in 

contraction or stagnant since 2008. In the 

second quarter of 2015 construction permits 

stood at 33% of their 2008-03 totaL This 

decline in investment highlights the need for 

foreign investment in key sectors of Puerto 

Rico's economy. 

In recent trends, following a short period of 

moderate growth, construction permits 

resumed their decline. Cement soles 

continued declining in inter-annual terms. 

20 
320 


Insert offset folio 289 here 98944.289

After a sustained increase in construction 

permits from 2014-02 to 20 15-Q 1, the number 

of construction permits decreased by 10.8% 

during the first two (2) months of 2015-02. 

Cement sales showed inter-annual declines 

of 11.9% in 2015-01 and of 5.4% in 2015-02. 

Source: PR Plannlr,g Board (2015). Number of Construction Permits (lola/}. •up ur>!J'i lc~oy2015 

Growth ln Number of Construction Permits 

Quarterly 2008 Q3. 2015 ar 

Growth in Cement Soles 

Sovrce: PR Planning Soard (2D1S) Cf'menl Soles (lf"oousand> of94ib so<:KO). 'lnteronnuo: grow1f">< 

21 
321 


Insert offset folio 290 here 98944.290

Investment has declined in the past two 

years, and is now 29% or $559.4 million below 

the 2006 totaL Gross domestic investment is 

projected to continue to fall in the coming 

years as public spending declines. This 

generates a need for foreign private 

investment to help mitigate the negative 

effects of budget cuts in the coming years. 

Acts 20 and 22 could be used as tools to 

attract foreign investment and generate 

local employment. Investors could also 

contribute to the general fund, as their 

economic activity would generate tax 

revenue. 

Gross Domestic !nvestmeni Growth 

The following sections present the current 

state of the professional and technical 

services sector. This is one of the main sectors 

affected by Act 20 and 22. Although this has 

been a traditionally small sector within the 

Puerto Rican economy, it has been one of 

the few that has registered growth in 

In the past 25 years manufacturing 

employment in Puerto Rico has seen a 

consistent decline. During the same period 

professional services employment increased 

almost continuously with the exception of the 

employment in the past years. The local 

economy is dominated by the 

manufacturing sector which represents 47% 

of the GOP. Yet. measures must be taken to 

diversify the economy and incentivize 

growth in sectors that have strong growth 

potential. 

mid 2000s due in part to the beginning of the 

recession. Although employment has been 

growing ln service industries, it has not been 

enough to compensate for the loss in the 

manufacturing sector. The graph below 

presents salaried nonfarm employment for 

the period between 1990 and 2014. 

22 
322 


Insert offset folio 291 here 98944.291

This represents a shift in the employment 

available in Puerto Rico. given that is one of 

the few sectors that has registered significant 

growth. it implies that this type of work should 

be promoted and incentivlzed. Act 20 and 

22, when applied together, help attract 

individuals and businesses which help 

According to data from the Quarterly Census 

of Employment and Wages, employment in 

professional and technical services has been 

steadily increasing since 201 L In 2014 

employment stood at 29.287. slightly below 

the 2006 high of 29.708 but 12.7% higher than 

generate more employment in this growing 

sector. In the following sections the 

Professional and technical services sector as 

well as the management of companies and 

enterprises sector are presented. !tis in these 

sectors that the majority of Act 20 and 22 

beneficiaries should be classified. 

in 2011. Employment in management of 

companies and Enterprises registered a 

12.5% with respect to 2012, and in 2014 stood 

at 11,681. Professional services employment 

includes all services classified under NAICS 

sector 54 which includes: architectural, 

engineering, scientific, design, and publicity 

services among others. 

23 
323 


Insert offset folio 292 here 98944.292

In 2014, employment in Professional and 

Technical services, concentrated primarily in 

management and technical consulting 

services with 21.4% of all sector employment. 

This was followed by legal services with 17.9% 

and architectural and engineering services 

with 16.2%. Computer systems design and 

related services is the only other classification 

to represent more than 10% of employment 

in the sector. As more beneficiaries of both 

acts arise, a small shift in the distribution of 

professional and technical services 

employment could be observed. 

Distribution of Employment in Professional and ledmical 

Services 

24 
324 


Insert offset folio 293 here 98944.293

Wages in the professional and technical 

services sector have remained stagnant ln 

the past decade, the !ow est point coming in 

2010 when the average annual salary was 

$37.905. The average pay presented in the 

following graph has been adjusted for 

inflation and is presented in 2014 dollars to 

facilitate the comparison between the years. 

To adjust for inflation, the Consumer Price 

Management 

Index for Puerto Rico was used. In 2014 the 

average pay was up to $39,416. this is around 

$2.300 below its 2004 high. The average 

annual pay for management of companies 

and enterprises in 2014 stood at $47,561, up 

from the 20 lO low of $45,892. The average 

annual pay for management of companies 

and enterprises is also presented in 2014 

dollars. 

(/014-inHcllio:J Adjusted) 

In 2014 professional and technical services 

GDP reached $1,783.1 million, which 

represents 1.7% of Puerto Rico's GOP. 

Manufacturing represents nearly half of the 

Commonwealth's GDP. this is followed by the 

real estate and rental sector with 15.2%, and 

the govemment with 7.6%. 

25 
325 


Insert offset folio 294 here 98944.294

Government, 

Health Core, 

3.5% 

Profes~ionoi, Scientific:, 

and 1 echnical 

Se1viccs, 1./% 

Roal F.state and 

Rentol. 15.2% 

legal services comprise 24.9% of the 

professional and technical services sector, 

followed by management, scientific. and 

technical consulting with 22.3%. ArchitecturaL 

engineering, and relative services was the 

third biggest sector with 16.6'%and computer 

Manufacturing, 

47.7% 

systems design and relative services totaled 

1 0.8%. The smallest sector reported was 

specialized design services. This is another 

distribution that could change in the coming 

years thanks to law 20 & 22. 

26 
326 


Insert offset folio 295 here 98944.295

The economy's state calls for a wide ranging 

set of actions that will generate investment, 

stimulate the construction sector and 

provide the basis for development of an 

advanced services sector with export 

potential. Both law 20 and law 22 address 

these needs. Although difficult to quantify a 

number of beneficiaries of both laws have 

begun programs to improve the Island's 

capabilities in activities such as programing, 

knowledge management and C& IT in 

Since the validation of accuracy of the data 

reported to the DDEC. the conclusions of the 

study are solely based on reported data. 

The analyses presented throughout the 

section are based on a total of 360 decrees 

for Act 20. Note: The total decree numbers 

do not take into account pending cases for 

2015. Estimates from DDEC include close to 

204 additional decrees from decree 

applications which are in the process of 

approvaL Decrees by year will not add to the 

totaL since 10 decrees didn't have an 

approval date. 

genera!. This was made clear in a number of 

the interviews. The above overview of the 

economy and some of its main sectors is 

included to emphasize the need for initiatives 

that provide stimulus to investment and 

economic activity in generaL The current 

outlook of the local economy requires 

actions which stimulate local production 

beyond domestic demand. In this respect, 

both incentive programs will contribute to a 

more robust service sector and thus, higher 

exports. 

However, appropriate distinctions have 

been placed when describing results based 

on proposed accomplishments as reported 

in applications, rather than actual 

accomplishments, as informed in annual 

reports. 

2012 

2013 

2014 

2015 

33 

47 

121 

149 

In terms of the structure, the report provides an initial description of the decrees and their particular 

annual reports, complemented with certain sets of information from the application form, 

originally submitted by each decree holder. As outlined in the data gathering section, certain 

caveats influence the results of this report yet the data has been interpreted following a 

representative sample- type of approach- in which the annual reports that were gathered will be 

extrapolated to the universe of total annual reports. 

27 
327 


Insert offset folio 296 here 98944.296

Centers for Electronic data processing 

Educational and Training Services 

Storage and Distribution Centers 

Research and Development 

Commercial arts and graphic services 

Hospitals and Laborotori'3s 

Promoter 

Shared Services Centers 

Voice and Data Telecommunications 

*Only filed decree reported theiJ main service type. 

As noted in the above graph, most Act 20 

companies selected Consulting as their main 

service type 1s. Nonetheless, a limited number 

of companies specified the type of 

consulting (i.e. economic, environmental, 

marketing. etc.). Of those who reported the 

type of consulting. most of them are related 

to financial services. 

Advertising and Public Relations follows in 

second place when establishing the type of 

service. The number is relatively high due to 

the fact that these companies include 

several other services. When data is 

individually analyzed, only 11 companies are 

solely dedicated to advertising and public 

relations. The other 32 companies reported 

other business activities. 

As noted in the graph, the services with the 

highest share are high-skill services in the 

areas of business. advertising, accounting, 

management and legal services. Production 

of computer programs is the 7th highest. 

These are usually associated with high valueadded activities. 

Due to the way the information is obtained 

from applicants there is no data field 

indicating if the company is a local business 

was used 

28 
328 


Insert offset folio 297 here 98944.297

or a recently established business from 

abroad. Applicants were asked to inform if 

they were performing eligible services in 

Puerto Rico prior to obtaining a decree19• If 

one assumes that a local business will most 

probably perform an eligible service in 

Puerto Rico prior to obtaining a decree, then. 

it could be argued that dose to 20% of Act 

20 grantees are local businesses and c!ose to 

80% of applicants are from other jurisdictions. 

This is only a proxy since there is a chance 

that foreign businesses could be performing 

eligible activities in Puerto Rico prior to a 

decree, among other plausible scenarios. 

Based on the information provided in the 

annual reports, the following table illustrates 

the top export services destinations. Due to 

Puerto Rico's trade integration with the US 

more than half of exports are destined to the 

US market. The Dominican Republic and 

Mexico follow in second and third place 

respectively. Beyond the top 20 destinations 

below, others include: New Zealand British 

Virgin Islands, Costa Rica, Trinidad & Tobago, 

Netherlands, Ecuador, Bermuda, France, 

Two of the main indicators of economic 

impact are total employment and 

investment, this is particularly relevant for Act 

20 grantees since export services generate 

high~quality employment opportunities and 

generate high value~added investments. 

Using a hybrid approach {combining 

applications and annual reports) ETI 

estimated the average potential impact of 

Act 20 decrees. The information is 

Guatemala, Curacao, Japan, Taiwan, 

Denmark, Aruba, Tortola, Dubai, Argentina, 

Bahamas, South America, Estonia, Hong 

Kong, St. Kitts, St. Lucia, Antigua and Haiti. 

The results illustrate that almost 2/3 of the 

export market is concentrated in the USA. but 

the remaining 35% is wide spread around the 

world. 

Top2:0Export0esttnations 

# hportOe~tinations 

DoMI!liGiflRepubhc 

4 Un>tedKmgt!om 

5 Colombia 

6 GrandCayman 

tnd1a 

GermJny 

9 Chma 

10 Spam 

S.ra~d 

13 USVI 

16 Panama 

17 Canada 

" 19 

Frequency of Export 

Share 

609% 

U% 

1.7% 

17% 

14% 

14% 

segregated between eligible and noneligible activities, yet, most of the results and 

analyses are based on the overall economic 

activities performed by the grantees, As 

highlighted in the following tables, Act 20 

companies had a bigger share of eligible 

employees, thus, data suggest that most 

firms are a direct result of Act 20 incentives. 

Using the hybrid approach, data shows that 

annual payroll averages close to $43,000 per 

29 
329 


Insert offset folio 298 here 98944.298

job, and businesses had a total payroll of 

$137.2 million. When compared to Puerto 

Rico's average salary for al! private and 

public sector jobs ($27,510), Act 20 

companies almost double that figure. This 

salary level is closely related to the high 

value-added nature of services provided 

under the incentive program. 

~A veroge salary for both eligible and non-eligible 

employment 

SOUIC8: DOEC, lnpul·Output Matrix 2002 

The Direct, indirect and induced 

employment generated by Act 20 

companies account for a total of 

The payroll figures represent close to 3,349 

direct jobs that are generated by Act 20 

companies. These direct jobs in tum, helped 

to generate 2,163 indirect jobs and 1.520 

induced jobs. The Direct indirect and 

induced employment zo account for a total 

of 7,033 jobs. This estimation was carried out 

using the Input-Output Matrix for Puerto Rico 

(2002). Given the diversity of work offered by 

law 20 beneficiaries the multipliers for the 

service sector were used to estimate the 

impact of employment. 

Source: DDEC. !nput-Output Matrix 2002 

Out of the 3,349 jobs created 40% 

corresponds to non-eligible activities which 

were performed by program participants. 

Such non-eligible activities are considered 

due to the inability to determine if a portion 

of Act 20 companies are dependent on their 

non-eligible activities to maintain their 

eligible activities. Therefore, the non-eligible 

components are assumed to arise as a result 

of the eligible work. That is, that non-eligible 

work is still taking place in Puerto Rico and 

exists due to Act 20, even if it doesn't reap 

the benefits of the law. 

Estimated Impact of law 20 Firms in 

Puerto Rico 

Following the profile for Act 20 companies -

in which most grantees are performing 

consulting services - the services with the 

highest share of new employment 

opportunities are also concentrated in 

consulting services. Nonetheless. advertising 

and public relations, call centers, 

architectural and engineering services. 

accounting and management services, also 

account for a substantial share of 

employment. In terms of highest salaries per 

employee. Centers for Electronic data 

processing, financial services, development 

of computer programs and centralized 

management setvices, reflect the highest 

compensation. On the other end, call 

30 
330 


Insert offset folio 299 here 98944.299

centers provide the lowest salary per 

employee but holds the second largest 

portion of new employment opportunities. 

If differences between service types are not 

considered, the average number of jobs per 

decree is close to 9.3 jobs. Based on 

information from applications and validated 

via interviews with local services providers 

and key industry informants. most of the 

contracting is done locally (87% of total 

employment is local), yet certain activities 

will have a higher propensity for local hiring, 

particularly if sklll sets are less specialized. It is 

important to note that contrary to 

manufacturing incentives. the performance 

of Act 20 incentives cannot be measured 

only via employment creation, but rather on 

the long-term effect of technical knowhow -

which spurs innovation and the 

intemationalization of the local service sector. 

The average number of jobs per 

decree is close to 

31 

Insert offset folio 300 here 98944.300

law 20 Employment, Total Payroll and Average Payroll by Type of Eligible Economic Activity 

2014 

EligibleActlvilies 

Type cA Activity 

Call Centers 

Total 

Non Eligible Total 

32 
332 


Insert offset folio 301 here 98944.301

The results on initial investment show that 

most of the investment is concentrated in 

rea! estate and machinery and equipment. 

This is typical of businesses which are 

establishing new operations in the Island. This 

validates the fact that most businesses - as 

previously mentioned - are new foreign 

companies establishing their operations in 

Puerto Rico. If businesses were mostly locaL 

one should expected less intensity in terms of 

rea! estate investments and equipment, 

particularly since local businesses can 

maximize their current real estate space and 

business operations. Furthermore, since these 

figures do not consider that businesses initially 

rent when entering a new market, bigger 

investment in real estate is to be expected as 

companies settle down in the ensuing years. 

As noted in the table, total investment is close 

to $143 million. This means that Puerto Rico's 

economy has benefited from an injection of 

productive capital of almost $70 million when 

Act 20 companies have reported total 

revenues of almost $1.2 billion. The share of 

eligible and non-eligible activities follows the 

same tendency as in the payroll information. 

That is, total revenues from eligible activities 

are substantially higher than revenues from 

non-eligible activities. Again, data confirms 

that most companies are export oriented 

businesses benefiting from the incentives 

promulgated in the law; thus, it could be 

real estate and machinery & equipment are 

add up. Is reasonable to expect a greater 

spillover effect to the local economy in both, 

the construction industry, and the equipment 

required for the type of businesses 

established. 

Estimated Impact of Law 20 Firms 

in Puerto Rico 

Told! investment is close to 

understood as a proxy for new economic 

activity. 

Total revenues of almost 

The table below shows that companies had 

an aggregate net income of $387 million of 

both eligible and non-eligible activities, 

which provides fiscal revenues of almost 

$343 mi!Hon in the form of corporate income 

taxes. Even though financial data is limited, 

33 
333 


Insert offset folio 302 here 98944.302

the levels of net income against total 

revenues highlight a highly profitable group 

of businesses with a good chance to keep 

their operations running in the Island. That is 

to say, that data is not showing a sector in 

decay which may compromise future fiscal 

revenues from the incentives program. 

While information for municipal tax paid was 

limited to annual reports. and no information 

is provided in applications, a simple linear 

estimate shows that almost $2.292,195 have 

been paid in municipal taxesn. 

Almost 

have been paid in municipal taxes 

Companies operating under this scenario 

are expected to have wider spill¥over effects 

in the local economy via outsourcing on 

Being an incentive program focused on 

businesses, the biggest share of the total 

economic impact emanates from business 

activity, however, other areas of the local 

economy benefit from the revenues of these 

services. Among those one could highlight 

personal income tax from Act 20 

employment and the sales tax from the 

consumption activity of such individuals. It is 

important to note that other sectors of the 

economy wi!l also produce additional fiscal 

revenues, and these are subject to change 

depending on public policy. 

local businesses and new potential ventures 

formed within the eligible services. This 

tendency provides a positive signaling to 

other local economic actors, which could 

tap into new foreign markets, not dependent 

on domestic demand. 

Operating Information of law 20 

Firms 

Act 20 companies reported a total payroll of 

$137.1 million and an average salary of 

$42,301; with this salary employees would 

have paid an estimated individual income 

tax of $17.6 million annually, under the 

current tax system 24 • Services such as 

consulting, centralized management 

services, architectural and engineering 

services, and advertising and public relations 

paid the highest amount of individual 

income tax. These companies either have 

high salaries or a large total payroll. 

tm 

34 
334 


Insert offset folio 303 here 98944.303

Estimated individual income tax of 

annually 

Following the previous analysis. half of the 

salary net of income tax was then multiplied 

by 7.0% to determine the SUT/VAT paid. This 

estimate is based on the fact that only 

around 50% of all consumption is subject to 

SUT/VAT. This totals $3.6 million on sales tax 

paid by the employment created under Act 

20 beneficiaries. 

on sales tax 

The table below summarizes the total fiscal 

contribution that is directly linked to Act 20. 

As noted in the table. Act 20 alone has 

generated close to $60 million in tax 

revenues. Almost 60% of all revenue is 

concentrated in direct business activity from 

corporate income taxes, however, since 

salaries from Act 20 businesses are relatively 

high, individual income tax represents dose 

to 30% of all tax revenues. 

Act 20 alone has generated close to 

in tax revenues 

Potential Fiscal Revenues 

Total $57,825,199 

35 

Insert offset folio 304 here 98944.304

Estimated Individual Income Tax Payable by Employees in Eligible and Activities 

2014 

Type of Activity Tax Payable in Tax Payable in Total Individual Income Eligible Non·Eiigible Tax Payable 

Total Sll, 127,367 

$t1,082,829 

$0 $0 $0 $0 $0 

$6,500,876 

$2,957,996 

$LCJ00.762 

$676,229 $499,549 

$17,628,243 

36 

Insert offset folio 305 here 98944.305

Estimated Sales and Use Tax Payable by Employees in Eligible and Non-Eligible Activities 

2014 

Type of Activity 

Total 

SUT Payable in 

Eligible 

$1,948,493 

SUT Payable in 

Non-Eligible 

$1,606,577 

Total SUT Payable 

$3,555,070 

37 
337 


Insert offset folio 306 here 98944.306

As an incentive program that promotes the 

development of new export activity, Act 20 

provides new dynamism to Puerto Rico's 

economy. Export activities, particularly in the 

service sector, have large positive 

externalities in the local economy. As 

presented in the section describing Puerto 

Rico's service economy. the service industry 

shows a growing tendency vis-a-vis 

manufacturing activity, and other sectors in 

the local economy. 

In generaL the service economy has high 

degree of mobility -less machinery/facilities 

and more human resources- and thus, allows 

for faster tangible effects in the economy, 

Moreover, the potential for new knowhow 

and its spillover effects can propel new 

economic activity. The fact that Act 20 

companies are concentrated in high-value 

added services, with highly specialized sk1!1 

sets, means that the local economy can 

participate in a more competitive market 

with potential technology transfers. 

To what extent this is achieved will depend 

on Puerto Rico's capacity to develop strong 

linkages with foreign firms and propel local 

management to seek target markets beyond 

the domestic demand. As previously 

mentioned, contrary to manufacturing 

incentives, the performance of Act 20/22 

incentives cannot be measured only via 

employment creation. but rather on the 

long-term effect of technical knowhow 

which spurs innovation and the 

internationalization of the local service sector. 

As illustrated in the abovementioned results, 

Act 20 companies have directly 

created/retained over 3.000 jobs since their 

enactment. These jobs are predominantly 

high-skill and provide a direct link with foreign 

businesses and intemational markets, This 

exemplifies both. an opportunity to increase 

the local knowhow and also the potential 

internationalization of local businesses. Since 

Puerto Rico has an ample service economy, 

incentives are naturally in place for Act 20 

businesses to capture local services and 

increase their productivity. 

In terms of the effects in the Gross National 

Product (GNP), Act 20 economic impact in 

the form of revenues could represent dose to 

1% of Puerto Rico's GNP for 2014. Taking into 

account the limited time the incentive 

program has been in place, the total effect 

in GNP is relatively high when compared to 

other incentive programs such as the EB5 

program in the USN'S. 

Act 20 economic impact in the form 

of revenues could represent close to 

It is important to distinguish Act 20 from Act 

22. particularly for the overall economic 

impact. since Act 20 provides a level playing 

field for all businesses within the Island while 

38 
338 


Insert offset folio 307 here 98944.307

Act 22 is directed to individuals. What could 

in turn have an effect on local businesses, is 

the fact that a more competitive market wH! 

require local service providers to increase 

Similar to the previous section, this analysis 

looks at the economic impact and benefits 

of law 22. However, the economic effects of 

As described in the data gathering section, 

for the purposes of this report, Act 22 has 

generated 573 approved decrees. The 

following figure illustrates the total number of 

decrees approved each year. At the time of 

the application a total of 344 grantees had a 

residence in Puerto Rico and 232 had a 

business established in the Island. 

date. 

2012 

2013 

2014 

2015 

18 

120 

262 

173 

their productivity. Additional policy tools will 

be required to create new market 

mechanisms that embed export services into 

the local ecosystem. 

Act 22 will vary from those of Act 20, mainly 

due to the incentive structure. Act 22 

provides incentives for individual investors 

and Act 20 tax incentives for export 

companies. 

In tenns of the main occupation identified by 

grantees, data shows that most grantees are 

consultants, traders within the financial 

industry, entrepreneurs and investors. Other 

occupations include attorneys, accountants, 

among others. Out of the total applications, 

Other 1"<<0\i,iVi<<ii<ii!i"ii,,;t;;, 52 

Consultont 51 

Trader 

Business Owner/Entreprenel'r 

Investor 

Business Director/President 

Financial Services 

Home Maker 

Real Estat"" 

CEO/COO 

Business Manager 

Retired 

Investment Manager 

MarKeting/Advertising 

Attorney 

Engineer 

Doctor 

39 
339 


Insert offset folio 308 here 98944.308

To gauge the place of origin of decree 

holders the field of prior residence in the 

application was used as a proxy. Out of 573 

decrees, 510 (89%) reported having their 

previous residence in the USA. The other 11% 

had previous residence in countries such as 

Venezuela, United Kingdom and Spain. 

USA 

Venezuela 

United Kingdom 

Spain 

US Virgin Islands 

Uruguay 

Dominican Republic 

Canada 

Hong Kong 

Nevis 

Brazil 

Russia 

BVI 

Holland 

Colombia 

Italy 

Monaco 

Argentina 

India 

510 

In terms of their distribution within the USA, 

most grantees come from Florida, followed 

by Texas. California, New York and Illinois. Yet. 

participants have come from all other states 

of the Union with the exception of Delaware, 

HowelL Maine, Mississippi and New Mexico. 

Florida, USA 73 

Texas USA 62 

California, USA 61 

New York, USA 53 

!l!inois USA 20 

USVI 18 

Nevada, USA 16 

Georgia. USA 16 

Connecticut, USA 15 

USA 15 

Massachusetts, USA 15 

New Jersey, USA 15 

Arizona. USA 13 

Pennsylvania, USA 11 

Texas, USA ll 

Colorado, USA 10 

Washington, USA 9 

North Carolina, USA 7 

Virginia, USA 

Maryland. USA 

Kentucky, USA 

Utah, USA 

Oregon, USA 

Ohio, USA 

Participants provided information of their 

main type of activity in their annual reports. 

As in Act 20, participants' main business 

(52.5%) is consulting and financial services. 

Centralized management services and 

advertising and public relations follow in 

order. The fact that participants of both 

programs have a similar profile with respect 

to their business activity, evidences that 

promotional efforts targeted the benefits of 

using both laws together. It is important to 

note that not al! Act 22 grantees reported 

having a business, thus, absolute numbers will 

not match the total number of decrees. 

40 
340 


Insert offset folio 309 here 98944.309

Distribution of Reports by Type of Business 

Consulting 

Financial Services 

Other 

Centralized Management Services 

Advertising and Public Relations 

Call Centers 

Hospitals and Laboratories 

Non-Service Industry 

Storage and Distribution Centers 

Development of Computer Programs 

Management 

32.2% 

20.3% 

11.9% 

8.5% 

5.1% 

3.4% 

3.4% 

3.4% 

3.4% 

1.7% 

1.7% 

Production of construction drawings. architectural and engineering 

services and project management 1.7% 

Professional Services such as legal tax and accounting 1.7% 

Being an individual investor program. Act 22 

has a strong economic impact in local real 

estate investments. The case of Puerto Rico 

has been particularly relevant since at the 

time of the enactment of the law, Puerto 

Rico had an excess inventory of high-value 

properties which had a very limited market 

within the Island. Using the hybrid approach 

(combination of applications and annual 

reports) ETI was able to estimate several 

aggregate data points which can be used to 

estimate the economic impact of Act 22 

beneficiaries. 

Information from property values shows that 

close to $266 million have been invested in 

the local real estate market. The average 

property value ranged between $1.1 and 

$1.8 million. In terms of 1-year value of rent, 

estimates reflect a total of $7.1 million. As 

initial investors mature in the local market, it is 

expected they will make a transition to 

purchasing local rea! estate 26 • Moreover, 

with a subsequent amendment to the 

enabling Act 27, new investors are required to 

purchase a residential property within the 

Island. 

This impact does not take into account other 

potential indirect effects of the program in 

41 
341 


Insert offset folio 310 here 98944.310

the economy, such as new businesses that 

have been created to provide services to 

Act 22 beneficiaries. Moreover, other 

potentia! investors have created new 

investments in the Island, betting on the new 

market that's been created due to these 

programs. This particular issue is partially 

measured in the data gathering section, 

under qualitative data and interviews to key 

industry informants. 

T otol Impact of Law 22 Individuals 

Hybrid {Application and Report} 

Planned Capital Investment 

Percentage of Individuals with Established 

Businesses in Puerto Rico 

Expected Employment from Business Activity 

Total Net Worth: 

Unspecified 

Less than 10 milflon 

10 million to 50 million 

50 million to 100 million 

IV\ore than 100 million 

Percentage of Capital Estimated to be 

Transferred: 

Unspecified 

0%-25% 

26%-50% 

51%-75% 

76%- 100% 

Other 

Total Value of Currently Purchased 

Properties 

1-year Value of Rent 

Percentage of Individuals Making Other 

Investments 

$228,381,000 

52.29% 

2,483 

22.3% 

66.4% 

9.9% 

1.2% 

0.2% 

39.5% 

17.9% 

10.6% 

9.1% 

15.7% 

7.1% 

$266,333,025 

$7,145,856 

39.3% 

42 
342 


Insert offset folio 311 here 98944.311

Based on the information provided by the 

program participants, close to 66% had a net 

worth of less than $10 million; only 10% had a 

net worth between $10 and $50 million. This 

means that their residential status in the 

island will create a bigger demand for 

consumer goods and services from local 

companies. Again, to maximize the 

economic benefits of this new capitaL local 

businesses wll! need to adapt their services to 

the particulars needs of such a market. 

Furthermore, individual spending in terms of 

consumer goods will have an impact in terms 

of fiscal revenues, but also with local 

businesses providing such goods. 

Act 22 Applications do not hold information 

on expected consumer spending, hence 

Annual Report data was used to determine 

total consumer spending from Act 22 decree 

holders2s. The data from 133 annual reports 

totaled $ J 7,884,645. The average spending 

per decree was used to estimate the total 

potential spending for all decree holders, this 

amounts to more than $73 million. 

The total potential spending for all 

decree holders amounts to more than 

On the other hand, these individual investors 

could have bigger effects in the economy if 

they develop new business ventures within 

the Island. Le. buying commercial facilities 

will have an impact in the economy, yet, 

injecting new capital improvements to those 

facilities could have a wider economic 

impact29. Act 22 grantees reported a total of 

$228 million in capital improvements 30 and 

52% had businesses established in Puerto 

Rlco31 • 

Act 22 grantees reported a total of 

in capital improvements 

The business activity of these individuals 

generate close to 2,483 new jobs within the 

Island. These direct jobs in turn, helped to 

generate L604 indirect jobs and Ll27 

induced jobs. The direct, indirect and 

induced employment32 accounts for a total 

of 5,214 jobs. This estimation was carried out 

using the Input-Output Matrix for Puerto Rico 

(2002). Given the diversity of work offered by 

local flows of money 

43 
343 


Insert offset folio 312 here 98944.312

Law 22 beneficiaries the multipliers for the 

service sector were used to estimate the 

impact of employment. 

The direct, indirect and induced 

employment accounts for a total of 

It is important to note that these jobs do not 

include employment generated by the 

consumption of services demanded by the 

household, such as domestic work or other 

incidental services required by a homeowner. 

To supplement the data obtained from Act 

20/22 decrees (applications and annual 

reports), several interviews were conducted 

with business leaders who have played key 

roles in the implementation and execution of 

these programs. This section is particularly 

relevant, as not all the direct effects of the 

incentives programs can be captured by 

DDEC reporting requirements for decree 

holders. 

In terms of the profile of the informants, it was 

very diverse, and included consulting firms, 

real estate companies, financial institutions 

and non-decree holders with local 

investments. Some informants provided 

robust data on current and future 

investments and others provided insights on 

new ventures developed as a result of these 

programs, including the creation of new 

divisions and hiring new personnel to deal 

with the new clientele. 

Information obtained from the consultations 

consists of data related to the general Act 

20/22 decree holders' profile, their 

The above employment figures represent 

jobs directly created by the Act 22 individuals 

and which exclude any potential 

overlapping with Act 20 jobs from individuals 

which hold decrees from both acts. 

investments in Puerto Rico, and other facts 

conceming the overall impact of these laws. 

In generaL most of the interviewees agree 

that both laws have a positive impact in the 

Island's economy and contribute to develop 

new investment opportunities. Moreover, 

informants agreed that both, Acts 20 and 22, 

play an important role in marketing the Island 

as an investment location in U.S. and 

intemational markets. Nonetheless, some 

informants recommended the govemment 

to consider enacting additional policy 

measures that guarantee a level playing field, 

for both local and foreign investors. 

As specified by informants, the highest influx 

of Act 20 and Act 22 applications was 

between the second semester of 2014 and 

the first semester of 2015. In their opinion, a 

decline in the number of persons interested 

in benefitting from these laws occurred 

during mid-2015, mostly due to the 

uncertainty arising from Puerto Rico's fragile 

fiscal situation. 

Informants stated that Act 22 participants 

have very diverse profiles, not only in terms of 

net worth. but in terms of occupations and 

interests. Not all decree holders are ''super 

44 
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Insert offset folio 313 here 98944.313

rich" as traditionally perceived, and they 

come from multiple cultural backgrounds 

and world regions. Mostly they are 

knowledgeable, highly educated individuals, 

who demand highly skllted services and high 

scale consumer products. This has generated 

an increase in the demand for specific 

products and services. particularly, organic 

products. high-end restaurants. concierge 

According to the interviewees, one of the 

main areas of impact is the commercial and 

residential real estate sector. Participants 

mentioned that Act 22 played an important 

role. particularly in the case of high-end 

projects in distress, both in completing 

projects and in selling units. This has been the 

case, not only with decree holders. but also 

with private investors who have been 

attracted to Puerto Rico since the 

enactment of this Law, even though they are 

not benefiting from it directly. 

Act 22 investors were initially more interested 

in renting properties rather than buying. This 

trend changed since mid-2014, when there 

was a noticeable increase in real estate sales. 

Information provided by agents confirmed 

that most Act 22 grantees who are buying 

homes in Puerto Rico, are acquiring real 

estate properties in San Juan {Condado 

Area), Dorado and Humacao (Palmas del 

Mar).Similarly, most renters are also located 

in San Juan's Condado Area and Dorado. 

In terms of residential real estate, they are 

mostly concentrated in Dorado, Humacao, 

Rio Grande and San Juan. Tofa! investment 

in residential real estate exceeds $150 million. 

The average property valve is around $ LS 

services, healthcare related services, among 

others. This in turn could cause the 

emergence of new businesses in the Island to 

satisfy the demand of this sector. Also. since 

most Act 20/22 decree holders move to 

Puerto Rico with theirfaml!ies. there has been 

an increase in the enrollment in local private 

educational institutions and other 

complementary services. 

million. Furthermore, major investors- who are 

not decree holders. but which are indirectly 

incentivized by both programs. were 

interviewed An investor reported initial 

investments of $76.6 mHiion for the purchase 

of a residential apartment building, 

commercial spaces and adjacent lots in San 

Juan. An additional $44.7 million in capital 

expenditures has been invested to finance 

the construction and renovations of the 

residential apartment complex and its 

commercial premises. 

Total investment in residential real 

estate exceeds 

As to commercial properties, the biggest real 

estate firms in Puerto Rico move around $40 

45 
345 


Insert offset folio 314 here 98944.314

to $50 million a year in transactions related to 

Act 20/22 investors. The acquisition, 

remodeling and improvement of hotels, 

office buildings, marinas, as well as 

partnerships with local businesses, have 

generated a total investment of $125 mH!ion 

as a result of Act 22. Informants indicated 

that, besides acquisition price, most 

entrepreneurs are planning to make 

additional investments in the properties 

acquired within the Island. The development 

of these commercial properties has also 

created direct jobs in administration and 

customer service, as well as construction jobs. 

Moreover, non-decree holders have also 

acquired commercial properties for a total 

approximate investment of $650 million. 

Some particular investments include a 

marina for $50.2 million and an additional 

$10.6 in renovations of the infrastructure. 

Some key informants have already awarded 

contracts for further commercial 

developments within the Island which total 

over $112 million for the following three years, 

Related to Act 20, interviewees stated that 

most participants are foreign companies that 

established offices in Puerto Rico to export 

services from the Island. These businesses are 

mostly engaged in financial, technological 

and consulting services. According to the 

informants, their profile has changed since 

the enactment of the Law in 2012. During 

2013, most Act 20 companies were leasing 

small office spaces; while in 2014-2015 most 

business in the technological industry, such 

as programmers, web designers, cloud 

hosting, web marketing. call centers, with 25 

to 50 employees needed larger facilities to 

carry out their setvices. 

in deposits from these clients. 

In terms of local financial setvices, Act 20/22 

decree holders have over 730 bank 

accounts in local banking institutions and 

some institutions reported having close to 

$100 million in deposits from these clients. 

Individual investors have generated over $85 

million in residential mortgages closings and 

used local baking setvices for investments of 

more than $5 m1Uion. Similarly. multiple credit 

cards have been granted and commercial 

credit lines of over $6 million are currently 

operating. Between 2014 and 2015 al! these 

figures have experience an average growth 

of more than 80%. 

46 
346 


Insert offset folio 315 here 98944.315
347 


Insert offset folio 316 here 98944.316

Estimates are based on DDEC's database. 

Additional qualitative data was gathered for 

validation, including interviews with key 

informants. Only official data was used to 

develop aggregate figures of economic 

impact. 

The information provided by the Department 

of Economic Development comprises four (4) 

years of decree approvals, which 

accumulate into 360 approved Act 20 

decrees and 57 4 Act 22 decrees. However, 

the only "complete year" of available 

information in annual reports is 2014. 

Additiona!!y, due to the incipient nature of 

the project, there is dearly not enough 

decree data to produce accurate forecasts 

for long periods based on extensive time 

series. 33 Finally, the potential results are 

greatly influenced by the agency resources 

Our forecasts took the approach of 

modellng the overall trend in the potential 

base of applicants for each Act, and 

deriving an estimated number of decrees 

from the parameters in said modeL This 

potentia! base was defined as the group of 

In order to estimate the potentia! long-term 

impact of Act 20 and Act 22 decrees, the 

potential trend in decree growth up to 2024 

was estimated. This provides a reasonably 

conservative estimate of expected decree 

counts. based primarily on the behavior of 

the potential demand for these decrees and 

the cumulative effects of promotional 

activities. 

involved in the programs: a significant 

change in these would heavily influence the 

outcome of the programs far beyond any 

statistical trend. and would not be 

explainable by the economic information of 

current applicants. Therefore. our forecasts 

hold a very "ceteris paribus" plausibility with 

limited statistical power, and should only be 

deemed as an assessment of plausible 

scenarios following particular trends. 

To simplify the analysis, all future decrees 

were assumed to be for residents and firms 

from the main markets which comprised the 

profile of decree holders. 

individuals having a shared set of 

determinant characteristics with the decree 

holders. Potential decree holders are 

expected to be "drawn" from this potentia! 

base, i.e. every applicant is assumed to 

come from this particular base (up to a 

margin of error). 

of the decree count particularly For such a long time 

span. 

48 
348 


Insert offset folio 317 here 98944.317

The potential base is not directly observable, 

but can be approximated by using a set of 

proxy variables. These proxies differ with 

respect to the original definition of potentia! 

base as defined above, but do serve as a 

parsimonious representation of it. Selecting 

the suitable proxies for each Act consisted of 

a multi-part process, involving l) ranking the 

most important characteristics of the 

eligibility requirements in each Act, and 2) 

evaluating the available pools of related 

variables for which there exists a reasonable 

amount of data avaHable. After several 

discussions and a consensus interpretation of 

the eligibility requirements, the following 

potential pools were identified: 

1) Establishments involved in Act 20 eligible 

activities 

a. An establlshment is defined by the US 

Census Bureau as "a business or 

industrial unit at a single physical 

location that produces or distributes 

goods or performs services" {US 

Census Bureau, 2015). The locational 

distinction is deemed important as 

U.S. firms are able to take advantage 

of Puerto Rico' s Act 20 by locating a 

particular establishment in the island, 

not necessarily creating a new firm. 

Also, only the activities performed by 

establishments located in the island 

would be eligible for Act 20 benefits. 

2} Owners of housing units with high 

property value 

a. A difficulty in determining the 

potential base of Act 22 decree 

holders was the extremely low 

response rate to the household 

income variable, which made 

income (as reported by participants) 

unviable as a defining characteristic 

of participants, Additionally. Act 22 

decree holders do not need to 

generate a high-level income in 

order to partake in the benefits. 

which are vested upon capital assets. 

b. However, a variable which was 

reported by most decree holders was 

the property values which they 

intended to purchase in the island 

The average value of primary 

properties purchased in Puerto Rico 

by Act 22 decree holders was 1.8 

million, and the bracket of owneroccupied housing units containing 

this value was selected as the proxy. 

The reasoning was that the 

characteristics of owners of highvalue real estate in the US roughly 

mirror the characteristics of Act 22 

decree holders, and hence are 

sufficiently correlated to the potential 

base to be used as a proxy. 

The next sections detail the data and 

forecasting methods used to extend the 

potential base of each Act into a long-term 

forecast up to 2024. 

49 
349 


Insert offset folio 318 here 98944.318

The data used are yearly establishment 

counts from the US Census Bureau's County 

Business Patterns database.34 This database 

contains information about employment, 

payroll and number of establishments for an 

administrative sample of establishments. This 

yearly establishment count differs from the 

Eligible activities are not classified by NA!CS 

codes: hence, a suitable NAICS code was 

imputed in order to relate the establishment 

counts to each activity. The level of detail 

was kept up to 3-digit NAICS codes (industry 

subsectors), due to the following factors: 

1) Eligible activities were already broad 

enough to be classified into more than 1 

Economic Census (also by the US Census 

Bureau), which is updated every five {5) 

years and includes an estimate of al! 

establishments/firms in a particular 

geographical jurisdiction. The establishment 

data are classified using the North American 

Industrial Classification System {NA!CS), with 

revisions also made every five (5) years. 

NAICS sub-sector, and even more if 

higher levels of detail were used: and 

2) More detailed subsectors would not be 

disclosed if they contained a high level of 

firm concentration, or too low an 

employment/establishment count 

The following table presents the imputed 

NAICS codes for Act 20 e!1gible activities. 

50 
350 


Insert offset folio 319 here 98944.319

The sample time period used was 2000-2013, 

the latest year for which County Business 

Patterns data was available. The NAICS 

underwent several major revisions from 1997 

through 2002. Including the broadening of 

the Telecommunications sub-sectors and the 

introduction of several new classifications for 

The technique involved forecasting the 

growth trend in the potential base using an 

Auto-Regressive model of lag 1 (known as an 

AR-1 process). This model was chosen 

following the approach given by Box and 

older sectors. Hence, only three {3) years of 

NAICS 1997 data were included. which 

coincided with the tum of the century and 

the dot-com explosion- a major structural rift 

in the history of service exports. for these 

years. the NAICS 1997 codes which most 

closely coincided with the NAICS 2002 

sectors [which already include the 

aforementioned changes) were used. 

Jenkins [1970). The growth in number of 

establishments was projected for the 2014-

2024 period - an 11 year span - due to the 

fact that the available information exists only 

up to 2013. The following table presents the 

estimates and margins of error for the modeL 

51 
351 


Insert offset folio 320 here 98944.320

This model did not consider exogenous 

factors which may affect the growth in 

number of establishments; it merely reflects 

the growth trend in the potential base. As 

can be seen, the margin of error actually 

exceeds the forecasted growth in the base 

case, owing to 1) the small amount of 

The data used are the counts of owner~ 

occupied housing units in the U.S. valued 

above $1 mi!!ion, according to the American 

Community Survey /-year Estimates. Note 

that our dedup!ication method for decrees in 

the real-estate value made possible the 

correspondence of 1 homeowner to exactly 

1 primary residence, since the Act 22 spouses' 

The sample time period was 2005-2014, the 

latest year for which the American 

As with the Act 20 forecasting, the technique 

utilized followed the approach by Box and 

Jenkins (1973). Using the lag specification, an 

AR-1 model was also utilized to model the 

growth rate of new housing units. The 

forecasting period was 2015-2014- a 10 year 

timespan. Mirroring the Act 20 forecast 

methodology, no exogenous factors were 

considered in the model. giving a trendestimate of the growth in housing-units. 

As can be seen in the following table, the 

number of data values available is of less size 

periodicity in the data [13 growth values) 

and 2] the large forecasting horizon, which 

basically doubles the size of the available 

data. However, this is a normal occurrence in 

models with such large time horizons (e.g. 

Hogarth &Makridakis, 1981). 

duplicated data was discounted in 

estimating the property value. Likewise, the 

value of owner-occupied housing units had 

a 1-1 correspondence with the primary 

residence, due to the occupation 

requirement of the estimated universe. 

Hence, the number of housing units (which is 

the variable provided by the Census data) 

can also be taken as the number of eligible 

homeowners (family or otherwise). 

Community Survey /-Year Estimates were 

available. 

as the forecasting period (9 growth values vs 

10 forecasted values]. As a result, the mean 

predictions take their own forecasted values 

as exact in the calculation of the longer-term 

forecasts, without taking any actual data to 

weigh these estimates. This compounds the 

margin of error by the inherent uncertainty in 

taking the point estimate as given (see 

Sorjamaa, Hao, ReyhanL Ji & lendasse, 2007). 

Note that this compounding is independent 

of the type of mode! used, since it comes as 

a result of the proxy characteristics. 

52 
352 


Insert offset folio 321 here 98944.321

Actual on<;! for$(:asted Number of Ownor·Oecvp1ed Hov~1ng \Jnib With l'roperfy Valve 

Abov. ~1 mHHoo 

After the potential base was forecasted a 

formula for deriving the decree estimates 

was used. This formula made use of an 

assumption which requires the introduction 

of two (2) important terms: 

1) The static capture rate {SCR) - also 

known as simply the capture rate, it is 

defined as the ratio of decrees to the 

potential base for a particular time 

period. An increase in the capture rate 

implies that the decrees represent a 

larger proportion of their potential base. 

2) The dynamic capture rate (OCR) - it is 

defined as the change in decrees. as a 

percentage of the change in the 

potential base. It is a measurement of the 

velocity at which decrees increase with 

respect to the potential base. Changes in 

the OCR correspond to the acceleration 

in the capture rate. or variations in the 

speed at which new decrees increase. 

53 
353 


Insert offset folio 322 here 98944.322

The primary assumption used was that the 

OCR remains constant throughout the period, 

that is, decrees will be added at a constant 

rate from 2016 onwards. Although highly 

restrictive, the aforementioned implication is 

consistent with the idea that our forecasts 

model the exogenous demand trends only. 

At any given time. the set of factors 

endogenous to the agency may significantly 

alter the velocity at which decrees are 

Due to the !ack of data in order to estimate 

k, a scenario approach was used instead. 

added, and thus violate the assumptions 

used in this forecast. 

The formula used to derive the number of 

decrees for each formula isDt+1 = k (Bt ... ,-

Bt) + Dt, where k is a constant, Bt is the 

potential base at time t , and Dt is the 

number of decrees at time t. The parameter 

of interest is k, which was determined using 

the methods described below. 

We evaluated the empirical estimates of the 

OCR by year, which are presented in the 

tables below. 

Esf!malion of the Dynamlc Capture Rate for Ad 20 

Year 

2013 

Change in 

Establishmenb 

?0.08.:? 

Change ln Home 

Owners 

Change in Act 20 Dynamic Capture Rate 

Deere~~ (OCR} for Act 20 

50 0.?477% 

Dynamic Capture Rate 

(OCR} lor Acl22 ---~-~--~--~~~--~~--~~----~-~-· 

2012 1),229 \8 ·0.149/"S 

54 
354 


Insert offset folio 323 here 98944.323

Using these estimates, the following 

scenarios were constructed for each Act: 

1) Base Scenario- the OCR for the forecast 

period is the average of the DCR in the 

two (2) most recent years. 

2) Optimistic Scenario- the OCR is the 

greater of the two (2) most recent years. 

3) Pessimistic Scenario- the OCR is the 

lesser of the two (2) most recent years. 

Due to the short time span since the Acts' 

approvaL only the two {2) most recent years 

were used to construct each scenario. 

These years are more likely to reflect a 

realistic DCR as the decree programs have 

more maturity. 

The following tables present the forecasts from 2015 to 2024, according to each of the scenarios 

discussed. 

Expected Trend lt! Act 22 !}E,~r@@s. by Scanarlo ~~~·~-·- ----~--· -~ -----·---· ---- ~-~~~---~~~-·--~--

bp&cl<!dlrendlnAd20Deere"",byScenotlo-

--·-·-······-····---· ...... ~·-····-·· .. -··-··-~-·---.. ----- ····--------.---

55 
355 


Insert offset folio 324 here 98944.324

Obtaining the impact for law 20 and 22 firms 

involved two (2) general steps: 1) measuring 

The following assumptions were held as true 

in both Act 20 and Act 22 forecasts: 

1) As with the decree forecast, each new 

decree is assumed to be "captured" 

from a potential base of applicants, 

which is approximated via proxies. 

2) The distribution of decrees by sector is 

dynamic, and will change over time 

according to the industrial/individual 

characteristics of each new entrant. 

Therefore, it cannot be held fixed across 

time. 

3) Each new entrant behaves according to 

the general trend of the currently 

Step 1: Measuring the Individual Footprint 

The trimmed mean served as the primary 

estimate for the footprint of evaluated 

variables. A trimmed mean 2.: with trim factor 

¢ E [O,SOJ is an average which excludes the 

top¢ percent of the highest~valued half of 

the data, and the bottom ¢ percent of the 

lowest-valued half of the data. The trimmed 

mean serves to remove out!lers from the 

estimates, thus providing a more robust 

the individual footprint of each decree, and 

2) establishing an appropriate dynamic for 

the behavior of each new entrant across 

time. The total impact is the aggregation of 

the decrees' dynamic footprint across the 

estimated time span. 

approved decrees with respect to 

employment and revenues. In other 

words, outliers were not considered in 

any of the footprint estimates. 

The last assumption is important since in 

more than one of the measured variables, a 

small set of outlying decrees represented a 

disproportionate amount of the total impact. 

We hold these values as probabilistically 

indistinguishable from 0, in that the base 

probability of new entrants with these 

characteristics, compounded over the 

considered time period, is basically 0. 

estimate when compared with the regular 

mean. With the exception of non-eligible 

employment, all trimmed means used a trim 

factor of 5%. Due to the small sample size in 

non-eligible employment, the trimmed mean 

for this variable used a trim factor of 2.5%. 

The following tables present the estimated 

decree footprint for each of the considered 

variables, using the data from the hybridapproach datasets discussed in previous 

estimates. 

56 
356 


Insert offset folio 325 here 98944.325

Estimates of the Act 20 Tax Decree Footprint 

Non-eligible Activltles $56,578 

Gros-s Income by Decree 

Eligible Activities $39.785 

Step 2: Establishing Behavioral Dynamics 

While the forecasting process involved only 

characteristics of the potential pools and 

obtaining an estimated number of decrees, 

the impact measurement involves additional 

assumptions regarding the long-term 

behavior of each decree. Due to the 

heterogeneity in the types of decrees, these 

were evaluated in a multi-generation 

approach which is detailed in the following 

subsections. 

Each year, a specified number of entrants is 

added to the already active decrees. We 

refer to this number as a generation of 

decrees. All generations follow a specified 

1 0-year behavior regarding their economic 

Estimates of the Act 22 Tax Decree Footprint 

Trirnrned Mcom 

(Excluding Rent ond Morlgoge) 

[mpioyment 

$101,802 

18 

footprint; however, they begin said pattem 

at different starting years, and thus each 

generation contributes a different amount 

per year. The specified behavior is as follows: 

1) Introduce the establishment with a1 

employees, and hire fj1 employees for 

three (3) more years (not necessarily in 

sequence); 

2) Generate a2 in yearly gross income; 

3) Produce a3 in payroll per year; and 

4) Pay a4 percent of the gross income in 

corporate income taxes. 

This pattern was generated for both eligible 

and non-e!lgible activities, with each type of 

activity differing in its starting values. As no 

assumption regarding the distribution of 

57 
357 


Insert offset folio 326 here 98944.326

decrees was made for each year- each 

generation originally had the same starting 

parameters for its corresponding eligible and 

non-eligible activities. To address this, three 

(3) sources of exogenous variation were 

introduced: 

1) The starting value for each decree's 

yearly revenue was updated according 

to growth in the US rea! GOP for the 

imputed NAICS sectors of the potentia! 

base. 

a. A 1 0-year trend forecast of real GOP 

growth in the US was made using 

AR!MA models. The resulting 

forecasted growths were then 

applied to the base revenue footprint 

of each decree during its respective 

entrance year. 

b. The data used for the forecast was 

the Value Added by Industry table 

from the Bureau of Economic Analysis, 

from 1997 to 2014. Some sectors were 

excluded from the estimate, as these 

tables did not hold the required levels 

of NAICS detail to include all 

categories, even at the general levels 

used for the imputation. 

2) The average wage paid in eligible 

activities was updated each year 

according to Puerto Rico's wage growth 

in the imputed NAICS sectors, assuming 

that the decree holders will maintain the 

PR wage scale when hiring workers. 

a. A 10-year trend forecast of quarterly 

wage growth and employment in 

eligible activlfies was made using 

ARIMA models, and the resulting 

growth in the average wage was 

applied to the base wage. 

b. The data was retrieved from the 

Quarterly Census of Employment and 

Wages, a quarterly dataset compiled 

by the Bureau of labor Statistics, from 

January 2001 to June 2015. Nondisclosed values at differing levels of 

detail in NAICS sectors were imputed 

using the either last known disclosed 

value for each series, or the value 

such that the annual averages 

coincide with the reported statistic. if 

said averages were available. 

3) The average wage paid in non-eligible 

activities was updated yearly according 

to Puerto Rico's overall growth in 

quarterly wages. 

a. The same treatment as with the 

previous series was given to this 

forecast. The data used was 

obtained from the same source as 

the forecast for eligible activities. 

The following tables present the forecasted 

growths for GOP and average wages in 

eligible and non-eligible activities. As can be 

seen, the margin of error is very wide for the 

average wage forecasts. due to 

compounded uncertainty for both wage 

and employment growths, This is particularly 

the case in eligible activities due to the 

additional imputation procedures which had 

to be made for non-disclosed data. 

58 
358 


Insert offset folio 327 here 98944.327

Forecasts & Actual Values of Real GOP Growth in the 

Potenfial Base of Eligible Acfivlfies {United States) 

Year Growth 

1997 $2,695 

1998 $2,830 5.0% 

1999 $2,963 

2000 $3,087 A,Z'.f, 

2001 $3,241 5.0% 

200? $3.313 2,2% 

2003 $3,405 2,8% 

2004 $3,553 4.3% 

2005 $3,123 4.8% 

2006 $3,855 

2007 $3.913 L'i% 

2008 $3,943 0.8% 

2009 $3,780 

2010 $3,886 2,8% 

2011 $3,980 2A% 

?.012 $4,112 3.3% 

2013 $4,177 ].6% 

2014 $4,331 3.7% --------------

2015 $4,469 +H48 3,2% 

2016 $4,604 +/-161 3.0% 

2017 $4,74) +/-!67 30% 

2018 $4.881 +/-172 2.95% 

2019 $5,025 -+Fill 2_95% 

2020 $5,173 +/-183 2.94% 

2021 +J./88 2.94% 

2022 $5,482 +/-i94 2.94% 

2023 $5,643 +/-199 2.94% 

2024 $5,809 +/·205 2.9<1':';'; 

enough deioii 1n ~ht'! GOP lob!es used to bo indudGd 

59 
359 


Insert offset folio 328 here 98944.328

forecasts & Actual Values of Real GOP Growth In the 

Potential Base of Non-eligible Activities {United States) 

Year Estimate (in bi!lions} Margin of Error Growth 

1997 $11/)35 

1998 $11.026 4.4% 

199') $12,066 

2000 $12,S60 4.1% 

:201..11 $12.682 

2002 $12,909 

2003 $13,271 

2004 $13.773 3.8% 

:;>00.) $14,234 3.3';£ 

2006 $14,614 

2007 $14.874 1.8% 

2008 $14,830 .0.3% 

2009 $l4,4l9 

2010 $14,784 

?011 1.6% 

201:/ $15,355 

2013 $15,583 1.5% 

2014 $L\962 

$16.355 +/-459 

2016 $16,753 +1-521 2.4% 

20)7 $!n5s +!-555 

.2018 $/7,572 +J-512 

2019 $11,99!> +/-586 2.41% 

2020 $18.428 +/-60) 2.41% 

2021 $1EW7J +J-6!5 

2022 $19324 +/-630 ?.40% 

2023 $19,789 ""'"1'""'"145 2.40% 

2024 $20264 +/-66/ ?..40% 

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Insert offset folio 329 here 98944.329

Forecasts & Actual Values of Average Wage in the 

Potential Base of Act 20 Eligible Acflvifies (Puerto Rico} 

Year Sose Vo!ue Margin of Error Growth 

/001 $21,-173 

$21,990 

200J .$n2B9 

2004 $23,078 

2((),) $23,895 

7J06 $24.849 4.0% 

2007 $25.7?9 

2008 $27.168 5.6% 

2009 $27,6?.7 l.l% 

$21),215 

$28,595 

:0'012 $28.8;)2 0.9% 

2013 $28.9SI o.:~% 

201-1 $29.629 2.3% 

2015" $30.396 +/-! 18")45 

1016 $30.661 +/-IS4A99 

2017 tJ0,936 0.88% 

2018 $31201 +/-234.149 0.88~.; 

2019 $31.480 +/-263,'}42 0.88% 

2020 $-11,755 +/-288,!53 0.137% 

?0?1 $32D33 +H09,997 0.87?-6 

?0?.2 +/-3?9.472 0.81% 

+/-.141.051 0.87% 

2024 0.87% 

61 
361 


Insert offset folio 330 here 98944.330

Forecasts & Actual Valves of Average Wage in the Potential 

~~~ -~~~~t ~.~~~":~~~~!~!! A~~~-ti~J~~!~ .R~~.~L ~·-~~ 

--~'!'_~~---~_::_~!__~~~~~~~~-~.?~~-- A-'01 $19,162 

The increment in average size by year for the 

three periods was determined by calculating 

the trimmed mean of employment by 

decree for each proposed year, and using it 

as an estimate of the growth in employment 

Trimmed Meon of Proposed Full~ Time Employees. 

per Act 20 Decree - Eligible Activities 

Year of Proposal Employment by 

Oecroo Growth 

size per decree holder during the hiring stage 

of each generation. The following table 

presents these calculations. Note that 126 

Act 20 decrees did not specify a date of 

commencement. 

Trimmed Mean of Proposed Full-Time Employees 

per Act 20 Decree - Non-eligible Activities 

62 
362 


Insert offset folio 331 here 98944.331

Continuing Impact of Existing Decree Holders 

Existing decree holders were also 

incorporated in the projection, since they 

also contributed to the economic impact for 

the forecast period. We assumed that these 

decrees were previous generations of 

decrees. which were at a particular stage in 

their employment gross income. tax and 

payroll growth. Therefore. the starting values 

used for existing Act 20 decree holders were 

the corresponding average values for their 

particular economic stage. 

The following assumptions about future 

decree holders were made in order to 

produce the estimates: 

1 ) Each decree holder made only one ( 1 ) 

purchase of a primary residence during 

the 1 0-year period; 

2) In the case of renters. each decree 

holder maintained the acquired rent 

contract from his/her entrance year to 

the end of the estimated timespan; 

3) The hiring stage of each decree holder 

was reduced from three \3) years to two 

(2). as there Is no employment 

requirement for approvaL in contrast to 

the Act 20 decree holders; 

4) for the same reason, the employment 

estimates were weighed by the 

proportion of Act 22 decrees expected 

to generate employment. contrary to the 

To impute their employment contribution, 

they were first classified by year of approvaL 

and assumed to follow a 3-year hiring 

window with the previous characteristics. 

Decrees approved in 2012 were assumed to 

be in their final hiring stage, decrees 

approved in 2013 were in their second hiring 

year, and so on. Calculated impacts which 

fell into the specified time period were also 

incorporated to the projections. 

Act 20 methodology where thls 

proportion was assumed to be 100%; and 

5) Each decree holder is assumed to spend 

the reported footprint of money spent in 

Puerto Rico from his/her entrance year to 

the end of the period. 

Estimates of purchased real estate were 

calculated by multiplying the estimated real 

estate footprint by the number of entrants 

each year. Rent estimates were calculated 

by accumulating the yearly rent value of 

each generation from the date of entrance 

to the end of the ten-year period. The same 

methodology was used for the estimate of 

money spent in Puerto Rico. finally, the 

employment created was estimated 

following the approach of the Law 20 

forecasts. The average growth in the 

employment footprint was approximated by 

calculating the growth in overage 

employment per decree, distributed by the 

effective date of the decree (for income 

purposes). 

63 
363 


Insert offset folio 332 here 98944.332

Trimmed Mean of Employment per Decree, by 

Effective Date for Income Purposes 

_v_ea_r __ E.mployment by Decree Growth 

2012 

2013 

2014 

2015 

2.1 

0.9 

3.1 

1.9 

-58.5% 

250.5% 

-37.5% 

Source: Data provided by the PR Deportment of Economic 

Development (2015). All estimates of employment by decree 

were himrned means, with a trimfoctorof2.5%. 

Continuing Impact of Existing Decree Holders 

As with Act 20. the existing Act 22 decree 

holders were assumed to exert a continuing 

impact throughout the 2015-2024 period, 

The following tables show the results under 

the base scenario of Act 20 decrees added 

by year, Over the 10-yearperiodfrom 2015 to 

2024, a total of 2.351 additional decrees are 

expected to be added. These are expected 

to generate an average of 4.237 employees 

per year, ora total of 44.656 new employees. 

Of this totaL 38,073 employees would be in 

and thus were incorporated into the overall 

impact. The methodology mirrors that for Act 

20. 

eligible activities, and 6,583 would be in non~ 

eligible activities. 

The gross income generated by these 

decree holders would amount to an 

additional $3,810.5 million per year, for a total 

of $38,51 0 million of new corporate income 

added over the 1 0-year period. The 

accumulated corporate income tax paid 

throughout the period would amount to 

$808.9 million. 

64 

Insert offset folio 333 here 98944.333

Projected impact of law 20 Decrees-- 2015 to 2019 

2016 

3,612 

'1,277 1,802 

820 

Gross Income Generated by Year {in millions) $896.0 $1,133.9 $1,710.2 Corporate lncome Tax Paid by Year {in millions) $26.6 $24.2 $36.6 

$24.7 

j 

$78.5 

2017 

4,918 

$2,320.9 $2,962.3 

$49.8 $63.6 

708 

$3,634.9 

$2,963.4 

$78.1 

$11,7622 

$252.3 

$200.7 

65 

Insert offset folio 334 here 98944.334

Projeded lmpad of law 20 Decrees • • 2020 to 2024 

Concept 2020 2021 2022 2023 2024 Accumulated Impact (2020-2024} 

Employment Generated by Year 1,525 4,726 5,335 5,495 5,639 22,720 44,656 

4,932 19_787 

690 708 2,933 

Gross Income Generated by Year (in millions} $6,657.4 $26,343.3 $38,105.5 

$5,975.6 

$681.7 

Corporate Income Tax Paid by Year $55-6.6 $808"9 

$488.4 $689, l 

$68.2 $119.8 

$1,912.3 $3,118.9 

$2,634.6 

66 
366 


Insert offset folio 335 here 98944.335

The following tables present the economic 

impact of Act 22 Decrees. Act 22 Decrees 

are expected to produce an average of 

1,195 jobs per year. for a total of 11,945 jobs 

forecasted impact of taw 22 

added over the 2015-2024 period. The value 

of real estate purchased by Act 22 decree 

holders could be of up to $1.7 bil!ion, 

depending on the available inventory. Their 

1-year value of rent payments could ascend 

to $832.7 million as well. 

67 
367 


Insert offset folio 336 here 98944.336

Act 20 companies are mainly exporting to 

the USA but are also engaging in business 

relationships with countries around the world. 

This has potentia! spillover effects in Puerto 

Rico's local economy, particularly in 

providing know-how of international markets, 

so that other local services providers could 

move beyond internal demand. 

In the long-run, maintaining both policy tools 

could render strong yields for the local 

economy. particularly if the local 

government and service providers are able 

to capture the spillover effects of these 

grantees. Moreover. having incentives to 

develop the service sector will enable Puerto 

In terms of policy, the DDEC should consider 

establishing thresholds related to 

employment and investment requirements 

and for Act 20 and Act 22. This will contribute 

to the achievement of the Department's 

objective in terms of economic impact. 

Promotional efforts should also focus on 

incentivizing local firms to obtain these types 

of decrees. Due to the many structural 

inefficiencies in the island, the benefits of tax 

alleviation to local firms are bound to be 

greater in comparison to foreign firms. The 

low entry requirement should be maintained 

for local firms, in order to increase the 

incentives effectiveness. 

Rico to absorb the economic activity 

generated by more robust service sectors. In 

contrast with the previous development 

strategy, which focused on manufacturing, 

incentivizing the service sector -even through 

the injection of foreign capital- will bring 

about stronger economic growth. That is, the 

entry barriers to the service economy are 

much lower than that of manufacturing and 

technology transfer is almost a natural 

condition of the knowledge economy. 

Given the short period of time since 

enactment one should expect the biggest 

returns once a healthy critical mass has been 

reached. 

These laws, specifically Law 20, should be 

seen as part of a broader framework of 

developing local start-ups in these eligible 

activities. A grant program for 

incubating/accelerating local Ad 20 firms 

could be considered, in order to promote a 

larger local base of these types of firms. 

For Act 22 decree holders. an investment 

requirement in conformity with the 

development of Act 20 firms or other types of 

enterprises should be included. The objective 

of Act 22 should be to incentivize the arrival 

of foreign entrepreneurs towards Act 20 

eligible activities or some other type of 

investment; this objective must be enforced 

by appropriate requirements which promote 

investment and growth in the local economy, 

68 
368 


Insert offset folio 337 here 98944.337
369 


Insert offset folio 338 here 98944.338
370 


Insert offset folio 339 here 98944.339

This information ls for illustration purposes only. Actual number of participants may vary. Source: DDEC. 

71 
371 


Insert offset folio 340 here 98944.340

The purpose of forecasting is to make predictions, or inferences regarding future characteristics 

given a representation of reality in a fixed state. There exist various types of forecasting techniques, 

with a wide variation in sophistication. This section compares the approach used by Estudlos 

Tecnicos, Inc. (ETI) with an extrapolation approach by the PR Department of Economic 

Development [DDEC, by its Spanish acronym), based upon certain assumptions regarding decree 

holders. 

There is no single "correct" approach to a forecasting, and the actual accuracy of a forecast 

can only be determined by the empirical forecast error. As neither method used statistical 

approaches to directly estimate the economic impact, estimates of forecast error do not exist. 

Hence, only the reasonability of the estimates can be evaluated, based upon the current 

historical experience. 

The DDEC used a series of internal assumptions with respect to the growth rate in upcoming years 

up to 2022. These assumptions were then applied to the historical trend in decrees, to derive the 

economic impact estimates. The following assumptions were used: 

Act 20 Assumptions 

1) From 2016 through 2018. the number of approved Act 20 decrees is expected to double; 

from 2019 to 2022, it is expected to grow by 10% each year. 

2) Each new Act 20 decree holder wiU pay $250,000 in taxes for 2016, and will increase this 

amount by $125.000 until reaching $1 million in 2022. 

3) Each Act 20 decree holder will begin with twelve ( 12) employees in 20 16; for the following 

years. each new generation of decrees will increase this employment footprint by six (6) 

new employees, until reaching 50 employees per decree in 2022. 

a. In other words, each new decree holder will have an employment footprint 6 units 

greater than the previous year. 

Act 22 Assumptions 

1) From 2016 onwards, Act 22 approved decrees will increase at a rate of 50%. 

2) Each new Act 22 decree holder wi!! pay $25,000 in taxes for 2016, and will annually increase 

in $4, 167 until attaining $50,000 in 2022, 

3) Each new decree wi!l generate (3) jobs throughout the period. 

limitations with the DDEC Approach -Act 20 

1) The assumed growth is extremely sensitive to forecast errors. For example, the assumption 

of 100% growth, or yearly doubling of Act 20 decree numbers, was based upon the 

average growth from 2013-20 J 5. 

a. For the employment and revenue estimates. this margin of error is compounded 

by the error margin in the decree footprint. for example, if the decree footprint in 

72 
372 


Insert offset folio 341 here 98944.341

employment grew by 5 employees each year instead of the expected 6. there 

would be a discrepancy of 65.929 employees. 

2) When using the hybrid~approach dataset by Estudios T6cnicos, Inc., it is readily seen that 

the average Act 20 employment per decree for the 3-year period {without discounting 

outliers) is approximately 1.8 employees per decree per year; yet the DDEC forecast begins 

at 12. 

a. The efficient scale for production in the service industry is not a constant function 

of time, but responds to technological. cost and market considerations. (contrast 

with manufacturing) 

3) In 2022 alone. ODEC forecasts that 3,701 new Act 20 decree holders will produce 50 

employees each. for a total job creation of approximately 185.000 employees. This implies 

that Act 20 firms alone would be able to produce as many jobs in one year as the entire 

retail sector in the island. The 610.934 cumulative employment estimate would double the 

size of the private sector in the island. 

a. Important to take into account that relocation costs are much higher for larger 

establishments than for smaller ones. Also one has to take into account the 

available inventories of capital. real estate, infrastructure, permits or additional 

services that such large establishments may require. 

Limitations with the DDEC Approach -Act 22 

1) As with the Act 20 forecasts, the total number is extremely sensitive to the growth 

assumption; a 5% increase would imply 3.353 more decrees are added at the end of the 

period. or 19.7% more than originally forecasted. 

2) In 2022 alone, DDEC forecasts that 6.031 new Act 22 decree holders will produce 3 

employees each, for a total job creation of approximately 18,094 employees. 

3) Even in the empirical record. there exists more Act 22 decree holders than Act 20 decree 

holders, with an average growth of 251% --or tripling every year. However, the current Act 

22 forecasts present a lower number of Act 22 decree holders than in Act 20. contrary to 

current experience. 

a. If we followed the same methodology as with Act 20, there would be an 

accumulated 99.000 decrees from 2016 through 2022 alone. This highlights the 

explosiveness of the Act 20 estimates, i.e. the methodology is highly sensitive to 

specific values in order to produce reasonable estimates. 

73 
373 


Insert offset folio 342 here 98944.342

For the past years Puerto Rico has experienced a continued reduction in capital investments. As 

reflected in the National Accounts, Gross Domestic Fix Investment has been declining since 2005. 

Reduction in capital investment, particularly when adjusted by inflation and ignoring specific 

outliers such as ARRA funds, has been sustained for the past decade. In Puerto Rico more than 

half of all capital investment was attributed to the construction industry, however, due to the 

economic contraction experienced since 2006, now construction represents close to 39% of al! 

investment. If construction investment was further broken down, housing construction will reflect a 

steep faiL The total investment in housing construction for 2014 represents 30% of the total housing 

construction of 2005. 

The graph below highlights the reduction in construction investment from 2005 to 2014. 

600 

500 

400 

300 

200 

100 

Real Construction Investment by Type 

Fisca/Years 2004 2014 

2003 2004 2005 2006. 2007 :2008 2009 2010 2011 2012 2013 2014 

The investment in construction has reduced close to 5.7% annually since 2006, which contrasts 

with a 2.2% annual increase in the previous 7 years. Moreover, one of the main challenges for the 

local economy is to increase capital investments which usually bootstrap additional productive 

ventures. In 20051nvestment in construction as a percentage of GNP represented close to 11.9%, 

yet, in 2014such figure only amounts to 5.1%. 

74 
374 


Insert offset folio 343 here 98944.343

The graph below illustrates the downward trend of investments in construction as a percentage 

of GNP. 

18.0% 

16.0% 

14.0% 

12.0% 

10.0% 

8.0% 

6.0% 

4.0% 

2.0% 

Investment in Construction as a Percentage of GNP 

17.1% 

Act 20 and Act 22 Investments constituted a change in direction in the downward trend in capital 

investments, Due to the limited time these incentives have been in effect, aggregate change 

may not be reflected in the national accounts. Total investment in construction totaled $3.534 

million in 2014, out of these, private construction represented $1,849 million (50% of total 

construction). Furthermore, since 2014 total investment in construction is close to $2,000 million less 

than 2003 construction levels of investment. 

Act 20 and Act 22 provide the enabling factors for creating new capital investments in the 

economy. By importing new capitaL the economy has captured capital inflows which will add to 

the total investment figures in the following years. Taking into account the forecasts presented in 

the study, by 2020 Act 22 grantees will have demanded dose to $1 .000 million in real estate 

investments (primarily housing) which will provide an injection of capital to the construction 

industry. Moreover, Act 22 grantees reported planned capital investments of $228 million up to 

2015. If this trend continues, the local economy should expect a boost in total investment from the 

private sector in the following years. 

75 
375 


Insert offset folio 344 here 98944.344

The following table describes the various stages or status of the applications and/or reports in CRM. 

Cancelled 

Incomplete 

Application 

Incomplete 

Application 

SubmiHed Online 

The applicant cancelled ah application/report in the system. Change 

of Status in CRM occurs automatically. 

The user has created an appHcation/report using the Platform and is 

still in process. The application has not been submitted for OlTE's 

approval. Change of Status in CRM occurs automatically 

Once the application/report has been filled and required documents 

have been uploaded, except for the sworn statement. 

Application/report maintains the same status. 

Platform user submits the application in CRM with all required 

appendix for OICTE's review. Change of Status in CRM occurs 

automatically. 

Complete Application Once OETl reviews the application, and determines it is complete, the 

status is change to Complete Appllcatfon by the user. The appllcant 

receives a notification to proceed with the swom statement. 

Pending filing The applicant submits the sworn application in the supporting 

documents screen in the Platform. The application is identified as 

Pending Filing. Filing fees must be paid to OETL for the case to be 

considered filed. Change of Status in CRM occurs automatically. 

Filed The applicant paid the filing fees. OETI' s personnel make a manual 

change and identifies the status In CMR as Filed. This step begins the 

application approval period in CRM. 

76 
376 


Insert offset folio 345 here 98944.345

Box, G, Jenkins, G, ( 1970), Time series analysis: Forecasting and controL San Francisco: HoldenDay. 

Hogarth, R. M. & Makridakis, S. (1981). Forecasting and planning: An evaluation. Management 

Science, 27{2), 115-138. 

Sorjamaa, A., Hao. J .. ReyhanL N .. JL Y. & Lendasse. A. {2007). Methodology for long-term 

prediction of time series. Neurocomputing, 70, 2861-2869. dol: 10.1 016/j.neucom.2006.06.0 15 

77 
377 


Insert offset folio 346 here 98944.346

78 
378 


Insert offset folio 347 here 98944.347

H EALTHCARE PUERTO RICO LTD 

PHARMACEUTICALS PR LTD/ABBVIE LTD 

AGROCHEMICAL PRODUCTS BV/BASF AGROCHEM!CAL PRODUCTS BV PR BR 

ELECTRONICS MICROCIRCUITS IN 

LLC/lANSSEN ORTHO LLC 

SUNDSTRAND DE PUERTO RICO 

CHILCOTT CO INC/WARNER CHILCOTT CO LLC 
379 


Insert offset folio 348 here 98944.348

U.S. Senate Committee on Energy and Natural Resources 

October 22,2015 Hearing: Puerto Rico's Economy, Debt aud Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

Questions from Ranking Member Maria Cantwell 

Question 1: Looking at the short term crisis we face, both the Administration and the 

Governor have outlined their approaches to a recovery plan which are similar, and 

feature: 

• extension of Chapter 9 bankruptcy coverage; 

• correcting the disparity in healthcare treatment; 

• establishing an oversight mechanism; and 

• extending investment incentives, such as the Earned Income Tax credit. 

These elements track closely to what you concluded in your testimony, but I'd like to 

give you an opportunity to comment on both of these plans and how you think they 

could be improved? 

Answer: In our view, the proposal put forward by the Obama administration is a good 

and positive first step in the process of developing a coherent Federal policy for Puerto 

Rico. That being said, we must point out that we still need to see the specific details of 

each of the proposals in order to provide a more informed opinion to the Committee. 

Second, the policy package announced by the Administration does not address Puerto 

Rico's short-term liquidity situation. According to information provided by the 

Government Development Bank of Puerto Rico, the Commonwealth faces maturities in 

excess of $1.2 billion between December 1, 2015 and January 31, 2016. As I mentioned 

in my testimony this is the most pressing issue that Puerto Rico faces in the short-term. 

If the cash flow projections made by Conway MacKenzie are valid and accurate, then 

Puerto Rico will not have enough cash on hand to meet all its obligations as soon as 

December of this year. 1 In that event, in the absence of either (1) access to an emergency 

liquidity facility or (2) forbearance from bondholders, the probability of a disorderly 

default is quite high, because the current administration has already stated its firm 

intention to keep essential government operations running and Puerto Rico cannot avail 

itself of relief under Chapter 9 of the U.S. Bankruptcy Code. 

Given the short time window, the policy options at the federal level boil down to (l) 

providing short-term financing to Puerto Rico to avoid a default or (2) enacting "fasttrack" legislation extending the application of Chapter 9 to Puerto Rico. So far, both the 

U.S. Treasury and the Federal Reserve Bank of New York (which has jurisdiction over 

financial institutions in Puerto Rico) have heen reluctant to provide any kind of shortterm financing to the government of Puerto Rico that could be characterized as a 

"bailout". 

Third, the Administration's proposal could be improved in several ways. For example, 

Puerto Rico is currently treated quite unfairly under the Medicare program. Some policy 

1 Conway MacKenzie, Commonwealth of Puerto Rico Uquidity Update, August 25. 2015. 
380 


Insert offset folio 349 here 98944.349

U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

recommendations that have been put forth by the Commonwealth, Senator Schumer (S. 

1961), and Rep. Velazquez (D-NY) to address this issue include, among others, the 

following: 

• Establish automatic enrollment into Part B for residents of Puerto Rico 

Unlike states and the other territories, Puerto Rico residents who are Medicareeligible are not automatically enrolled into Medicare Part B. Instead of an "optout" enrollment process, Puerto Rico residents have to "opt-in" to Medicare Part 

B coverage. This leads to some eligible beneficiaries going without Part B over 

the long run due to late enrollment penalties, and has resulted in a Medicare Part 

B participation rate that is reportedly well below the national average. This, in 

turn, can place fiscal pressure on the Commonwealth government and/or safety 

net health care providers because they have to provide services that would 

otherwise be covered by Part B. Automatic enrollment could instead apply to 

Puerto Rico residents. 

• Make Puerto Rico residents eligible for Medicare Part D Low Income Subsidy 

Residents in Puerto Rico and other territories are not eligible for Medicare Part 

D's Low Income Subsidy (LIS). The LIS could be expanded to make such 

residents eligible, which could reduce fiscal pressures on Puerto Rico's Medicaid 

program (to the extent that Puerto Rico is providing some drug assistance now) 

as well as make drug coverage more affordable for low-income Medicare 

beneficiaries in Puerto Rico. (This could be applied to other territories as well.) 

• Modify Medicare DSH payments for Puerto Rico hospitals 

Medicare Disproportionate Share Hospital payments are based, in part, on the 

share of patients on SSI, but residents of Puerto Rico and the territories are not 

eligible for SSI except for the N. Marianas Islands (though they may still be 

eligible for financial assistance under pre-SSI block grants that go to those 

territories). The formula could be modified to instead take into account Part A 

beneficiaries enrolled in those territorial programs. This proposal would 

presumably increase existing DSH payments going to hospitals in Puerto Rico. 

Another issue that could be included is Puerto Rico's treatment under the U.S. coastwise 

shipping laws, most notably the Jones Act of 1920. We understand this is a thorny and 

complicated issue, but granting a partial exemption to allow Puerto Rico to use non-U.S. 

flag vessels to import natural gas from the United States would help Puerto Rico to 

significantly lower its energy costs. 

Finally, the Administration's proposal does not address the issue of long-term growth in 

Puerto Rico. We will take up that issue in our answer to Question 6. 

Question 2: Looking at the longer term, on page four of your testimony you highlight the 

role that the decline in investment has had in Puerto Rico's economic decline over the 

2 
381 


Insert offset folio 350 here 98944.350

U.S. Senate Committee on Energy and Natural Resources 

October 22,2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

past 10 years. In addition to the extension of the Earned Income Tax Credit (EITC) that 

you recommended, what other longer-term investment strategies do you recommend? 

Answer: In this respect I would say that the ball is on Puerto Rico's side of the court. 

The island's government needs to establish a series of horizontal policies that cut across 

and provide support to a defined set of productive sectors. 

Some of those policies are: (1) cracking down on government corruption; (2) 

significantly improving Puerto Rico's Byzantine and unduly opaque financial reporting; 

(3) reforming an unnecessarily complicated permitting and licensing system that stifles 

innovation; (4) undertaking affirmative actions to materially lower energy and other costs 

of doing business in the island; and (5) substantially improving Puerto Rico educational 

standards, among others. 

For example, in terms of the permitting system, the chart on the next page depicts the 

permitting process for a typical real estate development in Puerto Rico circa 2006. 2 As 

evidenced by the chart, the current permitting process was not designed to promote or 

incentivize new investment. 

1 Steven J. Davis and Lnis Rivera Batiz, 'The Climate for Business Development and Employment 

Growth'' in The Economy of Puerto Rico: Restoring Growth, Snsan M. Collins, Barry P. Bosworth. and 

Miguel A. Soto-Ciass eds .. (Brookings Institution Press: Washington, DC, 2006). p. 29~. 

3 
382 


Insert offset folio 351 here 98944.351

U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: .Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

294 DAVIS/ RIVERA-BATIZ 

Figure 6-4. Permitting Process for Construction and Real Estate Development 

Projects, Puerto Rico 

,--P-lanru-·ng_B_oon!_-, 

Projects Environmental Quality Board 

Location and land use Environmental review 

Consultations Private 

r--P-ub--:H_c_T_P_riva-re--1----+---j E=~=~tal DIA ~~~: 

improvements projects Public 

4 
383 


Insert offset folio 352 here 98944.352

U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

Puerto Rico also needs to modernize its labor laws and regulations, most of which were 

developed for a predominantly industrial economy that no longer exists (the United States 

also needs to address this issue by the way). The problem is how to protect workers in an 

economy were full-time employment with a single employer for thirty or forty years is no 

longer the nonn, while (I) providing more flexibility to workers who want more control 

over the time they dedicate to work as well as more power to decide what projects they 

work on, and (2) avoiding abuses by employers (wage theft, shift changes on short notice, 

etc.) In this regard Denmark has developed some interesting policies that could prove 

useful in the case of Puerto Rico (but perhaps not so much in the case of the mainland 

states). 

Finally, as I mentioned in my testimony, Puerto Rico needs to develop and implement a 

new industrial policy, broadly defined, to attract new investment to the island. 

On the Federal side, the Department of Commerce, in consultation with the Departments 

of Energy and the National Science Foundation, could establish a Center for 

Manufacturing Innovation in Puerto Rico. Such Center would be part of the National 

Network for Manufacturing Innovation under the National Institute of Standards and 

Technology Act. 

Question 3: You concluded by stating your belief that any new economic strategy "is 

bound to fail if it ignores the fact that Puerto Rico has reached the limits of its 

development within the constraints imposed by its subordinate political status." Political 

status is not the immediate topic of this hearing, but it is certainly relevant to this 

committee's jurisdiction. 

I would appreciate your thoughts on what Puerto Rico's economic strategy and 

economic outlook would be under different status options- such as a State, as an 

independent Caribbean nation, or as a sovereign state in free association with the 

United States in a relationship that is similar to the U.S. relationship with the 

Pacific island nations of: The Federated States of Micronesia, Palau and the 

Republic of the Marshall Islands. 

Answer: This is an extremely difficult question to answer because of the enormous 

amount of economic and political variables that would be affected by a change in 

political status either to statehood or to some form of sovereignty3 The table on page 

seven sets forth some of the most important variables that could be affected by a change 

in political status. 

3 The Congressional Budget Office analyzed this issue twenty-five years ago. Sec, Congressional Budget 

Office, Potential Economic impacts of Changes in Puerto Rico's Status Under S. 712, April 1990: and 

more recently with respect to statehood, see United States General Accountability Office, Puerto Rico: 

Information on How Statehood Would Potential(v Affect Selected Federal Programs and Revenue Sources, 

GA0-14-31, (March 2014). 

5 
384 


Insert offset folio 353 here 98944.353

U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

First, it is important to note that the current crisis has clearly highlighted Puerto Rico's 

lack of economic and political powers to address it. Neither a sovereign country nor a 

state of the union, Puerto Rico has no authority to negotiate international treaties, no 

access to emergency financing from multilateral institutions, no monetary policy 

instruments, limited fiscal policy tools, nominal representation in Congress, and the U.S. 

Supreme Court has determined it is constitutionally permissible for Congress to 

discriminate against Puerto Rico in the application of federal programs as long as there 

exists a "rational basis" for doing so. Thus being neither fish nor fowl in terms of the 

U.S. Constitutional order, Puerto Rico lives in a state of permanent limbo. 

In terms of statehood the principal advantages would be (1) full representation in 

Congress to protect Puerto Rico's interests; (2) equal treatment under all federal 

programs; and (3) the elimination of the "Puerto Rico premium" that some U.S. 

companies and entrepreneurs require to invest in Puerto Rico given its ambiguous 

political status. 

In terms of independence or sovereign free association, the principal advantages would 

be (l) the ability to execute an independent monetary policy; (2) the authority to 

negotiate international treaties; (3) access to and representation in international 

organizations; and (4) the political power to establish economic and political institutions 

that are specifically designed to address Puerto Rico's problems. 

Finally, we note that while a change in political status would provide Puerto Rico with a 

set of policy tools it currently lacks, a change in status, in and by itself, is no guarantee 

that those policy tools would be used wisely. There are wealthy as well as poor states of 

the Union, just as there are wealthy and poor independent countries. Therefore, the 

eventual economic impact of any changes to Puerto Rico's political status would depend, 

to a large extent, on the economic policies adopted ex post. 

6 
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U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

570 BOSWORTH/COLLINS 

Table 10-1. Strengths and Concerns for Puerto Rican Growth 

Factor 

Macroeconomic 

Openness 

Stahle currency 

Low inflation 

Access to U.S. markets, 

including financial markets 

Free flow oflabor and capital 

Participant in U.S. open 

trade regime with rest of 

world 

Potential gateway to Latin 

American countries 

Institutions and Financial system 

business climate Access to mainland 

FDIC regulation of banks 

Legal system (including U.S. 

protection of intellectual 

property rights) 

U.S. social safety net 

Physical and human capital High educational attainment 

English-speaking workforce 

Strong infrastructure for the 

region 

Source: '!he Economy of Puerto Rico: Restoring Growth, p. 570. 

Concern or constraint 

Fiscal difficulties 

High and rising debt 

Lack of transparency 

No monetary independence 

U.S.law and treaties 

not designed for or by 

Puerto Rico 

Jones Act restrictions on 

trade with United States 

Exports poorly diversified 

Complex and inconsistent 

tax: policies 

Difficult regulatoty 

procedures 

Political seesaw and policy 

uncertainty 

Poor incentive structure of 

transfer programs 

U.S. minimum wage 

U.S. dependency issues 

Low investment, especially 

in the 1980s 

Concerns about school 

quality 

Weaknesses of the 

infrastructure compared 

with United States and 

Ireland 

Environmental 

Ouestion 4: Some members have expressed a concern that extending the full coverage of 

Chapter 9 of the Bankruptcy Code to Puerto Rico would unfairly impact average 

Americans who have pensions that are invested in Puerto Rico bonds. However, it is my 

understanding that pension funds have not held Puerto Rico debt since it was downgraded 

below investment grade because pension funds are required to sell such low-rated debt. 

Is that correct, or would extending Chapter 9 authority to Puerto Rico unfairly 

impact the pensions of average Americans? 

7 
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U.S. Senate Committee on Energy and Natural Resources 

October 22,2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

Answer: We do not have first hand knowledge about the exposure of U.S. pension funds 

to Puerto Rico debt. However, we note that total U.S. pension assets (public and private, 

defined benefit and defined contribution, and including IRAs) amounted to 

approximately $22.1 trillion in 2014 4 

Thus, even if we assume arguendo that all $72 billion of Puerto Rico debt was held by 

U.S. pension funds, Puerto Rico debt would amount to only 0.32% of all U.S. pension 

assets. In the unlikely event that Puerto Rico simultaneously defaulted or restructured all 

its outstanding debt, the impact on the value of U.S. pension assets, assuming U.S. 

pension fimd5 are adequately divers(fied, would therefore be marginal or insignificant 

and would be barely noticed, even to the third decimal place. 

Question 5: Currently, the U.S. Treasury has a Puerto Rico Working Group that is 

providing technical assistance to the Puerto Rico Government. In addition, the Governor 

is recommending the establishment of a local Control Board to implement elements of his 

5-year plan. 

Do you have any suggestions on ways that the local Control Board and the 

Treasury Working Group could be brought more closely together in partnership to 

better assure positive outcomes? 

Answer: This is really a political economy problem. On the one hand, if the Treasury 

Working Group takes over the fiscal oversight function completely it may suffer from a 

lack oflegitimacy and representation. On the other hand, the proposed Commonwealth's 

Control Board, as structured right now, may suffer from a lack of credibility with the 

capital markets and, it may fail, due to political pressures, to impose adequate 

accountability standards on other agencies of the Puerto Rican government. The problem 

therefore is to identify the proper tradeoff between these two options. 

In this case we recommend the Committee analyze the option of establishing a fiscal 

council with representatives from both the Federal and the Commonwealth governments 

and from the private sector. According to the International Monetary Fund: 

Fiscal councils are independent public institutions aimed at promoting 

sustainable public finances through various functions. including public assessments of 

fiscal plans and pctformance, and the evaluation or provision of macroeconomic and 

budgetary forecasts. By fostering transparency and promoting a culture of stability. they 

can mise repntational and electoral costs of undesirable policies and broken 

commitments. 5 

4 Towers Watson, Global Pension Assets Study 2015, February 2015, p. 6. 5 Intemational Monetary Fund, The Functions and Impact of Fiscal Councils, IMF Policy Paper. July 16. 

2013. p. I. 

8 
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U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: .Puerto Rico's Economy, Debt and Options for Congress 

Questions for the Record Submitted to Mr. Sergio Marxuach 

These councils have been used, with mixed success to be honest, in several countries to 

stabilize government finances and oversee the implementation of fiscal and economic 

reforms. 

Question 6: On page 5 of your testimony, you mention the Center for a New Economy's 

work with experts at Columbia, Brown, MIT, Brookings and others to develop a mediumto long-term industrial policy for Puerto Rico. 

Can you outline the general approach that this research is taking and when you 

expect that a formal paper resulting from this work could be made available to the 

Committee? 

Answer: What Puerto Rico needs the most is to grow its economy. Short-tenn fixes will 

not work and short sightedness by the government on matters pertaining to economic 

development is partly to blame for our current situation. It is important to understand that 

the comparable situation here is not that of a two-year business cycle. A more realistic 

time horizon for registering significant economic gains in a country could be up to 10 

years. 

Crafting development and growth strategies is an endeavor best suited to academics and 

economic development experts. It should also stem from a country dialogue process to 

insure legitimacy and sustained acceptance by civil society. A project like this is already 

underway and led by CNE. The project is identified as the Roundtable for a New 

Economy, and in it, CNE and its partners -Professor Joseph Stiglitz and the Initiative for 

Policy Dialogue at Columbia University (IPD), the Brookings Institution (BI), and the 

Watson Institute for International Studies and Public Affairs at Brown University- aim 

to create a transformation agenda based on well-thought policy solutions that command 

the support of a broad group of key stakeholders. This novel project combines top-notch 

research and civic engagement to transcend the current juncture and restructure the 

island's outdated economic model. 

Unique in resources, structure and processes, this bold initiative will inspire first-class 

actionable research and policy making as the foundation for a series of dialogues that will 

engage a wide swath of Puerto Rican stakeholders in considering, discussing, crafting and 

implementing the optimal policy solutions to current challenges. We are working within a 

three-year time horizon to produce and divulge specific research products and policy 

proposals, but are currently accelerating the project's timeline due to the urgency of 

Puerto Rico's situation. 

9 
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U.S. Senate Committee on Energy and Natural Resources 

October 22, 2015 Hearing: Puerto Rico's Economy, Debt and Options for Congress 

Question for the Record Submitted to Mr. Fetter 

Question from Ranking Member Maria Cantwell 

Question: What can the Federal Government do to encourage PREP A's interest in and 

commitment to the adoption of new technologies, modernize its equipment, and make its 

operations more efficient? 

Answer: 

a) The Aguirre Offshore Gasport is a linchpin project for moving Puerto Rico from heavy 

reliance on oil toward liquefied natural gas t!:ll:tQ.!Wm:.J~!irr~lli!.Q!!!lg§tm;Q!l£Qf!JLJ. 

The project has received approval from the Federal Energy Regulatory Commission but 

is awaiting a decision on its loan guarantee proposal filed by PREP A at the US 

Department ofEnergy, which would help finance construction and operation of the 

project 

I expect as PREP A proposes additional infrastructure improvements, DOE loan 

guarantees would be most beneficial. 

b) PREP A is facing environmental mandates that will be costly and difficult to meet I 

know delay with regard to environmental issues is controversial, but if the Environmental 

Protection Agency is willing to meet with PREP A and discuss possible strategies, that 

might help the utility to improve its efficiencies. 

c) I believe the Congress or the Executive Branch could help facilitate PREP A and/or the 

Energy Commission tapping the knowledge base held by individuals at NARUC, EEI, 

AGA, NGSA, APPA, FERC, etc. as well as retired former utility industry and regulatory 

leaders, either at no cost or the small cost of travel expenses. 

d) It is my understanding that relief from the Jones Act could assist PREP A in cutting 

costs with regard to maritime trade. 
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ALAS 

October 16, 2015 

Hon. Lisa Murkowski 

Chair, US Senate Committee on Energy and Natural Resources 

304 Dirksen Senate Building 

Washington, DC 20510 Via Fax: (202) 224-6163 

Cc: Hon. Maria Cantwell 

Re.: Puerto Rico 

October 22, 2015 

Dear Senator Murkowski: 

On behalf of the Alliance for Free Association (ALAS), we hereby submit our comments for the 

hearing of reference on Puerto Rico's economy, debt, and options for Congress in moving 

forward. ALAS, as you may know, is a relatively newcomer to the Puerto Rico political 

landscape. It is a civil society organization, which got it first taste of politics in the 2012 status 

plebiscite, representing the option of "ELA Soberano" (Free Association). Though it is a new 

group, some of our members have been around politics for decades and have witnessed 

numerous hearings in Congress, which have resulted in no movement forward. Hopefully, this 

time we will see the forward movement we all desire and expect. 

An expedited comment on the topics to be reviewed: (1) The economy has been at a standstill 

since 2006, as a result of the termination of Section 936 of the IRS code, which provided a 

potent tax incentive exclusively to subsidiaries of US companies established on the island; (2) 

The $72 billion debt, which rose to this level by senseless decision making by all parties 

involved or related in the issuing of debt; and (3) The options are many and they may be short, 

medium, and long range. But the one option that we all can't continue to kick down the road is 

the decolonization of Puerto Rico. That is to such extent part and parcel of the essence of the 

problem that it needs to be operationalized promptly: this is "non-negotiable" 
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The Economy 

The definite downturn of our economy did not result from the real estate bubble bursting in 

2008. That event added to the indisputable fatal blow to our economy, the elimination of 

Section 936 without any commensurate adjustments. Section 936 used to generate significant 

deposits to our banks for financing in other economic sectors, good paying jobs for our people, 

and funds to advance US foreign policy in Central America and the Caribbean as per the US 

Caribbean Basin Initiative (CBI). A congressional creation in 1976, Section 936 brought many 

benefits to our economy. However, it was phased-out and eventually terminated by Congress. 

By such action Congress contributed to inflicting a fatal blow to the economy of Puerto Rico. 

The Debt 

Many actors are to blame for the enormous amount of debt a small island like Puerto Rico has 

accumulated. Irresponsible administrators, issuing agencies, brokers, crediting agencies, as 

well as Congress. Keep in mind that Puerto Rico is a US territory subject to the plenary 

powers of the US Congress under the territorial clause of the US Constitution (Article IV, 

Section 3) and as such the island lacks the traditional tools sovereign countries enjoy and 

utilize to face fiscal or economic turmoil. The government of Puerto Rico has requested 

assistance from the US government. The White House has offered technical advice thru the 

Treasury Department, many meetings, and a lukewarm endorsement to the inclusion of Puerto 

Rico in Chapter 9 (federal bankruptcy law). Congress has done nothing, aside from introducing 

bills to include our public corporations under Chapter 9 of the laws of Bankruptcy. It has failed 

to fashion an economic relief package in the nature of the one conceded to the US automotive 

industry, by either purchasing our debt and/or offering federal guarantees to new debt. 

Congress has to remember its total political responsibility over Puerto Rico. Consequently, 

Congress has the authority to fashion whatever remedy it may see fit to help Puerto Rico out of 

this malady, particularly when it is responsible, in no small measure, for contributing, with its 

legal limitations on Puerto Rico's autonomy, to the chaotic economic situation we are presently 

living. 

Options 

There are many options which Congress could consider, short of taking the daily chores of 

directly governing the island. But, in order to do that, you need to have the courage to take 

bold and decisive action: 

Short term 

1. Repeal or eliminate the applicability of the 1920 Jones Act (PL 66-261 as 

amended) to Puerto Rico, also known as the US maritime or shipping law, 

which holds our people hostage to the regulatory scheme which limits our 
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freedom in our maritime transportation with the US. This would equate 

Puerto Rico with other US territories, which are exempt from the 1920 Jones 

Act, such as the Virgin Islands, the Marianas Islands, American Samoa and 

Guam. 1 According to the PR Senate Report to Senate Resolution 237, the 

Jones Act has cost Puerto Rico more than$ 29,000 billion from 1971 to 2012. 

Without question, a repeal of the application of the Jones Act to Puerto Rico 

shall provide a much-needed relief to our beat up consumer, who presently 

pays the highest sales tax under the US flag (11.5%) and who also earns less 

than their fellow citizens in the 50 states. 2 Needless to tell you, Puerto Rico 

also suffers from the highest poverty rate under US jurisdiction, with around 

47% of our population earning below the US poverty rate. Mississippi stands 

at 22% as of 2014. 

2. Making the foreign tax credit permanent at 10% for either type of tax that 

Puerto Rico chooses to impose to its foreign US corporations operating on 

the island. This would enable Puerto Rico to receive a steady stream of tax 

revenue without the concern of whether the US Department of Treasury will 

permit or not the credit to the US corporations operating on the island. 

3. Amend the current Free Trade Agreements to accelerate the entry of Puerto 

Rico products into the foreign countries subject to the Free Trade 

Agreements. And in NAFTA, provide the same consideration to Puerto Rican 

rum that is provided to the bourbon crafted in the states or to the tequila of 

Mexico or whiskey of Canada. Also, make permanent the cover over of the 

rum excise tax paid by Puerto Rican rum into the US Treasury at the full level, 

and limit (the government of Puerto Rico) the pass through to the private 

rum producing companies in the island. Exempt Puerto Rico from any future 

tax legislation to impose a tax to US controlled foreign corporations. 

4. Provide full health benefits to our people residing on the island under US 

federal programs to which we contribute (Medicaid and Medicare ). 

5. Consider extending the Suplemental Security Income (SSI ) to our old , 

disabled , and blind people many of whom live in extreme poverty. 

Medium Term 

This committee needs to bite the bullet and provide Puerto Ricans with a real 

opportunity to decide our political future. Not by appropriating funds for an educational 

campaign for a local plebiscite. But rather, by telling us what political options is 

Congress willing 

1 Guam has a partial exemption. 

2 Medium household income in Puerto Rico in 2014 was $23,168.00, and in the poorest state of the 

Union, Mississippi, it was $36,919.00. 
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to consider besides independence. It is mind-boggling how the US, the great promoter 

of freedom in the world, continues to keep Puerto Rico and other jurisdictions under the 

claws of colonialism. We want this issue resolved tomorrow. Puerto Ricans has held 

several plebiscites; has asked the United Nations for assistance in our struggle to end 

the present colonial relationship with the US; besides, foreign countries and other 

international organizations have called for the decolonization of Puerto Rico. 

As recently as in 2012, the last locally sponsored plebiscite was held, because 

Congress has evaded the issue since the late 1950's. In the 2012 local plebiscite, 54% 

of the voters rejected the present colonial status. They said NO to the Commonwealth, 

which has, since 1952, been colonial and subordinated to US sovereign powers in its 

very nature. Since the early 1900's, the essence of our political subordination to 

Congress as a non-incorporated territory has not changed, other than the adoption of a 

Constitution in 1952 (amended by Congress). The Insular cases decided by the US 

Supreme Court said clearly that as a non-incorporated territory, Puerto Rico is not part 

of the US; our US citizenship since 1917 did not entitled Puerto Ricans living on the 

island to full citizenship rights because the US Constitution accords full rights to citizens 

residing in any of the 50 states. The US citizens of the island lack full participation on 

nutritional assistance; are held to a cap on Medicaid; are treated different under 

Medicare, though we pay the same Medicare tax as citizens residing in the 50 states; 

there is no SSI for our disabled, blind , and old people. This is the consequence of the 

US Supreme Court decision ruling that we could be treated differently because Puerto 

Rico is a territory, a colonial possession, in other words. 

So, please bite the bullet and tell us what political options are actually available to 

Puerto Rico. Be candid, as New Zealand was during the 1960's to its colonial territories 

of the Cook Islands and Niue. Let us decide fair and square what kind of relationship 

we want to have with the US. How difficult can it be? New Zealand told quite frankly to 

the islanders that they had to choose between independence and free association 

because integration to New Zealand was not desirable nor planned for those islands. 

Tells us whether statehood is or not viable for Puerto Rico. Tell us if we can build a Free 

Association relationship similar to the one the United States has with several 

jurisdictions in the Pacific Ocean. Tell us. It is that simple. As you well know, the lack 

of a clear policy declaration by Congress, has deluded many Puerto Ricans to expect 

the concession of federal statehood within the United States, i.e, incorporation. As long 

as many Puerto Ricans support statehood (even though the condition of nonincorporated overseas territory means that Puerto Rico "was not intended to become a 

state") there will not be a clear majority for Free Association or for Independence, the 

net result being the continuation of a Commonwealth relationship that has been rejected 

by 54% of our voters as recently as 2012, i.e. has lost democratic legitimacy. We still 

suppose that you 
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sincerely believe in democracy: so please show it through actions, not just words, in the 

case of Puerto Rico. You may declare a thousand times that you recognize Puerto 

Rico's right to self-determination. However, as long as you entertain false hopes in the 

Puerto Rico statehood movement in the sense that federal statehood is viable for 

Puerto Rico by the lack of a clear policy established by Congress, your words and 

commitments to democracy and to respecting self-determination for Puerto Rico are 

undone by Congress's inaction regarding Puerto Rico. As you see, this is so because 

such inaction and inattention by Congress, leads to a stalemate in Puerto Rican politics 

as long as pro-statehood Puerto Ricans continue to be deluded to believe that 

statehood is a real option for Puerto Rican society under present distressful economic 

and social conditions. 

It is time to end the one-way street of Congress mandating statutory rules and Puerto 

Rico simply obeying. In our view, this is no longer acceptable by the Western 

democratic world and runs counter to the spirit of the twenty-first century. 

Long Term 

Transition to the next relationship, which we believe and expect to be a mutually 

convenient Free Association Treaty with the US, allowing Puerto Ricans to maintain 

a close relationship with the United States including the retention of free access to the 

United States by Puerto Ricans and to Puerto Rico by US residents, as well as the 

retention of the same type of US citizenship that Puerto Ricans have had since 1917, 

which, nowadays, is in no way incompatible with a Puerto Rican citizenship for matters 

regarding the Puerto Rican sovereign state created by the sovereign expression of the 

Puerto Rican people and by such Treaty of Free Association with the United States. 

These are the comments of ALAS as we move forward. Thank you. 

For the ALAS Executive Committee, 

Gladys Escalona, PHD. 

Ex-Chancellor University of Puerto Rico at Rio Piedras 

Sen. Jose A. Ortiz-Daliot, Esq. (PDP-2001-2004) 

Juan R. Fernandez, PHD 

Ex- Chancellor, University of Puerto Rico at Rio Piedras 

Angel Israel Rivera Ortiz, PHD. Senior Professor of Political Science 

University of Puerto Rico at Rio Piedras 

Enrique Vazquez-Quintana, MD 

Ex-Secretary of Health, Cabinet of Governor Rossell6 
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Statement of Luis E. Baco, Esq. • 

Hearing on "Puerto Rico: Economy, Debt, and Options for Congress" 

Senate Committee on Energy and Natural Resources 

October ZZ, 2015 

Madam Chairman Murkowski, Ranking Minority Member Cantwell, and Members of the 

Committee: 

Thank you for holding this hearing on Puerto Rico's "economy, debt, and options for 

Congress," and for the opportunity to submit a statement on this vitally important matter for the 

nearly 3.5 million fellow U.S. citizens residing on the Island and the 5.2 million residing in the 

states of the Union. 

The fact that there are less than 3.5 million U.S. citizens residing in Puerto Rico today 

constitutes, in itself, the most powerful indication of the magnitude of the crisis before us. The 

population of Puerto Rico, which had been steadily growing since at least the 1700's, has 

dramatically drifted downward in the last decade, but even more so during recent years. The 

nearly 9 percent decrease in population from 3.8 million in 2000 to 3.5 million in 2014 represents 

the first sustained decline since U.S. census-taking began in the early 20th century. Puerto Ricans 

are leaving their beloved but financially troubled island for the U.S. mainland in the largest 

numbers since the Great Migration that followed World War II. They are relocating to the states 

in extraordinary numbers, which, as U.S. citizens, they can do for the price of a one-way plane 

ticket. As a matter of fact, since this Committee's last hearing on Puerto Rico's political status in 

August of 2013, more than 100,000 Puerto Ricans have moved to the states and, unless 

immediate and dramatic measures are implemented, both locally and at the federal level, this 

exodus to the states will further increase in the future. The Census Bureau, for one, has projected 

that the island's population loss will continue through at least 2050, estimating that Puerto Rico's 

population will be less than 3 million by then. 

The undisputed fact, and primary cause of this exodus, is that the great U.S. colonial 

experiment in the Caribbean has blatantly failed. The U.S. Congress has held hearings on the 

subject; the President's Task Force on Puerto Rico's Status has hosted forums in Washington and 

San Juan; and the Obama Administration is said to be providing "technical advice and assistance" 

to the local government. National media coverage on the crisis and the local government's 

default has been unprecedented. By now, the Washington establishment is, or should be, fully 

aware of Puerto Rico's historic financial collapse. And yet, one thing seems patently and 

frustratingly clear: to this day, the Executive and legislative Branches of the federal government 

have reacted to the territory's predicament with the bureaucratic equivalent to Clark Gable's 

infamous "Frankly, my dear, I don't give a damn." In short, there's been much talk but little, if 

any, substantive action. 

Given that so much has already been said about Puerto Rico's economy and debt, I will 

instead focus my statement on the options before Congress while proposing a road map that 
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could lead to resolving the long-standing political and economic dilemmas before us once and 

for all. 

First, Congress needs to finally recognize that the root cause of Puerto Rico's crisis is the 

island's territorial relationship with the u.s., a subject that is well within the jurisdiction of this 

Committee. The fact is that Puerto Rico's current territorial status does not provide the island 

with the necessary tools to overcome, by itself, the current financial crisis. it is also true that 

Puerto Rico's current territorial status was never intended to be permanent In nature, but rather 

a transitional accommodation towards eventual Statehood or Independence. For decades, 

however, the federal government has stood by silently, perpetuating with its inaction this 

congressionally imposed hybrid and discriminatory political and economic model - or as 

President Ronald Reagan once said, Puerto Rico's "historically unnatural status." Washington's 

blatant procrastination regarding the island remains unaltered to this day, even after the people 

of Puerto Rico overwhelmingly and unequivocally voted to withdraw their consent to the current 

territorial relationship in November of 2012. This Committee held hearings on this very issue back 

on August 1, 2013 but, as usual, no action followed. 

The fact that this colonial experiment has resulted in Puerto Rico becoming the poster 

child for underdevelopment should come as no surprise, as any political or economic model 

founded on the basis of citizen inequality is doomed to fail miserably. And fail miserably it has ... 

As Resident Commissioner Pedro Pierluisi indicated during a September 29, 2015 Senate Finance 

Committee hearing on the financial and economic challenges in Puerto Rico, "Congress should 

not expect the island to have a first class economy if it treats Puerto Ricans as second class 

citizens." Furthermore, were it not for federal welfare handouts, economic stratagems such as 

Section 936 of the Internal Revenue Code, and other short-term, improvised and makeshift 

measures, Puerto Rico's economy would have collapsed long ago and in an even more dramatic 

manner. 

Thus, the federal government, as one of the main culprits of this unprecedented crisis, 

has a moral, political, and juridical obligation to intervene immediately. Why? A currently 

debated topic can provide some insight: when news first broke out on the depth of Puerto Rico's 

$73 billion debt problem, one of the local government's initial reactions was to call on Congress 

to amend the U.S. bankruptcy laws so as to make available to the island's public corporations the 

benefits of bankruptcy protection, a protective mechanism that is available to government 

entities in the 50 states, and which had been available to Puerto Rico until Congress amended 

the statute back in 1984. Uncharacteristically, this proposal has received almost unanimous 

support across the island's political spectrum, but remains languishing in Congress. Efforts by the 

Puerto Rico Legislature to enact a similar law locally resulted in the federal courts ruling that such 

statute was unconstitutional as it was preempted by federal law, leaving Puerto Rico, as is often 

the case, between "a rock and a hard place." This is just one, yet very recent, example of the 

territorial relationship's severe shortcomings. 

And this, Madam Chairman and Members of the Committee, exemplifies the real 

problem: U.S. citizens in the 215

' century that continue being discriminated against solely because 

of their place of residence and an absolute denial of the most elemental right in a democracy: 

the right to political representation. Those unfamiliar with Puerto Rico's 117 year-old colonial 

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dilemma should know that, although Puerto Ricans have been American citizens since 1917 and 

have valiantly served in every single war and conflict the U.S. has been involved in ever since, 

they are barred from voting for the President and from electing a proportionate congressional 

delegation which, given the island's population, would include no less than five members in the 

U.S. House of Representatives and the requisite two senators in this Chamber. Thus, Puerto Rico 

has a very limited capacity to use the federal political process to pursue its interests, which is the 

essence of our democratic system of government. Simply stated, the island's territorial status 

cannot be reconciled with the principles of self-determination, voting rights, democracy, and 

equality that the U.S. promotes all over the world, sometimes with the use of force, but fails to 

apply domestically in the case of Puerto Rico. 

Further, Puerto Ricans on the island are treated unequally in, or even totally excluded 

from, most federal programs, which essentially makes them, as stated before, second-class 

citizens of the U.S. The disparities that Puerto Rico faces in many federal programs, especially 

when their impact is considered cumulatively, have been devastating, not only to the U.S. citizens 

residing in the territory, but also to Puerto Rico's economy and fiscal well-being. These inequities 

are harmful to Puerto Rico's economy because billions of dollars in federal funding are lost every 

year, money that would have otherwise been available to be spent and invested. They are also 

detrimental to Puerto Rico's fiscal condition because the local government is obliged to spend or 

borrow money to compensate for the shortfall in federal support, exacerbating deficits and debt. 

Lastly, these disparities contribute to Puerto Rico's demographic disaster by compromising the 

quality of life of Puerto Ricans and, in many instances, forcing them to move to the U.S. mainland, 

where-unlike in Puerto Rico-they are entitled to equal treatment under all federal programs. 

The fact that we are still having this discussion in our nation, the greatest democracy that 

the world has ever known, is both unconscionable and shameful. Congress needs to stop 

procrastinating and start living up to its historical and constitutional responsibilities. Specifically, 

Congress should consider the following initiatives: 

Formally respond and act upon the democratic will of the people of Puerto Rico 

as expressed in the 2012 Plebiscite on Puerto Rico's status, the results of which 

have embarked the island on an irreversible path towards Statehood. Enactment 

of H.R. 727, introduced by Resident Commissioner Pedro Pierluisi with 110 House 

cosponsors but no Senate companion bill, would be a good starting point. Holding 

hearings is not good enough. We've had hundreds of them over the years with 

absolutely no result. The time to act is long overdue. 

Begin a gradual phasing-in of equal treatment in all federal programs where the 

U.S. citizens of Puerto Rico are currently being discriminated against when 

compared to their fellow citizens in the states. These include, but are not limited 

to, Medicaid, Medicare, the Earned Income Tax Credit (EITC), the Child Tax Credit 

(CTC), Veterans' TRICARE, Supplemental Security Income (SSI), Temporary 

Assistance for Needy Families (TANF), the Supplemental Nutrition Assistance 

Program (SNAP), and the Low Income Home Energy Assistance Program (LIHEAP). 

Urgent attention should be given to the Medicaid and Medicare funding and 

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provider-reimbursement disparities given the impending health care fiscal cliff 

that would completely devastate Puerto Rico's health delivery system and result 

in the exodus of many thousands more, particularly seniors and the medicallyindigent, to the states. 

Pass H.R. 870 and S. 1774, granting Puerto Rico with state-like treatment under 

Chapter 9 of the U.S. Bankruptcy Code, as it had been before 1984. 

• Ensure that Puerto Rican veterans are treated equally with their counterparts in 

the states. If our brave men and women- who, by the way, are not even allowed 

to vote for their Commander-in-Chief- were equal during their service in times of 

war, they should be equal upon their return home in times of peace. 

• Work with the Administration to provide Puerto Rico with a temporary and/or 

partial exemption from the Jones Act cabotage laws as a way to incentivize the 

island's economy. This would not be inconsistent with Statehood, as other states, 

including Alaska and Hawaii, are seeking similar remedies. 

Institute a policy where Puerto Rico would be granted state-like treatment in all 

future legislation enacted by Congress. Every effort must be made to close, and 

not enhance, the ever-growing gap between Puerto Rico and the states. The 

ultimate policy goal should always be to seek equality for all U.S. citizens, 

regardless of their place of birth or residence. 

• Consider the establishment of a Puerto Rico Federal Advisory Board, whose 

members would be appointed by Congress and the Administration, to provide 

recommendations, oversight, and technical assistance to the local government in 

areas such as federal fund administration, access to federal grant programs, debt 

restructuring, and budgetary matters. Said board should be strictly advisory in 

nature and report periodically to Congress and the White House. 

• Make the full Rum Cover Over reimbursement to Puerto Rico permanent, as it was 

prior to 1984, instead of having it partially subjected to the unpredictable 

enactment, or lack thereof, of Tax Extenders legislation. 

Enact comprehensive legislation that would put Puerto Rico on a path towards 

energy self-sufficiency, as an economic development and job creating tool as well 

as an environmental sustainability initiative that could serve as an example 

nationwide and in the Caribbean region. 

• Enact comprehensive legislation addressing Puerto Rico's recurring drought 

issues, using as basis S. 1894, The California Emergency Drought Relief Act 

introduced by Senators Feinstein and Boxer, particularly those provisions 

pertaining to the availability of assistance to drought-stricken communities and 

Page4of5 
398 


Insert offset folio 367 here 98944.367

farmers, desalinization and other technologies, water storage and reservoir 

capacity, water recycling, and conservation. 

While the aforementioned constitute specific steps that Congress could take to alleviate 

the plight of 3.5 million of its own citizens, it is by no means intended to suggest that the federal 

government is solely to blame for this crisis. On the contrary, local administrations in Puerto Rico, 

who must be adjudicated their proportionate share of the responsibility for the current fiscal 

crisis, for years have also "buried their heads in the sand," resorting to a sort of "wait until 

tomorrow" attitude where political expediency and improvisation have become the practical 

tools of economic policy. In simple language, they have been paying their credit card debts with 

other credit cards, until the time has come when they are realizing that the debt payment 

exceeds receipts, and there are no more credit cards. This should not come as a surprise in a 

pseudo-socialist economic model where close to 33 percent of all employment is in government, 

and emphasis is on government supremacy over the private sector. 

In summary, Congress, which is vested by the Constitution with nearly unlimited power 

over its territories, needs to live up to its responsibilities and finally recognize that the only way 

to resolve Puerto Rico's long-standing fiscal, economic, and political woes is to end, once and for 

all, the island's discriminatory territorial status. In so doing, Congress must act upon the 

democratic will of the island's electorate, which overwhelmingly voted in 2012 to reject the 

current territorial relationship and in favor of Puerto Rico becoming the 51st state of our great 

Union. In the meantime, years of procrastination and improvisation must be replaced by the 

proactive implementation of realistic and permanent pro-growth economic policies based upon 

the sacred principles of citizen equality and political empowerment. 

Madam Chairman and Distinguished Members of the Committee, 2017 will mark the 

centennial ofthe granting of U.S. citizenship to Puerto Ricans. The U.S. citizens of Puerto Rico are 

proud of being Americans and cherish their citizenship, but have become increasingly tired of the 

many inconsequential hearings, panels, forums, workshops, and task forces. For too long, the 

primary focus has been on treating the patient's symptoms rather than the actual disease. Gone 

are the days where we could remain silent and still, unfairly relegating and passing on to our 

sons, daughters, and future generations the tough decisions that we must make today. The time 

for action is long overdue. The 3.5 million U.S. citizens of Puerto Rico and our nation deserve no 

less. 

• Luis E. Bac6 is a Capital Member at the Puerto Rico-based McConnell Valdes law Firm and heads the Firm's 

Washington, D.C. office. He previously served as Chief of Staff to Congressman Luis G. Fortui'lo in the U.S. House of 

Representatives, Counsel in the McDermott, Will & Emery International law Firm, Deputy Executive Director of the 

Puerto Rico Federal Affairs Administration, and Deputy Chief of Staff and legislative Director to Congressman Carlos 

Romero-Barcelo in the U.S House of Representatives. 

Page 5 of 5 
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October 22, 2015 

The Honorable Lisa Murkowski 

Chairman 

Committee on Energy and Natural Resources 

U.S. Senate 

304 Dirksen Senate Office Building 

Washington, DC 20510 

The Honorable Maria Cantwell 

Ranking Member 

Committee on Energy and Natural Resources 

U.S. Senate 

304 Dirksen Senate Office Building 

Washington, DC 20510 

Dear Chairman Murkowski and Ranking Member Cantwell: 

The attached letter is to convey the views of the Competitiveness and Sustainable Economy Institute of 

Puerto Rico (CSEIPR) and the Puerto Rico Manufacturers Association (PRMA) on the important topics 

being examined today by the Senate Committee on Energy and Natural Resources at its oversight hearing 

entitled "Puerto Rico: economy, debt, and options for Congress." I ask that yo~ make this letter a part of 

the formal hearing record. 

The CSEIPR is a recently incorporated non-profit organization aimed at conducting educational activities, 

coordinate expert data gathering, studies and analysis that foster the socio-economic wellbeing of Puerto 

Rico. 

The Puerto Rico Manufacturers Association is a private, voluntary, non-profit organization established in 

1928 with the purpose of uniting all Puerto Rico's manufacturers and service industries into a strong and 

effective body in order to further their mutual interests as they relate to the private and public sectors of 

the Commonwealth of Puerto Rico. 

Both organization, in alliance with other Puerto Rico organizations are conducting studies and preparing 

for the intervention processes at the Puerto Rico Energy Commission, which is the focus of our 

communication to you given the present urgent nature of the Puerto Rico Energy Reform processes. 

Sincerely, 

Presidente, PRMA Energy Committee 

cc: The Honorable Alejandro Garda Padilla, Governor of Puerto Rico 

The Honorable Pedro R. Pierluisi, Resident Commissioner from Puerto Rico, U.S. House of 

Representatives 

• 
400 


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October 21, 2015 

Senator Lisa Murkowski 

United States Senate 

Committee on Energy and Natural Resources 

709 Hart Senate Office Building 

Washington, D.C. 20510-0203 

Honorable Senator Murkowski: 

The subject of energy reform is considered one of the top three areas of opportunities by Puerto 

Rico's private sector; our local government as stated in the Krueger Report; and the US government 

as stated in the White House Task Force on I'R report, to positively impact renewed economic growth 

for Puerto Rico. 

Pursuant to this opportunity, and the need by US government as well as Puerto Rico 

institutional debt-holder investors to see Puerto Rico's government and private sector leadership 

enact well planned, pro-growth, responsible structural economic reforms, in October 2014 a 

Memorandum of Understanding (MOU) between the US Department of Energy (DOE) and the 

Government of Puerto Rico was signed, including these objectives: 

'This Memorandum of Understanding (MOU) is intended to provide a framework for an ongoing 

Commonwealth-wide effort to realize Puerto Rica's vision for a modern, sustainable, energy infrastructure. 

The work under the MOU wi!J maintain the current public support for lang-term action that is widely 

recognized as necessary to a sustainable energy sector in Puerto Rico, in part by ensuring that a broad array 

of stakeholders is able to shape the direction and outcome of this transformation. This includes pursuing 

policies, technologies, deployment strategies, and financing approaches tailored to Puerto Rico's needs 

relating to: energy efficiency in the private and public sectors; renewable energy; alternate fuels; electric 

tran.o;mission and distribution systems; energy storage; alternative fuel vehicles and other forms of clean 

transportation~· and institutional capacity it. 

Notwithstanding, after a good commencement organized through the DOE's Energy Transition 

Initiative, where the local participating non-governmental organizations defined an initial objective 

along with DOE and our state energy office representatives (focused on the Puerto Rico's electrical 

system reform), meetings and further progress ceased. 

Another important issue we ask you and the US congressional leadership to urgently consider 

is related to Section 9. of the HR- 83, Consolidated and Further Continuing Appropriations Act, 2015. 

Section 9. titled "Study of electric rates in the insular areas" requires the following actions with 

regards to Puerto Rico energy reform needs and opportunities: 

• "not later than 180 days after the date of enactment of this Act, the Secretary shall, within 

the Empowering Insular Communities activity, establish a team of technical, policy, and 
401 


Insert offset folio 370 here 98944.370

financial experts- (1) to develop an energy action plan addressing the energy needs of 

each of the insular areas and Freely Associated States; and {2) to assist each of the insular 

areas and Freely Associated States in implementing such plan» 

As indicated in the act: 

The term "insular areas" means American Samoa, the Commonwealth of the 

Northern Mariana Islands, Puerto Rico, Guam, and the Virgin Islands. 

The term "Secretary" means the Secretary of the Department of Interior (DOl). 

To date, no action has been taken by the agency, and we know of no real efforts that may 

enable effective collaboration between the DOl's mandate and the DOE's MOU execution towards 

the common goal of achieving reduced energy costs through better use of indigenous energy 

resources in Puerto Rico's energy reform. 

The ongoing debt restructuring process of the financially distressed Puerto Rico Electrical Power 

Authority (PREPA) includes the PREPA June 1'' Report and July 22nd 2015 Public Disclosure cost 

structure as follows: Fuel- 8.1C; Purchased Power- 5.1 C; Operation and Maintenance- 8.6C; Capital 

Improvement- 1.4C; Debt Service- 6.1C; for a Total Energy Cost of 29.2(;/I<Wh. 

Simple analysis of PREPA proposed costs indicate unsustainable electrical energy rates for local 

businesses and rate-payers in general and offer no hope for renewed economic growth for PR. As an 

example, the Operation and Maintenance cost segment of 8.6C/KWh is equivalent to the Average 

Energy Rate for the West South Central US. Region for July 2015 of 8.62C/KWh; white 6.1¢/KWh 

allocated for the Debt Service is comparable to the West South Central US. Region Industrial Energy 

Rate for July 2015 of 5.69C/KWh. 

The present artificially tow average rates of around 21¢/KWh- though still twice us average 

rates- results from our public utilities financial non-compliance and the very low oil prices on which 

two thirds of our obsolete thermal generation fleet rely. The PREP A restructuring officer recently 

disclosed an estimated deficit of 7.9 <:/KWh, with regards to the current rate and PREPA's current 

cost structure. The officer has publicly stated for "all to share the burden" of the proposed debt 

restructuring alluding to rate-payers suffering an up to 4C/KWh increase. 

Forty eight percent (48%) of Puerto Rico's GOP results directly from its manufacturing sector. 

When other related primary sectors of our local economy are considered, a total of approximately 

70% of our GOP has relied and still relies on competitive electrical energy rates similar to other 

industrial island economies. 

Puerto Rico has endured a more than doubling of its energy cost since year 2000, with severe 

decreases in energy consumption, as well as growing manifestations of economic and social ills such 

as increasing migration, government deficits and massive toss of investment. Energy rates increased 

from 9.22 ~/KWh in residential, 12.19 ¢/KWh in commercial and 9.58 ¢/KWh in the industrial sector 

during FY 2000 to 23.51 ¢/KWh in residential, 24.17 C/KWh commercial, and 20.60 C/KWh in the 
402 


Insert offset folio 371 here 98944.371

industrial sector during FY 2015. At the same time, energy consumption has seen a significant 

decrease of 15.3% in the past 10years from 20,507.4 mmKWh in FY 2005 to 17,280.1 mmKWh during 

fY 2015; including a severe decrease in the industrial sector of 44.09% in 10 years from 4,177.4 

mmKWh in FY 2005 to 2,335.6 mmKWh during FY 2015. 

The above turmoil in the electrical energy sector has resulted in a significant decrease of 7% in 

our GDP, at constant value, from $11.379 Billion on 2005 to $10,581 Billion in 2014. Intervention by 

the federal government along with Puerto Rico's private sector leadership and local government are 

required to address and correct the current obstacles to energy reform, with specific attention to 

these four main areas of intervention: 

• Urgently reactivate existing MOU with the DOE providing vigorous strategic and tactical 

consulting support for intervention by local NGO's in the ongoing Integrated Resources 

Plan {IFlP) review at the Puerto Rico Energy Commission {PREC), and subsequent Rate Case 

analysis. 

• Urgent compliance by the DOl with HR- 83, specifically focusing resources on needed 

studies and system modeling, as part of the local government MOU with DOE which 

promised active participation by our private sector to jointly plan for the lowest Base 

Energy Cost possible pursuant to the IRP Review Process. 

" Amend the law with the exclusion of Puerto Rico in the federal Bankruptcy Code of 1984, 

specifically as it relates to the orderly reorganization of our public corporations and 

municipalities. 

• DOE financial guarantees that lower the costs of competitive fuel and power purchase 

suppliers as part of the system re-structuring towards a sustainable energy system. 

Senator Murkowski, prompt solutions to the unsustalnably high energy costs and resulting 

general economic distress in Puerto Rico cannot be achieved without a prompt congressional and 

federal government intervention. 

Sincerely,, 

Jose E. Rossi 

Institute de Competitividad 

y Sostenibilidad de P. R. 

President 

P. R. Manufacturers 

Association 

XC: The Honorable Maria CantweU, Ranking Member Comm1ttee on Energy and Natural Resources 

Ft!es 

President, Energy Committee 

P. R. Manufacturers 

Association 
403 


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To: 

"Puerto Rico: ..... ..., ...... ,..,. .. ,,._"~', Debt and 'IJ'IJuuAJt:s for .... ~,n~~ .. -~,:e;~ 

October 22, 2015 

SD-366 

I will like you to consider me "A Friend of the Senate" 

The basics is that this has a "Socialist ut:>JJ<.w::u 

this socialist attitudes the government of PR has 

and grow and grow by "'·'·lwu••14 

Water 

etc, 

At the same time, by laws or away coJrnJ;•etltton, 

establish monopolies that hinder and drive away 

new 

Although I can sound to be I have no choice other than establish as a fact that 

the actual party, Democratic has a greater amount of 

''"~'v"'~'cmu.y in this Socialist business like way to govern. 

tried to or 

from \-Vorkers 

has been in power and have 

groups, Print and Electronic and Churches, Etc. unleash 

powerful and emotional strikes, acts of violence and 

pressures that makes the government to back up their of 

and more efficient government. \\Then violence erupt, very few actors face 

never, never terms. 

1 6 
404 


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Unfortunately, the same NPP has a lot of blame because an "unofficial" but open policy 

of this party in the last 40 years is to appease the protestors many time without getting 

anything in return. Nor a compromise or even a "happy medium". 

Actually, the actual PR government do not want and refuse to close ofllces, layoff 

employees, sell assets or cut expenses. This government just want to stay as big as it is 

now. 

a. Should the local government be in the Broadcast business with TV & Radio stations? 

b. Should it have commercial offices in Peru, Ecuador, Colombia, Kissimmee, NY, that 

also acts like embassies of a foreign country? 

c. Should it be in the Higher Education business with a University with I I branches in 

different towns with a budged of $1.2 Billions annually? 

d. Should the government be in the business of Education with over I ,300 Government 

Schools? 

e. Should it be in the Insurance business with a Workers Compensation Insurance 

monopoly "that force'' all employers to subscribe in order to maintain an artificial 

payroll and several luxury big empty buildings? 

f. Should it be in the Water business with another monopoly made by Law? 

g. Should it be in the Electric business by avoiding or slowing competition? 

An inclusion in the bankruptcy laws will "De Facto" maintain all this Big Government 

intact. With the time, and if finances gets better, they will go back to basic to do exactly 

the same things and at the first opportunity they will go to the market to ask for more 

loaned money for they to use and others to pay. 

By allowing Puerto Rico to enjoy the US bankruptcy laws it will impede the opportunity 

to get rid of many government departments, agencies and offices like the Electric and 

Water Authorities that "claim they provide services" but the reality is that "the services" 

they provide are services needed to solve situations created by laws and regulations by 

the very same government. 

2-6 
405 


Insert offset folio 374 here 98944.374

The city of New York has one mayor for 8 J\ilillions residents. Puerto Rico has 78 

mayors ;v:ith a population of 3.5 Millions. Some of these mayors makes more salary 

than Mr. Bill de Blasia. 

It also has 120 government agencies. When a new government get in power they 

immediately hire 120 very well paid new directors with undisclosed amount of "people 

of trust", "Assistants" and "Assessors". See Exhibits #1 & #2 

In summary, this Socialist form of government make everything more complicate in 

order to keep a big bureaucratic and complicate way to do businesses. But the 

government is a 4 year monopoly so many politicians don't care too much to make life 

easier for the citizens until new elections approach. After elections passed, things will go 

back to basics. 

Political accountability could be a lot better if elections could be held every two years 

instead of four or Legislators could be elected for four years in mid-term elections aparl 

and separate of administrative elective positions. This will diminish the "winner takes it 

all" attitude that prevail when an opposition party sweep an elections. 

In summary: 

1. Any kind of help from Congress should be tied up to lower the amount of employees 

and government agencies under the average of other states based in population. 

2. Parity in Medicaid, Social Security and other federal programs should be welcome as 

long as they are tied to lower the amount of government agencies. 

3. Don't let this Banana Republic sort of government to survive as it is now. 

This socialist form of government needs to be overhauled to be a facilitator not an 

obstacle to free enterprise, private businesses and economic development. Bankruptcy is 

just a way to keep this Big government intact. 

3-6 
406 


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Pension funds 

solution is 

every two years. 

"No laws or regulations of Pension l'unds should be on purpose or 

in a way that it will the good will of its own n11rn''~"''" 

But the 

What this means is that: Pension Funds were created in "Good Will" to financial 

support to bonafide members of a class in their years. It was not created to 

enrich or Lavish of to a Few when the immense 

of that same class receive a very many times do not provide 

ordinary daily expenses. 

While many receive a very low amount of money like $600 or $800 per 

month some receive quantities with absurds amounts as 6, 7, even 10 thousands 

dollars per month fur life. 

As an example. The 9 Puerto Rico have to retire when 

to old and will receive their fiJI! salary for the rest of their lives. If they die, 

widow vviJl the same income for also the rest of her life of 

her age. While our nation has 9 for 320 Millions Puerto Rico has 9 for 

only 3.5 Millions. 

are or are not exc!mpte'd from taxes because the territorial government do not make 

available this kind :·) 

To secure the financial health of all Pension Funds in our Nation (and in the world that 

wiU copy it) a "CAP" should be a standard This three letters 

, will solve all Pension Fund blues in our 

4-6 
407 


Insert offset folio 376 here 98944.376

be ! and as soon as the Virgin islanders 

such a move, if they want to approve such a move, the two US Senators of Puerto 

will represent both territories and the that will represent the north-east 

of Puerto Rico, Culebra and Vieques will represent Saint John, Saint Thomas and 

Saint Croix. 

Any action by from now on should address the fact that "the use of the 

language to teach in Government Schools is De facto prohibited" but not in 

schools where politicians and the ruling classes send their children. 

Since 1943 until yes, until the use of the English language to teach is 

prohibited in all Government schools in the vVhat is in control of the 

government is in control of the and many times the of the 

people represent their political parties over the needs of the people they should 

represent. 

In 1991, then governor Hernande;r, Colon sent two bills to the Lel~I~Iatttre. 

May was labeled "The Spanish Only This one was adamantly 

of the New and it was with Law No.1 

In he sent another bilL This one to eonvert into law 

""''"'"""'r" of Mariano 

that prohibited the "Use of the to teach" in the 1,300 of the 

government. The of the the minority of the NPP voted in favor 'A.~th 

one abstention "a Law" the administrative order of !948. 

5 6 
408 


Insert offset folio 377 here 98944.377

g;o•vernn1ertt schools no classes of M;atb,enmtlcs, 

and the books for those classes 

not master 

Native teachers arc not found in any 

riPmcm<tr~:hr><T the discrimination 

sisters teachers from others states. The 

American teachers in this American 

schools where the send their children. 

teachers do 

In government schools at the children 

songs "in but never songs "in Behind" 

la\·VS, and and not even the US Constitution apply to this US 

That's to 

"Aifirmative Actions" to demonstrate that local politicians can be re-couc;ate:t1 to 

its from be tied 

thernselvcs in favor of the claim to represent. 

6 6 
409 


Insert offset folio 378 here 98944.378

By: The San Juan Star staff 

January 4,2001 

- The Science of the 

Piedras campus, has announced 

known to science. The new 

io,vernntellltitam Porto:rricensis." 

Portorricensis has one neutron, 12 assistant 

and 224 assistant 

312. These 312 are 

which are surrounded vast 

OW!lO!ll!l-Hice parttcll~s called peons. 

imrenl1menitlUJm Portorricensis has no it is inert. 

aetectect, as it every reaction with 

A small amount of Governmentium Portorricensis causes 

reaction to take over 4 to when it would .. "'""''"} take less than a second. 

In Govemmentium Portorricensis mass will increase 

over since each cause more morons to 

become neutrons b-u...n'""' tsoton,es. 

leads some scientists to 

is fonmed whenever 

concentration. This 

morass." 

When Portorricensis 

becomes ua:tm1etun1, an which radiates as much 

energy since it has as many peons but twice as many morons. 

www.BilingualSociety.Blogspot.com 
410 


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Insert offset folio 380 here 98944.380

55 Exchange Place, 5th Floor 

New York, New York 10005 

T. 212 2331!955 F. 212233 6996 

Jose Calderon, President, Hispanic Federation 

Written Testimony 

1522 K Street N.W., Suite 1130 

Wa•hingtoo. DC 20005-1225 T.2028420235 1'.2028870812 

United States Senate Committee on Energy and Natural Resources 

"Hearing on Puerto Rico: economy, debt, and options for Congress" 

October 22, 2015 

Chairman Murkowski, Ranking Member Cantwell, and distinguished members of the Committee on 

Energy and Natural Resources thank you for the opportunity to provide testimony on the crisis facing 

Puerto Rico. 

My name is Jose Calderon. 1 am the President of the Hispanic Federation. Hispanic Federation is the 

nation's premier Latino membership organization with a mission to advance and empower the Hispanic 

community locally and nationally. For over 25 years, Hispanic Federation has provided critical nonprofit 

capacity-building grants, launched innovative community programs and led public advocacy efforts in 

the areas of education, health, immigration, economic empowerment, ciVic engagement, civil rights and 

the environment. Through its network of nearly 100 affiliated community-based organizations, HF 

reaches thousands of Hispanics each year including a large number of Puerto Ricans living on the 

mainland. 

Recently, Hispanic Federation has been helping to lead efforts to support Puerto Rico and its 3.5 million 

U.S. citizens, along with an extensive coalition of Latino, labor, environmental, health and economic 

justice advocates from across the nation, With our partners, we have organized press conferences in 

several cities from Hartford to Orlando, collected signatures on a White House petition calling for the 

President to respond to the crisis and organizing a congressional briefing to inform our nation's leaders 

about the situation on the island. Two weeks ago we released a briefing paper, Puerto Rico's Economic 

Crisis: Overview ond Recommendations for Action in which we lay out Hispanic Federation's strong belief 

that the federal government bears a social, moral and economic responsibility to directly address the 

Puerto Rican debt crisis. 

The ramifications of the island's economic crisis have been far reaching: One hundred and fifty public 

schools have already been shuttered in the last five years. Puerto Rico has increased the retirement age 

and required heftier pension fund contributions from public sector workers. And more pain is coming. 

Puerto Rico passed a budget for the fiscal year beginning July 1, 2015 that increased the sales and use 

tax from 7 percent to 11.5 percent and reduced pubic investment by $674 million. 

Severe current and future government budget cuts threaten to undermine the already tenuous 

economic situation of hundreds of thousands of Puerto Ricans on the island. And there is good chance 

that the crisis will be increasingly felt in many US. states, through potential pension asset losses and a 

growing reliance on local social services by those who migrate to the U.S. In short, Puerto Rico's near· 

calamitous economic crisis, if left to fester, will almost certainly reverberate far beyond the geographic 

limits of the island. 

1 
412 


Insert offset folio 381 here 98944.381

The reasons behind the island's current economic woes are complex, with plenty of blame to go around: 

poor budget practices by the island, federal funding shortfalls and tax policies that hamper economic 

growth, predatory lending by hedge funds, and the complicated and oft unjust relationship between the 

U.S. and Puerto Rico, to name just a few. There are also wider forces to blame, such as the Great 

Recession, outmigration from the island, and escalating energy and health care costs. 

Setting the stage for the crisis were stagnant economic conditions in Puerto Rico over the past 10-15 

years, brought about by the elimination of Section 936 of the Internal Revenue Code. Section 936 

encouraged mainland companies to locate on the island. Unfortunately, when the tax breaks were 

eliminated by Congress, these companies moved out. The Great Recession of 2008 compounded this 

stagnation, leaving almost half the island's residents in poverty and unemployed. Forced to seek 

economic opportunity, hundreds of thousands of Puerto Ricans moved stateside to places like Florida, 

draining the island's tax base which funds basic public services. 

However, structural economic inequalities- in part driven by Federal policies- date back long before 

the recent decline. A prime example is the burdensome costs oftransporting goods created by the U.S. 

Jones Act, which has increased shipping costs by billions over many decades. In effect, the law requires 

every car, food item or other product that enters or leaves Puerto Rico to be carried on a moreexpensive U.S.-flagged vessel. If a foreign-flagged ship enters the island, high taxes and customs fees 

essentially double the price of transported goods. 

Puerto Rico also faces growing costs to its public services. The electricity system led by the Puerto Rico 

Electric Power Authority (PREP A) is more than $8 billion in debt. A recent deal to restructure the debt 

still leaves the systemic challenge of reducing sky-high energy costs to homeowners and businesses 

from the outdated and unhealthy use of fossil fuels, as opposed to cleaner, renewable energy systems. 

Federal healthcare funding inequities have also contributed to the ongoing crisis. Approximately 60% of 

the island's population is enrolled in Medicaid or Medicare, both which face an uncertain future due in 

part to an archaic capping of federal contributions which was imposed upon Puerto Rico. As a result, 

healthcare costs represent an estimated $25 billion of its $72 billion debt. 

Declining tax revenue forced risky borrowing to keep public utilities and local government running, 

which in turn generated massive debt because of predatory interest rates aimed at creating a big fiscal 

windfall for hedge funds looking to make a fast buck at the island's expense. In fact, these same hedge 

fund interests were backers of changes in the island's constitution that mandated the local government 

to first pay debt relief before continuing to fund schools, energy and other vital public services. 

Unfortunately, these measures will only help to exacerbate the current vicious cycle of outmigration, 

with the only certainty being that more pain for Puerto Rico is in store in the near future. Below are 

more details regarding the main causes of the island's financial troubles, focusing on labor force decline, 

the health care crisis, and debt and debt service costs. 

The depth and scope of Puerto Rico's economic crisis has forced leaders on the island to make difficult 

and painful choices. The Commonwealth has already laid off over 30,000 employees, raised utility and 

college tuition prices, raised taxes, cut public health and pension benefits, closed schools, and raised the 

retirement age. On September 8th, the Governor announced a new round of austerity measures that 

2 
413 


Insert offset folio 382 here 98944.382

calls for additional cuts to social services, layoffs and reductions in job protections. Meanwhile, Puerto 

Rico is also bracing for a health care crisis with federal funds rapidly diminishing and no clear plan on 

how to keep island residents covered in the coming years. 

Puerto Rico is considering reforms to all aspects of its economy and governance, including taxes, labor 

laws and administrative practices. Negotiations are underway to explore debt restructuring and other 

options, but financial interests are resisting payment reductions. Meanwhile, there are estimates that 

this year's $5 billion principal and interest payments alone would require $1,400 in increased tax levies 

for every resident of the island, roughly 9% of per-capita income. Unfortunately, Puerto Rico does not 

have the cash flow or tax base to make anything close to the required payments. 

Despite these cuts and the pain they're causing millions of American citizens on the island, the same 

hedge fund interests who urged the Commonwealth to continue to unwisely borrow well beyond its 

means are now calling for further severe austerity and privatization measures to protect their financial 

windfall. The !MF's "Krueger Plan" perfectly encapsulates this thinking with its severe budget cuts and 

related proposals calling for even more massive school closures and wage reductions. 

While there will undoubtedly be further fiscal pain for the families of Puerto Rico, we do not believe the 

island can or should cut its way through this crisis. Further reductions to government services and 

pensions threaten to undermine the Puerto Rican economy so deeply that it may take generations to 

recover. Any realistic solution must instead include reasonable debt restructuring and relief, immediate 

federal investment and reforms, and a long·term economic growth and diversification strategy that will 

create living-wage jobs, grow small businesses, improve infrastructure and provide opportunities for 

local residents. 

President Obama and Congress cannot stand on the sidelines when it comes to Puerto Rico. Elected 

officials and civil servants in both the executive and legislative branches have a legal and moral 

obligation to support Puerto Rico in its time of dire need. Over 35 million U.S. citizens are counting on 

them to act immediately to help the island get through this fiscal crisis and on a path to economic 

recovery. Below are select key actions the Federal Government can undertake to offer resources and 

enact reforms to assist Puerto Rico through this fiscal and economic crisis. 

Bankruptcy Protection: Congress should pass legislation granting Puerto Rico the right to declare 

Chapter 9 bankruptcy or another orderly and fair alternative in order to renegotiate the debt and 

establish a fair repayment plan. See Puerto Rico Chapter 9 Uniformity Act-H.R. 870, introduced by 

Representative Pedro Pierluisi (D-PR) and Senators Richard Blumenthal (O-CT) and Charles Schumer (DNY). 

Debt Renegotiation & Relief: President Obama should convene a Working Group on Financial 

Markets to bring all parties to the table in order to negotiate a fair debt repayment and relief deal. In 

doing so, the President could sit down with all relevant stakeholders and explore a Federal Reserve loan 

or any other bridge or gap financing options for the Commonwealth of Puerto Rico. In addition, the 

President should exercise his authority to convene both the Government of Puerto Rico and its 

creditors, and urge the parties to find an orderly negotiated resolution of this crisis in order to avoid 

further costs to the vulnerable residents and populations in Puerto Rico. 

Health Care: Congress should bolster Puerto Rico's health care safety net by passing legislation 

that will eliminate the annual Medicaid/Mi Salud funding cap on Puerto Rico in favor offunding based 

on FMAP per-capita income. Congress should include all U.S. territories in this legislation. Congress 

3 
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Insert offset folio 383 here 98944.383

should also improve the formula for the Medicare Disproportionate Share Hospital Program, reduce by 

50% the fee on insurers in the territories, and establish a floor for Medicare payments. In the interim, 

the President should establish a multi-billion dollar health care program as has been done in some states 

to ensure vital health care services continue past 2017, when existing funds will run out. See Improving 

the Treatment of the U.S. Territories Under Federal Health Programs Act of 2015 H.R. 2635 introduced 

by Representative Pedro Pierluisi (D-PR). 

Energy and the Environment: President Obama should direct the Department of Energy (DOE} 

and Environmental Protection Agency {EPA) to engage in a full review and collaborative analysis of all 

federal policies and programs that apply to Puerto Rico in the areas of clean energy generation and 

environmental cleanup. This will ensure the development of a comprehensive policy plan that addresses 

the energy, clean environment, safety and health needs of Puerto Rico, including the cleanup of toxic 

sites within the island municipalities of Vieques and Culebra. 

Jones Act: The President should grant a temporary waiver and Congress should pass legislation 

that amends the costly shipping mandates dictated by the Jones Act, which unfairly increases the prices 

of imports and exports to and from Puerto Rico. Any funds from foreign-vessel fees should also be 

directed to the Puerto Rico Treasury. 

Tax Policy: Following the loss of Section 936 tax incentives, the Federal Government should 

institute tax policies that foster economically-diverse and living-wage job creation. President Obama 

should also support local government implementation of an Earned Income Tax Credit (EITC) that 

rewards work and supplements earnings to low-income workers in Puerto Rico. 

Federal Policy & Funding Formula Assessment: There should be a full Administration and 

Congressional review of all federal policies that apply (or not) to the Commonwealth of Puerto Rico. This 

review should seek to eliminate or reduce the impact of federal policies that put the island at an 

economic disadvantage, as well as look for ways to expand access to Federal investments and programs. 

Puerto Rico and its citizens are inextricably intertwined with the United States by history, emigration 

and economics. Puerto Ricans, both on the island and stateside, have fought valiantly in every war since 

World War I, and its citizens have contributed to this nation in innumerable ways. Its diaspora- five 

million strong, still intimately connected to the island- are a visible presence in communities 

throughout the fifty States of the Union. Just as significantly, three out of every four municipal funds in 

the country hold Puerto Rico's bonds. 

Because of these intimate interconnections, what affects Puerto Rico affects the U.S. The fact that 

Puerto Rico faces the worst economic crisis in more than a century should be of the highest concern to 

all Americans. If Puerto Rico is forced to enact even more draconian cuts to its budget, the island will 

almost certainly spiral into an even deeper crisis. Given the interpenetration of the Puerto Rican 

population and economy with the U.S., this will have incalculable repercussions on communities, towns 

and cities stateside. 

The time to debate or assign blame is past, as is any hope that the U.S. could avoid economic fallout 

from this crisis. The real question is, do we have the will to act in order to ameliorate its very worst 

effects? 

To do so, we urge the Administration and Congress to resist calls by hedge funds to force more cuts to 

social services. We urge Congress to give Puerto Rico the ability to file for bankruptcy protection and to 

pass legislation rectifying economic inequities including the Jones Act and Mi Salud. We urge the 

President to call for a full federal agency review of policies that are economically harmful to Puerto Rico, 

4 
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Insert offset folio 384 here 98944.384

including health care reimbursement, and convene his Working Group on Financial Markets to develop 

an in-depth debt relief, repayment, and investment plan to stabilize the island's economy. 

We urge the Congress to take strong, substantive and constructive action that stabilizes Puerto Rico and 

protects the livelihoods of 3.5 million American citizens living on the island. 

Thank you for your time and consideration. 

Jose Calderon 

President 

Hispanic Federation 

5 
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Insert offset folio 385 here 98944.385

Franklin D. Lopez 

La Paz St 703, Miramar 

San Juan, PR 00907 USA 

Former-Journalist for United Press International and 

The Associated Press; Businessman; Writer, Political Prisoner 

@trueblue51, www.franklindelanolopez.com 

Statement for the record of the Natural Resources Committee 

of the U.S. Senate 

October 2015 

THE TIME FOR. EQUALITY and REPARATION IS NOW! 

The beginning of this American Paradox, the political limbo of a U.S. territory, started in the office of newspaper 

publisher and tycoon William Randolph Hearst. With his control of newspapers in San Francisco and New York 

Hearst was competing for influence and circulation with another tycoon Joseph Pulitzer, owner of the 

New World. Their competition was fierce and promoted the publishing unfounded and false stories to incite 

public opinions in promoting their business interests and political policies objectives, 

Hearst was the prime mover of the Spanish American War of 1898. He used his in every conceivable way to 

spark the war againat Spain. Hesent Frederic Remington, an artist hired by to provide illustrations to 

accompany a series of articles on the Cuban Revolution,soon became bored with seemingly peaceful Cuba and wired 

Hearst on January 1897: "Everything is quiet. There is no trouble. There will be no war. I wish to return." To which 

Hearst's alleged reply was: "Please remain. You furnish the pictures and I'll furnish the war." Then, !be war shi'P 

Maine was blown by a massive "'unknown" explosion in Havana harbor and the Spanish American War 'began. It 

was a short war. It started in April and ended on December 10, 1898 with the signing of the Treaty of Versailles. Spain 

sold the Philippines for $20 millions; Cuba became a protectorate and Puerto Rico and Guam were ceded to the 

United States. 

States Congress absolute control of the new territories. After 2 years of military governors 

Puerto was given civilian control of the governments with the Foraker Act and in 1917 the Jones Act granted 

American citizenship. During the first 25 years the United States Supreme Court issued a series of opinions in the so 

called Insular Cases in which the citizens living in Puerto Rico were labelled "aliens" "not fit for the Anglo-Saxon 

culture" and through judicial fiat and discrimination. Francis Torres writing for the llrown 

tlnlviirsll)i l>tilitical review said: of the Cml War aod Reconstruction led some to believe tha< 

the relationship between Americans and !be of these new territories would be based upon the newly 

established concept of political equality racial groups on the mainland. However, these notions were 

thrown out the window in the wake of popular social Darwinism and the nationalistic mythns of Manifest Destiny. 

Under this ideological framework, American views of their new subject populations leaned towards the paternalistic 

and racist:~ 

It is true !bat Puerto Rico was an abandoned and and powerless metropolis of 

Spain. When the United States assumed the University of Puerto Rico 

and many other infrastructure and public works were built to of social, econo,;ic and political 

development. The overwhehning majority of the citizens of Puerto under abismal levels of and 

poverty: Just take a photographic tour of the pictures in the National Archive of that time period. 

Nevertheless since the granting of citizenship American citizens in Puerto Rico have contributed to our Nation in 

many forms aod ways. Let's see !he most outstanding: 
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2 

1- More than 275,000 have served with dignity and honor defending liberty democracy in all major conflicts of the 

20th and 21st century. Thousands have given their lives for the causes of democracy and liherty denied to them. 

2- Puerto Rico is among the 20th purchaser of U.S. goods and services in the World creating hundreds of thousands 

of jobs in all the slates of the union. 

3- Puerto Rico pays more Federal taxes than Alaska, Vermont, Montana, Maine, North Dakota and Wyoming. 

Despite this fact that American citizens paid 100% oJ the Social tal<('s they are discriminated by Congress 

denying the application of certain benefits. Congress has extended applicability of all Social Security benefits to 

AmericartS abroad and to those retired in republics like Costa Rica. Taxation without 

representation? St•e The Economist: 

4- American citizens from Puerto Rico have enriched the diversity of American culture in show business, moviesf 

literature, sports and in all aspects of the human exparience. Examples of this contributors are: Jose Ferrer; Rita 

Moreno, Benicio del Toro, tennis player Gigi Fernandez, baseball stars like Roberto Clemente, Peruchin Cepeda and 

many others. 

5- There are five millions American citizens from Puerto Rican ancestry living in all of the 50 states of the union and 

generating billions of dollars to fhe American economy. Since the granting of the so called "estado libre asociado" 

free associated slate in 1952 more fhan 2.3 millimtS have departed seeking the American dream. 

6- Dozens of Air Force, Naval and Army facilities in an Island 100 miles by 35 miles, including use of two populated 

islands with Uve target practice and multiple intelligence gathering & listening posts. 

The other side of the coin: 

1- Since conquering Puerto Rico, the United States government, particularly Congress, established an apartheid and 

segregated policies towards American citizens residing in Puerto Rico. Federal laws full benefits to 

Americans living in fhe states and a different standard in the territory. For example, su:ppl,etrten!al 

paid !o American citizens residing in the Republic of Costa Rica by an act of Congress. 

2- American citizen-; serving in the U.S. Armed Forces were segregated in the same matmer African Americans were. 

They were also discriminated in promotions within the ranks of the armed forces. 

3- During the 1930s the Rockefeller Foundation funded a program under the management of U.S. Army Colonel 

Cornelius P. Rhoads, an oncologist and pathologist. He experimented with Puerto Ricans, using cancerous cells to 

find ''a cure" for this deadly disease. He wrote a letter to a colleague of his in Boston the name Fred W. Stewart 

and this is what he said about PuertoRicans: "They are beyond doubt the dirtiest, most and 

thievish race of men ev-er inhabiting this sphere. It makes you sick to inhabit the same island with 

even lower than Italians." 

4-Federal court system and law enforcement agencies are been used to pe1rse,cute ene1ni<\S 

the sole objective of maintaining the status quo. 

5~American citizens residing in the territory are forced to use American ships for importation and 

exportation of goods and services. 

6-Since 1952 the Ut\iled States have adopted the disgraceful pnlicy that Puerto Rico "solved" it's political statns with 

the adoption of the territorial constitution (Law 600) approved by the U.S. Congress. This policy denied American 

citizens the right for a self determination process gnaranteed by United Nations Resolution 1541-XV. 

On July 25, 1979 the Carter Administration, pressed by Puerto Ricans who supported his candidacy in 

the pressures from The White House and the State Department and crossed the street into the United to 

denounce the colonial nature of the "commonwealth s!atosl" As a direct result the White House issued the 

Alternative Futnre Presidential Executive Order. This was the beginning of a path to be followed by future 

presidents to maneuver the s!atos question into abridge to nowhere. But it was a beginning on the end of 

"commonwealth" colonial status. It was also l:he 1st lime that the presidency made an official policy statement 
418 


Insert offset folio 387 here 98944.387

3 

"guaranteeing" the right self-determination to choose between indepE.".ndencef statehood or the so called 

commonwealth. 

President George H.W. Bush issued a memorandum on November 30, 1992, to heads of executive departments and 

agencies establishing the current relationship between the Federal Government and the commonwealth of Puerto 

Rico. This memorandum directs all Federal departments, agencies, and officials to treat Puerto Rico administratively 

as if it were a State insofar as doing so would not disrupt Federal programs or operations. 

On December23, 2000, President William). Clinton signed executive Order 13183, which established the President's 

Task Force on Puerto Rico's Status and the rules for its membership. This executive Order outlines the policy and 

functions of the Task Force in identifying the options for Puerto Rico's future status and the process for realizing an 

option. On April30, 2001, President George W. Bush amended executive Order 13183, extending the deadline for the 

Task Force to forward a report to the President until August 2001. 

President George W. Bush signed an additional amendment to executive Order 13183 on December 3, 2003, which 

established the TaskForce co-chairs and instructed the Task Force to issue reports as needed, but no less than once 

every two years. 

President Barack Obama validated the Executive Order en a Task Force was re-appointed an issued 

a reportThe Obama Administration Inter Agency Committee on Puerto Rico clearly stated that Puerto Rico's 

economic quagmire is tied to it's political status. On March 11, 2011 it released its report and the first 

recommendation made was the following: 

"The Task Force recommends that all relevant parties-the President, Congress, and the leadership and people of 

Puerto Rico-work to ensure that Puerto Ricans are able to express their will about status options and have that will 

acted upon by the end of 2012 or soon thereafter." Obama in multiple letters to the colonial governor and political 

leader said "is to to you to decide. You vote and I will act." 

All of these carefully planned intervention by presidents from Carrer to Obama, even though they are better than 

nothing, were hollow policies initiatives with great sound bytes and lip service labels! There more things "change" ... 

the more they remain the same. 

Soon there after on November 6, 2012 the People of Puerto Rico in a historical plebiscite voted on two questions: 

1- Whether tu remain a colonial territory under the "commonwealth status." For the first time in its history the 

People spoke clearly with 54 per cent rejecting the present non incorporated colonial territory. So the Unired States 

has a territory that has rejecied the colonial status and does not have the collllent of the governed. 

2- The second question asked the People's preference in favor of independence, statehood (political equality) or free 

association. The People "{>ain expressed their preference by voting for statehood with 61 per cent of the vore. We 

votecHwo.and half years ago. Even-theugh, President Obama issued the Lexington Doctrine of Nation building first 

for his second term PuertoRico is seating in the back of the bus. Washington through its web of control and 

upersuasive perversions" maintains out of the political discussion agenda the issue of the right of self determination 

of 3.6 millions American citizens. This is no longer benign neglect of a Nation sequestering the final destiny of a 

People. It is gross negligence and violations of the Charter of the United National, the United States' Constitution 

and the right ro pursue its final status. 

The present crisis facing the territory is a massive un-payable public debt together with high unemployment;, real 

estate deflation, the largest non performing loans portfolios of all colonial banks in recorded history and a massive 

population exodus. Today PuertoRico is the place in all of the Americas with the highest cost of living and taxes. 

Maintaining a policy of passivity and non intervention, while the Island's family structure is dismembered by the 

massive population exodus, is a crime against humanity1 

The U.S. Census projected that by 2050 the population of Puerto Rico will decrease to 2.3 millions. The same amount 

when ucommonwealth" and the Constitution were adopred in 1952. The number of American citizens leaving the 

Island for 2015 is estimated at 80,000. The tax base and government revenues is shrinking fast. Jet Blue has expanded 

their flights from the Island to Florida, Georgia, North Carolina, Virginia, Pennsylvania, Ohio and New Jersey. All 
419 


Insert offset folio 388 here 98944.388

4 

"battle ground states!" Therefore if Washington does not react PuertoRkans will abandon a bankrupt and nearly 

empty archipelago to the United States. 

The Gallup Orgtmization made two polls ;,. Puerto Rico i~> 1990 a~Jd 1991 atJd asked the American citizens living in 

the territory, what would they do if the Island was granted Independence or Free Association (Associated Republic). 

Ninety two per cent (92%) said that they would tnove to the United States. This is not surprising. Poll• made by 

Frank Luntz for the for Governor of Dr. Pedro J. Rossello revealed that 97% treasured their American 

citizenship the most. So, states that PttertoRicans love the most shmlld be prepared for the tidal wave of 

t>opulation from the territory to a neighborhood near you. 

The United States owes the People of Puerto Rico reparations for all its colonial abuses and regime 

of apartheid and segregation for 117 years. Giving us billions in welfare and subsidies programs is substitote 

for our right to be equal. We have paid a very high price of 117 ye.ars of colonial rule. There is an admission bill 

introduced by Resident Commissioner Pedro J. Pierluisi to sponsor Federal plebiscite asking for a vote on statehood 

yes or no. That's the democratic path to follow to resolve this American Paradox! Latin America, the Caribbean and 

the World are watching how the United States treats this issue affecting the lives of 3.6 millions American citizens of 

Hispanic origin. It will reveal if the United States has changed its policies of force and imperialism and has truly 

become a beacon of democracy, liberty and equality, Passivity is not an option 

Franklin Delano lopez is a former United Press International and The Associated Press 

journalist. He served as NationaL Field Coordinator of the Carter-Mandate Presidential 

Campaign in 1976. He was the first elected State Democratic Chairman of the 

Democratic Party pf Puerto Rlco. He was National Director for Ethnic Affairs of the 

Carter Mandate Campaign in 1980. He was a member of the 1st Circuit Court 

Nominating Pane!; the National Small Business Presidential Commission and member 

of the transition team of three U.S. Presidents. 
420 


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Mr. Jaime Pia Executive President 

For the HP.:~rir1o Record 

Senate Committee on and Natural Resources 

!"Hearing on l'nerto Rico: economy, debt, and for 

!congress" 

I October 22, 2015 I !Contact: 

' 

batme Pia cortes, Executive President 

!Puerto Rico Hospital Association 

!vma Nevarez Professional Center 

isuite 101 

:san Juan, PR 00927 

:(787) 764-0290 

!chairman Murkowski, Ranking Member Cantwell and distinguished Members of 

!the Senate Energy & Natural Resources Committee, thank you for the I opportunity to provide this Statement for the Record on behalf of the Puerto 

!Rico Hospital Association. Our organization represents the 69 hospitals 

!serving approximately 3.6 million U.S. Citizens residing in the U.S. Territory of 

iPuerto Rico; a population larger than twenty States. Our Hospitals employ 

l approximate 50,000 health professionals and represent the centerpiece of 1

20% of Puerto Rico's GDP. 

Notably, we are particularly proud that not only was our organization founded 

in 1942 but we are the home of the America's oldest continuously operated 

hospital: El Hospital La Concepcion of San German, founded in 1524. Many of 

our Hospital Systems have served our U.S. Territory prior to the granting of 

U.S. Citizenship in 1917. 
421 


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We appreciate the interest of the Committee in the current state of Puerto 

Rico's economy as well as the fiscal crisis facing our local government and its 

institutions. Unfortunately, our island's weak economy, high level of poverty, 

record unemployment and troubled government finances are contributing to 

the challenges we face in managing a health care system designed to provide 

the best quality care for the U.S. Citizens we serve each and every day. 

Frankly, we face a larger challenge as we work to deliver quality health care. 

Our Medicaid funding is capped and our treatment under Medicare is 

significantly less than that received by Identical stateside hospitals. However, 

we are expected to deliver the same level of quality care for our atlzens and 

visitors as that provided by our sister stateside institutions. 

The Government of Puerto Rico is behind In its Medicaid reimbursements to 

the tune of at least $200 million today. Since 43% of our local population is 

living in poverty every one of our member hospitals serves Medicaid patients. 

This combined with our lesser Medicare reimbursement levels has put an 

incredible strain on the operations of every hospital. We also note that 20% 

of our island's population is Medicare eligible. However, Medicare represents 

40% of the utilization of our hospitals. 

We recently surveyed our member hospitals and found that over the 

past twelve months almost every institution has been forced to scale 

back operations in some way due to the Government oF Puerto Rico's 

delayed Medicaid payments due to the inability to obtain an 

additional line of credit through the Government Development Bank. 

This reduction in services has resulted in employee cutbacks and 

reduced hours impacting thousands of employees, with many 

hospitals reducing beds, closing floors and eliminating specialized 

services as well as an additional delay in payment of bills and 

payroll. One hospital has already closed its doors after the local 

government owned electrical utility cut off its electricity service due 

to late payment of bills. 

The facts show that Puerto Rico's hospital system is in a crisis due to the 

combination of the government's delay in reimbursing its medical providers 

and the secondary treatment our hospitals receive under Medicare. We are 

struggling to maintain our staff and see many of our experienced doctors, 

nurses and other health professionals recruited away with offers of better 
422 


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compensation by stateside hospitals. In fact, official census data suggests 

Puerto Rico loses on average one doctor a day. 

You've noted in your opening statements as well as through comments by 

individual Members during this hearing that you wish to focus on solutions 

that can have a meaningful impact on the U.S. Citizens residing in Puerto Rico. 

While there are many areas in health care where the disparity in treatment 

under Medicare can be identified, my intent with this statement is to ask your 

attention to the initiatives where Congress can make a difference in the short 

term. In fact, each of these initiatives addresses a fairness issue resulting 

from disparate treatment of Puerto Rico hospitals. These are our priorities: 

ISSUE#l: MEDICARE'S IPPS SINGLES OUT PUERTO RICO'S HOSPITALS 

The federal government reimburses hospitals who admit Medicare patients for 

inpatient care under a system known as the Inpatient Prospective Payment 

System, or IPPS. The IPPS payment is intended to cover the costs that a 

reasonably efficient hospital would incur in furnishing high quality care. 

The current IPPS results in the federal government reimbursing Puerto Rico 

hospitals that treat Medicare patients a lower amount than hospitals in the 50 

states and other Territories. Puerto Rico's hospitals are not paid the same 

base rate as identical hospitals in the states1 resulting in these hospitals 

receiving lower payments than identical hospitals elsewhere receive per 

discharged patient. This is because hospitals in Puerto Rico do not receive a 

base rate based on 100% of the national average operating and capital costs 

associated with running a hospital. Instead{ they receive a base rate based 

on 75 percent. When combined with the disparity in the Medicare Wage 

Index administered by CMS1 Puerto Rico hospitals only receive 52% of the 

reimbursement given to identical hospitals elsewhere. 

Puerto Rico's hospitals are the only U.S. hospitals treated under the IPPS in 

this fashion. Even the other Territories are not treated this way. We ask your 

support for correcting this disparity when the Senate Finance Committee 

considers appropriate legislation. We believe identical hospitals should be 

treated equally as they work to serve Medicare patients1 provide quality care 

and remain financially stable. It's a fundamental issue of fairness. 

There is no principled basis to treat Puerto Rico hospitals under the Medicare 

IPPS as Puerto Rico residents pay the Medicare payroll tax just like their fellow 

citizens in the 50 states and District of Columbia. This disparate treatment 
423 


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significantly hampers Puerto Rico's hospitals' goal of providing the highest 

quality care for almost 3.6 million U.S. citizens; a population larger than 20 

States. 

Legislation to address IPPS for Puerto Rico is offered by Senator Schumer and 

other Members, as part of a broader package of reforms is included in S. 

1961. This legislation would eliminate this disparity and treat Puerto Rico's 

hospitals under the IPPS the same as identical hospitals elsewhere. This 

solution has been endorsed by both the American Hospital Association and the 

Puerto Rico Hospital Association. 

ISSUE #2: INUUDE PUERTO RICO HOSPITALS IN THE HITECT ACT 

The Health Information Technology for Economic and Clinical Health (HITECH) 

Act was enacted in 2009. The goal of the HITECH Act is to advance the 

design, development and operation of a nationwide health information 

infrastructure that promotes the electronic use and exchange of information. 

Doctors and hospitals are encouraged to use electronic health records (EHR), 

so, patient care is improved, medical errors are curtailed and lower health 

care delivery costs. 

To promote the adoption of EHRs, the HITECH Act authorizes bonus payments 

under both Medicare and Medicaid for eligible doctors and hospitals that 

become "meaningful users" of certified EHR systems. The Medicare incentive 

program consists of both "carrots" and "sticks" in that physicians and hospitals 

will be penalized 1f they fail to adopt EHR technology by a certain date. 

Unfortunately, apparently due to a drafting error, the final HITECH legislation 

omitted Puerto Rico hospitals from the Medicare component of the incentive 

program. The current law makes Puerto Rico physicians eligible for both the 

Medicaid and Medicare payments and Puerto Rico's hospitals are eligible for 

the Medicaid bonus payments, yet our hospitals were omitted from the 

Medicare provision, which is likely attributed to the definition of an eligible 

hospital as a "subsection (d) hospital"1 an acute care hospital located in the 

fifty states or District of Columbia. The proposed amendment would simply 

add for purposes of this Act the inclusion of subsection (d) hospitals in Puerto 

Rico, thus putting Puerto Rico hospitals on parity with those in the States. 

This inadvertent exclusion significantly hampers Puerto Rico's hospitals' efforts 

to adopt EHR systems putting at stake a vital modernization initiative. 
424 


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Unfortunately, only Puerto Rico was excluded from the program by a drafting 

error. 

Bi-partisan legislation known as the Puerto Rico Hospital HITECH Amendments 

Act of 2015 to correct this oversight has been introduced in the Senate, S. 

1602, by Senators Menendez, Nelson and Rubio. Both the Puerto Rico 

Hospital Association and the American Hospital Association {AHA) has 

endorsed this fix. 

We also noted during the hearing the comments of one witness who justified 

disparate treatment of Puerto Rico under Medicare with a two pointed 

argument. First, it was said that health care funding levels should not be 

considered as part of an economic development strategy. Second, it was 

noted while workers in Puerto Rico pay taxes into the Medicare system, they 

do not all typically pay Federal income tax. We respond by noting that 

Congress has made it a policy priority to ensure access for quality health care 

for all American regardless of whether they are rich or poor. If U.S. Citizens 

do not believe they can obtain quality health care in Puerto Rico, they then as 

U.S. Citizens have the right to find that quality health care elsewhere within 

the United States. 

We do not ask for a bailout and never have. However, we ask for fair 

treatment and note that equal treatment for all American Citizens is a guiding 

prindple for our great Nation. Parity is a fair request. 

Mr. Chairman, Ranking Member cantwell and Members of the Energy & 

Natural Resources Committee, our health care system is in a crisis. We have 

offered a set of priorities and ask to work with you to ensure fair treatment for 

all U.S. Citizens when it comes to health care. These priorities deserve 

prompt action and are solutions within your Committee's jurisdiction and we 

look forward to working with you. 

Thank you for the opportunity to share our statement with you. 
425 


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Below is a Forbes op-ed by Rossell6 set to run at 6am ET tomorrow 

A New Path Forward for Puerto Rico 

By Ricardo Rossell6 

Another hearing will be held today on the fiscal crisis of Puerto Rico; this time by the 

Senate Energy and Natural Resources Committee. Washington seems intent on figuring 

out what the Federal government should do to help the island's government pay its public 

debt of over $70 billion dollars. Yet, despite all of the attention Congress is not 

addressing the root cause of the problem. The debt is just the symptom of the problem. 

The real underlying issue is the island government's addiction to spending a habit 

which produces $6 billion dollar deficits per year and a government centered economic 

model which leads to stunted growth. To put it into perspective, even if the island 

completely defaulted on its roughly $3 billion dollar per year debt service payments, this 

still does not address half of the deficit problem. 

This is what scares financial markets and undermines the credibility of the 

government. This is why there are several other jurisdictions that have much higher debt 

to GDP ratios than Puerto Rico and still have better credit ratings than the island. 

Defaulting on the debt or deferring payment for several years as Governor Alejandro 

Garcia-Padilla has proposed as a renegotiation strategy would clearly only aggravate the 

island's credibility problem. Investors would have a hard time believing they will 

eventually get paid and, in the end, the government would have a bigger future debt 

service burden. 

To address the real challenges Puerto Rico faces, I propose a new path forward for Puerto 

Rico; one that begins with the basic premise that the Puerto Rican government can and 

should pay its debts and that it does not need any type of bailout from Washington to 

meet the responsibilities it has assumed. 

The new path I propose calls for three specific strategies: first, we must once and for all 

dismantle the current government apparatus that is costly and ineffective; second, we 

should simultaneously implement real and strong free market reforms that open up our 

economy and lead to robust growth and job creation; and third, a new independent 

mechanism should be created to manage the debt, based on a collaboration between the 

government of Puerto Rico and the Federal government, in order to restore investor 

confidence and allow the island's government to regain access to the financial markets. 

We should start by creating a new government structure that significantly reduces the 

cost and enhances its function. The current structure allows for 118 agencies in the 

executive branch, at a price tag of $21.8 billion per year. All of the services provided by 

these agencies, 340 in total, must be reassessed to determine if some of them can be 

consolidated, delegated to the private sector, and which ones are simply not necessary. 

The strategy could provide up to a 70% reduction in the government's sprawling 

administrative stmcture. We can achieve this through a few key steps. First, making the 
426 


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government a single employer, so that it can allocate human resources where they are 

most needed and avoiding layoffs. Second, implementing a zero-based budgeting 

approach, where all govemment expenses have to be justified to show that they are truly 

necessary and meet the needs of the citizens and where expenditures are strictly 

scrutinized to avoid waste. Third, using technology to transform the government's 

processes to be efficient and transparent in order to ensure accountability and continuous 

improvement 

Puerto Rico must also articulate and implement an economic development model based 

on the principles of global competitiveness and sustainability that will enable the private 

sector to lead this recovery. The complexity and cost of doing business in Puerto Rico 

must be dramatically reduced by utilizing technology to streamline government 

processes, updating our antiquated labor laws to support a modern and dynamic 

economy, partnering with the private sector to reduce our dependence on oil as a primary 

fuel source to generate electricity, and reducing the cost of basic infrastructure services. 

Partnering with the private sector also means taking small bets on economic activities 

that leverage Puerto Rico's geographic, cultural, and human capital assets, in order to 

accelerate the expansion of the visitor economy, the export of knowledge-based services, 

and entrepreneurial innovation and R&D. 

Puerto Rico must begin to restore investor confidence by being completely transparent 

and truthful about its financial condition including the release of audited financial 

statements and its negotiations with bondholders. In order to overcome the damage 

already done to the government's credibility, an independent third-party, namely the 

Federal IRS, should collaborate with the territory government and oversee the efficient 

collection of income and other tax revenues. 

Puerto Rico's public corporations, which represent an important component of the 

island's total debt burden, each have provisions for the case of default but would benefit 

from embarking on a formal path towards the establishment of public-private 

partnerships for appropriate aspects of their operations, including the necessary 

provisions for the management of their debt burdens. More than the short-term 

restructuring of the upcoming debt-service payments, it's these public-private 

partnerships that will provide long-term repayment guarantees to bondholders and most 

important, a much needed reduction in the cost and improvement in the quality and 

accessibility of basic infrastructure services to the island's residents and businesses. 

While all these measures combined will ensure that Puerto Rico puts its house in order, 

there is one more thing that Washington must do, and which is absolutely necessary for 

Puerto Rico to fully develop economically: put the island on a path towards full 

incorporation and statehood. 

Puerto Rico will continue to lack a stable business climate that attracts investors under 

the current territorial status. Its uneven patchwork of state and federal laws -some federal 

laws apply, other do not- confuses many investors and dissuades them for putting their 

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money to work on the island. They do not know if they are dealing with a foreign 

country or a U.S. state. Many go to Puerto Rico seeking the economic advantages and 

guarantees that the U.S. government provides, only to find out that certain key federal 

rules do not apply to the island. 

The time has come for Puerto Rico to embark on a bold transformation. A new path 

forward is needed today to finally implode that antiquated state centered model that still 

exists in Puerto Rico and build a thriving economy, open to private investment and able 

to create good paying jobs for the people of the island. 

Ricardo Rossell6 is a scientist, researcher and college professor at the Metropolitan 

University£?[ Puerto Rico, and is a candidatefi.Jr governor of Puerto Rico. 

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U.S. Army Lieutenant Colonel (R) Armando M. Santos: Vice-President, Council of Soldiers 

and Veterans of Puerto Rico 

Opening Statement before the U.S. Senate Committee on Energy & Natural ResourcesHearing on Puerto Rico: Economy, Debt and Options for Congress 

October 22, 2015 

Honorable Chairman, Ranking Member and distinguished committee members I would 

like to thanks you for the opportunity to address the committee in relation to Puerto Rico's 

economy, debt and options for Congress and its effects on Veterans and their Families. I am 

honored to representing one hundred eighty thousand Veterans, Service members and about three 

hundred fifty thousand dependents living in the beautiful island of Puerto Rico. In essences, our 

veteran community and their dependents represent on or about 17 percent of our population. 

lam here today, to advocate for the Veterans and for those who believe that Puerto Rico 

must join the union by becoming the 51st state of United States of America. I dream for a secured 

future for my Family, for Veterans and their Families and for generations to come. In the 

meantime I do invite you to represent us while we deal with the unfinished business of American 

Democracy. Please join me to end colonialism in Puerto Rico, work a plan to set the conditions 

to improve the economy and to transform Puerto Rico in the Capital of and for the 

Americas. (Emphasis added) 

Economy 

I have met with Veterans from VFW, American Legion and Vietnam Vets just to mention 

some of them, to discuss the Commonwealth of Puerto Rico (CPR) economy. We have 

concluded that Puerto Rico is not equipped with the tools to stay relevant and responsive before 

the ongoing and fast-pace globalization. Moreover, Puerto Rico's economy is not aligned with 

our nation economy, it is not comparable. Simple, you do no take a four cylinder car to compete 

in a NASCAR Race. No matter how many concessions or privileges the CPR may receive from 

Congress, the colonial system will impede growth and prosperity. If Puerto Rico's economy 

were growing, we would be much better positioned to address its fiscal crisis and might have 

avoided it altogether. 

Moreover, the negative effects of Puerto Rico's economy have caught the Veterans and 

their Families in the impact area. The 45% of Puerto Rico's population live under the federal 

poverty line. Due to the lack of accurate statistics about Veterans, we can say that Veterans are 

under the same percentage as well. What would happened if we allow the economy to continue 

its free fall? What would be the negative effects in the VA-Hospital? What would be the new 

demand if a significant amount of veterans are forced to request more VA benefits? 

Secretary McDonald said on July 22,2015 before the House Committee on Veterans 

Affairs that "to meet growing requirements next year, VA needs the adequate funding the 

President's 2016 budget request. However, the House proposed$1.4 billion reduction means 
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$688 million less for Veterans Medical Care- meaning as many as 70,000 Veterans may not 

receive medical care". lt is well known, that Puerto Rico is the first on line for federal cuts and 

last on line to receive any funding increase. 

In addition, the Veterans employment rate is on or around 43 percent. There is a 

significant percentage of Veterans that are not counted in the work force. The question is why? 

What are they doing to support their self and their Families0 What is the status of the Jobs for 

Vets Program? Who is monitoring these actions at a federal level? What is the status of the 

programs designed to advance Veterans oppo1iunities in the business field? 

Debt 

Puerto Rico's $72 billion debt is m01·e than 100 percent of its gross national product 

(GNl>). This debt does not take into account of another $35 billion in unfunded pension 

liabilities, which also need to be considered. Confronting this massive debt will require difficult 

political decisions. 

Current Administration led by Governor Garcia Padilla said the he is not going to pay the 

constitutional debt. We, Service members, Veterans and Families do not support such decision. 

We are men and women who embrace values, so we as community do support Puerto Rico's 

debt must be paid, period. I urge you to help and assist Puerto Rico to pay its debt, which is the 

right way to do. 

Options for Congress 

The economic prosperity was one of the most powerful argument used during the 

admission campaigns of the 37 admitted states. The promise of rapid economic development was 

one of the more powerful arguments used by the statehood advocates. It appealed to everyone, 

regardless of class. For the poor, the prospect of a general redistribution of wealth was a 

powerful reason for joining the statehood crusade. For the growing middle class and the rich, 

statehood offered multiple economic opportunities. 

At the nation scene, the President and Congress also used as a supporting argument for 

admission the "loyalty" to the Union demonstrated by Vermont, Maine, West Virginia, Alaska 

and Hawaii. We- Puertorricans- are loyal and proud citizens, let leave no question about it. We 

have gave our lives and blood fighting in every conflict since 1917, that's a fact. 

Closing 

l do invite you to join me to ensure the Federal Government does not break the promises 

made to American Veterans and their Families. We loyally served, traumatically bled, and shed 

sad tears as we fought hard to protect all of us. 

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