, The Operation and Effect 

of the Pcissessions Corporation 

System of Tax a ti on 

Fifth Report 

Department of the Treasury 

July 1985 
THE OPERATION AND EFFECT OF THE 

POSSESSIONS CORPORATION SYSTEM OF TAXATION 

FIFTH REPORT 

DEPARTMENT OF THE TREASURY 

JOLY 1985 

For sale by the Superintendent of Documents, U.S. Government Printing Office 

Washington, D.C. 20402 
THE SECRETARY OF THE TREASURY 

WASHINGTON 

JUL 3 1 1985 

Dear Mr. Chairman: 

The Report of the Committee on Finance on H.R. 10612 (Public Law 

94-455), the Tax Reform Act of 1976, provides that "the Treasury 

is to submit an annual report to the committee setting forth an 

analysis of the operation and effect of the possessions corporation system of taxation," and that the reports are to be 

submitted within 18 months following the close of the calendar 

year, with the first report covering calendar year 1976. 

Pursuant to that provision, I hereby submit the fifth annual 

report entitled, The Operation and Effect of the Possessions 

Corporation System of Taxation. This report covers tax return 

information for 1982. 

The Tax Equity and Fiscal Responsibility Act of 1982 provided new 

rules for the allocation of income between a U.S. parent corporation and an affiliated possessions corporation. The effect of 

the new provisions, which apply to tax years beginning after 

December 31, 1982, will be examined in future annual reports. 

I am sending a similar letter to Bob Packwood, Chairman, 

Committee on Finance. 

Sincerely, 

~ .. 1'~ ~m~s A. Bake;, III -

The Honorable Dan Rostenkowski 

Chairman, Committee on Ways and Means 

United States House of Representatives 

Washington, D.C. 20515 

Enclosure 

(.lBRARY 

ROOM 5030 

' UG 2 9 1985 

JREA~URY DEPARTMENT 
THE SECRETARY OF THE TREASURY 

WASHINGTON 

JUL 3 1 1985 

Dear Mr. Chairman: 

The Report of the Committee on Finance on H.R. 10612 (Public Law 

94-455), the Tax Reform Act of 1976, provides that "the Treasury 

is to submit an annual report to the committee setting forth an 

analysis of the operation and effect of the possessions corporation system of taxation," and that the reports are to be 

submitted within 18 months following the close of the calendar 

year, with the first report covering calendar year 1976. 

Pursuant to that provision, I hereby submit the fifth annual 

report entitled, The Operation and Effect of the Possessions 

Corporation System of Taxation. This report covers tax return 

information for 1982. 

The Tax Equity and Fiscal Responsibility Act of 1982 provided ne~ 

rules for the allocation of income between a U.S. parent corpora~ 

tion and an affiliated possessions corporation. The effect of 

the new provisions, which apply to tax years beginning after 

December 31, 1982, will be examined in future annual reports. 

I am sending a similar letter to Dan Rostenkowski, Chairman of 

the Committee on Ways and Means. 

The Honorable Bob Packwood 

Chairman, Committee on Finance 

United States Senate 

Washington, D.C. 20510 

Enclosure 

~ 

l. 

2. 

3. 

4. 
-iTABLE OF CONTENTS 

List of Figures and Tables 

8!,apter 

iii--v 

l. 

2. 

3. 

4. 

INTRODUCTION AND SUMMARY ........ •' • ........................ . 1 

UNITED STATES AND PUERTO RICAN LAW . . . . . . . . . . . . . . . . . . . . . . . . . 5 

I. United States Tax Provisions 

A. Historical Background •••••••••••••••••••••••••••• 5 

B. Tax Reform Act of 1976 ••••••••••••••••••••••••••• 6 

c. Tax Equity and Fiscal Responsibility Act of 1982 • 8 

D. Passive Income Limitation under TEFRA •••••••••••• 11 

II. Puerto Rican Tax Provisions •••••••••••••••••••••••••• 11 

A. Taxation of Non-Exempt Corporations •••••••••••••• 12 

B. Taxation Under an Old Exemption Grant •••••••••••• 12 

c. Taxation Under an Old Exemption Grant "Converted" 

to the 1978 Industrial Incentives Act •••••••••••• 13 

D. Taxation Under a New Exemption Grant ••••••••••••• 14 

ECONOMIC DEVELOPMENT IN PUERTO RICO •.••••••••••••••••••••••• 17 

I• Growth Since 1948 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 

II. Investment in Puerto Rico •••••••••••••••••••••••••••• 25 

CHARACTERISTICS OF POSSESSIONS CORPORATIONS AND REVENUE 

EFFECT OF SECTION 936 •••••••• • • • • • • • • • • •••••••••••••••••••• 33 

I. Assets and Income in Tax Year 1982 ••••••••••••••••••• 34 

A. Asset Composition of Puerto Rican Investment ••••• 34 

B. Retained Earnings •••••••••••••••••••••••••••••••• 41 

C. Total Receipts ••••••••••••••••••••••••••••••••••• 42 

D. Net Income per Tax Return • • • • • • • • • • • • • • • • • • • • • • • • 42 

E. Distributions • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 46 

I I. Estimated Tax Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 

III. Payroll and Employment in Tax Year 1982 •••••••••••••• 48 

IV. Summary Data for 1974-1982 ••••••••••••••••••••••••••• 51 

V. Estimates of Linkages •••••••••••••••••••••••••••••••• 53 

A. Forward Linkages ••••••••••••••••••••••••••••••••• 53 

B. Backward Linkages •••••••••••••••••••••••••••••••• 55 
-iiTABLE OF CONTENTS 

VI. Revenue Impact of Section 936 •••••••••••••••••••••••• 

A. Revenue Estimates and Estimating Procedure ••••••• 

B. Alternative Tax-saving Routes •••••••••••••••••••• 

5. IMPACT OF 936 FINANCIAL ASSETS ON PUERTO RICO GROWTH -

RECENT DEVELOPMENTS ••••••••••••••••~••••••••••••••••••••••• 

I. Introduction ••••••••••••••••••••••••••••••••••••••••• 

II. Recent Regulatory Changes by the Government of Puerto 

Rico ................................. • • • • • • • • • • • • • • • • 

A. Summary of the February 1, 1982 Regulations •••••• 

B. Summary of Regulations Effective September 1, 

1983 •............••...•.......•..•..•......••...• 

c. The April 17, 1984 Regulations ••••••••••••••••••• 

III. Empirical Analysis ••••••••••••••••••••••••••••••••••• 

APPENDICES 

A. The Inflow and Accumulation of 936 Funds, Net 

Capital Inflows, and Real Investment in Puerto 

Rico ............................................ . B. Distribution of 936 Funds Among Banks and Brokers 

in Puerto Rico ••••••••••••••••••••••••••••••••••• 

C. 936 Funds Eligible Assets, and the Interest Rate 

on 936 Deposits •••••••••••••••••••••••••••••••••• 

A. OPERATION OF THE POSSESSIONS CORPORATION SYSTEM OF TAXATION 

IN AMERICAN SAMOA, GUAM, AND THE VIRGIN ISLANDS •••••••••••• 

I. American Samoa and Guam •••••••••••••••••••••••••••••• 

A. Federal and Possessions Taxation ••••••••••••••••• 

B. Characteristics of Possessions Corporations 

Operating Outside Puerto Rico •••••••••••••••••••• 

II. Virgin Islands ••••••••••••••••••••••••••••••••••••••• 

A. Taxation of Corporations Operating in the Virgin 

Islands •••••••••••••••••••••••••••••••••••••••••• 

B. Taxation of Dividends Received from Corporations 

Operating in the Virgin Islands •••••••••••••••••• 

C. Allocation of Income Attributable to Intangibles • 

D. Characteristics of Corporations, Partnerships, and 

Sole Proprietorships Eligible for Virgin Islands 

Tax Rebates • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 

Pag! 

57 

57 ~. 

59 

63 

63 

63 

65 

65 

c. 

66 D, 

68 

~ 68 3 

72 

74 3 

~ 

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79 3 

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·7 

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9 

3 

3 

3 

5 

5 

6 

. 

C, 

D, 

-iiiTABLE OF CONTENTS 

POSSESSIONS CORPORATIONS IN TAX YEAR 1981 •••••••••••••••••• 

I. Assets ·and Income in 1981 . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. Assets ••••••••••••••••••••••••••••••••••••••••••• 

B. Re ta i ned Earnings •••••••.••••••••••••••••••••••••• 

C • To ta 1 Rec e i pt s • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 

D. Net Income per Tax Return •••••••••••••••••••••••• 

E. Reduction in U.S. Tax Liability •••••••••••••••••• 

F. Distributions •••••••••••••••••••••••••••••••••••• 

II. Payroll and Employment in 1981 ••••••••••••••••••••••• 

SOURCES AND LIMITATIONS OF THE DATA•••••••••••••••••••••••• 

TAX FORMS FROM WHICH DATA INCLUDED IN THIS REPORT WERE 

OBTAINED ••••••••••••••••••••••••••••••••••• • ••••••••••• • • •• 

Page 

91 

91 

91 

91 

91 

95 

95 

95 

95 

103 

107 

tigures 

3-1 Total and Per Capita Gross National Product of Puerto 

Rico, 1947-1983 • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 19 

3-2 Components of Real Investment in Puerto Rico, 1960-

1983 .....•.••.....•..........•.....•..•....•........... 26-27 

~ 

3-1 Total and Per Capita Gross National Product of Puerto 

Rico, 1947-1983 • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 20 

3-2 

3-3 

Net Migration of Residents of Puerto Rico ••••••••••••• 

Puerto Rican Unemployment Rate and Distribution of 

Employment in Selected Years, 1950-1983 ••••••••••••••• 

3-4 Net Federal Payments to Puerto Rico Selected Fiscal 

21 

22 

Years 1968-1983 • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 24 

3-s 

3-6 

Components of Real Fixed Investment in Puerto Rico 

Fiscal Years 1960-1983 •••••••••••••••••••••••••••••••• 

Net Income Originating in Puerto Rican Manufacturing, 

Fiscal Years 1960, 1970, 1980, and 1983 •••••••••••••••• 

28 

31 
Tables 

4-1 

4-2 

4-3 

iv 

Selected Balance Sheet Information by Industry, 1982 •• 35-37 

Possessions Corporations and Corporations Operating in 

the U.S. -- Net Plant, Equipment and Property as a 

Percentage of Total Assets, Year-end 1982 •••••••••••••• 

Possessions Corporations and Corporations Operating in 

the United States: Before Tax Operating Income as a 

Percent of Operating Assets, 1982 •••••••••••••••••.•••• 

38 

40 

4-4 Selected Income Statement Information and Tax Benefits 

4-5 

4-6 

4-7 

4-8 

4-9 

4-10 

4-11 

5-1 

5-2 

5-3 

5-4 

5-5 

by Industry, 1982 ••••••••••••••••••••••••••••••••••••• 43-45 

Net Income, Possessions Tax Credits Claimed and Estimated Tax Benefits by Industry, 1982 ••••••••••••••••••• 

Tax Benefits per Employee and as a Percent of Compensation by Industry, 1982 •••••••••••••••••••••••••••.••• 

Distribution of Tax Benefits and Rmployment by Industry, 

1982 ....•..•............•....••.•...•....•....•...•..•• 

Tax Benefits, Employment, and Compensation of Employees 

by Size of Tax Benefits Per Employee, 1982 ••••••••••••• 

Summary Data on Possessions Corporations, 1974-1982 •••• 

Destination of Shipments by Puerto· Rican Manufacturing 

Indus tr i es , 19 7 7 ••••••••••••••••••••••••••••••••••••••• 

Federal Revenue Cost Estimates, Possessions Corporation 

Provisions, 1973-1982 •••••••••••••••••••••••••••••••••• 

Estimated Composition of the Financial Investments of 

Possessions Corporations at Year-end 1983 •••••••••••••• 

Components of the Puerto Rico Capital Account, 1970-

1982 •..•.................•••...•.•.•....•••....•••••.•• 

Gross Private Investment in Puerto Rico •••••••••••••••• 

Distribution of 936 Funds and Excess Eligible Assets -

April 1984 ..........................................• · · 

Brokers Activities in February 1982 and April 1984 ••••• 

49 

52 

53 

55 

58 

69 

71 
v 

~ 

37 ~bles 

38 

&O 

9 

·o 

2 

3 

5 

8 

4 

9 

1 

3 

5 

5-6 

5-7 

A-1 

A-2 

Total Incremental Eligible Activity vs. Total Investment Requirement - All Banks ••••••••••••••••••••••••••• 

Interest Rates on 936 Deposits As a Percentage of Eurod o 11 a r Ra t e s • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 

934(b) Corporations in the Vitgin Islands - Selected 

Balance Sheet and Income Statement Items and Tax Bene76 

78 

fits by Type of Corporation, 1982 •••••••••••••••••••••• 87 

934(b) Corporations in the Virgin Islands - Selected 

Balance Sheet and Income Statement Items and Tax Benefits by Industry, 1982 ••••••••••••••••••••••••••••••••• 89 

B-1 Selected Balance Sheet Information by Industry, 1981 •• 92-94 

B-2 Selected Income Statement Information and Tax Benefits 

by Industry, 1981 •••••••••••••••••••••••••••••••••••••• 96-98 

B-3 Tax Benefits, Employment, and Compensation of Employees 

by Industry, 1981 • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 99 

B-4 Tax Benefits, Employment and Compensation of Employees 

By Size of Tax Benefits Per Employee, 1981 ••••••••••••• 101 
Chapter 1 

INTRODUCTION AND SUMMARY 

This is the fifth report to the U.S. Congress on the possessions 

corporation system of taxation. Possessions corporations, also known 

as 936 corporations, are u.s.-chartered companies 1/ which are exempt 

Under section 936 of the Internal Revenue Code 2/ from Federal tax on 

business income and qualified passive investment income from Puerto 

~ico and certain other U.S. possessions. Almost all possessions 

~orporations operate in Puerto Rico. This report covers tax return 

lnformation for possessions corporations filing full year returns for 

Calendar year 1982, or for a fiscal year ending on or before June 30, 

1983 (and other economic data available through mid-1984). It does 

not reflect the amendments to section 936 made by the Tax Equity and 

~iscal Responsibility Act of 1982 (TEFRA). 

In Puerto Rico, the possessions corporation system is based upon 

the interaction of the tax laws of the United States and those of the 

Commonwealth. This report first reviews those tax laws and then 

analyzes their economic impact. Chapter 2 summarizes the U.S. 

legislation concerning possessions corporations, including the 

ltlodifications to that legislation in the Tax Equity and Fiscal 

~esponsibility Act of 1982 (TEFRA). TEFRA provided special rules for 

the allocation to a possessions corporation of income from patents, 

trademarks, and other intangibles. These amendments reflected 

Congressional concern that corporations operating in the United States 

were shifting substantial income from intangibles to their subsidiaries in Puerto Rico in order to increase the tax savings provided 

Under section 936. The TEFRA provisions are effective for taxable 

Years beginning after 1982. Chapter 2 also reviews the relevant 

Puerto Rican tax legislation. 

Chapter 3 surveys Puerto Rican economic growth since 1948 and the 

1

Inpact of the U.S. and Puerto Rican tax exemptions in shaping that 

9towth. The tax exemptions contributed to a shift in the basis of the 

~conomy from agriculture in the 1950s to manufacturing, services, 

rade, and government in the 1970s. The effect of low wages relative 

to the United States and exemption from U.S. tariffs also contributed 

to the sustained high rate of Puerto Rican industrialization and 

~conomic growth in the 1948-1972 period. Puerto Rican real gross 

!I Al though Puerto Rico and other U.S. possess ions are included in 

some definitions of the United States, the term "United States" in 

this Report includes only the fifty States and the District of 

Columbia. 

~/ Unless otherwise indicated, all section references are to the 

Internal Revenue Code of 1954, as amended (the "Code"). 
-2-

national product (GNP) grew at an average annual rate of six percent, 

and real GNP per capita grew by five percent per year. The most 

buoyant sector of growth was manufacturing, where employment rose from 

55,000 in 1950 to 142,000 in 1972. 

Since 1972, however, Puerto Rican economic progress has slowed. 

The economy was badly hurt by the U.S. recessions of 1974-75 and 

1981-82. Increases in Puerto Rican wages and cuts in U.S. tariffs 

have reduced Puerto Rico's ability to compete with foreign locations 

as a s i t e for U • S • i n vestment • Em p 1 o ym en t i n man u fact u r i n g was 

stagnant in the period 1972-83, despite an expansion of jobs in hightechnology ind us tries such as pharmaceuticals and electronics. In 

constant dollars, private investment in plant and equipment fell in 

most years after 1973, so that its level in 1983 was about half of itS 

level 10 years earlier. 3/ The Puerto Rican economy was in recession 

in the two-year period ending in June 198 3. With the resumption of 

growth in the U.S. economy in 1983, Puerto Rican growth has also 

resumed. The unemployment rate reached an all-time annual high of 

23.4 percent in the year ending June 1983, but subsequently declined· 

It was 21.6 percent in January 1985. 

Chapter 4 describes the characteristics, by industry, of 

possessions corporations. It presents data for tax year 1982 on their 

assets, income, tax benefits, employment, and payroll. It is estimated that in 1982 there were 447 possessions corporations engaged in 

manufacturing, and that they earned net income of $4.1 billion and 

derived tax benefits of $1.7 billion. The average ratio of operatin9 

income to operating assets for these companies was more than five 

times that ratio for all mainland manufacturing companies. 

In enacting section 936, Congress sought to assist Puerto Rico in 

obtaining employment-producing investments. Matching income ta~ 

return information with Federal unemployment insurance tax returns for 

individual section 936 corporations provides an indication of the 

extent to which this objective has been realized. Based on the sample 

of corporations for which employment information is available1 

employment in all possessions corporations in manufacturing industrie~ 

is estimated at approximately 81,250, which represents 11 percent ~ 

total employment in Puerto Rico and 60 percent of all employees in 

Puerto Rico's manufacturing sector in 1982. 

1/ Although private refinery construction represented 30 percent ~f total private investment in Puerto Rican plant and equipment l~ 

the period 1970-72, it had dropped to 4 percent in 1973 an 

remained at approximately that level during most subsequent years• 

The short-lived boom of the Puerto Rican petrochemical industrY 

was based on Puerto Rico's large allocation of U.S. oil import 

quotas for foreign oil (which before 1973 was cheaper than 

domestic oil). 

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:, Possessions corporations' U.S. tax benefits in relation to their 

1t ~mployrnent vary substantially by industry. In 1982, tax benefits per 

,rn ~mployee averaged $69,200 in the pharmaceutical industry and $3,00-

4,ooo in the low-technology, labor-intensive industries. Over all 

manufacturing industries, possessions corporations' tax benefits 

averaged $20,650 per employee, or 147 percent of the average 

Compensation per employee of $14,070. 

s 

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f 

Chapter 4 also presents summary data for the period 1974 through 

1982. Net income of possessions corporations in the manufacturing 

Sector rose from about $800 million in 1974 to $4 billion in 1982. 

't'he percentage of total net income of manufacturing possessions 

Corporations earned by the pharmaceutical industry was 40 to 50 

Percent through the period 1974-1981 and 54 percent in 1982. The 

Share of net income earned by the electrical and electronics industry 

varied between 15 percent and 20 percent in most years, except 1981, 

when it rose to 26 percent; it was 22 percent in 1982. 

Possessions corporations held approximately $11 billion in Puerto 

~ican financial assets as of year-end 1983. Chapter 5 analyzes the 

lmpact of these assets on Puerto Rican growth. It first reviews 

tecent regulatory changes by the Puerto Rican government in its 

Continuing effort to channel section 936 financial assets to 

Ptoductive uses in Puerto Rico. The chapter then attempts to evaluate 

~he impact of f i nan c i a 1 i n v es tm en ts by sect i on 9 3 6 corpora t i on s on 

lnterest rates, capital inflows, and real investment in Puerto Rico. 

'I'he evidence suggests that, while the Puerto Rican government has 

tecently been successful in forcing down the interest rate paid to 936 

Corporations, the impact of the Qualified Possession Source Investment 

Income ( QPS I I) provision on rea 1 i nves tmen t in Pu er to Rico has been 

llloaest. 

Appendix A describes the operation of the possesions corporation 

system of taxation in American Samoa, Guam, and the Virgin Islands. 

Appendix B reports on the assets, income and tax benefits of 

Possessions corporations in Puerto Rico in tax year 1981. 

Appendix C discusses the sources and limitations of the data used 

in the report. 

Appendix D contains copies of the tax forms from which the data 

were obtained. 
-5-

Chapter 2 

UNITED STATES AND PUERTO RICAN LAW 

The possessions corporation system of taxation consists of a set 

of rules under which a U.S. manufacturing corporation deriving 

qualifying income from Puerto Rico pays no tax on that income to the 

United States and currently pays, on average, approximately 5 percent 

Of that income in taxes to Puerto Rico. 

Like other u.s. corporations, a 936 corporation is subject to 

~ederal tax on its worldwide income. However, a special credit avail- ~ble under section 936 fully offsets the Federal tax on income from a 

~rade or business in Puerto Rico and from qualified possession source 

lnvestment income (QPSII). A u.s. parent corporation can, in turn, 

Offset dividends received from a wholly owned 936 subsidiary with a 

~00 percent dividends-received deduction, which frees the dividend 

tncome from Federal tax. 

. Puerto Rico has primary jurisdiction to tax Puerto Rican source 

tncome; the United States has secondary jurisdiction to tax the Puerto 

~ican source income of U.S. corporations, citizens, and residents. 

tfowever, because the Puerto Rican rules have been fashioned to take 

advantage of the Federal rules and have changed when the Federal rules 

have changed, the Federal rules are described first. 

l. United States Tax Provisions 

A. Historical Background. The main elements of the possessions 

~orporation tax exemption became part of U.S. law as section 262 of 

the Revenue Act of 1921. These provisions were adopted primarily to 

h(elp u.s. corporations compete with foreign firms in the Philippines 

a U.S. possess ion before 1946). Under these provisions, U.S. 

~orporations which met two gross income tests were exempt from tax on 

ai1 income derived from sources outside the United States. To qualify 

for the exemption, a u.s. corporation had to derive 80 percent or more 

?f its gross income from the possessions, and 50 percent or more of 

lts gross income from the active conduct of a trade or business in the 

Possessions. These gross income tests had to be satisfied in the tax 

Year in which the exemption was claimed, and also in the two preceding 

tax years if the corporation had conducted a trade or business in a 

~ossession during that period. A corporation which met the 80-50 

lncome tests was known as a "possessions corporation." Such a 

~orporation was usually organized as a special purpose subsidiary of a 

· S. parent company in order to ensure that the 80-50 income tests 

were met. Under the 1921 Act, dividends paid by a posssessions 

~Orporation to a corporate shareholder were fully taxable. In effect, 
-6-

a u.s. corporate shareholder was granted deferral from U.S. tax on the 

foreign source income of a possessions corporation (from both within 

and without the possessions) until it was repatriated. !/ 

B. Tax Reform Act of 1976. The possessions corporation exemption 

remained unchanged until the Tax Reform Act of 1976. Many U.S. firms 

had established plants in Puerto Rico after 1948, when Puerto Rico 

enacted a program of tax exemption for manufacturing firms. Propo ... 

nents of continued u.s. tax exemption argued that the possessions 

corporation system of taxation was needed to offset the u.s. minimum 

wage requirement, the requirement to use u.s. flag vessels in trans ... 

porting goods to the United States, and other Federally imposed 

requirements which tended to reduce Puerto Rico's ability to compete 

with neighboring countries for U.S. investment. 

In order to continue to promote Puerto Rico's industrial develop ... 

ment, the Tax Reform Act of 1976 left intact the exemption for income 

derived by U.S. corporations from operations in a possession, and 

exempted from tax dividends remitted by a possessions corporation to 

its u.s. parent. But to prevent the avoidance of tax on income 

invested in foreign countries by possessions corporations, the Ta-" 

Reform Act eliminated the exemption for income derived outside of the 

possessions. The changes in the tax treatment of possessions 

corporations were effected by removing possessions corporations from 

section 931 of the Internal Revenue Code and placing them in a newla 

created Code section 936. The differences between sections 931 an 

936 are: 

o Change in the scope of and method of effecting the ~ 

exemption. Before 1976, a possessions corporation was exempt 

from u.s. tax on all income derived from sources outside the 

United States. Under the Tax Reform Act of 1976, the 

exemption was limited to two kinds of income: 

Income from the active conduct of a trade or business in a 

possession, or from the sale or exchange of substantiallY 

al 1 of the assets used by the corporation in the active 

conduct of such trade or business: and 

f Foreign-chartered corporations also benefit from the deferral 0 

U.S. tax on foreign source income until profits are remitted to 

the United States. However, in the first part of this centur~ U.S. companies preferred not to incorporate subsidiaries unde 11 foreign laws: foreign operations were typically conducted throu9 

either a branch of the u.s. parent or a u.s.-chartered subsidiarY· 

2 

...

3 

....

4 

....
e 

n 

n 

e 

" e 

$ 

0 

-7-

QPSII, which is non-business income derived from the 

possession in which the corporation has its trade or business 2/ and which is attributable to the investment of 

funds<ferived from such trade or business. 

Instead of actually exempting this income from U.S. 

taxation, section 936 provides a credit equal to (and, thus, 

fully offsetting) the U.S. tax on this income. The section 936 

credit is not available for other income earned by a possessions corporation. However, a regular foreign tax credit may 

be claimed for foreign (including possession) taxes paid or 

accrued with respect to income which does not qualify for the 

936 credit. 

Exemption from u.s. tax on dividends remitted by a possessions 

corporation to its U.S. parent. Prior to 1976, dividends paid 

by a possessions corporation to its U.S. parent were fully 

taxable to the u.s. parent, but amounts received upon 

liquidation of a possessions corporation were exempt from tax. 

As a consequence, 931 corporations accumulated substantial 

earnings and invested them in the Eurodollar market in anticipation of a tax-free liquidation. 3/ To accelerate the 

repatriation of earnings and to remove the tax incentive to 

liquidate, the Tax Reform Act of 1976 allowed u.s. parent 

corporations to claim a dividends-received deduction for 

dividends from an affiliated possessions corporation. If the 

possessions company is a wholly owned subsidiary (as most 

are), the deduction equals 100 percent of the dividend and, 

thus, the dividend is free of any U.S. tax. 

o Requirement that a possessions corporation elect the benefits 

of section 936 for 10 years. Under section 931, as construed 

by a court decision, 4/ a possessions corporation which 

suffered a loss in a g-rven year could join its parent and 

other affiliated corporations in filing a consolidated return 

for such year. The parent of a 931 corporation thus avoided 

taxes in profitable years but was able to offset any loss 

against other taxable income in unprofitable years. Under 

section 936, a possessions corporation must elect the benefits 

....____---------~~-

2/ 

- The requirement that QPSII must be derived from the possessipn in 

which the corporation has its trade or business means that a 

possessions corporation with a trade or business in Puerto Rico 

cannot convert interest on Eurodollar deposits into possession 

source income by routing such deposits through a Guamanian bank. 

Such had been the practice prior to 1976 under section 931. 

~/ Possessions companies were not generally subject to the U.S. 

accumulated earnings tax. 

4/ 

- ..!!_urke Concrete Accessories, Inc., et al. 

..!Eternal Revenue, 56 Tax Ct. 588 (1971). 

Rev. Rul. 65-293, 1965-2 C.B. 323. 

v. Commissioner of 

This case overturned 
-8-

of section 936, and that election is irrevocable for 10 years. 

During this period it cannot join with its parent in filing a 

consolidated return, although it can delay electing 936 status 

until profitable years begin. 

In explaining the reasons for the amendments made by the TaX 

Reform Act of 1976, Congress cited its desire to leave undisturbed the 

tax exemption of earnings from a trade or business in Puerto Rico or 

from investments made with those earnings for use in Puerto Rico. At 

the same time, Congress wished to end the exemption for passive income 

from funds invested in foreign capital markets and to hasten their 

repatriation. Congress stated that it sought to: 

assist the U.S. possessions in obtaining employment-producing 

investments by U.S. corporations, while at the same time encouraging those corporations to bring back to the United States the 

earnings from these investments to the extent they cannot be 

reinvested productively in the possession. ~/ 

C. Treatment of Income from Intangibles under the Tax Equity a_!!! 

Fiscal Responsibility Act of 1982. Before 1982, there were no 

explicit statutory guidelines on the allocation to a possessions 

corporation of income from intangibles, such as patents, trademarks, 

and tradenames, which had been developed and paid for by an affiliated 

U.S. corporation and subsequently transferred to the possessions 

corporation. In many instances, U.S. corporations attempted t 0 

increase the income which was exempt from tax under section 931 or 93 6 

by transferring to an affiliated possessions corporation incomeproducing intangible assets. These corporations construed the law to 

require no allocation to the U.S. parent of income generated by the 

intangibles. For example, a pharmaceutical company might develop 8 

patentable drug in its U.S. laboratory and transfer the patent to itS 

wholly owned possessions corporation. The possessions corporati~ 0 

would produce, in whole or in part, the patented drug and would clal~ 

the income from the patent as possession source gross income. The 

view of the Internal Revenue Service, however, was that income 

generated by the transferred intangibles had to be allocated to the 

U.S. parent corporations. 6/ This issue has resulted in lengthY 

litigation. 21 -

~/ 

.§_/ 

Report of the Committee on Ways and Means, U.S. House of Re~ 

sentatives, on H.R. 10612, Report No. 94-658, November 12, 197 ~ 

p. 255; and Report of the Committee on Finance, United St~ 

Senate, on H.R. 10612, Report No. 94-938, June 10, 1976, p. 279· 

For a description of the pre-1982 rules relating to intercorpora~~ transfers of assets and the allocation of income, see pages 14- ~ 

of The Operation and Effect of the Possessions Corporation S~ 

of Taxation, Fourth Report, U.S. Treasury Department, FebruarY' 

1983. 

C no· 21 See, for example, Eli Lilly and Co. v. Commissioner, 84 T. • 

6 5 ( May 2 8 , 19 8 5 ) • 

Con 

Cor 

Pro 

tax 

R' 

C~q ta >I 

~EF 

Co 

Opt 

fta 

in 

Co 

Ot 

Pto 
-9-

S· In the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), 

a !Congress provided statutory rules for the allocation to a possessions 

us ~orporation of income from intangibles. The purpose of these 

Provisions was "to lessen the abuse caused by taxpayers claiming 

tax-free income generated by intangibles developed outside of Puerto 

ax ~ico." 8/ TEFRA added a new section 936(h) to the Internal Revenue 

he Coae providing, as a general rule, that income from intangibles is 

or taxable to the u.s. shareholders of the possessions corporation. 

~t ~EFRA also provided that a possessions corporation and its affiliates 

ne ~Ould "elect out" of the general rule under either a "cost sharing" 

ir 0Ption or a "50/50 profit split" option. These options provide a 

~tamework under which a possessions corporation may claim certain 

lncome from intangibles developed or purchased by its affiliated 

g ~orporations. These options apply to the products produced in whole 

r-- 0r in part by a possessions corporation (so-called "possession 

e Ptoducts"). 

1. Cost Sharing Option. Under the cost sharing opt ion, a 

Possessions corporation is required to make a cost sharing payment 

~d equal to a fraction of the current year's research expenditures of the 

~ ~ffiliated group in the "product area" in which the possession product 

s a11s. 9/ The fraction is equal to the ratio of third party sales of 

the pos5ession product to third party sales of all products in the 

Product area by the affiliated group. The cost sharing payment is to 

s ~educe the amount of deductions otherwise allowable to the appropriate 

·S. affiliates. 

The quid pro quo for the cost sharing payment is that the 

o ~Ossessions corporation is treated as the owner of the manufacturing 

e ll1tangibles (but not marketing intangibles) associated with the 

a 1t0 ssession product. Thus, a determination will have to be made under 

s the cost sharing option as to what portion of the final sales price of 

n t~e possession product is a return to manufacturing intangibles (and 

~ p erefore tax-exempt income to the possessions corporation) and what 

e i

0 ttion is a return to marketing intangibles (and therefore taxable 

e l1come to its affiliates). The generally applicable regulations under 

e section 482 are to be used for this purpose. 

"------------

.... 

v 

I ~/ s 

Joint Committee on Taxation, General Explanation of the Revenue 

Provisions of the Tax Equity and Fiscal Responsibility Act of 

1982, December 1982, pp. 81-83 . -

The "product area" is defined by reference to the 3-digit 

classification of the Standard Industrial Classification code. 

Examples of 3-digit codes are drugs, electronic components, and 

beverages. 
-10-

2. 50/50 Split of Combined Taxable Income from the Possessio_!!.. sa 

Product. Under the profit split option, SO percent of the combined JPe 

taxable income of the possessions corporation and its u.s. affiliates a~ 

derived from sales of the possession product to foreign affiliates or 

unrelated persons will be allocated to the possessions corporation, 

and the remainder will generally be allocated to the U.S. affiliates· 

This option permits the possessions corporation to obtain part of the 

return on all intangibles related to the possession product. For 

purposes of computing the combined taxable income from the product, 

all direct and indirect expenses relating to the product are taken 

into account. 

Proposed regulations issued by the Treasury Department under 

section 936(h) 10/ provide rules for the computation of income from 

the "possessionproduct" in the case that the product is not sold 

directly to foreign affiliates or unrelated persons, but is a 

component of, or one stage of processing in, a product sold to 

unrelated persons. 

3. Eligibility. To be eligible to use the cost sharing or profit 

split option to compute income from a possession product, ?, 

possessions corporation must have a "significant business presence 

with respect to that product in a possession. This requirement is met 

if the possessions corporation meets one of two tests: 

0 

0 

25% Value added test. The possessions corporation must shO~ 

that it incurred production costs (other than the cost o 

materials) with respect to the product which are not less than 

25 percent of the difference between (a) the gross receipts 

from sales of the product to unrelated parties by th~ 

possessions corporation or its affiliates, and (b) the dir~c 

costs of materials purchased by the possessions corporat~ ~ 

or its affiliates from unrelated parties in connection w1 t 

the manufacture of the product. This test is equivalent to a 

25 percent value-added requirement. 

·on 65% labor test. Alternatively, the possessions corporatl. 

must show that it incurred, for labor services per formed ~ the possession, at least 65 percent of the total labor co7t 

of the possessions corporation and its affiliates in producin9 

the product or service during the taxable year . .!.!_/ 

Under the proposed regulations, start-up operations of new. 93: 

corporations and new possession products of existing 936 corporat 10~y 

could meet the "significant business presence" requirement 

10/ Federal Register, January 10, 1984, pp. 1,227-1,243. 

·on .!..!_/ As a variant of this test, the proposed regulations under sectl d 

936(h) permit certain Puerto Rican construction costs to be use 

to meet the business presence requirement. 

f 

iii 

p 

(g 

ca 

Co 

d 

s. 

p 

0 

9u 

p 

f 

~ 

t 

l 

p 

i 

0 

q 

i 

q 

l 

i 

l 

a 

( 

t 

t 

a 

l 

" 
-- --

-11-

~ satisfying a lower threshhold of value-added or labor cost than the 

ed Percentages referred to above. For such start-up operations, the 

es applicable percentages under the proposed regulations are as follows: 

or 

1 

n, Business Presence Tests for 

~~ Start-up Operations 1 

Year 

2 3 

or 

t, 

en 

er 

ont 

1d 

a 

tO 

Value Added Test 10% 

Labor Test 35% 

15% 

45% 

20% 

55% 

The proposed regulations under section 936(h) would provide a ~lexible definition of the term "possession product." The term 

tncludes any item of property which is the result of a manufacturing 

Process, including components and so-called "end-product forms" 

(products which are treated as not including certain of their 

components for purposes of the business presence test and the 

computation of income from the possession product) • This flexible 

it I definition would permit a possessions corporation to satisfy the 

a Significant business presence test with respect to some possession rt Product, and then to compute its income under the cost-sharing option 

et 0 r profit-split option with respect to that same product. 

I D. Passive Income Limitation under TEFRA. In addition to the new 

9Uidel ines on income from intangibles, TEFRA raises from 50 to 65 

Percent the share of its gross income that a corporation must derive 

from the active conduct of a possessions trade or business in order to 

qualify for the section 936 credit. This increase is phased in so 

that the percentage rises to 55 percent for taxable years beginning in 

1983, and to 60 percent for taxable years beginning in 1984. As under ~tior law, the gross income test must be met for the three-year period 

tmmediately preceding the close of the taxable year or for such part 

Of such period as may be applicable. The greater level of required ~Ctive business income will mean that proportionately less passive 

lnvestment income can be earned by a corporation still wishing to 

qualify for effective tax exemption under section 936. 

lt. Puerto Rican Tax Provisions 

. Since 1948, Puerto Rico generally has provided its own tax ~ncentives for manufacturing and other ~pecified ~usiness a?tivities. ~ Puerto Rico currently grants partial exemptions from income tax ~na other taxes to approved businesses for specified periods of time t9e~erally 10 to 25 years). Possessions corporations in the rnanufac- t~ring sector in Puerto Rico normally hold an exemption contract from 

a e Puerto Rican government. In 1983 such corporations paid, on lt~erage, an estimated 5 percent of their income in taxes to Puerto 

l.co . 

......_________ _ 

!3_; Pages 23-25 of the Fourth Report summarize the history of the 

Puerto Rican Industrial Incentives Act. 
-12-

This section discusses, in turn, Puerto Rican taxation of non- inc 

exempt corporations, taxation under an old (pre-1978) exemption Pe i 

contract, taxation under a "converted" exemption contract, and exE 

taxation under a new exemption contract. of 

A. Taxation of Non-Exempt Corporations. Puerto Rico's authority 

to enact its own income tax system derives from the Organic Act of Pa 

1917, known as the Jones Act. In 1954 the Puerto Rican legislature lio~ 

adopted its present income tax system, based on the U.S. Internal te 1 

Revenue Code of 1939. In the absence of a tax exemption grant, Puerto a 

Rico taxes all Puerto Rican source income earned by U.S. and foreign exE 

persons (including corporations) and taxes the worldwide income of all to : 

reside.nts and Puerto Rican corporations. Corporate income tax rates 

are graduated, ranging from 22 percent for taxable income under 

$25,000 to 45 percent for taxable income in excess of $300,000. Gross ~ 

income and allowable deductions are defined in much the same way as no 

under the U.S. Internal Revenue Code. However, the Puerto Rican code Ju 

contains a "flexible depreciation" provision which permits taxpayers Ole 

to recover the cost of "qualifying property" in any taxable year or ne

years chosen by the taxpayer, up to a limit of 50 percent of net in' an

come, without regard to the useful life of the property. Generally, 

property acquired for use in agriculture, construction, manufacturin9 1 

hotels, or shipping qualifies for flexible depreciation. ex 

ta 

In addition to its income tax, Puerto Rico imposes a "tollgate ta 

tax" on dividends paid out of Puerto Rican source earnings and profi~S 9r 

to a u.s. or foreign parent corporation. If the parent corporation ~s 

not engaged in a trade or business in Puerto Rico, the dividend is 

subject to a 25 percent tollgate tax withheld at source. However, t~~ 

rate of tollgate tax is reduced to 10 percent if the dividend is pal 

out of income derived from the operation of a hotel, manufacturing, or 

shipping business. Upon liquidation, a 29 percent tollgate ta~ 

applies to any Puerto Rican source gain received by the paren 

corporation. 

· rltl B. Taxation Under an Old Exemption Grant. In general, a fl 

which has a tax exemption grant under the 1963 Industrial IncentiV~ 

Act is 100 percent exempt from tax on business income and 0 

investment income from certain designated assets 13/. This tax-exempt 

13/ The assets which give rise to tax-exempt passive investment incom~ -- generally known as 2(j) assets -- include Puerto Rican gove~np 

ment bonds, loans for the construction of buildings or acquisit 10 

of equipment used by a tax-exempt business, mortgages insured ~~ the Puerto Rican Housing Bank and Finance Agency, and certificat~s 

of deposit in certain banks doing business in Puerto Rico. aanhe 

receiving these tax-exempt deposits are required to reinvest tot 

funds within Puerto Rico, although this requirement was n re 

strictly enforced until 1980. Puerto Rican regulations which wee~ 

in effect through March 31, 1980 permitted banks to "warehoUf\o 

936 deposits outside Puerto Rico for up to six months. puer re 

Rican rules regarding tax-exempt financial investments a 

explained in Chapter 5, below. 
-13-

1- income is called Industrial Development Income. The firm is also 100 

'n Percent exempt from property and gross receipts taxes. The tax ~d exemption grant lasts from 10 to 30 years, depending on the location 

of the plant. 

:y Dividends paid out of Industrial Development Income to a U.S. 

,f Parent corporation are subject to the 10 percent tollgate tax. 

re liowever, the rate is reduced to 7 percent where the tax-exempt firm 

l retains a certain percentage of its annual earnings in Puerto Rico for 0 a specified period of time. On liquidation, a firm with an old tax 

n exemption grant may distribute all accumulated earnings free of the 

.1 tollgate tax. ~s 

r 

s 

s 

e 

s 

r 

e 

s 

s 

s 

e 

d 

r 

" t 

Jt1 

e 

~ 

I 

C. Taxation Under an Old Exemption Grant •converted• to the 1978 

~dustrial Incentives Act. The 1978 Industrial Incentives Act does 

not affect the terms of tax exemption grants which were issued before 

June 1978, but it provides opportunities to firms operating under 

0ld tax exemption grants to convert to partial tax exemption under the 

new Act. The election to convert had to be made by December 31, 1979, 

ana two optional conversion plans were available: 

Option One. During the years remaining until the end of the 

existing grant, the exempted business will pay a maximum effective 

tate of tax from 3 percent to 12 percent of income, with the higher 

tate applicable to a firm which has fewer years left on its original 

9tant, as follows: 

Years Left on Exemption Maximum Effective 

Original Grant Percentages Tax Rate 

0-4 years 73.3% 12.0% 

5-8 years 77.7 10.0 

9-12 years 85.5 6.5 

13-16 years 90.0 4.5 

17-20 years 91. 0 4.0 

More than 20 years 93.3 3.0 

~ After the period of original exemption has expired, the firm ~lecting this option is automatically entitled to operate partially 

t~empt from taxation for ten more years. During the first five of 

s 0 se ten years, 50 percent of income will be exempt. During the Q~cona five years, between 35 percent and 50 percent will be exempt, 

~Pending on the location of the plant. 

~\l ..Qption Two. A company with six or more years remaining on its 

~>c trent tax exemption may make an alternative election. It may 

th~luae 90 percent of its income from taxation, and may credit twoltds of the corporate income taxes actually paid against the 
-14-

tollgate tax on dividends paid from current earnings. A company that its 

elects this second option may apply for a ten-year extension when the int 

current grant expires, but the extension is not automatic. exe 

for 

As a f u r the r ind u cement to f i rm s to con v e r t to par ti a 1 ta" bus 

exemption, the 1978 Act provides that, under either conversion option, fir 

a firm may credit tollgate taxes paid on distributions from pre-1978 to1 

earnings against the income taxes due in future years, up to 50 fol 

percent of such liability in any given year. In addition, dividends 

paid by converted firms out of pre-1978 earnings may benefit from a 

reduced tollgate tax rate. On liquidation, pre-1978 earnings of 

"converted" firms are exempt from tollgate tax. 

D. Taxation Under a New Exemption Grant. New grants issued under 

the 1978 Industrial Incentives Act provide 90 percent exemption from 

income and property tax in the first five years of a firm's operation 

and a gradually decreasing rate of exemption during each subsequent 

five-year period until the expiration of the grant, as follows: 

Percentage of Effective Tax Rate on 

Years of Exemption from Income Income Derived from 

Exemption Manufacturing 14/ and Property Tax Minimum Maximum 

1-5 90% 2.20% 4.50% 

6-10 75 5.50 11. 25 

11-15 65 8.75 15.75 

16-20 55 9.90 20.25 

21-25 50 11. 00 22.50 

The duration of a firm's grant will vary from 10 to 25 years, depend"" 

ing upon the location of its plant. 

The actual effective tax rates will be somewhat lower than th 05 ~ shown because of two additional incentives provided by the 1978 Act f1 

encourage labor-intensive operations and assist small firms. A f 

grants issued under the new Act allow the firm an added deduction. 0

9 five percent of production worker payroll from its manufactur ~e income, up to 50 percent of such income. As an alternative ~o t nY 

payroll deduction, a firm whose profits are less than $500,000 in. ast 

given year is allowed a 100 percent tax exemption on the fir 

$100,000 of income. 

14/ Th ~ . . d . t t d ' ' f' per iOd e minimum an maximum ax ra es uring a given ive-year rY 

are computed on the basis of the statutory tax rates, which va 

from 22 percent to 45 percent, depending on the firm's income. 
-15-

If a firm with a partial exemption grant reinvests all or part of 

hatits earnings in Puerto Rican 2(j) assets, then the dividends, 

he interest, and rents derived from those assets will be 100 percent 

exempt from Puerto Rican income tax. The intent of the tax exemption 

for 2 ( j) earnings is to induce 936 corporations to reinvest their 

ta~ business profits in Puerto Rico. However, the main incentive to a 

on, firm to retain its profits in the Commonwealth arises from the 

978 tollgate tax provisions of the new Industrial Incentives Act, as 

50 follows: 

ndS 

~ a 

of 

d 

y 

Dividends paid out of income earned by a tax-exempt business 

are subject to a tollgate tax of 5 percent, instead of 10 

percent, provided that (a) 50 percent of such income is 

invested for five years in 2(j) assets or in the firm's own 

capital assets, and (b) not more than 10 percent of the net 

income is distributed in each of the succeeding five years. 

The 50 percent of income reinvested during this period can be 

repatriated after the fifth year. 

On liquidation, undistributed earnings are subject to a 

tollgate tax of 4 percent, rather than 10 percent, provided 

that 50 percent of such earnings have been invested in the 

firm's own capital assets or in 2(j) assets for a period of at 

least five years. 
-17-

Chapter 3 

ECONOMIC DEVELOPMENT IN PUERTO RICO 

Puerto Rico is a small island with a population of almost 3.3 

illion and few natural resources. Its economy is closely integrated 

With the U.S. economy. Puerto Rico and the United States have a 

~ommon currency and common external tariffs. There are no barriers to 

the free flow of goods, labor, or capital between the two economies. 

During the year ending June 30, 1982, approximately 84 percent of 

~Uerto Rico's exports were to the United States. In recent years 

~bout 90 percent of gross fixed investment in Puerto Rico has been 

derived from u.s. sources. Federal statutes other than domestic tax 

laws generally apply to Puerto Rico, some (such as minimum wage legislation) with large economic impacts. With a few important exceptions, 

~ederal grant-in-aid programs and income maintenance programs apply to 

~Uerto Rico. Residents participate fully in the Social Security and 

Unemployment Insurance programs. However, Puerto Rico administers 

~Utritional assistance (such as Food Stamps) under a block grant 

~~stead of an entitlement program, and Federal payments to Puerto 

lean residents for Medicaid and Aid to Families with Dependent 

Children are subject to a cap. 

The ties between Puerto Rico and the United States have helped 

Shape the push for Puerto Rican economic development that began in 

i94a. This chapter briefly surveys Puerto Rican economic growth since 

t~48, and the impact of the combined u.s. and Commonwealth tax exemplons in shaping that growth. 

The recent history of Puerto Rican economic development can be 

toughly divided into two periods. In the period 1948-1972, there was 

~ sustained rise in private investment which created a modern manufactl.lting sector. Employment in manufacturing grew from 55,000 in 1950 

0 142, 000 in 1972. Gross National Product and GNP per capita also 

9tew rapidly. In the period 1973-1983, however, Puerto Rican economic 

~togress slowed. Total employment and employment in the manufacturing 

~ctor were stagnant. Real GNP per capita has changed little since 

Q~/4· Private investment in plant and equipment as a percentage of 

19P fell steadily from 10.3 percent of GNP in 1973, to 4.6 percent in 

83. 

t In part, the decline in Puerto Rico's economic performance is 

9

taceable to the u.s. recessions of 1974-75 and 1981-82. Puerto Rican 

~towth has also been reduced by the erosion of the u.s.-Puerto Rican 

t~ge differential, U.S. tariff and tax cuts, and structural changes in 

e world economy. 
-18-

1. Growth Since 1948 !/ 

Puerto Rico's economic growth in the period from 1948 through 1973 

has often been referred to as an "economic miracle." Figure 3-1 and 

Table 3-1 show total and per capita GNP for Puerto Rico during the 

194 7-1983 period. According to this information, Puerto Rican GNP 

(expressed in 1972 dollars) increased at an average annual rate of 5.3 

percent in the 1950s and 7.0 percent in the 1960s, compared to u.s. 

average annual growth in this period of 3. 7 percent. Puerto Rico's F 

remarkable growth was accompanied by the transformation of the 

agricultural economy of the 1940s to an economy based primarily on 

services and manufacturing. Manufacturing net income surpassed ] 

agricultural net income in 1955, while manufacturing employment 1 

surpassed agricultural employment in 1966. Real GNP per capita, whicP 

reflects substantial emigration from Puerto Rico, rose at an average 

annual rate of 4. 7 percent in the 1950s and 5. 5 percent in the 196051 ~illio

compared to 2.2 percent in the 1950-70 period in the United States. ~ 

Total employment in Puerto Rico grew much less quickly than GNP1 

and more slowly than U.S. employment. Total employment grew by 15 iJoo 

percent in Puerto Rico between 1950 and 1970, compared to a 35 percent 

increase in civilan employment in the United States. Emigration was 

substantial during that period. Presumably in response to cheaper ai! ~ 

fares and better opportunities for employment on the mainland, emigra; 

tion averaged nearly 50,000 persons per year between 1950 and 1960 and 

20, 000 per year in the fol lowing decade. (See Table 3-2). Si nee 

1970, emigration patterns have fluctuated. The average net outflO~ tloo 

was approximately 13, 000 persons per year in the four-year perio 

1978-81, but increased in 1982 and 1983 to an average rate of 35,ooO 

per year. ~ 

Table 3-3 shows the change in the sectoral distribution of 

employment in Puerto Rico from 1950 to 1983. The replacement ~f ~ employment in home needlework and agriculture by employment 1n 

manufacturing and government was the most fundamental change of the 

1950s and 1960s. Employment in manufacturing grew at an average ~ 

annual rate of 3.9 percent and 5 percent, respectively, in the 1ate ·~ 

1950s and 1960s. Employment in government grew almost as rapidlY 

through the 1950s and 1960s, and employment in construction and othe~ services increased strongly in the 1960s. Total nongovernmen ~ 

employment declined in the 1950s but increased in the 1960s. 

!/ Throughout this chapter, unless otherwise noted, years are pue~t~ Rican fiscal years; e.g., 1972 means the twelve months end 10 

June 30, 1972. 
n3 

md 

:he 

iNP 

•• 3 

S· 

) 's 

.he FIGURE 3-1 

Total and Per Capita Gross National Product of Puerto Rico, 

1947-1983 (Constant 1972 Dollars) 

on 

1ed 

nt 

ell 

ge 

Is, ~ii lions 

o 

p, 

15 ~ 

nt 

as 

i! 

a .. ~o 

nd 

ce 

ow ~ 

od 

oo 

of 

of 

p1 

e 

e 

~r 

t 

0 

g 

·Ooo 

·Ooo 

~ 

~ 

•• •• •• •• 

•• 

•• •• 

•• •• 

Total 

(left scale) 

••••• • • ••••••• • 

Per Capita 

(right scale) 

'80 '85 

Dollars 

2,500 

2,000 

1,500 

1,000 

500 
Total and Per Capita Gross 

Fiscal Year 

1947 

1948 

1949 

1950 

1951 

1952 

1953 

1954 

1955 

1956 

1957 

1958 

1959 

1960 

1961 

1962 

1963 

1964 

1965 

1966 

1967 

1968 

1969 

1970 

1971 

1972 

1973 

1974 

1975 

1976 

1977 

1978 

1979 

1980 

1981 

1982 

1983 

Off ice of the Secretary 

Off ice of Tax Analysis 

-20-

Table 3-1 

National Product 

GNP 

(millions) 

(constant 1972 

1,260.0 

1,307.9 

1,462.0 

1,569.4 

1,652.1 

1,814.4 

1,931.2 

1,972.5 

2,033.4 

2,117.7 

2,182.l 

2,247.5 

2,435.4 

2,631.l 

2,791.2 

3,007.4 

3,251.8 

3,462.9 

3,749.2 

4,001.7 

4,178.2 

4,385.2 

4,793.6 

5,181.9 

5,488.2 

5,770.9 

6,059.7 

6,134.2 

6,026.3 

6,176.7 

6,471.6 

6,817.9 

7,188.7 

7,281.0 

7,370.8 

7,103.8 

6,950.9 

of Puerto Rico, 1947-1983 

GNP per 

caEita 1/ 

dollars) 

586 

601 

667 

7ll 

742 

813 

871 

893 

911 

941 

968 

986 

1,054 

1,124 

1,173 

1,240 

1, 316 

1,373 

1,458 

1, 534 

1,586 

1,650 

1,780 

1,911 

. 1,995 

2,045 

2,112 

2,129 

2,068 

2,073 

2,125 

2,201 

2,289 

2,287 

2,284 

2,182 

2,129 

J:.! Based on average of population estimates at the 

beginning and end of the fiscal year. 

Source: Puerto Rico Planning Board, Economic ReEort to the 

Governor, 1980-1981, Table 1. 

~ 

9so 

9Go 

970 

979 

979 

980 

981 

982 

983 
'--Fi seal Year 

~50-1960 

j60-l 970 

j70-1977 

979 

j79 

9ao 

~81 

992 

993 

-21-

Table 3-2 

Net Migration of Residents of Puerto Rico 

Net Migration of Residents 

of Puerto Rico 

-493,000 

-201,000 

-43,640 

-20,282 

-6,078 

-16,101 

-10,460 

-33,297 

-44,433 

Annual Rate 

per mid-period 

population 

-2.19% 

-.79 

-.22 

-.65 

-.19 

-.51 

-.32 

-1.02 

-1. 36 

Utce: Puerto Rico Planning Board, Economic Report to the Governor, 

1980-1981, Table 1; U.S. Bureau of the Census, Current 

Population Reports, Series P-25, Nos. 80, 336, and Puerto 

Rico Department of Labor and Human Resources. 
Table 3-3 

Puerto Rican Unemployment Rate and Distribution of Employment in selected Years, 1950 - 1983 

(in thousands) 

Unemploy- 'lbtal : Govern- 'lbtal Non- Agricul- Manuf ac- Hane Construe- Wholesale Finance, Transporta-: Other Year ment Employ- : ment !f Government ture turin<J Needle- ti on 

and :Retail Insurance, tion and Services Rate rnent Dnplo~nt \VOrk Trade Real Estate Utilities 

1950 12.9% 596 45 551 214 55 51 27 90 3 28 77 

1955 14.3 539 50 489 164 66 29 34 89 n.a. n.a. 69 

1960 13.1 543 62 481 124 81 10 45 97 6 39 75 

1965 11.7 617 82 535 107 106 6 56 109 n.a. n.a. 103 

1970 10.7 686 106 580 68 132 * 76 128 13 45 116 

1971 11.2 699 111 588 61 132 * 81 134 15 47 117 

1972 11.9 738 131 607 58 142 * 80 135 16 49 126 

1973 11.7 745 141 604 49 139 * 78 144 18 49 125 

1974 12.2 744 140 604 52 141 * 77 141 17 51 123 

1975 15.3 699 143 556 47 130 * 65 134 17 49 114 

1976 19.2 678 149 529 44 126 * 50 132 17 44 114 

1977 20.0 691 157 534 40 135 * 40 136 18 46 119 

1978 18.7 722 167 555 36 145 * 41 139 19 46 128 

1979 17.5 735 173 562 36 146 * 44 141 19 46 130 

1980 17.0 753 184 569 40 143 * 44 138 21 47 135 

1981 17.9 759 185 574 38 141 * 44 142 23 49 137 

1982 21. 7 719 171 548 35 134 * 36 141 21 48 132 I 

1983 23.4 703 170 533 37 131 * 30 136 22 45 132 rv 

rv 

Aver~e annual 2rowth rate I 

1950-1960 -0.9% 3.3% -1.3% -5.3% 3.9% -15.0% 5.2% 0.8% 7.2% 3.4% -0.3% 

1960-197~ 2.4 5.5 1.9 -5.8 5.0 5.4 2.8 8.0 1.4 4.5 

1970-1980 0.9 5.7 -0.2 -5.2 0.8 -5.3 0.8 4.9 0.4 1.5 

1980-1983 -2.2 -2.6 -2.2 -2.6 -2.9 -12.0 -o.s 1.6 -1.4 -0.7 

Off 1ce of the Secretary 

Off ice of Tax Analysis 

!I Includes only public administration. 

* Less than 2,000 

n.a. - not available 

Sources: Puerto Rico Planning Board, F.conanic Report to the Governor, 1982-1983, Table 24; Puerto Rico Developnent Administration, 

Economic Anallsis of the Industrial Incentive Program of Puerto Rico, 1978; Institute of International I.aw and F.conanic 

Devel.opnent, Puerto Rico Industrial Sector Study, Draft Report for the U.S. Department of carmerce, April 1978. 

Note: Figures for 1971 through 1981 were revised in the F.conanic Report to the Governor, 1982-1983. 
-23-

A number of factors contributed to the growth of Puerto Rican 

ployment during the 1960s. Exemptions from local taxes played a key 

He in inducing U.S. firms to locate plants in Puerto Rico. As 

~plained in the Fourth Report, Puerto Rican labor was low-cost 

Hative to mainland levels and contributed to Puerto Rico's 

ttraction as a site for investment. Puerto Rico also had the 

4vantage, compared to low-wage foreign countries, that it was inside 

~e U.S. tariff wall and offered a more stable political and economic 

limate than countries in Latin America or the Far East. 

Growth in government employment continued to be strong in the 

l970s, from 1970 through 1981, declining only in the recession of 1982 

na 1983. However, manufacturing employment was virtually stagnant in 

the period 1970-1983 and total non-government employment declined 

throughout most of the decade 1973-1983. In the period 1974-75 and 

~ain in the 1980s, the Puerto Rican economy was adversely affected by 

he U.S. recession and high U.S. interest rates. The Puerto Rican 

~trochemical industry suffe,red from the sharp increase in the price 

f foreign oil in 1973-74. The traditional Puerto Rican manufacturing 1

tldustries, such as apparel, shoes, and textiles, faced increased 

ompetition from low-wage foreign countries. The Puerto Rican economy 

~~Perienced a recession in 1974-76, and then grew by an average annual 

rate of 4.2 percent between 1976 and 1981. Real GNP fell 3.6 percent 

n the year ending June 1982 and 2.2 percent in the year ending June 

983, reflecting the U.S. recession and a reduction (in real terms) of 

~deral payments to Puerto Rico. 

The unemployment rate, shown in column 1 of Table 3-3, has 

~~nerally been very high by U.S. standards. Unemployment declined 

htough the 1960s to just under 11 percent, but then rose steadily in 

the period 1970-77, when it peaked at 20 percent. With the U.S. 

~~cession and the elimination in U.S. fiscal year 1981 of 21,173 

~erto Rican public service jobs financed through the Federal 

t

0mprehensive Employment and Training Program (CETA), the unemployment 

l;te increased again, from 17. 0 percent in 1980 to 23. 4 percent in 

h 83. The unemployment rate might have been even higher had it not 

~en for a decline in the adult labor force. Labor force 

~atticipation as a percentage of adult population fell from 44.5 

t~tcent in the early 1970s to 41.0 p~rcent in 1983. The ~nemployment 

~ate reached an all-time annual hi·gh of 23.4 percent in the year 

Utlding June 1983. By May 1984, it had dropped to 20.5 percent. 

tlemployment was at 21.6 percent in January 1985. 

t High levels of unemployment and low labor force participation 

thtes explain most of the poverty in Puerto Rico. It is estimated 

lat one-half of Puerto Rican families lived below the Federal poverty 

~"el in 1983. 

~ Federal payments to Puerto Rico are an important component of 

~tsonal income. As shown in Table 3-4, Federal payments include 

~tants to the Puerto Rican government, Federal taxes earmarked for 

sl..lerto Rico; and net transfer payments to individuals, less social 

~~cur i ty taxes and other contributions by Puerto Rico. Net Federal 

aYments in current dollars were $286 million in 1968, and $3,320 
-24-

Table 3-4 

Net Federal Payments to Puerto Rico 

Selected Fiscal Years 1968-1983 !/ 

(millions of dollars) 

1968 

Federal grants to Puerto Rican Commonwealth 

and municipal governments, total 129 

Food and nutrition assistance 2/ ---5 

Education programs -

Public assistance 3/ 31 

Community development block grants 15 

Low-rent public housing 11 

Employment and training programs 8 

All other grants 59 

Federal taxes transferred to Commonwealth 

government, total 93 

Alcoholic beverage and tobacco 

excise taxes 66 

Customs duties 27 

Net Federal transfer payments to 

individuals, total 4/ 64 

Old age, survivors, and 

disability insurance l 

Veterans benefits 59 

Excess of withdrawals over deposits 

in Unemployment Trust Fund -3 

All other payments 7 

TOTAL 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

1981 

1,893 

--gn 

97 

103 

115 

96 

220 

269 

319 

236 

83 

846 

502 

231 

-27 

140 

3,058 

1982 

l, 778 

1,016 

92 

118 

94 

86 

90 

283 

290 

239 

51 

l, 144 

648 

274 

38 

184 

3,212 

1983 

1, 722 

946 

74 

124 

95 

118 

82 

283 

389 

326 

62 

1,209 

712 

280 

5 

212 

3,320 

lllil: 

(Pu 

to 

Pay1 

tea

dee 

hb

~ed 

11. 

tea 

~ic 

194 

~o 

in 

Pt 

ern~ 

I ~i 

In 1968, both the Federal and Puerto Rican 

fiscal years ended on June 30, and therefore 

all data for FY 1968 is based on the same 

time period. In 1976, however, the Federal 

fiscal year was changed, beginning on 

October 1, 1976 and ending on September 30, 

while the Puerto Rican fiscal year remained 

unchanged. With the exception of certain 

Federal transfer payments to individuals, 

data for 1979-1981 are based on the Federal 

fiscal year. 

11t' 

figures comparable, all food stamp payllleat' te 

to individuals prior to July 1, 1982 11 t• I Pt 

included within the category of block 9r3 ti 

for food and nutrition assistance. 

Effective July 1, 1982, the food stamp 

program in Puerto Rico was terminated and 

replaced by a nutritional assistance grant 

program. In order to make the yearly 

,ce' Pl 

Includes Medicaid, child support enf0 ,11~ Pe 

ment, maintenance assistance (AFDC), 

low-income home energy assistance. 

·at~ Al 1 transfer payments are net of assoclt ot 

payments by or on behalf of curren et' 

future recipients, such as emP ~1011' employee, and sel £-employment contribll 

for Social Security. 

in 

~e 

~o 

Sources: 

~n 

$4 

$3 

9s21 r ~ U.S. Department of Commerce, Bureau of the Census, Federal Expenditures by State, FY 1

0 5• ~ FY 1983 i U.S. Department of the Treasury, Federal Aid to States 1 FY 1981, FY 1982 i tot eq 

Department of the Treasury, Statistical Appendix to the Secretary's Annual Repo_!!..i 011s ho 

1968; and Puerto Rico Planning Board, Economic Report to the Governor, -Table 19 (var ~e 

years). t~ 
-25-

~illion in 1983. As a percentage of income from productive activity 

(Puerto Rican GNP), net Federal payments rose from 7.7 percent in 1968 

to 23.6 percent in 1983. The current-dollar amount of net Federal 

Payments continued to increase somewhat between 1981 and 1983, but in 

tea1 (inf lat ion-corrected) terms they declined by 2 percent. The 

~ecline reflects principally the termination of the public service 

Jobs programs and to a lesser extent, the statutory ceiling imposed on 

Pederal nutritional assistance to Puerto Rico. 

11. Investment in Puerto Rico 

The basic goal of any economic development program is to increase 

t~al income per capita. As indicated in the preceding section, Puerto ~lco' s development program made substantial headway in the period 

1947-1973, and real GNP per capita rose from $586 to $2,112 (in 

~onstant dollars). Physical investment leads to an increase in income 

ln two ways, by providing the necessary capital to create new, more 

Productive jobs, and by inc~easing the productivity of those currently 

employed. ~./ 

. Components of fixed investment in Puerto Rico are illustrated in 

F'igure 3-2 and Table 3-5 for the years 1960-1983. Private refinery 

~onstruction is excluded from the total, because the boom in this 

~ndustry between 1970 and 1972 was based on the large allocation to 

Uerto Rico of u.s. quotas for imported oil (which before 1973 was ~heaper than domestic oil), rather than on low wages, locational 

ad~antages, or other market considerations. The OPEC increase in the 

Price of oil in 1973 and the consequent termination of the Federal 

quota system eliminated Puerto Rico's previous advantage. In March 

~~ 79, the Commonwealth Oil Refining Company (CORCO), the principal oil ,,, efiner and the largest private corporation in Puerto Rico, filed for 

,~t' t:otection under Federal bankruptcy laws. Private refinery construcl.on accounted for almost one-third of total private investment in 

~~ ~lant and equipment between 1970 and 1972, but represented less than 4 ,~u t-e tcent of the total in 1973 and most later years. 

a~ i It is clear from Figure 3-2 and Table 3-5 that total and private 

~ e'' p nv~stment (expressed in constant ~ 972 dollars) grew rapidly in the jo~' ~etlod 1960-73, but dropped off during the 1974-76 recession and have 

q0 ntinued to decline in most years since the recession. For example, 

$nnua1 private investment in machinery and equipment, which exceeded 

$400 million (in 1972 dollars) in the early 1970s, dropped to about 

62 , e

300 million during the 1974-76 recession and continued to decline in 

5· e~ery year between 1978 and 1982. It rose slightly in 1983 to a level 

· ~; h qua1 to 60 percent of the average in the early 1970s. Similarly, 

p

0Using construction, which rose almost continuously until 1972 to a 

t~ak of $472 billion, declined sharply in nearly every year after 

at. 

'------------

y A second major contributor to economic growth is investment in 

.h_uman capital -- the formal education and on-the-job training of 

the labor force. 
FIGURE 3-2 

Components of Real Investment in Puerto Rico, 1960-1983 

(Constant 1972 Dollars) 

$Millions 

600 

500 

1960 

600 

500 

400 

300 

200 

100 

0 

1960 

65 

65 

Industrial and Commercial Buildings, Private Enterprises 

70 75 80 85 

Machinery and Equipment, Private Enterprises 

70 75 80 85 
FIGURE 3-2, Continued 

Components of Real Investment in Puerto Rico, 1960-1983 

(Constant 1972 Dollars) 

$Millions 

600 

500 

400 

Housing 

300 

200 

100 

0 

1960 65 70 75 80 85 

Government and Public Enterprise Investment 

600 

500 

400 

300 

200 

100 

0 

1960 65 70 75 80 85 

2000 

1750 

Total Gross Investment 

1500 excluding private refinery construction 

1250 

1000 

750 

500 

250 

0 

1960 65 70 75 80 85 
Year 

1960 

1961 

1962 

1963 

1964 

1965 

1966 

1967 

1968 

1969 

1970 

1971 

1972 

1973 

1974 

1975 

1976 

1977 

1978 

1979 

1980 

1981 

1982 

1983 

Total 

Excluding 

Private 

Refinery 

Construction 

539 

538 

634 

683 

776 

879 

978 

1,051 

1,111 

1,205 

·l, 296 

1,413 

1,565 

1,499 

1,420 

1,352 

1,263 

1,074 

1,090 

1,080 

1,066 

997 

777 

703 

-28-

Table 3-5 

Components of Real Fixed Investment in Puerto Rico 

Fiscal Years 1960-1983 

(in millions of 1972 dollars !_/) 

Private Non-Residential 

Industrial and 

Commercial Buildings 

Total, Exclud mg 

Total Refinery 

71 

89 

129 

121 

115 

173 

155 

222 

221 

197 

391 

422 

332 

194 

203 

186 

152 

93 

81 

77 

85 

97 

82 

68 

Construction 2/ 

67 

82 

122 

117 

89 

94 . 119 

117 

134 

108 

118 

134 

136 

170 

181 

117 

125 

81 

71 

67 

64 

84 

72 

59 

Investment 

Machinery 

and 

Equipment 

145 

123 

158 

195 

235 

249 

265 

290 

263 

341 

413 

433 

426 

432 

357 

312 

360 

354 

379 

375 

361 

331 

228 

255 

Housing 

145 

161 

190 

195 

227 

292 

351 

380 

407 

423 

396 

441 

472 

437 

398 

336 

295 

249 

291 

250 

228 

192 

165 

149 

Off ice of the Secretary 

Off ice of Tax Analysis 

Government 

and Public 

Enterprise 

Investment 

182 

172 

164 

176 

225 

244 

243 

264 

307 

332 

369 

405 

531 

460 

484 

586 

483 

389 

348 

388 

413 

390 

313 

240 

Investment expenditures in current dollars are translated into constant 1972 

dollars on the basis of the pr ice deflators for equipment and construction 

provided in Table 20 of the source document. 

Puerto Rico's large allocation of U.S. oil import quotas for foreign oil led to 

a boom in refinery construction between 1970 and °1972. 

Sources: Puerto Rico Planning Board, Economic Report to the Governor, Tables 2, 12, 

and 20, (1983 and prior years)~ and unpublished estimates of the Puerto Rico 

Planning Board of private refinery construction. 

E 

nves 

ovet 

ilU 

'O UJ 

largE 

ln. r 

lhaq 

~OVeJ 

Dill: 

in.vei 

~hys 

l960 

~ere~ 

Sinc1 

~l. 1 

inve 

qnnu 

in B 

tat 

~n. t3 

u, s. 

~Ueri 

tna 

"-.._ 

~oo 

~Pp 

~e 

~a't) 

~a 

e1e 

~/ 

~/ 

e 
-29-

Figure 3-2 also shows the expansion of Puerto Rican government 

nvestment since 1960. Total investment by the Puerto Rican 

overnment plus investment by public enterprises rose from about $300 

illion in 1969 to almost $600 million in 1975, and then fell sharply 

·O under $300 million in 1983. Commonwealth investment was financed 

argely from external borrowing, in the United States and elsewhere. 

tn resp9nse to rising interest costs, the Commonwealth cut back 

harply on borrowing after 1975, and the rate of new investment by 

~~vernment and public enterprises has generally been less than $0.4 lllion annually since 1976. 

, The last graph in Figure 3-2 combines all components of physical 

lnvestment except private refinery construction. It shows that annual 

fuysical investment in Puerto Rico rose in nearly every year between 

960 and 1973. The annual rate of investment declined by nearly 30 

~ercent between 1973 and 1978, from $1. 5 billion to $1. l billion. 

~ince 1978 annual investment has fallen by another 35 percent, from 

l.1 billion to $0. 7 bill'ion. In the 1980s total fixed annual 

lnvestment in Puerto Rico has represented less than 15 percent of 

annual GNP, compared to 25 percent in the period 1966-73. 

, A number of factors are responsible for the decline in investment 

tn Puerto Rico. As explained in detail in the Fourth Report 5/, wage 

tates in manufacturing industries rose much faster 1n Puerto RTco than 

n the mainland between 1955 and 1971, and rose slightly faster than 

~·S. wages between 1971 and 1982. The rise in wages rates reduced 

iQerto Rico's ability to attract investment in labor-intensive 

naustries, such as apparel, leather products, and tobacco products. 

~ Changes in U.S. tax law since 1962 -- the investment tax credit 

,na the reduction in the maximum statutory rate from 52 to 46 percent lh reduced the effective tax rate on income from physical capital and 

S ereby reduced Puerto Rico's tax advantage relative to the United 

ttates. The accelerated cost recovery system enacted .in 1982 further 

~duced the effective tax rate on income from capital, as shown below: 

Effective U.S. Tax Rates on Rew Depreciable 

Assets, Selected Industries 6/ 

1979-1981 1981-82 Post-1982 

~ndustry 

~ooa 

~Pa rel ~ ernicals 

~bricated metals 

~chinery and instruments 

ectrical and electronic 

~ipment 

s; 

' See pages 43-47. 

Law 

43.5 

40.6 

28.6 

4 7. 3 

38.2 

31. 9 

Law Law (TEFRA) 

20.4 26.7 

23.1 28.9 

8.5 17.7 

24.7 32.2 

18.6 25.7 

15.8 25.7 

~/ These effective tax rates are derived from the Treasury Department 

depreciation tax model. They are based on investment patterns by 

corporations in the United States, using the actual asset mix in 

each industry and assuming a 4 percent real after-tax rate of 

return and 6 percent inflation. 
-30-

By reducing the basis of depreciable property by a portion of the 

investment tax credit and by tightening certain leasing provisions, 

TEFRA offset roughly one-third of the 1982 tax cut on income from 

physical capital. 

The changes in Puerto Rican wage rates and u.s. tax law reduced 

Puerto Rico's locational advantages relative to the United States as a 

site for plant and equipment. Changes in the U.S. tariff structure in 

the 1960s reduced the locational advantage of Puerto Rico relative to 

foreign countries, as the price advantage which Puerto Ricad products 

could enjoy in the u.s. market relative to foreign products was cut. 

After the Kennedy round of tariff negotiations in the 1960s, the 

United States cut its tariff rates by 40-50 percent on average, which 

exposed Puerto Rican (and U.S.) manufacturers to more vigorous import 

competition. Foreign competitors utilizing low-wage labor penetrated 

the u.s. market, and U.S. investors also started manufacturing in lowwage countries and exporting back to the United States. u.s. 

investors who established foreign manufacturing subsidiaries could 

obtain the benefit of 100 percent U.S. tax exemption on current income 

from physical assets, since the United States generally does not tax 

such income until it is repatriated to the United States. 21 

Changes in Puerto Rico's relative comparative advantages are 

reflected in the basic change in the manufacturing sector since 1970· 

Puerto Rican business expansion has been concentrated in four hightechnology industries, chemicals (including pharmaceuticals), 

scientific instruments, electrical and electronic equipment, and 

machinery. These U.S. industries are among the leaders in investment 

in research and development (R&D) spending. 8/ Under current law, 

when a possessions corporation produces, in whole or in part, a 

product in Puerto Rico, the return on the R&D and other intangible 

property associated with the product enjoys unique tax advantages 

under u.s. law. 

Table 3-6 presents the industry composition of Puerto Rican 

manufacturing income. Between 1960 and 1970, the composition of the 

manufacturing sector changed little, except that the food industrY 

declined as a percent of the total and chemicals, increased sharply as 

a percent of the total. Between 1970 and 1983, however, the 

?_/ 

§_/ 

This exemption is also available for subsidiaries incorporated in 

the U.S. possessions. 

In 1980, electrical and electronic equipment took first place 

among 16 manufacturing industry categories in the dollar amount of 

spending on R&D in the United States, with estimated total 

spending of $8. 9 billion. As a percentage of spending on plar:t 

and equipment, R&D spending was 103% in instruments, 92% 10 

electrical and electronic equipment, 50% in non-electrical 

machinery, and 37% in chemicals. Figures are based on actual 198~ 

spending, and are from Annual McGraw-Hill Survey of Busine~ 

Plans for Research and Development Expenditures, 1981-84. 
Table 3-6 

Net Income Originating in Puerto Rican Manufacturing 

Fiscal Years 1960, 1970, 1980, and 1983 

(dollars in millions) 

1960 ... 1970 . .. 1980 

Amount Percent ... Amount Percent . .. Amount Percent 

of Net of . . . of Net of ... of Net of 

Income Total ... Income Total . .. Income Total 

All Manufacturing Industries 288.8 100.0% 957.6 100.0% 4,808.7 100.0% 

Food and kindred products 66.7 23.1 161.3 16.8 548.5 11.4 

Tobacco products 10.4 3.6 36.4 3.8 46.3 1. 0 

Textile mill products 13.9 4.8 41.1 4.3 39.6 0.7 

Apparel 50.7 17.6 172. 0 18.0 360.7 7.5 

Furniture and wood prodcts 8.8 3.0 26.2 2.7 29.6 0.6 

Printing and publishing 11. 2 3.9 22.6 2.4 58.8 1.2 

Chemicals 9.8 3.4 109.3 11.4 1,583.2 32.9 

Stone, clay and 

glass products 18.8 6.5 49.1 5.1 95.4 2.0 

Machinery and metal 

products 54.7 18.9 191. 5 19.4 1,453.7 30.2 

Other manufacturing 43.7 15.1 148.0 15.5 597.0 12.4 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

p - Preliminary figures 

Source: Puerto Rico Planning Board, Economic Report to the Governor, 1980-1983, 

Table 7; and other years. 

. .. 

. .. Amount 

. .. of Net . .. Income 

5,764.6 

670.0 

58.0 

27.0 

343.9 

25.1 

65.4 

2,120.0 

69.5 

1,953.3 

432.4 

1983p 

Percent 

of 

Total 

100.0% 

11.6 

1.0 

0.5 

6.0 

0.4 

1.1 

36.8 

1.2 

33.9 

7.5 

I 

w 

f-J 

I 
-32-

manufacturing sector experienced .a basic change by moving from certain 

labor-intensive industries into high-technology industries. The 

combined income shares of the food, apparel, and stone & clay & glass 

industries fell from 40 percent to 19 percent. Chemicals became the 

largest industry by far, growing from 11 percent to 37 percent .of the 

total income originating in Puerto Rican manufacturing, while the 

income of the machinery and metal products industries {including 

electrical and electronic equipment) grew from 19 percent to 34 

percent of the total income in Puerto Rican manufacturing. Nearly all 

investments in these industries have been made by possessions 

corporations. The amount of current investment of possessions corporations, by industry, and the employment associated with these 

investments, is the subject of the next chapter. 

As noted in Table 3-3, employment figures for 1971 through 1981 

were revised downward in the 1982-83 Economic Report to the Governor· 

The data on distribution of employment in Puerto Rican manufacturing 

industries, published by the Puerto Rican Department of Labor in its 

Census of Manufacturing Industries in Puerto Rico and cited in the 

Fourth Report (Table 3-8, p. 53) have not been revised accordingly· 

However, the pattern presumably remains the same as indicated in the 

Fourth Report, namely a shift in employment away from tobacco, 

textiles, apparel, leather goods, wood products, and stone, clay and 

glass products to chemicals {including pharmaceuticals), electrical 

and electronic equipment, scientific instruments, and machinery and, 

to a lesser extent, to the food-processing, paper and plastics 

industries. 

p 

t 

m 

f 

i 

c 

m 

$ 

c 

p 

l 

e 

a 
-33-

Chapter 4 

CHARACTERISTICS OF POSSESSIONS CORPORATIONS 

AND REVENUE EFFECT OF SECTION 936 

This chapter describes the characteristics, by industry, of 

Possessions corporations. It presents data on their assets, income, 

tax benefits, employment, and payroll in tax year 1982 1/. The information presented is drawn from unaudited tax and employment returns 

filed by possessions corporations for tax year 1982 (pre-TEFRA). It 

is estimated that 554 corporations, of which 447 were manufacturing 

companies, claimed possessions tax credits in 1982. The 447 

manufacturing firms claimed estimated possessions tax credits of 

$1,843 million, 2/ and derived estimated tax benefits of $1,679 

million. In estimating the tax benefit, the total credit claimed is 

adjusted downward to take account of other tax benefits (e.g. 

accelerated depreciation, investment tax credits and foreign tax 

credits) which such corporations might have claimed if, instead of 

Operating as possessions corporations, they had operated in the United 

States. Activities other than manufacturing generally did not qualify 

~or exemption grants in Puerto Rico, and the evidence suggests that, 

ln the absence of the section 936 credit, the foreign tax credit for 

Puerto Rican taxes paid would have offset most of their U.S. tax 

liability. For this reason, it is assumed that only corporations 

engaged in manufacturing derive tax benefits. Thus the tables in this 

chapter focus primarily on manufacturing possessions corporations. 

Not all of the tax and employment information is available for all 

447 manufacturing corporations. 'l'he most detailed information is 

available for 417 manufacturing corporations which had filed their 

returns prior to the cut-off date for processing the returns for this 

study. In the interests of completeness, that detailed information is 

Shown in Tables 4-1 through 4-4, even though it does not represent the 

entire universe. Table 4-5 presents data on net income, credits 

c~aimed and estimated tax benefits both for that group of 417 corporat1ons and for the full group of 447 manufacturing companies, including 

the 30 which filed after the cut-off date. Employment data is availa~le for 324 of the manufacturing possessions corporations. Those 

figures are shown in Tables 4-6 and 4-7, and are the bas is for the 

estimates in Table 4-6 for all manufacturing possessions corporations • 

. !/ 

2/ 

-

Includes accounting periods ending between July 1, 1982 and 

June 30, 1983. As most possessions corporations file on a 

calendar year basis, tax year 1982 corresponds closely to calendar 

year 1982. 

If part-year returns are included in the total, credits claimed 

amount to $2,056 million. However, as there is insufficient data 

on those returns, only full year returns are reported on. 
-34-

This chapter also presents summary data for 1974 through 1982. 

These data indicate the following trends for this period: 

The number of possessions corporations in manufacturing haS 

tended to fluctuate between 400 and 500, ranging from a low of 

385 (in 1977) to a high of 502 (in 1979). 

The possessions corporation tax benefits rose from about $400 

million in 1974 to approximately $1.7 billion in 1982, a 

change of 255 percent in inflation-corrected dollars. 

Between 1974 and 1982, the tax benefits rose from 92 percent 

to 147 percent of total compensation of employees of 

possessions corporations. 

The final section of this chapter explains the method used iO 

estimating the tax benefits of section 936. It also examines the 

extent to which Federal tax revenues would increase in the absence of 

section 936. 

I. Assets and Income in Tax Year 1982 

As noted above, Tables 4-1 through 4-4 contain 1982 data for those 

possessions corporations which filed tax returns before the cut-off 

date for processing the return for this study. They include data fot 

522 corporations, of which 417 are manufacturing corporations. 

A. Asset Composition of Puerto Rican Investment. Only physical 

and financial assets are directly observable from balance sheets 

because intangible assets, which are usually the result of R&D and 

sales promotion activities which have been expensed, are general~}' 

carried on a corporation's books at a zero basis. Table 4-1, which is 

based on corporate balance sheets filed as part of u.s. tax returns, 

indicates that the total assets of the possessions corporations 

included in this table were $17.8 billion at year-end 1982. Seventy~ 

seven percent of the total assets, or $13.8 billion, were held b}' 

manufacturing companies which benefit from total or partial exempti ~ 

from Puerto Rican taxes. (Non-manufacturing firms generally do no 

benefit from Puerto Rican tax exemption.) Net plant and equipment of 

936 manufacturing firms (shown as "net depreciable assets" on Table 

4-1) amounted to $1.6 billion, of which $691 million, or 43 percent, 

was owned by the pharmaceutical industry. The chemical industrYf 

other than pharmaceuticals, accounted for an additional 15 percent 0 s 

the total. The electrical and electronic equipment, and food proauc~ 

ind us tries also had substantial amounts of plant and equipment ~o Puerto Rico, with 11 percent and 10 percent of the to ta ' 

respectively. 

Relative to corporations operating in the United States, posse~; 

sions corporations have a disproportionately small share of thel / 

assets in real fixed assets. Net plant, equipment, and property ).9 represented 12 percent of the total book assets of manufactur1° 

The value of property (i.e., land holdings) reported b~ manufacturing possessions corporations was $45 million. The 5 

assets are included in the "Other assets" category on Table 4-1· 
Table 4-1 

Selected Balance 91eet Infonnation by Iooustry, 1982 

(Dollar amounts in thousaoos) 

All Manufacturi~ Industries 

Iooustries Manufacturing Food & Kioored Textile Mill Apparel Paper Olanicals 

Total Products Products Total :A1annaceut1cals: All other 

Number of corporations 522 417 21 5 60 7 79 48 31 

Total Assets 17,830,919 13,774,788 996,325 20,247 408,580 39,309 7,227,780 6,317,284 910,495 

Cash 2,497,750 2, 134, 072 270,987 10,635 72, 792 2,615 838,304 816,765 21,539 

J\ccounts receivable 3,746,667 2,855,476 263,284 3,901 143,857 7,320 1,459,807 1, 031, 214 428,592 

Inventories 1,499,052 1,328,604 166,335 3,405 48,880 2,915 487,900 374,798 113,101 

G:>verrment obligations 469,257 412,662 812 857 3,302 0 282,853 257,764 25, 088 

other current assets 1,085,922 1,053,457 15,439 42 10,470 240 364,379 357,167 7,212 

M:>rtgage & real estate loans 1,104,947 147,634 0 0 3,049 0 38,468 38,468 0 

other investments 4,296,358 3,846,468 62,535 493 92,113 23,803 2,650,459 2,598,131 52,328 

Depreciable assets 4,014,026 2,610, 719 241,009 2,372 36,786 3,632 1,483,547 926,056 557 ,491 

Less: Accunulated depreciation 1,408,086 991,314 83,020 1,523 16,907 1,380 554,524 235,029 319,495 I 

Net depreciable assets 2,605,939 1,619,405 157,989 848 19,879 2,252 929,022 691,026 237,995 w 

U1 

other assets 525,023 377, 005 58,939 62 14,235 161 176,583 151,947 24,636 I 

Total Liabilities aoo Stockholders' Equity 

Accounts payable 1,465,044 679,072 82,954 670 40,392 2,732 210,707 169,034 41,673 

lt>tes payable in less than 1 year 238,338 162,301 20,716 43 2,923 0 92,144 86,392 5,752 

other current liabilities 1,366,760 323,432 57,512 339 10,126 787 148,761 144,798 3,963 

lt>tes payable in 1 year or more 726,394 177,673 20,600 0 4,291 0 122,136 115,881 6,255 

other liabilities 215,282 157,826 19,226 0 1,116 0 100,443 86,693 13,750 

Capital stock 1,701,816 733,829 42,365 142 16,214 911 444,366 241,960 202,405 

Retained earnings, total 12,117,281 11,540,651 752,948 19,051 333,514 34,878 6,109,220 5,472,525 636,695 

Appropriated 91,424 37,902 13,577 0 0 0 2,900 2,265 634 

Unappropriated 12,025,857 11,502,749 739,371 19,051 333,514 34,878 6,106,319 5,470,259 636,060 
Table 4-1 - continued 

Nonnanufactur1!!9: Industries 

Nonnanu- Transportation,: Finance, other 

facturing Construction Camtunications : ~olesale Tra::ie Retail Trade Insurance, Services and 

Total and utilities Real EState Industry Not 

Re~rted 

Nlmlber of corporations 105 6 6 26 12 23 32 

Total Assets 4,056,131 36,064 910,940 662,699 219,305 2,149,617 77,503 

Cash 363,678 1,493 42,828 180,766 16,500 116,274 5,813 

Accounts receivable 891,191 5,050 52,250 224,784 45,984 532,691 30,430 

Inventory 170,447 2,372 15,840 99,597 43,884 4,993 3,757 

Goverrment obligations 56,595 0 0 447 0 56,130 16 

other current assets 32,465 2,798 3,927 2,489 17,254 4,854 1,140 

M'.>rtgage & real estate loans 957,313 32 0 0 0 957,281 0 

other investments 449,889 1,096 13,175 29,928 23,640 377, 697 4,350 

Depreciable assets 1,403,306 8,302 1,049,462 190,679 99,768 21,448 33,645 

Less: Accunulated depreciation 416,772 3,291 276,854 82,213 41,595 1,933 10,885 

Net depreciable assets 986,533 5,011 772,608 108,466 58,173 19,514 22,759 I 

w 

other assets 148,018 18,208 10,310 16,219 13,866 80,179 9,234 °' I 

Total Liabilities and Stockholders' B]uity 

Accounts payable 785,971 2,524 19,871 51,483 49,384 649,127 13,581 

Notes payable in less than 1 year 76,037 16,846 10,891 3,513 8,649 35,196 939 

other current liabilities 1,043,327 5,710 42,361 6,690 11,659 970,848 6,057 

Notes payable in 1 year or more 548, 721 5,536 111,537 9,446 41,609 376,151 4,439 

other liabilities 57,456 281 54 194 3,104 51,190 2,631 

Capital stock 967,987 293 7U,789 137, 715 25,241 66,679 23,267 

Retained earnings, total 576,629 4,871 11,435 453,655 79,656 423 26,587 

Appropriated 53,522 0 10,159 2 8,603 34,757 0 

Unappropriated 523,107 4,871 1,276 453,653 71,053 -34,333 26,587 

Office of the Secretary 

Office of Tax Analysis 
Table 4-1 - continued 

Manufacturi!!S Industries - continued 

~r Leather and Stone, Clay, & Fabricated Machinery, Electrical ali3 InstrlJDellts All Other 

Products Leather Glass Products ~tal Products Except Electronic and !elated Manufacturing Products Electrical Equipnent Products 

Number of corporations 10 14 4 24 10 100 34 49 

Total Assets 75,054 95,056 18,143 234,467 291,405 2,679,623 732,678 956,114 

cash 4,360 22,873 4,141 15,957 18,692 614,335 146,745 111,630 

Accounts receivable 27,366 15,458 1,529 63,243 52,216 438,817 177,317 201,356 

Inventory 8,736 15,570 1,833 36,762 29,389 254,106 63,036 209,731 

Goverrment obligations 0 18,440 0 323 23,983 55,267 25,281 1,538 

Other current assets 123 608 115 25,964 55,797 480,741 7,438 92,095 

M:>rtgage & real estate loans 0 332 0 0 1,261 101,001 0 3,521 

Other investments 8,422 17,442 10,254 21,377 85,398 519,449 206,130 148,588 

Depreciable assets 31,354 7,564 435 71,563 24,041 317,915 122,232 268,263 

Less: 1\ccunulated depreciation 7,452 3,342 282 23,733 7,810 131,681 33,038 126,614 

Net depreciable assets 23,901 4,222 152 47,829 16,230 186,233 89,193 141,648 I 

w 

Other assets 2,143 108 116 23,007 8,437 29,670 17,535 46,001 -..J 

I 

Total Liabilities and Stockholders' Equit;t 

Accounts ~yable 3,795 6,587 239 20,320 23,537 123,261 53,380 110,491 

Notes payable in less than 1 year 787 822 200 6,240 1,000 26, 708 1,419 9,294 

Other current liabilities 1,745 1,850 244 3,001 4,550 65,812 12,885 15,815 

M:>rtgages more than 1 year 0 3,278 0 8,101 1 14,060 1,182 4,020 

Other liabilities 1,566 64 1 1,180 4,575 15,389 3,194 11,066 

capital stock 7,415 -3,721 3,346 10,602 7,276 97,236 26,518 81,153 

Retained earnings, total 59,743 86,173 14, 111 185,020 250,462 2,337,155 634,098 724,271 

Appropriated 0 3,588 0 0 0 8,403 8,870 561 

Unappropriated 59,743 82,585 14,111 185,020 250,462 2,328,751 625,227 723, 710 
-38-

Table 4-2 

Possessions Corporations and Corporations Operating in the U.S. -- Net Plant, 

Equipnent and Property as a Percentage of 'lbtal Assets, Year-end 1982 

Industry 

936 Assets by 

Industry as a 

Percent of All 

936 Assets .!( 

Net Plant, Equipnent and Property 

as a Percent of 'lbtal Assets 

by Industry 

936 

Corporations 

Corporations 

Operating in 

the U.S. 

Column 2 

-. Column 3 

All Manufacturing Industries 100.0% 12% 30% y 40% 

Food and kindred prcducts 7.2 17 36 46 

Textile mill prcducts * 4 34 12 

Apparel 3.0 5 n.a. 

Paper and allied prcducts * 6 56 11 

Pharmaceuticals 45.9 11 28 40 

All other chemicals 6.6 26 45 58 

Rubber prcducts o.s 34 37 92 

Leather prcducts 0.7 4 n.a. 

Stone, clay, & glass prcducts * 1 49 2 

Fabricated metal prcducts 1.7 22 32 67 

Machinery, except electrical 2.1 6 32 19 

Electrical and electronic 

equipnent 19. 5 7 27 26 

Instruments and related Ercducts 5.3 13 32 40 ___./ 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

* 

1/ 

Less than 0.5%. 

'Ihe percentages by industry sum to 93 percent, rather than 100 percent, since data ;or 

industries with fewer than three firms are not shown separately. All manufacturing 

firms are, however, included in the aggregate data shown in row 1. 

The average for all corporations is a weighted average with industry weights based on 

the industrial mix of possessions corporations. The unweighted average for all 

c<:qX'rati0ns operating in the U.S. is 40%. 

n.a. - not available 

Source: Tax return Forffi 1120 filed by possessions corporations; and Federal Trade 

Ccxrmission, Quarterly Financial RefX?rt, Fourth Quarter, 1983. 

p 

i 

0 

b 

0 

r 

c 

i 

i 

u 

f 

m· 

t 

w 

r 

a 

r· 

1 

0 

i 

g 

a 

w 

p 

w 

h 

t 

d 

u 

0 

s 

! 

rn 

p 

p 

s 

4 

..... 

5 

....

6 

....
2 

3 

-39-

possessions firms 4/, compared to 30 percent for the same industries 

in the United States. Table 4-2 shows that the relatively small share 

of fixed real assets in total book assets of possessions companies was 

borne out in all industries for which data are available. The value 

of possessions corporations' fixed real assets is also small in 

relation to their income. At year-end 1982, manufacturing possessions 

corporations' net property, plant and equipment was 44 percent of net 

income per return, compared to almost 600 percent of before-tax net 

income in the case of manufacturing corporations operating in the 

United States. 21 

Table 4-3 compares, for possessions corporations and mainland 

firms, ratios of operating profits to operating assets in selected 

manufacturing industries. Operating income, which includes the return 

to intangibles, is expressed as a percentage of operating assets, 

Which include property, plant and equipment, inventories, and net 

receivables. In 1982, the before-tax return on operating assets for 

a11 manufacturing possessions corporations was more than 5 times the 

ratio for mainland manufacturing operations, 56.6 percent compared to 

10.2 percent. 

To some extent the possessions corporations ratios may be 

~verstated. The operating assets of possessions corporations do not 

include the value of land and buildings leased from the Puerto Rican 

9overnment. (See footnote 3 on this page.) Possessions corporations 

a:e less 1 ikely than mainland corporations to include corporations 

With start-up losses. There are also cost differentials between 

Puerto Rico and the mainland, although they can go both ways; lower 

w~ges in Puerto Rican manufacturing, for example, may be offset by 

high costs for utilities and transportation. However, as indicated in 

t~e Fourth Report ~/ such factors can explain only part of the large 

discrepancy in profitability of manufacturing in Puerto Rico and the 

United States. Taken together, they may account for up to one-third 

~ the difference. Income from intangible assets assigned to possessions corporations is an important factor in explaining the balance. 

lt is notable, for example, that the range of profit ratios for the 

mainland firms is only 8 points, from 10 to 18 percent, while for 

Possessions corporations the \ange is much wider, from 22 to 79 

Percent, with the highest profit ratios in the high-technology 

Sectors. 

!I 

~/ 

~/ 

The Commonwealth government owns land and buildings which it 

leases to private investors (936 firms, foreign firms, and Puerto 

Rican-chartered firms). Not all of that plant and property, 

Valued at $297 million in June 1983, is under lease at any given 

time. Assuming that three-fourths of the government-owned plant 

and property was under lease to 936 firms in 1982, and treating 

this property as 936 fixed assets, increases the ratio of 936 

fixed assets to total assets from 12 to 14 percent. 

See Tables 4-1 and 4-2 and Federal Trade Commission, Quarterly 

!_inancial Report, Fourth Quarter 1982. 

See pages 61-65. 
-40-

Table 4-3 

Possessions Corporations and Corporations Operating In 

The United States: Before Tax Operating Income 

as a Percent of Operating Assets, 1982 !/ 

bi 

CeJ 

Th• 

bi: 

th1 

PL 

th1 

(Q 

in 

Before Tax Operating Income Th 

as a Percent of Operating ca 

Assets - 1982 _.,, is 

Mainland I 936 1 i 

Industry Operations I Corporations_., 

All Manufacturing 10.2% 56.6% 

Food and kindred products 15.5 35.6 

Fabricated metal products 11. 4 21. 8 

Chemicals and related products 10.2 62.1 

Pharmaceuticals 17.6 78.8 

Machinery, except electrical 11. 4 58.0 

Instruments and Related products 14.4 62.3 

Electrical and Electronic equipment 12.1 67.8 

.!/ Operating income is defined as gr~ss sales less cost of goods sol~ and less all other deductions except taxes, interest an 

charitable contributions. Operating assets include net propertY1 

plant and equipment, inventories and net accounts receivable. 

Source: Tax return Form 1120 filed by possessions corporati~ns~ 

Federal Trade Commission, Quarterly Financial Report, F& 

Quarter, 1983. 

c 
___, 

te 

-41-

At year-end 1983, all possessions corporations held over $10 

billion in financial assets cash, net accounts receivables, 

certificates of deposit (CDs), and other financial investments 7 I. 

The cash assets category, which may include short-term CDs, was $2.1 

billion. The $10 billion in total financial assets in 1982 were more 

than six times the value of 936 manufacturing corporations' physical 

Plant and equipment net of depreciation. As explained in Chapter 5, 

the tax exemption for Qualified Possession Source Investment Income 

(QPSII) makes Puerto Rico a very advantageous location for financial 

investments compared to both the United States and foreign countries. 

The only limit on the amount of qualified financial investments which 

can be made by a possessions corporation out of its retained earnings 

is that no more than 50 percent of its gross income can come from such 

investments for the three-year period immediately preceding the close 

of its taxable year. (This limit was reduced under the Tax Equity and 

Fiscal Responsibility Act to 45 percent for tax years beginning in 

1983, 40 percent for tax years beginning in 1984, and 35 percent 

thereafter.) ' 

In principle, the distinction between financial investment and 

Physical (or real) investment should not be important. By providing 

the funds that permit businesses and individuals to purchase plant and 

equipment, build homes, and hold inventories, financial investments 

Should lead to real investments. However, the data presented in 

Chapter 5 suggest that 936 financial investments in the Puerto Rican 

capital ·market made only a small contribution to the financing of 

Physical investment in Puerto Rico through 1981. The large inflows of 

936 funds to Puerto Rico through 1981 tended to flow out again through 

the banking system or to result in shifts in the ownership of Puerto 

Rican government debt and in investment abroad by Puerto Rican 

9overnment corporations. Between year-end 1981 and year-end 1982, the 

level of 936 corporations' financial investments in Puerto Rico 

declined slightly. The resumption of the accumulation of 936 

financial investments in 1983 did not seem to be reflected in a 

comparable increase in real investment in Puerto Rico. ~/ 

B. Retained Earnings. Table 4-1 also shows the incentive for 936 

lllanufactur i ng companies to retain earnings. At the end of tax year 

1982, these companies reported $11.5 billion of retained earnings on 

their balance sheets. Forty-seven percent of these retained earnings, 0 r $5.5 billion, were held by possessions corporations in the 

~~armaceuticals industry. One-fifth of the retained earnings, or $2.3 

lllion, were held by the electrical and electronics industry. 

Retained earnings represented 84 percent of total liabilities and 

Stockholders' equity of manufacturing possessions corporations. The 

comparable figure for manufacturing corporations operating in the 

----------

._ 7; 

~/ 

See Table 5-1 for the composition of these financial investments • 

See Chapter 5 for a discussion of the impact of financial investments of possessions corporations through 1983. 
-42-

United States in the same industries was 42.3 percent. 9/ The high 

level of 936 retained earnings is a response to limited alternative 

opportunities under the Internal Revenue Code for making tax-free 

financial investments, as well a response to Puerto Rico's tollgate 

tax on profits. As explained in Chapter 2, the rate of tollgate tax 

is reduced from 10 percent to 4 or 5 percent if a company operating in 

Puerto Rico retains within Puerto Rico a specified percentage of its 

profits. 

c. Total Receipts. Table 4-4 shows that total receipts of the 

manufacturing possessions corporations included in the table were 

$10. 7 billion, of which $10.1 billion was attributable to business 

receipts. Most of the remainder, or $578 million, was attributable to 

interest on nongovernment securities, such as CDs in Puerto Rican 

banks. Interest on Puerto Rican, State, and local government securities is excluded from gross income for Federal tax purposes, and 

therefore is not included in the total receipts shown in Table 4-4. 

The amount of such exempt interest income reported by possessions 

corporations for tax year 1982 was $12 million. 

The pharmaceutical industry accounted for 34 percent of the 

business receipts of all manufacturing possessions companies. After 

pharmaceuticals, the manufacturing industries with the greatest 

business receipts were electrical and electronic equipment, food 

products, and chemicals other than pharmaceuticals. 

D. Net Income per Tax Return. Net income per return (total 

receipts minus total deductions on Table 4-4, or taxable income on the 

U.S. corporation income tax return) amounted to $3.8 billion for all 

manufacturing possessions corporations included in the table. This 

amounts to 2.4 times the net depreciable assets of those corporations• 

(See Table 4-1). The industry with the greatest amount of net income 

was pharmaceuticals with $2.0 billion of net income, 52 percent of the 

total net income of manufacturing possessions corporations and 2. 8 

times the net depreciable assets of the pharmaceutical corporations9 

The electrical and electronic equipment industry accounted for 1 

percent of the combined net income of manufacturing firms; their net 

income of $725 million represented 3.9 times the net depreciable 

assets. 

~/ Data for manufacturing corporations operating in the United states 

are from U.S. Department of Commerce, Bureau of the census, 

Quarterly Financial Report, Fourth Quarter 1983. There .ar~ significant differences between the industry mix of possess 10

0 corporations and that of manufacturing corporations operating . 1 

the United States. To correct for the differing industrial ~: 

the ratio of retained earnings to total liabilities and stoc to 

holders' equity, by mainland industry, was weighted according he 

the share of 936 assets in the industry to total 936 assets. T 4 

unweighted ratio for firms operating in the United States was 36· 

percent. 
- 'v v ' ... ;,..) m m ... tn >:I - ,...... Pl rr Ul r\ ;:r tn• 0..\~0tn(t)(t) 

Table 4-4 

Selected Income Statement Information and Tax Benefits by Industry, 1982 

(Dollar aroc>unts in thousands) 

All & Kindred Textile 

Manufactur1!!2 Industries 

Industries :Manufactur-: Food Apparel Paper Chemicals 

i!!9 'lbtal Products Mill Products 'lbtal :Pharmaceuticals: All Othf 

Number of corporations 522 417 21 5 60 7 79 48 31 

'lbtal receiEts 13,304,156 10,745,101 1,104,385 35,097 419,480 37,232 4,455,106 3,729,417 725,68 ~' 

Business receipts 12,374,153 10,061,778 1,066,256 35,062 401,956 34,904 4,108,368 3,394,785 713,582 

Interest 752,587 577,562 35,087 10 15,763 2,280 294,725 283,884 10,841 

Other receipts 177,415 105,760 3,041 25 1,760 47 52,012 50,747 1,265 

'lbtal deductions 9,309,940 6,957,987 868,497 31,179 335,186 24,716 2,358,518 1,772,918 585,599 

Cost of sales 6,666,966 5,128,592 624,751 29,496 308,013 20,796 1,356,664 861,727 494,937 

Depreciation 230,932 140,566 12,465 69 2,049 384 72,051 48,070 23,980 

All other deductions 2,412,041 1,688,827 231,280 1,613 25,123 3,535 929,802 863,120 66,681 I 

:Estimated net incane ~r return 3,994,215 3,787,114 235,888 3,918 84,294 12,516 2,096,588 1,956,498 140,090 .i::i. 

w 

I 

:Estimated net in<XJne ~r books 3,920,810 3,716,425 232,216 5,073 80,502 12,373 2,016,667 1,878,076 138,590 

Reduction in u.s. tax liabilit~ 1,538,292 1,538,292 97,534 1,785 35,144 5,668 846,744 792,695 54,048 

Distributions 2,767,424 2,290,440 113,680 209 25,695 1,000 1,432,599 1,349,297 83,302 
Table 4- 4 - continued 

Leather and Manufactur~ Industries - continued 

Rubber Stone I Clay : Fabr cated : Machinery I : Electrical and Instn1nents All other 

Products Leather and Glass Metal Except Electronic and Related Manufacturing Products Products Products Electrical Equi~nt Products 

Number of corporations 10 14 4 24 10 100 34 49 

'lbtal receiEts 87,511 124,653 7,838 185,885 224,490 1,823,086 568, 798 1,671,532 

Business receipts 86,272 120,531 5,843 177,809 209,878 1,673,217 530,562 1,611,116 

t«:>ngovernrnent interest 806 3,607 192 5,436 13,673 145,509 32,010 28,457 

other receipts 433 513 1,802 2,639 939 4,359 6,225 31,959 

'lbtal deductions 63,104 103,162 5,181 148,703 153,948 1,097,697 331,219 1,436,872 

Cost of sales 47,515 93,208 3,530 126,895 135,083 915,735 238,956 1,227,946 

Depreciation 1,404 552 20 5,189 2,799 21,051 8,400 14,127 

All other deductions 14,185 9,401 1,630 16,617 16,065 160,910 83,863 194, 798 

Estimated net incane i:>er return 24,407 21,490 2,657 37,182 70,542 725,389 237,578 234,660 

I 

Estimated net incane ~r books 23,609 21,598 2,776 40,151 67,843 754,025 232,791 226,794 ii::.. 

ii::.. 

I 

Reduction in U.S. tax liabili t~ 10,369 9,606 1,259 15,705 29,093 294,087 103,348 87,944 

Distributions 14,245 2,016 357 20,563 27,121 447,732 48,843 156,374 
Table 4- 4 - oontinued 

Nonmanufacturin2 Industries 

Non-Manu- Transportation Finance, Services and 

facturing Construction Conmunications Wholesale Trade Retail Trade Insurance, Industry Not 

Total and Utilities Real Estate Re~rted 

Number of corporations 105 6 6 26 12 23 32 

Total ReceiEts 2,559,054 46,848 341,068 1,207,286 659,747 177,817 126,287 

Business receipts 2,312,375 43,950 328,936 1,174,934 635,705 19,338 109,509 

Nongovernment interest 175,025 613 2,447 29,458 179 141,406 921 

Other receipts 71,654 2,284 9,685 2,893 23,862 17,072 15,856 

Total Deductions 2,351,953 43,216 267,769 1,072,360 655,062 196,508 117,036 

Cost of sales 1,538,373 36,230 2,795 984,231 472,664 1 42,451 

Depreciation 90,366 1,262 71,168 6,867 7,506 1,451 2,108 

All other deductions 723,213 5, 723 193,805 81,261 174,891 195,055 72,476 

Estimated net income flE!r return 207,101 3,632 73,299 134,926 4,684 -18,691 9,250 I 

~ 

Estimated net income per books 204,384 4,108 73,244 128,666 6,167 -15,619 7,817 U1 

I 

Reduction in U.S. tax liabilit:( 0 0 0 0 0 0 0 

Distributions 476,983 519 9,672 277,624 24,773 . 65,084 99,308 

Off 1ce of the Secretary 

Off ice of Tax Analysis 
-46-

E. Distributions. The final line in Table 4-4 shows that 

manufacturing possessions corporations reported $2,290 million of 

distributions, which was 60 percent of their net income in tax year 

1982. This represented a large increase over the 1981 level of 

distributions, which was 41 percent of net income. Fifty-nine percent 

of total distributions by manufacturing corporations in 1982 was 

attributable to the pharmaceutical industry. 

II. Estimated Tax Benefits 

Table 4-5 shows the net income, possessions tax credits claimed, 

and estimated reduction in U.S. tax liability for the 522 possessions 

corporations for which data is presented in Tables 4-1 through 4-4 and 

for the total group of 554 possessions corporation filing full year 

returns for tax year 1982. 

The possessions credits claimed by all manufacturing corporations 

amounted to $1,843 million. This figure exceeds the estimated ta>' 

benefit received of $1,679 million. The tax benefit figure was 

estimated by applying to possessions corporations in manufacturing the 

same U.S. tax rules which applied to corporations operating within the 

United States in 1982 (i.e., accelerated depreciation and the 

investment tax credit), and then subtracting from the tentative u.s. 

tax liability income and tollgate taxes paid to Puerto Rico. IO 

calendar year 1982, Puerto Rico collected $89 million in tollgate 

taxes. It also collected $180 million in income taxes from all 

corporations (including Puerto Rican corporations) which operated 

under partial income tax exemption grants. The combined tollgate 

and income tax collections paid by manufacturing possessio~s 

corporations in 1982 amounted to approximately 6 percent of their 

combined net income. Half of the tax benefit was accounted for by the 

pharmaceutical industry and another 20 percent by the electrical and 

electronic equipment industry. Other manufacturing industries 

typically accounted for less than 5 percent of the total. 

The possessions credits claimed by nonmanufacturing companies 

amounted to $121 million. However, no tax benefit is attributed .t0 

those credits. It is assumed that 936 companies in nonmanufactur1n~ 

industries did not qualify for a Puerto Rican tax exemption grant an 

that the taxes which they pay to Puerto Rico would, if viewed a~ creditable foreign income taxes, offset 100 percent of their U.S. tda 

liability. While the Puerto Rican Industrial Incentive Acts 0 

provide exemptions to designated nonmanufacturing industries (in par; 

ticular hotels, medical laboratories, movie production, and, af~eo 

1978, various services produced for export), the total posses~ 10 e 

income of possessions corporations in these industries was neglig1bl 5 in 198 2. Moreover, a sample of the 197 8 Puerto Rican tax retu:n 5 filed by possessions corporations in all nonmanufacturing industrieh 

suggests that the average effective Puerto Rican tax rate for sue 

companies was roughly 40 percent. 
Table 4- 5 

Net Income, Possessions Tax Credits Claimed and Estimated 

Tax Benefits by Industry, 1982 

Preliminary Data Estimated Final Data 

I 522 companies; 417 manufacturing 554 companies; 447 manufacturinq 17 

Net Income I Credit Claimed j Tax Benefit 

($000) ($000) ($000) 

Net Income I Credit Claimed r Tax Benef1~ 

($000) ($000) ($000) 

All Manufacturing Industries 

Food and kindred products 

Textile mill products 

Apparel 

Chemicals 

Pharmaceuticals 

Other chemicals 

Rubber and plastic products 

Leather 

Fabricated metal products 

Machinery, except electrical 

Electrical and electronic 

equipment 

Instruments and related products 

All other manufacturing 

Nonmanufacturing 

Total 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

$3,787 

236 

4 

84 

2,097 

1,956 

140 

24 

21 

37 

70 

725 

238 

251 

204 

3,991 

1,690 

105 

2 

37 

940 

877 

63 

11 

10 

17 

31 

322 

107 

108 

106 

1,796 

1,538 

97 

2 

35 

847 

793 

54 

10 

10 

16 

29 

294 

103 

95 

0 

1,538 

$4,130 

237 

9 

102 

2,212 

2,054 

158 

24 

31 

45 

71 

896 

252 

252 

222 

4,352 

1,843 

106 

4 

44 

991 

920 

71 

11 

14 

21 

31 

398 

114 

109 

121 

1,964 

1,679 

98 

4 

42 

893 

832 

61 

10 

u 

19 

29 

363 

110 

96 

0 

1,679 

.!/ The final number of corporations mentioned here is slightly understated. The data for the corporations which filed after the 

cut-off date exclude any loss corporations. An estimate of the income and employment of such loss companies was made, based on 

the preliminary sample, and added to the final numbers, but no attempt was made to assign those imputations to a specific 

number of companies. The adjustment was small. 

I 

• ....... 

I 
-48-

According to Table 4-5, four industry groups accounted for 85 

percent of the tax benefits provided to possessions corporations: 

Industr 

Reduction in U.S. tax liability 

(dollars in millions) 

All industries 

Pharmaceuticals 

Electrical and electronic 

equipment 

Instruments 

Food and kindred products 

$1,679 

832 

363 

110 

98 

III. Payroll and Employment in Tax Year 1982. 

Percent 

of total 

100% 

50 

22 

7 

6 

In enacting section 936 in 1976, Congress sought to assist Puerto 

Rico in obtaining employment-producing investments. Matching 

possessions corporations' U.S. income tax returns with payroll and 

employment data from the companies' Federal unemployment insurance taX 

returns provides one indication of the extent to which this objective 

has been attained. Table 4-6 presents, by industry, section 936 taX 

benefits per employee and as a percent of labor compensation. The 

actual tax benefits received by a possessions corporation depend, oi 

course, on the amount of income which it earns, not on the number o ~ 

workers a l e it employs. Table 4-6 is based on 324 possessions corpor d ,~ 

tions in the manufacturing sector for which 1982 employment an 

payroll data could be obtained. The actual figures for those 

corporations are blown up to represent the total 447 manufacturing 

corporations by assuming that the relationship within each industrY 

sector between employment and cost of goods sold is the same for ~h~ 

complete group of 44 7 companies as for the 324 companies for wh1C 

employment and payroll data were available. The numbers used to make 

these extrapolations are shown in Appendix C, p. 105. 

Table 4-6 shows that, for manufacturing in general, the estimate~ Federal tax benefits per employee averaged $20,656, or 147 percent 0 

the average compensation per employee. Tax benefits as a percentage 

of total employee compensation varied substantially from industry t~ industry. In the pharmaceutical industry the average Federal . ta 6 benefits amounted to $69, 200 per employee, or more than three t~rne 11 the average compensation of the comparatively well-paid Puerto Rica 

pharmaceutical employee. In the electrical and electronics indust~; the average tax savings amounted to $13,931 per employee, or 1. 0 percent of average compensation. In the apparel industry, {y 

contrast, the average tax savings per employee were $3,030, on 

one-third of employee compensation. 

Table 4-7 illustrates the distribution of tax benefits in relat~~~ to number of employees. The chemical industry (primar 1 re 

pharmaceuticals) was the only manufacturing sector in which the sha d 

of tax savings exceeded the share of employment. Chemicals accounte 

" " " i 
All aanutacturing industries 

Food and kindred producta 

Textile •ill product 

Apparel 

Mena and boys 

Womens and children 

Hats, caps, etc. 

All other 

Chemicals 

Industrial chemicals 

Pharmaceuticals 

Soaps, cleaners, etc. 

Other 

Rubber and plastic products 

Leather 

Footwear 

Other 

Fabricated metal products 

Can and containers 

Other 

Machinery, except electrical 

Electrical and electronic 

equipment 

Radio, TV, c01111Unication 

Electroninc c011ponents 

Other 

Instruments and related products 

Scientific inatr\lments 

Other 

All other manufacturing !I 

I Jgt!Jll dota 

I I 

I I 

I Rwplgyeo3 I 

59,063 

11,697 

766 

11,581 

2,945 

5,884 

566 

2,186 

11,469 

1,435 

9, 104 

479 

451 

1,076 

1, 783 

1,460 

323 

673 

317 

356 

1,268 

16, 109 

3,0Jf7 

3,6211 

9,Ji38 

5,500 

531 

4,969 

II. 1111 

Office ot the Secretary ot the Treasury 

Office of Tax Analysis 

324 QCWP'" f CUI 

Compensation 

CSQOO) 

$839,438 

72, 123 

7, 106 

103, 703 

26,292 

52,757 

11,783 

19,871 

245,515 

39,058 

189,045 

7,347 

7,065 

12,883 

16,414 

13,232 

3, 182 

9,977 

5,305 

11,672 

20,228 

214,482 

38,394 

47, 163 

128,925 

76,2ll2 

6,339 

69_. 903 

63,783 

Eaplgyoo:s 2/ 

81,257 

5,934 

1,184 

lll,015 

12,027 

2,251 

1,585 

3,517 

1,564 

1, 309 

26,065 

6,625 

5,181 

I Average 

Compensation 21 I Compensation 

CSQOO) I por owpl oyeo 

$1, 1113, 307 

91, 117 

10. 986 

125,Ji90 

301,908 

249,741 

52,17Ji 

18,977 

32,374 

23,185 

20,882 

3Ji7 ,029 

91,836 

79,523 

111,070 

15,355 

9,279 

8,95ll 

20,765 

23, 178 

11, 973 

9,206 

14,824 

15,953 

13,31ll 

13,862 

15,3ll9 

g09p1nton ]/ 

I 

I Tax Benefit 

I gee ewplgyoo 

20,656 

16,11911 

3,547 

3,030 

62,580 

69,200 

23,057 

6,552 

3,888 

12, 157 

22,205 

13,931 

16,5ll5 

18, Jlll1 

Tax Benefit .31 aa I gt Cpegonnettgn 

1Jl6.8 

107.11 

38.2 

33.8 

296.0 

333.3 

99.5 

511.7 

ll2.2 

82.0 

139.2 

1011.6 

119.Ji 

120.1 

lJ The final number of corporations mentioned here is slightly understated, perhaps by 2 to 4 companies. The data for corporations which tiled after 

the cut-off date exclude any loss corporations. An estimate or the income and employment of such loss companies was made, based on the prelillinary 

sample, and added to the final number, but no attempt was made to assign those imputations to a specific number or companies. The adjustment was 

small. 

~ Number of employees and compensation are estimates calculated by weighting the actual figures shown in columns 1 and 2 (for the 324 tiras for which 

payroll and eaployaent data were available) by the ratio or the coat of gooda sold for that group, by industry, tor the 11117 companies to the coat or 

goods sold in that saae industry by the saaple or 3211 corporations tor which employment data was available. The industry data on cost of goods sold are shown in Appendix C Table 1, p. 

I 

ii::. 

\.0 

I 
-soTable 4-7 

Distribution of Tax Benefits and Employment, by Industry, 1982 

(percent of total) 

I Tax Benefits 

All Manufacturing Industries 

Food and kindred products 

Textile mill products 

Apparel 

Chemicals 

Pharmaceuticals 

Other 

Rubber and plastic products 

Leather 

Fabricated metal products 

Machinery, except electrical 

Electrical and electronic equipment 

Instruments and related products 

Other manufacturing 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

100% 

5.8 

0.3 

2.5 

53.2 

49.6 

3.6 

0.6 

0.8 

1.1 

1. 7 

21. 6 

6.5 

5.7 

Employees 

100% 

7.3 

1. 4 

17.2 

18.0 

14.7 

3.2 

1. 9 

4.3 

1. 9 

1. 6 

31. 9 

8.1 

6.4 

___. 

___.., 

Source: Tax benefits from Table 4-5, column 6. Employees from Table 

4- 6 , co 1 um n 3 • 

fo

W

th

Pe

el 

be 

tu

be 

tr

em

Pe

Pe

tna

Co 

Su 

tna

Of 

th 

be 

th 

no 

Co 

on 

'I'h

em 

f o 

be 

tv 

Po 

an 

in 

!9 
-51-

for 53 percent of the benefits but only 18 percent of the employees. 

Within chemicals, the pharmaceutical industry provided 15 percent of 

the employment of all manufacturing companies, and accounted for 50 

Percent of the total section 936 tax savings. The electrical and 

electronic equipment industry accounted for 22 percent of the tax 

benefits, but provided 32 percent of the employment of all manufacturing possessions corporations. The next largest shares in the tax 

benefits were derived by the instruments and related products indus-

:..- tries (7 percent of the tax benefits, 8 percent of the manufacturing 

=-- employment) and the food industry (6 percent of the tax benefits and 7 

Percent of the employment). The apparel industry derived only 2. 5 

Percent of the tax benefits but contributed 17 percent of the 

manufacturing employment. 

Table 4-8 ranks by the amount of tax benefit per employee the 

corporations for which this information is available. There is not 

Sufficient company by company information to include all of the 

manufacturing possessions corporations in this table; it includes 324 

Of the 447 corporations {72 percent), which contribute 78 percent of 

the combined net income. 

At the top of the ranking are 14 companies for which the U.S. tax 

btenefits represented $100,000 or more per employee in Puerto Rico. At 

he low end are the companies which incurred losses and thus derived 

no immediate tax benefit from section 936. The top 14 possessions 

corporations accounted for 29 percent of the tax benefits but provided 0 nly 5 percent of the employment of the 324 manufacturing companies. 

?he top 38 possessions corporations, those for which tax savings per 

employee equalled or exceeded $50,000 in 1982, collectively accounted 

~or 55 percent of the tax benefits and 13 percent of employment tax 

enefits. 

lV. Summary Data for 1974-1982 

Table 4-9 presents data for the period 1974-1982 on the 

Possessions corporations, their net income, estimated tax 

~na tax benefits in rel a ti on to payroll and employment. 

~nc1 ude the complete sample . of the returns for all years, 982. The table reveals a number of trends: 

number of 

benefits, 

The data 

including 

0 

0 

The number of possessions corporations in manufacturing was 399 in 

1974 and 447 in 1982. Throughout the period 1974-82, the 

Pharmaceutical industry and electrical and electronic equipment 

industry accounted for approximately 10 percent and 20 percent, 

t esp e c t iv e 1 y , of the tot a 1 number of possess ions man u fact u r in g 

corporations. 

Net income of manufacturing possessions corporations rose from 

approximately $800 million in 1974 to $4 billion in 1982. In 

inflation-corrected dollars, net income in 1982 amounted to 295 

Percent of income in 1974. The percentage of total net income 

earned by the pharmaceutical industry stood at approximately 50 
-52-

Table 4-8 

Tax Benefits, Employment, and Compensation of Employees 

By Size of Tax Benefits Per Employee, 1982 

__./ 

(Ualif ied I Tax Benefits Employees -.:-1 Number of Possession I 

Returns I Net Income I Amount I Percent of Numbe I Percent 0 

I ($000) 1/ I ($000) I Total r I Total/ 

All Manufacturing 

Corporations 324 3,209,553 1,349,031 100.0 59,063 loo.o 

$100,000 or more 14 960,930 396,697 29.4 2,955 s.O 

$ 50,000 under $100,000 24 823,496 346,849 25.7 4,834 a. 2 

$ 10,000 under $ 50,000 118 1,129,183 482,644 35.8 20,836 35.8 

$ 5,000 under $ 10,000 47 188,540 78,225 5.8 10,744 18.2 ("

co 

2s.3 0

$ 1,000 under $ 5,000 77 104,583 43,453 3.2 14,944 7 

~ 

$ 500 under $ 1,000 6 1,899 732 * 986 i.7 °

..

$ 1 under $ 500 18 1,444 431 * 1, 723 3.0 t

8 

tax benefits 3.5 ...

No 20 -513 0 0 2,041 .&

'I

~ 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

* Less than 0.5% 

. pliJS !./ F.quals net income from the active conduct of a trade or business in a possession 

net qualified possession source invesbnent income. 
~ U\ 0 -..l I..>-> t-..> CD t-..> 0 0 n-

~ ~ 

7:!1.b.Le 4 - .9 

Summary .D!ta on Ebssessions Corporations, 1974-1982 

1974 1975 !976 !977 !978 1979 I980 1981 !982 

NUmber of corporations, aII industries 596 595 528 519 637 672 709 635 554 

Manufacturing industries 399 394 395 385 460 502 458 497 447 

Rlarmaceuticals 44 47 52 53 58 65 61 56 48 

Electrical and electronic equipnent 76 76 81 80 90 112 116 120 100 

All other manufacturing 279 271 262 252 312 325 281 321 269 

t«>nnanufacturing industries 197 201 133 134 177 170 251 138 107 

Net income, all industries ($000) 852,058 1,108,881 1,627,213 1,800,313 2,484,572 3,088,304 3,629,761 4,216,511 4,351,853 

Manufacturing industries 813,057 1,055,060 1,551,677 1, 714,321 2,361,446 2,798,156 3,161,116 4,100,561 4,130,105 

Rlarmaceuticals 405,355 547,060 779,954 876,576 1,053,252 1,325,309 1,507,001 1,867,684 2,212,197 

Electrical and electronic equipnent 167,389 195,593 323,249 231,475 417,629 543,195 744,981 1,049,049 895,690 

All other manufacturing 240,313 312,407 448,474 606,270 890,565 929,652 909,134 1,183,828 1,180,247 

l«>rEanufacturing industries 39,002 54,059 75,536 85,992 123,126 290,148 468,645 115,950 221,748 

Estimated tax benefits ($000) 

Manufacturing industries 1/ 397,021 478,367 698,839 771,444 998,120 1,167,529 1,326,406 1,711,352 1,678,535 

Illarmaceuticals - 181,508 245,486 350,941 394,459 438,695 552,020 626,376 791,535 832,267 

Electrical and electronic equipnent 75,231 89,106 145,575 104,164 184,501 219,771 326,036 433,059 363,130 

All other manufacturing 140,282 143,819 202,322 272,821 374,924 395,738 373,994 486,758 483,1~ 

Tax benefits per employee, ($) 

Manufacturing industries 2/ 6,310 8,512 11,454 11,217 14,250 15,690 17,297 18,007 20,656 I Illarmaceuticals - 38,129 39,031 47,166 39,337 48,669 51,417 57,632 62,078 69,~00 U1 

Electrical and electronic equipnent 6,237 9,488 10,816 11,315 11,988 15,439 14,169 19,930 13,931 w 

All other manufacturing 3,479 3,987 5,300 4,432 9,639 8,415 8,943 8,584 11,192 ' 

Tax benefits as a percent of conpensation of employees 

Manufacturing industries 2/ 91.7 116.l 143. 3 135.9 133.2 135.4 145.2 137.9 146.8 

Illarmaceuticals - 425.5 389.1 428.1 327.5 357.3 343.8 368.4 346.0 333.3 

Electrical and electronic equipnent 93.5 126.0 129.2 126.6 122.6 138.9 126.1 152.3 104.6 

All other manufacturing 52.7 55.8 72.3 62.2 94.6 77. 7 65.5 70.6 88.4 

Of hce of the Secretary of the Treasury 

Office of Tax Analysis 

y 'lhe estimated tax benefits shown here differ fran the corresponding years shown in Table 4-11 because that table is based on calendar and Federal 

fiscal years, whereas the data above are based on the tax years of possessions corporations. 

y 'lhese figures 

details. are weighted averages based on those returns for which employment and canpensation of employees were available. See Table 4-6 for 
0 

0 

0 

v. 

-54-

percent through this period. The share of the electrical and 

electronics industry varied between 15 percent and 20 percent in 

most years, except 1981, when it rose to 26 percent; in 1982 it 

amounted to 22 percent. 

The estimated U.S. tax benefits of possessions corporations 

increased from $400 million in tax year 1974 to about $1.7 billion 

in tax year 1982, a change in inflation-corrected dollars of 255 

percent. 

The U.S. tax benefits in relation to the number of employees in 

l

. n 

possess ions corporations rose from about $6, 300 per employee 

1974 to $20,650 per employee in 1982. 

Despite the increase in the average compensation paid by 936 

companies (from $6,973 in 1974 to $14,070 in 1982) tax benefits 

rose from 92 percent to 147 percent of average employee 

compensation in this period. 

Estimates of Linkages 

The preceding sections related the tax benefits of the possessions 

corporation system of taxation to the employment and payroll of 936 

companies. In addition to creating jobs directly, the new industn' 

encouraged by this system of taxation may bring indirect benefits t~ 

Puerto Rico. The development of one industry may encourage the grow~ 

of other industries that are users of the products which . 1 t 

manufactures, a phenomenon cal led "forward 1 inkages." Manufactur ~n9 

also gives rise to "backward (supplier) linkages." Product1°~ 

requires raw materials, intermediate goods, and services, a portion ~ 

which are supplied by the local economy; and investment in plant 10 

Puerto Rico creates jobs in the construction industry. 

A. Forward Linkages. "Forward linkages" are usually evaluated bY 

examining the percentage of total sales to various types of customers; 

When one industry sells a substantial part of its output to anothe 

local industry, it is plausible that forward linkages have occurref) 

Conversely, where an industry produces a consumer good (e.g., apparehe 

or where it sells most of its output abroad, it is unlikely that t 1 industry is an important stimulant to the development of 1oca 

"downstream" (customer) industries. 

The latest year for which Census data on the destination of puer~~ Rican shipments are available is 1977. Table 4-10 shows the percen 

ages of manufacturing ind us tries' shipments in 1977 to Puerto Ric~~ the United States, and foreign countries, respectively, but does 0 t 0 

distinguish between sales to individual consumers and sale~ ct 

manufacturers. For manufacturing as a whole, 33~ 4 percent of a 1 r?09 shipments went to Puerto Rico, 59.2 percent to buyers (includ~ 0 

parent companies) in the United States, and 7. 4 percent to fore 1Js 

purchasers. If indirect shipments outside of Puerto Rico (i.e., gooto 

sold to other Puerto Rican manufacturers who, in turn, sold them 1 , 

the United States or foreign countries) could be estimated separate rd 

Puerto Rico's sales to the United States and foreign markets wou 

appear larger than Table 4-10 indicates. 
1d 

in 

it 

e 

l 

0 

, 

t 

0 

t 

g 

0 

BG 

0 

, 

d 

-55-

Table 4-10 

Destination of Shipments by Puerto Rican 

Manufacturing Industries, 1977 

(Percentage of total) 

Industry Puerto United 

Groue Rico Statesl/ 

All Manufacturing Industries 33.4% 59.2% 

Food and kindred products 55.l 39.2 

Tobacco products 45.3 54.7 

Textile mill products 27.8 72.2 

Apparel 18.6 76.3 

Lumber and wood products 100.0 

Furniture and fixtures 87.1 12.2 

Paper and allied products 87. 6 4.0 

Printing and publishing 53.8 44.4 

Chemicals 9.2 74.2 

Drugs 1.6 71. 2 

Petroleum refining 68.9 28.7 

Rubber products 20.0 79.8 

Leather and leather products 2.5 97.2 

Stone, clay and glass products 83.8 15.3 

Primary metal industries 49.l 34.0 

Fabricated metal products 76.5 20.9 

Machinery except electrical 27.8 71. 7 

Electrical and electronic equipment 7.3 84.8 

Transportation equipment 9.1 84.6 

Instruments and related products .4 95.4 

Miscellaneous manufacturing 

industries 3.4 95.2 

Off ice of the Secretary 

Off ice of Tax Analysis 

Foreign 

Countries 

7.4% 

5.8 

* 

* * 

* 8.2 

1. 7 

16.6 

27.2 

2.4 

.5 

.1 

.8 

16.9 

2.5 

.5 

.8 

6.2 

4.1 

1.1 

Source: U.S. Department of Commerce, 1977 Economic Censuses of 

Outlying Areas, Manufactures, Puerto Rico, November 1980, 

Chapter 2, Table 3. 

y 

* 

Figures for shipments to the United States represent direct 

exports by Puerto Rican manufacturing establishments to the United 

States and the U.S. Virgin Islands. 

Less than 0.05 percent. 
-56-

Table 4-10 shows that some industries' forward linkages with other 

sectors of the Puerto Rican economy are stronger than others. The ou 

lumber and wood industry sells its entire limited output to Puerto em 

Rican users, and its primary customers -- the furniture and paper ba 

industries -- also sell almost exclusively to the local market. BY a 

contrast, the chemical and electrical and electronic equipment pr 

industries sold 9.2 percent and 7.3 percent, respectively, of their in 

total production to Puerto Rican buyers. These two industries, al 

together with the consumer good industries, apparel and food products, ad 

account for 72 percent of the business receipts of all possessions mu 

manufacturing corporations. The evidence of Table 4-10 would 93 

therefore suggest that possessions corporations are not generally an Ag 

important stimulant to the development of "downstream" industries. 6 

There could be subsequent rounds of downstream effects not captured bY us 

the s a 1 e s d a ta o f Tab 1 e 4 - 1 0 , bu t they a re no t 1 i k e 1 y to be am 

quantitatively important. 

B. Backward Linkages. Backward linkages refer to the generation di 

of income and employment in "upstream" (supplier) industries as a es 

result of an industry's purchases of local goods and services. The Un 

First Annual Report on possessions corporations estimated that in most co 

Puerto Rican manufacturing industries, one-third to one-half of all rnu 

materials were purchased from Puerto Rican sources. The usefulness of th 

this data is limited, however, because it is based on import coefficients for 1963 and because it does not distinguish between pur- '71 

chases of materials from 936 manufacturing companies and all other 

companies. 

The Puerto Rican government views the electronics industry as the 

centerpiece for expanding locally-owned electronics, metal product~' 

and plastics industries. Locally-owned firms are increasing thel~ 

sales of materials to 936 electronics firms. Puerto Rico's appare 

industry also obtains much of its inputs from locally owned companieS· 

A substantial service sector in Puerto Rico provides banking, transportation, and utilities to all 936 manufacturing firms. Employment 

in these "supplier" industries is not included in employment figures 

reported in Table 4-6, above. 

Several studies have attempted to use Puerto Rican input-output 

tables to estimate the indirect effect on the island of purchases bY 

936 corporation and services. For example, Dr. H. Calero conclud~S 

that 1.35 jobs are created indirectly for each 936 job • .!.Q./ Thl~ 

employment multiplier is similar to the employment multiplier ~o 

Puerto Rican manufacturing by the Puerto Rican Government Plann~n; Board in May 1985. Similarly, Fernando Zalacain used the Puerto 6 input-output table to find that employment multipliers for ~ g 

companies in Puerto Rico range from 1.4 to 3.3 in major manufactur 10 

industries • .!..!./ 

.!.QI Calero, H., Economic Challenges Facing Puerto Rico, CitibanK 

Conference, March 1985. 

QI Zalacain, Fernando "Los Mul tiplicadores del Sector Manufactu r ero 

936 en la Economia de Puerto Rico", April 1985. 
r 

e 

0 

r 

y 

t 

r 

, 

s 

d 

n 

y 

e 

n 

a 

e 

t 

1 

f 

r 

e 

I 

r 

1 

t 

y 

•S 

$ 

r 

g 

~o 

6 

g 

0 

-57-

However, these mechanical applications of Puerto Rican inputou tput data to 936 employment levels in order to estimate indirect 

employment effects do not give valid results. Input-output tables are 

based on transactions between establishments, not corporations. Thus, 

a shipment from a 936 corporation's bulk chemical plant to its final 

processing plant would be recorded as an indirect effect based on the 

input-output table, when in fact the enterprise's entire employment is 

already included in the direct employment levels in Table 4-6. In 

addition, 936 corporations obtaining goods and services in Puerto Rico 

must frequently use other 936 corporations as suppliers simply because 

936 corporations dominate many Puerto Rican manufacturing industries. 

Again these "indirect" effects would have been counted in the Table 4-

6 employment levels. The estimates of 936 indirect employment effects 

using conventional input-output tables therefore involve a substantial 

amount of double-counting and are seriously overstated. 

The Puerto Rican Government Planning Board has recognized the 

difficulties inherent in using published input-output tables to 

estimate the indirect employment created by 936 operations and are 

Undertaking to calculate new employment multipliers that wi 11 not 

contain double counting of employment. However, these new corrected 

multipliers unfortunately were not completed in time for inclusion in 

this report. 

VI. Revenue Impact of Section 936 

A. Revenue Estimates and Estimating Procedure. Table 4-11 

Presents the estimated U.S. tax benefits provided by the possessions 

corporation system for calendar and fiscal years 1973-1982. Adjusting 

the income of possessions corporations from the tax years of the 

corporations to Federal fiscal years requires apportioning the income 

teported on those returns filed for corporate tax years which overlap 

the fiscal year. This results in an estimate of $1,662 million in tax 

benefits under section 936 for calendar year 1982 (and of $1,678 

~ill ion for fiscal year 1982). 

As explained above, the section 936 tax benefits for tax year 1982 

are estimated by (1) subtracting from the qualified income of possesSions corporations the additional depreciation deductions which these 

Corporations would have enjoyed had they been eligible for the 

accelerated cost recovery system, and (2) applying the U.S. statutory 

tax rate to the adjusted qualified income. The revenue estimate 

thereby obtained is then reduced by the amount of the investment tax 

Ctedit which would have been available and by the tollgate and income 

taxes paid to Puerto Rico. The combined tollgate and income taxes 

Paid by manufacturing possessions corporations in 1982 amounted to 

approximately 6 percent of their net income. 

For accounting periods beginning after December 31, 1982, 

Possessions corporations are subject to the provisions of section 

936 (h), added to the Internal Revenue Code by TEFRA. Section 936 (h) 

Provides that only certain income from intangibles developed by a U.S. 

corporation may be allocated to an affiliated possessions corporation. 
-58-

Table 4-11 

Federal Revenue Cost Estimates, 

Possessions Corporation Provisions, 1973-1982 

(millions of dollars) 

Calendar Year Fiscal 

Year Recei ts Fore one 1/ Recei ts Fore one 1/ 

1973 269 254 

1974 393 325 

1975 4 73 429 

1976 692 572 

1977 763 724 

1978 988 864 

1979 1,156 1,121 

1980 1,312 1,234 

1981 1,694 1,503 

1982 1,662 1,678 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

!/ Estimates for 1973 through 1975 are based on the original 

possessions corporation provisions enacted in the Revenue 

Act of 1921. Estimates for 1976 and all subsequent years 

are based on the section 936 provisions of the Tax Reform 

of 1976. 

Source: The 1973 through 1975 figures are based on book 

income data taken primarily from Federal income tax 

forms (Form 1120) • The figures for 197 8-1982 are 

based on the estimated tax benefits as noted in 

Table 4-9, adjusted for each firm's tax year as 

noted on Form 5735. 

The 

the 

Of 

la 

ex~ 

the 

ye~ 

be~ 

~E 

COJ 

ta 

po 

in 

f o 

19 

co 

th 

mo 

in 
-59-

The remainder of the income from such intangibles must be allocated to 

the U.S. parent and be subject to U.S. tax. Because of the complexity 

of section 936 (h) and the uncertainty in the interpretation of prior 

law relating to the allocation of income from intangibles, it is 

extremely difficult to estimate accurately what the revenue effect of 

the new provision will be; and many of the returns showing the first 

year effect of TEFRA are not in yet. Thus no revenue projections have 

been provided. 

In addition to the rules relating to income from intangibles, 

~EFRA reduces the amount of passive investment income which a 

corporation can receive if it wishes to qualify for the possessions 

tax credit. Under law applicable to tax years beginning in 1982, a 

Possessions corporation could receive up to 50 percent of its gross 

income in passive investment income. This is reduced to 45 percent 

for tax years beginning in 1983, 40 percent for tax years beginning in 

1984, and 35 percent thereafter. These reductions affect only those 

corporations which currently earn passive income in amounts close to 

the current 1 imi t. Because the passive investment income earned by 

most possessions corporations is well below 50 percent of their gross 

income (the passive income of all 936 manufacturing companies represented roughly 16 percent of their combined gross income in 1982 12/), 

the revenue effect of the new passive income limitation under TEFRA is 

expected to be small. 

B. Alternative Tax-saving Routes. Whether the elimination of the 

Possessions corporation exemption would result in a gain to the U.S. 

Treasury of the tax benefits provided under section 936 depends on the 

tax-saving alternatives available to possessions corporations and on 

the induced effect on the aggregate level of investment by U.S. 

Persons. The relative tax advantages of a Puerto Rican location vary 

for physical and financial investments and for the use of intangible 

assets. _!l/ Puerto Rico can be, on tax grounds, a more attractive 

11_! A rough measure of income from financial assets , in 1982 may be 

obtained by summing the taxable interest ($578 million) and the 

tax exempt interest ( $12 mi 11 ion) reported by possess ions manufacturing corporations in tax year 1982. The total of $590 

million in gross interest income represented 16 percent of the net 

income of 936 manufacturing corporations. This estimate does not 

take into account the overhead or other expenses of earning f inanc ial income, nor does it take into account non-interest income on 

financial investments. The proportion of financial income in 

total 936 income is estimated to rise after 1982 because of the 

rise in interest rates and the reinvestment of interest income. 

dJ.; "Physical investment" consists of expenditures to buy newly 

produced capital goods, plant, equipment, and inventories. 

"Financial investment" means the purchase of securities, such as 

stocks and bonds and certificates of deposit (CDs). Some 

"intangible assets," such as patents and know-how, are produced by 

investment in research and development and training; other 

intangibles, such as trademarks, acquire value because of 

expenditures on advertising and promotion. 
-60-

location than the United States for plant and equipment and other 

operating assets. But the tax advantages of a Puerto Rican location 

for physical assets may not be significantly better than those 

available in a low-tax developing country. On the other hand, Puerto 

Rico under section 936 offers unique advantages for financial assets, 

such as deposits and bonds, and for the use of certain intangible 

assets. 

1. Physical assets. If section 936 were repealed, a possessions 

corporation could continue to obtain the benefit of U.S. tax exemption 

on current income from physical assets by remaining in Puerto Rico as 

a Puerto Rican chartered corporation or by moving to a foreign 

country, because the foreign earnings of a corporation incorporated 

outside the United States are generally not subject to U.S. tax until 

the earnings are repatriated to the United States. Where a U.S. 

parent corporation derives foreign source income, the U.S. tax on that 

income may be reduced by a credit for foreign income taxes paid. 

If a possessions corporation derives most of its income from 

investment in physical assets, it might elect to reincorporate in 

Puerto Rico or in a foreign country if section 936 were repealed· 

With respect to firms that took this course, the repeal of the 

possessions corporation credit would not transfer to the U.S. Treasury 

a large proportion of the tax benefits provided under section 936· 

Those possessions corporations with the highest percentage of the it 

income attributable to physical assets are in the low-technologY 

industries -- including food products, apparel, and fabricated metal 

products. 14/ In 1982, the combined income of possessions companies 

in low-technology industries represented only 11 percent of the income 

of all 936 manufacturing corporations. 

2. Financial Assets. A possessions corporation could continue to 

benefit from U.S. tax exemption on current income from financial 

assets by incorporating in Puerto Rico and not distributing the 

earnings to the United States, provided that it met the tests of 

section 957(c) by deriving 80 percent of its gross income from sources 

within Puerto Rico or a U.S. possession and 50 percent or more of itS 

gross income from the active conduct of any of the enumerated trades 

or businesses. Income from financial .assets represented approximate~Y 

16 percent of total 936 income in 1982, and will rise somewhat in 

later years. 

14/ For a discussion of the relative shares of possessions corporations' income from physical and intangible assets, see the~ Report, pp. 61-66. Low-technology industries are defined as thoS~ 

industries where R&D as a percentage of capital spending and 0 

sales is below the average for all U.S. manufacturing industrie 5 • 

Low-technology industries include textiles; stone, clay, and gl~S= products; paper; and rubber products; as well as those industrie1 mentioned in the text. Industry data are for 1982, from~ 

McGraw-Hill Survey of Business' Plans for Research and Developm~ 

Expenditures, 1982-85, Tables IV and V. 

tnea

acce 

900 

Par 

Pos 

inc 

Cha 

Or 

to 

On i 

~ea 

free 

t!oq 

~qu 

~ay 

tet 

if 

tha 

fac 

Ot 

~/ 
-61-

3. Intangible Assets. Income from intangible assets generally 

~eans income derived from patents, know-how, trademarks, brand names, 

access to established marketing and distribution channels, and 

9oodwill with customers. Prior to the enactment of TEFRA, many U.S. 

Parent corporations transferred intangibles (tax-free) to affiliated 

Possessions corporations, which in turn claimed as part of their 

income the return attributable to the intangibles. As explained in 

Chapter 2, TEFRA provides that 936 corporations which meet a signifi-

~ant business presence test in a possession are eligible for tax 

~xemption on certain income from intangibles developed by their 

affiliates. 

In the absence of section 936, income from intangibles developed 

Ot purchased by a U.S. corporation would, in general, be fully subject 

to U.S. tax regardless of whether the intangibles are used in the 

United States or abroad. U.S. law, as amended by the Deficit 

~eduction Act of 1984, provides that in the case of an otherwise taxftee transfer of intangible property from a U.S. person to a foreign 

~orporation, the transferor is treated as receiving an annual payment 

~qual to the value of the intangible in that year. Such deemed 

~ayments are U.S. source income. 15/ This provision is intended to 

~etain the U.S. taxing authority over income from an intangible .even 

lf transferred to a foreign corporation. The Fourth Report estimated 

that, in tax year 1980, roughly 50 percent of the income of 936 manufacturing corporations may have been a return on intangibles developed 

0t purchased by an affiliated corporation • .!.§_/ 

!2_; Under pre-1984 law, a U.S. corporation which transferred to a 

foreign corporation the U.S. rights to an intangible was required 

to include in the transfer's gross income the fair market value of 

the intangible, less the adjusted basis in the hands of the 

transferee, which was normally zero. Such income would be subject 

to tax. However, in general, no tax was imposed on the transfer 

by a U.S. corporation of the foreign rights to an intangible if 

the intangible was used in foreign manufacture. The special 

treatment of transfers of foreign rights to intangibles was eliminated by the Deficit Reduction Act of 1984. 

~/ See Fourth Report, pages 61-66, 128. 
-63-

CHAPTER 5 

THE IMPACT OF 936 FINANCIAL ASSETS ON PUERTO RICAN GROWTH 

- RECENT DEVELOPMENTS -

I. Introduction 

This section reviews recent developments in the continuing attempt 

by the Puerto Rican government to use the financial assets retained in 

Puerto Rico by 936 corporations to promote Puerto Rican development. 

Table 5-1 presents the financial portfolios of all 936 corporations in 

Puerto Rico at the end of 1983. The size of these financial investments are enormous for an economy the size of Puerto Rico's. They 

amount to more than $3,000 for each person living on the island. 

The goal of the Puerto Rican government's efforts has been to use 

these financial assets to reduce the cost of capital in Puerto Rico 

compared to that in world capital markets and thereby to stimulate 

teal investment on the island. This chapter first reviews the recent 

changes in the Puerto Rican regulations governing the use of 936 ~unds. 1/ It then attempts to evaluate the impact of the financial 

investments by 936 corporations on the Puerto Rican capital market. 

The relationship between the volume of financial investments by 936 

corporations in Puerto Rico on the one hand, and net capital flows and 

teal investment on the other, is examined. In addition, the forces 

determining the interest rate paid on 936 funds are described, because 

a low rate relative to world capital markets creates the opportunity 

for 936 funds to have a beneficial impact on Puerto Rico. The 

evidence suggests that, while the Puerto Rican government has recently 

been successful in forcing down the interest rate paid to 936 

corporations, the impact of the Qualified Possession Source Investment 

Income provision on real investment in Puerto Rico has been very 

rnoaes t. 

tr. Recent Regulatory Changes by the Government of Puerto Rico 

In order to make sure that increasing financial investment in 

Puerto Rico by 936 corporations leads to increased real investment on 

the island, it is necessary to separate the market for 936 funds from ~Otld capital markets by preventing arbitrage between them. The 

Puerto Rican government has therefore since 1976 issued a series of t~lings and regulations which have progressively limited the 

discretion of financial institutions in using 936 funds. These 

;u1 ings and regulations identify the assets whose acquisition are 

eligible" uses of 9 36 funds by f inane ial institutions. They also 

Specify the financial investments by 936 corporations that have to be 

lllatched with eligible assets by financial institutions, and how the 

lllatching is implemented. For example, they give the base period for 

....._______ _ 

11 An explanation of the provisions in the U.S. Internal Revenue Code 

and Puerto Rican law on which the exemption for Qualified Possession Source Investment Income is based is given in Chapter 2. 
- .64-

Table 5-1 

Estimated Composition of the Financial Investments 

of Possessions Corporations at Year-end 1983* 

Financial Investments . . 

Total ••••••••••••••••••••••••••••••••••••••• 

Investments in Puerto Rico, total ••••••••• 

Deposits in Puerto Rican banks, 

including repurchase agreements ••••••• 

Repurchase-Resale agreements not 

included in banks funds ••••••••••••••• 

Puerto Rican source GNMA mortgages 

Loans to other possessions 

• • • • • • 

corporations •••••••••••••••••••••••••• 

Puerto Rican government 

obligations ••••••••••••••••••••••••••• 

Mortgage and real estate loans •••••••••• 

Other investments in Puerto Rico • • • • • • • • 

Investments outside of Puerto Rico, 

including U.S. municipals and 

preferred stock of U.S. corporations 

Off ice of the Secretary 

Off ice of Tax Analysis 

+ Denotes approximation. 

• • • • 

$ billions 

11.1+ 

10.6+ 

6.0** 

.9 

1.4 

.4+ 

.4+ 

1.3+ 

.2+ 

.s 

* Some of the funds referred· to as 936 deposits may include 

deposits by exempt firms which have not made a 936 election, 

e.g., local exempt firms. These, however, are likely to be a 

small part of the total. 

The financial assets listed do not include accounts receivable 

or other working capital. 

** This includes about $800 million in savings banks. 

I 

the 

eli 

I sir 

19E 

the 

tnos 

Ce 

to 

ti 

te 

ti 
the calculation of 

eligible 936 funds. 

since the end of 1981. 

-65-

incremental eligible 

This section reviews 

assets and incremental 

regulatory developments 

I A. Summary of the February 1, 1982 Regulations. On December 17, 

1981, the Puerto Rican Treasury announced new regulations governing 

the use of 936 funds that became effective on February 1, 1982. The ~ost important changes from previous rules included: 

(1) The base for the calculation of incremental eligible 

assets in banks was moved up to July 1, 1981 from 

April 30, 1975. 

(2) The regulations for the first time covered ultimate 

recipients of eligible funds. Banks had to be able to 

establish to the satisfaction of the Puerto Rican 

Seer etary of the Treasury that eligible funds had been 

used properry and not simply to purchase financial 

assets. 

(3) Brokers could become eligible to act as intermediaries 

for the use of eligible 936 funds. They could use any 

underlying assets in obtaining 936 funds in a repurchase 

agreement ("repo"). However, the proceeds of the repo 

had to be invested in the same range of eligible assets 

that banks were restricted to in their use of 936 funds. 

In addition, the February 1, 1982 regulations mandated that a 

Certain portion of eligible assets be in the form of mortgage loans 

for new housing. At the same time that it announced the new regulations, the Puerto Rican Treasury issued an administrative ruling which 

testricted the use of 936 funds loaned by banks to brokers to the 

financing of eligible Puerto Rican assets. 

B. Suamary of Regulations Effective September 1, 1983. On ~ugust 2, 1983, the Puerto Rican Treasury issued a series of 

amendments to the December 17, 1981 regulations to remedy what it 

t>erceived to be continuing defects in the regulatory regime. The 

Changes included: 

(1) A limit on the number of times 936 funds can be 

redeposited or transferred among banks and brokers before 

being loaned to the ultimate eligible recipient. After 

September 1, 1983, a bank or broker receiving eligible 

funds from a 936 corporation may only transfer or redeposit them once. At that point, the bank or broker 

receiving the funds becomes the "ultimate recipient" and 

must invest them in eligible assets, which means that the 

funds cannot be invested in CDs, repos, or other 

financial assets. 

(2) A change in the burden of proof on the bank or broker in 

establishing that 936 funds have been invested in eligible activities. There is a presumption that the funds 
-66-

have not been properly applied if the collateral provided 

in support of the loan includes assets not related to 

eligible activities, such as CDs or other financial 

assets owned by the ultimate recipient for less than 45 

days. On the other hand, there is a presumption of 

proper use if the collateral is made up of assets resulting from or related to the production and sale of 

goods or services in Puerto Rico by the ultimate 

recipient. 

(3) A restatement of the list of eligible activities. 

Instead of a long list of items specifically identified 

as eligible, the amended regulation indicates which 

activities are not eligible, e.g., consumer loans and 

offshore investments. Eligible activity is described in 

rather broad terms, apparently to give eligible institutions more flexibility in generating new areas of 

eligible activity. 

(4) An attempt to move from a base period-incremental system 

to a transaction-by-transaction tracing system in 

determining eligible activities. A bank is no longer 

free to make unrestricted use of 936 deposits, even if it 

has excess eligible assets when the 936 funds are 

received. If a relationship is established between an 

inflow of 936 funds and the acquisition of ineligible 

financial assets, there is a presumption of improper use 

of the funds. 

{ 5) Banks and brokers who receive 936 funds indirectly as 

"ultimate recipients" have to report to the Secretary of 

the Treasury on how the funds were utilized. 

Most of these changes appear to affect the timing of transactions 

without necessarily having a substantive impact on the assets that are 

acquired. For example, the 45-day rule mentioned above may require 

merely that banks and brokers acquire their collateral a litt~e 

earlier, and, since they accrue interest during that time, there is 

little added cost. Similarly, the attempt to introduce "tracing" or a 

"transaction-by-transaction" system is not significant as long as an 

excess of eligible assets over 936 funds tends to be generated. IO 

that case, a bank or broker can time its acquisition of eligible 

assets to meet the tracing requirements, e.g., by not booking eligible 

loans until they have a 936 deposit in hand. 

C. The April 17, 1984 Regulations. As indicated later in thi 5 

chapter, the September 1, 1983 regulations did not seem to have ~ 

substantial impact on the market for 936 funds, at least as reflect~n 

in the interest rate on 936 deposits compared to Eurodollars and ~n 

the excess of eligible assets over investment requirements. 

contrast, the regulations effective on April 17, 1984, had a much more 

immediate and dramatic effect on the Puerto Rican capital market. 

th 

el 

br 

th 

re 

93 

th 

in 

1 

a1 

a

t 

e 

a 

a 

r 

r 

T 

c 

b 

d 

u 
-67-

d By far the most important change in the April 17 regulation was 

.o the linking of the interest paid on 936 funds and the amount of 

1 eligible assets a bank or broker is required to generate. If banks or 

1 5 brokers pay interest on the 936 funds that is less than 65 percent of 

f the comparable Eurodollar rate, the amount of eligible activity 

required matches the amount of 936 funds received. However, if the 

f 936 rate is 65 percent or higher, the eligible activity has to exceed 

e the amount of 936 funds received, with the penalty increasing as the 

interest rate rises. The complete schedule is as follows: 

d 

h 

d 

n 

f 

~ 

n 

r 

t 

Interest rate on 936 funds 

as a percentage of 

the Eurodollar rate 

0 to 64.9 

65 to 69.9 

70 to 74.9 

75 to 79.9 

80 to 84.9 

85 to 89.9 

90 and upwards 

Eligible Activity 

to be generated per 

dollar of 936 funds 

$1.00 

$1. 05 

$1.15 

$1. 22 

$1.36 

$1. 54 

$2.00 

e The purpose of this penalty schedule is to drive down the interest 

n rate on 936 funds by restricting the ability of banks or brokers to 

e bid for funds when rates are high. 

e 

In the first few months after the promulgation of the April 17, 

1984 regulations, there was some ambiguity about their exact 

s application. Some banks interpreted the penalty on the schedule to 

f apply only to the first month of a 936 CD's term. For example, they 

thought that they could issue a 6-month CD to a 936 corporation at the 

end of the month and only have to generate the penalty amount of 

s additional eligible activity for the day remaining in the first month 

e and not for the remainder of the CD's term. Interest rates therefore 

e rose at the long end of the term structure relative to short term 

e rates. However, the reporting forms issued by the Puerto Rican 

s Treasury in July made it clear that this interpretation was not 

a correct, and that the penalty amount of extra eligible activity had to 

be maintained to cover the original 936 deposit. Rates therefore 

dropped at the long end of the market, because banks and brokers were 

Unwilling to risk locking themselves into a long term penalty. 

~ n 

e 

The other major changes made by the April 17, 1984, regulations 

"Were: 

(1) An eligible institution can consider one-twelfth of its 

annual operating expenses (excluding cost of funds) as 

eligible activity. 

(2) A full 100 percent of 936 funds is subject to the 

investment requirements, instead of 95 percent. 
-68-

(3) Eligible assets can no longer include cash on hand, cash 

items in process of collection, demand deposits with 

banks, interest and accounts receivable, prepaid 

expenses, or (imputed) interest on bad loans. 

III. Empirical Analysis 

A. The Inflow and Accumulation of 936 Funds, Net Capital InflowsL 

and Real Investment in Puerto Rico. One indication of whether the 

Qualified Possession Source Investment Income (QPSII) provision has 

been successful in increasing investment in Puerto Rico can be found 

in the capital account component of the Puerto Rican balance of 

payments. Real investment in any economy can be financed by (a) 

private domestic saving, (b) government saving, or (c) capital inflows 

from abroad. The QPSII provision was intended to increase the third 

source of capital, inflows from abroad. The objective was to increase 

the flow into Puerto Rico of the large pool of funds that had been 

invested in the Eurodollar market. Any increase in this source of 

investment would be reflected in a change in net capital inflows into 

Puerto Rico. This section reviews the relationship between increased 

financial investments in Puerto Rico by 936 corporations and ~ 

capital inflows. In addition, because increased real investment is 

the ultimate goal of the QPSII provision, the relationship between 936 

financial investment and real investment in Puerto Rico is examined. 

Table 5-2 presents the various components of the capital account 

of the Puerto Rican balance of payments and also the net overall ~ 

balance through fiscal year 1983. It gives both changes in foreign W\ 

holdings of Puerto Rican assets and changes in Puerto Rican holdings ~ 

abroad. Financial investments by 936 corporations are included in I 

direct investment. While direct investment also includes investment 

in plant, equipment, and working capital, the data on 936 deposits in 

Puerto Rican banks indicate that the large swings in direct investment 

are attributable almost exclusively to changes in financial 

investments. 

For the 10 years from 1972 through 1981, there were only modest 

changes in the net annual inflow of capital into Puerto Rico. There 

were very large changes in individual components, such as the large 

increase in foreign direct investment after 1975. This mainlY 

reflected the large inflow of 936 funds from the Eurodollar market as 

a result of the Qualified Possession Source Investment Income 

provision in 936 enacted in 1976. Foreign direct investment was also 

very high in 1980 and 1981 as 936 corporations continued to inve~t 

their retained earnings in Puerto Rican financial assets. Thl 5 

increase in Puerto Rican investments by 936 corporations was offset bY 

outflows through the banking system, investments offshore by Puerto 

Rican public corporations, and shifts in the ownership of Puerto Rican 

public debt. The changes in the 1976 law regarding investment in~om~ 

therefore seemed to have a relatively modest impact on net capita 

inflows in Puerto Rico through 1981. In addition, there seemed to ~e 

little relationship between the large swings in direct investment in 

Table 5-2 and the small changes in pr iv ate real investment in Table 

5-3. 
o~ m rt rt ~rt:3rt:3tn:3~rt O'\tn rte40 H\:3 m o..tn-H\O..tn m ... 0.. ::r ::r 

n.b.Ze 5-Z 

Coip>l•ata of the Puerto Rico capital Accomlt, 1970-1982 

(mllllona of dollar•) 

I(+) atflecta I~ irwmm.at in Puerto Rico by nonreeldenta and liquidation of foreign UMta by Puerto Ricmm. , (-) ienecta •le of PUerto Rican aaets by nonr•ldenta or PUerto Rican purdaue of asaeta abroad.] 

w lil>n«= 

: 1970 ! 1971 : 1972 : 1973 : 1974 : 1975 ! 1976 ! 1977 : 1978 : 1979 ~ 1980 ~ 1981 1982 I 1983 I JUNE 30 . . . . . I I 

Direct lnveement 

In Puerto Rico - chanJe 

in the ueet9 of 

corporatlorw (•Inly 936 • •) 

controlled offshore 330 686 626 792 735 625 1,483 1,698 1,682 878 2,305 2,636 -115 621 

llet 8horb-tem bmtilllJ 

nawa 182 32 -25 114 39 306 59 -5'4 -211 -440 -557 -1,362 -655 -171 

Ponlgn holding• of 

bank debta 45 20 102 248 227 453 48 -91 -72 197 -13 -38' 11' -357 

llWMtmmlt by tuerto 

Rican banta abroad -110 79 -4 -174 -25 -168 70 -457 -197 -763 -490 -1,007 -127 -533 

llt:emal dlpmlt8 In 

PUerto Rican bar*a 2n -67 -123 40 -163 21 -59 4 58 133 -95 29 58 19 

llllt foreign lnu•tmaat ln 

lODJ-tem Puerto Rican ' Q>ftrrment obligatlom 181 307 448 404 590 896 175 352 -139 617 344 186 349 719 \.0 °' 

fUerto Rican lnveemmt ' tnu.s.~ 

MCUrltl• -15 -20 9 113 13 -29 -310 124 -191 -U2 24 -· 5 

llltt fOEeign lllN9'-"t 

ln 8hort-tem debts of 

Puerto Rican pj>Uc 

corporatlorw 25 67 42 15 153 -37 111 -13 31 289 -11 169 -36 

llaort-tem tnveam.t 

llbroac! by PUerto 

Rican public corporatlon1 -7 -2 -15 0 -21 -88 -25 -48 -204 77 -631 -41 175 40 

All other 195 86 18' -131 -59 -9 18 94 321 370 -25 161 301 210 

lft>tali Met 891 1,156 

Office of the Secretary 

1,327 1,252 1,412 1,896 1,644 11353 l,s&o 1,362 1,583 1,593 128 688 

Of flee of Tu Analysis 

source a Raerto Rico Plamfng Board, aireau of a:onaatc Acoomlta and aenausee. 
-70-

Table 5-2 indicates that in fiscal 1982 net capital inflows almost 

disappeared compared to the level that ha,d been maintained in the 

previous decade. There was a reduction of more than $2.5 billion in 

foreign direct investment, presumably reflecting the large repatr iations by 936 corporations in response to low financial returns in the 

first half of 1982. This is consistent with the decline in 936 

deposits in the first part of 1982, as will be discussed later. 

Somewhat surprisingly, the other components of the capital account did 

not act to offset the change in direct investment in order to leave 

net inflows unchanged. In other words, 1982 was not the mirror image 

of years in which there were large increases in financial investments 

in Puerto Rico by 936 corporations and capital flowed out through the 

banking system. Outflows through the banking system, while below the 

1981 peak, continued at a high level. 

Several factors may have contributed to this decline in net 

capital inflows. Table 5-3 indicates that there was a decline in 

private investment in Puerto Rico in 1982. The demand for capital maY 

not have been sufficient to attract capital from offshore. In 

addition, the continued increase in exports combined with the 

recession-induced decline in imports reduced the requirements for 

capital inflows. In any case, whatever the independent contribution 

of the changes in the demand for capital or in the trade account, the 

fact that direct investment and 936 financial assets declined in 1982 

suggests that 936 funds could have had little positive impact on 

Puerto Rico in that year. 

Does the fact that in 1982 the substantial decline in real private 

investment coincided with the large drop in both direct investment and 

the accumulation of 936 financial assets suggest that real investment 

had been stimulated by the inflow of 936 funds before 1982? ProbablY 

not, because in 1982 real private investment and 936 funds were each 

subject to different forces, and their parallel behavior is largelY 

coincidental. Real investment was strongly affected by the 1982 

recession, as is clear from the fact that the change in inventorY 

investment explains most of the decline. On the other hand, financial 

investments by 936 corporations declined because the more restrictive 

February 1, 1982 regulations drove down the interest rate on 936 fun~s 

and caused large repatriations. If anything, the dramatic decline in 

the interest rate on 936 funds in early 1982 as a result of the new 

regulations should have stimulated investment, not discouraged it. ~o 

the extent that real investment and 936 funds are related, it is 

probably the level of real investment which influences the inflow of 

936 funds rather than the reverse. The extent to which banks can 

acquire 936 funds depends on the amount of "eligible" loans available 

which are, in turn, related to the amount of real investment takin9 

place. The fact that fluctuations in Puerto Rican real investment are 

almost exclusively due to cyclical changes in inventories suggests 

that the impact of 936 funds on real investment is weak. 

Foreign direct investment, which reflects the assets of 93 6 

corporations, did recover somewhat in fiscal 1983, suggesting that the 

pace of repatriations diminished. Net inflows largely matched the 

recovery in direct investment. Banking outflows increased but not bY 

---

19 

19 

19 

19 

19 

19 

19 

19 

19 

19 

19 

19 
-71-

Table 5-3 

Gross Private Investment in Puerto Rico 

(millions 

...._ 

F'iscal Residential 

~ear Total Construction 

1970 1,065 289 

1971 1,234 312 

1972 1,268 374 

1973 1,227 392 

1974 1,138 411 

1975 1,183 385 

1976 1,197 357 

1977 873 309 

1978 1,255 428 

1979 1,317 394 

1980 1,569 343 

1981 . 1,312 305 

1982 416 290 

1993 747 269 

Qf f ice of the Secretary 

Office of Tax Analysis 

of current dollars) 

Industrial Machinery 

and Commer- and 

cial Building Equipment 

344 382 

391 417 

332 426 

208 435 

248 375 

261 398 

220 482 

133 492 

133 569 

136 611 

162 657 

210 671 

193 475 

164 540 

Source: Puerto Rico Government Development Bank 

Change in 

Inventories* 

50 

114 

136 

192 

104 

139 

138 

-61 

125 

176 

407 

126 

-542 

-226 

Part of the net change in inventories may include inventories held 

by public agencies. 
-72-

as much as the increase in direct investment. Therefore, in fiscal 

1983, net capital inflows paralleled the change in direct investment 

more closely. This may reflect some success in the attempt by the 

Puerto Rican Treasury to control the use of 936 funds, particularly 

through the February 1, · 1982 regulations. Still, net inflows in 

absolute terms remained below the level in the early 1970s prior to 

the passage of the Qualified Possession Source Investment Income 

provision in 1976. Furthermore, Table 5-3 indicates that the 

resumption of the growth of 936 financial assets in 1983 was not 

associated with a comparable recovery of private investment. 

The Use of Data on Capital Flows to Evaluate the Impact of 936 

Funds - Is it Valid? 

It is true that the balance of payments data cannot be looked at 

Cha 

Ci~ 

Bat 

Cot 

Fi~ in isolation without also consulting data on real savings and 

investment in Puerto Rico. For example, an inflow of capital to ~t 

Puerto Rico could lead to increased capital investment and eventually 

to increased domestic saving because of higher Puerto Rican income. 

If the increased domestic saving is invested abroad, there would in 

the long run be no net capital inflow. In other words, the additional 

capital investment would appear to have been financed by increased 

domestic saving. The data on Puerto Rican investment in Table 5-3 

suggest that this is not the case. 

Bai 

Bai 

Sc 

l 

Bai 

Bai 

Bal 

Ro 

Ot 

Tota 

BaJ 

It can also be argued that 936 funds can be lent to e~porters who 

will expand their operations, increase the export surplus, and therebY 

reduce capital inflows. Although this may happen in the long run, it 

implies a large change in 936 exports as a direct response to the 

increased investment. Again, the data do not support the argument. Ba 

Ro B. Distribution of 936 Funds Among Banks and Brokers in Poer~ Tota 

Rico. Table 5-4 gives the distribution of 936 funds among Puerto 

Rican banks on April 1984 and the change from December 1981. 

The market for 936 funds continued to become more competitive from 

December 1981 through April 1984. There were several factors 

contributing to increased competition for 936 funds over the period· 

One was the entry of the First National Bank of Boston branch in 

Puerto Rico. Another was the disproportionate growth of 936 funds in 

the local commercial banks. The smaller Puerto Rican banks, included 

in the "other local banks" category, in particular became significant 

participants in the 936 market. They accounted for almost 20 percent 

of the total growth of 936 funds in banks over the period. The 

savings banks accounted for about another 25 percent of the growth. 

Table 5-4 shows that the increasing role of the smaller commercia~ 

banks and the savings banks occurred through the intervention o 

brokers. Approximately 75 percent of their 936 funds were derived 

from repos arranged by brokers. The excess eligible assets in the 

system have tended to be concentrated in these small commercial and 

saving banks. The brokers' intermediation is frequently necessary to 

mobilize these excess eligible assets because of the added securitY1 

usually in the form of explicit guarantees, which brokers provide to 

936 depositors. 

Grari 

Al ...__ 

Qffi 

Of 

• 1 
-73-

ll. 

t 

e Table 5-4 

y Distribution of 936 Funds and Excess Eligible Assets - April 1984 

n (Millions of dollars) 

0 

e Funds Change in I Excess 

e Direct Obtained Redeposits Total Total 936 I Eligible 

t Deposits through from other 936 funds from I Assets 

Sank and Repos brokers banks funds Decerpber 1981 April 1984 

Chase Manhattan 1, 355 0 0 1,355 +420 125 

Citibank 1, 312 117 0 1,429 -21 114 

Bank of America 421 0 0 421 +18 7 

t Continental Illinois 176 13 7 196 -111 9 

B First National Bank 

0 of Boston 145 0 3 148 +148 10 

Total, U.S. Banks 3,409 13) 9 3,549 +455 265 

Banco Popular 420 138 79 637 +188 37 

l Banco de Ponce 248 47 77 372 +96 35 

Scotia bank de 

Puerto Rico 00 0 27 107 +6 2 

6 Banco Central 106 129 112 347 +4 31 

Banco de San Juan 49 40 20 109 +32 11 

Banco de Santander 80 2 2 164 +16 63 

Roig 7 77 13 97 +44 11 

Other local banks 61 162 5 228 +192 126 

Total, Local Commercial 

g Banks 1,051 595 415 2,061 +578 316 

Ban1c of Nova Scotia 166 0 0 166 -118 7 

i Royal Bank 209 0 48 257 -77 28 

b Total, Canadian Banks 374 0 48 422 -196 34 

~ederal Saving Banks 181 619 9 009 +266 247 

n Ql"and Total, ; All Banks 5,015 1, 343 481 6,358* +1,057* 862 

Office of the Secretary 

Office of Tax Analysis 

• The overall total does not include redeposits because this would count the same funds twice for the 

system as a whole. 

Solll"ce: Puerto Rico Government DeveloIJDent Bank 
-74-

The overall activities of brokers, both in receiving 936 funds and 

in generating eligible assets, are presented in Table 5-5. The table 

covers the period from February 1982 through April 1984, because 

brokers were first included in the Puerto Rican reporting system in 

February 1982. The $1,287 million of eligible activities generated 

through banks in April 1984, essentially matches the $1, 343 million 

obtained through brokers by banks that is given in column 2 of Table 

5-4. It does not represent a net addition to the amount of 936 

activity presented for banks on Table 5-4. However, Table 5-5 

indicates that brokers have become much more active in generating 

eligible activity directly rather than going through banks. Table 5-5 

also indicates that brokers became much more important overall 

intermediaries for 936 funds in the period. These are further 

indications of the competitiveness of the 936 market. 

c. 936 Funds, Eligible Assets, and the Interest Rate on 93~ 

Deposits. Table 5-6 gives the level of eligible activity in all 

Puerto Rican banks, the eligible investment required which reflects 

the level of 936 funds, and the amount of eligible assets in excess of 

requirements. The table indicates that there was relatively steady 

growth of eligible assets and 936 funds from early 1980 through 

January of 1982. The amount of excess eligible assets in the system 

was substantial and remained in the range of from $700 million to $1.1 

billion. As indicated in the Fourth Report, 2/ this substantial level 

of eligible assets meant that banks and brokers could actively bid for 

936 funds. As a result, the interest rates offered on 936 funds 

remained high from early 1980 through the end of 1981, generally in 

excess of 80 percent of the rate on Eurodollars. 

The February 1, 1982 regulations reduced the amount of excess 

eligible assets to less than $200 million. In part this was due to 

moving up the beginning date for computing incremental assets from 

April 30, 1975 to July 1, 1981. In addition, the Federal Savings 

banks did not choose to be declared eligible ins ti tut ions and their 

assets were not available for supporting 936 deposits~ 

Table 5-6 shows that the amount of eligible activity declined from 

$6,059.8 million in January 1982 to $5,155.6 million in February 1982, 

which was lower than the investment requirement of $5,480.5 million in 

December 1981. The only way the system could remain in equilibrium, 

at least in the short run when a major expansion in eligible assets is 

unlikely, was for 936 corporations to reduce 936 funds through 

repatriation. This is evident in the decline in investment requirements of almost $800 million from the end of 1981 through July 1982· 

Eligible assets remained only slightly in excess of requirements from 

February 1982 to April 1983. 

2/ See pages 89-94. 
-15-

Table 5-5 

Brokers Activities in February 1982 and April 1984 

(Monthly averages in millions of dollars) 

Eligible Activities 

Eligible Activities 

Directly Generated 

Eligible Activities 

Generated Through Other 

Eligible Institutions · 

(Banks) 

936 Funds Received 

Received Directly 

Through Repos 

With Exempt Businesses 

Received Through 

Loans and Repos 

from Banks 

Off ice of the Secretary 

Office of Tax Analysis 

February 

1982 

116 

819 

385 

477 

Source: Puerto Rico Government Development Bank 

April 

1984 

726 

1,287 

1,797 

179 
Month 

1980 May 

June 

July 

August 

September 

Octobe r 

November 

December 

1981 January 

February 

March 

April 

May 

June 

July 

August 

September 

October 

November 

December 

1982 January 

February 

March 

April 

May 

June 

July 

August 

September 

October 

November 

December 

1983 January 

February 

March 

April 

May 

June 

July 

August 

September 

October 

November 

December 

1984 January 

February 

March 

April 

-76-

Table 5-6 

Total Incremental Eligible Activity 

vs. 

Total Investment Requirement 

All Banks 

(monthly averages in millions of dollars) 

Incremental 

Eligible 

Activity 

4,203.7 

4,158.0 

4,097.4 

3,995.2 

4,201.l 

4,371.4 

4, 641. 1 

4,776.1 

4,750.3 

4,799.6 

4,808.7 

4,847.9 

5,069.1 

5,197.7 

5,121.1 

5,463.7 

5,701.3 

5,865.7 

6,085.9 

6,202.0 

6,059.8 

5,155.6 

5,293.9 

5,366.6 

5,275.4 

5,085.3 

5,079.2 

5,265.0 

5,198.8 

5,158.7 

5,322.9 

5,397.8 

5,380.0 

5,401.6 

5,563.2 

5,502.l 

6,493.0 

6, 641. 2 

6,422.3 

6,542.7 

6,628.2 

6,721.3 

6,956.7 

6,978.0 

6,896.2 

7,164.3 

7,175.1 

7,384.2 

Investment 

Requirement 

on 936 Funds 

3,414.2 

3,342.8 

3,132.7 

3,094.9 

3,094.2 

3,397.3 

3,622.5 

3, 777.9 

3,837.0 

3,918.1 

3,854.5 

3,854.6 

4,025.8 

4,233.6 

4,236.0 

4,540.8 

4,855.3 

5,100.3 

5,375.8 

5,480.5 

5,272.1 

4,998.1 

5,137.4 

4,978.9 

4,950.7 

4,740.7 

4,682.5 

4,949.7 

4,860.5 

4,968.2 

5,132.2 

5,105.l 

4,996.4 

5,231.9 

5,323.7 

5,155.7 

5,915.2 

5,986.9 

5,670.1 

5,869.2 

5,967.7 

6, 116. 5 

6, 381. 5 

6,244.5 

6,087.1 

6,429.8 

6,387.0 

6, 521. 7 

Of f1ce of the Secretary 

Off ice of Tax Analysis 

Source: Puerto Rico Government Development Bank 

Excess 

Eligible 

Assets 

789.5 

815.2 

964.7 

900.3 

1,106.9 

974.1 

1,018.6 

998.2 

913. 3 

881. 5 

954.2 

993.3 

1,043.3 

964.1 

885.1 

922.9 

846.0 

765.4 

710.1 

721. 5 

787.7 

157.5 

156.5 

387.7 

324.7 

344.6 

396.7 

315.3 

338.3 

190.5 

199.7 

292.7 

383.6 

169.7 

239.5 

346.5 

577.8 

654.2 

752.2 

673.5 

660.5 

604.7 

575.2 

733.4 

809.2 

734.5 

787.5 

862.4 

dee 

on 

Feb 

eno 

exe 

fun 

re 

sav 

ex 

198 

f u 

93 

ra 

to 

fr 

ef 

Pe 

ra 

th 

el li

el 

ra 

ex 

su 

ra 

f u 

ra 

ra 

di 
-77-

Table 5-7 indicates that 936 interest rates after their steep 

decline in February 1982 continued to be low in relation to the rates 

on Eurodollars through April 1983. For much of the period from 

February 1982 to April 1983, interest rates on 936 funds were barely 

enough to make 936 corporations indifferent between investing in 

exempt 936 deposits and investing in taxable Eurodollar deposits. 

This market equilibrium, in which 936 corporations had to withdraw 

funds from the 936 market in order to balance assets with investment 

requirements, was disturbed in May 1983 with the reentry of the 

savings banks into the regulatory system. As a result, the level of 

excess eligible assets almost returned to the level prior to February 

1982. The increased ability of banks and brokers to compete for 936 

funds drove up the interest rates offered. Table 5-7 indicates that 

936 interest rates were generally 80 percent or more of the Eurodollar 

rates from June 1983 to March 1984. 

The April 17, 1984 regulations forced the 936 interest rates back 

to the 60-65 percent range in May and June of 1984. This is 

frequently the pattern after a new round of regulations, but the 

effect may be longer lasting in this instance. The severe 36 percent 

Penalty in terms of additional required eligible assets if the 936 

rate is 80-85 percent of the Eurodollar rate, makes it unlikely that 

the interest rate will ever rise to that level. 

Table 5-6 indicates that the system has tended to have excess 

eligible assets equal to about 12 percent of requirements. In the 

light of the penalty schedule, this suggests that if all the excess 

eligible assets are mobilized, the long run 936 rate will be in the 

range of from 65 to 75 percent of the Eurodollar rate. This 

expectation is based on the assumption that 936 firms will not 

Substantially increase repatriations if the rate remains in this 

range. The possibility of repatriations as the rate goes lower may 

further suggest that 70-75 percent of Eurodollars is the most likely 

range in the long run. Another factor restraining the drop in 936 

rates is the possibility of disintermediation as 936 corporations make 

direct loans to local firms in order to avoid the penalty. 
1982 

1983 

1984 

-78-

Table 5-7 

Interest Rates on 936 Deposits 

As a Percentage of Eurodollar Rates* 

February 1982 - June 1984 

Month Ratio of 936 Rates 

Eurodollar Rates 

Feb. 71. 0 

March 57.0 

April 53.5 

May 62.0 

June 64.0 

July 66.0 

Aug. 64.0 

Sept. 71. 5 

Oct. 64.5 

Nov. 61. 5 

Dec. 63.5 

Jan. 64.5 

Feb. 65.5 

March 62.5 

April 70.0 

May 73.0 

June 78.0 

July 83.5 

Aug. 81.0 

Sept. 81. 5 

Oct. 86.0 

Nov. 77.5 

Dec. 80.0 

Jan. 87.5 

Feb. 84.5 

March 86.0 

April 79.0 

May 63.0 

June 65.0 

to 

Of f1ce of the Secretary 

Office of Tax Analysis 

* Rates used for comparison are interest rates on 3-month 

certificates of deposit. Monthly data are averages of 

published semimonthly ratios. 

Source: Puerto Rico Government Development Bank. 

Rev 

Gua 

Vir 

qua 

as 

Sam 

Of' 

F'ea 

l\me 

Cor 

inc 

A.me 

~he 

~Os 

app 

ace 

~e \.j 

the 

on 

is 

the 

but 

ino 

h~ 

teb $a. 

Sub 

....__ 

!1 

~/ 

~/ 
-79-

Appendix A 

0peration of the Possessions Corporation Syste• 

of Taxation in American Samoa, Guam, and 

the V1r91n Islands 

The term "possession" as used in section 936 of the Internal ~evenue Code includes not only Puerto Rico, but also Arner ican Samoa, G~am, and other smaller U.S. territories. 1/ It does not include the 

Virgin Islands. U.S. corporations operating in American Samoa or Guam 

qualify for special tax treatment under section 936 in the same manner 

as U.S. corporations operating in Puerto Rico. Moreover, American 

Samoa and Guam, like Puerto Rico, provide exemptions from, or rebates 

Of, their local possession income tax to complement the exemption from 

Peaeral tax under section 936. 

The first part of this Appendix describes the income tax laws of ~erican Samoa and Guam. It is estimated that possessions 

~orporations operating in Guam were subject to an effective Guam ~ncome tax rate of 10 percent; possessions corporations operating in 

"'mer ican Samoa were generally subject to no possession income tax. ~he reduction in U.S. Federal tax provided under section 936 to all ~ossessions corporations operating outside of Puerto Rico was 

approximately $1.5 million in tax year 1982. 

The second part of the Appendix describes the tax treatment ~<::corded to corporations operating in the Virgin Islands. Under the 

tevised Or ganic Act of 1954, section 28(a) 2/, all "inhabitants" of 

he Virg in Islands satisfy their liability for U.S. tax by paying tax ~n their worldwide income to the Virgin Islands. The Virgin Islands ~s required by the Naval Appropriations Act of 1922 3/ to administer 

bhe U.S. income tax laws as the Virgin Islands territorial income tax, .ut may rebate the tax which it collects on Virgin Islands source tn~ome earned by u.s. or V.I.-chartered corporations operating ~t1marily in the Virgin Islands. In 1982, the amount of income tax ~ebated under the Virgin Islands tax-incentive program is estimated at 

8.3 million, of which $4.2 million is attributable to Virgin Islands 

Subsidiaries of U.S. corporations. 

/ 

~/ 

Other territories to which section 936 benefits apply are the 

No r thern Mariana Islands and Wake and Midway Islands. Section 936 

also applied to the Panama Canal Zone until September 30, 1979. 

Pursuant to the Panama Canal Treaties of 1977, the United States 

ceased to have jurisdiction over the Panama Canal Zone on 

October 1, 1979. 

48 u.s.c. 1642. 

48 u.s.c. 1397. 
-80-

I. American Samoa and Guaa 

A. Federal and Possession Taxation. American Samoa and Guam, 

like Puerto Rico, constitute income tax jurisdictions separate from 

that of the United States. American Samoa and Guam have primary 

jurisdiction to tax 'u.s. corporations operating there, and the United 

States has secondary jurisdiction. 

In 1963, the legislature of American Samoa adopted the "Samoan 

Income Tax Act", which provides that: 

f iJ 

sec 

Ste 

ini 

u. 

i~~ in 

Pr "The income tax and the income tax rules in force in the United Pr 

States of America and those which may hereafter be enacted or re 

adopted, where not clearly inapplicable or incompatible with the me 

in tent of this section, are adopted by American Samoa, and shall in 

be deemed to impose a separate territorial income tax, payable to fa 

the government." 

American Samoa generally applies the U.S. Internal Revenue Code as the 

American Samoan Income Tax by substituting "American Samoa" for 

"United States," where appropriate in order to give the income tax laW 

proper effect in American Samoa. 

The legislature of American Samoa has from time to time amended 

the locally applicable U.S. income tax laws. American Samoa also 

provides exemptions from tax on American Samoan source income to 

businesses whose investments are deemed to promote Samoan economic 

development. In order to qua! ify for tax exemption, a corporation, 

partnership, or sole proprietorship must employ a work force at least 

75 percent of which consists of American Samoan residen t s. For 

purposes of the 75 percent work force rule, a resident means anY 

person who has continuously resided in American Samoa for at least 

five years. Tax exemption grants generally last 10 years and are 

subject to renewal. However, the period of tax exemption maY 

terminate sooner if the cumulative amount of all taxes forgiven und:r 

the grant equals 200 percent of the business's total investment in 

American Samoa. 

Guam, unlike American Samoa and Puerto Rico, does not have the 

authority to adopt its own income tax system, and the income ta~ 

system which Congress provided for it is closely integrated with th~ 

income tax jurisdiction of the United States. The Organic Act of 195 

4/ requires that Guam administer the income tax laws in force in the 

United States as the Guam territorial ihcome tax, the so-called GuaJll 

"mirror" tax. The U.S. Internal Revenue Code is generally applied as 

the Guam territorial income tax by substituting "Guam" for "United 

States" where appropriate in order to give the income tax law pr~pe~ effect in Guam. Section 935 of the Internal Revenue Code provide 

that individuals who are residents of Guam but derive income from t~= United States file a single income tax return with Guam; individua J1l 

who are residents of the United States but derive income from Gua 

!/ 48 u.s.c. 142li. 

en 

ef 

ti 

in 

Qp 

in 

Co 

Pr 

in 

Of 
-81-

file a single return with the United States. In addition, Code 

section 881 (b) provides that, under certain conditions relating to 

stock ownership and the source of the corporation's total income, ~, interest, dividends, and other passive investment income received from ~ U.s. sources by corporations chartered in Guam is exempt from the U.S. 

tax withheld at source on such gross amounts. Similarly, passive ~d investment income received from Guam sources by corporations chartered 

in the United States is exempt from the Guam tax withheld at source on 

n such gross amounts. 

No Federal provision explicitly limits the authority of Guam to ~d Provide income tax relief through rebates. Under the tax-incentive 

r Program of Guam, the Guam Economic Development Authority provides 

e tebates of up to 100 percent of Guam income taxes to corporations that 

1 ~eet minimum investment and certain other requirements (such as 

increasing employment, replacing imports, or creating needed 

facilities). The rebate is allowed for up to 20 years. 

0 

e Most possessions corporations operating in Guam in 1982 were 

r entitled to a rebate of 75 percent of Guam income taxes. Given the 

t\f effective exemption from U.S. tax under section 936, these corpora- ~ions paid an over-all effective tax rate of about 10 percent on 

lncome from the active conduct of a trade or business in Guam and on 

9Psrr (i.e., Guam source income derived from the reinvestment of d 

0 

0 

c 

I 

t 

r 

y 

t 

e 

y 

r 

n 

e 

" e 

0 

e 

J1l 

s 

d 

r 

s 

e 

s 

J1l 

lncome from the Guam trade or business). Many of these 936 

corporations enjoyed, in addition, exemption from the Guam real ~roperty tax. Dividends paid by certain tax-exempt corporations to 

lndividual shareholders were also eligible for a rebate of 75 percent 

Of the Guam shareholder level income tax. 

B. Characteristics of Possessions Corporations Op~rating Outside ~erto Rico. For tax year 1982, we have data for 7 active 936 

corporations operating in possessions other than Puerto Rico. The q~alified possession net income of the 7 corporations was $3. 9 ~lllion, of which 58 percent was attributable to possessions 

Corporations operating in Guam. These 7 corporations claimed tax 

credits of $1.7 million under section 936, representing an estimated 

$1.s million reduction in U.S. tax compared to the liability in the 

absence of section 936. 

11. Virgin Islands 

A. Taxation of Corporations aperating in the Virgin Islands. The ~irgin Islands is not treated as a possession for purposes of section ~36. However, corporations operating in the Virgin Islands receive 

enefits similar to those provided to 936 corporations. 

The Naval Appropriations Act of 1922 requires the Virgin Islands 

to administer the income tax laws in force in the United States as the ~irgin Islands territorial income tax, the so-called Virgin Islands ~irror" tax. In 1954, Congress enacted section 28(a) of the Revised 

Organic Act in order to allocate taxing responsiblities ~ith respect 
-82-

to persons who were "inhabitants" of the Virgin 

transfer additional revenues to the Virgin Islands. 

provides that: 

Islands and to 

Section 28 (a) ~n c 

" [inhabitants of the Virgin Islands] shall satisfy their income 

tax obligation$ under the taxing laws of the United States bY 

paying their tax on income from all sources both within and 

without the Virgin Islands into the Treasury of the Virgin 

Isl ands." 

In other words, Virgin Islands "inhabitants" are subject to Virgin 

Islands tax on their worldwide income and generally pay no tax to the 

United States, even on U.S. source income. "Inhabitants" of the 

Virgin Islands include U.S. citizens who are resident in the Virgin 

Islands as of the last day of their taxable year, corporations 

chartered in the Virgin Islands, and certain U.S. corporations which 

operate primarily in the Virgin Islands. 

ons 

ev Section 934(a), added to the Internal Revenue Code in 19601 er prohibits the Virgin Islands from granting relief, directly or ~d 

indirectly, from Virgin Islands income tax. However, an exception iS 

made under section 934 (b) with respect to non-u.s. source income of 

U.S. or Virgin Islands corporations that have derived at least 80 

percent of their gross income from Virgin Islands sources and at least 

50 percent of their gross income from the active conduct of a trade or 

business in the Virgin Islands during the three-year period preceding 

the close . of the taxable year (or applicable part of such period)· 

TEFRA increases the SO-percent active trade or business test to 65 

percent for taxable years beginning after December 31, 1984. The 

provision is phased in so that the required percentage of active tra~e 

or business income rises to 55 percent for taxable years beginning in 

1983 and to 60 percent for taxable ye ars beginning in 1984. 

The Virgin Islands has established an industrial incentive progra~ 

which provides tax rebates for corporations which meet the gross 

income tests of section 934 (b) and certain further · criteria. The 

principal requirements are that the corporation: 

(1) 

(2) 

( 3) 

( 4) 

invest at least $50,000, exclusive of 

Virgin Islands industry or business; 

inventory, in a 

agree in writing 

contracting to 

corporations; 

to give preference in employment and 

Virgin Islands residents and v. I· 

ob ta in approval from the Commissioner of Labor for the 

hiring of any nonresident workers; and 

conform to ecological standards established by Federal or 

local law. 

fir 

Om c. 

'l. v 

en 

en 

er 

the 

ene 

Or 

ts1 

l'ld 

ue"E 

11 

e .. 

(J 
-83-

:o 

a) In addition to these specific requirements, which must be met by 

n applicant for Virgin Islands tax relief, the Virgin Islands ~onsiders applications in light of the following general guidelines: 

ne 

~y 

d 

n 

~n 

e 

e 

(1) the extent to which the proposed enterprise may pollute 

the environment; 

(2) the applicant's requirements for utilities, social 

services, and other resources; 

( 3) the applicant's capacity to employ Virgin Islands 

resident labor; and 

(4) the proposed industry's compatibility with existing 

businesses in the Virgin Islands. 

Corporations which are beneficiaries of the V.I. Industrial 

, evelopment Program generally receive rebates of 7 5 percent or 90 

r ercent of income taxes paid, rebates of 90 percent of customs duties, 

s na;or 100 percent exemptions from the V.I. real property tax, gross 

f ·eceipts tax and/or excise tax. Rebates of income tax do not, 

o owever, apply to corporate tax on interest income, capital gains, and 

t ·ertain types of rental income. Any particular package of benefits is 

r ~egotiated between the applicant and the Virgin Islands Industrial 

g Jevelopment Commission. 

·5 ~. In general, the duration of a tax exemption grant is 10 years. A ~e ,lrm is allowed the option of determining when the tax benefits 

Jen ·~rnmence, provided they are initiated at some point during the first I tve years of business operations. An additional five years of 

Jene f i ts (or up to 1 O ye a r s at not more than 5 0 per cent o f the 

~~nef its) are granted to corporations which locate their plants in 

~ ~hrtain economically depressed areas. Moreover, any beneficiary under 

s ~ e Industrial Development Program may be granted a renewal of those 

e ~enefits subject to approval of the Governor of the Virgin Islands. A 

t

0 rporation which is deemed to be an "inhabitant" of the Virgin ~Slands within the meaning of section 28(a) of the Revised Organic Act 

a na which qualifies under Code section 934(b) and the Industrial ~evelopment Program for a rebate of 75 percent of income taxes, pays 

~i average effective corporate income tax rate in the Virgin Islands 

d approximately 10 percent. 

th B. Taxation of Dividends Received from Corporations Operating in 

~Virgin Islands. U.S. law generally imposes a 30 percent tax on 

e l e gross amount of dividends, interest, and certain other passive 

fnvestment income paid by U.S. persons to nonresident aliens and 

,~teign corporations when that income is not effectively connected 

r ~h~h the conduct of a u. S. trade or business by the foreign per son. 

ls 30 percent tax is often reduced or eliminated by income tax 

~~eaties, but the Virgin Islands is not a party to U.S. income tax ~ eaties. The Government of the Virgin Islands and the U.S. Internal s~"'enue Service take the position that the mirror system imposes a 

lrnilar 30 percent tax withheld at source on the gross amount of 

assive investment income paid from Virgin Islands sources to non-
-84-

· · 1 d · 1 d · 5/ s · · t by 

V1rg1n Is an s persons, inc u ing U.S. persons. _ A u .. rec1p1en tho

of passive investment income from the Virgin Islands can take a~erc 

foreign tax credit for any such tax against its U.S. tax liability, be 

but the amount of the credit is limited to the U.S. tax liability on are

foreign source net income. Therefore, the 30 percent tax on V. I· 

source gross passive investment income frequently results in such 

income being taxed at a higher rate than similar income earned by u.s. cor 

persons in the United States or foreign treaty countries. The Virgin 9

34

Islands cannot rebate this tax under section 934 (b) since the tax iS tsl

upon the u. S. recipient and not upon the corporations operating in the Of 

Virgin Islands. -in

To remove this disincentive to investment by U.S. persons in the 

Virgin Islands, Congress in December 1982 passed legislation adding a 

new section 934A to the Internal Revenue Code. This section reduces 

from 30 percent to 10 percent the rate of Virgin Islands tax imposed 

on payments of Virgin Islands source passive investment income to u.s. 

corporations, citizens and resident aliens. 6/ The Act allows the 

Virgin Islands, at its discretion, to use rebates to further reduce or 

eliminate this 10 percent rate. However, the Act continues the 30 

percent rate for dividends paid to U.S. persons out of earnings and 

profits accumulated during taxable years beginning before January 121 

1983. The Act treats dividends as first coming out of earnings and 

profits accumulated during taxable years beginning before January 121 

1983, so that the 10 percent tax rate on dividends received by u.S· 

persons will apply only after a corporation operating in the Virgin 

Islands has distributed all pre-1983 earnings and profits. 

Dividends received from a U.S. subsidiary operating in the Virgin 

Islands are eligible for the dividends-received deduction under 

section 243 of the Code. However, the United States does not allow a 

U.S. parent to take a dividends-received deduction for dividends paid 

~/ 

~/ 

The U.S. Court of Appeals for the Third Circuit cast doubt on thi 5 

interpretation of the mirror system. Viteo v. Government of~ 

Virgin Islands, 560 F. 2nd 180 (3rd Cir. 1977), cert. denied, 43d 

U.S. 180 (1978). However, the Report of the Committee on ways an 

Means on H.R. 7093 (Public Law 97-455), an Act to reduce the rate 

of the Virgin Islands tax from 30 percent to 10 percent 00 

payments to U.S. persons, states that, "The bill makes clear the 

Virgin Islands right both to impose the tax and to collect it bY 

requiring withholding." H.R. Rep No. 833, 97th Congress 2nd sesS· 

4 (1982). 

Public Law 97-455, section 1 (1983). 

~he 

-inJ 

lir< 

Cor

Sub 

div 

for 

~to 

u. s 

Con 

ava 

abo 

Cor 

Ot 

~to 

~et 

bus 

Ser 

beg 

'-

~I 
-85-

t by a subsidiary incorporated in the Virgin Islands. 7/ Thus, even 

n though the profits of a 934 (b) Virgin Islands subsidiary may be 75 

a Percent or 90 percent tax-free in the Virgin Islands, the profits will Y~ be subject to the normal u. S. corporate rate of income tax once they 

~.are repatriated. 

~h In 1980, the Internal Revenue Service ruled that a u.s.-chartered '~ Corporation which satisfied the 80-50 gross income tests under Section ts 934 (b), conducted all significant business operations in the Virgin 

he ts lands, held all shareholder meetings in the Virgin Islands, and all 

Qf whose officers were Virgin Islands residents, constituted an 

-inhabitant" of the Virgin Islands. 8/ The ruling does not make clear 

he ~hether all these conditions must be satisfied to qualify as an 

a ~inhabitant" of the Virgin Islands, and most U.S. investors in the 

es virgin Islands continue to operate through Virgin Islands-chartered 

ed Corporations. Thus, their income from the Virgin Islands becomes 

Subject to U.S. tax at the time it is repatriated in the form of 

S· dividends, and a foreign t~x credit is allowed (subject to the general ~~ foreign tax credit limitation) for taxes paid to the Virgin Islands. 

30 

d C. Allocation of Income Attributable to Intangibles. TEFRA ~tovides rules for the allocation of income from intangibles between a 

U.s. parent corporation and an affiliated U.S. 934 (b) corporation to 

Conform the tax benefits available to such corporations with those 

a'1ailable to possessions corporations. As explained in Chapter 2 · above, these rules permit a 936 corporation or a U.S. 934 (b) 

Corporation to compute its business income with respect to a product 

Qt type of service under the R&D cost-sharing method or the 50/50 

·n ~tofit split method. To qualify for either of these income allocation ~ethods, the 936 or 934 (b) corporation must meet a significant ~ business presence test in a possession with respect to the product or 

bervice. These provisions are generally effective for taxable years 

eginning after December 31, 1982. 

? • 

This follows from the treatment of Virgin Islands-chartered 

corporations as foreign corporations for purposes of U.S. income 

taxation. The general rule with respect to foreign corporations 

is that a U.S. corporate shareholder is allowed the dividendsreceived deduction only if 50 percent or more of the foreign 

corporation's income has been derived, for the 36 months (or 

lesser period that the corporation has been in existence) ending 

with the close of the taxable year in which the dividends are 

paid, from a U.S. trade or business, and in that case only to the 

extent of the corporation's U.S. effectively connected income. A 

corporation which met the so-called "80-50 gross income tests" 

required to be eligible for V.I. relief tax relief would not 

qualify for the deduction even with respect to dividends 

attributable to U.S. source income (Code section 245(a)). 

Revenue Ruling 80-40, 1980-2 C.B. 175. 
-86-

D. Characteristics of Corporations, Partnerships, and So~ 

Proprietorships Eligible for Virgin Islands Tax Rebates. Tables A-1 

and A-2 present data on assets, income, tax rebates, and employment 

for corporations and other entities which qualified in 1982 for income 

tax rebates under Code section 934(b) and the Virgin Islands 

Industrial Incentive Program (hereinafter referred to as 934(b) 

entities) • The tables cover accounting periods ending in calendar 

year 1982, and are based on income tax returns filed with the Virgin 

Islands. Tables A-1 and A-2 are based on the 40 active 934 (b) 

entities for which both balance sheet and income statement data are 

available. 

1. Assets, Income·, and Income Tax Benefits by Type of Entity. 

Table A-1 presents data on the assets, income, and income tax benefits 

of 934 (b) entities by type of entity. Of the 40 active 934 (b) 

entities for which data are available, 6 were Virgin Islands-chartered 

subsidiaries of U.S. corporations, and 30 were Virgin Islands 

corporations with no parent or Virgin Islands partnerships or sole 

proprietorships. The remaining four 934 (b) corporations were U. s ... chartered corporations. 

The 40 entities had assets of $1,464 million. Ninety-thr~e 

percent of these assets, or $1,360 million, were held by virg~n 

Islands subsidiaries of U.S. corporations. Locally controlled vir910 

Islands corporations, partnerships, and sole proprietorships accounte~ for an additional $66 million, or 5 percent, of the total assets 0 

934(b) entities; and the remainder, or 2 percent, were u.s.-chartered 

companies. 

Net plant and equipment of 934(b) entities (shown in Table A-1 a~ 

net depreciable assets) were $406 million, or 27. 7 percent of to ta 

assets. The share of net depreciable assets in total assets was m?': 

than twice as large in 934 (b) entities as in 936 manufactur~nq 

corporations. The comparable figure for 936 manufacturin 

corporations was 11. 8 percent, as shown in Table 4-1, ·above. 

Ninety-four percent of the net plant and equipment of 934(b) 

entities belonged to Virgin Islands subsidiaries of U.S. companieSt 

Virgin Islands subsidiaries of U.S. companies also accounted for m05

1 (approximately 99 percent) of the $5. 2 billion in 934 (b) tota 

receipts. 

Business receipts provided 91 percent of the gross receipts ~ 934 (b) entities. Information on nongovernment interest and oth~e investment income of 934 (b) corporations is not available, but ;at 

high share of business receipts in total receipts suggests t re 

passive investment income represents a relatively insignificant shads 

of the income of 934(b) entities. As noted above, the Virgin rsla~al 

Industrial Development Program, unlike the Puerto Rican Industr 1

00 Incentive Acts, does not provide relief from tax on interest a 

certain other kinds of passive investment income. 
'::3~0...'°'~";S"«>O 

ea ....... ~~~~-~ 

Table A-1 

934(b) Corporations in the Virgin tslands - Selected Balance Sheet and Income Statement 

Items and Tax Benefits by Type of Corporation, 1982 

(Dollar amounts in thousands) 

All V. I. Corporations : V.I. Corporations 

Entities with a u.s. Parent with No Parent, 

:V. I. Partnerships ' I 

:Sole Pro2rietorshi2s1 

Nu•ber of corporations 40 6 30 

Total assets 1,464,316 1,360,471 65,866 

Inventories 490,333 482,175 6,480 

Depreciable assets 871,558 834 ,824 JO, 719 

Accuaulated depreciation 465,619 454,662 9, 777 

Net depreciable assets 406,485 380,262 21,389 

Total receipts 5,185,170 5,121,441 49,869 

Business receipts 4,732,162 4,675,086 45,275 

All other receipts 453,008 446, 355 4, 594 

Total deduction• 4,865,551 4,805,555 46,919 

cost of sales and operations 4,582,798 4,548,572 28,017 

All other deductions 282,753 256,983 18,902 

Taxable incoae 319, 619 315,886 2,950 

Virgin Islands lncoae tax rebates 8,333 4,247 1, 772 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

!I Rebates may exceed taxable income due to losses, as the taxable income figure is net of loss. 

u.s. Corporations 

4 

37,979 

1,678 

6,015 

1,181 

4,834 

13,860 

11,801 00 ' 

-.....J 2,059 ' 

13,077 

6,209 

6,868 

783 

2,315 y 
-88-

Taxable income equals the difference between total receipts and 

total (current} deductions, less net operating loss carryovers and 

certain special deductions for dividends received. The combined 

taxable income of the 40 entities shown in the table amounted to 

approximately $320 million, of which Virgin Islands subsidiaries of 

U.S. corporations reported $316 million, u.s.-chartered firms $1 

million, and locally-controlled V.I. entities $3 million. 

Virgin Islands income tax rebates due, which represented in most 

cases 75 or 90 percent of income taxes paid, were estimated to be 

about $8 million. u.s.-controlled Virgin Islands firms accrued 

somewhat more than $4 million in tax rebates for 1982, while Virgin 

Islands entities with no parent and U.S. corporations each accrued 

approximately $2 million in tax rebates. 

2. Assets, Income, and Tax Rebates by Industry. Table A-2 covers 

the same entities as Table A-1, but presents the asset, income, and 

tax benefit data by industry. 

Eight corporations in the chemical industry accounted for 77 

percent of all net plant and equipment and 95 percent of the combined 

net income of 934 (b} entities. These 8 corporations accrued ta~ 

rebates of slightly less than $3 million, or 35 percent of the Virgin 

Islands income tax rebates for all ind us tries. Some of these 

companies had been listed under the category "Petroleum refinin9 1 

alumina processing and concrete products" in the previous report. 

Other 934(b} firms with substantial plant and equipment were 

hotels, with almost $32 million in net depreciable assets. The 

fifteen 934 (b) hotels reported less than one million of taxable 

income, net of losses, in 1982. 

The manufacture of other goods, including watches, was another 

principal activity of 934 (b) firms in 1982. The 10 Virgin Island5 

manufacturers reported $4 million in net plant and equipment and 

earned almost $32 million in business receipts. These industry firm~ 

reported aggregate taxable income of nearly $11 million and accrue 

over $4 million in income tax rebates. 
Table A-2 

\U 1 \U 0 \Jl 

n.'=:l n.ro rt 

934(b) Corporations in the Virgin Islands - Selected Balance Sheet and Income Statement Items 

and Tax Benefits by Industry, 1982 

(Dollar amounts in thousands) 

All Chemicals Watches Other Hotels Other 

Industries Manufacturing Services 

Number of Corporations 40 8 3 7 15 7 

Total Assets 1,464,316 1,284,773 4, 132 55,461 50, 4 73 69,477 

Inventories 490,333 483,846 604 4,902 619 361 

Depreciable assets 871, 558 741,407 180 6,606 44,510 78,854 

Accumulated depreciation 465,619 429,734 113 2,670 12,668 20 I 434 

Net depreciable assets 406,485 312,120 67 3,936 31,842 58,520 

Total Recei12ts 5,185,170 5,081,906 4,135 28,541 35,089 35,500 

Business receipts 4,732,162 4,633,893 4,123 27,468 31,908 34 I 171 

All other receipts 453,008 448,014 12 1, 073 3,181 729 

Total Deductions 4,865,551 4,776,638 3,841 18I114 34,374 32,583 

Cost of sales and 

operations 4,582,798 4,558,145 3,539 13, 628 6,601 884 

All other deductions 282,753 218,493 302 4,486 27,773 31, 699 

Taxable income 319,619 305,268 293 10,427 715 2,916 

V. I. income tax rebates 8,333 2,915 8 4,227 859 !I 324 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

!/ Rebates may exceed taxable income due to losses, as the taxable income figure is net of loss. 

I 

00 

"° I 
-91-

Appendix B 

Possessions Corporations in Tax Year 1981 

This appendix presents data on the assets, income, and tax 

benefits of all possessions corporations in tax year 1981, which 

includes accounting periods ending between July 1, 1981, and June 30, 

1982. Tax year 1981 corresponds closely to the calendar year because 

most possessions corporations have calendar year accounting periods. 

Tables B-1 through B-3A below are similar to Tables 4-1 through 4-4 in 

the text, covering tax year 1982. However, these tables include all 

of the returns filed for 1981, whereas those in Tables 4-1 through 4-4 

exclude some returns filed after the cut-off date. 

It is estimated that in tax year 1981 the tax benefits provided 

under section 936 were $1.7 billion, up from $1.3 billion for tax year 

1980. The net income of possessions corporations in manufacturing 

tose 30 percent between , 1980 and 1981, compared to a 19 percent 

increase in manufacturing profits in the U.S. The increase was 

Particularly strong in electrical and electronic equipment, where 

Profits rose 40 percent. The profits of the pharmaceutical industry 

tose 34 percent in this period. l/ 

I. Assets and Income in 1981 

A. Assets. Table B-1 shows that at year-end 1981, the book value 

of the total assets of possessions corporations was $20.1 billion, of 

which $15.2 billion were held in manufacturing industries. Net plant 

and equipment of 936 manufacturing firms amounted to $1.9 billion at 

Year-end 1981. 

B. Retained Earnings. At the end of tax year 1981, possessions 

companies reported $12.6 billion of retained earnings on their balance 

Sheets, with 97 percent of these held by manufacturing companies. 

~early half, or $5.5 billion, was held by pharmaceuticals. The 

electrical and electronics industries held $2.8 billion in retained 

earnings. For all manufacturing possessions corporations, retained 

earnings represented 80 percent of total liabilities and stockholders' 

equity. The comparable figure for manufacturing corporations 

Operating in the U.S. was 37 percent. ~/ 

c. Total Receipts. Table B-2 shows that the total receipts of 

manufacturing possessions corporations were $12. 5 billion in 1981. 

~inety-four percent of total receipts was attributable to business 

teceipts, and the remainder was attributable primarily to interest, 

l! For data on possessions corporations in 1980, see Table 4-9, page 

5 3. 

~/ Federal Trade Commission, Quarter!~ Financial Report, First 

Quarter, 1982. 
Table B-1 

Selects! Balance Sheet tnfonmtion by ln!uatry, 1981 

(Dollar mKU'lta in thousands) 

All 

: Manufactur il'IJ : FOOd ' tdliJraJ 

Manufacturl!!f Industries 

tn!uatriee : Textile Mill : Appl!l l : Paper a.nlciia 

'ft>tal Products Products : re 'ft>tai :ifiaonaceutlcala: Ali Ot:Fiir 

lblt.r of coqmratlona 635 497 26 1 78 5 85 56 29 

'lbtal Aaet• 20,101,014 15,166,013 1,186,524 74,169 Ul,955 13,359 7,533,037 6,639,m 893,260 

calh 3,069,282 2,673,295 2n,902 2,281 47,645 881 1,141,836 1,088,741 53,0M 

Accomt• receivable 3,132,321 2,705,491 256,642 14,508 177,433 5,268 1,155,143 813,0ll 342,111 

Inventories 1,739,695 1,604,881 215,913 6,561 56,961 4,190 511,307 391,229 120,078 

u.s. GoYerment obligations 426,815 415,447 0 0 745 0 274,800 262,957 11,843 

State am local cbligationa 116,657 116,658 0 0 223 0 76,025 38,859 37,165 

other current asaeta 1,102,824 822,825 7,785 878 9,837 18 362,275 352,579 9,696 

Mortgage ' r•l estate loma 2,051,074 130,620 0 0 624 0 51,251 51,251 0 

other investments 4,574,251 3,943,964 78,118 45,734 92,407 0 2,381,403 2,341,325 40,078 

Depreciable Aaets 4,234,246 2,873,711 293,193 10,705 50,269 3,9t6 1,561,061 1,028,181 532,880 

less: ~latfd depreciation 1,372,145 1,012,426 92,318 6,598 25,176 1,303 530,102 241,483 288,618 I 

Net depreciable asaeta 2,862,100 1,861,285 200,874 4,106 25,093 2,643 l,030,959 786,697 244,261 \0 

Other assets 1,025,980 891,542 149,288 96 20,981 357 st8,034 513,102 34,931 N 

I 

'lbtal LtablUtiee and Stockholders' !!!1~ 

Accolmts payable 1,423,517 867,696 96,857 2,763 51,266 2,155 276,617 208,952 67,664 

R>tes payable in less than 1 year 245,523 130,784 26,307 13,461 2,513 874 37,189 35,764 1,425 . 

other current liabilities 2,307,482 316,565 48,976 1,170 13,517 148 105,481 96,496 8,984 

lt>tes payable in 1 year or mre 744,835 275,894 26,318 469 3,649 0 200,672 195,404 5,268 

other liabilities 689,454 221,083 35,009 766 4,359 2,848 90,883 72,394 18,489 

Ospital stock 2,131,234 1,225,690 96,499 729 21,073 1,475 705,010 513,901 191,109 

Retained earnings, tot.al 12,558,958 12,128,299 856,556 54,807 335,576 5,857 6,117,181 5,516,863 600,318 

Appropriated 492,566 433,681 0 0 0 0 397,280 20,007 377,273 

lhawropriat:a! 12,066,392 U,694,617 856,556 st,807 335,576 5,857 5,719,901 5,4~,856 223,otS 
Table B-1 - continued 

ManufacturI Iiiiustrles - continued 

ROOber : Leather am ! Stone, Clay, & : Fabricata3 : Machinery, Electr ca nstr\llenta : All other 

: Products Leather 

; Glass Products • Except Electronic and Related Manufacturing Producta : Metal Products • El t i • • ec r ca 1 !J!!ipnent Products 

tbnber of corporatlona 10 16 10 27 11 120 42 60 

'lbtal As8etll 56,720 108,567 46,601 215, 780 262,055 3,230,795 739,088 1,267,358 \ 

cam 4,635 23,868 3,068 32,494 26,960 808,849 132,962 169,909 

Accowlta re::elvable 19,159 29,079 24,832 37,177 31,952 551,222 140,566 262,sot 

Inventory 5,966 17,051 6,158 31,309 U,216 392,798 63,853 249,591 

u.s. Goverment obllgatlona 0 2,929 0 0 4,986 109,832 17,771 4,380 

State am local cbllgatlone 0 17,012 0 0 18,412 983 0 4,000 

Other currmt assets 546 510 506 17,172 9,941 285,867 13,301 114,182 

MortxJ-.ie' ~l estate loma 0 0 0 0 0 74,533 3,897 312 

Other investments 6,778 13,028 9,574 34,130 105,300 722,360 244,592 210,535 

Depreciable aaeeta 25,686 10,776 7,782 72,264 26,528 400,492 105,482 305,521 

Cesa: AccullulataJ depreciation 7,289 5,883 5,657 18,687 7,780 153,923 28,947 128, 757 

Net depreciable asaets 18,397 4,893 2,125 53,577 18,747 246,568 76,535 176, 763 I 

\0 

Other aaaeta 1,236 193 335 9,917 2,536 37,778 45,607 75,179 w 

I 

~tal Liabilities and Stockholders' ftlui~ 

Accotmta payable 2,574 6,972 1,978 18,562 12,163 143,114 60,773 191,896 

tbtes payable in less than 1 year 4,961 548 216 1,111 11,090 10,025 5,904 16,579 

Other current liabilities 2,653 1,813 795 4,793 6,315 74, 780 17,894 38,224 

tbtes payable In 1 year or more 452 1,357 67 3,738 65 14,601 2,513 21,988 

Other liabilities 1,138 1,325 2,245 577 6,126 50,396 5,466 19,939 

capital stock 10,699 577 3,226 32,865 7,696 108,944 67,211 169,681 · 

Aet.ained earnings, total 34,240 95,973 38,070 154,131 218,597 2,828,932 579,325 809,047 

Appropriata:! 1,885 0 2,118 409 1,480 13, 745 6,201 10,559 

tl'lappr<>Pr:tab!d 32,354 95,973 35,952 153, 721 217,116 2,815,186 573.124 798,487 
tbnnanur f acturirJJ 

Total 

a.her of corporations 138 

'lbtal Assets 4,935,001 

Cash 395,986 

Aa:.-omlt• receivable 426,829 

Invmtory 134,814 

u.s. Governnent obligations 11,368 

State am local obligations 0 

Other current asaets 279,998 

~rbjage' r•l estate loans 1,920,454 

Other investments 630,287 

Depreciable uaeta 1,360,534 

l:eS8: ~at:ad depreciation 359,719 

Net depreciable aaaets 1,000,815 

Other asaeta 134,438 

'lbtal Liabilities am Stockholders' !)uity 

Accotmta payable 555,821 

tt>tea payable in less than 1 year 114, 739 

other current Uabili ties 1,990,916 

tt>tes payable in 1 year or more 468,940 

other liabilities 468,371 

Capital &,tock 905,543 

Retained earnilJ)s, total 430,659 

Appropr iat:ad 58,884 

lhappro1Eiat8' 371, 775 

Off Ice of the secretary 

Off ice of Tax Analyaia 

'ntble B-1 - continued 

Transportation 

NonnanufacturI!!I 

Constrtrtion : Ccnmunications : Wholesale Trade 

and Utilities 

7 5 25 

41,910 872,712 476,364 

4,121 13,431 63,156 

3,886 41,970 45,599 

8,840 15,803 75,483 

0 573 352 

0 0 0 

409 4,641 1,420 

16 0 0 

2,384 10,317 167,421 

6,790 1,000,687 185,659 

2,397 231, 707 74,675 

4,393 768,979 110,984 

17,858 16,994 11,946 

4,494 J7,4n 16,919 

19,258 6,379 2,238 

933 29,354 4,055 

7,423 113,514 390 

200 78 3,633 

2,755 674,942 131,422 

6,845 10,965 317,704 

753 7,497 0 

6,091 3,468 317,704 

- a - - s::::us M 0 ;:J ~· llJ 

Hncn:i 

- -- ('() tr '"O tr -{/) ;:J ..a llJ 0 OJ 1--' ~ r: ~ en >< 

Industries 

: 

: Retail Trme 

42 

139,919 

8,731 

7,070 

29,561 

30 

0 

16,519 

0 

21,656 

72,010 

29,320 

42,689 

13,659 

51,883 

5,452 

2,594 

24,631 

2,699 

15,776 

36,881 

7,178 

29,702 

'"O '"O ~ ,....,, rt 

<D <D ~· 0 <D 

HHrt'HO 

Pinance, 

Insurance, 

Real nltate 

26 

3,335,863 

298,371 

31'0,994 

0 

10,413 

0 

255,903 

1,920,439 

419,588 

66,734 

11,036 

55,698 

64,455 

432,259 

74,230 

1,949,633 

318,420 

457,'46 

63,786 

40,087 

43,456 

-3,369 

Other Services 

ard Irdustry 

tbt Re~rted 

33 

68,231 

8,174 

17,307 

5,125 

0 

0 

1,103 

0 

8,919 

28,653 

10,582 

18,070 

9,523 

12,787 

7,180 

4,344 

4,559 

4,314 

16,860 

18,175 

0 

18,175 

'O ,_.. 'O c.a ,_.. O::JCO::J 

en H < n 

I 

\0 

+--

I 
-95-

including QPSII. Interest on Puerto Rican and state and local 

government securities is excluded from gross income for Federal tax 

Purposes and, therefore, is not included in the total receipts shown 

in Table B-2. The amount of such excluded interest income reported by 

Possessions corporations in tax year 1981 was $17.4 million. 

The pharmaceutical industry accounted for 28 percent of the 

business receipts of all possessions manufacturing firms. After 

Pharmaceuticals, the industries with the greatest business receipts 

were electrical and electronic equipment (with 21 percent), and food 

Products (with 11 percent). 

D. Net Income per Tax Return. Net income per return (total 

teceipts minus total deductions on Table B-2) amounted to $4.1 billion 

for all possessions corporations in manufacturing. The industries 

~ith the greatest amount of net income were pharmaceuticals, with 46 

Percent of the total, and electrical and electronic equipment, with 26 

Percent of the total. 

E. Reduction in U.S. Tax Liability. Table B-2 shows that U.S. 

tax liabilities were reduced by $1,711 million in tax year 1981 by the 

Possessions corporation system. The pharmaceutical industry obtained 

tax benefits of $792 million, and the electrical and electronic 

~quipment industry obtained tax benefits of $433 million. Other 

industries which obtained substantial tax benefits were food products 

($113 million) and instruments ($98 million). 

F. Distributions. The final line of Table B-2 shows that 

~anufacturing possessions corporations reported $1,692 million of 

distributions. These distributions represented 41 percent of net 

income. Approximately one-half of the distributions by manufacturing 

corporations were attributable to the pharmaceutical industry. 

lI. Payroll and Employment in 1981 

Table B-3 provides an industry-by-industry comparison of 936 tax 

benefits per employee and as a percent of industry compensation. 

~able B-3 is based on all possessions firms in the manufacturing 

Sector for which 1981 employment and payroll data could be obtained 

ftom the companies' Federal unemployment insurance tax returns. The 

376 corporations included in the table represent 76 percent of the 

number and 80 percent of the net income of the manufacturing 

Corporations included in Tables B-1 and B-2. 

Table B-3 shows that, based on those 376 manufacturing firms the 

~ederal tax benefits per employee in Puerto Rico for all manufacturing 

~orporations are estimated to have averaged $18,007. Tax benefits per 

~tnployee, or as a percentage of total employee compensation, varied 

~Ubstantially from industry to industry. In the pharmaceutical 

tnaustry, the average Federal tax benefits amounted to $62,078 per 

~tnployee, or more than triple the average compensation of the 
Table B-2 

Selected Incane statanent: Inf0Dn11tion ard Tu Bl!nefit• by In!uatry, 1981 

(Dollar arnomta in t:homands) 

All '111nufac- : FOOd , Klnfrai +eitlle 

J1anulacturl!!l Iii!llBtrles 

Irduatri• z : ~el~ Alper a..lcil• 

:turi!!CJ 'l\:>tal: Products s Mi 11 Products 'n>tal :nlamaceutlcala: ill ot:Fier 

amber of corp>ratlom 635 497 26 7 78 5 85 56 29 

'lbtal r.,.i~ 14, 770,300 12,473,198 1,364,715 66,833 525,365 23,436 4,534,289 3,'59,603 174,615 

a.l~ recetpta 13,382, 732 ll,662,9H 1,307,666 64,963 509,495 23,180 4,120,956 J,2'0,401 860,555 

lbl)CM!l'mmt intm:eet 963,443 674,409 47,691 1,697 12,194 246 331,276 318,741 12,535 

other r..-eipt• 424,125 135,844 9,357 172 3,675 10 82,055 80,461 1,593 I 

'lbtal dal!actlane 10,553,788 1,372,637 1,091,742 62,167 452,126 21,401 2,511,716 1,791,911 nt,167 ()\ '° 

• I 

0>8t of Ml• 7,193,484 6,521,170 862,034 52,883 384, 753 19,145 1,623,501 913,736 639,115 

D!prectatlon 227,332 141,375 U,895 955 2, 727 257 66,926 44,870 22,056 

All other detuetlane 2,U2,971 1,710,091 214,812 8,328 38,345 1,998 821,357 763,312 58,045 

91tlmtel! •t lncme 2!! return 4,216,511 4,100,561 272,972 4,665 99,538 2,035 2,022,503 1,867,684 154,118 

llltS-t-' net lncme 2!!: boolal 4,013,782 3,922,218 262,414 3,654 96,579 1,998 1,952,998 1,824,JOI 128,691 

All!uetlon In u.s. tax Ulblll~ 1,711,352 1,711,352 113,H4 1,275 40,459 852 853,ot9 791,535 61,514 

Dlstributlom 1,800,787 1,692,443 135,169 403 Sl,853 610 984,491 906,6'6 77,825 
Table B-2 - continued 

Aiinul'actur I l~ustrles - contlnuec! 

: Rubber : teat a Stone, ay : Fabr cat:m : Electr c a Instrments All other ! Products Leather : and Glass Metal Electronic and Related : Manufactur Ing I Products Products : Products ftluipnent Products 

tlaber of corporatlom 10 16 10 27 11 120 42 60 

'ft>tal recei~ 64,885 117,678 44,324 164,190 269,654 2,647, 755 556,585 2,093,483 

a.tnem receipt. 62,455 113,450 42,122 153,900 257,655 2,447,631 514,697 2,044,767 

Non)cwernnent intereat 769 3,182 271 4,634 11,665 192,836 33,316 34,626 

Other receipt. 1,660 1,045 1,930 5,655 333 7,287 8,570 14,090 

'ft>tal da!ur:tiam 47, 791 92,980 37,085 121,482 191,433 1,598,705 326,804 1,843,429 

O>st of eal• 38,974 83,814 31,560 107,895 163,087 1,308,696 237,548 1,607,273 I 

Depre::iation 875 933 540 3,277 2,64J. 24,475 6, 735 16,132 \O · 

-.......J All other ded~OM 7,941 8,232 4,984 10,309 25, 704 265,532 82,519 220,023 I 

lltlmta! net lncme ~ return 17,094 24,697 7,238 42,708 78,221 1,049,049 229,780 250,053 

lltbaata! net tncme 2!! books 17,854 26,689 7,222 41,685 75,166 983,861 222,069 230,022 

Reduction In U.S. tu UabiU~ 7,027 10, 767 3,357 16, 799 33,725 433,059 98,006 99,527 

DiatdbutiOM 11,389 6,025 589 20,865 29,848 280,660 n,m 98,636 
Table B-2 - continued 

NonnanufacturI Industries 

tt>n-Manu- . : Transportation F nance, . . . tv oes 

facturing : Constru:tlon : Contn.micatlons : Wholesale Trade : Retail Trade : Insurance, : and Industry 

Total : and utilities : Real Dltate : tt>t Reported 

lbDber of corporatlona 138 7 5 25 42 26 33 

'lbtal Receipt• 2,297,102 32,699 285,593 1,019,795 485,240 379,730 94,043 

aminess receipta 1,719,788 29,550 37,188 993,452 482,829 94,606 82,160 

tbl)overnnent interest 289,033 678 2,357 23,155 1,452 261,032 357 

Other receipts 288,280 2,470 246,047 3,187 958 24,091 11,525 

'lbtal Dadur:tlona 2,181,151 27,407 238,089 934,649 477,731 416,257 87,015 

O>st of •l• 1,372,314 24,251 .39,696 877,324 363,228 16,334 51,479 

Depreciation 85,956 714 67,998 6,536 4,916 3,573 2,216 I 

All other da!uctiona 722,880 2,440 130,394 50,788 109,586 396,349 33,319 \0 

00 

I 

Bltbmte! net l1'1C09 J!!r return 115,950 5,292 47,503 85,145 7,509 -36,527 7,026 

P.lltbMtm net lncam l'!.! books 91,564 3,371 46,298 69,245 3,934 -38,909 7,623 

Reduction in u.s. tax liabllitf 0 0 0 0 0 0 0 

Dlatr ibutlorw 108,344 1,024 46,880 56,081 387 490 3,479 

Of flee of the Secretary 

Off ice of Tu Analysis 

n.b1.e ~3 

Tax Benefits, Snplo}'IDE!llt, and carpensation of .Brployees by Iooustry, 1981 
'nlb1.e B;-3 

r.tx Benefits, Snplo}ment, am Corpensation of Btployees by Industry, 1981 

Quallf1ed Tax Benefits F.q>loyees Canpensat1on tbnber of Possession : of &nelO)leeS 2/ Tax Benefits Average Tax Benefits 

:Corporations Net Incane -Amo:---un-.t~: Pe::--r-cen~t=--o_,f,......------==Pe,_.r-cen-...-t-o-f"'":~1mo...;;;..:;;.un--=;t~:.;;.Pe~r:;:cen:.....;::;'-t-o_,f.,.:.. per Enployee Enployee as a Percent 

($000) 1/ ($000) : Total lbnber Total : ($000) Total ($) Cmlpensation canpensation 

($) of Employees 

All Manufacturing Industries 

Food aoo kioored products 

Textile mill products 

Apparel 

376 3,297,876 

155,318 

1,430,322 100.0 72,543 100.0 964,040 100.0 18,007 y 

8,073 

13,059 y 137.9 y 

Men's and boys' 

wanen•s aoo children's 

Hats, caps, etc. 

All other 

Olenicals 

Iooustrial chanicals 

Pharmaceuticals 

Soaps, cleaners, etc. 

All other 

Rubber aoo plastic products 

Leather 

Footwear 

All other 

Stone, clay, and glass 

Fabricated metal products 

Metal cans and containers 

OJtlery, hand tools, 

17 

4 

66 

17 

27 

12 

10 

67 

8 

44 

8 

7 

8 

12 

7 

5 

5 

17 

4 

screws, bolts 3 

All other 10 

Machinery, except electrical 9 

Electrical aoo electronic 

equipnent 

Radio, TV, carmunication 

Electronic canponents 

All other 

Transportation equipnent 

Instr\ll\eOtS aoo related 

94 

11 

27 

56 

5 

products 34 

Scientific instr\11lel'lts 11 

All other 23 

All other manufacturing 4/ 38 

314 

87,976 

20,495 

40,374 

9,265 

17,842 

1,748,717 

97,004 

1,605,939 

37,478 

8,296 

12,977 

18,342 

15,122 

3,220 

5,418 

27,009 

8,632 

5,205 

13,172 

56,250 

824,631 

91,911 

i58, 769 

573,952 

8,432 

199,049 

26,322 

172, 727 

153,443 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

* IA!SS than 0.5t 

67,762 4.7 8,393 11.6 109,930 11.4 

157 * 204 * 1,878 * 

37,746 2.6 14,892 20.5 139,041 14.4 

7,904 .6 4,639 6.4 46,926 4.9 

17,474 1.2 6,838 9.4 61,288 6.4 

4,297 * 1,485 2.0 13,346 1.4 

8,071 .6 1,930 2.7 17,481 1.8 

755,981 52.9 14,015 19.3 259,572 26.9 

38,284 2.7 1,765 2.4 44,590 4.6 

698,013 48.8 11,244 15.5 201,745 20.9 

16,110 1.1 803 1.1 10,933 1.1 

3,574 * 203 * 2,304 • 5,271 • 1,001 1.4 10,422 1:1 

7,969 .6 2,358 3.3 21,107 2.2 

6,596 .5 2,015 2.8 17,857 1.9 

1,373 * 343 .5 3,250 * 

2,373 • 286 * 4,634 .5 

11,696 .8 1,193 1.6 17,048 1.8 

3,533 * 257 • 3,639 

2,311 * 

5,852 • 

23,797 1.7 

362,064 25.3 

39,454 2.8 

71,535 5.0 

251,075 17.6 

3,801 • 

86,987 6.1 

11, 719 .8 

75,268 5.3 

64,718 4.5 

349 

587 

1,956 

18,166 

3,537 

3,097 

11,532 

596 

5,246 

682 

4,564 

4,237 

.5 

.8 

2.7 

25.0 

4.9 

4.3 

15.9 

.0 

7.2 

.9 

6.3 

5.8 

4,356 

9,053 

25,456 

237,658 

41,379 

36,998 

159,281 

6,465 

69,484 

7,650 

61,834 

61,345 

• 

.5 

.9 

2.6 

24.7 

4.3 

3.8 

16.5 

.7 

7.2 

.8 

6.4 

6.4 

769 

2,534 

1,703 

2,555 

2,893 

4,181 

53,940 

21,690 

62,078 

20,062 

17,605 

5,265 

3,379 

3,273 

4,002 

8,297 

9,803 

13,747 

6,621 

9,969 

12,166 

19,930 

11,154 

23,098 

21,772 

6,377 

16,581 

17,183 

16,491 

15,274 

13,097 

9,205 

9,336 

10,115 

8,962 

8,987 

9,057 

18,521 

25,263 

17,942 

13,615 

11,349 

10,411 

8,951 

8,862 

9,475 

16,202 

14,290 

14,159 

12,481 

15,422 

13,014 

13,082 

11,698 

11,946 

13,812 

10,847 

13,245 

11,217 

13,548 

14,478 

y Bquals net incaae fran the active conduct of a trade or business 

in a possession plus net qualified possession source invesbnent 

inoane. 

y Conpensation of enployees and nmiler of eaployees used to oonpJte 

these anounts were weighted, by industry, by using the ratio of 

income in Table B-2 to income in this Table. The unweighted 

figures are the following: tax benefits per eaployee, $19, 716 

average enployee catp!rlSation, $13,2891 and tax benefits as a percent of coopensation, 148.4'. '11le 1982 data in Chapter 4 have 

been weighted by cost of goods sold rather than income. The 

former gives a better measure of employment; however the necessary 

data were not available with which to revise the 1981 estimates. 

y Compensation of enployees was oonputed by DJltiplying 1.234 times 

payroll. '!he 23.4 percent reflects the enployer-paid portion of 

social security, Ul'lE!llployment insurance, and other non-payroll 

costs. 'lbe 23.4 percent is the average for all U.S. manufacturing 

industries in 1981. Source: U.S. Deparbnent of Coamerce, survey 

of OJrrent Business, July 1983, Tables 6.58 and 6.68. 

y Inclldes manufacturing industries where data were available for 

fewer than 3 corporations. 

61.6 

8.4 

27.l 

16.8 

28.5 

32.2 

46.2 

291.2 

85.9 

346.0 

147.4 

155.l 

50.6 

37.8 

36.9 

42.2 

51.2 

68.6 

97.l 

53.l 

64.6 

93.5 

152.3 

95.3 

193.3 

157.6 

58.8 

125.2 

153.2 

121.7 

105.5 

I 

\0 

\0 

I 
-100-

comparatively well-paid Puerto Rican pharmaceutical employee. In the 

electrical and electronics industry, the average tax benefits amounted 

to $19,930 per employee, or 152 percent of average compensation. The 

industries where average tax benefits per employee were lowest were 

textiles and apparel. The sixty-six apparel firms included in Table 

B-3 provided 20 percent of the total employment and received, on 

average, $2,534 in tax benefits per employee. 

Table B-4 is based on the same 376 possessions corporations shown 

in Table B-3, but ranked according to the Federal tax benefits per 

employee. At the top of the ranking are 19 companies for which the 

U.S. tax benefits under section 936 represented more than $100,000 per 

employee in Puerto Rico. At the low end are companies which incurred 

losses and thus claimed no immediate tax benefit from section 936. 

The top 19 possessions corporations in this table accounted for 25 

percent of the tax benefits under section 936 but provided only 3 

percent of the employment of the 336 manufacturing companies. The top 

41 possessions corporations, those for which tax savings per employee 

were at least $50,000 in 1981, collectively accounted for 46 percent 

of the total tax benefits and 9 percent of total employment. 
.. __ .. __ 

... - --- -- ~ 

' 

' 

Table B-4 

Tax Benefits, Bnplo)ll'Oent, and Cmtpensation of Bnployees 

By Si7.e of Tax Benefits Per Employee, 1981 

()Jallfied Tax Benefits Bnployees Total Cmtpensation Average Tax Benefits 

NlJnber of Possession of Bnployees 2/ Tax Benefits Bnployee as a Percent of 

Returns Net Incane lm:>unt ,Percent of tbnbe I Percent of lm:>unt J Percent of per Bnployee Cmtpensation Cmtpensation 

($000) 1/ ($000) Total r Total ($000) Total ($) ($) of Employees 

All Kmufactur ing 

Corporations 376 3,297,875 1,430,322 100.0 72,543 100.0 964,040 100.0 18,007 y 13,059 y 137.9 y 

$100,000 or more 19 815,305 352,165 24.6 2,196 3.0 40,620 4.2 160,366 18,497 867.0 

$ 50,000 under $100,000 22 687,322 300,278 21.0 4,180 5.8 76,241 7.9 71,836 18,239 393.9 

$ 10,000 under $ 50,000 140 1,465,716 629,245 44.0 26,083 36.0 410,511 42.6 24,124 15,738 153.3 

$ 5,000 under $ 10,000 49 174,320 73,482 5.1 10,240 14.1 130,619 13.5 7,175 12,755 56.3 

I 

$ 1,000 under $ 5,000 92 173,654 72,828 5.1 23,074 31.8 232,817 24.2 3,156 10,090 31.3 ...... 

0 

$ 500 under $ 1,000 16 4,629 1,643 * 1,976 2.7 21,676 2.2 831 10,969 7.6 ...... 

$ 100 under $ 500 14 2,613 657 * 2,266 I 

3.1 21,256 2.2 289 9,380 3.1 

$ 1 under $ 100 3 126 24 * 629 * 5,455 .6 38 8,672 * 

No tax benefits 21 -25,792 0 0 1,899 2.6 24,845 2.6 0 13,083 0 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

* Less than o.5t 

y B:Juals net incane fran the active condu::t of a trade or business in a possession plus net qualified possession source invesbnent incane. 

y Compensation of enployees was canputed by multiplying 1.234 times payroll. '!be 23.4 percent reflects the anployer-paid portion of social security, 

unanployment insurance, and other non-payroll costs. '!be 23.4 percent is the average for all U.S. manufacturing industries in 1981. Source: u.s. 

Department of Ccmnerce, &Jrvey of Olrrent Business, Tables 6.58 and 6.68. 

y Compensation of employees and n\11\ber of enployees used to canpute these anounts were weighted, by iooustry, by using the ratio of incane in Table S-2 to 

incane in Table S-3. 
Coverage 

-103-

Appendix C 

Sources and Limitations of the Data 

on Possessions Corporations 

The data in Chapter 4 on possessions corporations for tax year 

1982 and the data in Appendix B for tax year 1981 include corporations 

Which filed full year possessions corporation returns within 12 months 

of the end of the tax year. However, the more detailed data in Tables 

4-1 through 4-4 for 1982 cover only those corporations which filed as 

possessions corporations within seven months of the tax year (522 of 

the estimated total of 554 corporations.) Figures for all years prior 

to 1981 (e.g., those in Table 4-7) have also been revised to include 

corporations which filed as possessions corporations within 12 months 

of the end of the tax year. The data in Tables 4-9 and 4-11 are based 

on all corporations that either excluded income under section 931 in 

one or more of the years 1973, 1974, 1975 and 1976, or have made an 

election under section 936. 

Income Statement and Balance Sheet Data 

Income statement and balance sheet data for 1977-1982, and some 

income data for 1976, are from Form 1120, "U.S. Corporation Income Tax 

Return." Additional income data are from Form 5 735, "Computation o-fPossessions Corporation Tax Credit Allowed under Section 936." 

The primary source of income data for 1973-1975 and some data for 

1976 was Form 5712, "Election to be Treated as a Possessions 

Corporation under Section 936." If the corporation filing Form 5712 

or any other member of its controlled group excluded income under 

section 931 for any taxable year beginning in 1973, 1974, or 1975, the 

net income per books of that corporation for each year was reported on 

the form filed for 1976. An additional source of income and tax data 

for 1973-1975 were income tax returns (Form 480. 20) filed with the 

Puerto Rican government. 

~ployment and Payroll Data 

The employment and payroll data for all years were taken from Form 

940, "Employer's Annual Federal Unemployment Tax Return." These 

teturns are filed on a calendar year basis. For companies with a 

non-calendar year accounting period, the Form 940 data were associated 

with income data for the accounting period most nearly corresponding 

to the calendar year. For example, the calendar year 1982 Form 940 

data were associated with taxable years ending between July 1, 1982 

ana June 30, 1983. 
-104-

The number of employees was computed by dividing total taxable 

wages (line 5, Form 940) by $6,000, 1/ the maximum amount per employee 

subject to unemployment tax. This procedure gives an estimate of the 

number of full-time equivalent employees during the year, rather than 

the actual number of persons employed at any particular time during 

the year. If the corporation paid its workers less than $6, 000 (the 

minimum wage in several industries was sufficiently low in the 1970s 

that this could have occurred), the number of employees could be 

understated. On the other hand, because the $6,000 ceiling is tied to 

individual employees, the procedure could over-estimate employment for 

a company with relatively high wages and part-time employees or a high 

labor turnover rate. Secondary data from Form 940 and other sources 

suggest that the method used here provides reasonably accurate 

estimates of full-time equivalent employment. 

Some corporations did not report an amount for total remuneration 

or reported the same amount as for wages subject to unemployment tax. 

In the latter case, the firm's reporting was assumed to be correct. 

For the few corporations that did not report total remuneration, the 

reported amount of taxable wages was used. Total remuneration may 

therefore be slightly understated. 

Total compensation was computed by multiplying total remuneration 

(line 1, Form 940) by a factor representing the ratio of total 

compensation to total wages and salaries for U.S. manufacturing 

industries. The value of this factor was 23.4 percent and 23.5 

percent for 1981 and 1982, respectively. It is computed from Tables 

6. SB and 6. 6B of the Survey of Cur rent Business, U.S. Department of 

Commerce, Bureau of Economic Analysis, July 1983. Total compensation 

exceeds wages and salaries by the amount of employer contributions to 

social security, private pensions, and health insurance, and by other 

fringe benefits. 

Employment and payroll data were available for only 324 of the 447 

possessions corporations in manufacturing. The information from that 

sample was blown up to represent the full group on the assumption that 

within each manufacturing sector the relationship between employment 

!/ For 1973-1977, the corresponding amount was $4,200. 

anc 

lat 

ma~ 
-105-

and cost of goods sold for the sample group would also hold for the 

larger group of companies. The figures for cost of goods sold used in 

making this estimate are as follows: 

All Manufacturing 

Food 

Textiles 

Apparel 

Chemical 

Pharmaceuticals 

Other Chemicals 

Rubber and Plastic 

Leather 

Fabricated Metal 

Machinery except Electrical 

Electrical and electronic 

Instruments 

All Other Manufacturing 

Cost of Goods Sold 

324 Cos. I 447 Cos. 

($000) 

$4,195,107 

387,336 

28,861 

287,005 

1,174,332 

718,650 

455,682 

33,115 

61,116 

67,820 

130,809 

772,434 

203,027 

1,049,252 

$5,553,684 

489,345 

44,628 

347,314 

1,461,964 

949,386 

509,493 

48,789 

120,549 

157,596 

135,126 

1,249,872 

244,590 

1,253,910 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 
-107-

Appendix D 

Tax Forms from Which Data Included 

in This Report Were Obtained 
rorm 5712 Election to be Treated as a 

Possessions Corporation Under Section 936 OMB No. 1545-0215 

'~ev. January 1982) 

Deputment of the Treasury (Do NOT Attach to Your Tax Return-File Separately) Expires 9-30-84 

:ntern1I Revenue Service 

The corporation named below elects under section 936(e) of the Internal 

Revenue Code to be treated as a possessions corporation for income tax purposes. ~ 

Name of corporation Employer identification number 

..... 

Number and street Date of incorporation 

..... 

City or town, State and ZIP code Place of incorporation 

....._ 

Business code number I Principal business activity Principal product or service 

I ..... Descrrptron of each class of stock 

Number of shares 

of each class 

issued and outstanding 

.. .. _____ ----------------------------... ------------------------------------...... ------------.. -----------------------... ---------------------------. ·----------------------... -----------

......... ---------------------------------------------------------------------------------------------------------------------------------------· ----------------------------------. 

..... ... ________ ,.. ___ ... __ ...... -------------------------------------------------------------------------------------- --------------------------------- --------------------------------... --· 

Submit the following information for each shareholder who owns 10% or more of the issued and outstanding stock of any class: 

Name of shareholder Identifying number Address Class of stock Number of shares owned ....._---~~~~~~~~~~~-1-~~~~~~~~1~~~~~~~~~~~~~~~-1-~~~~~~~11~~~~~~~~~~~ 

..... _____ -------------------------------- --· ------------------------ ----------------------------------------------- ----------------------· ---------... --.. ------------.. --------.. 

...... _______ ______________________________ --------------------------- ----------------------------------------------- ----------------------- ------------------------------... -.. -· 

' ..... ____ -------------------------------- -----------·--------------· ----------------------------------------------. ----------------------- ·----------------------------------

.......... ___ --------------------------------- -------------------------------... ---------------------------------------__ .. -----------------------

.. .. ..... ___ --------------------------------... ---------...... -----.. -------------------------------------------------------.. ----------------------- ----------------------------------· 

......... ----------------------------------- . -------------------------- --.. ------------------------------------------- ----------------------... -----------------------------------

..... ... __ ---------------------------------- --------.. ------------------ . ---------------.. ------------------------------

...... .. ..... ------------------------------.. -- --------------------------- --... ------------------------------------------- ------------... ---------.. . ------------------------------.. ---

.... .... _ ---------------------------------- --------------------------- ·----------------------------------.. ----------- ... ----------------------

·' .. .. ... _ ..... ... ---·--------·--------... ---------

'• .... ... ... .. -.. -------------------------------

~lection takes effect for the tax year beginning (month, 

tt~Y. year) 

Date corporation began business in a Annual return will be filed for the tax year end· 

U.S. possession ing (enter the month or "unknown") 

'I Under penalties of perjury, I declue that I have been duly 1uthorized by the 1bove· named corpor1tion to mike this election and th1t the st1tements made ue to the best 

l'lly knowledge 1nd belief, true, correct, and complete. 

~iu-re--.; n'd-t"itie-oTot'ficer--------· -----· ---------· ---------------------------------------------------· -· -----------------------· 

~or Paperwork Reduction Act Notice, see instructions on back. 

oaie ____ -------------------------· 

Form 5712 (Rev. 1-82) 
Instructions 

Paperwork Reduction Act Notice 

The Paperwork -Reduction Act of 1980 says we 

must tell you why we are collecting this information how 

we will use it, and whether you have to give it to u~. We 

ask for the information to carry out the Internal Revenue 

laws of the United States. We need it to ensure that you 

are complying with these laws and to allow us to figure 

and collect the right amount of tax. You are required to 

give us this information. 

Who Can Elect 

Only domestic c9rporations can elect to be treated 

as possessions corporations. 

When to File 

File Form 5712 by the due date (including extensions) of the first return to which the election is to apply. 

Where to File 

File this form with the Internal Revenue Service 

Center, Philadelphia, PA 19255. File it separately from 

your regular income tax return. 

U.S. Possessions 

For purposes of this election, U.S. possessions include Puerto Rico but not the Virgin Islands. 

Period of Election 

The election applies to the first tax year for which 

such election was made and for which the domestic corporation qualifies under section 936(a). 

To revoke this election for any tax year that starts 

within 9 tax years after the tax year for which the elec· 

tion takes effect, you need the Secretary's consent. YoU 

do not need it to revoke the election after that. 

Form 5735 

For every year the election is in effect, you must 

complete Form 5735, Computation of Possessions cor· 

poration Tax Credit Allowed Under Section 936, and at· 

tach it to your income tax return. 

Consolidated Returns 

A corporation may not join in filing a consolidated 

return for any year for which this election is in effect. 

Business Classification 

Refer to the Codes for Principal Business ActivitY 

and Principal Product or Service in the Instructions tor 

Form 1120 and enter the (1) business code number, (2) 

principal business activity, and (3) principal product or 

service. 

Identifying Number 

The identifying number for individu'als is their 

social security number. For all others it is their employer 

identification number. 

(Re 

Dep1 

lnte1 

Fo1 

Nar 

Signature 

This form must be signed by the president, vice ! 

president, treasurer, assistant treasurer, chief account· {!. 

ing officer, or other corporate officer (such as tax officer) 1 

who is authorized to sign. 2 

3 

~ Ii 

6 

lCl 

1 

l~ 

13 

l 

15 

.!! 

F 
arts 

dee· 

YoU 

ivitY 

~ tor 

(2) 

:tor 

vice 

unt· 

cer) 

F~rm 5735 

(Rev. January 1982) 

Department of the Treasury Internal Revenue Service 

Computation of Possessions Corporation 

Tax Credit Allowed Under Section 936 OMB No. 1545-0217 

Expires 5-31-84 

~ Attach to your tax return 

For calendar year 19 .......... or other tax year beginning ......................•............. , 19 .......... , and ending .................................... , 19 .......... . 

Name I Employer identification number 

1:1.ftl- Gross Income in Applicable Period 

Tax year (Use a separate line for each tax year Periods in which trade or ending with or within your Name of U.S. possession business was actively conducted applicable period. Start in which trade or in a U.S. possession with the earliest such tax business was actively (Oates are inclusive) 

year. See instruction 8.) conducted 

Beginning Ending From- To-

(•) (b) (c) (d) (e) 

Gross income during periods shown in columns (d) and (e) 

Gross income from the active conduct of a trade All other gross income or business in a U.S. possession Gross qualified possession From From all From source sources other sources From sources From all other From sources investment in sources in in U.S. sources out- in the income U.S. outside the possessions side the U.S. U.S. possessions the U.S. U.S. 

(f) (g) (h) (I) (J) (k) (I) 

JI 

1 Total gross income in applicable period (add totals of columns (f) through (I)) 1 

2 Gross income in applicable period from sources in U.S. possessions (add total of columns (f), (i), and (j)) . 2 : 

3 Divide line 2 by line 1 (if less than 80%, do not complete Part 11) . 3 

4 Gross income from the active conduct of a trade or business in a U.S. possession (total of columns (f), (g), and (h)) . 4 

5 Divide line 4 by line 1 (if less than 50%, do not comp.lete Part II) . 5 •:r.r.•1- Computing the Possessions Corporation Tax Credit 

6 Qualified (a) From gross sources income outside in current the U.S. year: from the active conduct of a trade or business m·-···----~ - ~

(b) From in a U.S. sources possession outside the U.S. from sale or exchange of substantially all of assets 6(a) ·---· 

used in a possessions trade or business ·. 6(b) ••• 

(c) Gross qualified possession source investment income . . . • . 6(c) ~ --~ (d) Amounts received in the U.S. . _6_(.._d_)_, ____ .._,.. __ 11 ,.,,.~ -

(e) Total (add lines 6(a), 6(b), and 6(c) and subtract line 6(d)) • I 6Ce) 

7 Applicable deductions (attach schedule): • ---·· 

(a) Definitely allocable deductions (see instructions) . I 7(a) I • 

(b) Ratable part of deductions not definitely allocable . . 7(b) -

(c) Total (add lines 7(a) and 7(b)) . • • . • • • • • • • . • • . • . . . • • . l-7_(_c)_1 ______ _ 

8 Qualified taxable income before loss adjustments (line 6(e) less line 7(c)). If loss, do not complete below . _s __ 

9 Loss adjustments (attach schedule}: ••• 

(a) Current year losses from non-qualified sources (see instructions) . • . . . . 9(a) ••• 

(b) Recapture of prior year overall foreign losses (see instructions) . 9(b) • 

(c) Net capital loss or short-term capital loss adjustment (see instructions) . 9(c) ~ (d) Total (add lines 9(a), 9(b), and 9(c)) • _9_(d_)_ 1 _____ _ 

10 Qualified taxable income (subtract line 9(d) from line 8) . 

11 Total taxable income from all sources (enter taxable income from your tax return) 

12 Adjustments to taxable income from all sources (see instructions) . 

13 Subtract line 12 from line 11 . 

14 Divide line 10 by line 13 . 

15 Total U.S. income tax against which section 936 credit is allowed (see instruction C) . 

16 Section 936 credit (multiply line 14 by line 15). Enter here and on your tax return . 

For Paperwork Reduction Act Notice, see instructions on back. 

~ 

10 

11 

12 

13 

14 

15 

. .... 16 
Instructions 

(References are to the Internal Revenue Code) 

Paperwork Reduction Act Notice.-The Paperwork Re· 

duction Act of 1980 says we must tell you why we are col· 

lecting this information, how we will use it, and whether 

you have to give it to us. We ask for the information to 

carry out the Internal Revenue laws of the United States. 

We need it to ensure that you are complying with these 

laws and to allow us to figure and collect the right amount 

of tax. You are required to give us this information. 

GENERAL INSTRUCTIONS 

A. Purpose.-A domestic corporation that has elected 

to be treated as a possessions corporation must attach 

Form 5735 to its income tax return for each year that the 

el.ection is in effect. Complete Form 5735 to figure the pos· 

sessions corporation tax credit under section 936. The 

credit is allowed against income tax imposed by Chapter 1. 

Puerto Rico is a U.S. possession for this credit, but the 

Virgin Islands are not. 

B. Qualifying for the Credit.-To qualify for the pos· 

sessions tax credit, a corporation must: 

(1) have filed a valid Form 5712, Election to be Treated 

as a Possessions .Corporation Under Section 936; 

(2) have derived 80% or more of its gross income from 

sources in a U.S. possession during the applicable period 

immediately before the tax year ended; and 

(3) have derived 50% or more of its gross income from 

the active conduct of a trade or business in a U.S. posses· 

sion during the applicable period immediately before the 

tax year ended. 

The "applicable period" is generally the shorter of 36 

months or the period when the corporation actively con· 

ducted a trade or business in a U.S. possessior.. 

C. Restrictions.-A corporation is ineligible to take 

the possessions tax credit for any tax year it is a DISC or 

former DISC, or for any tax year in which it owns stock in a 

DISC or former DISC. (Section 936(f).) 

The credit is not allowed against the following taxes: 

• minimum tax on tax preference items (section 56). 

• tax on accumulated earnings (section 531). 

• personal holding company tax (section 541). 

• additional tax for recovery of foreign expropriation 

losses (section 1351). 

• tax increase on the early disposition of investment 

credit property (section 47). 

• tax on certain capital gains of electing small business 

corporations (section 1378). 

D. Where to File.-Attach Form 5735 to your income 

tax return and file your return with the Internal Revenue 

Service Center, Philadelphia, PA 1925'5. 

SPECIFIC INSTRUCTIONS 

Follow sections 638 and 861-864 to determine if the 

source of gross income, deductions, and taxable income 

is in or outside the U.S. or in a U.S. possession. If you re· 

ceived any income in the U.S., regardless of its source, do 

not include it as income from sources outside the U.S. (sec· 

tion 936(b)). 

You cannot take a deduction or foreign tax credit tor 

taxes you paid or accrued to a foreign country or U.S. pos· Form 

session, if any of the income on which those taxes were Dep1rt

paid or accrued is used in computing the possessions cor· ~ 

poration tax credit. Chee• 

Part I.- A. Con 

Column (i).-Enter gross qualified possesston source ~: ::: 

investment income in column (i). You must establish to Pl& 

the satisfaction of the Secretary that this income is fror11 

either the investment in a U.S. possession of funds derived 

in the active conduct of a trade or business in that posses· ..__ 

sion, or from the investment itself. Temporary Regulation 

7.936-1 gives information about certain deposits in Puerto 

Rican banks and other financial institutions that may earn 

qualified income. ~ 

In Part II subtract applicable deductions from this in· o 

come to figure how much investment income qualifies for g 

the credit. "'" 

~ 

Part 11.-

Line 6(b).-lnclude gross income that came fror11 

sources outside the U.S. from selling or exchanging sub· 

stantially all the assets the possessions corporation used 

in the active conduct of its trade or business. 

Line 7(a).-On line 7(a) include the reduction tor the 

"rate differential portion" (as defined in section 904(b) 

(3)(F)) of any net capital gain that comes from a foreign 

source and is included on line 6(e). Also, include the cor· 

poration's other definitely allocable deductions. 

e 

c:s 

Line 7(b).-Enter on line 7(b) the ratable part of de· 

ductions that cannot be definitely allocated to qualified in· 

come. To obtain this figure, reduce the deductions by the 

amount entered on line 7(a). Multiply this result by the 

amount obtained when you divide the amount entered on ~ 

line 6(e) by the gross income on your income tax return· ·2 

Line 8.-Do not include income from selling or excha~g· t3 

ing any asset whose basis is determined by reference to its ~ basis in another person's hands. If, however, the asset's ~ basis is determined by reference to its basis in the hands) 

of another person to whom section 931, 936, or 957(c 

applied during the whole period the asset was held, the 

income may qualify (see section 936(d)(3)). 

Line 9(a).-lf you sustain a loss for the current year in 

the U.S. or on any type of income for which a separate 

foreign tax credit limit applies, allocate the loss to posses· 

sions income that qualifies for the credit in proportion. tog 2 

the ratio of that income to total taxable income, exclud1n 

the loss. ~ 

Line 9(b).-lf you sustai_n an overall foreign loss in ~nY year, the loss is recaptured in later tax years by treatin5

g 

part of your taxable income from sources outside the U. · 

as income from sources in the U.S. (section 904(f)). 

Line 9(c).-To the extent any net capital loss or short~ term capital loss from sources outside the U.S. is used te ~ determine capital gain net income, it is also used to redUCr ~ income against which the credit is allowed. First, howevi~ decrease the loss by the "rate differential portion" oft r 

excess of net capital gain from non-qualified sources o~eti net capital gain. Enter on line 9(c) the amount by .whic ( 

the loss reduces the corporation's income that qualifies fO 

the credit. Attach your computation. 

Line 12.-lf line 11 includes income from selling ore:~ changing capital assets, enfer the reduction for the ''ra 

differential portion" of net capital gain. 
tor 

10s· 

~re 

:or· 

Form 1120 

Deputment of the Treasury lntern1I Revenue Service 

Check if aU.S. Corporation Income Tax Return 

For calendar year 1982 or other tax year beginning .................... , 1982, ending .................... , 19 ........ . 

.... For Paperwork Reduction Act Notice, see page 1 of the Instructions 

OMB No. 1545--0123 

~®82 Name D. Employer id1ntiflc1tion number 

A. Consolid1ted return 0 

rce •. Person1I Holdinll Co. D 

C. Business Code No. (See 

Use 

IRS 

label. 

Otherwise 

please 

print 

Number and street E. D1te incorpor1ted 

I tO Pll• 9 of Instructions) 

oni 

ved 

;es· 

ion 

~rto 

iarn 

., 

e in· 8 

for s 

II) 

oni 

ub· 

ed 

II) 

e (.:J 

City or town, State, and ZIP code 

or type. 

1 (a) Gross receipts or sales $ ------------------ (b) Less returns and allowances $ __ ---------------·· Balance .... 

2 Cost of goods sold (Schedule A) and/or operations (attach schedule). 

3 Gross profit (subtract line 2 from line 1 (c)) . 

4 Dividends (Schedule C) . 

5 Interest. 

6 Gross rents 

7 Gross royalties 

8 Capital gain net income (attach separate Schedule D) . 

9 Net gain or (loss) from Form 4797, line ll(a), Part II (attach Form 4797) . 

10 Other income (see instructions-attach schedule) 

11 TOTAL income-Add lines 3 through 10 . 

F. Tot1i 1Ssets (see Specific Instructions) 

$ 

1 (c) ------------------------· ____ _ 

2 

3 ------------------------· ----- 4 

5 --·------------------------· ----- 6 

7 

8 --·------------------------ ----- 9 

10 

11 

12 Compensation of officers (Schedule E) . ~ ·------------------------ ____ _ 

13 (a) Salaries and wages .......................................... 13(b) Less jobs credit .......... .. ............................. Balance .... 13(c) -------------------------

14 Repairs (see instructions) • ~ ------------------------- ____ _ 

15 Bad debts (Schedule F if reserve method is used) . 15 ------------------------- ·----

16 Rents 16 ------------------------· 17 Taxes 

18 Interest . 

19 Contributions (not over 10% of line 30 adjusted per instructions) 

20 Depreciation (attach Form 4562) 

21 Less depreciation claimed in Schedule A and elsewhere on return . 

22 Depletion 

23 Advertising • 

24 Pension, profit-sharing, etc. plans (see instructions) • 

25 Employee benefit programs (see instructions) . 

26 Other deductions (attach schedule) . 

27 TOTAL deductions-Add lines 12 through 26. 

17 

18 

. . . . . . . . . 19 · I 

-

20 I 

------------------------- -

~ ------------------------- -----· 

. 21(a) ( ) 2l(b) -------------------------

22 

--·------------------------ ----· 23 

24 

25 ------------------------- ----· 26 

27 

28 Taxable income before net operating loss deduction and special deductions (subtract line 27 from line 11) . . 28 ------------------------· ____ _ 

29 Less: (a) Net operating loss deduction (see instructions-attach schedule) . · 129(a) !------------------------· 

(b) Special deductions (Schedule C) . 29(b)_ 29 ""-!.... 30 Taxable income (subtract line 29 from line 28). _3_0_, _________ , __ 

31 TOTAL TAX (Schedule J) . . . . . . . . . . . . . 31 

32 Credits: (a) Overpayment from 1981 allowed as a credit I -~.------------------------- ·---- ::: ~::,2 r:;~~~·:~dl~~~ ~7i:.~~d ;,. applied for on Form 4466: .~::::::::::::::::::::; .1-·. 

(d) Tax deposited: Form 7004 .................. Form 7005 (attach) .................. Total .... ~~~~~~~~~~~~~~~~~~~~~~~~~---· (e) Credit from regulated investment companies (attach Form 2439) . ------------------------- m 

(f) Federal tax on special fuels and oils (attach Form 4136) . 32 --·1---------11--- 33 TAX DUE (subtract line 32 from line 31-lf line 32 is greater than line 31, skip line 33 and 

go to line 34). See instruction C3 for depositary method of payment . . . . . 33 

(Check .... O if Form 2220 is attached. See instruction 0.) .... $ ____________________________________________ - ~#~ ~ 

34 OVERPAYMENT (subtract line 31 from line 32) . 34 

ei" '-l....35 Enter amount of line 34 you want: Credited to 1983 estimated tax .... Refunded .... _3_5_, ________ , __ 

ate ~ rlease Under penalties of perjury, I ~e~lare that I have examined this return, !ncluding accompanying schedules and statements, and to the best •·ign of ~Y knowledge and belief, 1t 1s true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of Q which preparer has any knowledge. 

~~r_e ____ --t~~.....;;S~ig~n~a~tu~r~e~o~f~o~ff~ic-e~r-------------------------------.l~D~a=te:=========~~~~T~it~le~----~------------------~ ~i'd Preparer's ~ I Date I Check if IPreparer's social security no . • ~1 . self-em· , , rr signature ploved ...._ D ! ! 

~ eparer's Firm's name (or ~ \ E 1 N ' 

'e Only yours, if self-employed) • .---------------------- · · 0· .... : 

........_________ ~a_n_d_a_d_d_re_s_s ______________________________________________________ .:....;;Z~l~P~c~o~de:...! .... ~------------------~ 
--------- ----------------- ---------- ------------------------------------

-----------------------

-----------------

·---------------
-

Form 1120 (1982) 

Schedule J Tax Computation (See instructions for Schedule J on page 7) 

Note: Fiscal year corporations, see instructions on page 10. If you are not a member of a controlled group 

of corporations (sections 1561 and 1563), omit lines 1 and 2, and enter on line 3, the amount from 

line 44, Part Ill, of the fiscal year worksheet provided on page 11 of the instructions. 

Calendar year corporations, see instructions for Schedule Jon page 7. If you are not a member of a con· 

trolled group of corporations (sections 1561 and 1563), omit lines 1 and 2, and start with line 3. 

__. 1 Check if you are a member of a controlled group (see sections 1561 and 1563) • . • D 

;:....; 2 If line 1 is checked, see instructions and enter your portion of the $25,000 amount in each taxable income 

bracket: 

(i) $------------------------------ (ii) $--------·--·----·------------- (iii) $------------------------------ (iv) $------------------------------ 3 Income tax (see instructions to figure the tax; enter this tax or alternative tax from Schedule D, whichever 

Page 3 

• 

is less). Check if from Schedule D ~ D . • 

a 4 ~:: r:~::~::;~ :;:::c;~~~:~~~~~: . :~~:::~.:~:~:::::~~~~~~.::.:_::_:~ ··~-----········· .._.. (d) Employee stock ownership credit (applies only to fiscal year 1982-al corpora- -

tions--see instructions) • ·-

~: ~~ ::::~:;e:! ~~:;~he::;:%~~ ~735) . ~:::::::::::::::::~::::::::: -····--~~- (g) Alcohol fuel credit (attach Form 6478) . ----------------------------

~ (h) Credit for fuel produced from a nonconventional source (see instructions) • 

..-- S Total-Add lines 4(a) through 4(h) • 

••· 6 Subtract line 5 from line 3 • 

--·· '1 Personal holding company tax (attach Schedule PH (Form 1120)) • 

...- 8 Tax from recomputing prior-year investment credit (attach Form 4255) • 

9 Minimum tax on tax preference items (see instructions-attach Form 4626) • 

I 

.. lo Total tax-Add lines 6 through 9. Enter here and on line 31, page 1 • 

~dditional Information (See page 8 of instructions) Yes !!!, 

I Q Did you claim a deduction for expenses connected with: 

I (1) Entertainment facility (boat, resort, ranch, etc.)? • -

I (2) Living accommodations (except employees on business)? 

Yes No 

(d) Enter highest amount owed by you to such owner during I 

(e) ~:t~e:~g:s~-~~-~~~~-~~~-~-;~-~~~-~~-~~~~-~~~-~;-~~-r~~;-· ~ J (3) Employees attending conventions or meetings outside the 

North American area? (See section 274(h)) • 

(4) Employees' families at conventions or meetings? • 

If "Yes," were any of these conventions or meetings outside 

the North American area? (See section 274(h)) • 

(5) Employee or family vacations not reported on Form W-27 • 

"' ~ (1) Did you at the end of the tax year own, directly or indirectly, 

50% or more of the voting stock of a domestic corporation? 

(For rules of attribution, see section 267(c).) • .... 

--· 

-·· 

If "Yes," attach a schedule showing: (a) name, address, and 

identifying number; (b) percentage owned; (c) taxable income 

or (loss) (e.g., if a Form 1120: from Form 1120, line 28, page 

1) of such corporation for the tax year ending with or within 

your tax year; (d) highest amount owed by you to such corporation during the year; and (e) highest amount owed to you by 

such corporation during the year. 

(2) Did any individual, partnership, corporation, estate or trust at 

the end of the tax year own, directly or indirectly, 50% or more 

of your voting stock? (For rules of attribution, see section 

267(c).) If "Yes," complete (a) through (e) • . • • • • 

(a) Attach a schedule showing name, address, and identifying 

the year ..... ----------------------------------------------------

- (Note: For purposes of H(l) and H(2), "highest amount owed" includes loans and accounts receivable/payable.) 

~ ~ I Refer to page 9 of instructions and state the principal: 

Business activity·--__________________________ -------____________________ _ 

Product or service . ------------------------------------------------------ I J Were you a U.S. shareholder of any controlled foreign corpora· 

~ tioh? (See sections 951 and 957.) If "Yes," attach Form 5471 for 

each such corporation • 

~ ~ K At any time during the tax year, did you have an interest in or a 

~ signature or other authority over a bank account securities ac· I count. or other financial account in a foreign country (see in· I l ::: ::>~: g;ant~r ~f, ~r lr~ns;ero; to: a ~r;ign . tru~ ~hie; I existed during the current tax year, whether or not you have any I beneficial interest in it? • 11 If "Yes," you may have to file Forms 3520, 3520-A or 926. 

M During this tax year, did you pay dividends (other than stock 

~ ~ dividends and distributions in exchange for stock) in excess of 

~ your current and accumulated earnings and profits? (See secnumber. ~~ tions 301 and 316) . • • • • • • • • • • • • 

(b) Enter percentage owned ...... --------------------------------- ~ If "Yes," file Form 5452. If this is a consolidated return, answer 

(c) Was the owner of such voting stock a person other than a here for parent corporation and on Form 851, Affiliations SchedU.S. person? (See instructions) • _ ule, for each subsidiary. 

-·· If "Yes," enter owner's country .... -------------------------11 N During this tax year was any part of your tax accounting records 

~ . maintained on a com uterized s stem? . . • • • • • • 
Form 1120 (1982) 

Schedule L Balance Sheets 

ASSETS 

1 Cash . • • • 

2 Trade notes and accounts receivable • 

(a) Less allowance for bad debts . 

3 Inventories . . • • . • • 

4 Federal and State government obligations • 

5 Other current assets (attach schedule) . 

6 loans to stockholders • • . • 

7 Mortgage and real estate loans . . . 

8 Other investments (attach schedule) . . 

9 Buildings and other depreciable assets • 

(a) less accumulated depreciation • 

10 Depletable assets • • • • • 

(a) Less accumulated depletion • . 

11 Land (net of any amortization) • . • 

12 Intangible assets (amortizable only) . 

Beginning of tH yHr End oftHyHr 

(A) (8) (C) (0) 

~~----------------------- -------------------------· - ~~~ ·---------------------------· ~~ 

Form 

Deput

Intern

--...

If inc

ma k

nec9

ch 

-

A Di

--------------------------~ ---------------------------- - ~ 

~~ :::::::::::::::::::::::::::: ~ ~~~--~--~-~--~~--~~--~-- ~ -------------------------- - ·---------------------------· ~~ ~ Exe

(a) Less accumulated amortization • • •••. 13 Other assets (attach schedule) • • ·---------------------------· ~--·- ---------------------- nee 

14 Total assets . . . . • . • • w;jjj 3 Pa 

~= :~:~~~~~::.~~::DP:::~l~:~:~s:aEn~~l:ar. ~ ~~ ~ ~:~

17 Other current liabilities (attach schedule) • • • ·-- -. __.. 6 Cred 

!~ :~::. :~~~;i:;:::~~::::::~:~:,f) ye~r o; m~re : . ~ ~:_:;_:_: __ :_:_:_:_:::_~:_:_::_:_:;_:_~:_:_:: • :~~~:~:~~~~~~:~~~~~~~ i:

21 Capital stock: (a) Preferred stock • -------------------------- - ---------------------------- ~,I (d

(b) Common stock • ...- (e

~: ~:~:;~ed '.:;::::=:~~:pri~ted0 (a~ac~ sc~.) : : ···-u :::::::::::::::::::::::::::: ··--::::::~:::::::::::::::·:: ~ ~: 26 Total 

~:::i:::, liabilities •:;•;;.~,u~·.~:~o~ria'.ed and stockholders' equity. : : : . . - . • . ,------------------------) ··-

~ 

,-----------------:j ~ a EntE 

Reconciliation of Income Per Books With Income Per Return Do not complete this schedule if your total Schedule M-1 4 ~ot~ assets (line 14, column (D), above) are less than $25,000. __,.-s a:~

1 Net income per books • • . • • • • -------------------------- 7 Income recorded on books this year not in- ~ 

2 Federal income tax . • • • • • • • • • -------------------------- eluded in this return (itemize) ~ 

3 Excess of capital losses over capital gains • • • • -------------------------- (a) Tax-exempt interest $.................... l Groc 

4 Income subject to tax not recorded on books this year ------------------------------------------------ ~ Ma 

(itemize) ·------------------------------------------------ ·------------------------------------------------ ---------------------···· a Ent 

·---------------------------------------------------------- -------------------------· 8 Deductions in this tax return not charged • Ent 

5 Expenses recorded on books this year not deducted in against book income this year (itemize) S Cree

this return (itemize) (a) Depreciation • • • $................ 6 iota 

(a) Depreciation • • • • • $.................... (b) Contributions carryover . $................ } Les

(b) Contributions carryover • • $.................... ·------------------------------------------------ : Bal~ _________________________________ ------ _ ----------- _ ------ • ____________ ------ _ --------- _ _ _ __ _ _ _ ___ _ _ ___ _ __ ____,.,-

0

0ve 

--------------------------------- ~- ----------------------- · 9 Total of lines 7 and 8 . . . • ___...,, 6 Total of lines 1 throurh 5 . . . . . 10 Income (line 28, page 1)-line 6 less 9 . . _____.,:_ 'l--J 

Analysis of Unappropriated Retained Earnings Per Books (line 24 above) Do not complete this schedule flabiri 

if your total assets (line 14, column (0), above) are less than $25,000. _____,.,- , You 

Schedule M-2 

1 Balance at beginning of year • • • • . • • 

2 Net income per books • • . • • • • • • 

3 Other increases (itemize) ·-------------------------------

4 Total of lines l, 2, and 3 • 

E I NO 22· 158-1686 

~der 

••• •• tie, : 

. ·-------------------- 5 Distributions: (a) Cash . 

(b) Stock • • 

(c) Property 

6 Other decreases (itemize) ·---------------------

------------------········ J'I• ~ 

. -------------------------

------------------------------------------------ ,__.....,, 1 

_______ 1 7 Total of lines 5 and 6 . . . ___.--/' 

8 Balance at end of year (line 4 less 7) • • • _ __,-/ 
4 

- Form 940 Employer's Annual Federal OMB No. 1545-0028 

Unemployment (FUTA) Tax Return Department 

Internal Revenue 

of the 

Service 

Treasury 

~ For Paperwork Reduction Act Notice, see page 2. ~®82 T 

I I FF 

Name (as distinguished from trade name) Calendar Year FD If incorrect, 

make any~ 1982 FP 

necessary Trade name, if any Employer identification number I 

change. T Address and ZIP code 

L _J 

A Did you pay all required contributions to your State unemployment fund by the due date of Form 940? . . D Yes D No 

~ If you check the "Yes" box, enter amount of contributions paid to your State unemployment fund . . ~ $ ____________________ _1 ______ _ 

8 Are you required to pay contributions to only one State? . . D Yes D No 

~ If you checked the "Yes" box, (1) Enter the name of the State where you are required to pay contributions . ~ -------------------------------· ......_ (2) Enter your State reporting number(s) as shown on State unemployment tax return . • . . . . 

l@IM Computation of Taxable Wages and Credit Reduction (To Be Completed by All Taxpayers) -~ 

l Total payments (including exempt payments) during the calendar year for services of employees . r---'----~~~~~~~-1: 

~ Exempt payments. (Explain each exemption shown, attaching additional sheets if Amount paid 

necessary) ~ ____________________ . __________ . _ _ _ _ _ _ _ _ ___ _ _ __ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __ _ _ ___ _ _ _ _ ___ __ _ _ _ ____ ____ ___ _ _______________________ --· ·-- ___ .. 

·------------.. -----------------------------------------... -------,-------------------------------------------------- -..... --------... ----------... ----. ----... -

... 

... 

. ~I 

... Df.•1• Tax Due or Refund (Complete if You Checked the 11Yes" boxes in Both Items A and B Above) 

·") l FUTA tax. Multiply the wages on line 5, Part I, by .007 and enter here . 

~ Enter amount from line 7, Part I . 

a Total FUTA tax (add lines 1 and 2) • 

4 Less: Total FUTA tax deposited for the year from your records .. 

S Balance due (subtract line 4 from line 3-if over $100, see Part IV instructions). Pay to IRS. ~ 

l,9verpayment (subtract line 3 from line 4) . . . . . . . . . . . . . . . . ~ 

~•11• Tax Due or Refund (Complete 1f You Checked the "No" Box in Either Item A or Item B Above. Also complete Part V) -----

... 

Gross FUTA tax. Multiply the wages on line 5, Part I, by .034. 

I 1-·· 

- ~ Maximum credit. Multiply the wages on line 5, Part I, by .027 . 

3 Enter the smaller of the amount on line 11, Part V, or line 2, Part Ill • 

4 Enter amount from line 7, Part I .... S Credit allowable (subtract line 4 from line 3) • 6 iotal FUTA tax (subtract line 5 from line 1) . . . 

~ less: Total FUTA tax deposited for the year from your records . . . . . . . • . • 

8 

9 

Balance due (subtract line 7 from line 6-if over $100, see Part IV instructions). Pay to IRS. -~ Overpayment (subtract line 6 from line 7) . .~ ,,_..,..._.__ .. . . 

---

-- v lift1l'• Record of Quarterly Federal Tax L1ab1hty for Unemployment Tax (Do not include State hab1hty) 

'-. Quarter I First I Second I Third I Fourth , ____ To_t_al_f_o_r _Y_ea_r __ _ 

~ liability for quarter 

~u will not have to file returns in the future, write "Final" here (see general instruction "Who Must File") • • ~ I :~der penalties of perjury 1 declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief, it is true, correct, and com- •• ,• ete, and that no part of' any payment made to a State unemployment fund claimed IS a credit WIS or is to be deducted from the payments to employees • 

..... ,, 

,•' ~-~------------Si~gn_•_tu_re_~----------------------T-lt_ie_c_ow_n_er_._e_~_.>_~----------~ 
Form 940 (1982) Page 2 

l@l'M Computation of Tentative Credit (Complete if You Checked the "No" Box in Either Question A or Bon Page 1 See Instructions) :orm 

Name of State 

State reporting number(s) 

as shown on employer's State contribution returns 

Taxable payroll 

(as defined in State act) 

State experience rate period 

4 

State Contributions if Contributions pay- Additional credit Contributions ·epartm

experi· rate had been able at experience (col. 6 minus actually paid ternal 

ence 2.7% (col. rate (col. col. 7) If 0 or to State rate 3X2.7%) 3 xcol. 5) less, enter O. 

~_..:;.1~-l·~~~~~~-1-~~~~~~-1-~~~-1-~~~-1~5~ 6 7 8 3 From- To- 9 

io---f~t~-1~--:--------------------:-~- i-----

1 __ _....:....-~ 

11 Total tentative credit (add line 10, columns 8 and 9-see instructions for limitations) • • ~ 

Highlights 

Changes for 1983.-Public Law 97-248 

increased the wage base to $7,000 and increased the tax rate to 3.5% for 1983. 

For deposit purposes, multiply by .008 

that part of the first $7,000 of each em· ployee's annual wages that you paid during 

the quarter. Follow the deposit rules in Part 

IV on page 4. 

1. Household Employers: You do not have to 

file this form unless you paid cash wages of 

$1,000 or more for household work in any calendar quarter in 1981 or 1982. 

2. Household and Other Employers Who File 

Form 940: If your total Federal unemployment 

(FUTA) tax for 1982 is not more than $100, you 

do not have to deposit the tax. If you do not 

have to deposit FUTA tax and you: 

(a) made all required payments to your State 

unemployment fund, 

(b) are required to make payments to the unemployment fund of only one State, and 

(c) paid wages subject to Federal unemployment tax that are also subject to State un- employment tax, 

complete Parts I and 11. Otherwise, complete Parts 

I, Ill, and V. 

3. Employers Who Are Required to Deposit FUTA 

Tax: If you meet tests (a), (b), and (c) above, 

complete Parts I, 11, and IV. Otherwise, complete 

Parts I, Ill, IV, and V. 

General Instructions 

Paperwork Reduction Act Notice.-We ask 

for this information to carry out the Internal 

Revenue laws of the United States. We need 

it to ensure that you are complying with 

these laws and to allow us to figure and col· 

lect the right amount of tax. You are required 

to give us this information. 

Purpose of Form 940.-Use it for the an· 

nual reporting of tax under FUTA. This tax is 

paid only by the employer. The gross tax rate 

is 3.4% (.034) on the first $6,000 of wages 

paid to each employee during 1982. 

Who Must File.-ln general, every em· ployer who during 1981 or 1982 (a) paid 

wages of $1,500 or more in any calendar 

quarter or (b) had one or more employees 

for some part of a day in any 20 different 

weeks must file. Count all regular, tern· 

porary, and part-time employees. A part· 

nership should not count its partners. If 

there is a change in ownership or other 

transfer of business during the year, each 

employer who meets tests (a) or (b) above 

must file. Neither should report wages 

paid by the other. Organizations described in 

Code section 501 (c)(3) do not have to file. 

As an agricultural or household employer, 

you must file Form 940 if any of the following apply to you: 

(1) You paid cash wages of $20,000 or 

more to farmworkers during any calendar 

quarter in 1981 or 1982. 

(2) You employed 10 or more farmwork· 

ers during some part of a day (whether or 

not at the same time) for at least one day 

during any 20 different weeks in 1981 or 

1982. Count aliens admitted to the U.S. on a 

temporary basis to perform farmwork to de· 

termine if you meet either of the above tests. 

However, wages paid to these aliens are not 

subject to FUTA tax prior to 1984. 

(3) You paid cash wages of $1,000 or more in any calendar quarter in 1981 or 

1982 for household work in a private home, 

local college club, or a local chapter of a col· 

lege fraternity or sorority. Note: See Form 

942 for a definition of household work in a private home. 

If you receive a form and are not liable 

for Federal unemployment tax for 1982, 

write "Not Liable" across the front and re· 

turn it to IRS. If you will not have to file 

returns after this, write "Final" on the line 

above the signature line. 

Due Date.-Form 940 for 1982 is due by 

January 31, 1983. However, if you made 

timely deposits in full payment of the tax 

due, your due date is February 10, 1983. 

Where to File.-

If your principal busi- ness, office, or agency is located In 

... New Jersey, New York City and counties of Nassau, Rockland, Suffolk and Westchester 

New York (all other counties), 

Connecticut, Maine, 

Massachusetts, New Hampshire, Rhode Island, Vermont 

Delaware, District of Columbia, 

Maryland, Pennsylvania 

Alabama, Florida, Georgia, 

Mississippi, South Carolina 

Michigan, Ohio 

Arkansas. Kansas, Louisiana, New Mexico, Oklahoma, Texas 

Alaska, Arizona, Colorado, 

Idaho, Minnesota, Montana, 

Nebraska, Nevada, North Dakota, 

Oregon, South Dakota, Utah, 

Washington, Wyoming 

Illinois, Iowa, 

Missouri, Wisconsin 

California. Hawaii 

Indiana, Kentucky, North Carolina, Tennessee, 

Virginia, West Virginia 

File with the Internal Revenue Service Center at 

... 

Holtsville, NY 00501 

Andover, MA 05501 

Philadelphia , PA 19255 

Atlanta, GA 31101 

Cincinnati, OH 45999 

Austin, TX 73301 

Ogden, UT 84201 

Kansas City, MO 64999 

Fresno, CA 93888 

Memphis, TN 37501 

If you have no legal residence or principal place 

of business in any IRS district, or if your principal 

place of business is in Puerto Rico or the U.S. 

Virgin Islands, file Form 940 with the Internal Rev· 

enue Service Center, Philadelphia, PA 19255. 

Employer's Name, Address, and Identification Number.-Use the addressed Form 

940 mailed to you. If you must use a non· 

addressed form, type or print your name, 

trade name, address, and employer identifi· 

cation number on it. See Publication 583, 

"--

Information for Business Taxpayers, for de· Did 

tails on how to make tax deposits, file a re· If 

turn, etc. if these are due before you receive yo

your number. Are 

Penalties and lnterest.-Avoid penalties If yo

due 

and 

and 

interest 

filing 

by 

a 

making 

correct 

tax 

return 

deposits 

and paying 

w~en ~ 

• 

the proper amount of tax when due. The laW ~ 

provides penalties for late deposits and late iota

filing unless you show reasonable cause fo1 

the delay. If you are late, attach an explana· Exe

tion to the return. The law also provides} nece

penalty of 25% of the overstatement 1 • 

without reasonable cause, you overstate the ··----

amount you deposited. f>aym

There are also penalties for willful failure emp

to pay tax, keep records, make returns. 

and for filing false or fraudulent returns· iota

Credit for Contributions Paid into statte ·'tota

Funds.-You can claim credit for amoun s Cred

you pay into a certified State (including 

Puerto Rico and the U.S. Virgin Islands) u~ (a) 

employment fund by the due date of for (b) 

940. 

"Contributions" are payments that Stat~ (c) 

law requires you to make to an unemplo~ (d) 

ment fund because you are an employe ~ ( 

These payments are "contributions" onlYd~· e) 

the extent that they are not deducted or (f) 

ductible from the employees' pay. ('f ~ 

You may not take credit for volunta . • 

payments or for penalties or interest paY ~ 

ments to a State. ~UTA 

If you have been granted an experienc~ tn 

rate lower than 2.7% (.027) by a State f~. te

the whole or part of the year, you are.eis lota

titled to an additional credit. This credit y- less

equal to the difference between actual pan a 

ments and the amount you would have bee ala

required to pay at 2.7%. e ~ 

The total credit allowable may not be rnor 

than 2.7% of taxable FUTA wages. Q 

Special Credit for Successor Employers·; ross 

If you are claiming special cred.it as ~(e) t.1axi 

cessor employer, see Code section 33 the Ente

or Circular E (Rev. October 1981) for t 

conditions that you must meet. nte

Specific Instructions 

p rt 1. All filers must complete Questions A, B, and a 00e 

Use Part II if you pay contributions to onlY af 

State unemployment fund, you made all State /tne 

ments by the due date of Form 940, and all 0 ent 

FUTA wages are subject to the State's unemploY~ete fund taxes. Otherwise, skip Part II and com 

Parts 111 and V. ar iS 

Complete Part IV if your total tax for the ye 

more than $100. edit 

Part !.-Computation of Taxable Wages and Cr 

Reduction tal 

Line 1-Total payments.-Enter th.e t~he payments you made to employees durin~ble· calendar year, even if they are_ n<?t tax feeS• 

Include salaries, wages, comm1ss1on~.5 paid 

bonuses, vacation allowances, amoun AJ 

(Instructions continued on page 

Cred

1otal 

less: 

~la 

.~erp 
2 

- 940 5 ·tpartment of the Tre1Sury 

id ~ternal Revenue Service 

Employer's Annual Federal 

Unemployment (FUTA) Tax Return 

OMB No. 1545-0028 

~®82 

YOUR Calendar Year 

1982 

Employer identification number 

- CC COPY 

de· Did you pay all required contributions to your State unemployment fund by the due date of Form 940? . . D Yes D No 

re· 

ive If you check the "Yes" box, enter amount of contributions paid to your State unemployment fund . . ..... $ ················----J_ ____ _ Are you required to pay contributions to only one State? . . D Yes D No 

·es If you checked the "Yes" box, (1) Enter the name of the State where you are required to pay contributions. 

1en i>..._(2) Enter your State reporting number(s) as shown on State unemployment tax return . . . . . . ..... ------························· 

~; filtilM Computation of Taxable Wages and Credit Reduction (To Be Completed by All Taxpayers) 

...... 

te iotal payments (including exempt payments) during the calendar year for services of employees . fol r--"--"--------·1,.,, 

na· Exempt payments. (Explain each exemption shown, attaching additional sheets if Amount paid 

s 3 necessary) ..... -----·-·····-····-·-··-············-·-···············-·····-·---···---·--··-········-····-····· .......................... . if, 

he ·······················-·····-···········-·-················································-········-····-····· ···-·····-···············-· ··-···· 

Payments for services in excess of $6,000. Enter only the excess over the first $6,000 paid to individual 

re employees exclusive of exempt amounts entered on line 2. Do not use State wage limitation . 

-

~I I 

lotal exempt payments (add lines 2 and 3) . 

iotal taxable wages (subtract line 4 from line 1). (If any portion is exempt from State contributions, see instructions) . . ..... 

Credit reduction for unrepaid advances to the States listed. Enter the wages included on line 5 above for each State and multiply by the rate shown. 

(a} AR ------------------ x .003 -------------------- (g) Ml ------------------ x .003 ··------------------ (m) VT ------------------ x .006 --------------------

(b) CT ------------------ x .007 ·····--------------- (h) MN------------------ x .003 ··------------------· (n) WV----------------·· x .003 ·-------------------

13te (c) DE ------------------ x .006 -------------------- Outside the U.S. 

o'f' ef· (d) DC ·-----------------· x .006 --------------------

(i) NJ ····-------------- x .006 --------------------

(j) OH----------------·· x .003 ··-····-······------

to (e) IL ------------------ x .006 -------------------- (k) PA ------------------ x .006 --------------------

(o) PR --···-·-··-------· x .006 -·····--------------

(p) VI --·····--·-······- x .006 ·-------------------· 

de· (f) ME------------------· x .009 -------------------- (I) RI ------------------ x .006 ------·············-

rJ ~tal credit reduction (add lines 6(a) through 6(p) and enter on line 2, Part II or line 4, Part Ill). . 

~'f' ~-•• Tax Due or Refund (Complete if You Checked the "Yes" boxes in Both Items A and B Above) 

. ...,. I 

' 

~UTA tax. Multiply the wages on line 5, Part I, by .007 and enter here . 

tnter amount from line 7, Part I . 

'total FUTA tax (add lines 1 and 2) . 

Less: Total FUTA tax deposited for the year from your records .......... -- Qalance due (subtract line 4 from line 3-if over $100, see Part IV instructions). Pay to IRS. ..... ~erpayment (subtract line 3 from line 4) . . . . . . . . . . . . . . . . . . ..... re~. ~ Tax Due or Refund (Complete 1f You Checked the "No" Box m Either Item A or Item B Above. Also complete Part V) 

·.,,,,., Qross FUTA tax. Multiply the wages on line 5, Part I, by .034. IJC' la ce) '"aximum credit. Multiply the wages on line 5, Part I, by .027 . 

the Enter the smaller of the amount on line 11, Part V, or line 2, Part Ill . __ ,_··- -

tnter amount from line 7, Part I . . . 

Credit allowable (subtract line 4 from line 3) • 

~otal FUTA tax (subtract line 5 from line 1) . . 

less: Total FUTA tax deposited for the year from your records . . . . . . . . . . 

Qalance due (subtract line 7 from line 6-if over $100, see Part IV instructions). Pay to IRS ; • . . . ...... 

9'ierpayment (subtract line 6 from line 7) . . . . . . . . . . . . . . . . . . . . . . ..... 

~ Record of Quarterly Federal Tax Liability for Unemployment Tax (Do not include State liability) 

r jS ~ Quarter I First I Second I Third I Fourth , ____ To_t_a_I f_o_r_Y_ea_r __ _ 

• ~Y for quarter 

dit ~will not have to file returns in the future, write "Final" here (see general instruction "Who Must File") . ..... 

"ii lhis Copy for Your Records-You must keep this copy and a copy Fo~ More lnfor!llat!on-See Publication 15, Circular E, Employ~r's Tax 

tal each related schedule or statement for a period of 4 years after the Guide, and Publlcat1on 539, Employment Taxes, for more detailed informatl'le -e_the tax is due or paid, whichever is later. These copies must be available tion. Household employers should see Publication 503, Child and Disabled 

ble· 11lspection by the Internal Revenue Service. Dependent Care. 

eS• 

aid 

'4.) 
Form 940 (1982) Page 4 

l:ttil'M Computation of Tentative Credit (Complete if You Checked the "No" Box in Either Question A or Bon Page 1-See Instructions) 

State Contributions if Contributions pay- Add itional cred it State reporting number(s) State experience rate period Contributions Taxable payroll experi- rate had been able at experience (col . 6 minus Name of State as shown on employer's 2.7% (col. rate (col. col. 7) If 0 or actually pa id (as defined in State act) 4 ence State contribution returns to State rate 3X2.7%) 3xcol. 5) less, enter 0. 

1 2 3 From- To- 5 6 7 8 9 

-------------------------------------------1---------1 

10 Totals . . .... ~~llll#M'~#~, __ __;.., __ 11 Total tentative credit (add line 10, columns 8 and 9-see instructions for limitations) . . .... - to temporary or part-time employees, and 

the value of goods, lodging, food, and cloth· 

ing. Enter the amount before any deductions. 

How the payments are made is not important in determining if they are wages. 

Thus, you may pay wages for piecework or 

as a percentage of profits, and you may pay 

wages hourly, daily, weekly, monthly, or 

yearly. You may pay wages in cash or some 

other way, such as goods, lodging, food, or 

clothing. For items other than cash, use the 

fair market value at the time of payment. 

Line 2-Exempt payments.-"Wages" 

and "employment" as defined for FUTA purposes do not include every payment and 

every kind of service an employee may perform. In general, payments excluded from 

wages and payments for services excepted 

from employment are not subject to tax. You 

may deduct these payments from total payments only if you explain them on line 2. 

Enter such items as the following: 

(1) Agricultural labor if you (a) paid cash 

wages of less than $20,000 for such labor 

for each calendar quarter in 1981 and 1982 

AND did not employ 10 or more farmworkers during any part of a day during any 

20 different weeks in 1981 or 1982, (b) 

paid wages to aliens admitted to the United 

States on a temporary basis to perform 

farmwork before 1984. 

(2) Benefit payments for sickness or injury under a worker's compensation law, 

insurance plan, and certain employer plans. 

(3) Household service if you paid cash 

wages of less than $1,000 in each calendar 

quarter in 1981 and 1982. 

(4) Certain family employment. 

(5) Certain fishing activities. 

(6) Non-cash payments for farm work or 

household services in a private home that 

are included on line 1. Only cash wages to 

these workers are taxable. 

(7) Value of certain meals and lodging. 

(8) Any other exempt service or pay. 

For more detailed information, see Circular E, Employer's Tax Guide. 

Line 3.-Enter the total of the amounts 

you paid each employee in excess of $6,000. 

For example, if you have 10 employees 

whom you paid $8,000 each during the year, 

enter $80,000 on line 1 and $20,000 on line 

3. The $6,000 wage limitation is for FUTA 

purposes only. Do not use the State wage 

limitation for this entry. 

Line 5-Total taxable wages.-lf any part 

of these wages is exempt from State unemployment taxes, you must fill out Parts II I 

and V, even if you checked questions A and 

8 "Yes." 

Line 6.-Enter any wages included on line 

~ subject to the unemployment compensation laws of Arkansas, Connecticut Delaware, District of Columbia, lllinofs, 'Maine, 

Michigan, Minnesota, New Jersey, Ohio, 

Pennsylvania, Puerto Rico, Rhode Island, 

Vermont, Virgin Islands, or West Virginia. (If 

in doubt, ask your local IRS office.) Multiply 

the wages by the appropriate rate. This adjustment is required by Internal Revenue 

Code section 3302(c)(2). If no wages are 

subject, enter "none" on line 7. 

Part 11.-Tax Due or Refund 

Use this part if you made payments to only one 

State by the due date of Form 940, and all your 

wages shown on line 5 of Part I are subject to the 

State's unemployment fund taxes. The tax rate of 

.007 gives you credit for your payments to your 

State's unemployment fund. 

Part 111.-Tax Due or Refund 

Use this part if you do not qualify for Part II. 

Line 3.-Enter the smaller of (1) line 11, 

Part V-Total tentative credit, or (2) line 2, 

Part 111-2.7% of taxable FUTA wages. This 

is the maximum credit allowable for your 

payments to the State unemployment fund . 

Line 4.-Enter the amount from line 7, 

Part I. Subtract this amount from line 3, 

Part Ill. The result on line 5 is your allowable 

credit for payments to the State. 

Part IV.-Record of Federal Tax liability 

Complete this part if your total tax (line 

3, Part II or line 6, Part Ill) ·is over $100. To 

figure your FUTA tax liability for each of the 

first 3 quarters of 1982, multiply by .007 

that part of the first $6,000 of each em -

ployee's annual wages you paid during the 

quarter. Enter this amount under that quarter. 

Your liability for the 4th quarter is the 

total tax (line 3, Part II or line 6, Part Ill) 

minus amounts deposited for the year. If 

this is over $100, deposit the entire amount 

by January 31 in a qualified depositary. If it 

is $100 or less, you can either make a de· 

posit or pay it with your Form 940 by 

January 31. 

The total liability must equal your total 

tax. Otherwise, you may be assessed a failure to deposit penalty computed on your 

average liability. 

If the amount subject to deposit (plus any 

undeposited amount of $100 or less for any 

earlier quarter) is more than $100, deposit it 

by the last day of the first month following 

the close of the quarter. 

If you deposited the proper amounts, following these rules, the balance due with 

Form 940 will never be more than $100. 

Deposit Federal unemployment tax in an 

authorized financial institution or the Federal Reserve bank for your area according 

to the instructions on the back of a preinscribed Federal Tax Deposit (FTD) Form 508 

which must accompany each deposit. 

Preinscribed FTD Forms 508 are mailed 

to yo'u·around the end of March for your use 

throughout the year. The number of cards 

you receive is based on your history of pat 

rnents during the previous two years. If yo~ 

do not r~ceive a supply of cards or nee 

more than the number sent to you, you can order cards by telephoning the toll-free IRS 

number for your area or by writing the serv· 

ice Center where you file Form 940. Your re· 

quest should show your name, address, erri· 

player identification number, the kind of ta ~ 

(FUTA), the tax period ending date (Dece~· 

ber 31), and the number of cards you nee · 

Taxpayers who willfully claim credit f

0

J 

deposits not made are subject to fines an 

other criminal penalties. 

Part V.-Computation of Tentative Credit 

Com~lete this schedule if: (1) You made payme~ts. to the unemployment fund of more than one Sta~~ (2) You did not make your State payments by t 0 due date of Form 940; or (3) Any wages subject te 

Federal unemployment tax were exempted from state 

unemployment taxes .. If you have a State experience 

rate lower than 2. 7% for all or part of the year, us 

columns 1 through 9. If you have no experience ratef 

use columns 1, 2, 3, and 9 only. If you have a rate 0 

2.7% or higher, use columns 1, 2, 3, 4, 5, and 9 on l~ If you were granted an experience rate for only par 

of the year or the rate was changed during the ye~h enter in the appropriate columns the period ea e· 

separate rate applied to, your payroll rate, and r 

quired contributions for each period. 

Column 1.-Enter the name of the sta~ or States (including Puerto Rico and the U. y 

Virgin Islands) that you were required to pa 

contributions to. 

Column 2.-Enter the State report ~ number that was assigned to you when Yte· registered as an employer with your Sta 

Column 3.-Enter the taxable payroll t~~i you must pay taxes on to the unemployrn e· fund of the State in column 1. If your ef Pof 

rience rate is zero, enter the amoun n if 

wages that you would have had to pay 0 

the rate had not been granted. . nee Columns 4 and 5.-Your State expene 0 ur 

rate is the rate at which the State taxes YseS· 

payroll for State unemployment purp~ fl'l e 

This rate may be adjusted from t ime to ~ate based on your "experience" with the Sent 

fund, that is, claims for unemployrriees 

compensation by your former emploY 01J( 

and other factors. If you do not know YritY 

rate, contact your State employment secLJ 

agency. I· . co Column 8.-Subtract the amount '" nte' umn 7 from column 6. If zero or less, e 

''O." . 

t(I' 

Column 9.-Enter the amount of co~ butions actually paid into the State fun · • 1 0 I 

Line 11.-Add the total of 11ne.t fo' 

columns 8 and 9. The allowable cred1 dLle 

State contributions you make att~r: theForf11 

date (or extended due date) for f1l1ng redit 

940 may not be more than 90% of the c ad 

that would have been allowed if you date· paid the State contributions by the due 

z6J5 *U.S. GOVERNMENT PRINTI NG OFFICE: 1985- 481 - 787') 
Department of the Treasury 

Washington, D.C. 20220 

Official Business 

Penalty for Private Use, $300