The Operation and Effect 

of the Possessions Corporation 

System of Taxation 

Second Annual Report 

Department of the Treasury 

June 1979 
ERRATA 

Page 28, 2nd paragraph, line 8: The word •over• should be deleted. 

Page 43, 2nd paragraph, line 3: Forty-four percent of these retained 

earnings, or $3.3 billion, were held 

by pharmaceuticals, NOT forty-seven 

percent, or $3.5 billion. 

Page 47, 2nd paragraph, line 5: One half of total distributions, or 

$581 million, were attributable to 

the chemical industry, NOT the 

pharmaceutical industry. 

Page 64, 3rd paragraph, line 4: Dividend distributions by possessions 

corporations were $1.15 billion in 

1978, · NOT $1.5 billion. 

Page 67, 3rd paragraph, line 3: Collections under the tollgate tax 

amounted to $49.1 million in the year · ending June 30, 1978, which represents an effective rate of about 4.1 

percent, NOT 4.5 percent. ----

Page 71, Note: Dollar amounts are in thousands. 

, 
The Operation and Effect of the Possessions 

'

1

' Corporation System of Taxation ; 

SeeeOO Annual Report .!../ 

LJ.S, Depar£ment. of the TreasuryLJ'BRJs:~'G 

June 1979 

JUL2 :i 1979 

l\OOM 5004 

TREASURY DEPARTMENT 

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

Washington, o. C. 20402 Stock No. 048-000-00329-0 
THE SECRETARY OF THE TREASURY 

WASHINGTON 

JUN 2 8 1979 

Dear Chairman Ullman: 

The Report of the Committee on Ways and Means 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 second 

(1977} annual report entitled~ "The Operation and Effect of 

the Possessions Corporation System of Taxation." 

I am sending a similar letter to Senator Russell B. 

Long, Chairman of the Committee on Finance. 

Sincerely, 

w. Michael Blumenthal 

The Honorable 

Al Ullman, Chairman 

Committee on Ways and Means 

House of Representatives 

Washington, D.C. 20515 

Enclosure 
THE SECRETARY OF THE TREASURY 

WASHINGTON 

JUN 2 8 1979 

Dear Chairman Long: 

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 second 

(1977) annual report entitled, "The Operation and Effect of 

the Possessions Corporation System of Taxation." 

I am sending a similar letter to Representative 

Al Ullman, Chairman of the Committee on Ways and Means. 

The Honorable 

Russell B. Long, Chairman 

Committee on Finance 

United States Senate 

Washington, D.C. 20510 

Enclosure 

Sincerely, 

W. Michael Blumenthal 
Chapter 

I. 

II. 

III. 

Table of Contents 

Introduction and Summary •••••••••••••••••••••••••• 

Taxation in the United States and Puerto Rico, and 

the Puerto Rican Industrial Incentives Program •••• 

A. U.S. Taxation of Domestic and Foreign 

1 

8 

Operations of U.S. Corporations............... 8 

1. General Structure of the Corporate 

Income Tax. • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 8 

2. Anti-abuse Provisions..................... 10 

3. Foreign Branch Operations................. 11 

4. Foreign Subsidiary Operations.............. 12 

B. U.S. Taxation of Business Operations in Puerto 

Rico and U.S. Possessions..................... 15 

1. Taxation of Possessions Persons........... 15 

2. Treatment of Possessions Source Income of 

Non-Possessions U.S. Persons.............. 16 

a. Adoption of Section 931............... 17 

b. Section 931 Prior to 1976............. 17 

c. Section 936........................... 21 

C. Taxation in Puerto Rico and the Industrial 

Incentives Program............................ 23 

1. Taxation in Puerto Rico................... 23 

2. The Industrial Incentives Program......... 25 

3. Recent Changes in the Tollgate Tax and 

the Industrial Incentives Program......... 26 

Puerto Rican Economic Growth and Development 

and the Possessions Corporation System •••••••••••• 31 

A. Puerto Rican Economic Growth Since 1948....... 31 

B. Long Range Development of the Puerto Rican 

Economy •••••••••••••••••••••••••••••••• ~...... 38 

1. Financing Investment in Puerto Rico....... 39 

a. Gross Internal Savings................ 41 

b. Federal Transfers..................... 41 

c. Direct Investment..................... 43 

d. External Borrowing by Puerto Rican 

Governments........................... 44 

e. All Other External Sources............ 44 

2. Profitability and Location in Puerto Rico. 44 
Chapter Page 

IV. 

c. The Costs and Benefits of the Possessions 

Corporation System............................ 48 

1. Costs..................................... 48 

2. Direct Benefits........................... 49 

3. Indirect Benefits......................... 49 

a. Backward Linkages..................... 49 

b. The Multiplier........................ 50 

c. Forward Linkages...................... 51 

D. Cost Effectiveness of the Possessions 

Corporation System............................ 52 

Statistical Data on the Operation and Effect 

of the Possessions Corporation System ••••••••••••• 53 

A. Federal Tax Expenditure on Possessions 

Corporations.................................. 53 

B. Basic Statistical Data on Possessions 

Corporations.................................. 56 

1. Summary Data for 1973-1977................ 56 

2. Detailed Data for 1977.................... 58 

C. Estimates of Backward Linkage and Multiplier 

Effects • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • 68 

D. Impact of the Adoption of Section 936 and 

Recent Changes in the Puerto Rican Tollgate 

Tax and Industrial Incentives Program......... 71 

1. Change in Costs........................... 71 

2. Change in Benefits ••• ~.................... 73 

3. Change in Cost Effectiveness.............. 82 

Appendix 

A. Operation of the Possessions Corporation System 

of Taxation in American Samoa, Guam, the Panama 

Canal Zone, and the Virgin Islands................ 84 

B. Sources and Limitations of the Data, and Detailed 

Tabulations for 1973-1976 ••••••••••••••••••••••••• 100 

c. Tax Forms from which Data Included in the Report 

was Obtained...................................... 115 
Figure 

I 

II 

III 

IV 

Table 

.1 

2 

3 

4 

5 

6 

7 

List of Figures and Tables 

Total and Per Capita Gross National 

Product of Puerto Rico, 1947-1978 

(Constant 1974 Dollars) ••••••••••••••• 

Total Government Expenditure Plus Net 

Investment of Public Enterprises, Own 

Source Revenue Plus Federal Taxes 

Covered Over, Federal Grants-In-Aid, 

and Total Borrowing of Puerto Rico, 

32 

1960-1978............................. 36 

Components of Investment in Puerto 

Rico, 1965-1978 ••••••••••••••••••••••• 

Financing Inv stment in Puerto Rico, 

40 

1965-1977............................. 42 

Puerto ·Rican Labor Force, Unemployment, 

and Employment by Major Industry, 

Fiscal Years 1973-1978 ~................ 33 

Federal Transfer Payments, Grants, and 

Taxes •covered aver• to Puerto Rico, 

Fiscal Years 1~68~and 1978 ••••••••••••• 35 

Federal Tax Expenditure Estimate and 

Projections, Possessions Corporation 

Provisions ••••••••••••••••••••••••••••• 54 ' . 

Summary Data on Possessions Corporations, 1973-1977 ••••••••••••••••••••••• 57 

Major U.S. Manufacturing Corporations 

Indicating a Tax Saving Under Section 

936 on Their SEC 10-K Reports •••••••••• 59 

Number of Possessions Corporations, 

Selected Balance Sheet and Income 

Statement Items, and Estimated Tax 

Expenditure by Industry, 1977 •••••••••• 61 

Tax Expenditur , Employment and 

Compensation of E ployees by 

Industry, 1977 ••••••••••••••••••••••••• 65 
Table 

8 

9 

10 

11 

12 

13 

A-1 

A-2 

A-3 

B-1 

B-2 

B-3 

Tax Expenditure, Employment and 

Compensation of Employees by 

Size of Tax Expenditure Per 

Employee, 1977 ••••••••••••••••••••••••• 67 

Tax Expenditure as a Percent of 

Compensation of Employees, of 

Direct Expenditure in Puerto 

Rico, and of Direct and Indirect 

Expenditures in Puerto Rico for 

Manufacturing Industries •••••••••••••• 

Elections under Section 936 by 

69 

Industry.............................. 75 

Estimated Composition of Financial 

Investments of Possessions Corporations at Yearend 1978 ••••••••••••••••• 

Sales of Bonds by the Government 

Development Bank for Puerto Rico, 

October 1976-April 1979 ••••••••••••••• 

Total Manufacturing Employment in 

Puerto Rico by Industry, Calendar 

Years 1973-1978 ••••••••••••••••••••••• 

Income and Estimated Tax Expenditure 

for American Samoa, Guam, and the 

Panama Canal Zone, 1977 ••••••••••••••• 

Overall Tax Rates on Earnings 

Repatriated ~rom the Virgin Islands 

79 

80 

83 

88 

and Puerto Rico....................... 96 

Tax Expenditure, Employment, and 

Compensation of Employees of u.s.-

Controlled Tax-Exempt Subsidiaries 

in the Virgin Islands, 1977........... 9~ 

Income and Estimated Tax Expenditure 

by Industry , 19 7 6 • • • • • • • • • • • • • • • • • • • • • 10-3 

Income and Estimated Tax Expenditure 

by Industry, 1975 ••••••••••••••••••••• 104 

Income and Estimated Tax Expenditure 

by Industry, 1974 ••••••••••••••••••••• 105· 
~- -~- --

Table 

B-4 

B-5 

B-6 

B-7 

B-8 

B-9 

B-10 

B-11 

B-12 

Income and Estimated Tax Expenditure 

by Industry, 1973 ••••••••••••••••••••• 106 

Tax Expenditure, Employment and 

Compensation of Employees by Industry, 1976.................................. 107 

Tax Expenditure, Employment and 

Compensation of Employees by Industry, 

1975.... . . . . . . . . . . . . . . . . . . . . . . . • . • • . • . 108 

Tax Expenditure, Employment and 

Compensation of Employees by Industry, 1974.................................. 109 

Tax Expenditure, Employment and 

Compensation of Employees by Industry, 1973.................................. 110 

Tax Expenditure, Employment and 

Compensation of Employees by Size of 

Tax Expenditure Per Employee, 1976 •••• 111 

Tax Expenditure, Employment and 

Compensation of Employees by Size of 

Tax Expenditure Per Employee, 1975 •••• 112 

Tax Expenditure, Employment and 

Compensation of Employees by Size of 

Tax Expenditure Per Employee, 1974 •••• 113 

Tax Expenditure, Employment and 

Compensation of Employees by Size of 

Tax Expenditure Per Employee, 1973 •••• 114 
CHAPTER I. INTRODUCTION AND SUMMARY 

Adopting language similar to that used in the Reports of 

the House Committee on Ways and Means and the Senate 

Committee on Finance, the General Explanation of the Tax 

Reform Act of 1976 states: 

"It is the understanding of Congress that the 

Department of the Treasury is to review the 

operations of section 936 corporations in order to 

apprise Congress of the effects of the changes made 

by the Act. The Treasury is to submit an annual 

report to the Congress setting forth an analysis of 

the operation and effect of the possessions 

corporation system of taxation. Among other 

things, the . report is to include an analysis of the 

revenue effects to the provision as well as the 

effects on investment and employment in the 

posssessions." !/ 

Congressional interest specifically in investment and 

employment effects stemmed from the belief that adopting 

section 936 to replace its predecessor, section 931, would: 

"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." ~/ 

This is the second annual report to the Congress on 

section 936" or "possessions" corporations, which are 

companies incorporated in the United States but exempt under 

section 936 and related provisions of the U.S. Internal 

Revenue Code from Federal tax on income from operations in 

!I Pages 277-278. 

~/ Page 274. 
-2-

Puerto Rico, American Samoa, Guam, and the Panama Canal 

Zone. ·~_1 

As in the First Annual Report, the body of this Report 

deals almost exclusively with Puerto Rico. Various 

Committee reports and other Congressional documents relating 

to the possessions corporation system of taxation reflect 

Congress' primary concern with its impact on Puerto Rico, 

and as indicated below Puerto Rico accounts for over 98 

percent of the Federal tax expenditure associated with the 

possessions corporation provisions of the Internal Revenue 

Code. Appendix A of this Report describes the system of 

taxation as it affects American Samoa, Guam, and the Panama 

Canal Zone. The tax exemption for U.S. corporations 

operating principally in the Virgin Islands is delimited by 

section 934, which was unaffected by the Tax Reform Act of 

1976. Because the Virgin Islands is also a possession, and 

because section 934 has many features similar to those of 

section 936, the taxation of U.S. controlled companies 

operating in the Virgin Islands is also described in 

Appendix A. 

In Puerto Rico, the possessions corporation system 

builds upon and reflects the complex interaction of the 

special provisions in the U.S. tax law and the tax law and 

Industrial Incentives Acts of the Commonwealth. The system 

also forms but a part of the governmental fiscal and private 

economic relationships between the United States and Puerto 

Rico. Chapters II and III of this Report are devoted, 

respectively, to a description of these legal and economic 

frameworks. Chapter IV presents available statistical data 

on the actual operation and effect of the possessions 

corporation system. 

Chapter II beg ins with a description of the general 

rules applicable to U.S. taxation of corporate income. This 

review covers the corporate rate structure, the definition 

of taxable income, treatment of intercorporate dividends and 

affiliated groups of corporations, and major anti-abuse 

provisions. Rules governing foreign operations in branch 

1/ Although Puerto Rico and the possessions are included in 

some definitions of the United States, for convenience 

of exposition the term "United States" in this Report 

will - mean only the fifty states and the District of 

Columbia. The Panama Canal Zone was never a U.S. 

possession, but has been treated as such under the U.S. 

Internal Revenue Code. 
-3-

and foreign subsidiary form are then covered. These rules 

include those dealing with the source of income, computation 

of the foreign tax credit, transactions with foreign 

subsidiaries, and the anti-abuse provisions that apply to 

foreign operations. With this general background, the 

Chapter then turns to the special treatment afforded 

business operations in Puerto Rico and the possessions in 

the U.S. tax system. 

In many respects, Puerto Rico and the possessions are 

treated much like foreign countries, and their residents 

much like other non-u.s. persons, for purposes of the 

Federal income tax. However, there are major exceptions to 

this treatment, in particular the possessions corporation 

provisions. The legislative history of these provisions is 

sketched, and a detailed description given of section 931 

and its successor, section 936 • 

. The final section of Chapter II begins with an overview 

of the Puerto Rican tax system and the Puerto Rican corporate income and withholding ("tollgate") tax on corporate 

dividends as in effect prior to 1976. .Puerto Rico's 

Industrial Incentive Acts, which have provided exemptions of 

income, excise, and property taxes as well as direct 

subsidies to manufacturers, are then reviewed. The Chapter 

concludes with a description of the rather complex changes 

since 1976 in the Puerto Rican tollgate tax and Industrial 

Incentive Act. 

Chapter III begins by documenting Puerto Rico's 

impressive postwar economic growth through the early 1970s, 

the causes of the 1973-1977 recession, and steps taken by 

the Federal and Puerto Rican governments to mitigate its 

impact. The role of "real" investment -- plant, equipment, 

government infrastructure, etc. -- in economic development 

and the sources available for financing this investment in 

Puerto Rico are then considered. Through several direct and 

indirect means, including the possessions corporation 

provisions, the Federal government has played a major role 

in providing external sources of funds for investment in 

Puerto Rico. The particular role of the possessions 

corporation tax exemption system as a means of stimulating 

investment in Puerto Rico is then considered. It is noted 

that tax exemption is only attractive to firms that would 

otherwise be profitable in Puerto Rico -- because of lower 

wage rates, greater proximity to the U.S. market, tariff 

protection, and similar factors that make Puerto Rico a 

competitive location for investment by u.s. firms. The 

competitive position of Puerto Rico, however, has changed 

over the postwar period as a result of rising wage rates 
-4-

(due in part to application of the U.S. minimum wage), 

tariff reductions in the 1960s, changes in relative prices 

(particular! y for petroleum products) , and other factors. 

One apparent result of these changes has been a shift in the 

type of firm attracted to Puerto Rico by the possessions 

corporation system. 

The final two sections of Chapter III contain an 

analysis of the costs, benefits and cost effectiveness of 

the possessions corporation system. The major cost of the 

system is the Federal tax expenditure, or revenue foregone, 

on the income of possessions corporations. The Puerto Rican 

government also foregoes tax revenues and incurs expenditures on behalf of possessions corporations -- some direct 

(such as for cash grants and interest subsidies), and others 

indirect (such as for special transportation facilities and 

additional general government services). Additional costs 

may be placed on Puerto Rico by firms that degrade the 

environment or impose other external costs. 

A possessions corporation provides direct benefits to 

the Puerto Rican economy through the additional wages and 

fringe benefits it pays to Puerto Rican employees. It also 

provides indirect benefits through its purchases of raw 

materials, intermediate and capital goods, and services in 

Puerto Rico ("backward linkages") which in turn produce 

local employment and income, and through the "multiplier" 

effect of employee spending on food, clothing, etc. However, the total amount of income generated by these backward 

linkage and multiplier effects will overstate the net benefit to the Puerto Rican economy to the extent that labor and 

other resources had alternative economic uses or "opportunity costs." (For example, land used by possessions 

corporations might otherwise be used for agricultural 

purposes.) The total income generated, less these opportunity costs, represents the correct measure of the benefit 

of the possessions corporation system to Puerto Rico. 

The cost effectiveness of an industrial incentive 

program is measured by comparing the ratio of benefits to 

costs for each firm, or at least each industry, against 

alternatives. Variations in these benefit-cost ratios would 

indicate that the cost effectiveness of the program could be 

improved by shifting spending, including tax "spending" or 

revenues foregone, from industries with low benefit-cost 

ratios to industries with high ratios of benefits to costs. 

There is reason to expect the possessions corporation system 

not to be cost effective because the main incentive it 

provides -- Federal tax exemption -- is in no way contingent 

on the value of benefits generated in Puerto Rico. 
-5-

Chapter IV presents statistical data on the operation 

and effect of the possessions corporation system. The first 

section covers estimates and projections of the total 

Federal revenue foregone, or tax expenditure, on the 

possessions corporation provisions. This tax expenditure 

has risen from $255 million in 1973 to $662 million in 1977, 

the most recent year for which reasonably complete tax 

return data are available, and is projected to reach $1.2 

bill ion by 1984. The second section presents data, by 

industry, on the Federal tax expenditure, employment, 

employee compensation, receipts, deductions, net income, 

assets, retained earnings, and other characteristics of 

possessions corporations. The industry data show that the 

Federal tax expenditure is highly concentrated by industry; 

in 1977 about 45 percent {$290 million) accrued to the 

pharmaceutical ind us try alone and an addition al 15 percent 

{ $104 million) to the electrical and electronic equipment 

industry. The Federal tax expenditure is also highly 

concentrated among a few parent corporations. If all the 

possessions corporations of each U.S. parent are 

consolidated, the Federal tax expenditure on the possessions 

corporation system was concentrated as follows in 1977: 

Number of 

Parent Corporations 

Top 5 

Top 10 

Top 20 

Top 30 

Percent of Total Federal Tax 

Expenditure on All Corporations 

29.7% 

47.1 

67.9 

76.2 

These data also reveal that the tax expenditure per 

employee in 1977 for all possessions corporations was 

$8, 222, which is slightly less than the average employee 

compensation paid of $8, 507. This means that for every 

dollar of compensation paid to a Puerto Rican employee by a 

possessions corporation, Federal tax revenues were reduced 

by nearly one dollar. However, there are wide variations; 

for example, the pharmaceutical industry showed a tax 

expenditure per employee of $34,966, or nearly three times 

the average employee compensation for that industry, while 

for the apparel industry tax expenditure per employee was 

$1,396 or less than one-fourth of average employee 

compensation. The retained earnings of possessions 

corporations at the end of 1977 exceeded $5.7 billion, which 

represented about 60 percent of total liabilities and 

stockholders' equity of $9.8 billion. Fifty percent of 
-6-

total retained earnings and 35 percent of total assets were 

accounted for by the pharmaceutical industry. 

The third section of Chapter IV provides estimates, for 

manufacturing industries, of the ratio of direct (employee 

compensation) and indirect (backward linkage and multiplier) 

benefits to the Federal tax expenditure. While these 

benefit-cost ratios are too high, because benefits are 

overstated and costs understated, they do reveal a wide 

variation by industry -- from 12.5 for textile mill products 

to 1.2 for pharmaceuticals. This wide interindustry 

variation provides a statistical indication of the cost 

ineffectiveness of the possessions corporation system. 

Chapter IV concludes with an analysis of the impact of 

the adoption of section 936 and the recent changes in the 

Puerto Rican tollgate tax and Industrial Incentive Program. 

These changes have had their primary effect on: 

o Dividend repatriation -- Prior to 1976, most 

possessions corporations accumulated their 

earnings until the company was liquidated, 

usually at the end of its tax exemption grant. 

In 1977, possessions corporations began to 

repatriate dividends at an annual rate of 

approximately $1.2 billion. This represents 

nearly 70 percent of current earnings. 

o Composition of financial portfolios Prior 

to 1976, the substantial financial portfolios 

of possessions corporations were invested 

outside of Puerto Rico, primarily in the 

Eurodollar market. Those portfolios continue 

to grow, but there has been a major shift in 

their composition. At year-end 1978, it is 

estimated that out of a financial portfolio of 

$6.5 billion, over $4.0 billion was invested 

in Puerto Rican assets, and $600 mill ion in 

U.S. assets. 

o Puerto Rican tax revenues Prior to 1976, 

Puerto Rico collected little tax on the income 

of possessions corporations. In the last two 

years, annual tax collections from their 

revised tollgate tax have averaged $50 million 

per year. Additional revenues of $15-$25 

million may be generated by the recent 

revisions to the Puerto Rican Industrial 

Incentive Act, which place possessions 

n 

b 

C
-7-

corporations on a partially taxable basis. 

Total Puerto Rican income tax collections from 

possessions corporations are expected to 

represent about 5 percent of their pre-tax 

income. 

These U.S. and Puerto Rican legislative 

not, however, had a dramatic effect on the 

benefits, or cost effectiveness of the 

corporation system. 

changes have 

basic costs, 

possessions 

o Costs -- Federal tax expenditure, the major 

cost of the possessions corporation system, 

has been reduced somewhat by the relatively 

small increase in Puerto Rican tax 

collections. But as noted above, the Federal 

tax expenditure was nearly $662 mill ion in 

1977, and is expected to reach $1.2 billion by 

1984. 

o Benefits -- Benefits to Puerto Rico may also 

have been marginally reduced, through the 

disincentive effect of the tax increases, 

al though available statistical data are not 

clear on this point. It does not appear that 

the financial investment incentives contained 

in the new U.S. and Puerto Rican laws has had 

any appreciable effect to date on the 

availability of credit or long run interest 

rates in Puerto Rico. 

o Cost effectiveness -- On balance, the cost 

effectiveness of the possessions corporation 

system may not have been altered in any 

significant degree by the recent legislative 

changes. A comparison of recent growth rates 

of employment with computed benefit-cost 

ratios of the possessions corporation system 

for manufacturing industries suggests that the 

system will continue to attract the high 

profit, and therefore high Federal tax 

expenditure, operations of U.S. firms in 

particular industries that provide relatively 

few benefits to the Puerto Rican economy. The 

system may provide less of an incentive in the 

future to the traditional, labor-intensive 

industries. 
-8-

CHAPTER II. TAXATION IN THE UNITED STATES AND PUERTO RICO, 

AND THE PUERTO RICAN INDUSTRIAL INCENTIVES 

PROGRAM 

The possessions corporation provisions of the U.S. 

Internal Revenue Code and the Puerto Rican Industrial 

Incentive Acts represent substantial departures from the 

normal U.S. and Puerto Rican tax rules that would otherwise 

apply to a U.S. company operating in Puerto Rico. The 

intent of these departures is to reach a non-tax pol icY 

objective: increased employment in Puerto Rico. In thiS 

chapter, both the normal and these special provisions of 

U.S. and Puerto Rican law are covered in order to explain, 

and clarify, the nature of the special rules and the manner 

in which they operate. 

A. u.s. Taxation of Domestic and Foreign Operations of u.s..!- Corporatioi:i~ 

1. General Structure of the Corporate Income Tax 

The United States imposes a tax upon the worldwide 

taxable income of corporations organized under the laws of 

the United States, the District of Columbia, or any of the 

states. The rate of tax is graduated, rising from 17 percent 

of the first $25,000 of taxable income, to 46 percent (48 

percent prior to 1979) on corporate taxable income in excess 

of $100, 000. Taxable income is generally defined for both 

corporations and individuals as the gross income from a 

trade or business or from investments, less the ordinary and 

necessary expenses incurred in earning that income. 

The United States has a "classical" system of taxin9 

corporate earnings; that is, corporate earnings are taxed at 

the corporate level as they are earned and a second time, at 

the shareholder level, upon the distribution of dividends· 

The "double taxation" of corporate earnings would raise a 

serious obstacle to multiple-tiered corporate operations if 

separate tax liabilities were imposed at the subsidiarY 

level, and again upon distribution of the subsidiary's 

earnings to its parent corporation. To eliminate thiS 

obstacle, the Internal Revenue Code makes two special prov1s1ons. First, an 85 percent dividends received deduction 

is allowed for any dividend received by one U.S. corporatio~ 

from another. Second, in the case of an "affiliated group 

of corporations, the members of the group may report their 
-9-

income on a consolidated basis, or any corporation may claim 

a 100 percent dividends received deduction for any dividend 

received from another member of the group. !/ 

The shareholder level tax on corporate earnings is 

imposed only when amounts are actually distributed as 

dividends to the shareholders. In addition, shareholders 

are subject to tax on the gain from the sale, exchange, or 

other disposition of the shares of the corporation. If a 

shareholder has held his shares for more than one year the 

gain will normally constitute long-term capital gain, 

taxable at special rates. The special rate for individual 

shareholders is achieved by allowing them a deduction equal 

to 60 percent of their net long-term capital gain; for 

corporations, the special rate is the lower of the 

ordinarily applicable rate or 28 percent. 

The Internal Revenue Code taxes property gain only upon 

sale, exchange, disposition, or other alienation, in a legal 

sense, of the property; it does not tax the mere change in 

market value of property in a taxable period. The existence 

of a one-time tax on disposition, together with an exemption 

in the absence of disposition, has led Congress to confer 

"nonrecognition" treatment upon certain transactions in 

Property. "Nonrecognition" treatment applies principally in 

circumstances in which a taxpayer has alienated property, in 

a legal sense, so that he has "realized" whatever gain or 

loss he has borne on the property; but in which the taxpayer 

retains a continuing interest either in the property, the 

essential interests it represented, or in similar property, 

after the transaction. The "nonrecognition" provisions play 

a significant role in giving businesses freedom to arrange 

and rearrange the legal form in which they are conducted. 

The simplest and perhaps most important cases involve the 

transfer of property by a shareholder to a wholly owned 

corporation. The transaction involves an "exchange" of the 

Property for an interest in the corporation, which 

constitutes a "realization" of any gain or loss the taxpayer 

has on the property. But the taxpayer has a "continuing 

interest" in th-e old property, and for this reason the tax 

law permits (and in most cases requires) that he not 

"recognize" the gain or loss for tax purposes. 

!I An "affiliated group" of corporations is defined as a 

group of corporations including a "common parent," which 

owns at least 80 percent of one of the other corporations in the group, and in which all corporations other 

than the common parent are at least 80 percent owned by 

other members of the group. 
-10-

2. Anti-abuse Provisions 

The Internal Revenue Code includes a wide variety of 

measures designed to prevent persons from manipulating 

corporate form for tax avoidance purposes. The highest 

corporate tax rate (now 46 percent) is, and since the early 

days of the income tax has been, lower than the highest rate 

applicable to individuals (now 70 percent). For this 

reason, there would be, in the absence of an ti-abuse 

provisions, motivation for high-bracket taxpayers to 

transfer income-producing property to a wholly or closely 

owned corporation, an "incorporated pocketbook." To prevent 

this, the Code since 1936 . has imposed special penalty taxes 

upon "personal holding companies." A personal holding 

company is subject to a 70 percent tax on its income. 

A second abuse to which corporations were subject is the 

accumulation of earnings in a corporation in order to avoid 

or to defer the shareholder's tax liability on dividends 

distributed by the corporation. To combat this, the 

Internal Revenue Code imposes an "accumulated earnings tax" 

at graduated rates of 27-1/2 percent and 38-1/2 percent of 

the company's accumulated taxable income, which are earnings 

in excess of the reasonable needs of the business. 

A third abuse to which corporations are potentiallY 

subject is "splitting" of income among several corporations 

to avoid taxation at higher graduated rates. To avoid thiS 

possibility, the Internal Revenue Code provides that the 

aggregate amount of income of the corporations in a 

controlled group qualifying for the rates applicable to the 

lower brackets cannot exceed the amounts which would qualifY 

for those rates in the case of a single corporation. 

A fourth potential abuse involves the "shifting" of 

items of income or expense between two related corporations 

in order to reflect greater amounts of income in one of the 

corporations. The classic case involves "transfer pricing" 

between a parent corporation and its wholly owned 

subsidiary. A company may have tax motivations for 

reflecting greater profits in the subsidiary, for example, 

if the subsidiary has substantial losses or other deductions 

to offset income shown by it. Profits may be shifted to (or 

from) the subsidiary by having the parent charge an 

artifically low (or high) "transfer price" on its sales to 

the subsidiary, or the subsidiary may charge an artificiallY 

high (or low) transfer price on its sales to the parent• 

Alternatively, the parent may provide management services at 

little or no charge to a subsidiary, or may charge an 

excessive amount for them; it may make loans to, or borro~ 
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money from, a subsidiary at excessive or uncommercially low 

rates; and so forth. 

The Internal Revenue Code provision that addresses 

profit shifting between related companies is section 482, 

which authorizes the Secretary of the Treasury to 

"distribute, apportion, or allocate gross income, 

deductions, credits, or allowances" between or among any 

related organizations, trades, or businesses, if the 

Secretary determines that "such distribution, apportionment, 

or allocation is ne·cessary in order to prevent evasion of 

taxes or clearly to reflect the income of any of such 

organizations, trades, or businesses." 

In addition to the above, specific provisions, the 

Internal Revenue Code contains more general provisions aimed 

at combatting the avoidance or evasion of tax through 

manipulation of the corporate form. The most important of 

these is section 269, which provides that if any persons 

acquire control of a corporation, or acquire property of a 

corporation in certain kinds of transactions, and the 

Principal purpose of the acquisition is "evasion or 

avoidance of Federal income tax by securing the benefit of a 

deduction, credit, or other allowance which such person or 

corporation would not otherwise enjoy," then the Secretary 

is authorized to disallow the deduction, allowance, or 

credit. 

3. Foreign Branch Operations 

The United States imposes tax on the worldwide taxable 

income of U.S. corporations. That is, all income is 

included in the tax base, regardless of the geographic place 

it was derived, and all allowable items of expense, 

deduction, and credit are taken into account, regardless of 

the place the income to which such i terns were related was 

derived. 

Difficult questions arise when the foreign countries in 

Which U.S. companies operate also impose taxes on the income 

derived by these companies. The questions concern the 

Possibility of international "double taxation" and the means 

Of avoiding it. By statute, the United States supplies the 

basic means by which double taxation of U.S. companies is 

avoided. This is the foreign tax credit. A U.S. company is 

Permitted a dollar-for-dollar credit against its U.S. tax 

liability for income, war profits, or excess profits taxes 

Paid or accrued to foreign governments. The amount of 

credit a company may claim is limited to the U.S. tax 

liability attributable to foreign source income. This 
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amount is computed by multiplying the ratio of the company's 

foreign source taxable income to its worldwide taxable 

income by the company's pre-credit U.S. tax liability. The 

computation of foreign source taxable income is determined 

by explicit statutory rules governing the "sourcing" of 

income, and by regulations issued by the Treasury Department 

governing the allocation and apportionment of deductions to 

or among different classes of gross income, and gross income 

in different statutory source "groupings." 

Companies operating in branch form overseas accordingly 

account currently for items of income, loss, deduction, 

expense, or credit attributable to their foreign branches, 

and claim foreign tax credits for any taxes paid to foreign 

governments with respect to their operations. 

4. Foreign Subsidiary Operations 

Tax consequences substantially different from those 

flowing from foreign branch operations arise if a U.S. 

company conducts its foreign business operations through a 

corporation organized under the laws of a foreign country. 

The profits of a foreign corporation are generally not taxed 

currently by the United States; a foreign corporation is 

taxed by the United States only on certain U.S. source 

investment income, and on its income "effectively connected• 

with a U.S. trade or business. However, the U.S. parent 

corporation will be taxable on any dividends received from 

the foreign corporation. The insulation of the foreign 

corporation's profits from a corporate level U.S. tax makeS 

the essential devices for mitigating the impact of the u.s. 

"double-tax" system on corporate organization the 

dividends received deduction and the opportunity to report 

income on a consolidated basis -- unnecessary in the context 

of foreign subsidiaries. Therefore, U.S. companies may not 

claim a dividends received deduction for dividends from a 

foreign corporation which did not earn income from a u.s. 

business, and foreign corporations may not be included in a 

consolidated return. However, a U.S. corporation which owns 

10 percent or more of a foreign corporation may take a 

"deemed pa id n credit for foreign income taxes pa id by t~e 

foreign corporation on income represented by dividends paid 

to the U.S. corporation. The amount of deemed paid cred~t 

is 1 imi ted in the sam.e way as is the foreign tax cred 1 t 

claimable by U.S. companies operating in branch form abroad· 

The insulation of foreign corporations from current u.s. 

tax, and the ability of U.S. companies (and other persons) 

to hold property or to conduct business through a foreign 

corporate organization, create special potentials for abuse 

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which require special anti-abuse provisions. The 

"nonrecognition" provisions, for instance, create 

substantial abuse potentials in the foreign corporation 

area. When a person transfers appreciated property (such as 

a patent) to a U.S. corporation, there is relatively little 

possibility for avoiding or deferring a capital gains tax in 

the event of a subsequent disposition of the property by the 

corporation; the transferee corporation is subject to a 

comprehensive U.S. tax liability, just as the transferor 

would be. Where the transfer is made to a foreign 

corporation, however, a much greater abuse potential arises. 

In those circumstances, the foreign corporation will not be 

taxable upon a subsequent disposition of the property; thus 

the capital gains tax will be deferred indefinitely until 

a is tr ibution of the proceeds to the u. s. shareholder, and 

may by certain devices be ultimately avoided. · 

A related problem grows out of the practice of u. S. 

corporations using a branch form for startup operations in 

foreign countries and incorporating the branch when the 

operations reach a "break-evenn point. Startup business 

operations often entail substantial "front end" losses; 

these losses may be used by the companies to offset other 

income in computing their total u.s. tax liability. But 

some of those losses may be the product of deductions which, 

though allowable by the terms of the Internal Revenue Code 

in the year claimed, are properly allocable to income which 

Will be produced in subsequent years. For instance, a 

company may incur substantial research and development 

expenses, which may be deducted for U.S. tax purposes in the 

Period during which they are incurred. But these expenses 

may be productive of substantial royalty or other licensing 

type income not realized until years subsequent to the time 

the expenses are incurred. By incorporating foreign 

Operations in a timely manner, a corporation can exaggerate 

the deferral effect of the insulation of foreign corporate 

earnings from U.S. tax, for it has claimed deductions 

~9ainst U.S. source income currently, but in "income years" 

it will not incur any U.S. tax on the foreign earnings. 

The Internal Revenue Code has two devices to combat 

these two related potentj al abuses. First, a 35 percent 

excise tax is imposed on the amount of untaxed 

appreciation borne by property transferred by a U.S. person 

as a contribution to the capital of a foreign corporation, 

Unless the transferor satisfies the Internal Revenue Service 

that the transfer does not have a tax avoidance purpose. 

This excise tax essentially replaces the capital gains tax 

that is being avoided by the transfer. Second, in order to 

secure nonrecognition treatment on certain transfers to 
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foreign corporations which would be nonrecognition transfers 

under the otherwise applicable Code provisions, a transferor 

must obtain a ruling from the Internal Revenue Service that 

the transfer does not have a tax avoidance or evasion 

purpose. If the Service refuses such a ruling 

nonrecognition treatment is not accorded the transaction 

the company is compelled to pay a "toll charge." 

A third potential abuse arises from opportunities to 

manipulate "source" rules to reflect income in "tax haven" 

jurisdictions, and thereby to escape corporate level or 

current taxation of the income. For instance, income from 

the disposition of personal property is "sourced" in the 

jurisdiction where title passes. This "source rule" permits 

persons selling goods to the United States, for instance, to 

pass title through a foreign base company and thereby to 

avoid U.S. source income, which would be taxable by the 

United States. Similarly, income from shipping, from the 

performance of certain architectural, engineering, 

managerial or other services, or income from underwriting 

insurance contracts may be derived in such a manner as to 

characterize the income as having a source in a foreign 

base. In this way, the income can be sheltered from current 

U.S. tax through foreign incorporation; and it may receive 

effective exemption from current tax if the corporation iS 

organized in a low- or no-tax "haven" jurisdiction. TO 

combat this practice, the United States requires that u.s. 

shareholders of "controlled foreign corporations" currentlY 

include in their income portions of the corporation's income 

attributable to certain base company or passive inves'ttnent 

income. 

A fourth potential abuse is the ability of a u.s. 

shareholder of a foreign corporation to "transmute" what 

would be ordinary dividend income of a foreign corporation 

into lower taxed "capital gain" income by selling shares of 

the company or liquidating it, instead of distributin9 

accumulated profits from a company. In addition, a u.s. 

company could 1 iquidate an 80 percent owned foreign 

subsidiary free of tax, receiving "nonrecognition" 

t_reatment. In the absence of special provisions, it could 

therefore gain control of accumulated profits without the 

occurrence of any taxable event. To forestall "bailouts" ?f 

this type, the Internal Revenue Code requires that the gain 

realized on the sale of shares of any foreign corporation bI 

a U.S. person who was more than a 10 percent shareholder 0 

the company be treated as a dividend to the extent of the 

accumulated profits of the company. It also requires that 

in liquidating a foreign subsidiary, a U.S. person receive a 

ruling from the Internal Revenue Service that the 

liquidation does not have a tax avoidance purpose. 

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A fin al and important potential abuse of foreign 

corporations grows out of the ability of companies to 

"shift" profits from one corporate entity to another through 

artificial transfer pricing and other artificial pricing of 

intercorporate transactions. By shifting profits to a 

foreign subsidiary, a U.S. parent may secure deferral of {or 

exemption from) U.S. tax on what may in reality be genuine 

U.S. business activity. This problem is especially acute 

where profits may be shifted to a tax haven jurisdiction 

where they will be taxed at a rate substantially lower than 

that imposed by the U.S. As in the case of profit shifting 

between domestic corporations, this potential abuse is 

addressed by section 482 of the Internal Revenue Code. 

B. U.S. Taxation of Business Operations in Puerto Rico and 

U.S. Possessions 

1. Taxation of Possessions Persons 

Under the Internal Revenue Code, comprehensive tax 

liability is imposed upon all individual residents and 

citizens of the United States, and upon domestic 

corporations. Section 932 provides that citizens of 

possessions {other than Guam), who are "not otherwise" U.S. 

citizens and who are not U.S. residents are treated as 

nonresident aliens under the Code. This makes them subject 

to tax only on their U.S. source investment income and 

income "effectively connected" with the conduct of a U.S. 

trade or business. 

Only domestic corporations are subject to comprehensive 

U.S. tax liability under the Internal Revenue Code. 

Domestic corporations are defined as corporations organized 

Under the laws of the United States or of one of the states. 

Foreign corporations are defined as any corporations which 

are not domestic. Accordingly, a corporation organized 

Under the laws of one of the possessions, or under the laws 

of the Commonwealth of Puerto Rico, is deemed to be a 

foreign corporation for purposes of the Internal Revenue 

Code. Such a corporation is taxable on a withholding basis 

on certain U.S. source investment income, and is taxed on 

income effectively connected with a U.S. trade or business; 

but it is exempt with respect to other income, including its 

foreign source business income. 

Section 933 of the Internal Revenue Code modifies the 

taxation by the United States of u.s. citizens resident in 

Puerto Rico, by allowing such residents to exclude from 

9ross income amounts derived from Puerto Rican sources. Such 
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residents may not claim deductions properly allocable to 

excluded income against other income taxed by the United 

States. They also may claim a foreign tax credit for taxes sc 

paid to Puerto Rico on their other income, including U.S. ac 

source income. c1 

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their u.s. income tax liability by payment of income taxes s

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2. Treatment of Possessions Source Income of e 

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The Internal Revenue Code never uses the colloquial ~ 

terms "domestic" and "foreign" source income; it speaks of 

income "from sources within" and "from sources without" the 

United States. Since under the Code "United States" when 

used in its geographic sense includes only the states 

thereof, and also the District of Columbia, "possessions 

source" income is income "from sources without" the United 

States within the meaning of the Code. In addition, the 

Code explicitly permits taxes paid the possessions to be 

credited against U.S. tax liability to the same extent a 

credit for taxes paid foreign governments is permitted· 

Accordingly, even in the absence of special provision fo! 

possessions source income, embodied in section 936 (and 

formerly section 931) of the Internal Revenue Code1 

companies could claim a foreign tax credit for income 

derived from the possessions. This, together with the 

prov1s1on that possessions-incorporated corporations are 

foreign corporations, would give the companies the same 

option they have with any foreign operation -- between a 

foreign branch and foreign subsidiary -- with virtuallY 

identical tax consequences. Possessions subsidiaries are 

subject to the anti-avoidance measures described above to 

the same extent as any other foreign corp.orations. !:_/ 

But U.S. companies have a third option -- the 

possessions corporation qualifying for the benefits of 

section 936. The mechanics of this option, its evolution 

from its predecessor governed by section 931 of the Internal 

Revenue Code, and the scope of the advantages it confers' 

are described below. 

~/ An exception to this general rule arises in the case of 

possessions-incorporated subsidiaries that meet the 

requirements set out for possessions corporations' 

except for the U.S. incorporation requirement. 
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a. Adoption of Section 931 -- The essential elements of 

section 931 of the Internal Revenue Code of 1954 were 

adopted as part of the Revenue Act of 1921. Certain U.S. 

companies had sought a .provision in that law exempting from 

U.S. income tax the income of any domestic corporation which 

derived 80 percent or more of its gross income from foreign 

sources. The principal argument advanced in support of the 

provision was that U.S. firms were placed at a tax-induced 

disadvantage vis-a-vis United Kingdom competitors, because 

United Kingdom law did not impose income tax upon the 

earnings of firms until the firms remitted the earnings. The 

compromise reached was an exemption for U.S. firms deriving 

80 percent or more of their gross income from U.S. 

possessions. 

This compromise in fact went further toward meeting the 

demands of the proponents of foreign exemption than might 

appear from a current vantage point. Support for the 

exemption system came primarily from a group of firms then 

operating in the Philippines, a U.S. possession in 1921. 

Those firms argued that tax exemption would encourage U.S. 

trade with the Far East from the u.s. base in the 

Philippines, while at the same time reducing incentives for 

U.S. firms operating there to reincorporate outside the 

United States. Little attention was paid to the effect of 

this law on the Philippine economy; other possessions, 

including Puerto Rico, were virtually ignored in the public 

debate. 

b. Section 931 Pripr to 1976 -- Prior to adoption of 

the Tax Reform Act of 1976, section 931 provided that 

individual citizens of the United States and domestic 

corporations which met certain "income tests" should be 

taxable in the United States only on their u.s. source 

income. Other income was excluded from their tax 

computation. There were two income tests: an "80 percent 

test" -- that 80 percent of the person's gross income be 

Possessions source; and a "50 percent test" that 50 

Percent of the person's income be derived from the active 

conduct of business in the possessions. Both tests are made 

over a three-year period closing with the end of the taxable 

Year with respect to which the tests are applied, or for a 

Shorter period, if the person has not conducted a trade or 

business in a possession for the entire three year period. 

A possessions (or "931") corporation under this statute was 

tequired to be a domestic corporation. 

The exclusion created by section 931 was different from 

the foreign tax credit in one crucial respect. The foreign 

tax credit shields a u. s. company's foreign earnings from 
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tax only if and to the extent that the company pays tax to a 

foreign government. The 931 exclusion applied whether or 

not the company actually paid a foreign or possession income 

tax. The exclusion thus "preserved" the economic benefit of 

any tax incentive legislation adopted by a possession. The 

application to 931 corporations 9f the two basic means for 

mitigating the impact of the "classical" system on corporate 

organization, that is, permissive consolidation and the 

dividends received deduction, were modified. Prior to 1976, 

the Internal Revenue Code provided that a corporation 

"entitled to the benefits of section 931" could not be an 

"includible corporation" in an "affiliated group." Failure 

to qualify as an includible corporation made the company 

ineligible for consolidation. And parent corporations could 

not take a dividends received deduction for dividends paid 

by 931 corporations. 

Corporations qualifying for section 931 therefore had 

difficulty distributing their accumulated earnings, because 

the parent corporation would be subject to tax on the full 

amount of any dividends the 931 paid. However, the parent 

company could claim a "deemed paid" credit for any taxes the 

9 31 corporation may have pa id to a possess ion (or foreign 

country) on its earnings, and for any withholding tax 

imposed by the possess ion upon the dividend. The dividend 

was considered foreign source income which increased the 

recipient's foreign tax credit limitation. In addition, the 

931 company was effectively insulated from the u.s. 

accumulated earnings tax, since that tax is based on 

accumulated taxable income, and by virtue of the exclusion 

under section 931, the company had little if any taxable 

income. On the other hand, if 8 0 percent owned by a 

domestic corporation, a 931 corporation could be liquidated 

into its parent free of capital gains tax either to the 

subsidiary on any appreciated property distributed to the 

parent, or to the parent, on the appreciation of shares 

surrendered in exchange for the property distributed. Thi 5 

could be achieved without a ruling from the Internal Revenue 

Service that the transaction did not have a tax avoidance 

purpose of the kind which would have been required had t~e 

corporation been a regular foreign corporation or had lt 

been organized in the possession. 

As a consequence of these rules, the typical 93l 

corporation would accumulate earnings derived in Puerto Rico 

or a possession, and then would invest the earnings outsid~ 

the United States, where earnings on the reinvestmen 

continued to enjoy exemption from u. S. income taxes· 

Companies operating in Puerto Rico frequently placed 1ar9~ 

investments in the "Eurodollar" market in Europe, ei the 

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directly or through Guamanian banks. (Since Guam is a 

possession, interest on a bank deposit in Guam was 

"possessions source", and therefore helped the 931 

corporation meet its 80 percent test). After a number of 

years, usually at the end of Puerto Rican tax exemption, the 

company would be liquidated (tax-free) into its U.S. parent. 

Corporations operating under section 931 were excepted 

from most of the anti-abuse provisions applicable to foreign 

corporations. Nonrecognition transfers of appreciated 

property (such as patents) to 931 corporations were excepted 

from the provisions requiring a ruling that the transfers 

were not for a tax avoidance purpose, and from those 

imposing excise taxes on transfers as contributions to 

capital of a foreign company. These exceptions applied even 

though 931 corporations, because of their tax exemption, 

were subject to the same abuses as foreign corporations in 

this regard. 

Further, the sale of shares of a 931 corporation was not 

subject to the provisions characterizing gain on such sales 

as dividend income to the extent of the earnings of the 

company. This was true even though 931 corporations, 

because of their tax exemption on foreign source earnings, 

could be used to transmute those earnings from ordinary 

income to capital gain on the sale of shares. To an extent, 

the non-application of this provision was of little meaning, 

because the liquidation option permitted a company to 

realize the benefits of the possessions subsidiary's 

earnings without paying any current tax on the income. But 

that liquidation was itself a product of a variation of the 

laws which would have applied to a foreign corporation, 

Which would have conditioned nonrecognition of gain in the 

absence of a tax avoidance purpose. In addition, because a 

Possessions corporation was a domestic corporation, it could 

not be deemed a "controlled foreign corporation" for 

Purposes of the anti-tax haven provisions of the Internal 

~evenue Code. 3/ Accordingly, either corporations chartered 

in the possessTons or domestic corporations qualifying under 

section 931 could be used as tax haven base companies if 

they could fit base company income into the terms of the 

Puerto Rican tax holiday legislation. 

2/ Those prov1s1ons also except corporations organized in 

Puerto Rico and the possessions that otherwise meet the 

general requirements of a possessions corporation. 
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One anti-abuse provision which did apply to 931 

corporations was section 482, the intercompany transactions 

provision. The Internal Revenue Service first began 

substantial investigations of the transfer pricing practices 

of 931 corporations and their parents in the late 1950s. In 

August 1959, the Governor of Puerto Rico formally protested 

to the Secretary of the Treasury the transfer pricing 

standards then being applied by the Internal Revenue 

Service. The Governor complained that to the extent 

affected industries qualified for tax exemption, the 

standards hurt Puerto Rico's ability to attract u.s. 

investment; to the extent affected industries did not 

qualify, the standards allegedly detracted from Puerto 

Rico's tax collections. The Government suggested the 

establishment of procedures, analogous to competent 

authority procedures under bilateral tax conventions, to 

settle profit allocation disputes between Puerto Rico and 

the United States. The Internal Revenue Service undertook a 

review of its section 482 standards and suspended action on 

pending section 482 cases between 1961 and 1963. 

In 1963, the Internal Revenue Service issued a revenue 

procedure governing allocations between possessions 

corporations and their U.S. parents. Although these 

standards were applicable only to transactions between 931 

corporations and their parents, they became the basis for 

generally applicable intercompany transaction regulations 

issued in 1968. But the 1963 procedure did not break the 

backlog of profit allocation cases. The 1963 standards 

threatened to result in substantial reallocations of income 

from possessions corporation subsidiaries and _ pending 482 

cases were again suspended in 1965. In 1968, the TreasurY 

Department issued comprehensive intercompany transaction 

regulations, and at the same time issued a revenue proceau:~ 

permitting 931 companies to rely on the 1963 standards 1 

those standards produced more favorable results than the 

1968 regulations. 

Intercompany allocations have nevertheless remained an 

area of difficulty. The Internal Revenue Service has 

recently instituted litigation against one major 

pharmaceutical manufacturer which transferred a patent on a 

prominent prescription drug its possessions subsidiarYf 

The current Governor of Puerto Rico wrote the Secretary 0

2 the Treasury in 1978, protesting that the section ~8 

practices of the Internal Revenue Service are inhibi t~n9 

Puerto Rico's ability to attract new investment through 1tS 

tax exemption program, and that they threaten to er~de Puerto Rico's tax base. This latter problem is be1n9 

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addressed by a mutual agreement procedure between the Puerto 

Rican Treasury and the Internal Revenue Service, completed 

early this year, that is designed to resolve cases of double 

taxation between the United States and Puerto Rico. 

c. Section 936 -- In considering the Tax Reform Act of 

1976, Congress perceived two substantial problems with the 

operation of the 931 provisions. First, the exclusion of 

all foreign source income, together with the tax deterrent 

to nonliquidating distributions by 931 corporations to their 

U.S. parents, were viewed as producing an unjustified 

revenue loss, and as creating incentives to uneconomic 

investments of retained earnings by 931 corporations. As 

noted above, most of these earnings were invested in the 

Eurodollar market, where they continued to enjoy tax 

exemption. Congress was concerned because these investments 

did not benefit the Puerto Rican or possessions' economies, 

while at the same time they involved a revenue loss to the 

United States. In addition, Congress believed that if the 

earnings could not be profitably invested in the 

possessions, companies should be free to choose on the basis 

of non tax considerations whether to invest in the United 

States or abroad. 

The second problem grew out of the wording of the 

statute defining an "affiliated group." That statute 

Provided that a corporation "entitled to the benefits of 

section 931" did not qualify as an "includible corporation." 

In years when their 931 subsidiaries ran losses, u.s. 

companies sought to take advantage of the losses currently, 

offsetting them against other income subject to taxation, on 

grounds that the subsidiaries were entitled to no "benefit" 

in the years they had no income. The Internal Revenue 

Service resisted this theory, but in 1971 the Tax Court 

accepted it. This gave 931 subsidiaries a best-of-bothworlds quality: parent companies could treat them like a 

branch in loss years, taking the losses currently, but like 

a foreign corporation in income years, excluding the income 

from taxation. 

Congress responded by amending section 931 and adding 

section 936 to the Internal Revenue Code. The amendments 

made section 931 applicable only to individual citizens of 

the United States. New section 936 applies only to domestic 

corporations meeting the same "80-50 tests" as are 

applicable under section 931. But unlike 931, section 936 

does not permit an exclusion from income by the 936 company. 

Instead, it permits the company to credit against its U.S. 

tax liability the portion of that liability attributable to 

the favored income. This credit does not depend upon tax 
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having been paid to the possession, so that, like the 931 

exclusion, it "preserves" the effect of any possessions tax 

holiday. But the favored income is not, as it was under 

section 931, all foreign source income. Instead, the 

favored income includes only ( 1) income derived from the 

active conduct of a trade or business in the possession; and 

( 2) qualified possession source investment income, defined 

as income derived from investment of accumulated trade or 

business profits in the same possession as the trade or 

business is conducted. 

To receive the benefits of section 936, a corporation 

must make an election, and any election so made is 

irrevocable for a period of 10 years. The "includible 

corporation" definition was amended in 1976 to exclude anY 

corporation which had made a 936 election. Thus, Congress 

prevented companies from an "in and out" game with the 

possessions provisions, electing consolidated reporting in 

loss years, and credit or exclusion in gain years. In order 

to encourage repatriation of accumulated earnings which 

would not be profitably invested in the possessions, 

Congress amended the dividends received deduction provision 

to permit a dividend from a section 936 corporation to 

qualify for a 100 percent deduction if received by another 

member of the corporation's "affiliated group." Finally, in 

order to prevent a company from claiming a credit for 

foreign or possessions' taxes paid on income that is not 

taxed by the United States, Congress amended the foreign ta~ 

credit provisions to disallow a credit to a recipient of a 

dividend from a section 936 corporation for foreign or 

possessions' taxes paid on the dividend. !/ 

The 1976 changes did not alter the power of a 

corporation to liquidate its possessions corporation 

subsidiary tax-free and take out retained earnings in that 

manner. It did, however, eliminate the necessity for doin9 

this in most circumstances, by permitting companies to take 

a 100 percent dividends received deduction on nonliquidatin9 

distributions. 

The 1976 changes also left unaffected the insulation of 

possessions corporations from most of the anti-abuse 

provisions applicable to foreign corporations. ThUSr 

companies still need not obtain a ruling from the Internal 

!/ In the Revenue Act of 1978, Congress limited thi 5 

disallowance to corporate shareholders, since 

noncorporate shareholders generally are fully taxable on 

dividends received from possessions corporations. 
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>r 

~r 

n 

s 

e 

y 

s 

e 

n 

-23-

Revenue Service to secure nonrecognition treatment on 

transfers of appreciated property to a possessions 

corporation, nor are they subject to an excise tax on such 

transfers. The owners of such companies, even individuals, 

are not subject to current tax on their share of the· 

personal holding company or base company income of 

possessions corporations, even in circumstances where 

similarly situated shareholders would be currently subject 

to tax on such income if earned by a foreign corporation. 

Companies still need not treat gain realized on the 

disposition of shares in possessions corporations as 

dividend income, even in circumstances where they would have 

to do so were the corporation involved a foreign corporation. However, the intercompany transa ~tion questions 

raised under the pre-1976 law continue to be raised under 

the new law. · '! 

~ c. Taxation in Puerto Rico and the Industrial Incentives 

Program 

1. Taxation in Puerto Rico 

As noted above, the Federal income t~x does not apply in 

Puerto Rico, and this is generally _true of Federal estate 

and gift taxes. Federal excise taxes likewise do not apply 

in Puerto Rico, nor do they (or State and local sales and 

excises taxes) apply to goods shipped to Puerto Rico from 

the United States. Customs duties are not imposed on 

shipments from Puerto Rico to the United States, or on 

shipments from the United States to Puerto Rico. However, 

the full U.S. schedule of customs duties is imposed on goods 

coming into Puerto Rico from foreign countries, but the 

proceeds are "covered over" to the Puerto Rican Treasury. 

The Federal social security and unemployment taxes also 

apply in Puerto Rico, which participates fully in the 

benefits as well as the contribution sides of both programs. 

In addition to Federal customs duties and social 

security and unemployment trust fund contributions, the 

Puerto Rican Commonwealth and municipal governments impose a 

full system of taxation, consisting of individual and 

corporate income, excise, property, estate, gift and various 

license taxes. Of particular interest is the Puerto Rican 

corporate income tax, which in most respects is quite 

similar to its Federal counterpart. ~/ The Puerto Rican tax 

This similarity is largely due to the fact that the 

Puerto Rican income tax is based on the u.s. Internal 

Revenue Code of 1939. 
-24-

applies to the gross income, less allowable deductions, of 

Puerto Rican corporations and to the Puerto Rican operations 

of non-Puerto Rican (which includes U.S.) corporations. 

Gross income and allowable deductions are defined in much 

the same way as under the Federal tax code. However, the 

Puerto Rican code contains a "flexible depreciation" 

provision which permits taxpayers, subject to certain 

restrictions, to recover the cost of "qualifying property" 

in any taxable year or years designated by the taxpayer, 

without regard to the usef~l life of the property. 

Generally, property acquired to be used in agriculture, 

construction, manufacturing, hotels, or shipping, and 

certain property leased to a manufacturing, hotel, or 

shipping business qualifies for flexible depreciation. 

The applicable Puerto Rican corporate income tax rate 

consists of two parts. The normal tax rate of 22 percent 

applies to "normal tax income" (net income less an 85 

percent dividends received deduction). The second part 

applies to "surtax net income" (generally, normal tax income 

in excess of $25,000) on a graduated scale, ranging from 9 

percent on surtax net incomes under $75,000 to 23 percent on 

surtax net incomes in excess of $275, 000. Thus, the top 

rate of 45 percent generally applies to corporations with 

normal tax incomes in excess of $300,000. 

In addition to its regular corporate income tax, Puerto 

Rico imposes a "tollgate" or withholding tax on dividends 

paid to nonresident shareholders of Puerto Rican corporations, or non-Puerto Rican corporations that conduct 

substantially all of their business in Puerto Rico (for 

example, possessions corporations). Prior to October 1, 

1976 the rate was 15 percent on dividends paid out of 

manufacturing, hotel, or shipping income to any non-Puerto 

Rican parent corporation without business operations of itS 

own in Puerto Rico. However, the tax only applied if the 

nonresident parent corporation could claim a foreign ta" 

credit for the tax. As noted above, prior to 1976 U. S • 

parent corporations could claim a credit for the Puerto 

Rican withholding tax so the tax did apply to dividends paid 

by 931 corporations. Because the parent was taxable on the 

dividend, but not on a liquidating distribution, such 

dividend payments were rare. 

The tollgate tax does not apply to dividends paid to 8 

resident parent corporation (e.g., a u.s. manufacturer which 

wholesales and retails its products in Puerto Rico)· 

Instead, dividend payments to such a corporation would b; 

subject to the regular Puerto Rican income tax. The 8 
f 

s 

h 

e 

" 

n 

" 

I 

, 

~ 

c 

-25-

percent dividends received deduction would, however, reduce 

the effective rate on dividends from a possessions corporation to a resident parent corporation to no more than 6.75 

percent (45 percent of 15 percen~). · 

Rather than pay a tollgate tax of 15 percent or a 

regular corporate tax of up to 6. 75 percent on dividend 

payments, most U.S. parents of possessions corporations took 

advantage of the fact that prior to 1978 Puerto Rico did not 

impose any tax on liquidating distributions of the tax 

exempt income of possessions corporations, provided that the 

parent owned at least 80 percent of the stock of the 

possessions corporation (as was almost always the case). 

Normally, therefore, a possessions corporation could 

accumulate earnings free of u.s. or Puerto Rican tax until 

its industrial exemption expired, and then those accumulated 

earnings could be distributed to the U.S. parent through 

1 iquidation of the possessions corporation, again free of 

any U.S. or Puerto Rican tax. 

2. The Industrial Incentives Program 

The modern history of industrial tax exemption in Puerto 

Rico begins in 1948. Prior to that year, Puerto Rican 

development strategy stressed · government ownership and 

operation of key industries, such as cement, glass, 

paperboard, and shoes. When the financial requirements of 

such a program were recognized, Puerto Rico shifted the 

emphasis to private enterprise. Tax exemption became the 

keystone of an industrial incentive program that also 

included providing plants at low rent, cash grants to cover 

start-up costs, and low interest loans. 

The Industrial Incentive Act of 1948 offered qualifying 

firms an exemption from income, property, and municipal 

taxes, while the excise tax act exempted raw materials, 

machinery, and equipment used in manufacturing for export or 

sold to other manufacturers in Puerto Rico. To qualify for 

tax exemption, a firm had to produce items not produced on a 

commercial scale in Puerto Rico prior to 1948, or produce 

certain specified items such as wearing apparel and 

Processed food products. The 1948 Act further provided that 

the period of total tax exemption would end in 1959, with 

the exemption rate falling to 75 percent, 50 percent, and 25 

Percent in 1959, 1960, and 1961, respectively. All 

exemptions were to end in 1962. 

Many firms established plants in Puerto Rico in the 

early 1950s in response to these incentives. Textiles were 

the fastest growing industry, but shoes and other leather 
,-- --- ~- ------- -._- --- ------ ~ 

-26-

goods and assembly of mechanical, electrical and electronic 

devices were also important. After a few years, however, a 

tax exemption with a 1959-1961 phaseout became less attractive, and in 1954 the Industrial Incentive Act was amended. 

The 1954 Act provided for a ten-year exemption for new 

applicants. Because an established firm could lose its 

exemption but a new applicant could qualify for a ten-year 

exemption, the 1954 Act placed limitations on the ability of 

an existing firm to obtain a new grant. If a firm received 

a new grant of exemption for a product produced under an old 

grant, the new grant would be terminated if the level of 

output in the predecessor operation was reduced. In 

addition, plant, equipment, and other property that had been 

used in the production of an exempt product could not be 

used by another enterprise to produce a similar exempt 

product. Both prohibitions were subsequently weakened, and 

the Governor had the power to waive them if he deemed it to 

be in the public interest. 

An expanded Industrial Incentive Act was adopted in 

1963, offering exemptions for periods of 10, 12, 15, 17, or 

25 years, depending on the degree of economic development of 

the zone in which . the plant was located. In addition, a 

partial exemption for up to twice the length of the original 

grant could be elected. A company could postpone the start 

of the exemption period for two years and 90 days after its 

first payroll, which permitted it to save the exemption for 

profitable years, rather than wasting it during the period 

of start-up losses. 

In the early 1970s, Puerto Rico redefined the 

tax-exemption zones and lengthened some exemption periods 

(exemptions of 10, 15, 25, or 30 years became available)· 

An amendment was introduced classifying passive income from 

certain financial investments in Puerto Rico as "industrial 

development income," benefitting from the same tax exemption 

as trade or business income. This provision was an attempt 

to encourage possessions corporations to invest a larger 

portion of their earnings in Puerto Rico •. 

3. Recent Changes in the Tollgate Tax and the 

Industrial Incentives Program 

Anticipating the passage of section 936 and the other 

Federal provisions relating to possessions corporations, in 

1976 Puerto Rico modified its tollgate tax in two important 

ways. The rate was reduced from 15 to 10 percent and the 

tax became applicable to U.S. shareholders, even though theY 

were denied a foreign tax credit by the 1976 U.S. ta~ 

c 

t 

r 

J

I 

1 
-27-

changes adopted with section 936. The two changes taken 

together had the effect of subjecting dividends paid to 

nonresident U.S. parent corporations to a 10 percent Puerto 

Rican tax. (The taxation of dividends paid to resident U.S. 

parents was not changed .• ) Although the tax rate seemed low, 

the potential source of dividends included not only new 

income earned under section 936, but also earnings 

accumulated under section 931. 

The 10 percent tollgate rate instituted in 1976 remains, 

but the effective rate has been subsequently reduced by a 

series of amendments and rulings. In summary: 

1. Dividends paid out of accumulated "931" 

industrial development income (i.e., income earned 

prior to October 1, 1976) are subject to a tollgate 

tax of 7 percent, rather than 10 per_cent, if no 

more than 25 percent of the balance at the 

beginning of the year is paid out and a matching 25 

percent is invested in "designated Puerto Rican 

assets in that year. Designated Puerto Rican 

assets include working capital, deposits in Puerto 

Rican banks, Puerto Rican government bonds, 

mortgages insured by the Puerto Rican Housing Bank 

and Finance Agency, and loans or other guaranteed 

mortgage bonds executed by any government pension 

or retirement plan. Thus, part of the accumulated 

earnings may be brought home subject to a reduced 

tollgate tax rate if a matching amount from such 

earnings is invested in designated assets. 

2. Dividends paid out of accumulated "936" 

industrial development income (i.e., earned 

subsequent to October 1, 1976) are subject to a 

tollgate tax of 7 percent, rather than 10 percent, 

if no more than 75 percent of such income is paid 

out and if at least 25 percent of such income is 

reinvested in designated Puerto Rican assets for a 

period of at least 8 years. 

3. Dividends paid out of interest earned on 

investments in designated Puerto Rican assets are 

exempt from the tollgate tax. 

4. A credit equal to 3 percent of new 

investment (made subsequent to the later of 

March 31, 1977 or the second year of tax exemption) 

in buildings and other structures used in 

manufacturing is allowed against the tollgate tax. 
-28-

In December 1977, the Puerto Rican Treasury issued 

guidelines concerning the tax treatment of dividends paid 

out of income earned outside of Puerto Rico (e.g., 

Eurodollar investments). As long as a company has both 

undistributed earnings from Puerto Rico and earnings from 

foreign sources, a dividend may be paid out of the foreign 

sourced portion without the imposition of a Puerto Rican 

tollgate tax as long as an equal amount is distributed out 

of the Puerto Rico sourced portion. That is to say, the 

tollgate tax in these instances will be imposed on only 50 

percent of the total distribution, thereby reducing the 

effective rate of tax. 

On June 2, 1978, Puerto Rico enacted major revisions to 

the Industrial Incentive Act. The new provisions affect 

both the terms of new grants and the terms of old grants if 

the holders elect to convert them to a partially exempt 

status. The primary features of the legislation affecting 

new grants are: 

1. New grants will exempt from taxation only 

a declining fraction of income. That fraction is 

90 percent in the first five years, 75 percent in 

the sixth through tenth year, 65 percent in the 

eleventh to fifteenth years, and 55 percent the 

sixteenth to the twentieth years. The first 

$100,000 of real property will be exempt from 

property tax, and the remainder will be exempt in 

the same proportion as income is. 

When the original grant expires, the company 

may apply for a ten year extension. If the 

extension is granted, 50 percent of income may be 

excluded for the first five years; for the second 

five years, between 35 percent and 50 percent may 

be excluded, the exact percentage depending on the 

location of the investment in Puerto Rico. 

2. Companies earning less than $500, 000 may 

also exclude the first $100,000 of income from 

taxation; companies earning more than $500,000 have 

no such exemption (the exemption applies to the 

entire controlled corporate group). Corporations 

ineligible for, or not claiming, the $100,000 

exemption may, however, deduct an amount equal to 5 

percent of production worker payroll costs. This 

extra payroll deduction cannot exceed 50 percent of 

otherwise taxable income. 
-29-

3. The regular tollgate tax will be red·uced 

to 5 percent for funds reinvested in designated 

Puerto Rican assets and withdrawn according to the 

following schedule: 10 percent may be withdrawn 

annually for five . years, and the remaining 50 

percent may be withdrawn at the end of the five 

years. The list of designated assets was expanded 

to include investment of earnings in the company's 

own business or in paying off its own debt. 

4. Upon liquidation, a 4 percent tollgate tax 

will apply to accumulated Puerto Rican income. 

5. Export oriented service industries 

(architectural, insurance, engineering, management 

consul ting firms, etc.) , which had been fully 

taxable under prior law, will be able to exempt 50 

percent of their export service income, provided 

that 80 percent of their employees are residents of 

Puerto Rico and 80 percent of the cost of the 

services was incurred in Puerto Rico. 

The 1978 legislation also contains provisions permitting 

currently tax-exempt corporations to elect to move to a 

partially exempt status. The election, which would first 

apply in either 1978 or 1979, must be made when the 

corporation files its Puerto Rican income tax return for the 

fiscal year which includes December 31, 1978. Thus a 

possessions corporation whose fiscal year corresponds to the 

calendar year could have elected in April 1979 (the usual 

filing date) to become partially taxable for either 1978 or 

1979. If 1979 was elected, then the first return indicating 

taxes actually due would be filed in April 1980. 

The election is subject to the following four 

Provisions: 

1. During the years remaining until the end 

of the existing grant, the following percentages of 

income will be exempt from tax: 

Years Left on 

Original Grant 

0-4 years 

5-8 years 

9-12 years 

13-16 years 

17-20 years 

More than 20 years 

:Maximum Effective 

Exemption : Tax Rate 

:Percentages: (Percent) 

73.3 

77.7 

85.5 

90.0 

91.0 

93.3 

12.0 

10.0 

6.5 

4.5 

4.0 

3.0 
.. 

~ ;.. 

! 

-30-

After the period of original exemption has 

expired, the companies electing this option are 

automatically entitled to operate partially exempt 

from taxation for ten more years. During the first 

five of those ten years, 50 percent of income will 

be exempt; during the second five years, between 35 

percent and 50 percent (depending on the location 

of the investment) of income will be exempt. 

2. Companies with six or more years remaining 

on their current tax exemption may make an alternative election. They may exclude 90 percent of 

their income from taxation and credit two thirds of 

their net income taxes paid against· the 

post-conversion tollgate tax imposed on dividends 

paid from current earnings. Companies electing 

this second option may apply for a ten-year 

extension when the current grant expires, but the 

extension is not automatic. 

3. For all companies, 50 percent of all 

tollgate taxes paid on distributions of income 

earned before converting to partial exemption are 

creditable against the post-conversion income tax 

liability. Dividends will also benefit from 

special reductions in the tollgate tax. 

Accumulated earnings will be subject to a 4 percent 

tollgate tax provided that pre-1973 earnings are 

paid out over a two-year interval, and that 

1973-1977 earnings are paid out over a five-year 

interval (no more than 10 percent can be paid out 

in each of the five years, and the balance at the 

end). Income earned in 1978 or thereafter will be 

subject to a reduced 5 percent tollgate tax, 

provided that each year's income is paid out 

according to the five-year schedule just described. 

All earnings whose distribution is deferred to 

benefit from a reduced tollgate tax rate must be 

invested in designated Puerto Rican assets, in 

plant and equipment to· be used in Puerto Rican 

industrial development, or in retiring the 

principal of the company's debt. 

4. Textile, apparel and shoe producers whose 

exemption grants expire within the next five years 

are automatically entitled to a 90 percent tax 

exemption for an additional five years. 
-31-

CHAPTER III. PUERTO RICAN ECONOMIC GROWTH AND DEVELOPMENT 

AND THE POSSESSIONS CORPORATION SYSTEM 

Puerto Rico is a small, crowded Island with few natural 

resources. It shares a very close economic and political 

interdependence with the United States. Puerto Rico and the 

United States have a common currency and common external 

tariffs. There are no barriers to the free flow of goods, 

labor or capital between the two economies. Most Puerto 

Rican exports are to the United States, and most imports are 

from the United States. Virtually all investments in Puerto 

Rico by non-Puerto Rican firms have been made by U.S. 

companies. Federal statutes generally apply to Puerto Rico, 

some (such as m1n1mum wage legislation) with potentially 

large economic impacts. Most Federal grant programs for 

state and local governments and most Federal income 

maintenance programs for individuals also apply in Puerto 

Rico, although only partially in some cases. 

All of these ties between Puerto Rico and the United 

States have helped shape, and have in turn been shaped by, 

the push for economic growth and development in Puerto Rico 

that began in 1948. This Chapter begins with an overview of 

the growth in Puerto Rican gross national product since 

1948, the setbacks during the ·1973-1977 recession, and the 

recent recovery. Long range Puerto Rican development issues 

are then taken up, followed by an analysis of the costs, 

benefits, and cost effectiveness of the possessions 

corporation system. 

A. Puerto Rican Economic Growth Since 1948 

Puerto Rico's economic growth after 1947 has often been 

called an "economic miracle." Figure I traces the growth in 

Puerto Rican gross national product (GNP) in dollar and per 

capita terms (adjusted for price inflation) from 1947 to 

1978. The population statistics used in determining GNP per 

capita reflect not only birth and death rates, but also net 

migration from Puerto Rico (in recent years more Puerto 

Ricans have returned to Puerto Rico than have moved to the 

United States). Between 194 7 and 1972, Puerto Rican total 

and per capita GNP grew at average annual growth rates of 

better than 6 percent and just under 5 percent, 

respectively. By any historical or international yardstick, 

this was a remarkable performance. !/ 

l/ Over this same quarter century, real GNP in the United 

States grew at an annual rate of 3. 7 percent, and GNP 

per capita at a rate of 2.2 percent. 
-32-

FIGURE I 

Total and Per Capital Gross National Product of Puerto 

Rico, 1947-1978 (Constant 1974 Dollars) 

$Millions 

7,000 

6,000 

5,000 

4,000 

3,000 

2,000 

1,000 

Total 

(left scale) 

Dollars 

2,400 

2,200 

2,000 

1,800 

1,600 

1,400 

1,200 

1,000 

800 

600 

1947 '48 '50 '52 '54 '56 '58 '60 '62 '64 '66 '68 '70 '72 '74 '76 '78 

Source: Puerto Rico Planning Board 
-33-

Table 1 

Puerto Rican Labor Force, Unemployment, and Employment by Major Industry, 

Fiscal Years 1972-1978 

Fiscal Year 

1972 1973 1974 : 1975 I976 !977 I~J7B 

Labor Force (000) 837 858 884 872 890 920 960 

Unemployment (000) 100 101 109 134 172 184 180 

Unemployment rate (μercent) 12.0% 11.8% 12.3% 15.4% 19.4% 20.0% 18.8% 

Enlployment by irrlustry (000) 

All industries 1/ 737 757 775 738 718 739 780 

Agriculture 58 49 53 49 46 41 38 

Construction 79 80 79 69 53 43 44 

Manufacturing 141 142 147 137 133 144 156 

Transportation, ccmnunications, 

and utilities 49 50 54 49 46 49 50 

Wholesale arrl retail trade 135 146 148 141 140 145 150 

Finance, insurance, and real estate 16 18 18 18 18 19 21 

Services 126 127 128 120 121 127 138 

Government y 131 143 147 151 158 168 180 

otf 1ce of the Secretary of the Treasury 

Off ice of Tax Analysis 

Source: Puerto Rico Planning Board, Economic Repcrt to the Governor, 1977-78. 

1/ Includes a small number of employees in industries not shown separately. Y Excludes effil?loyment in Puerto Rican government enterprises, which is included in the 

figures for other industries. 
-34-

However, Puerto Rico's economic growth decelerated 

sharply in the 1970s. As shown in Figure I, real GNP slowed 

its growth in 1974, declined in 1975, remained more or less 

stagnant in 1976, before increasing in 1977. In part 

because of the influx of native Puerto Ricans returning from 

the United States, Puerto Rican GNP per capita declined 

steadily from 1973 to 1977. Table 1 illustrates the effect 

of the recession on employment and unemployment in Puerto 

Rico, providing a second, though closely related, measure to 

the GNP figures. The traditionally high rate of unemployment 

in Puerto Rico, which had been gradually reduced to just 

over 10 percent in the late 1960s, started edging up in the 

early 1970s, and reached 11.8 percent in 1973. Thereafter, 

it rose steadily, and reached 21.5 percent in April 1977. 

Part of this large increase in the unemployment rate was due 

to a rapidly expanding labor force, which increased from 

858,000 to 920,000 workers, or 7.2 percent, between 1973 and 

1977. In addition, however, total employment fell over the 

period from 757,000 to 739,000, or by 2.4 percent, 

despite increases between 1973-1974 and 1976-1977. Most 

affected was construction which lost 37,000 jobs, a fall of 

nearly 50 percent, between 1973 and 1977. Agriculture 

continued its long-term decline, while manufacturing, which 

lost jobs between 1974 and 1976, was slightly above its 1973 

level by 1977. Other sectors tended to follow the manufacturing pattern, with the major exception of government 

which provided steadily increasing employment. The Puerto 

Rican economy began a recovery in late 1977, and in 1978 

employment rose sharply while the unemployment rate fell 

despite a large increase in the measured labor force. By 

April 1979, the unemployment rate was down to 16.2 percent. 

The prolonged recession in Puerto Rico would have been 

deeper had it not been for offsetting expenditures by the 

Federal and Commonweal th governments. Total Federal 

transfers to Puerto Rico increased very rapidly between 1968 

and 1978 -- see Table 2. By 1978, net Federal transfers 

directly to individuals (the bonus value of food stamps, net 

social security and med icare payments, veterans benefits, 

etc.) of $1. 3 bill ion represented 15 percent of personal 

income, which was three times the 5 percent average for the 

United States. Net Federal transfers to individuals plus 

grants to Puerto Rican governments represented 25 percent of 

Puerto Rican GNP in 1978, also three times the 8 percent 

U.S. average. 

The efforts of the Commonweal th government to cushion 

the recession on the Puerto Rican economy are reflected in 

Figure II. Total spending by the Puerto Rican government 
-35-

Table 2 

Federal Transfer Payments, Grants, and Taxes "Covered OVer" 

to Puerto Rico, Fiscal Years 1968 and 1978 1/ 

(millions of dollars) 

Net Federal transfer -payments to individuals, total 2/ 

Focrl stamps - -

Old age, survivors, and disability insurance 

Veterans benefits 

Uneffil?loyment canpensation 

All other 

Federal grants to Puerto Rican Corranonwealth and 

municipal goverrnnents, total 

Child nutrition and special milk programs 

Human developnent 3/ 

Off ice of F.ducation programs 

Public assistance 

Canmunity develoμnent block grants 

I.ow rent public housing 

Employment and training programs 

All other 

Federal taxes "covered over" to Puerto Rican 

treasury, total 

Customs duties 

Alcoholic beverage arrl tobacco excises 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

FY 1968 

68 

1 

59 

1 

7 

129 

-5 

6 

31 

15 

11 

7 

54 

93 

27 

66 

290 

FY 1978 

1,321 

~ 

326 

198 

33 

82 

885 

62 

36 

62 

38 

56 

56 

246 

329 

271 

7I 

200 

2,477 

Sources: U.S. Department of the Treasury, Federal Aid to States: Fiscal Year 

1978, arrl the Statistical Appendix to the Secretary's Annual Report for 

1968; and Puerto Rico Planning Board, Economic Report to the Governor 

(various years) • 

.!/ 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 1977, 

however, the Federal fiscal year was chanaed, beginning on October 1, 1976 

arrl endin:J on September 30, while the Puerto Rican fiscal year again ended 

on June 30. With the exception of certain Federal transfer payments, all 

data for 1978 is based on the Federal fiscal year. 

!:.! All transfer payments are net of associated payments by or on behalf of 

current or future recipients, such as employer, employee, arrl selfemployment contributions for QA.SDI. 

Fonnerly, "child" developnent. 
If 

~ 

\I 

Ii 

II 

-36-

FIGURE II 

Total Government Expenditures Plus Net Investment of 

Public Enterprises, Own Source Revenue Plus Federal 

Taxes Covered Over, Federal Grants-in-Aid, and Total 

Borrowing of Puerto Rico, 1960-1978 

$Millions 

4,000 

3,500 

3,000 

2,500 

2,000 

1,500 

1,000 

500 

250 

Total government expenditures plus 

net investment of public enterprises 

t 

Own source revenue 

plus federal taxes covered over 

.. ,,, 

' ,,_ .,., .,., -.,, Federal grants-in-aid ,.-'' Total borrowing ' .. , ... 

+ ,' --~-~-::-..--i;;-=-:--:-=::=:;::-. ,. __ ·' ~ 

0 ti-------------------.,.,~,- ~ ~~ ~-~---~ --., ,., , ,~'----------------------------------

-250 

1960 '61 '62 '63 '64 '65 '66 '67 '68 '69 '70 '71 '72 '73 '74 '75 '76 '77 '

78 

Source: Puerto Rico Planning Board 
r 

-37-

plus investment by public enterprises went from $1.5 billion 

in 1970 to $2.8 billion in 1974, a 90 percent increase in 

four years. (In recent years the Puerto Rican government 

has taken over the telephone company, the sugar industry, 

and other private enterprises, and investment spending by 

public enterprise has become an instrument of public 

finance.) However, Puerto Rico's ability to offset economic 

fluctuations through its own monetary or fiscal policy is 

limited. With the dollar as its currency and a free flow of 

capital between San Juan and New York, Puerto Rico has no 

real control over local interest rates or the availability 

of credit. Government and public enterprise spending was 

increased to mitigate the recession, but the impact was 

dissipated by the high propensity to import. In recent 

years, roughly 75 percent of Puerto Rican GNP has been spent 

on imports, primarily from the United States. Even if all 

government spending is limited to Puerto Rican-produced 

goods and services, a dollar of government spending probably 

results in no more than a $1. 33 increase in Puerto Rican 

GNP. (The Puerto Rican multiplier is discussed more fully 

below.) With a multiplier of only 1. 33, Puerto Rico's 

pursuit of a countercyclical fiscal pol icy can only meet 

with limited success. 

Further, to the extent Puerto Rican government spending 

is financed from external borrowing (in the United States or 

elsewhere), repayment requires a transfer of real goods and 

services from Puerto Rico at some point in the future. Such 

external borrowing, if carried too far, can also raise the 

interest rate lenders demand on government bonds. (This was 

particularly true in 1975, when the near default by New York 

City affected the entire state and local government bond 

market.) Until 1968, total public sector borrowing in 

Puerto Rico had never exceeded $100 million per year; by 

1975, new public sector borrowing exceeded $600 million. 

Higher interest costs forced the former and the current 

Administrations to cut back on their rate of net new 

borrowing. By 1977, new borrowing was down to $300 million, 

and the premium Puerto Rico had paid to market its bonds had 

been pared. 

The reasons for the prolonged recession of the Puerto 

Rican economy are many. First and most obviously, the Puerto 

Rican economy is closely tied to the U.S. economy. Roughly 

45 percent of Puerto Rican gross domestic product is 

exported to the United States, so recessions in the U.S. 

economy, such as those in 1969-1971 and 1974-1975, are 

transmitted to Puerto Rico. High interest rates that have 

accompanied U.S. anti-inflation policy have also affected 

the Puerto Rican economy. In 1973, interest rates increased 
, 

.r 

. 

.. " 

.. 

" 

It 

.. 

It 

-38-

as the Federal Reserve tightened the money supply to fight 

inflation. High borrowing and construction costs and the 

general economic downturn greatly reduced the demand for new 

condominiums and left a large stock of unsold uni ts. The 

result was a large decline in employment of highly paid 

construction workers, as noted above. 

An additional cause of the recession, but one with much 

longer-run implications, was the large increase in oil 

prices in 1973. In the 1960s the Puerto Rican government 

viewed petroleum refining as a centerpiece for a growing 

petrochemical and plastics complex, and a foundation on 

which the island's future prosperity could be based. Puerto 

Rico's advantage was due, however, to its large allocation 

of the U.S. oil import quota (which allowed imports of 

foreign oil, which before 1973 was cheaper than domestic 

oil) rather than to low wages or other locational 

advantages. The OPEC increase in the price of foreign oil 

and the consequent termination of the Federal quota scheme 

eliminated Puerto Rico's previous advantage. In March 1978 

the Commonwealth Oil Refining Company (CORCO), the principal 

oil refiner and the largest private corporation in Puerto 

Rico, filed for protection under Federal bankruptcy laws. 

Finally, it has been suggested that changes in the U.S. 

tax law and the Puerto Rican tollgate tax in 1976, changes 

in the administration of the Industrial Incentives Program, 

and the anticipation of changes to the structure of the 

Industrial Incentives Program created sufficient uncertainty 

among potential new or expanding investors to adversely 

affect investment in Puerto Rico during 1976 and 1977. This 

question is addressed in Section D of Chapter IV. 

Whatever the immediate causes of the 1973-1977 Puerto 

Rican recession, it appears that both its length and breadth 

can only be adequately explained by looking beyond these 

causes to more fundamental, long range problems. 

B. Long Range Development of the Puerto Rican Economy 

The basic goal of any economic development program is to 

increase real income per capita. As indicated in the 

preceding Section, Puerto Rico's development program has 

been very successful in achieving this goal, at least 

through the early 1970s. A major contributor to economic 

growth is investment in the plant, equipment, and 

inventories of private firms as well as in publicly provided 

infrastructure -- streets and highways, water supplies, etc. 

and in public buildings and equipment used by government in 

carrying out its general functions. Investment also 
-39-

includes new housing, which produces housing services 

(shelter) over its lifetime, and thereby contributes to real 

economic income over many years. These components of 

investment in Puerto Rico are illustrated in Figure III for 

the years 1965-1978. 2/ It is clear from Figure III that 

while both total and business investment in Puerto Rico grew 

quite rapidly in the late 1960s, the rate showed in the 

1970s. In fact, if the business investment figures were 

adjusted for high inventory accumulations during the 1973-77 

recession, both the business and total investment figures 

would be essentially level throughout the 1970-1978 period. 

Investment can lead to an increase in income in two 

ways: by providing the necessary capital to create new jobs: 

and by providing additional capital to, and therefore 

increasing the productivity of, those currently ·employed. 

In Puerto Rico, with traditionally high rates of 

unemployment, the first way providing the necessary 

capital for new entrants to the labor force is 

particularly important. This fact was clearly recognized by 

Congress, which in commenting on the retention of the basic 

possessions corporation system in 1976 stated that by so 

doing it wanted to "assist the U.S. possessions in obtaining 

employment-producing investments by U.S. corporations." The 

possessions corporation provisions, however, represent only 

part of the Federal government's role in the economic 

development of Puerto Rico. To place the possessions 

corporation system of taxation in proper perspective, it is 

necessary to consider the full role of the Federal 

government, as well as the roles played by the Puerto Rican 

government and the private sectors in Puerto Rico and the 

United States in providing investment in Puerto Rico. 

1. Financing Investment in Puerto Rico 

For investment to occur, there must be corresponding 

sources of funds to finance the investment. Investment in 

Puerto Rico is financed from five basic sources. These 

sources, illustrated in Figure IV for the years 1965-1977, 

are as follows: 

~/ Figure III illustrates only investment in physical capital. A second major contributor to economic growth is 

investment in human capital -- the formal education and 

on-the-job tra1n1ng of the labor force. 
t 

1t 

. 

~ 

. 

!: 

.. 

I• 

... 

I• 

•• 

.. 

$Millions 

2,500 

2,000 

1,500 

1,000 

500 

-40-

FIGURE Ill 

Components of Investment in Puerto Rico, 1965-1978 

.. .. .. .. .. .. · . 

. •. . 

. . 

.. . .. . .. : ... . . . . . . . . . . . . Gross Domestic Investment --+: ._ . . . . . . . . . . 

. . · ····· . .

.. ······1·· ..... · ·· .. .·· .. . ... .. . ... . . . . . . . . . Government 

• • . • . . . . j ,,\ 

, \ , \ . , \ . . . . . . 

. . 

. 

·------- , \ , _r___ _, \ ,' ............ ---- \ , ... __ \ 

, \ 

,' \ -- ,' , \ ,,--- / Housing 

········ 

•• ,, ,, ,, 

,, ... ··' l ---- ---------- --

Business 

o....._ __________ .__ ____ .._ ____ _,_ ____ _,_ __________ _._ __ :.__._ ____ -L ____ --'-____ _._ ____ __.. ____ __ 

1965 66 67 68 69 70 71 72 73 74 75 76 77 78 

Source : Puerto Rico Planning Board 
-41-

a. Gross Internal Savings -- This source is 

the sum of savings by the Commonwealth and 

municipal governments, Puerto Rican businesses, and 

households in Puerto Rico. As measured here, 

government savings represents the excess of current 

receipts from own sources over current expenditures, where both receipts and expenditures include 

the current transactions of government enterprises. 

Gross business savings are the sum of retained 

earnings and depreciation reserves. Household 

savings are the excess of household income (less 

net Federal tran~fers) over household consumption. 

As shown in Figure IV, gross internal savings in 

Puerto Rico was small, but positive, through 1970. 

Thereafter, Puerto Rico dissaved internally, with 

the amount of dissaving rising very rapidly since 

1974, to a level of $2 billion (i.e., -$2 billion 

of saving) by 1977. 

The excess of investment over gross ·internal 

savings represents the amount of investment that 

must be financed from external sources. The excess 

in recent years has actually been greater than the 

amount of investment because of Puerto Rican 

internal dissaving. For example, in 1977 

investment stood at $1.7 billion and internal 

dissaving at $2 bill ion, so the requirement for 

external sources of funds was $3. 7 billion. The 

remaining four sources of Puerto Rican investment 

funds are all external. 

b. Federal Transfers -- These consist of net 

transfer payments to individuals (for example, food 

stamps and social security benefits net of contributions); grants to the Puerto Rican Commonweal th 

and municipal governments (for example, child 

nutrition and special milk programs); and Federal 

customs duties and alcoholic beverage and tobacco 

taxes "covered over" to the Puerto Rican treasury. 

It is clear from Figure IV that this source has 

grown dramatically since 1965. The sources of this 

growth are evident from 1Table 2, which provides a 

breakdown of Federal transfer payments in FY 1968 

and FY 1978 by major category. Net Federal 

transfers to individuals increased by a factor of 

nearly 20, from $68 million in FY 1968 to over $1.3 

billion in FY 1978, led by the food stamp program 

which was not introduced in Puerto Rico until FY 

1975, but had reached $682 million by FY 1978. 
.... 

• 1 ,,. 

$Millions 

2,500 

2,000 

1,500 

1,000 

500 

-42-

FIGURE IV 

Financing Investment in Puerto Rico, 1965-1977 

r .............. I ......... I \ 

I \ 

I \ •• ,,,/E ______ 1 ·' 

Gross Domestic---.,.,,, All Other External •• • \ 

Investment I Sources •• •• 

I l External : I Borrowing by : 

/ Puerto Rican : I Governments : -~ ... . ------ .. . . / .. . : 

/ .· ········· ·. . .,,,,,.,,,,, .·· r ·.. .. --..................... ..·· ·.. . ..-- ····· . . ... --- •• •• •••• ,• Direct Investment •• •• • •• 

.......... .. .. .. .. l .. .. .. ----- ----------------------- ---------~r·-----------~~ ~, ,, ______ , ---- ,, ,,, 

0 

-500 

- 1,000 

-1,500 

Federal Transfers '• 

l 

Gross Internal Savings ~ (Net of External Transfers) 

- 2,000 --~~---~~ ....... ~~--~~--~~---~~---~~ ...... ~~ ...... ~~---i---~~..__~~..._~__, 1965 66 67 68 69 70 71 72 73 74 75 76 77 

Source: Puerto Rico Planning Board 
-43-

Grants to Puerto Rican governments increased in all 

major program areas, from a total of $129 million 

in FY 1968 to $885 million in FY 1978, or by nearly 

600 percent. And Federal taxes covered over 

increased from $93 million to $271 million between 

FY 1968 and FY 1978. 

c. Direct Investment -- This represents the 

increase in net worth of U.S. (and other non-Puerto 

Rican) corporations operating in Puerto Rico. The 

great majority of these funds represent the 

unrepatriated earnings of possessions corporations; 

they also represent the retained earnings of Puerto 

Rico-incorporated subsidiaries of U.S. and other 

non-Puerto Rican companies, and other U.S.- and 

non-Puerto Rican-controlled corporate activity in 

Puerto Rico. Direct investment by U.S. companies 

has been a major source of funds for Puerto Rico 

throughout the postwar period, but has grown 

particularly fast in the 1970s. 

It is important to note that direct investment 

is merely a source of funds and does not give any 

indication of the amount of actual plant, 

equipment, and inventory investment of U.S. firms 

in Puerto Rico. In fact, many of these funds may 

ultimately not be invested in Puerto Rico at all. 

Under section 931, a very substantial amount of 

possessions corporations' retained earnings was 

invested through Guamanian banks or directly in the 

Eurodollar market. Under section 936, interest on 

Eurodollar deposits is taxable and therefore much 

less attractive, but alternative non-Puerto Rican 

investments such as U.S. state and local bonds and 

preferred stock of U.S. corporations have become 

major investment outlets for possessions 

corporations. 3/ These outflows show up as 

reductions to "all other" external sources of 

funds. 

Further, it should be noted that an increase 

in direct investment funds (or funds from any other 

source) may merely represent a displacement of 

funds from other sources rather than a net addition 

to sources for financing investment. For example, 

the purchase of Puerto Rican government bonds by 

l/ The impact of section 936 on the financial investments 

of possessions corporations is treated more fully in 

Section D of Chapter IV. 
-44-

possessions corporations may merely reduce the 

external borrowing of Puerto Rican governments, 

without affecting the total availability of funds 

or interest rates in Puerto Rico. 

d. External Borrowing by Puerto Rican 

Governments -- Bonds issued by the Commonwealth and 

municipal governments may be purchased by 

nonresident individuals, corporations, and other 

non-Puerto Rican entities, in which case sale of 

the bonds provides an external source of finance. 

e. All Other External Sources This 

residual category includes Puerto Rican business 

and household external borrowing, non-Federal 

unilateral transfers, certain inter-bank transfers, 

and various other sources, all net of financial 

outflows from Puerto Rico. As shown in Figure IV, 

"all other external sources" was actually negative 

in 1977, primarily because of large repayments of 

head office loans by Puerto Rican branches of U.S. 

banks. 

A prominent feature of the external sources of 

investment funds for Puerto Rico is the important 

role played by the Federal government, either 

directly or indirectly, in making those funds 

available. The Federal government directly provides transfers to individuals and governments in 

Puerto Rico. These transfers are quite distinct 

from all other external sources in that they carry 

no obligation for future repayment. Puerto Rican 

government bonds are subsidized, through exemption 

from Federal, state, and local income taxes under 

Federal statute. And the encouragement of U.S. 

firms to locate in Puerto Rico, and to reinvest 

there in employment producing assets, is the stated 

Congressional purpose for maintaining the 

possessions corporation system of taxation. 

2. Profitability and Location in Puerto Rico 

The possessions corporation system has provided, under 

section 931 and subsequently section 936, that profits 

earned by U.S. corporations from operations in Puerto Rico 

be exempt from Federal tax. The combined possessions 

corporation system and Puerto Rican tax exemption do not 

create profitable investment opportunities in Puerto Rico; 

they can only make otherwise profitable investments more 

prof~ table by exempting the profits from such investments 
-45-

from tax. A U.S. firm will not locate in Puerto Rico unless 

the firm can expect to earn a before tax rate of return on 

an investment in Puerto Rico equal to its after tax rate of 

return on an investment in the United States. Thus, Puerto 

Rico must be a competitive location aside from tax exemption 

for a U.S. firm considering investment (or reinvestment) 

before tax exemption will provide any attraction to the 

firm. 

Before turning to a consideration of the factors that 

determine the competitiveness of Puerto Rico as a location 

for investment by U.S. firms, one important aspect of a 

profit tax exemption system should be noted. Since the 

amount of tax saving depends directly on the amount of 

profits attributed to the possessions corporation, the 

exemption system creates very strong incentives to shift 

profits from fully-taxed operations in the Uni tea· States to 

the tax exempt operations in Puerto Rico. There are a 

number of ways such profit shifting can occur. For example, 

a possessions corporation may overcharge its parent for 

exports; the parent may undercharge the possessions 

corporation for raw materials or component parts, or fail to 

charge it for expenses undertaken in its behalf; or the 

possessions corporation may benefit from intangibles 

developed by the parent (e.g., a patent or trademark) without proper accounting for the costs incurred in developing 

the intangible or the manner in which it is used. As 

indicated in Chapter II, there are several anti-abuse 

provisions in the Federal tax law which are aimed at such 

profit shifting activities. However, the complexity of both 

the legal issues and the specific transactions involved, as 

well as the desire not to interfere in the legitimate tax 

benefits intended for possessions corporations by the 

Congress, have left this area of the Federal tax exemption 

somewhat unsettled over many years. The essential point 

here is that in instances where profits are shifted, it is 

not clear whether the possessions corporation located in 

Puerto Rico because of the underlying locational 

competitiveness of Puerto Rico, or merely because of the 

Potential for profit shifting. 

When the tax exemption program was introducted in 1947, 

a combination of factors made Puerto Rico a highly 

competitive location for U.S. firms. These factors included 

Political stability, a common currency, protection under the 

U.s. tariff schedule, the general application of Federal 

statutes, and proximity to the United States. As noted 

~bove, a disproportionate allocation of the Federal oil 

import quota prior to 1973 provided the main basis for 

development of the petrochemical industry in Puerto Rico. 
-46-

Perhaps the single most important factor, however, was low 

unit labor costs resulting from both low wages and the high 

productivity of Puerto Rican workers. These factors 

provided the necessary profit making opportunities for the 

tax exemption program to work. Taken together, Puerto 

Rico's locational advantages and the tax exemption program 

contributed substantially to the rapid growth of the Puerto 

Rican economy throughout the 1950s and 1960s, noted above. 

However, since 1947 the competitive position of Puerto Rico 

has been significantly altered by changes in these 

underlying locational factors. 

U.S. firms have exhibited an increasing willingness to 

invest abroad in jur1sdictions that provide low cost labor 

and acceptable political risks. For firms that have already 

invested in Puerto Rico, this may grow out of a desire to 

diversify their operations over a broader geographical area. 

The Kennedy round of tariff reducti0"1s in the 1960s exposed 

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

competition from imports. Unlike trade with foreign 

countries, trade between Puerto Rico and the United States 

must be carried on higher-cost U.S. flag ships. The 1973 

oil embargo and subsequent large increases in world oil 

prices removed Puerto Rico's relative advantage in 

petrochemicals, as previously noted. Finally, a number of 

changes have occurred in the Puerto Rican labor market. 

Wages have risen, in part due to successful economic 

development, but also due to other forces which have put 

upward pressures on wages in spite of a continually high 

rate of unemployment. Chief among these forces is U.S. 

minimum wage legislation, which has been gradually applied 

in Puerto Rico, with virtually full application to be 

achieved by 1981. In addition, the Puerto Rican government 

has mandated observance of more holidays than are generally 

observed in the United States, as well as a fairly generous 

system of employee fringe benefits. The disproportionate 

level of relatively well paid government employees in Puerto 

Rico (Federal, Commonweal th and municipal) may add upward 

pressure on private sector wages. And the introduction of 

the food stamp program in 1975 and the expansion of other 

Federal income maintenance programs may affect the Puerto 

Rican labor market by reducing work incentives and 

encouraging higher labor turnover rates. 

While the preceding represent basically adverse changes 

in Puerto Rico's competitive position, some changes have had 

a favorable effect. Through formal education and on-the-job 

training, the skills and therefore productivity of the 

Puerto Rican labor force have risen steadily. General 

devaluation of the dollar since 1973 has made goods produced 

i11 

me 

A~ 

Sc 

1 

a. 

hi 

u 

c 

e 

t 

I 

9 

¥ 

] 
I 

-47-

in Puerto Rico more competitive in both the U.S. and foreign 

markets. In addition, the recent Orderly Marketing 

Agreements limiting shoe exports to the United States from 

South Korea and Taiwan and the Multifiber Arrangements 

limiting textile and apparel exports from eighteen 

developing countries should benefit these industries, which 

have traditionally invested heavily in Puerto Rico. 

At the same time that changes were taking place in the 

underlying competitiveness of Puerto Rico as a location, 

changes were affecting both the U.S. and Puerto Rican tax 

exemptions for possessions corporations. Direct changes to 

the tax exemptions, including the series of Industrial 

Incentive Acts in Puerto Rico, the 1976 Federal revisions, 

and the 1976 and subsequent Puerto Rican tollgate tax 

changes are covered in detail in Chapter II. In addition to 

these, a series of changes to the U.S. Internal Revenue Code 

had an indirect effect on the relative profitability of 

locating in Puerto Rico. The top Federai corporate tax 

rate, which stood at 38 percent in 1947, rose to 52 percent 

by 1952 and remained at that level until 1963. Thereafter, 

With the exception of the surtax years of 1968-70, the top 

rate has been reduced in several steps to its current level 

of 46 percent. The investment tax credit was introduced in 

1962 and has generally been in effect since then. Its terms 

have been 1 iber al i zed on sever al occasions, and the rate 

increased from an initial 7 percent to the current level of 

10 percent. In 1971 the asset depreciation range ( ADR), a 

major liberalization of the period over which assets could 

be depreciated for Federal tax purposes, was introduced. 

These three changes since 1962 -- the investment tax 

credit, lower statutory rates, and ADR combined to 

Significantly lower the overall effective Federal tax rate 

0 n income earned in the United States. As U.S. effective 

tax rates fell, the relative attraction of tax exemption 

Offered by the possessions corporation system was steadily 

~iminished. Some Federal tax changes, however, may have 

lncreased the relative attractiveness of Puerto Rico. In 

Particular, this may be true of the anti-tax haven 

P~ovisions adopted in 1962, which do not apply to Puerto 

a1co or to possessions corporations, as noted in Chapter II. 

t In summary, many fundamental changes have taken place in 

~e Puerto Rican, u. S., and world economies which have a 

~lrect and substantial bearing on the competiveness of 

~erto Rico as a location for U.S. investment. As suggested 

a ove, one result of these changes appears to have been a 

~Uch longer and deeper recession in Puerto Rico, beginning 

tn 1973, than affected the United States. A second result, 
-48-

which emerges from the statistical data presented in Chapter 

IV, is that the focus of the possessions corporation system 

has become highly concentrated in a few industries. 

c. The Costs and Benefits of the Possessions Corporation 

System 

The combination of the possessions corporation 

provisions in the U.S. Internal Revenue Code and the Puerto 

Rican Industrial Incentives Program impose direct as well as 

indirect costs on the Federal government and Puerto Rico, 

and produce direct as well as indirect benefits to the 

Puerto Rican economy. All costs and benefits, direct and 

indirect, ideally should be identified and taken into 

account in assessing the possessions corporation system. 

However, while the major costs and benefits of the system 

are fairly readily identified and are measurable with 

reasonable accuracy, it would be very difficult (if not 

impossible) to identify and measure all associated costs or 

benefits. This limitation should be borne in mind in the 

following discussion in which the major costs and benefits 

are identified and their measurement discussed, and in 

Chapter IV in which actual measures of some of these costs 

and benefits are presented. 

1. Costs 

The most obvious cost of the possessions corporation 

system is the Federal tax expenditure (i.e., Federal tax 

revenue foregone) arising from the exemption afforded 

possessions corporations. The size of the Federal tax 

expenditure depends, in the first instance, on the amount of 

exempt income earned by possessions corporations. In 

addition, however, some estimates or assumptions must be 

made about the amount of income possessions (or other, 

possibly unrelated) corporations would earn in the absence 

of Federal tax exemption, and the rate of tax that would 

have applied to those earnings. It is important to note 

that, because of the interaction between the Federal and 

Puerto Rican tax codes (in particular, through the foreign 

tax credit provisions), the estimates and assumptions made 

regarding the Federal tax expenditure will affect the 

measured Puerto Rican tax expenditure arising from the 

income tax exemption Puerto Rico provides possessions 

corporations through its Industrial Incentive Program., 

In addition to the possible loss of income tax revenues, 

Puerto Rican revenues are reduced by the exemption grant7d 

for property, municipal, and excise taxes. On the expenditure side of the Puerto Rican budget both the direct costs 
-49-

-- such as for cash grants and interest and rent subsidies 

-- and indirect costs -- such as for special transportation 

facilities, utility connections, and additional police, 

fire, and other government services -- should be included. 

Further, in cases where the possessions corporation system 

attracts industries that degrade the Puerto Rican 

environment or impose other external costs, these costs 

should be added to the budgetary costs of the system. 

2. Direct Benefits 

When a possessions corporation locates in Puerto Rico, 

it generates both direct and indirect benefits to the Puerto 

Rican economy. The major direct benefit is additional wages 

and fringe benefits paid to Puerto Rican workers. In the 

case of workers that would otherwise be unemployed, the 

entire amount of wages and fringe benefits is "additional," 

and should be included fully in measured benefits. In the 

case of workers that would otherwise be employed (presumably 

at a lower total compensation) only the additional 

compensation of the workers should be included in measured 

benefits. A direct benefit may also arise if the financial 

investments of possession corporations increase the 

availability of funds, and lower interest rates in Puerto 

Rico. However, any such benefit would presumably entail an 

offsetting cost in credit markets in the United States. 

3. Indirect Benefits 

In addition to creating these direct benefits, the 

possessions corporation will generate indirect benefits 

through the impact of its purchases, and the additional 

remuneration it provides its employees, on the Puerto Rican 

economy. !/ 

a. Backward Linkages When a possessions 

corporation purchases raw materials, intermediate 

goods, insurance and other services, or plant and 

equipment, some of the purchases may be made 

!I As a general practice, the Treasury does not estimate 

the linkage and multiplier impacts of specific tax 

prov1s1ons. This is because tax changes are usually 

taken in the context of an overall Federal budget. The 

purpose of undertaking the analysis here is to assess 

the impact of the possessions corporation system on 

Pu er to Rico al one, not on the United States and Pu er to 

Rico taken together. 
-50-

directly from U.S. or other non-Puerto Rican 

sources, and therefore represent a "leakage" from 

the Puerto Rican economy. Other purchases, however, are made directly from Puerto Rican suppliers 

that in turn provide employment and increase Puerto 

Rican incomes through wage and salary payments and 

possibly interest, profits, and other returns to 

Puerto Rican owners of capital. These suppliers 

must also make purchases of raw materials, 

intermediate goods, etc., some of which will be 

from non-Puerto Rican suppliers and some from other 

Puerto Rican suppliers -- who in turn will provide 

additional income payments to Puerto Ricans. However, the sum of all the income generated in Puerto 

Rico by the purchases of possessions corporations 

through · these "backward linkages" undoubtedly 

overstates the net indirect benefits they provide 

to Puerto Rico.~-This is because the Puerto Rican 

resources purchased by possessions corporations and 

their suppliers have alternative uses -- they would 

not be unemployed in the absence of possessions 

corporations. 

Capital must be diverted from other productive 

uses. Water and land are scarce in Puerto Rico; 

their use by possessions corporations (and their 

suppliers) precludes their use in other sectors, 

such as agriculture. Some purchased inputs, such 

as gas, oil, sugar, wood, or alcohol, are standard 

commodities which must be bought or could be sold 

overseas. A proper assessment of the benefits 

generated by backward linkages should therefore 

reduce total measured benefits by these 

"opportunity costs" in order to reflect only the 

additional benefits to the Puerto Rican economy. 

b. The Multiplier -- In addition to the income 

generated by payroll and purchases of locally 

produced materials, expenditures by possessions 

corporations have a multiplier impact on the local 

economy. The original, increase in spending 

generates income, part of which is used to purchase 

locally produced goods and services, thereby 

inducing a secondary increase in spending and 

income. Lacking any econometric model of the 

Puerto Rican economy, one must resort to less exact 

methods to estimate the size of the Puerto Rican 

multiplier. According to standard textbook 

macroeconomic analysis, the size of the multiplier 

for an increase in spending (assuming, as seems 
-51-

reasonable in the case of Puerto Rico, that the 

government cannot change the rate of interest or 

credit conditions) is: 

1 

s+m 

The symbols s and m represent the fraction of an 

increase in GNP which is saved or is spent on 

imports, respectively. Saving and importing 

represent "leakages" -- the opposite of "linkages" 

from the spending-income cycle. The greater 

these leakages are, the more quickly the impact of 

increased spending will be dissipated, and the 

smaller the multiplier will be. 

In Puerto Rico, the propensity to save appears 

to be small, and the propensity to import high. In 

1978, imports equaled about 75 percent of G~P. If 

the marginal propensity to save, s, is assumed to 

be zero and the marginal propensity to import, m, 

to be .75, then the formula given above indicates a 

multiplier of 1.33. That is to say, if spending 

increases by $1. 00, an addi tionai $. 33 in local 

spending will be subsequently generated, so the 

total increase in income will be $1.33. 21 

c. Forward Linkages -- In addition to backward 

1 inkages and any multiplier effect, some 

possessions corporations may generate additional 

benefits to the Puerto Rican economy by inducing 

other firms, that will purchase from the 

possessions corporation, to also locate in Puerto 

Rico and therefore generate additional income and 

employment. Although such "forward linkages" seem 

plausible, and undoubtedly occur in some cases, 

generally suppliers locate near their customers 

rather than customers locating near suppliers. It 

would therefore be inappropriate in most cases to 

impute any benefit to a forward linkage that in 

fact was not caused by the possessions corporation. 

Further, if the customer firm is itself a 

possessions corporation the benefit of the 

.?./ This estimate ignores government taxation and 

spending. If part of an additional dollar of 

income is paid in taxes and the Puerto Rican 

government does not increase its spending by a 

matched amount, the "leakage" will be greater, and 

the multiplier will be smaller, than this simple 

analysis indicates. 
-52-

additional income it generates in Puerto Rico will 

already be counted in the direct, indirect, and 

multiplier measures, and should therefore not be 

counted again to any extent. 

D. Cost Effectiveness of the Possessions Corporation System 

The final step in assessing the possessions corporation 

system is to compare costs and benefits. Ideally perhaps, 

this comparison should be made for each possessions 

corporation. Realistically, however, the comparison can 

only be made on an industry-by-industry basis. Quite 

obviously, if for any industry the costs of the system 

exceeded the benefits to the Puerto Rican economy, the 

system would not be cost effective in that industry; a net 

benefit could be d~rived by not extending the system to that 

industry at all. Less obvious but of equal importance is 

the fact that even though benefits exceed costs for all 

industries, the system is still not cost effective if the 

ratio of benefits to cost in some industries are lower than 

the comparable ratio in other industries. In this case, a 

net benefit could be derived by providing more incentive to 

industries with high ratios of benefits to costs, and less 

incentive to industries with low ratios. 

Even in the absence of any measures of actual costs and 

benefits, there is reason to expect that the possessions 

corporation system may not be cost effective between 

industries. This expectation of cost ineffectiveness stems 

from the fact that the system relies primarily on Federal 

profit tax exemption to attract firms to Puerto Rico. A 

basic feature of a profit tax exemption system is that, even 

in the absence of profit shifting, it provides an incentive 

to locate investment in Puerto Rico irrespective of the 

amount of employment or other benefits that the investment 

might provide, directly or indirectly, to the Puerto Rican 

economy. Thus, location of a highly capital-intensive 

(e.g., petrochemical) plant in Puerto Rico may be as 

expensive to the Federal treasury in revenue foregone as the 

location of several labor-intensive (e.g., apparel), plants 

but would provide many fewer employment opportunities for 

unemployed or under employed Puerto Ricans. Alternatively, 

the lack of cost effectiveness may be viewed as follows. A 

job in the petrochemical industry costs the Federal 

government more foregone revenue than does a job in the 

apparel industry. Therefore, more jobs will be created in 

Puerto Rico if Federal revenue "spending" is diverted from 

the petrochemical industry to the apparel industry. 

CI 

g 

p 

d 

0 

a 

iJ 

a 

Il 
m 

-53-

CHAPTER IV. STATISTICAL DATA ON THE OPERATION AND EFFECT 

OF THE POSSESSIONS CORPORATION SYSTEM 

n The preceding Chapter presented an overview of economic 

growth in Puerto Rico since 1947, the role of the 

Possessions corporation system in that growth, and a 

0 description of the costs, benefits, and cost effectiveness 

e of the system. This Chapter focuses on the actual operation 

of the system in 1977, the latest year for which data on the 

income, employment, and other characteristics of possessions 

corporations are available. Data for years 1973-1976 are 

Presented in summary form only; more detailed data for these 

Years are contained in Appendix B. !/ 

The Chapter is divided into four sections. The first 

Presents estimates and projections of the total Federal tax 

expenditure on possessions corporations; the second presents 

basic statistical data, on an industry basis, for 

Possessions corporations; and the third extends industry 

measures of Puerto Rican benefits to include backward 

linkage and multiplier effects. The Chapter concludes with 

an assessment of the impact of the recent changes in U.S. 

and Puerto Rican law. 

A. Federal Tax Expenditure on Possessions Corporations 

Table 3 presents estimates and projections for calendar 

and fiscal years 1973 through 1984 of the Federal tax 

expenditure on possessions corporations. Puerto Rico 

accounts for over 98 percent of these tax expenditures in 

a11 years, which have risen from $255 million in calendar 

1973 to $662 million in calendar 1977, the latest year based 

~n reasonably complete data from actual tax returns. Taking 

into account the recent increases in Puerto Rican taxes due 

to changes in their tollgate tax and Industrial Incentive 

l! As explained more fully in Appendix B, most of the data 

on possessions corporations are taken from Federal tax 

returns, which are classified by year according to the 

accounting period of the corporation. For example, data 

for 1977 are taken from tax returns filed for 

possessions corporations' fiscal years ending between 

July 1, 1977 and June 30, 1978. 
Year Total 

1973 255 

1974 368 

1975 440 

1976 605 

1977 662 

1978 733 

1979 747 

1980 822 

1981 904 

1982 994 

1983 1,094 

1984 1,203 

-54-

Table 3 

Federal Tax Expenditure Estimates and Projections, 

Possessions Corporation Provisions 1/ 

(millions of dollars) -

Reduction in Calendar Fiscal Year 

Year Tax Liabilities Receipts Foregone 2/ 

Canpanies Operating in: Companies OperatTng in: 

:All Other U.S.: :All Other U.S. 

Puerto Rico Possessions Total Puerto Rico Possessions 

250 5 239 3/ 234 ll 5 lf 

362 6 289 284 5 

437 3 390 385 5 

602 3 490 487 3 

658 4 631 627 4 

729 4 694 690 4 

742 4 739 735 4 

818 4 781 777 4 

900 4 859 855 4 

989 5 945 940 5 

1,089 5 1,039 1,034 5 

1,198 5 1,143 1,138 5 

Off 1ce of the Secretary of the Treasury 

Office of Tax Analysis 

..!/ 'Ihe 1973 through 1975 figures are estimates based on book income data taken 

primarily fran election forms (Form 5712). The 1976 estimates are based on net 

income data taken primarily from Federal income tax forms (Form 1120). 'Ihe 1977 

figures are estimates based on the 1976 to 1977 growth rate of income for those 

companies for which data from Form 1120 for both years was available. Figures 

for 1978 arrl all subsequent years are projections based on an assurned 10 percent 

growth rate. All figures are based on the assumption that in the absence of the 

possessions corporation provisions, the incane of possessions corporations would 

be subject to an effective Federal corporate tax rate of 40 percent for 1973 to 

1978, and 38 percent for 1979 arrl all subsequent years (the statutory Federal 

corporate tax rate is reduced 2 percentage J;x:>ints -- from 48 percent to 46 percent~ beginnin:J in 1979). For canpanies operating in Puerto Rico, the 

calendar year 1973 through 1978 figures are net of estimated tax payments to 

Puerto Rico; the figures for 1979 and subsequent years are net of an assumed 5 

}?ercent effective Puerto Rican (corporate plus tollgate) tax rate. Note that the 

section 936 credit, which applies in 1976 and subsequent years, is based on tax 

liabilities computed without regard to such tax preferences as the investment ta~ 

credit, or with reqard to Puerto Rican taxes, which are taken into account in 

computing the tax expenditure figures. 'Iherefore, the actual section 936 credit 

claimed will exceed the tax expenditure figure for the corresponding year. 

'!:..! Calculated on the basis of normal relationships between calendar year corp::>rate 

tax liabilities arrl fiscal year receipts. Fiscal years through 1976 end on 

June 30 of the corresponding calendar year; thereafter on Se~tember 30. The 

transition quarter in 1976 is not shown separately. The receipts estimate for 

that quarter is $91 million. 

lf Reflects in part reduced calendar year 1972 tax liabilities, which are estimated 

to have been 10 percent lower than the estimates shown for 1973. 
-55-

Act and the reduction in the Federal corporate tax rate, 2/ 

and assuming a 10 percent growth rate, the Federal tax 

expenditure is projected to reach $1.2 billion by 1984. In 

interpreting these data on Federal tax expenditures, it 

should be noted that the figures essentially represent 

spending out of after-tax income; a comparable direct 

spending program, which would result in pre-tax income to 

recipients, would therefore need to be considerably larger 

- in dollar amount. 

t 

e 

In making these estimates and projections, it has been 

assumed that in the ~bsence of the possessions corporation 

provisions, the effective rate of U.S. tax that would have 

applied to the income of possessions corporations (before 

any credit for Puerto Rican or foreign taxes) would have 

been 40 percent in 1973-1978, and 38 percent thereafter. 3/ 

The effective rate would have been less than 48 percent (46 

percent after 1979), the maximum statutory rate, because 

other provisions of the Internal Revenue Code (e.g., the 

investment tax credit and accelerated depreciation) would 

have reduced the tax burden by an estimated 8 percentage 

points. Puerto Rican and foreign taxes would have been 

creditable against the Federal income tax 1 iabil i ty and, 

thus, have further reduced the net saving of U.S. taxes. 

The Federal tax expenditure estimates and projections 

are also based on the assumption of "no behavioral change." 

The assumption of no behavioral change should not be taken 

literally; undoubtedly possessions corporations (and other 

Persons) would behave differently in the absence of the 

possessions corporation provisions. The reason for 

following the assumption here is that it allows tax 

expenditures to be estimated using available information on 

existing law and behavior. Estimating the effect on tax 

expenditures of behavioral changes would require additional 

analysis of, and assumptions about, what would happen if the 

Possessions corporation provisions were repealed, and 

knowledgeable observers may differ in their assessment of 

What would happen. 

l! The top statutory Federal corporate income tax rate was 

reduced 2 percentage points from 48 percent to 46 

percent -- beginning in 1979. 

l/ See Department of the Treasury, "Effective Income Tax 

Rates Paid by United States Corporations in 1972, May 

1978. 
-56-

B. Basic Statistical Data on Possessions Corporations 

1. Summary Data for 1973-1977 

Table 4 presents data on the number, net income, 

estimated tax expenditure, tax expenditure per employee, and 

tax expenditure as a percent of compensation of employees of 

all possessions corporations and possessions corporations in 

selected industries for 1973-1977. In interpreting these 

data, it is important to note that the data for 1977 iS 

preliminary, and still incomplete. Therefore, accurate 

comparisons cannot be made between the number of possessions 

corporations, their income, or Federal tax expenditure in 

1977 and in earlier years. Several important conclusions, 

however, can be drawn from Table 4: 

0 

0 

0 

0 

The number of possessions corporations has 

apparently fallen somewhat between 1973 and 

1976, while the ratio of manufacturing to total 

has risen slightly. 

Net income and estimated tax expenditure have 

more than doubled between 1973 and 1976. 

Nearly all (over 90 percent) net income and 

estimated tax expenditure is attributable to 

manufacturing industries. 

Over 45 percent of total net income and 

estimated tax expenditure in each year (except 

1973) are attributable to the pharmaceutical 

industry alone, and an additional 15-20 percent 

to the electrical and electronic equipment 

industry. 

The expenditure per employee in all industries 

rose from $2,118 in 1973 to $8,222 in 1977, an 

increase of nearly 300 percent. 

o In the pharmaceutical industry, tax expenditure 

per employee was $27,293 in 1973 and $34,966 in 

1977. 

o Tax expenditure as a percent of compensation of 

employees rose from 35.3 percent to 96.6 

percent for all industries between 1973 and 

1977, while for manufacturing industries, the 

comparable figures rose from 38. 9 percent in 

1973 to 120.8 percent in 1977. 

J Man 

E 

A 

Non 

~t i 

Mar, 

I 

I 

Nol 

'l'al< 

Sat 

I o 

l 1 
-57-

Table 4 

Sumnary Data on Possessions Corporations, 1973-1977 l/ 

1973 1974 1975 1976 1977 2/ 

~r of corporations, all industries 568 596 595 528 479 

Manufacturirq irrlustries 385 399 394 395 348 

e, Pharmaceuticals 39 44 47 52 48 

nd Electrical arrl electronic equiμnent 64 76 76 81 79 

of All other manufacturing 282 279 271 262 221 

»onmanufacturing irrlustries 183 197 201 133 131 in ~t incane, all industries se 650,515 852,058 1,108,881 1,627,213 1,591,671 

is ~anufacturing irrlustries 591,724 813,057 1,055,060 1,551,677 1,464,386 

Pharmaceuticals 251,897 405,355 547,060 779,954 722,170 

te Electrical arrl electronic equiμnent 116,277 167,389 195,593 323,249 262,136 

ns All other manufacturing 223,550 240,313 312,407 448,474 480,080 

»onrnanufacturirq irrlustries 58,792 39,002 54,059 75,536 127,285 in 

IStimated tax expenditures, s, all 

l'ldustries 3/ 258,278 372,507 446,863 651,348 638,735 

Manufacturil"XJ irrlustries 242,116 352,908 425,213 621,190 587,609 

Pharmaceuticals 103,533 161,341 218,210 311,948 290,050 

Electrical arrl electronic equiμnent 46,749 66,872 79,164 129,400 104,870 

All other manufacturing 91,834 124,695 127,839 179,842 192,689 

»onrnanufacturirq irrlustries 16,162 19,599 21,612- 30,158 51,126 

r~ expenditure per employee, 4/ all us tries 2,118 4,567 6,164 8,762 8,222 

Manufacturing irrlustries 2,287 5,609 7,566 10,181 9,971 

Pharmaceuticals 27,239 33,892 34,694 41,925 34,966 

Electrical arrl electronic equipnent 2,995 5,544 8,434 9,614 10,058 

All other manufacturing 1,317 3,092 3,544 4,711 3,939 

»onrnanufacturil"XJ irrlustries 1,007 1,051 1,326 2,263 2,724 

~aic . Sat. expend1 ture as a percent of canpenM ion of employees, y all industries 35.3 64.8 81.3 105.7 96.6 

anufacturil"XJ irrlustries 38.9 81.5 103.2 127.4 120.8 

Pharmaceuticals 377.1 378.2 345.9 380.5 291.1 

Electrical arrl electronic equiμnent 47.7 83.1 112.0 114.8 112.5 

llll other manuf acturinq 23.8 46.8 49.6 64.3 55.3 

»ollnanufacturil"XJ irrlustries 14.7 13.8 15.7 23.4 29.3 

~ ~~ of the Secretary of the Treasury 

ice of Tax Analysis 

l! ~ncludes data for p::>ssessions corporations operating in American Samoa, Guam, and the Panama Canal 

one. These non-Puerto Rican operations account for less than 2 percent of total tax expenditure in 

2/ ~ny year (see Table 3) • 

!; relllllinary statistics; see text. ~te that the figures shown here differ fran the corresponding years shown in Table 3 because Table 3 

~ basea on calendar arrl (Federal) fiscal years, whereas the data in this and subsequent tables is 

!I sea <Xl the taxable years of p::>ssessions corporations, as explained more fully in Appendix B. 

~e~ figures are based only on those returns for which employment and canpensation of employees was va1lable. (See Tables 7 and 8, and B-5 through B-12 for details.) 
0 

-58-

For the pharmaceutical industry, tax expend iture was over 300 percent of compensation of 

employees in every year from 1973 to 1976, and 

just under that amount in 1977. This means 

that for every $1. 00 of wages and fringe 

benefits paid to Puerto Rican workers by the 

pharmaceutical industry, the Federal government 

lost over $3 of tax revenue. 

2. Detailed Data for 1977 

Because most of the statistical data presented in thiS 

Section is based on tax returns, the identities and 

characteristics of individual possessions corporations or 

their parent corporations cannot be made public. ManY 

parent companies must, however, file 10-K Reports with the 

U.S. Securities and Exchange Commission and these Reports, 

which are available to the public, provide information on 

the importance of section 936 to individual parent 

companies. To explain why Federal income tax payments are 

less than 48 percent (the statutory Federal tax rate prior 

to 1979) of pre-tax book income, the SEC requires 

corporations to indicate which provisions of the Internal 

Revenue Code reduced their tax liability by more than 2.4 

percent of pre-tax book income. A survey of 10-K Reports, 

for calendar year 1977 provides the information shown in 

Table 5. 

In interpreting these data, three points should be kept 

in mind. First, because specific procedures for estirnatin9 

the dollar value of various tax preferences have never been 

set forth by the SEC, the statistics presented in Table 5 

should be regarded as only rough estimates of the importance 

to the companies of section 936. Second, companies for who~ 

the tax savings may be large in dollar terms, but less tha~ 

2.4 percent of book income before taxes, need not an 

generally do not report this i tern separately. Third, even 

when tax savings exceed 2. 4 percent of book income' 

companies may combine the tax savings attributable to 

possessions corporation subsidiaries with other items (e.g., 

deferral or DISC). Companies following this practice were 

excluded from Table 5. 

Tables 6, 7 and 8 are based on preliminary data from. th! 

actual Federal tax returns of individual posse~s1on 5 corporations filed for the taxable year 1977, which includ~ 8 fiscal years ending between July 1, 1977 and June 30, 19 e 

(most returns are for calendar year 1977). Al though som t 

possessions corporations' returns for 1977 were no; 

processed in time to be included in these tables, a compar 

-

BluE 

CPC 

Che

Con 

Dig 

E 

~ 

a 

a. 

~o 

t-b 
tis 

nd 

or 

nY 

he 

s, 

on 

nt 

re 

r 

~s 

~1 

4 

.n 

t 

g 

J1 

-59-

Table 5 

Major U.S. Manufacturing Corporations Indicating a Tax Saving 

Under Section 936 on Their SEC 10-K Reports for 1977 

Corporation 

Blue Bell 

CPc 

Chesebrough-Pond's 

Conagra 

Digital F.quipment 

Esmark 

(hu1a 

aanes Corporation 

a. J. Heinz 

Morton-Norwich 

~torola 

Industry 

Textile and Apparel 

Food Prc:rlucts 

Toiletries 

Fcxxl Prcrlucts 

Office F.quiprnent 

Fcxxl Prcrlucts 

Automotive F.quipment 

Textile and Apparel 

Fcx:rl Products 

Chemicals 

Electronics 

Sub-total - 11 Non-pharmaceuticals 

~tt Laboratories ~erican Hospital StJP.?ly 

Baxter Travenol 

Becton Dickinson 

8tistol Myers 

Johnson & Johnson ~li Lilly Merck 

Pfizer 

~icharoson-Merrell 

Schering Plough G.n. Searle 

Stni th-Kline 

Squitt> 

tlJ;ljohn 

Warner Lambert 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Sub-total - 16 Pharmaceuticals 

Total - 27 Manufacturers 

~ of the Secretary of the Treasury ff1ce of Tax Analysis 

Tax Sav1nqs 

: Percent of 

Amount : Book Incane 

:($ millions):(Before Taxes) 

$ 4.5 3.5% 

3.4 1.4 

3.7 2.9 

2.0 8.2 

14.4 7.9 

7.4 7.5 

1.2 0.8 

3.1 9.6 

9.7 5.9 

_2. 3 4.3 

9.1 5.0 

$63.3 4.5% 

21.8 12.2 

10.3 8.2 

17.9 17.1 

3.4 4.3 

18.6 6.0 

21.1 5.0 

19.3 5.2 

22.6 5.1 

46.4 18.2 

5.6 5.3 

47.4 19.9 

16.6 19.l 

19.6 14.9 

29.1 18.5 

20.6 14.1 

24.0 7.3 

$344.3 9.9% 

$407.6 8.3% 

Source: Taxation with Representation, Tax Notes (recent issues). 
-60-

ison with the completed file for 1976 returns indicates that 

over 76 percent of the possessions corporations filing in 

1976, accounting for 80 percent of the total 1976 net 

income, are also included in the 1977 statistics. 

Table 6 presents industry detail on several items 

summarized in Table 4 (number of corporations, net income, 

and estimated tax expenditure), and on selected balance 

sheet and income statement items. The total assets of 

possessions corporations stood at $9.8 billion at year-end 

1977, with over 75 percent of the assets held by manufacturing companies. Within manufacturing, the pharmaceutical 

industry accounted for $3. 5 bill ion, or 4 7 percent of the 

total, and the electrical and electronic equipment industrY 

for $1.1 billion, or 15 percent of the total. 

The relatively small amount of "real" assets (net value 

of plant and equipment) shown in Table 6 clearly reflects 

the unique operating characteristics of possessions 

corporations. For manufacturing possessions corporations' 

these real assets represented only 18. 4 percent of total 

assets, whereas for U.S. manufacturers as a whole, the 

comparable figure (in 1975) was 27.3 percent. 4/ The 

counterpart to relatively little investment in real assets 

by possessions corporations is relatively large investments 

in financial assets. 

Some of this difference could be attributed to 

differences in the industry mix of possessions corporations 

and all U.S. corporations engaged in manufacturing. TO 

correct for differing industrial mix, the total assets of 

possessions corporations in each industry were distributed 

between these real and all other assets in the same manner 

as were assets of all U. s. corporations in the same 

industry. These "U.S.-weighted" amounts were then summef 

over industries to get u.s.-weighted amounts for tota 

manufacturing. Taking the ratio of actual to u.s.-weighted 

figures for total manufacturing gives 24.9 percent for these 

real assets. Thus, the differing industry mix betw~en 

possessions corporations and all U.S. corporations explains 

only about one-fourth (27.3-24.9)/(27.3-18.4) of the 

difference between the types of assets held. 

iO The continuing incentive to retain earnings 

possessions corporations is also clearly reflected in the 

!/ Data for all U.S. corporations is from U.S. Department 

of the Treasury, Source Book, Statistics of Income 19.12J_ 

Corporation Income Tax Returns. 
U1 U1 

-- ------

Table 6 

Number of Possessions Corporations, Selected Incane Statement and Balance Sheet Items, and Estimated Tax Expenditures by Industry, 1977 lf (Dollar amounts in thousands) 

Manufacturing Industries 

All =------=---foorana---:Tooacco : Textile Chemicals Rubber -

---~------ -~- ~-----I_n_d_u_s_t_r_i_e_s~~~To--t_a_l_ ~:K_i_n_d_r~ed_P_r_od_u_c~t~s~:~P~rod.::_:_u~c~t~s~:~M~i~l~l_P,_r~od"-'-'u~c~t~s~:_..;.;;Appli:.li...a~r~e~l::.......:._~To~t~a~l~~=~P~h=a~rrn~a~ce~u~t~i~c=a=l~s~:Al:.=.:l:.......::O~t~h=e=r~:~P~r~od::::.:u~c~t::::.s 

Number of corporations 

Balance Sheet Items: 

Total assets 

Depreciable assets 

Less: accumulated depreciation 

Net depreciable assets 

Retained earnings, total 

Unappropriated 

Appropriated 

Incc:xne statement items: 

Total receipts 

Business receipts 

Nongovernment interest 

Other receipts 

Total deductions 

Cost of sales and operations 

All other deductions 

Net incane per return 

Net income per books 

Estimated tax expenditures 

479 

9 ,811, 454 

2,189,328 

637,265 

1,552,063 

5,735,368 

5,619,545 

115,823 

5,785,545 

5,419,321 

245,952 

120,272 

4,193,874 

3,248,977 

944,897 

1,591,671 

1,546,950 

638,735 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

348 

7,384,647 

1,357,249 

468,524 

888,725 

5,535,769 

5,449,908 

85,861 

4,581,786 

4,347,720 

165,871 

68,195 

3,117,400 

2,459,359 

658,041 

1,464,386 

1,454,254 

587,609 

18 

616,493 

106,344 

39,054 

67,290 

473,173 

473,173 

613,737 

593,949 

17,915 

1,873 

482,575 

395,589 

86,986 

131,162 

122,918 

52,662 

4 

141,173 

29,433 

8,452 

20,981 

84,539 

84,539 

190,416 

187,174 

2,814 

428 

167,875 

85,075 

82,800 

22,541 

22,209 

9,013 

6 

9,136 

2,639 

603 

2,036 

6,414 

6,414 

13,485 

6,986 

81 

6,418 

ll,170 

5,285 

5,885 

2,315 

1.909 

931 

75 

610,830 

27,974 

12,134 

15,840 

205,788 

201,076 

4,712 

61 

3,964,097 

843,433 

277,957 

565,476 

3,152,524 

3,150,058 

2,466 

291,656 1,905,610 

277,538 1,785,356 

2,212 98,702 

11,906 21,552 

238,938 

215,246 

23,692 

52,718 

57,045 

21,179 

1,081,129 

747,245 

333,884 

824,481 

824,605 

330,966 

48 

3,452,649 

412,284 

84,527 

327,757 

2,862,869 

2,860,403 

2,466 

1,433,351 

1,314,800 

97,644 

20,907 

7ll,181 

428,966 

282,215 

722,170 

726,501 

290,050 

13 

5ll,448 

431,149 

193,430 

237, 719 

289,655 

289,655 

472,259 

470,556 

1,058 

645 

369,948 

318,279 

51,669 

102,3ll 

98,104 

40,916 

1/ Preliminary statistics; see text. Includes data for possessions corporations operating in American Samoa, Guam, and the Panama Canal Zone. These - non-Puerto Rican operations account for less than 2 percent of total tax expenditure in any year (see Table 3). 

8 

33,090 

15,520 

4,815 

10,705 

22,749 

22,749 

35,061 

34,451 

256 

354 

29,564 

18,840 

10, 724 

5,497 

5,067 

2,194 

I 

(j'\ 

f-J 

l 
Table 6 - continued 

Manufacturing Industries - continued 

Leather and :Stone, Clay, and: Fabricated : Machinery, : Electrical and :Transportation:Scientific 

:Leather Products: Glass Products :Metal Products:Except Electrical:Electronic Equipnent: Equipnent :Instn.unents 

Number of corporations 

Balance Sheet Items: 

Total assets 

Depreciable assets 

Less: acct.nnulated depreciation 

Net depreciable assets 

Retained earnings, total 

Unappropriated 

Appropriated 

Incane statement items: 

Total receipts 

Business receipts 

Nongoverrunent interest 

Other receipts 

Total deductions 

cost of sales and operations 

All other deductions 

Net incane per return 

Net inccme per books 

Estimated tax expenditures 

Of flce of the Secretary of the Treasury 

Office of Tax Analysis 

11 

51,216 

5,616 

2,813 

2,803 

41,327 

34,386 

6,941 

48,045 

46,580 

790 

675 

40,401 

36,424 

3,977 

7,644 

7,739 

3,071 

4 

296,545 

15,181 

6,163 

9,018 

46,535 

46,535 

46,484 

38,930 

1,094 

6,460 

33,473 

27,740 

5,733 

13,011 

12, 777 

5,202 

23 

110,263 

31,167 

10,032 

21,135 

98,627 

97,731 

896 

101,288 

99,103 

1,749 

436 

79,144 

71,900 

7,244 

22,144 

22,523 

8,880 

5 

9,448 

737 

94 

643 

6,413 

6,413 

14,337 

13, 710 

79 

548 

8,744 

7,011 

1,733 

5,593 

5,119 

2,235 

79 

1,071,156 

158,859 

60,973 

97,886 

1,036,028 

974,050 

61,978 

726,295 

691,134 

33,195 

1,966 

464,159 

404,835 

59,324 

262,136 

262,104 

104,870 

3 

8,861 

1,370 

737 

633 

4,426 

4,426 

10,930 

10,808 

122 

9,882 

8,291 

1,591 

1,048 

1,061 

417 

24 

176,137 

20,713 

5,215 

15,498 

149,723 

140,855 

8,868 

101,421 

97,239 

3,230 

952 

59,752 

46,436 

13,316 

41,669 

37,893 

17 ,021 

All Other 

:Manufacturing 

28 

413,202 

98,263 

42,295 

56,000 

207,503 

207,503 

483,021 

464,762 

3,754 

14,505 

410,594 

389,442 

21,152 

72,427 

181,285 

28,965 

I 

CTI 

N 

I 
Table 6 - continued 

Nonmanuracturing Inaustnes 

:Transportation,: Finance, Miscellaneous 

:Carmunications Wholesale Insurance, and 

Total :and Utilities Trade Retail Trade Real Estate Services Not Available 

Nt.nnber of corporations 131 10 15 50 24 12 20 

Balance Sheet Items: 

Total assets 2,426,807 624,598 148,130 111,186 1,408,214 88,137 46,524 

Depreciable assets 832,079 703,706 9,190 50,060 24,512 32,584 12,027 

Less: accumulated depreciation 168,741 131,293 2,420 21,550 4,024 5,797 3,657 

Net depreciable assets 663,338 572,413 6, 770 28,510 20,488 26,787 8,370 

Retained earnings, total 169,637 3,358 25,789 27,090 56,144 63,529 23,689 

Unappropriated 169,637 2,683 25,667 26, 725 27,855 63,529 23,178 

Appropriated 675 122 365 28,289 511 I 

CTI 

w 

Incane statement items: I 

Total receipts 1,203,759 173,081 466,510 320,935 114,144 61,251 67,838 

Business receipts 1,071,601 165,046 462,377 310,965 14,486 53,417 65,310 

Nongovernment interest 80,081 117 62 186 78,043 1,416 257 

Other receipts 52,077 7,918 4,071 9,784 21,615 6,418 2,271 

Total deductions 1,076,474 129,629 438,171 311,743 89,187 49,166 58,578 

Cost of sales an:l operations 789,618 65,555 405,366 231,295 2,648 34,308 50,446 

All other deductions 286,856 64,074 32,805 80,448 86,539 14,858 8,132 

Net incane per return 127,285 43,452 28,339 9,192 24,'957 12,085 9,260 

Net incane per books 92,696 43,094 13,409 6,085 11, 776 11,685 6,647 

Estimated tax expenditures 51,126 17,383 11,484 3,750 9,969 4,835 3,705 

Office of the Secretary of the Treasury 

Off ice of Tax Analysis 
-64-

$5. 7 bill ion of retained earnings they held at year-end 

1977. $2.9 billion, or 50 percent of these retained 

earnings were being held by pharmaceuticals, for which 

retained earnings represented over 80 percent of total 

liabilities and stockholders' equity. The latter ratio for 

all manufacturing possessions corporations was 75.0 percent, 

compared to 29.6 percent for all U.S. manufacturing 

corporations. 2_/ 

Table 6 shows that gross receipts of possessions 

corporations were $5.8 billion in 1977, with $5.4 billion 

( 93. 7 percent) attributable to business receipts and $366 

million (6.3 percent·) attributable to all other receipts, 

primarily interest on nongovernment securities. (Note that 

interest on government securities is excluded from gross 

income for Federal tax purposes, and therefore does not 

appear in the figures shown in Table 6.) Total deductions 

of $4. 2 billion consisted primarily of "Cost of sales and 

operations" of $3.2 billion. Net income per return (= gross 

receipts - total deductions) amounted to $1.6 billion. 

The final line in Table 6 shows estimated tax expenditure which, as explained above, is obtained by applying an 

assumed 40 percent effective U.S. tax rate to net income per 

return. (Puerto Rican tax payments are not available on an 

industry basis and have therefore not been taken into 

account in Table 6, but are reflected in the estimates shown 

in Table 3.) 

Tables 7 and 8 are based on 317 possessions corporations 

for which 1977 employment and payroll data could be obtained 

from their Federal unemployment tax returns. While the 

coverage represents only 66 percent of the number of 

companies included in Table 6, the combined net income of 

the sample, $1,169 million, represents nearly 75 percent of 

the net income of all possessions corporations. 

The first three columns of Table 7 present information 

comparable to that in Table 6. Columns 5 and 7 indicate the 

number of employees and the total employee compensation' 

respectively, in each industry in 1977. Finally, the last 

three columns indicate the tar expenditure per employee, the 

tax expenditure as a percent of total compensation, and 

average compensation. 

2_/ Using the same weighting scheme described above, the 

industry mix corrected ratio is 31.7 percent. 
Table 7 

Tax Expenditure, Employment and Canpensation of Employees by Industry, 1977 .Y 

-Canpensat10n :Tax Expenditure 

Tax Ex~nditure Emplo:c:ees of Elllployees ~~:Tax Expenditure:as a Percent of 

Industry Group Number of :Net Incane: Alrount :Percent of: :Percent of: Alrount :Percent of: Per Employee :Canpensation of 

:Corporations: ($000) ($000) Total Number Total ($000) Total ($) Ernplox_ees 

All industries 317 1,169,375 468,914 100.0 51,251 100.0 437,504 100.0 8,222 ll 96.6 ll 

Manufacturing industries 257 1,080,124 433,138 92.4 40,357 78.7 337,828 77.2 9,971 ll 120.8 ll 

Food and kindred prcrlucts 12 61,834 24,857 5.3 4,970 9.7 38,537 8.8 5,001 64.5 

Textile mill prcrlucts 4 2,177 868 .2 597 1.2 4,339 1.0 1,461 20.0 

Apparel 64 36,961 14,875 3.2 10,653 20.8 63,672 14.5 1,396 23.3 

Chemicals, total 39 629,522 252,272 53.8 7,258 14.2 87,038 19.9 34,757 289.8 

Pharmaceuticals 34 624,366 250,214 53.3 7,156 14.0 85,967 19.6 34,966 291.l 

All other chemicals 5 5,156 2,058 .4 102 .2 1,071 .2 20,176 192.2 

Rubber prcrlucts 7 3,161 1,260 .3 303 .6 2,368 .5 4,158 51.0 

Leather and leather prcrlucts 9 7,210 2,898 .6 1,802 3.5 10,920 2.5 1,608 26.5 

Fabricated metal prcrlucts 15 17,628 7,078 1.5 994 1.9 9,522 2.2 7,121 74.3 

Electrical and electronic equipnent 60 214,142 85,684 18.3 8,519 16.6 76,137 17.4 10,058 112.5 

Scientific instruments 21 32,447 13,334 2.8 2,143 4.2 18,018 4.1 6,222 74.0 

All other manufacturing !f 26 75,042 30,012 6.4 3,118 6.0 27,277 6.2 9,625 110.0 

Nonmanufacturirq industries 60 89,251 35,776 7.6 10,893 21.3 99,676 22.8 2, 724 ll 29.3 y 

Transportation, ccmnunications, 

utilities 5 40,057 16,028 3.4 7,680 15.0 63,197 14.4 2,087 25.4 

Wholesale trade 9 28,002 11,251 2.4 382 .7 4,819 1.1 29,453 233.5 

Retail trade 13 6,519 2,639 .6 269 .5 2,785 .6 9,810 94.8 

Finance, insurance, real estate 13 3,564 1,417 .3 752 1.5 7,087 1.6 1,884 50.2 

Services 10 8,222 3,291 .7 842 1.6 13,088 3.0 3,909 25.1 

Miscellaneous and not available 10 2,887 1,150 .2 968 1.9 8,698 2.0 1,188 33.2 

-------- Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Preliminary statistics; see text. 2/ Canpensation of employees was computed by multiplying 1.212 times payroll. 'l'he additional 21.2 percent reflects the employer-paid portion of social - security, unemployment insurance, and other non-payroll labor costs. 'l'he 21.2 percent is the average for all U.S. manufacturing industries in 1977; 

see the U.S. Department of c.annerce, Survey of Current Business, July 1978, Tables 6.5 and 6.6. · 3/ Canpensation of employees and number of employees used to compute these anounts were weighted by industry u.sing the ratio of tax expenditure in Table 6 - and tax expenditure in this Table. 

!f Includes manufacturing industries where data were available for less than 3 corporations. 

Average 

Employee 

:Canpensation 

($) 

8,507 y 

8,252 ll 

7,754 

7,268 

5,977 

11,992 

12,013 

10,500 

8,145 I 

6,060 0\ 

Vl 

9,579 I 

8,937 

8,408 

8,748 

9,309 ll 

8,229 

12,615 

10,353 

9,424 

15,544 

8,986 
-66-

Table 7 highlights the relationship between Federal tax 

expenditures and Puerto Rican employment. For the manufacturing companies covered, the tax expenditure per employee 

averaged $9,971 which was about 20 percent greater than the 

average compensation per worker, $8,252. Table 7 also indicates that th€ tax expenditure per employee varied from one 

industry to another. In the pharmaceutical industry the 

Federal tax expenditure represented almost $35, 000 per employee, or approximately three times the total compensation 

of the comparatively well paid Puerto Rican pharmaceutical 

employee. By contrast, in the apparel industry, the tax 

expenditure per employee was $1,396, or 23.3 percent of the 

average wage. The tax expenditure per employee in all manufacturing corporations except pharmaceuticals was $5,494. 

Table 8 is based on the same 317 possessions 

corporations shown in Table 7, but ranked according to the 

Federal tax expenditure per employee. According to Table 8, 

the top 6 possessions corporations had tax expenditures per 

employee in excess $100, 000; together they accounted for 

14.9 percent of the total tax expenditure but only 1.0 

percent of the total employment of the 31 7 companies for 

which employment information was available. The top 17 

possessions corporations, those for which tax savings per 

employee exceeded $50, 000 in 1977, collectively accounted 

for 39.6 percent of the total tax expenditure and 4.2 

percent of total employment. Because the coverage of 

employment and payroll statistics is not complete, 

possessions corporations with tax savings exceeding $50,000 

per employee may in fact have realized a somewhat smaller 

percentage of the total tax expenditure and accounted for a 

smaller percentage of the total employees of all possessions 

corporations than was the case for the 317 companies 

represented in Table 7. ~/ 

Finally, both Tables 7 and 8 indicate a direct relationship between a company's tax saving per employee and its 

total compensation per employee. This reflects a tendency 

of the high-profit industries to employ more highly skilled 

workers and/or a willingness to pay those workers more than 

they would have been paid by other Puerto Rican employers. 

~/ ':!-'hese inferences are based on the assumption that tax 

expenditure per employee for companies missing from the 

sample equal the average tax expenditure per employee 

for companies in the same industry see Table 7. 

Because the pharmaceutical companies tend to be over 

represented in the sample, the biases indicated in the 

text may have occurred. 
Table 8 

Tax Expenditure, Employment and Canpensation of Employees by Size of Tax Expenditure Per Employee, 1977 !/ 

Canpensat1on --=--------:Tax Expenditure Average 

Size of Tax Expenditure 

per Employee 

_.,,.T.:...ac-.x.:......,E_x_.,pe..:..;,:n.:...d.::.i.:...tu""r:_e:;._-r----Emp'-;;o..::l'-o..._y..:.ee.:...s..:..---,--T---,=--o'-f;......,.Emp_......::.lo=-y.._e:_e~s y : Tax Expenditure: as a Percent of Employee Number of :Net Inccme: Arrount :Percent of: :Percent of: Arrount :Percent Of: Per Employee :Canpensation of :Canpensation 

:Corporations: ($000) ($000) Total Number Total ($000) Total ($) Employees ($) 

All corporations 

$100,000 or rrore $ 50,000 under $100,000 

$ 10,000 under $ 50,000 

$ 5,000 under $ 10,000 

$ 1,000 under $ 5,000 

$ 500 under $ 1,000 

$ 100 under $ 500 

$ 1 under $ 100 

U:>ss corporations 

317 

6 

ll 

71 

43 

ll3 

22 

23 

6 

22 

1,169,375 468,914 

175,228 70,087 

290,121 ll6,042 

411,483 164,549 

149,626 59,825 

138,028 55,143 

6,031 2,400 

2,180 858 

31 10 

-3,353 

Office of the Secretaryof the Treasury-----------------

Office of Tax Analysis 

1/ Preliminary statistics; see text. 

100.0 

14.9 

24.7 

35.l 

12.8 

ll.8 

.5 

.2 

* 

51,251 100.0 437,504 100.0 8,222 y 96.6 y 

533 1.0 9,060 2.1 131,495 773.6 

1,618 3.2 20,468 4.7 71, 719 566.9 

8,411 16.4 91,866 21.0 19,564 179.1 

8, 718 17.0 73,071 16.7 6,862 81.9 

24,075 47.0 183,820 42.0 2,290 30.0 

2,992 5.8 23,224 5.3 . 802 10.3 

3,350 6.5 23,307 5.3 256 3.7 

422 .8 3,452 .8 24 .2 

1,131 2.2 9,234 2.1 

-------------------

2/ Canpensation of employees was ccmputed by multiplying 1.212 times payroll. 'ftle additional 21.2 percent reflects the employer-paid portion of - social security, unemployment insurance, arrl other non-payroll labor costs. The 21.2 percent is the average for all U.S. manufacturing industries 

in 1977; see the U.S. Department of Cotrnerce, Survey of Current Business, July 1978, Tables 6.5 and 6.6.' 

3/ Canpensation of employees atX! number of employees used to canpute -these anounts were weighted by industry using the ratio of tax expenditure in Table 6 

- and tax expenditure in Table 7. 

* Less than 0.05 percent 

8,507 

16,998 

12,650 

10,922 

8,382 

7,635 

7,762 

6,957 

8,180 

8,164 

y 

I 

G'\ 

-.I 

I 
-68-

c. Estimates of Backward Linkage and Multiplier Effects 

In the preceding Section, the Federal tax expenditure on 

possessions corporations was compared to the employment and 

payroll of those companies. As indicated in Chapter I I I, 

however, in addition to these direct benefits a possessions 

corporation may generate indirect benefits through the 

impact of its purchases and the additional compensation it 

provides its employees on the Puerto Rican economy. The 

first step in estimating these "backward linkage" and 

"multiplier" effects is to compute the ratio of compensation 

of employees to total direct expenditures in Puerto Rico. 

This ratio, by industry, provides a means of estimating the 

backward linkage effects of possessions corporations based 

on data for employee compensation, such as those ·presented 

in Table 7. No new data have become available since 

publication of the First Annual Report which would allow 

updated estimates to be made of these ratios. Therefore, 

the same ratios used in the First Annual Report are used 

here. The very rough estimate of the Puerto Rican 

multiplier presented in Chapter II, 1. 33, will be used to 

estimate multiplier effects. ' 

In interpreting results obtained from using these ratios 

and multiplier estimates, it must be kept in mind that they 

provide estimates of indirect benefits that are undoubtedly 

overstated because they do not take into account the 

"opportunity costs," or other alternative uses, to which 

some Puerto Rican resources could be put in the absence of 

possessions corporations. It should also be noted that, as 

indicated in Chapter III, the Federal tax expenditure is the 

most obvious, but not the only, cost of the possessions 

corporation system. Puerto Rico also foregoes tax revenues, 

and it incurs direct expenses for cash grants, interest 

subsidies and other items under its Industrial Incentive 

Program, as well as indirect costs for special transportation facilities, utility connections, and additional general 

government services provided to possessions corporations. 

Thus, if the ratio of Federal tax expenditure to employee 

compensation of possessions corporations overstates their 

costs relative to benefits generated, the ratio of Federal 

tax expenditure to total (di re ct and ind ire ct) income 

generated by possessions corporations probably understates 

their costs relative to benefits. 

Table 9 shows for various manufacturing industries 

Federal tax expenditures as a percentage of direct labor 

costs, of total direct expenditures on Puerto Rican inputs, 

and of Puerto Rican income directly or indirectly associated 

with those expenditures. The first percentage is identical 
Table 9 

Tax Expenditures as a Percent of Canpensation of Ernployees, of Direct Expenditure in Puerto Rico, 

and of Direct and Indirect Expenditures in Puerto Rico, for Manufacturing Industries 

:Tax Expendr"ture:Rat10 of Compensat1on:Tax Expend1ture------;;f"aX--Expenditure as Percent: : as a Percent :of Employees to Total:as Percent of Total: of Total Direct and 

:of Compensation: Direct Expenditures :Direct Expenditures: Indirect Expenditures in ______ I_nd_u_s_t_ry.....__ __________ :o_f_Emp__._l_o .... y_e_e_s y: in Puerto Rico y in Puerto Rico y Puerto Rico!/ 

Manufacturing industries 

FCX'.)d arrl kindred prcrlucts 

Textile mill products 

Apparel 

Chemicals , total 

Pharmaceuticals 

Rubber products 

Leather and leather prcrlucts 

Fabricated metal products 

Electrical arrl electronic equipnent 

Scientific instruments 

120.8 .370 

64.5 .219 

20.0 .531 

23.3 .665 

289.8 .274 

291.1 .381 

51.0 .607 

26.5 .749 

74.3 .558 

112.5 .548 

74.0 .671 

44.7 33.6 

14.1 10.6 

10.6 8.0 

15.5 11.6 

79.4 59.7 

110.9 83.4 

31.0 23.3 

19.8 14.9 

41.4 31.2 

61.6 46.3 

49.6 37.3 

Total Direct and 

Indirect Expenditures 

in Puerto Rico Divided 

by Tax Expenditure 2/ __ _ 

3.0 

9.4 

12.5 

8.6 

1. 7 

1.2 

4.3 

6.7 

3.2 

2.2 

2.7 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

------------------

1/ Fran Table 7, column (10). 

2/ Fran First Annual Report, Table 8, line (10). 

3/ Column (1) times column (2). 

4/ Column (3) divided by 1.33. 

~ Inverse of column ( 4) • 

I 

O'\ 

\.0 

I 
-70-

to that in Table 7, the second (in column three) is obtained 

by multiplying the first by the ratio of compensation of 

employees to total direct expenditures in Puerto Rico (from 

Table 8 in the First Annual Report), and the third (in 

column four) by d1v1d1ng the second by the multiplier. 

Finally, the fifth column is simply the inverse of the 

fourth column Puerto Rican expenditures directly or 

indirectly generated by possessions corporations per dollar 

of Federal tax expenditure. 

Table 9 indicates that Federal tax expenditure in some 

industries is associated directly or indirectly with more 

Puerto Rican expenditures or income than in other 

industries. The average for all manufacturing is 3. 0. In 

some industries (e.g., food and kindred products, textile 

mill products, and apparel), the ratio is over eight, 

reflecting a low level of tax-exempt income and/or substantial purchases of goods and services from the Puerto 

Rican economy. In other industries, (e.g., chemicals 

including pharmaceuticals, electrical and electronic 

equipment, and scientific instruments) the ratio is less 

than three, usually because the tax-exempt income is high 

and local purchases are only average. 

In summary, taking account of the backward linkages and 

the multiplier effect significantly expands -- and probably 

overstates -- the total benefit to Puerto Rico associated 

with the possessions corporation system. And while the 

measured cost-benefit ratios are reduced, they continue to 

vary widely from one industry to another. 7 / This wide 

interindustry variation in benefit-cost ratios indicates 

that the possessions corporation system is not cost 

effective as an incentive program; there is no close 

]_/ Note that a benefit-cost ratio of 1.0 does not mark the 

boundary between a "good" program and a "ba~one. For 

the reasons indicated above, the total income associated 

directly or indirectly with possessions corporations may 

overstate the benefits to Pu er to Rico, and the Fed er al 

tax expenditure is not the only cost of the system. 

More importantly, the benefit-cost ratio of one program 

should be compared not to some fixed benchmark, but 

rather to the ratio for alternative programs. For 

example (and only for example), a public-works program 

funded by the Federal government would, because of the 

multiplier ef feet, have a benefit-cost ratio of 1. 3. 

The alternative program could, of course, be a 

restructured tax incentive. 
-71-

close relationship between the costs of the program in each 

industry and the benefits to the Puerto Rican economy 

generated by the industry. 

D. Impact of the Adoption of Section 936 and Recent 

Changes in the Puerto Rican Tollgate Tax and 

Industrial Incentives Program 

The preceding Sections of this Chapter have presented 

statistical data on the total costs, benefits, and 

cost effectiveness .of the possessions corporation system. 

This Section is concerned with changes in the costs, 

benefits, and cost effectiveness of the system due to the 

adoption, in the Tax Reform Act of 1976, of section 936 in 

place of section 931 of the U.S. Internal Revenue Code; to 

the coincident changes in the Puerto Rican tollgate tax, and 

its subsequent modifications; and to the June 2, 1978, 

restructuring of the Puerto Rican Industrial Incentive Act. 

The effects of these three sets of legislative changes 

are difficult, if not impossible, to separate one from the 

other, or to separate as a group from the other short- and 

longer-range changes, discussed in Chapter III, taking place 

in the Puerto Rican economy. This difficulty stems both 

from the close interrelationships that existed prior to 1976 

between the possessions corporation provisions of the U.S. 

Internal Revenue Code, the tollgate tax, and the industrial 

Incentive Acts, and from the fact that all three were 

changed within a relatively short period. In spite of these 

difficulties, however, an increasing amount of statistical 

evidence and analysis permits some tentative observations to 

be made. 

1. Change in Costs 

The change from section 931 to section 936, by making 

exempt only income from certain investments in the same 

Possession as the trade or business is conducted, made 

former investments outside Puerto Rico -- in particular in 

Eurodollar market either directly or through Guamanian banks 

taxable. The change also removed the U.S. tax cost (due 

to the disallowance of a dividends received deduction for 
-72-

parent corporations) to repatriation. 8/ To the extent 

possessions corporations retained -non-Puerto Rican 

investments in their financial portfolios, Federal tax 

expenditures have been reduced. In 1976, income earned 

prior to October from non-U. S. financial investments was 

still exempt, and since then the majority of investments 

outside Puerto Rico have been withdrawn (see below). 

If the combination of the dividends received deduction 

and the taxabil i ty of non-Puerto Rican investment income 

leads, on balance, to more investment in Puerto Rico than 

would otherwise have occurred, the Federal tax expenditure 

will increase; if on balance to less investment in Puerto 

Rico, the Federal tax expenditure will decrease. While 

there is some reason to think the balance may tip toward 

more investment in Puerto Rico, the effect cannot be 

separated from the coincidence (and later) changes in the 

Puerto Rican tollgate tax and Industrial Incentive Act. 

The changes to these Puerto Rican laws, by increasing 

Puerto Rican tax collections, will also reduce the Federal 

tax expenditure because it is computed net of Puerto Rican 

(and any foreign) income or tollgate taxes paid, which would 

be creditable against U.S. tax in the absence of the 

possessions corporation system. The initial changes in the 

tollgate tax became effective at the same time as section 

936 (October, 1976) but few dividends were paid over the 

next few months because: (a) firms hoped to persuade the 

Puerto Rican Government to lower the rate or repeal the tax 

(as noted in Chapter II, the rate was subsequently altered 

in several ways, generally lowering the effective rate); (b) 

liquidations were still free of any tollgate (this is still 

true for firms on old grants, but not for firms with new or 

converted grants); and ( c) some companies were concerned 

that paying even $1 of dividends would force them to "book" 

a tollgate tax liability on all accumulated earnings, thus 

depressing earnings in the quarter the dividend was paid. 

Accounting firms eventually ruled that if dividends did not 

exceed current earnings, no provision for a tollgate tax on 

accumulated earnings needed to be made • 

.!!./ This had only a negligible effect on increasing the 

Federal tax expenditure, since firms could always escape 

the tax cost through liquidating distributions, and 

parent corporations th t did receive dividends could 

take a foreign tax credit for any Puerto Rican or 

foreign taxes paid, or use the dividend to absorb excess 

credits on foreign source income. 
-73-

Because of the subsequent developments in tollgate tax 

and accounting practice dividends picked up, reaching an 

estimated $1.0 billion in the year ending June 30, 1978, on 

which tollgate tax of $46 million, representing an effective 

rate of about 4.5 percent, were paid. In the year ending 

June 30, 1979, Puerto Rico anticipates tollgate tax 

collections of $55 million, which will again represent about 

4.5 percent of the $1.2 billion of expected dividends paid 

by possessions corporations. 

In addition to tollgate tax collections, Puerto Rico has 

begun to receive modest amounts of tax revenues from 

companies operating under the new Industrial Incentive Act, 

which provides for only a partial exemption from income tax 

for new, or converting old, firms. 9/ Since the first firms 

were not taxable until this year, -no data is available on 

Puerto Rican income tax collections under the new Act. 

However, the current estimates of the Puerto Rican Treasury 

are for collections of $12-$15 million in the current year, 

$20-$24 million in 1980, and $45 million by 1985 • .!.Q_/ 

Combining the above estimates on Puerto Rican tax 

collections from the tollgate tax and new Industrial 

Incentive Act, it appears that together they will reduce the 

Feder al tax expenditure by about 5 percentage po in ts, or 

from 38 percent to 33 percent of pre-tax income for 1979 and 

subsequent years. The combination would reduce the Federal 

tax expenditure further to the extent these taxes discourage 

U.S. firms, that would have located in Puerto Rico under the 

old tollgate tax and Industrial Incentive Act, from making 

an investment in Puerto Rico. This point is taken up below. 

2. Change in Benefits 

The changes in u. S. and Puerto Rican law may increase 

benefits to Puerto Rico from the possessions corporation 

system in two ways: {a) by making the system more attractive 

for U.S. firms, and therefore encouraging more to locate in 

Puerto Rico than would have under prior law, thus increasing 

employment and wages paid as well as backward 1 inkage and 

multiplier benefits: and { b) by making a net addition to 

funds available to finance investment by others in Puerto 

~ico, and thereby encouraging such investment through lower 

interest rates. 

~/ See, Section C of Chapter II for a full discussion of 

changes in the Industrial Incentive Act • 

.!.Q_/ Chemical Week, April 11, 1979. 
.:...74-

As suggested in the preceding, it is not clear from an 

examination of the changes in the U.S. and Puerto Rican laws 

whether the possessions corporation system provides more or 

less of an attraction to U.S. firms than it did before the 

changes. The U.S. change from section 931 to section 936 

may have discouraged location in Puerto Rico by restricting 

U.S. tax exemption on investment income to "qualified 

possession source investment income," and by requiring firms 

to make binding 10 year elections which carry a prohibition 

from inclusion in a consolidated return, so that in loss 

years possessions corpo~ations can no longer bring the loss 

home to offset income of its parent corporation. But it may 

have encouraged investment in Puerto Rico by allowing U.S. 

parent corporations a 100 percent dividends received 

deduction for dividends from a possessions corporation. 

Table 10 presents data on the number of co~panies that 

have made an election under section 936. As of June 1979, 

736 corporations had filed a section 936 election form. 

Taken together, these 736 companies accounted for over 99 

percent of the income excludable under section 931 in 1975. 

Of these, 600 were included in one or more of the tables for 

1973 to 1977 in this Report. The remaining 136 corporations 

are "new" 936 corporations; that is to say, they excluded no 

income under section 931 between 1973 and 1975, nor did they 

claim a section 936 credit for a fiscal year ending before 

July 1, 1978. Forty-one of these 136 new companies were 

incorporated in 1977 or 1978, while the remaining 95 were 

incorporated prior to 1977. This last group includes 

several companies incorporated in the last five years, but 

which presumably had start-up losses making an earlier 

section 936 election disadvantageous. Table 10 does not 

include companies who recently obtained a tax exemption from 

Puerto Rico, but have delayed their 936 election until they 

are past their start-up losses. Table 10 indicates that the 

new · 936 corporations have very much the same industrial 

composition as the old ones do. 

In interpreting the data in Table 10, two points must be 

kept in mind. First, electors are reacting to all other 

forces, including changes in Puerto Rican law, as well as 

underlying locational advantages (discussed at length in 

Chapter III) in Puerto Rico. It is not clear, therefore, 

whether the number electing is higher or lower than it would 

have been without changes. Second, as already noted above, 

virtually all of the income earned in 1976 and 1977 by 

electing 936 corporations was earned by companies that were 

already operating in Puerto Rico, under section 931, in 

1975. 
Table 10 

Elections under Section 936 by Industry 

Industry 

All irrl us tries 

Manufacturing industries 

Focrl and kindred prcrlucts 

Apparel 

Chemicals, total 

Fabricated metal products 

Total 

as of 

:June 1979: 

736 

564 

123 

100 

37 

Electrical arrl electronic equipnent 109 

All other manufacturing 195 

Nonmanufacturing irrlustries 172 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

Included in Report New Elecf1o0s ______ _ 

~----- :Date of Incorporatfon: 

Before 

Total :1976 or 1977: 1976 

Date of Incorporation --Before 

Total :1977 or 1978: 1977 ~-----------------~-------------~ 

600 54 546 136 41 95 

469 44 425 95 35 60 

104 10 94 19 6 13 

86 4 82 14 5 9 

30 3 27 7 3 4 

91 12 79 18 8 10 

158 15 143 37 13 24 

131 10 121 41 6 35 

I 

-.....] 

U1 

I 
-76-

The basic result of the changes in the Puerto Rican law, 

both the tollgate tax and the new Industrial Incentive Act, 

was to impose new or additional taxes on possessions 

corporations. Because the effective rate of tax, at least 

initially, is very low for most firms, and because some 

firms undoubtedly would invest in Puerto Rico even with full 

taxation, these new taxes may provide little disincentive to 

investment in Puerto Rico. And for some firms the new 

Industrial Incentive Act provides incentives not available 

under prior law. In particular, export oriented service 

industries, which had been fully taxable under prior law, 

can qualify for partial tax exemption under the new Act. 

Also, firms with existing grants could convert to a new, 

partially taxable status and receive a guarantee of an 

automatic 10 year extension of the grant whereas under prior 

law extensions (or the availability of a new grant) were not 

guaranteed. 

One indication, however, of an overall disincentive 

effect of the new Industrial Incentive Act is the fact that 

just prior to its adoption in June 1978 there was a very 

large number of petitions filed for full tax exemption under 

the old Act. Some of these petitions were undoubtedly filed 

by firms merely wishing to keep their options open and will 

never result in an actual operation. Others appear to have 

been filed by companies that will make investments in Puerto 

Rico, but avoid the terms of the new Act. Consistent with 

this observation is the fact that there were relatively few 

petitions ( 90) filed under the new Act as of early May, 

1979. And of these 90, more than half were filed by firms 

that expect to earn profits of under $100,000 per year and 

therefore be fully tax exempt under an exception in the new 

Act, as they would have been under the old Act. None of the 

petitions were for firms engaged in export oriented service 

industries, in spite of the more favorable treatment 

afforded them under the new Act. Only about one third of 

the petitions were filed by non-Puerto Rican firms, and of 

these about half were filed by firms that already have 

operations in Puerto Rico. 

A much larger number, 213, of conversion petitions were 

filed by April, 1979 (the originally scheduled deadline for 

most firms). This represents about 15 percent of grants 

outstanding under prior Industrial Incentive Acts. Conversions, of course, do not represent new firms investing in 

Puerto Rico or even new investment by existing firms. But 

they may represent, because of the guaranteed extension 

feature of conversion, some commitment to continued 

operations in Puerto Rico. As with filings under the old 

Acts, the fact that most petitions were filed just ahead of 
-77-

the deadline suggests many firms were merely maintaining 

options. The issue is further clouded by the fact that the 

previously untried conversion procedure is still being 

established within the Puerto Rican government. Regulations 

have not been issued, but are expected by mid-summer. 

Further, a new filing deadline of December 31, 1979, may be 

approved. These changes may encourage some additional 

conversion petitions to be filed and also encourage some 

firms that have already filed to carry through with their 

conversion plans. 

The second way in which the changes in U.S. and Puerto 

Rican law might increase benefits from the possessions 

corporation system is by lowering interest rates in Puerto 

Rico, thereby encouraging additional real investment. The 

specific change in U.S. tax law aimed at this goal was the 

investment provisions of section 936, which limits the U.S. 

tax exemption for income from financial investments to 

certain investments in the same possession in which the 

trade or business giving rise to the investable funds is 

conducted. At the same time, however, by allowing parent 

companies a 100 percent dividends received deduction 

Congress wanted to encourage possessions corporations to 

repatriate their earnings to the United States. Taken 

together, the net effect of these two changes on incentives 

to increase financial investments in Puerto Rico is 

uncertain. For reasons given below it is even less certain, 

in any event, whether a change in financial investments by 

possessions corporations would have any real impact on the 

availability of credit or interest rates in Puerto Rico. 

Prior to 1976, the Puerto Rican tollgate tax did not 

apply to dividends paid to a parent corporation if the 

parent could not receive a foreign tax credit for the tollgate tax in its country of residence. Since the combination 

of a dividends received deduction and the 936 credit 

exempted most, if not all, income of possessions corporations from U.S. tax, Congress disallowed any credit to U.S. 

shareholders for possessions or foreign withholding taxes, 

including the Puerto Rican tollgate tax, imposed on 

dividends paid by possessions corporations. Therefore, the 

Puerto Rican tollgate tax had to be revised in 1976 in order 

for it to apply to dividends paid by possesssions corporations. By imposing a tax cost on such dividends, the tollgate encourages possessions corporations to postpone 

repatriation of earnings, thereby increasing their potential 

for making financial investments in Puerto Rico. 
-78-

The estimated composition of possessions corporations 

financial portfolios at the end of 1978 is shown in Table 

11. The total portfolio of $6.5 billion is growing at an 

annual rate of approximately $500 million, the difference 

between annual earnings of $1.8 billion, and dividend 

payments plus other uses of funds (real investment, debt 

repayment, etc.) of $1.3 billion. Some $4 billion, or about 

two thirds of these portfolios, is invested in Puerto Rico. 

This represents a very sizeable increase in such investments 

since early 1976, when only a few hundred million dollars 

(out of a total portfolio of approximately $4 billion) was 

invested in Puerto Rico. Over half of the increase (from 

under $100 million to $2 billion) was due to new deposits by 

possessions corporations in Puerto Rican banks, . including 

the Puerto Rican branches of large U.S. banks which hold 

over half of these deposits. The remaining increase in 

possessions corporations' portfolio investments in Puerto 

Rico has gone primarily into GNMA mortgages and bonds issued 

by the Puerto Rican Commonwealth and municipal governments, 

which absorbed roughly $800 million each of possessions 

corporations' portfolio investments. Additional investments 

of an estimated $100 million have been in the form of loans 

to other possessions corporations and $200+ million in 

miscellaneous Puerto Rican assets. 

Of the $2. 4+ bill ion invested outside Puerto Rico by 

possessions corporations, approximately $200 million has 

gone into tax exempt U.S. state and local bonds, and $400+ 

million into preferred stock of U.S. corporations. 11/ The 

balance of $1.8+ billion is invested in the Eurodollar 

market, Canada, and other non-Puerto Rican, non-u.s. assets, 

or cannot be fully accounted for. 

While possessions corporations have greatly increased 

their portfolio investments in Puerto Rico since 1976, there 

is little evidence that the increase has had any significant 

effect on the total availability of credit, or long term 

interest rates, in Puerto Rico. While precise interest rate 

comparisons are difficult because of differences in the 

maturity, risk, and other factors attached to financial 

instruments, a reasonable comparison is possible for government bonds. Table 12 shows that the interest rate spread 

(column 6) between interest rates paid on bonds sold by the 

11/ A possessions corporation can take an 85 percent 

~ dividends received deduction for the preferred 

dividends, making the maximum U.S. tax on $100 of such 

dividends 46% x $15 = $6.90. 

'l'ot 

Inv 

In 
-79-

Table 11 

Estimated Canposition of the Financial Investments 

of Possessions Corporations at Yearend 1978 

Investment 

'I'otal investments •••••••••••••••••••••••••• 

Investments in Puerto Rico, total •••••••••• 

Deposits in Puerto Rican banks •••••••••• 

Puerto Rican source GNM~ mortgages •••••• 

Loans to other possessions corporations • 

Puerto Rican government bonds ••••••••••• 

Other investments in Puerto Rico •••••••• 

Investments in the United States, total •••• 

U.S. rnunici~als arrl project notes ••••••• 

Preferred stock of U.S. corporations •••• 

Other investments, total ••••••••••••••••••• 

$ billions 

6.5 

4.0+ 

2.0 

.8 

.1 

.8 

.2+ 

.6+ 

~ 

.4+ 

1.8+ 

Of"=~f~ice---o~f.--t~h-e---Se_cr __ e_t_ary ____ o_f...__t-he __ Tr __ e_a_s_u_ry----------------------------~-----

Of f ice of Tax Analysis 
Table 12 

Sales of Borrls by the Goverrnnent Developnent Bank for Puerto Rico 

October 1976 - April 1979 

Average :Net Interest:Bond Buyer's: 

Arrount Life Cost Index of 

Issuing Agency Date : ( $ millions): (years) (percent) 20 Bonds .!f: 

(1) (2) (3) (4) (5) 

Water Resources Authority 10-13-76 60.0 18.13 8.23 6.25 

Goverrnnent Develoμnent Bank y 12-06-76 85.0 8.65 7.75 5.96 

Aqueduct & Sewer Authority 12-l0-7n 35.0 15.40 7.88 5.96 

Highway Authority 2-18-77 62.5 13.66 7.61 5.83 

Conmonwealth Series 1977 4-14-77 300.0 24.24 7.89 5.70 

Goverrnnent Develoμnent Bank y 7-13-77 50.0 6.21 6.15 5.64 

Highway Authority 8-10-77 75.0 22.38 6.99 5.63 

Ports Authority 11-17-77 29.5 20.06 7.33 5.45 

Public Buildings Authority 2-14-78 110.0 14. 71 7.98 5.61 

Irrlustrial Developnent Canpany 3-31-78 40.0 16.80 7.98 5.69 

Government Development Bank y 5-05-78 50.0 7.64 7.08 5.89 

Telephone Authority 6-24-78 100.0 22.20 7.99 6.31 

Water Resources Authority 9-26-78 125.0 22.10 7. 71 6.12 

Telephone Authority 11-01-78 25.0 15.20 7.67 6.22 

Corrmonwealth Series 1978 11-10-78 100.0 16.24 7.98 6.10 

Developnent Fund (ffiB) 12-07-78 25.0 10.00 8.00 6.29 

Public Buildings Authority 4-05-79 125.0 N/A 7.90 6.25 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

.!/ Bond Buyer Index, 'lbe Weekly Bond Buyer. 

'!:} Issued directly to 936 corporations. 

Sourcet Cbvernment neve1-0tltlent Bank for Puerto Rico 

Point 

Spread 

(4-5) 

(6) 

1.98 

1. 79 

1.92 

1. 78 

2.19 

.51 

1.36 

1.88 

2.37 

2.29 

1.19 

1.68 

1.59 

1.45 

1.88 

1. 71 

1.65 

I 

(X) 

0 

I 
-81-

Government Development Bank for Puerto Rico and the Bond 

Buyer's index for 20 ( u. S. municipal) bonds has changed 

little, if at all, since October 1976 (the effective date of 

section 936). 

There are several explanations for the general lack of 

impact of possessions corporations' financial portfolios on 

credit conditions in Puerto Rico. Bank deposits may simply 

finance loans to Puerto Rican subsidiaries of large U.S. 

companies (or to other possessions corporations) which would 

otherwise have borrowed from their parent corporations; they 

may, at least temporarily, be "warehoused" in U.S. investments, such as U.S. Treasury securities; and, in the case of 

Puerto Rican branches of U.S. (and other non-Puerto Rican) 

banks, they may simply reduce the branches' loans from its 

home office. Similarly, possessions corporations' purchases 

of Puerto Rican GNMAs, government bonds, and other· assets 

may only substitute for other non-Puerto Rican purchasers, 

and therefore not affect total funds available in Puerto 

Rico to finance investment. Further, most of the bank 

deposits of possessions corporations are in the form of 

short term certificates of deposits, and many of the Puerto 

Rican GNMAs and government bonds are held under repurchase 

agreements with brokers or banks, thus effectively 

converting them into short-term investments. Banks (and 

brokers) cannot risk making additional long term loans, the 

type of loan needed to finance real investment in Puerto 

Rican plant and equipment, if the funds at their disposal 

from possessions corporations are only committed for short 

Periods of time. 

It is reasonably clear why possessions corporations are 

unwilling to over commit their financial portfolios in 

Puerto Rico. They, like any other investors, have 

alternative uses for funds, including investments in the 

United States and other non-Puerto Rican assets, as well as 

the option to repatriate funds to their U.S. parents. 

Unless the after-tax return on an investment in a Puerto 

Rican asset is at least as high as from a non-Puerto Rican 

~sset of equal risk, a possessions corporation (or any other 

investor) has no incentive to purchase the Puerto Rican 

~~set. 12/ The fact that the Puerto Rican capital market is 

lghly integrated with the u. s. capital market means that 

-------------

.!3_! Note th a t because of tax exemption a possess ions 

corporation bears all risk on investments, whereas a 

taxable corporation shares some risk with the 

government. Therefore, a possessions corporation will 

be relatively less willing to finance risky investments. 
-82-

all investors, including possessions corporations, can 

readily compare after-tax rates of return in Puerto Rico and 

the United States, and will quickly adjust their financial 

portfolios in response to changes in these returns. A 

"good" investment in Puerto Rico will be financed with or 

without the financial portfolios of possessions 

corporations; a "bad" investment will not. 

3. Change in Cost Effectiveness 

From the preceding, it appears that the cost 

effectiveness of the possessions corporation system was not 

greatly altered by the 1976-1978 changes in the U.S. and 

Puerto Rican laws. Costs have been reduced somewhat through 

the relatively small increases in U.S. and Puerto Rican tax 

collections, while benefits may have fallen slightly because 

of new disincentives to invest which have probably not been 

offset by improved credit conditions in Puerto Rico. 

Some additional indication of recent changes in the 

cost effectiveness of the system can be obtained bY 

comparing the growth rate of employment in manufacturin9 

industries with their benefit-cost ratios. Table 13 shows 

manufacturing employment by industry for 1973-1978, and the 

rate of growth of that employment over the entire period and 

for the 1976-1978 period. A comparison of these growth rate 

figures with the benefit-cost ratios shown in column 5 of 

Table 9 indicates the following. The three industries with 

the lowest benefit-cost ratios -- chemicals (includin9 

pharmaceuticals), electrical and electronic equipment, and 

scientific instruments -- have been three of the fastest 

growing industries over both the entire 1973-1978 period, 

and the more recent 1976-1978 period. The reverse is true 

of the three industries with the highest benefit-cost ratio~ 

-- food and kindred products, textile mill products, an 

apparel. These three industries have grown very slowly, or 

actually lost employment, between 1976 and 1978 and over th~ 

entire 1973-1978 period. These comparisons suggest t~\ 

that the possessions corporation system as revised w1l 

continue to make Puerto Rico most attractive to relativelY 

high profit operations of U.S. firms in selected industries 

that produce relatively fewer benefits to Puerto Rico than 

the traditional, labor-intensive industries. 
Table 13 

Total Manufacturing Employment in Puerto Rico by Industry, 

Calendar Years 1973-1978 

(thousands) 

01 

·------ -------~~~~---:-Percenfage-: Percentage~ 

Year Change Change 

Industry Group -rg-79-----1977-- 1976 1975 1974-----19g-- 1973-1978 1976-1978 

All Manufacturing Industries 152.4 146.2 142.5 135.2 150.9 152.1 .2% 

Nondurable goods 101.1 99.0 97.7 93.5 103.9 105.3 -4.0 

Food and kindred products 24.6 23.9 24.1 23.8 24.1 24.0 2.5 

Tobacco products 3.0 3.7 4.9 5.1 5.4 5.5 -45.5 

Textile mill products 4.8 4.7 4.6 5.1 7.4 7.6 -36.8 

Apparel 36.4 36.5 37.5 34.6 38.1 40.3 -9.7 

Paper and allied products; 

Printing and publishing 4.4 4.4 4.1 4.0 4.2 4.3 2.3 

Chemicals 15.7 14.2 11. 4 10.4 11. 6 10.6 48.1 

Petroleum refining; Rubber products; 

Plastics 6.4 6.3 5.9 5.5 6.6 6.7 -4. 5 

Leather and leather products 5.7 5.3 5.2 5.0 6.2 6.4 -10.9 

Durable goods 51. 3 47.2 44.9 41. 7 46.9 46.8 9.6 

Lumber and wood products; 

Furniture and fixtures 3.7 3.4 3.7 3.9 4.4 4.9 -24.5 

Stone, clay and glass products 5.3 5.2 5.6 6.1 7.3 7.3 -27.4 

Primary metal products; Fabricated 

metal products 5.9 5.3 5.4 5.8 5.6 6.8 -13. 2 

Machinery, except electrical; 

Transporation equipment 5.7 5.2 4.4 3.5 2.3 1.9 200.0 

Electrical and electronic equipment 15.2 10.0 11. 8 9.6 13.9 14.0 8.6 

Scientific instruments 12.1 11. 2 10.9 10.1 9.3 8.6 40.7 

Miscellaneous manufacturing industries 3.4 2.8 3.0 2.8 3.0 3.2 6.3 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

Sources: Economic Development Administration, Commonwealth of Puerto Rico; and Office of the Governor, 

Commonwealth of Puerto Rico, An Agenda for a Socio-Economic Study of Puerto Rico, Part Two - Problems 

Affecting Development of Puerto Rican Society, June 1977, Table III-A-4, p. 166. 

6.9% 

3.5 

2.1 

-38.8 

4.3 

-2.9 

7.3 

37.7 

8.5 

9.6 

14.3 

0 

-5.4 

9.3 

29.5 

28.8 

11. 0 

13.3 

I 

c:o 

w 

I 
-84-

Appendix A -- Operation of the Possessions Corporation 

System of Taxation in American Samoa, Guam, 

the Panama Canal Zone, and the Virgin Islands 

The term "possession" as used in section 936 of the 

Internal Revenue Code includes not only Puerto Rico, but 

also American Samoa, Guam, the Panama Canal Zone, and other 

smaller U.S. territories. 1/ It does not include the Virgin 

Islands. U.S. corporations operating in American Samoa, 

Guam, and the Canal Zone qualify for special tax treatment 

under section 936 in the same manner as U.S. corporations 

operating in Puerto Rico. As in the case of 936 companies 

in Puerto Rico, the Federal tax expenditure associated with 

section 936 and related provisions depends upon the amount 

of income tax paid by each 936 company to the host 

possession. The loss of revenue to the Federal Treasury is 

the amount of U.S. tax liability on each company's qualified 

income in the absence of either a foreign tax credit or 

section 936, less the tax payments to the host possession. 

The first section of this Appendix describes the income 

tax law and tax-incentive programs of American Samoa, Guam, 

and the Panama Canal Zone. It shows that the overall effective rate of tax paid by 936 corporations was 11.5 percent 

on income derived from Guam and zero percent on income derived from the Canal Zone. The combined Federal tax expenditure for all three possessions was $2.2 million in 1977. 

The second section of the Appendix compares the tax 

treatment accorded to 936 companies with that accorded to 

u.s.-controlled corporations operating in the Virgin 

Islands. Certain corporations operating in the Virgin 

Islands are exempt from U,S. tax under section 28(a) of the 

Revised Organic Act of the Virgin Islands. The confusion 

regarding the proper interpretation of section 28(a) iS 

described, as well as the tax law and tax-incentive progra~ 

of the Virgin Islands. Depending upon the interpretation of 

section 28(a), the overall effective tax rate on V.I.-source 

income could vary from zero to 46 percent. The Federal taX 

expenditure associated with section 28(a) was approximatelY 

$13.5 million in 1977. The average Federal tax expenditure 

per employee of tax-exempt corporations was $4,300. 

!/ Other territories to which section 936 benefits applY 

are the Northern Mariana Islands and Wake and MidwaY 

Islands. As of 1977, no 936 corporations were operatin9 

in these territories. 
e 

t 

n 

, 

t 

s 

s 

il 

-85-

I. American Samoa, Guam and the Panama Canal Zone 

A. Federal and Possessions Taxation 

American Samoa and Guam, like Puerto Rico, constitute 

tax jurisdictions separate and distinct from that of the 

United States. Corporations organized in the United States 

and operating in American Samoa and Guam are generally 

considered foreign corporations for purposes of the 

possessions income tax laws. Thus, a 936 corporation files 

a tax return with the host possession as well as with the 

United States. 

The income tax laws in effect in American Samoa and Guam 

are a "mirror image• of those in force in the Uni~ed States. 

This means that the U.S. Internal Revenue Code is applied as 

a local territorial tax code, with the .words "American 

Samoa" or "Guam" substituted for the words "United States" 

Wherever they appear in the U.S. Code. In American Samoa, 

the "mirror system" was enacted by the local legislature in 

the American Samoa Income Tax Act, effective January 1, 

1963. In Guam, the "mirror system" was provided for under 

section 31 of the Federal Organic Act of Guam ( 48 u. S. C. 

142l(i)), effective January 1, 1951. Under this section, 

"The income tax laws in force in the United 

States of America and those which may hereafter 

be enacted shall be held to be likewise in 

force in Guam." 

Although both American Samoa and Guam use the U.S. 

In tern al Revenue Code as a local territorial tax, special 

Provisions in the Code exempt from tax dividends, interest, 

ana other passive investment income paid by companies 0 Perating in Guam to U.S. persons. Under the "mirrored" 

Versions of sections 88l(b) and 1442(c), a U.S. parent 

corporation is not subject to tax, or to withholding of tax 

~t source, on payments derived from Guam. Under section 

3S(c), a U.S. individual is similarly exempt from tax on 

PaYments derived from Guam. 

l\m No Federal provision explicitly limits the authority of 

r erican Samoa or Guam to provide income tax relief with 

tesp~ct to possessions source income. Under the 

ax-incentive program of American Samoa, the government of 

~erican Samoa grants to qualifying corporations temporary 

0 xemptions from the payment of some or all income taxes. In 

r~d7r to qualify, the corporation must be owned by a 

S1dent of American Samoa and employ a work force at least 
-86-

75 percent of which consists of American Samoan residents. 

The period of tax exemption is for up to 10 years, although 

it may be made to terminate earlier if the cumulative amount 

of income taxes forgiven equals 100 percent of the net 

current investment in American Samoa. 

The Guam Economic Development Authority grants rebates 

of up to 100 percent of Guam income taxes to corporations 

that meet minimum in~estment and certain other requirements 

(such as increasing employment, replacing imports, or 

creating vitally needed facilities). The rebate is allowed 

for up to 20 years. 

As of 1978, all 936 corporations operating in Guam 

received a rebate of 75 percent of Guam income taxes. Given 

the 936 forgiveness of their U.S. tax liability, these 

corporations paid a maximum effective tax rate of 11.5 

percent on income from the active conduct of a trade or 

business in Guam and on passive income derived from the 

reinvestment of income from the trade or business. Many of 

these corporations enjoyed, in addition, a 10-year exemption 

from the Guam real property tax. In the case of a few 

tax-exempt corporations, the individual shareholders were 

granted rebates of 75 percent of the income tax on anY 

dividends received. 

The Panama Canal Zone imposes no local territorial 

income tax. A Federal agency (the Panama Canal Company)' 

administers the Canal Zone 2/ and finances its expenditures 

through toll collections. Possessions corporations 

operating in the Canal Zone thus do not file a territorial 

tax return in addition to the u.s. return. Since section 

936 relieves them from Federal tax on qualified Canal zone 

income, they are effectively exempt from any tax. on income 

derived from the active conduct of a trade or business in 

the Canal Zone and on passive income derived from the 

reinvestment of profits from that trade or business. Thus, 

the Federal tax loss resulting from section 936 forgiveness 

of U.S. tax liability is the dollar amount of the qualified 

Canal Zone taxable income, multiplied by the effective 

Federal corporate tax rate. After taking into account all 

!:_/ As a result of the Panama Canal Treaties of 1977, the 

United States will cease to have jurisdiction over th~ 

Canal Zone on October 1, 1979; on that date, the canaf 

Zone will cease to be a possession for purposes o 

section 936. 
-87-

provisions of the Internal Revenue Code, the effective U.S. 

tax rate on domestic income of U.S. manufacturing 

corporations is 38 percent. ll 

B. Characteristics of Possessions Corporations 

Table A-1 shows that in 1977, there were four 936 

corporations operating in American Samoa and Guam. These 

corporations had a net income of $2.7 million (and a book 

income of $2.0 million). Under section 936, they obtained 

tax savings of $1.1 mill ion. These figures compare with 

1975 book incomes of $5. 2 mill ion and tax savings of $2 .1 

million for seven 936 corporations in American Samoa and 

Guam. 

There were five 936 corporations operating in the Panama 

Canal Zone in 1977. They had a net inc_ome (and a book 

income) of $2.8 million and accounted for a Federal revenue 

loss of $1.1 million under section 936. These figures 

compare with 1975 book incomes of $2.0 million and tax 

savings of $0.8 million for six 936 corporations. 

II. Virgin Islands 

A. Federal and Virgin Islands Taxation 

The Virgin Islands are not treated as a possession for 

Purposes of section 936. However, corporations operating in 

the Virgin Islands receive benefits similar to those 

Provided to 936 corporations. Under section 28 (a) of the 

Revised Organic Act of the Virgin Islands, "inhabitants of 

the Virgin Islands" are taxed on their worldwide income by 

the Virgin Islands and are exempt from any income tax 

~iability to the Federal Treasury, even on their u.s.-source 

income. All corporations chartered in the Virgin Islands 

are considered to be "inhabitants of the Virgin Islands." 

It has not been established by the Internal Revenue Service 

or the Courts whether a United States corporation may 

qualify as an "inhabitant of the Virgin Islands" within the 

.~/ A 1978 study by the Department of the Treasury, 

Effective Income Tax Rates Paid by United States CorporatTons1n-f97~£ound--ffiat the average- effecflve 

income tax rate was 40 percent, compared to a maximum 

statutory corporation income tax rate of 48 percent. 

The maximum statutory rate was reduced to 46 percent by 

the Tax Revenue Act of 1978. It is estimated that this 

also reduced the average effective rate by two 

Percentage points. 
-88-

Table A-1 

Incane and Estimated Tax Expenditure 

by Possession, 1977 

Number Net Estimated 

of Incane :Tax Expenditure 

Possession :Corporations: ($000) ($000) 

American Samoa and Guam 

Panama Canal 

Total 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

4 

5 

9 

$2,679 

2,809 

$5,488 

$1,069 

1,121 

$2,190 

I1 

( 

I 

I 
-89-

meaning of section 28(a). For this reason, most U.S. 

companies wishing to operate a trade or business in the 

Virgin Islands and to benefit from tax savings under section 

28(a) incorporate subsidiaries under Virgin Islands law. 

There is a loss of Federal tax revenue whenever the 

United States gives up the right to tax income. In the case 

of 936 corporations, this right is effectively given up 

through the credit mechanism of section 936. In the case of 

u.s.-controlled corporations operating in the Virgin 

Islands, this right is given up through the exemption of 

"inhabitants of the Virgin Islands" from U.S. tax under 

section 28(a) of the Revised Organic Act. The amount of the 

revenue loss to the Federal Treasury under section 28(a) is 

the difference between the corporate taxes which would have 

been paid to the United States in the absence of section 

28(a) and the actual tax payments to the Virgin Islands. The 

larger the tax payments to the Virgin Islands, the larger 

would be the U.S. foreign tax credit in the absence of 

section 28(a) and, hence, the smaller the Federal tax loss 

as a result of section 28(a). 

The income tax laws in effect in the Virgin Islands are 

a "mirror image" of those in force in the United States. 

The U.S. Internal Revenue Code is applied as a local territorial tax code, with the words "Virgin Islands" substituted 

for the words "United States" wherever they appear in the 

U.s. Code. The "mirror system" was provided for under the 

Federal Naval Appropriations Act of 1921 (48 u.s.c. 1397). 

Effective for taxable years beginning in 1960, section 

934 of the Federal Internal Revenue Code limits the power of 

the Virgin Islands government to grant relief from 

territorial income taxes. This section prevents the Virgin 

~slands from granting rebates for taxes attributable to 

income derived from sources within the United States. With 

r~spect to non-u. s. source income, section 934 1 imi ts the 

6lrgin Islands' authority to grant cor?orate tax rebates to 

t.s. and V.I. corporations which meet the so-called "80-50 

Vests," used also in section 936. That is, to qualify for 

a·I~ tax rebates under section 934, a corporation must have 

t~r1ved for the past three taxable years (or applicable part 

a ereof) 80 percent of its gross income from V. I. sources 

end at least 50 percent of its gross income from the active 

onduct of a trade or business within the Virgin Islands. 

~ The Virgin Islands Industrial Development Program (Act 

a~~ 3748) provides rebates to certain U.S. and V.I. corpor10ns of 90 percent of the V.I. income tax attributable to 
___.... - - - - - -- --

-90-

income derived from the Virgin Islands. 4/ In order to 

qualify for these rebates, a corporation must meet the 

requirements of section 934 and certain other requirements. 

The principal requirements are that it: 

( 1 ) invest at least $50,000, exclusive 

inventory, in a Virgin Islands industry 

business: 

of 

or 

(2) agree in writing to give preference in 

employment and contracting to Virgin Islands 

residents and V.I. corporations: 

( 3) obtain approval. from the Commissioner of Labor 

for any nonresident workers prior to a grant of 

permission to hire such persons: and 

(4) conform to ecological standards established by 

Federal or local law. 

In addition to these specific requirements which must be 

met by an applicant for V.I. tax relief, the Virgin Islands 

considers applications in 1 ight of the following general 

guidelines: 

(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 beneficiaires of the v.1· 

Industrial Development Program may receive rebates of 90 

percent of corporate income taxes paid, rebates of 90 

percent of customs duties, and/or 100 percent exemptions 

from the V.I. real property tax, gross receipts tax and/0 ' 

excise tax. Any particular package of benefits is negotiate~ between the applicant and the V. I. Industrial Developmen 

!/ These rebates do not apply, however, to Virgin Islands 

tax on interest income, capital gains, and certain types 

of rental income. 

c 

l 

t 

I 

t 
.o 

e 

-91-

Commission. Subsidies and exemptions are permitted for 10 

years, but the beneficiary may elect partial benefits for up 

to 20 years in 1 ieu of full benefits for 10 years. The 

percentage of the benefits available for each term chosen by 

the taxpayer is given in the following table: 

Percent of Subsidy 

Term or Exemption 

10 years 100.0% .!/ 

11 years 90.9 

12 years 83.3 

13 years 76.9 

14 years 71.4 

15 years 66.7 

16 years 62.5 

17 years 58.8 

18 years 55.5 

19 years 52.6 

20 years so.a 

.!/ For purposes of this table, a bene-fi t percentage of 100 

percent corresponds to the 90 percent income tax and 

customs rebates provided by the Industrial Development 

Program. 

An applicant for benefits is allowed the option of 

determining when the tax benefits commence, provided they 

are initiated at some point during the first five years of 

Operating of the business. An additional five years of 

benefits (or up to 10 years at no more than 50 percent of 

~he_benefits) are granted to corporations which locate their 

Us1ness in certain economically depressed areas. Moreover, 

~ny beneficiary under the Industrial Development Program may 

e granted a renewal of those benefits subject to the 

approval of the Governor of the Virgin Islands. 

the A corporation which is deemed to be an "inhabitant of 

th Virgin Islands" within the meaning of section 28(a) of 

e Revised Organic Act and which qualifies under Code 

~ection 934 and the Industrial Development Program for a 

O-year subsidy of 90 percent of income taxes, pays a 

Inaximum effective corporate income tax rate in the Virgin 

Islands of 4. 6 percent. ~/ The actual effective V. I. tax 

2/ Th e maximum effective corporate rate was 4.8 percent for 

tax years beginning before 1979, when the corporate tax 

rate reduction under the Federal Revenue Act of 1978 

Went into effect. 
-92-

rate is probably less if the impact of other tax prov1s1ons, 

such as the investment tax credit and accelerated 

depreciation, is taken into account. Given that the 

effective U.S. tax rate on domestic income of U.S. V 

manufacturing corporations is 38 percent, 6/ a corporation a 

which qualifies for a tax subsidy and is -deemed· to be an U 

"inhabitant of the Virgin Islands" is probably subject to an ~ 

effective rate of income tax in the Virgin Islands of 3.8 a 

percent. I 

I 

A U.S. corporation is treated as a foreign corporation t 

for purposes of Virgin Islands taxation. Therefore, it is 1 

subject to the 30 percent withholding tax on dividends, 

interest, royalties, and other passive investment income 

which it may receive from a corporation operating in the 

Virgin Islands. 7/ This tax cannot be forgiven under 

section 934 since the tax is upon the U.S. recipient and not 

upon the company operating in the Virgin Islands. However, 

a 1977 decision of the United States Court of Appeals for 

the Thi rd Circuit 8/ has cast serious doubt on the 

jurisdiction of the Virgin Islands to withhold tax upon 

payments to U.S. corporations under the "mirrored" Internal 

Revenue Code. If the 3 0 percent tax is pa id, either at 

source or directly by the U.S. recipient, it is creditable 

(subject to limits) against U.S. tax liability. 

~/ 

J__I 

!!_/ 

See footnote 3. 

The tax is imposed unless the dividends are paid by a 

V. I. subsidiary which derives less than 20 percent of 

its gross income from V.I. sources or by a U.S.(or other 

foreign) corporation which derives less than 50 percent 

of its gross income from V.I. sources. Neither corpor' 

ation would qualify for an income tax subsidy by virtue 

of the section 934 eighty and fifty percent source 

requirements. 

Viteo, Inc. vs. Government of the Virgin Islands. 
; ' 

~d 

-93-

te Dividends paid by a U.S. subsidiary operating in the 

;. Virgin Islands qualify for the 85 percent dividends-received 

>n deduction for purposes of computing the parent company's 

tn United States tax 1 iabil i ty. However, the United States 

tn does not allow a U.S. parent to take the dividends-received 

8 deduction for dividends received from a subsidiary incorporated in the Virgin Islands. 9/ Thus, even though the 

profits of a qualifying 934 subsidiary may be 90 percent 

1n tax-free in the Virgin Islands, the profits will be subject 

s to the normal U.S. corporate rate of income tax once they 

, are repatriated. 

e 

e There are four principal differences between the tax 

treatment accorded to a U.S. parent corporation of a 

t subsidiary deemed an "inhabitant of the Virgin Islands," and , that accorded to a U.S. parent of a 936 -corporation in 

r Puerto Rico. Al though many questions are unresolved 

t: 

Cl 

r 

regarding the proper tax treatment of a U.S. corporation 

Which claims to be an "inhabitant of the Virgin Islands," 

for purposes of this discussion the questions will 

~I This follows from the treatment of V.I. 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 1s 

allowed the dividends-received deduction only if more 

than 50 percent of the foreign corporation's income has 

been derived, for the past three years, from a U.S. 

trade or business, and in that case, only with respect 

to dividends distributed from u.s.-source income. 

Dividends from V. I .-source income would therefore not 

qualify for the deduction. A corporation which met the 

so-called "80-50 source tests" required to be eligible 

for V. I. tax subsidies would not qualify for the 

deduction even with respect to dividends from U.S. 

source income (Code section 245(a)). 

Al though both the Code definition of the United States 

(section 770l(a)(9) and 770l(a)(4)) and judicial 

Precedent for the Virgin Islands have established that 

V.I. entities are foreign with respect to the U.S. 

income tax jurisdiction, this treatment is at issue in a 

Pending Internal Revenue Service ruling. 
-94-

tentatively be answered in the way most favorable to the 

taxpayer • .!.Q./ 

!Q./ 

(1) Tax on repatriated earnings. Dividends 

paid by a V.I. subsidiary to a U.S. parent corporation are subject to the normal rate of U.S. tax 

upon receipt by the parent. Dividends paid to a 

U.S. parent by a U.S. subsidiary in the Virgin 

Islands are taxable at only 15 percent of the normal 

corporate rate, since they qualify for an 85 percent 

dividends-received deduction. Dividends paid by a 

Puerto Rican 936 pubsidiary to its U.S. parent are 

not taxable in the United States. (They qualify for 

a 100 percent dividends-received deduction.) Before 

the 1977 decision in the Viteo case (discussed 

above), the Virgin Islands imposed a 30 percent 

withholding tax on outflows of dividends, with no 

rebates of the withheld tax. Puerto Rico imposes a 

maximum 10 percent tollgate tax on outflows of 

dividends; special provisions reduce the average 

effective rate of this tax to five percent. 

(2) Eligibility for foreign tax credit. A 

parent with a subsidiary operating in the Virgin 

Islands, whether incorporated under U.S. or V.I. 

law, may claim a foreign tax credit for V. I. taxes 

paid with respect to repatriated earnings. A U.S. 

parent of a 936 corporation cannot claim a foreign 

tax credit for tax withheld on repatriated earnings 

or for Puerto Rican taxes on income with respect to 

which the U.S. tax liability is forgiven under 

section 936. 

(3) Consolidation with the U.S. parent. A 

U.S.-incorporated "inhabitant" of the Virgin Islands 

may be a member of an affiliated group for purposes 

of filing a consolidated return, although the law is 

untested by the courts. A corporation which elects 

the benefits of section 936 cannot join with its 

parent in filing a consolidated return for the 

10-year period for which, the election is made. 

The question of whether a U.S. corporation can be an 

"inhabitant of the Virgin Islands" is the subject of 

a pending I. R. S. revenue ruling. The purpose of 

this discussion is to illustrate the consequences of 

a ruling which supported the U.S. corporation's 

claim to be an "inhabitant of the Virgin Islands." 
he 

-95-

However, it can delay electing 936 status until its . 

operations return a profit. 

(4) Treatment of liquidating distributions. In 

order to avoid the 30 percent withholding tax and at the 

same time "repatriate" V.I.-source earnings, the U.S. 

parent may permit its subsidiary to accumulate its 

earnings in the Virgin Islands and then 1 iquidate the 

subsidiary. If the liquidating subsidiary was 

incorporated in the United States and at least 80 

percent owned by a U.S. corporation, gain on the 

distribution of the subsidiary's assets would be exempt 

from U.S. tax. However, it would not be possible for 

the subsidiary to be liquidated free of V.I. tax unless 

it received a ruling from the Virgin Islands that the 

liquidation did not have a tax avoidance purposes. 

Likewise, in Puerto Rico, it would nqt be possible for a 

u. S. parent corporation to avoid the tollgate tax by 

liquidating its 936 subsidiary. 

It is clear from the above that the incentives to U.S. 

investment in the Virgin Islands which obtain under section 

28 (a) of the Revised Organic Act depend significantly on 

whether a U.S. parent corporation can sustain the burden of 

proving that its U.S. subsidiary is an "inhabitant of the 

Virgin Islands." It is not settled whether a U.S. 

corporation may be an "inhabitant of the Virgin Is 1 ands" 

within the meaning of section 28(a). Assuming that it could 

qualify, the U.S. parent corporation would enjoy tax 

benefits more favorable than those enjoyed by a U.S. parent 

of a 936 corporation and also more favorable than those 

foreseen by the Congress when it enacted section 28 (·a) of 

the Revised Organic Act. The parent of the V.I. 

"inhabitant" would pay no U.S. tax on the income of its 

subsidiary, yet could claim a foreign tax credit for any 

withholding taxes and income taxes paid to the Virgin 

Islands with respect to earnings repatriated to the parent. 

This credit could offset U.S. tax liability on income 

sourced in low-tax countries which had not been fully offset 

by the foreign tax credit for those countries. 

Table A-2 presents estimates of the effective tax rates 

on qualified possessions source income which obtain for the 

~:S· parent of three types of corporations -- a V.I. 

"~nhabitant" organized in the Virgin Islands, a V.I. 

inhabitant" organized in the United States, and a 936 

~orporation operating in Puerto Rico. It is based on the 

allowing assumptions: 
-96-

Table A-2 

Overall Tax Rates Repatriated fran the Virgin Islands and Puerto Rico 

U.S. parent able to use 

full V.I. foreign tax 

credit against U.S. tax 

on other foreign source 

income 

U.S. parent limited to 

V.I. credit only 

"Inhabitant" of 936 

the Virgin Islands : Corporation 

:V.I. subsidiary : U.S. subsidiary: in Puerto Rico 

46.0% 1/ 0.0% 2/ 5.0% 4/ 

46.0% 1/ 33.2% 3/ 5.0% 4/ 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

1/ Earnings repatriated from a V.I. (or other foreign) subsidiary are subject 

to the U.S. statutory corporate rate of tax, arrl a foreign tax credit is 

granted for V. I. taxes paid with respect to such earnings. For tax years 

beginnirg before 1979, the statutory rate was 48 percent. 

'!:_! The net V.I. incane tax on, say, $100 of earnings is $4.60 under a system 

of 90 percent incane tax rebates. The V.I. tax withheld on repatriated 

dividends is 30 percent of $95.40, or $28.62. '!be total of v.r. taxes paid 

on this $100 is thus $33.22. The U.S. parent receives an 85 percent 

dividends-received deduction for the dividend, and has U.S. tax liability 

of .46 x (.15)(95.40), or $6.58. This u.s. liability is offset by the 

$33.22 of taxes paid to the Virgin Islands. '!be excess foreign tax credit 

with respect to V.I.-source incane is used to offset U.S. liability on 

income from other foreign sources. 'Ibis result is possible because it is 

assumed that the U.S. parent has U.S. tax liability on incane sourced in 

low-tax countries which has not been fully offset by the foreign tax 

credit. 

The assumptions here are the same as in the preceding case, except that the 

U.S. parent does not have U.S. tax liability on foreign source incane which 

has not been fully offset by the foreign tax credit. '!be total of V.I. 

taxes paid on, say, $100 of V.I.-source earnings is $33.22 (see footnote 

2). 'Ibis anount offsets only the U.S. tax liability on this income. 

4/ Current beneficiaries of the Puerto Rican tax-incentive program are·fullY 

exempt from Puerto Rican income taxes. '!be average effective Puerto Rican 

tollgate tax on dividerrls paid to a U.S. parent is 5 percent. The U.S. tai 

liability on these earnings is forgiven under section 936. 
-97-

(1) There is full repatriation of the subsidiary's 

earnings to its U.S. parent annually. 

(2) The V.I. "inhabitant" receives a grant of 

income tax exemption from the Virgin Islands 

and elects a 10-year, 90 percent subsidy. 

(3) The 936 corporation in Puerto Rico is 

completely exempt from the Puerto Rican income 

tax. Dividends paid to the U.S. parent are 

subjected to a five percent Puerto Rican 

tollgate tax. 

The table shows that an effective tax rate as high as 46 

percent may apply to V.I.-source earnings repatriated by a 

v.r. subsidiary, while an effective tax rate as low as zero 

percent may apply to V.I.-source earnings repatriated by a 

U.S. subsidiary. This compares to an effective tax rate of 

5.0 percent on earnings repatriated by a 936 corporation in 

Puerto Rico. 

B. 

As 

active 

Virgin 

tions. 

in the 

Characteristics of Tax-exempt Corporations in the 

Virgin Islands 

of December 1, 1978, there were approximately 50 

firms which received income tax rebates from the 

Islands. Of these, 12 were u.s.-controlled corporaThe most substantial investments of U.S. capital were 

petroleum, mining, and . communications industries. 

Table A-3 shows the amount of Federal tax expenditure, 

employment, and compensation for tax-exempt u.s.-controlled 

subsidiaries. The income and tax data are taken from the 

most recent tax return which each of these companies filed 

With the Virgin Islands. 11/ For the tax years covered, the 

Federal revenue loss (tax-expenditure) from section 28(a) of 

the Revised Organic Act was $13.5 billion. This estimate 

represents the difference between the U.S. income taxes 

Which would have been paid in the absence of section 28(a) 

ana the actual income taxes paid to the Virgin Islands, net 

.!.!/ Two of these tax returns were filed for calendar year 

1976, four for tax years ending in 1977, and four for 

calendar year 1978. In Uie case of one U.S. corporation, no return has ever been filed with the Virgin 

Islands. In the case of two other companies, the 

businesses have been in operation too short a time to 

have filed a tax return. Thus, Table A-3 presents data 

for a total of nine corporations. 
Table A-3 

Tax Expenditure, Employment, and Canpensation of Employees 

of U.S.-controlled Tax-exempt Subsidiaries in the Virgin Islands, 1977 

:canpensat1on: Tax :Tax Expenditure: Average 

Employee 

:Canpensation 

Gross Tax of :Expenditure as Percent of 

:Number of Incane y :Expenditure 1/: Nt.nnber of :Employees 3/:per Employee: Ccxnpensation ______________ :C_o_rp:>"'--r_a_t_io_n_s_:_(.;...;$_0_0_0"-) ___ ___,_($'-O_O_O-=-) __ :Emp~_lo__,ilf,_ee_s y: ($000) - ($) of Employee 

u.s.-controlled subsidiaries 

Office of the Secretary of the Treasury 

Off ice of Tax Analysis 

9 2,767,018 13,492 3,146 37,396 4,289 36.1 

($) 

ll,887 

y Data are taken fran the most recent tax return which each of these canpanies filed with the Virgin Islands. 'Ille tax years covered fall 

within calendar years 1976 through 1978. 

y Employment data are taken in most cases fran V.I. Form W-3, "Transmittal of Incane and Tax Statements," filed by each of these canpanies for 

calendar year 1977. In a few cases, data are fran information provided by the canpanies in response to a survey conducted by the V.I. 

Department of cannerce. 

'Ille s:>urce of payroll data is the total wages and other ccmpensation reported by these canpanies on V.I. Form W-3 for calendar year 1977. 

Total canpensation of employees was canputed by multiplying 1.212 times payroll. 'Ille additional 21.2 percent reflects the employer-paid 

portion of Federal Social Security, unemployment insurance, and other non-payroll labor costs. 'Ille 21.2 percent is the average for all U.S. 

manufacturiBJ irrlustries in 1977; see the U.S. Department of Cacmerce, Survey of Current Business, July 1978, Tables 6.5 and 6.6. 

I 

ID 

co 

I 
-99-

of rebates. This difference is measured by the total 

corporate income tax rebates claimed by u.s.-controlled 

companies in the Virgin Islands. The $13.5 million estimate 

overstates the U.S. tax loss from section 28(a) to the 

extent that V.I. subsidiaries controlled by U.S. parents 

repatriate their earnings, since such earnings would be 

subject to the normal U.S. corporate income tax upon receipt 

by the U.S. parents. The $13.5 million estimate also takes 

no account of the fact that the parent of a u.s.-incorporated subsidiary may use V.I. taxes to offset U.S. tax 

liability on other foreign source income, as described 

above. To the extent that this occurs, the $13.5 million 

figure understates the Federal tax expenditure. 

In 1977, the number of people employed by these nine 

companies in the Virgin Islands was 3, 146, and the total 

compensation they received was $37. 4 million. The average 

Federal tax expenditure per employee was thus $4, 289, or 

36.1 percent of the average compensation for these 

employees. However, there is a wide variation among 

individual companies in the Federal tax expenditure per 

employee, from $59,390 for one company to zero in the case 

of two companies which had net operating losses. The 

average tax expenditure per employee of u.s.-controlled 

corporations in the Virgin Islands, estimated at $4, 289, 

compares to an average tax expenditure per employee . of 936 

corporations in Puerto Rico of $8,222. 
-100-

Appendix B -- Sources and Limitations of the Data, and 

Detailed Tabulations for 1973-1976 

This Appendix includes tables covering data for 

1973-1976 similar to text Tables 6, 7, and 8 covering data 

for 1977, and a discussion of the sources and limitations of 

the data. Tables B-1 through B-4 correspond to Table 6 in 

the text and provide data for 1976, 1975, 1974, and 1973 in 

that order. Similarly, Tables B-5 through B-8 correspond to 

Table 7 in the text, and Tables B-7 through B-12 to Table 8. 

Tables B-5 through B-12 are 1 imi ted to those corporations 

for which both income and employment data were available. 

Although these tables present data for less than the number 

of corporations included in Tables B-1 through B-4, their 

coverage in terms of income and tax expenditure are over 80 

percent for 1975 and 1976, and nearly 70 percent for 1974. 

The coverage for 1973, however, is considerably less 

extensive because employment data were less readily 

available. 

All of the data in the text and Appendix tables are 

based on 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 for 1976 or 

1977. Tables for each year are based on corporations' 

accounting periods ending between July 1 of the year and 

June 30 of the following year. For example, tables for 1973 

contain data for corporations with accounting periods ending 

on or after July 1, 1973 and on or before June 30, 1974. 

Sources and limitations of the data 

Income statement and balance sheet data for 1977, and 

some income data for 1976, are from Form 1120, "U.S. 

Corporation Income Tax Return"; additional income data are 

from Form 5735, "Computation of Possessions Corporation Tax 

Credit Allowed Under Section 936." (Appendix C contains 

copies of all tax forms from which data included in this 

Report were obtained.) 

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. 

One problem with this data is that the income for all years 
-101-

beginning in 1973-1975 was reported even though the 

corporation may not have excluded income under section 931 

in all of those years. In particular, some of these 

companies incurred losses in one or more years between 1973 

and 1975 and therefore presumably filed on a consolidated 

basis with their parent. Inclusion of such companies in the 

tables for these years may therefore cause an understatement 

of the amount of income excluded under section 931 for 

1973-1975. However, this understatement appears to have 

been relatively small in all three years, and does not 

affect the tax expenditure estimates which are based on the 

income of profitable firms only. In addition to Form 5712, 

some income data and all of the Puerto Rican tax data 

available on an individual company basis were obtained from 

income tax returns (Forms 480.20) filed with the Puerto 

Rican Government. 

The employment and payroll data for - all years was taken 

from Form 940, "Employer's Annual Federal Unemployment Tax 

Return." These returns are filed on a calendar year basis; 

for comganies with a non-calendar year accounting period the 

Form 940 data was associated with income data for the 

accounting period most nearly corresponding to the calendar 

year. For example, the calendar year 1973 Form 940 data was 

associated with annual accounting periods ending between 

July 1, 1973 and June 30, 1974. 

The number of employees was computed by dividing total 

taxable wages ( 1 ine 15, Form 940) by $4, 200, 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 $4,200 

(the minimum wage in several industries was sufficiently low 

that this could occur), the number of employees could be 

understated. On the other hand, because the $4,200 ceiling 

is tied to individual employees, the procedure could 

overestimate employment for a company with relatively high 

wages and part-time employees or a high labor turnover rate. 

However, secondary data, from Forms 940 and other sources, 

suggests that the method used here provides reasonably 

accurate estimates of full-time equivalent employment. 

Total compensation was computed by multiplying total 

remuneration ( 1 ine 11, Form 940) by a factor representing 

the ratio of total compensation to total remuneration. The 

value of this factor is noted in the tables for each year. 

Total compensation exceeds total remuneration because it 

includes certain fringe benefits and other i terns, such as 
-102-

the employer share of social security contributions, that 

are excluded from total remuneration. 

Some corporations did not report an amount for total 

remuneration or reported the same amount as for taxable 

wages. In the latter case, the firm's reporting was assumed 

to be correct. For the corporations that did not report 

total remuneration, the reported amount of taxable wages was 

used. Total compensation may therefore be slightly 

understated. 

The number of corporations included in the tables for 

any particular year is less than the number included in at 

least one year for several reasons. Some corporations were 

organized after 1973, in some cases as late as 1977, and 

therefore do not appear in tables for the years prior to 

their establishment. Similarly, some firms were liquidated 

(or became inactive) before 1977, in some cases as early as 

1974, and therefore do not appear in tables for the years 

following their liquidation (or cessation of active 

business). Finally, for some corporations that have not 

made an election under section 936 and are not related to an 

electing corporation, data from Puerto Rico Forms 480. 20 

were not available for all years 1973-1975. 

The number of corporations included in tables covering 

1976 and 1977 is less than the number included in tables 

covering 1975, for several reasons. The 1977 returns of 

some corporations were not received in time for inclusion in 

the tabulations. In addition, some of the corporations 

included in the tables for 1975 (as well as earlier years) 

are included solely on the basis of being related to an 

electing 936 corporation and having benefitted from section 

931 in at least one of the years 1973-1975. These corporations, for various reasons, have not themselves made an 

election under section 936 and in most instances therefore 

do not appear in the 1976 tables and will not appear even in 

complete 1977 data. For example, there were 87 corporations 

included in the 1975 tables that have not elected under 

section 936, compared with only 5 in 1976. (The 1976 tables 

include 122 corporations which had accounting periods 

beginning before January 1, 1976, and which therefore could 

still claim the benefits of section 931. Of these 122, 117 

have since elected under section 936.) A number of section 

931 corporations classified as non-manufacturing did not 

make an election under section 936. As a result, relativelY 

fewer non-manufacturing corporations are present in the 1976 

and 1977 data. 
-103-

Table B-1 

Incane and Estimated Tax Expenditure by Industry, 1976 1/ 

Industry Group 

All industries 

Manufacturin:J industries 

Food and kindred products 

Tobaccn products 

Textile mill products 

Apparel 

Chemicals, total 

Pharmaceuticals 

All other chemicals 

Rubber products 

Leather and leather products 

Stone, clay and glass products 

Fabricated metal products 

Machinery, except electrical 

Electrical and electronic equipment 

Transportation equipnent 

Scientific instruments 

All other manufacturing 

Nonmanufacturing 

Transportation, cornnunications 

and utilities 

Wholesale trade 

Retail trade 

Financ-e, insuranc-e, real estate 

Services 

Miscellaneous and not available 

Number of 

:Corporations: 

528 

395 

22 

6 

5 

93 

76 

52 

24 

8 

11 

5 

26 

7 

81 

4 

24 

27 

133 

11 

14 

52 

21 

13 

22 

Of'frce of the Secretary of the Treasury 

Off ice of Tax Analysis 

Net Incane :Estimated Tax 

Per Return Expenditure 

($000) ($000) 

1,627,213 

1,551,677 

95,870 

10,175 

-267 

65,474 

912,793 

779,954 

132,839 

1,578 

6,745 

10, 715 

21,419 

2,824 

323,249 

1,597 

46,208 

53,297 

75,536 

40,283 

2,972 

17,138 

3,184 

3,572 

8,387 

651,348 

621,190 

38,535 

4,067 

190 

26,226 

365,069 

311,948 

53,121 

629 

2,692 

4,282 

8,563 

1,128 

129,400 

637 

18,471 

21,301 

30,158 

16,106 

l,'182 

6,842 

1,268 

1,421 

3,339 

1' Includes data for μ:>ssessions cnrporations operating in American Samoa, 

Guam, and the Panama Canal Zone. These non-Puerto Rican operations 

account for less than 2 percent of total tax expenditure in any year 

( see Table 3) • 
-104-

Table B-2 

Incane and Estimated Tax Expenditure by Industry, 1975 1/ 

Industry Group 

All industries 

Manufacturirg irrlustries 

Food and kindred products 

Tobacco pr<rlucts 

Textile mill J?roducts 

Apparel 

Chemicals, total 

Phannaceuticals 

All other chemicals 

Rubber prc:rlucts 

Leather and leather products 

Stone, clay and glass prcrlucts 

Fabricated metal products 

Machinery, except electrical 

Electrical· and electronic equiμnent 

Transportation equipnent 

Scientific instruments 

All other manufacturing 

Nonmanufacturing industries 

Transportation, conmunications and 

utilities 

Wholesale trade 

Retail trade 

Apparel 

Finance, insurance, real estate 

Savirgs arrl loans 

Services 

Miscellaneous arrl not available 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

:Estunated Tax 

Number of :Book Incane: Expenditure 

:Corporations: ($000) ($000) 

595 

394 

23 

7 

8 

88 

69 

47 

22 

14 

14 

7 

26 

7 

76 

5 

27 

23 

201 

9 

12 

98 

80 

28 

9 

16 

38 

1,108,881 

1,055,060 

71, 746 

26,805 

-3,051 

43,557 

616,191 

547,060 

69,131 

1,444 

7,289 

8,419 

24, 714 

1,882 

195,593 

1,074 

33,688 

25,709 

54,059 

30,006 

3,144 

12,302 

1,844 

1,398 

808 

-107 

7,316 

446,863 

425,213 

28,652 

10,744 

265 

17,675 

246,470 

218,210 

28, 260 

571 

2,910 

3,384 

10,114 

759 

79,164 

430 

13,627 

10,448 

21,612 

10,062 

1,258 

5,164 

1,037 

633 

307 

1,623 

2,872 

.!/ Includes data for μ:>ssessions corporations operating in American Sanna, GUolfl' 

arrl the Panama Canal Zone. These non-Puerto Rican operations account for 

less than 2 percent of total tax expenditure in any year (see Table 3). 
-105-

Table B-3 

Incane and Estimated Tax Expenditure by Industry, 1974 1/ 

Industry Group 

:Estl.Illated Tax 

Number of :Book Income: Expenditure 

:Corporations: ($000) ($000) 

All industries 

Manufacturin:l industries 

Food and kindred prc:XJucts 

Tobacco prcrlucts 

Textile mill products 

Apparel 

Chemicals, total 

Pharmaceuticals 

All other chemicals 

Rubber prcrlucts 

Leather and leather products 

Stone, clay and glass prcrlucts 

Fabricated metal products 

Machinery, except electrical 

Electrical and electronic eauiQl\ent 

Transportation equipnent ·· 

Scientific instruments 

All other manufacturing 

Nonmanuf acturing industries 

Transportation, carmunications and 

utilities 

Wholesale trade 

Retail trade 

Finance, insurance, real estate 

Services 

Miscellaneous arrl not available 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

596 

399 

26 

6 

8 

94 

65 

44 

21 

14 

14 

6 

27 

7 

76 

5 

25 

26 

197 

7 

10 

103 

21 

14 

42 

852,058 

813,057 

65,123 

12,472 

-66,071 

42,052 

478,329 

405,355 

72,974 

2,150 

7,080 

8,684 

28,017 

2,281 

167,389 

1,100 

27,452 

36,998 

39,002 

16,701 

1,708 

11,994 

2,117 

-457 

6,939 

372,507 

352,908 

26,517 

4,938 

624 

17,542 

190,683 

161,341 

29,342 

922 

2,689 

3,418 

11, 221 

908 

66,872 

440 

11,044 

15,090 

19,599 

6,750 

704 

5,002 

926 

580 

5,637 

.!/ Includes data for {X)ssessions corporations operating in American Samoa, 

Guam, arrl the Panama Canal zone. These non-Puerto Rican operations 

account for less than 2 percent of total tax expenditure in any year 

( see Table 3 ) • -
-106-

Table B-4 

Incane and Estimated Tax Expenditure by Industry, 1973 1/ 

:Estimated Tax 

Industry Group Number of :Book Income: Ex-penditure 

:Corporations: ($000) ($000) 

All industries 

Manufacturing industries 

Food and kindred products 

Tobacco prooucts 

Textile mill products 

Apparel 

Chemicals, total 

Pharmaceuticals 

All other chemicals 

Rubber prooucts 

Leather and leather products 

Stone, clay and glass prcrlucts 

Fabricated metal products 

Machinery, except electrical 

Electrical and electronic equipnent 

Transportation equipnent 

Scientific instruments 

All other manufacturing 

Nonmanufacturing industries 

Transportation, conmunications and 

utilities 

Wholesale trade 

Retail trade 

Finance, insurance, real estate 

Services 

Miscellaneous and not available 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

568 

385 

24 

8 

16 

93 

57 

39 

18 

14 

19 

9 

24 

4 

64 

3 

23 

27 

·183 

6 

10 

96 

18 

16 

37 

650,515 258,278 

591,724 242,116 

60,939 21,960 

15,265 6,119 

-4,539 1,190 

36,991 15,245 

268,868 110,380 

251,897 103,533 

16,971 6,847 

1,606 1,149 

4,283 1,853 

6,273 2,505 

15,465 6,828 

1,830 732 

116,277 46,749 

601 240 

22,176 8,794 

45,689 18,372 

58,792 16,162 

6,952 2,843 

29,834 541 

10,689 4,430 

2,603 1,081 

-6,960 408 

15,674 6,859 

~-----

1/ Includes data for p:>ssessions corporations operating in American saiooa, GUaJ1l' 

arrl the Panama Canal Zone. These non-Puerto Rican operations account for 

less than 2 percent of total tax expenditure in any year (see Table 3) • 
Table B-5 

Tax Expenditure, Employment and Canpensation of Employees by Industry, 1976 

Canpensatlon : Tax Expenditure 

Tax Expenditure Employees of Employees.!/ _:Tax Expenditure: as a Percent of 

Industry Group Number of :Book Incane: Arrount :Percent of: :Percent of: Arrount :Percent of: Per Employee : Canpensation of 

:Corporations: ($000) ($000) Total Number Total ($000) Total ($) Employees 

All industries 363 l,430,ll8 572,583 100.0 60,357 100.0 507,445 100.0 8,762 y 105.7 y 

Manufacturinq industries 302 1,366,192 547,041 95.5 49,752 82.4 402,685 79.4 10,181 y 127.4 21 

Focrl and kindred prcrlucts 16 56,3ll 22, 716 4.0 5,007 8.3 38,883 7.7 4,536 58.4 

Td:>acco products 5 6,344 2,535 .4 1,882 3.1 13,365 2.6 1,346 19.0 

Textile mill products 4 -319 170 * 209 .3 1,549 .3 512 11.0 

Apparel 74 52,463 21,019 3.6 14,208 23.5 82,830 16.3 1,479 25.4 

Chemicals, total 56 827,085 330,798 57.7 9,150 15.2 108,387 21.4 36,152 305 .2 

Pharmaceuticals 39 708,280 283,2R7 49.4 6,757 11.2 74,453 14.7 41,925 380.5 

All other chemicals 17 ll8,804 47,5ll 8.3 2,393 4.0 33,934 6.7 19,854 140.0 

Rubber products 6 1,461 583 .1 219 .4 1,662 .3 2,789 35.1 

Leather and leather products 7 6,023 2,405 .4 1,363 2.3 8,648 1. 7 1,764 27.8 

Fabricated metal products 19 14,844 5,936 1.0 1,099 1.8 9,035 1.8 5,401 65.7 

Electrical and electronic equipnent 62 299,725 120,003 20.9 12,482 20.7 104,530 20.6 9,614 ll4.8 

Scientific instruments n 41,318 16,516 2.8 2,069 3.4 16,051 3.2 7,982 102.9 

All other manufacturing lf 29 60,927 24,360 4.2 2,074 3.4 17,746 3.5 ll, 740 137.3 

Nonmanufacturing industries 61 63,926 25,542 4.4 10,605 17.6 104,760 20.6 2,263 y 23.4 y 

Transportation, ccmnunications, 

utilities 7 63,926 15,265 2.6 5,582 9.2 55,215 10.9 2,913 27.7 

Wholesale trade 8 2,500 955 .1 416 .7 3,395 0.7 2,391 29.3 

Retail trade 14 15,046 6,023 1.0 2,683 4.4 25,941 5.1 2,249 23.7 

Finance, insurance, real estate ll 1, 710 676 .1 681 1.1 6,084 1.2 992 11.1 

Services 9 3,349 1,334 .2 440 .7 7,360 1.5 3,031 18.1 

Miscellaneous and not available 12 3,146 1,249 .2 803 1.3 6,762 1.3 1,555 18.5 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Canpensation of employees was canputed by multiplyinq 1.203 times payroll. '!he additional 20.3 percent reflects the employer-paid portion of social - security, unemployment insurance, aoo other non-payroll labor costs. The 20.3 percent is the average for all U.S. manufacturing industries in 1976; 

see the U.S. Department of Ccrrmerce, Survey of Current Business, July 1978, Tables 6.5 and 6.6. 

2/ Canpensation of employees aoo number of employees used to canpute these aJTPunts were weighted by industry using the ratio of tax expenditure in 

- Table B-1 and tax expenditure in this Table. lf Includes manufacturing industries where data were available for less than 3 corporations. 

* Less than .05 percent 

Average 

Employee 

:Canpensation 

($) 

8,293 y 

7,988 '!:_! 

7,765 

7,101 

7,4ll 

5,829 

ll,845 

ll,OJ8 

14,180 

7,589 I 

I-' 

6,344 0 

-.J 

8,221 I 

8,374 

7,757 

8,550 

9,688 y 

9,892 

R,161 

9,669 

8,933 

16,727 

8,420 
Table B-6 

Tax Expenditure, Employment and Canpensation of Employees by Industry, 1975 

Canpensat1on Tax Expenditure 

Tax Expenditure Emploxees of Emplo;r:ees y :Tax Expenditure as a Percent of 

Industry Group NLUnber of :Book Incane Altount :Percent of :Percent of Anount :Percent Of": Per Employee Canpensation of 

Corporations: ($000) ($000) Total NLUnber Total ($000) Total ($) Employees 

All industries 395 941,161 377,256 100.0 49,617 100.0 392·,309 100.0 6,164 y al.3 y 

Manufacturing industries 2a5 a96,45a 359,414 95.3 37,422 75.4 2a7,619 73.3 7,566 y 103.2 y 

Focrl and kindred prcducts 16 32,a63 13,13a 3.5 5,362 10.a 39,450 10.1 2,450 33.3 

Tobacco prcducts 5 5,4a7 2,271 .6 a61 1. 7 4,607 1.2 2,63a 49.3 

Textile mill prcducts 4 345 16a .o 104 .2 700 .2 1,615 24.0 

Apparel 66 24,096 9,aa3 2.6 7,409 14.9 40,510 10 . 3 1,334 24 . 4 

Chemicals, total 52 573,579 229,243 60.a a,oa3 16.3 a6,941 22.2 28,361 263 . 7 

Pharmaceuticals 37 5la,326 206,534 54.a 5,953 12.0 59,710 15.2 34,694 345.9 

All other chemicals 15 55,253 22,709 6.0 2,130 4.3 27,231 6.9 10,662 a3.4 

Rubber prcducts 10 l,3ao 532 .1 666 1.3 4,4a7 1.1 799 11.9 

Leather and leather prcducts 11 6,733 2,695 .7 l,62a 3.3 9,259 2.4 1,654 29.l 

Fabricated metal prcducts la 21,156 a,57a 2.3 l,24a 2.5 10,429 2.7 6,a73 a2.3 

Electrical and electronic equipnent 57 177,645 71,340 la.9 a,459 17.0 63,674 16.2 a,434 ll2.0 

Scientific instruments 22 25,912 10,47a 2.a 1,956 3.9 13,637 3.5 5,357 76.a 

All other manufacturing 24 27,262 ll,Oaa 2.9 1,646 3.3 13,925 3.5 6,736 79.6 

Nonmanufacturinq industries 110 44,702 17,a42 4.7 12,195 24.6 104,690 26.7 1,326 y 15.7 y 

Transportation, coomunications 

and utilities 6 2a,133 9,312 2.5 4,4a6 9.0 3a,465 9.a 2,076 24.2 

Wholesale trade a 2,291 916 .2 393 .a 3,957 1.0 2,331 23.1 

Retail trade 52 11,105 4,627 1.2 2,7a9 5.6 25,579 6.5 1,659 la.1 

Finance, insurance, real estate 15 930 465 .1 a69 i.a 7,60a 1.9 535 6.1 

Savings and loans a 7a5 29a .1 799 1.6 6,924 La 373 4.3 

Services 14 -156 1,604 .4 2,2a2 4.6 la,614 4.7 703 a.6 

Miscellaneous and oot available 15 2,399 9la .2 1,376 2.a 10,467 2.7 667 a.a 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

y Canpensation of employees was a:mputed by multiplying 1.191 times payroll. 'llle additional 19.l percent reflects the employer-paid portion of social 

security, unemployment insurance, and other non-payroll labor costs. 'llle 19.1 percent is the average for all u.s. manufacturing industries in 1975~ 

see the U.S. Department of catmerce, Survey of Current Business, July 197a, Tables 6.5 and 6.6. 

2/ Canpensation of employees and nLUnber of emPioyees used to canpute these amounts were weighted by industry using the ratio of tax expenditure in 

- Table B-2 and tax expenditure in this Table. 

: Average 

Employee 

:Canpensation 

($) 

7,5a2 y 

7,335 y 

7,357 

5,351 

6,731 

5,477 

10,756 

10,030 I 

...... 12,7a5 0 

6,737 (X) 

I 

5,6a7 

a,357 

7,527 

6,972 

a,460 

a,436 y 

a,574 

10,069 

9,171 

a,755 

a,666 

a,157 

7,607 
Table B-7 

Tax Expenditure, Employment and Canpensation of Employees by Industry, 1974 

Canpensat1on Tax Expenditure 

Tax ExPenditure Employees of Employees .!f ~:Tax Expenditure as a Percent of 

Industry Group Number of :Bcok Incane: Anount :Percent of: :Percent of: Anount :Percent of: Per Employee Canpensation of 

:Corporations: (SOOO) ($000) Total Number Total ($000) Total ($) Employees 

All industries 379 586,887 265,495 100.0 49,976 100.0 355,415 100.0 4,567 y 64.8 y 

Manufacturing industries 257 561,350 251,606 94.8 38,187 76.4 261,593 73.6 5,609 y 81.5 '!:_/ 

Focrl and kindred prooucts 17 28,635 12,125 4.6 4,803 9.6 32,689 9.2 2,524 37.1 

'lbbacco products 6 12,472 4,937 1.9 1,435 2.9 9,215 2.6 3,440 53.6 

Textile mill prcrlucts 4 -67,136 199 .1 2,492 5.0 19,314 5.4 80 1.0 

Apparel 64 27,823 ll,820 4.5 9,534 19.l 51,270 14.4 1,240 23.1 

Chemicals, total 32 371,490 146,918 55.3 5,378 10.8 53,430 15.0 27,318 275.0 

Pharmaceuticals 24 321,941 127,094 47.9 3,750 7.5 33,608 9.5 33,892 378.2 

All other chemicals 8 49,549 19,824 7.5 1,628 3.3 19,822 5.6 12,177 100.0 

Rul:X:>er products 12 2,158 922 .3 644 1.3 3,894 1.1 1,432 23.7 

Leather and leather prcrlucts 12 4,121 1, 775 .7 1,482 3.0 7,836 2.2 1,198 22.7 

Fabricated metal products 18 17 ,382 6,981 2.6 1,123 2.2 7,854 2.2 6,216 88.9 

Electrical and electronic ecruiμnent 49 102,125 40,789 15.4 7,357 14.7 49,090 13.8 5,544 83.l 

Scientific instruments 18 20,169 8,058 3.0 2,063 4.1 12,042 3.4 3,906 66.9 

All other manufacturing lf 25 42,lll 17,082 6.4 1,876 3.8 14,959 4.2 9,106 ll4.2 

Nonmanufacturinq industries 122 25,536 13,889 5.2 ll, 789 23.6 93,823 26.4 1,051 y 13.8 y 

Tr;mspcrtation, C011111unications 

and utilities 4 14,759 5,973 2.2 4,170 8.3 37 ,ll3 10.4 1,432 16.l 

Wholesale trade 6 1,064 445 .2 236 .5 2,250 .6 1,886 19.8 

Finance, insurance, real estate 8 1,362 578 .2 241 .5 2,137 .6 2,398 27.0 

Services 10 -761 465 .2 1,086 2.2 8,ll7 2.3 428 5.7 

Miscellaneous and not available ii 94 9,ll2 6,428 2.4 6,056 12.l 44,206 12.4 1,061 14.5 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

1/ canpensation of employees was canputed by multiplyinq 1.178 times payroll. '!be additional 17.8 percent reflects the employer-paid portion of social - security, unemployment insurance, and other non-payroll labor costs. '!be 17.8. percent is the average for all U.S. manufacturing industries in 1974; 

see the U.S. Department of carrnerce, Survey of Current Business, July 1977, Tables 6.5 and 6.6. 

2/ Canpensation of employees and number of employees used to canpute these anounts were weighted by industry using the ratio of tax expenditure in 

- Table B-3 and tax expenditure in this Table. 

3/ Includes manufacturit'Xl industries where data were available for less than 3 corporations. !f Includes nonmanufacturinq industries where data were available for less than 3 corporations. 

: Average 

Employee 

:Canpensation 

($) 

7,051 y 

6,878 y 

6,806 

6,442 

7,750 

5,378 

9,935 

8,962 

12,176 

6,047 I 5,287 I-' 

6,994 0 

\0 

6,673 I 

5,837 

7,974 

7,632 y 

8,900 

9,534 

8,867 

7,474 

7,300 
Table &-8 

Tax Expenditure, Employment and Canpensation of Employees by Industry, 1973 

Canpensation : Tax Expenditure Tax Expenditure Employees of Employees lf~:Tax Expenditure: as a Percent of 

Iooustry Group Number of :13ook Incane: l\Jrount :Percent of: :Percent of: l\Jrount :Percent of: Per Employee : Canpensation of 

:Coroorations: ($000) ($000) Total Number Total ($000) Total ($) Emolovees 

All iooustries 232 190,463 70,899 100.0 19,663 100.0 ll6,945 100.0 2,ll8 y 35.3 y 

Manufacturing industries 193 156,765 68,561 96.7 17,734 90.1 102, 774 87.8 2,287 y 38.9 y 

Food and kindred products 9 5,907 2,299 3.2 871 4.4 5, 724 4.8 2,639 40.2 

Tobacco products 5 2,339 918 1.2 562 2.8 2,870 2.4 1,633 32.0 

Textile mill products 11 -7,200 128 .1 2,949 14.9 14,767 12.6 43 .9 

Apparel 53 9,538 4,292 6.0 5,107 25.9 27,034 23.1 840 15.9 

Chemicals, total 26 108,220 45,919 64.7 2,095 10.6 15,067 12.8 21,918 304.8 

Pharmaceuticals 17 99 ,315 42,357 59.7 1,555 7.9 ll,233 9.6 27,239 377.1 

All other chemicals 9 8,905 3,562 5.0 540 2.7 3,834 3.3 6,596 92.9 

Rubber products 10 2,016 767 1.0 545 2.7 3,088 2.6 1,407 24.8 Lea~er aro leather products ll 2,396 948 1.3 947 4.8 4,902 4.1 1,001 19.3 

Fabricated metal products 13 3,476 1,382 1.9 491 2.4 3,179 2.7 2,815 43.5 

Electrical aoo electronic equipnent 26 22,241 8,745 12.3 2,920 14.8 18,315 15.6 2,995 47.7 

Scientific instruments 12 5,219 2,0ll 2.8 483 2.4 2,985 2.5 4,164 67.4 

All other manufacturing lf 17 2,613 1,152 1.6 764 3.9 4,843 4.1 1,508 23.8 

~nmanufacturing industries 39 33,698 2,338 3.2 1,929 9.8 14,171 12.1 1,007 y 14.7 2/ 

Wholesale trade 5 29,345 343 .4 338 1. 7 2,654 2.2 1,015 12.9 

Finance, insurance, real estate 7 2,031 812 1.1 202 1.0 1,626 1.3 4,020 49.9 

Services 9 534 378 .5 566 2.8 4,279 3.6 668 8.8 

Miscellaneous and rx>t available 4/ 18 1,788 805 1.1 823 4.2 5,612 4.8 978 14.3 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Canpensation of employees was ccmputed by multiplyinq 1.172 times ?ayroll. - 'Itle additional 17.2 percent reflects the employer-paid portion of social 

security, unemployment insurance, and other non-payroll labor costs. 'Itle 17.2. percent is the average for all U.S. manufacturing iooustries in 1973; see the U.S. Department of Carrnerce, Survey of Current Business, July 1977, Tables 6.5 and 6.6. 

2/ Canpensation of employees aro number of employees used to canpute these amounts were weighted by industry using the ratio of tax expenditure in - Table &-4 and tax expenditure in this Table. 

3/ Includes manufacturing iooustries where data were available for less than 3 corporations. !/ Includes nonmanufacturing industries where data were available for less than 3 corporations. 

Average 

EmpJoyee 

:Canpensation 

($) 

6,001 y 

5,871 y 

6,572 

5,107 

5,007 

5,294 

7,192 

7,224 

7,100 

5,666 I 

5,176 I-' 

I-' 

6,475 0 

I 

6,272 

6,180 

6,339 

6,853 y 

7,852 

8,050 

7,560 

6,819 
Table B-9 

Tax Expenditure, Employment and Canpensation of Employe;es by Size of Tax Expenditure Per Employee, 1976 

Canpensation -; Tax Expenditure : Average 

Size of Tax Expenditure 

per Employee Number of :Net Ina:me 

Corp:>rations: ($000) 

Tax Expenditure 

Amount :Percent of _Emp~_lo~y--=e=-e_s_-,---,..---=--o_f__,.Emp_._l....,o="y~e_e_s 1/ :Tax Expenditure: as a Percent of Employee :Percent of: Am:mnt :Percent Of": Per Employee : Canpensation of :Canpensation 

($000) Total Number Total ( $000 ) Total ( $ ) Employees ( $) 

All corporations 363 1,430,118 572,583 100.0 60,357 100.0 507,445 100.0 8,762 y 105. 7 y 

$ 100,000 or rrore 10 236,563 94,619 16.5 744 1.2 10,846 2.1 127,176 872.4 

$ 50,000 under $100,000 15 309,350 123,732 21.6 1, 726 2.9 19,829 3.9 71,687 624.0 

$ 10,000 under $ 50,000 80 596, 726 238,642 41. 7 12,458 20.6 132,370 26.1 19,156 180.3 

$ 5,000 under $ 10,000 43 100,509 40,174 7.0 5,916 9.8 50,845 10.0 6,791 79.0 

$ 1,000 under $ 5,000 124 169,794 67,844 11.8 25,254 41.8 190,518 37.5 2,686 35.6 

$ 500 under $ 1,000 50 15,710 6,254 1.1 8,658 14.3 64,977 12.8 722 9.6 

$ 100 under $ 500 24 3,282 1,297 .2 4,234 7.0 29,509 5.8 306 4.4 

$ 1 under $ 100 6 60 21 * 593 1.0 3,541 .7 35 .6 

Loss corporations 11 -1,876 774 1.3 5,009 1.0 

Office of the Secretary of the Treasury 

Off ice of Tax Analysis 

l/ Canpensation of employees was c:anputed by multiplying 1.203 times payroll. 'nle additional 20.3 percent reflects the employer-paid portion of 

social security, unemployment insurance, and other non-payroll labor costs. The 20.3 percent is the average for all U.S. manufacturing industries in 

1976; see the U.S. Department of Camlerce, Survey of Current Business, July 1978, Tables 6.5 and 6.6. 

2/ Canpensation of employees and number of employees used to canpute these arrounts were weighted by industry using the ratio of tax expenditure in Table 

- B-1 and tax expenditure in Table B-5. 

* Less than 0.05 percent 

8,293 y 

14,578 

11,488 

10,625 

8,594 

7,544 

7,505 

6,970 

5,971 

6,472 

I 

f-' 

f-' 

f-' 

I 
Table B-10 

Tax Expenditure, Employment and Canpensation of Employees by Size of Tax Expenditure Per Employee, 1975 

Size of Tax Expenditure 

per Employee 

Canpensat1on : Tax Expenditure Average 

--=-T_a_x--,E_xpe-=-=nd_i t_u_r...,e_-,,-___ EITlP~ __ l_o..._y=e_es_--,--=--=--o_f__,.Emp__.__lo__.y._e_e_s 1/ : Tax Expenditure: as a Percent of Employee 

Number of :Book Incane: lmount :Percent of: :Percent of: Arrount :Percent of: Per Employee : Canpensation of :Canpensation 

:Corporations: {SOOO) {SOOO) Total Number Total ($000) Total ($) ~loyees {$) 

All corporations 395 941,161 377,256 100.0 49,617 100.0 392,309 100.0 6,164 y 81.3 y 

$100,000 or m:::>re 6 73,694 29,477 7.8 229 .s 2,464 .6 128,721 1,196.3 

$ 50,000 under $100,000 16 283,096 ll3,242 30.0 1,605 3.2 17,630 4.5 70,556 642.3 

$ 10,000 under $ 50,000 54 328,239 130,122 34.S 6,026 12.l 55,213 14.1 21,593 235.7 

$ 5,000 under $ 10,000 41 128,577 51,418 13.6 6,831 13.8 67,726 17.3 7,527 75.9 

$ 1,000 under S 5,000 144 128, llS 46,999 12.S 18,784 37.9 135,453 34.5 2,502 34.7 

$ 500 under $ 1,000 39 9,068 3,585 1.0 4,810 9.7 31,091 7.9 745 ll.S 

$ 100 under $ 500 35 5,863 2,345 .6 7,067 14.2 52,730 13.4 332 4.4 

$ 1 under $ 100 8 459 68 * 981 2.0 6,265 1.6 69 

1.1 

Loss corporations 52 -15,949 3,284 6.6 23,738 6.1 

Office of the Secretary of the Treasury 

Off ice of Tax Analysis 

1/ Canpensation of employees was canputed by multiplyinq 1.191 times payroll. 'nle additional 19:1 percent reflects the employer-paid portion of 

- social security, unemployment insurance, and other non-payroll labor costs. 'nle 19.l percent is the average for all U.S. manufacturing industries in 

1975; see the U.S. Department of Carmerce, Survey of Current Business, July 1978, Tables 6.5 and 6.6. 

2/ Canpensation of employees and number of employees used to canpute these am:::>unts were weighted by industry using the ratio of tax expenditure in 

- Table B-2 and tax expenditure in Table B-6. 

* Less than .OS percent 

7,582 

10,760 

10,984 

9,162 

9,915 

7,211 

6,464 

7,461 

6,386 

y 

I 

I-' 

I-' 

N 

I 
Size of Tax Expenditure 

per Employee 

All corporations 

$ 50,000 or nore 

$ 10,000 under $ 50,000 

$ 5,000 under $ 10,000 

$ 1,000 under $ 5,000 

$ 500 under $ 1,000 

$ 100 under $ 500 

$ 1 under $ 100 

Loss corporations 

Table B-ll 

Tax Expenditure, Employment and Canpensation of Employees by Size of Tax Expenditure Per Employee, 1974 

Canpensation Tax Expenditure 

_"="T_a'-x-,.E_xpe""'-"n'"'"d'-i_· t_u_r":'"e ______ Emp..c....o._l_o...,ye'"'"e_s_-,-___ --=-_o.:...f"'---'Emp:;.;.;;a.:;;l,;.oy.._e.:...e=s .!./ : Tax Expenditure as a Percent of 

Nl.Ullber of Bcx:>k Inccrne: Anount :Percent of: :Percent of Aloount :Percent Of: Per Employee Canpensation of 

:Corporations ($000) ($000) Total Nl.Ullber Total ($000) Total ($) Employees 

379 586,887 265,495 100.0 49,976 100.0 355,415 100.0 4,567 y 64.8 y 

ll 159,709 63,884 24.1 933 1.9 8,999 2.5 68,472 709.9 

39 3ll,328 123,606 46.6 5,634 11.3 54,802 15.4 21,939 225.6 

33 54, 770 21,882 8.2 2,938 5.9 22,144 6.2 7,448 98.8 

135 126,607 50,420 19.0 21,407 42.8 142,013 40.0 2,355 35.5 

37 8,380 3,378 1.3 4,363 8.7 24,553 6.9 774 13.8 

40 6,288 2,264 .9 7,345 14.7 51, 714 14.6 308 4.4 

14 3, 710 61 * 1,469 2.9 9,015 2.5 41 .7 

70 -83,905 5,887 11.8 42,176 11.9 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

l/ Canpensation of employees was canputed by multiplying 1.178 times payroll. '!be additional 17.8 percent reflects the employer-paid portion of 

- social security, unemployment insurance, and other non-payroll labor costs. '!be 17. 8 percent is the average for all U.S. manufacturing industries in 

1974; see the U.S. Department of c.armerce, Survey of Curr~nt Business, July 1977, Tables 6.5 and 6.6. 

2/ Canpensation of employees and nl.Ullber of employees used to canpute these anounts were weighted by industry using the ratio of tax expenditure in 

- Table B-3 and tax expenditure in Table B-7. 

* Less than .05 percent 

Average 

Employee 

Canpensation 

($) 

7,051 y 

9,645 

9, 720 

7,537 

6,634 

5,627 

7,041 

6,137 

7,153 

I 

I-' 

I-' 

w 

I 
Table B-12 

Tax Expenditure, Employment and Canpensation of Employees by Size of Tax Expenditure Per Employee, 1973 

Canpensation : Tax Expenditure : Average 

Size of Tax Expenditure 

per Employee --::-T"'-a'-x--.-E_xpe-"--'-n=d"'-i_· t:;.:u_:;r..,:e--r----=Emp~l:;.:o:.i.y..;e..:.e.;;;.s_-,-__,,,..:___..:.o..:.f_Emp:::;:.:;i..::l;.::o:..i.y..:.e..:.es::;. y _:Tax Expenditure: as a Percent of &nployee Number of :Book Inccrne Am::>unt :Percent of :Percent of: Am::>unt :Percent of: Per Employee :Canpensation of :Canpensation 

:Corporations: ($000) ($000) Total Number Total ($000) Total ($) Employees ($) 

All corporations 232 190,463 70,899 100.0 19,663 100.0 ll6,945 100.0 2,ll8 35.3 y 

$ 50,000 or nore 10 73,732 29,493 41.6 433 2.2 3,544 3.0 68,ll3 832.2 

$ 10,000 under $ 50,000 19 42,472 16,903 23.8 960 4.9 6,694 5.7 17,607 252.5 

$ 5, 000 under $ 10,000 14 25,147 10,028 14.1 1,288 6.6 7,347 6.3 7,786 136.5 

$ 1, 000 under $ 5,000 75 28,944 ll,408 16.1 4,877 24.8 29,744 25.5 2,453 40.2 

$ 500 under $ 1,000 26 5,635 2,244 3.2 2,952 15.0 16,912 14.5 760 13.3 

$ 100 under $ 500 28 2,156 799 1.1 2,693 13. 7 15,499 13.3 289 5.0 

$ 1 under $ 100 16 28,848 45 .1 1,175 6.0 6,754 5.8 38 .7 

Loss corporations 44 -16,470 5,285 26.8 30,450 26.0 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Canpensation of employees was canputed by multiplying 1.172 times payroll. '!he additional 17.2 percent reflects the employer-paid portion of - social security, unernployment insurance, and other non-payroll labor costs. '!be 17.2 percent is the average for all U.S. manufacturing industries in 

1973; see the U.S. Department of carmerce, Survey of Current Business, July 1977, Tables 6.5 and 6.6. 

2/ Canpensation of employees and number of employees used to canpute these all'Ounts were weighted by industry using the ratio of tax expenditure in 

- Table B-4 and tax expenditure in Table B-8. 

6,001 

8,184 

6,973 

5,704 

6,099 

5,729 

5,755 

5,748 

5,761 

y 

I 

...... 

...... 

~ 

I 
-115-

Appendix C -- Tax Forms from which Data Included 

in this Report was Obtained 
Form 1120 U.S. Corporation Income Tax Return For calendar year 1977 or other taxable year beginning 

Department of the Treasury ~®77 Internal Revenue Service 

.....•..............................• 1977, ending ....•..................•....••....•• , 19 ...•...• 

(PLEASE TYPE OR PRINn 

Check If a-- Name D Employer identification number 

A Consolidated return 0 'ii ti 

~=~!------------------------------~-------~~~ B Personal Holding Co. 0 

C Business Code No. (See 

;·~: Number and street E Date incorporated 

~~~ 1---------------------------~--n-----~--:-~-::::: 11 

·[ City or town, State, and ZIP code F Enter total assets from lin!.c Page 8 of instructions) 

- column (0), Schedule L (See sr· 

Instructions) 

IMPORTANT-Fill in all appli~able lines and schedules. If the lines on the schedules ~re not sufficient, see instruction N. $ 

U> 

z 

0 

;::: 

(.) 

:::> 

c 

"" c 

1 Gross receipts or gross sales .................................... Less: Returns and allowances ................................... . 1 --------------------------·· 

2 Less: Cost of goods sold (Schedule A) and/or operations (attach schedule) 

3 Gross profit 

4 Dividends (Schedule C) • 

5 Interest on obligations of the United States and U.S. instrumentalities 

6 Other interest . 

7 Gross rents 

8 Gross royalties 

9 (a) Capital gain net income (attach separate Schedule D) . 

(b) Net gain or (loss) from line 9, Part II, Form 4797 (attach Form 4797) • 

10 Other income (see instructions-attach schedule) • 

11 TOTAL incom~Add lines 3 through 10 

12 Compensation of officers (Schedule E) • 

13 Salaries and wages (not deducted elsewhere) • 

14 Repairs (see instructions) • 

15 Bad debts (Schedule F if reserve method is used) • 

16 Rents 

17 Taxes (attach schedule) 

18 Interest • 

19 Contributions (not over 5% of line 30 adjusted per instructions-attach schedule) 

20 Amortization (attach schedule) • 

2 

. --3 _______ ,.. ____________ ... 

4 . --------------------- . _5 - --------------------

_6_ ---------------------·--· 

_7 _ -----·-·------------- . _8 _________________________ ...... 

9(a) ·--------------------· 

9(b) -------------------------·--' 

10 ___./ 

21 Depreciation from Form 4562 (attach Form 4562) ···-·····-··-····-·······-·······-·-···-· less depreciation 

c I a1me . d . S h d I A d I h t B ...._ _21 -------------------------·_., in c e u e an e sew ere on re urn ···············-·············-··························• alance ,,,... 

22 Depletion • • ~ ------------------------··_... 23 Advertising • • ~ ________________________ .. ...-

24 Pension, profit-sharing, etc. plans (see instructions) (enter number of plans...,. .............. ) ~ -------------------------····· 

25 Employee benefit programs (see instructions) • 

26 Other deductions (attach schedule) • 

27 TOTAL deductions-Add lines 12 through 26 • 

25 •. -····· 

:~~~ 28 Taxable income before net operating loss deduction and special deductions (line 11 less line 27) . • . . • ~ ------------------------····· 

29 Less: (a) Net operating loss deduction (see instructions-attach schedule) • ••· 12

29

9((ab)) !------------------------ ./ 

(b) Special deductions (Schedule I) • . ~ , 

31 

30 Taxable 

TOTAL 

income 

TAX 

(line 

(Schedule 

28 less 

J) 

line 

. . . . . . 

29) • 

• • . • • . • • ll 

~ ~ 

------------------------·/ 

32 Credits: (a) Overpayment from 1976 allowed as a credit • • • 1-----------------------· 

(b) 1977 estimated tax payments • • • • • • • . • -----------------------· 

(c) Less refund of 1977 estimated tax applied for on Form 4466 . ( ) -----------------------

(d) Tax deposited with Form 7004 (attach copy) • 

(e) Tax deposited with Form 7005 (attach copy) • 

(f) Credit from regulated investment companies (attach Form 2439) ---------------------·-

33 

(g) 

TAX 

U.S. 

DUE 

tax 

(line 

on special 

31 less 

fuels, 

line 

nonhighway 

32). See 

gas 

instruction 

and lubricating 

G for 

oil 

depositary 

(attach Form 

method 

4136) • 

of payment • •• 

__ 

3

-~ 

3

3

4 

-----./ 

34 OVERPAYMENT (line 32 less line 31) . ----- ~ 

35 Enter amount of line 34 you want: Credited to 1978 estimated tax .... Refunded .... 35 _

1 

is tfll'' 

Under penalties of perjury, I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief 1 

correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which the preparer has any knowledge. 

~ Signature of officer Date ~Paid preparer's signature and identifying number (see instructions) 

-·---·-----··----------·-·--------·---------·-----·-·----·---------------=·- ./. 

~ ----~----~--------~~~--:-:-.::-:;~~ . nu~ ~Title Paid preparer's address (or employer's name, address and identifying 

...
r Balance Sheets 

ASSETS 

Beginning of taxable year End of taxable year 

(A) Amount (B) Total (C) Amount (D) Total 

.. ~ ----- ------ -- --------------- ~-----------------~· . --------------------------~ ·--------------------------- -

. -------------------------- - ---------------------------- -

~ ba1anee Analysis of Unappropriated Retained Earnings Per Books (line 24 above) 

3 ~ inco:eb::in~ing of year • • • • • • • ·------------------------- 5 Distributions: (a) Cash • • • • • -------------------------· 

er increase: ~oks • • • • • • • • • ------------------------- (b) Stock • • • • • • --------------------------

' 

::·--·------~~~~:i~~:--~~~~~----_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-_-. ( c) Property • • • • • -------------------------- ···-. 6 Other decreases (itemize) _____________________ _ 

I ::;~~~~:~:~'.:~::=:::::::::::::::::::::::::- 7:::::::::::~;t~I::~;:;~;;:~:~;~:~:::::::::::::: i----- , • and 3 • • • • • • 8 Balance at end of year (line 4 less 7) • • • 
Form 5712 

{Rev. March 1978) 

Department of the Treasury 

Internal Revenue Service 

Election to be Treated as a 

Possessions Corporation Under Section 936 

._./ 

The corporation named below hereby elects under section 936(e) of the Internal 

Revenue Code to be treated as a possessions corporation for income tax purposes. __..,/ 

Name of corporation 

Number and street 

City or town, State and ZIP code 

Business code number I Principal business activity 

Description of each class of stock 

Employer identification number 

Date of incorporation 

Place of incorporation 

Principal product or service 

I 

Number of shares of each class . g 

issued and outst~ 

: : : : : :: : :: : : : :: ::: : : : : :: :: :: : : :: : : : : : : : : :: :: :: : : : : : : : : : : :: : : : : ::: :::::::: :: : : :: : : : : : :: ::: : : : : :: : : :: :: ::: ::: :::: ::: :::::::::::::: I:::::::::::::::::::-::-:: : ~ 

The following information must be submitted for each shareholder owning 10% or more of the issued and outstanding stock of 

any class: ::..:_::!.__._:.::..:..=.=.=.:..._~~~ ~~~~~~~~~~~-,-~~~~~~~~~~~~~~--.,,--~~~~~~--:-~~~~~~~~~wned 

Name of shareholder Identifying number Address Class of stock Number of shares~ 

---1 ~~~~~~~~~~-!-~~~~~~~1-~~~~~~~~~~~~'l~~~~~~__:_~~~~~-----;;;r Election is made for the taxable year beginning (month, Date corporation commenced busi- Annual return will be filed for the ta~~)ble day, year) ness in a U.S. possession ending (enter the month or "unknown 

For any taxable year beginning in 1973, 1974, or 1975 did you, or any other corporation which is (or was in that 

year) a member of your controlled group (as defined in section 993(a)(3)), exclude income under section 931? . 

If "Yes," for each such corporation (attach additional se;hedules if required): 

D Yes 

(1) 

(2) Complete 

Enter the corporation's 

the following schedul~ 

name and employer identification number .... -------------------------------- -- ---- -- ------------------ ---- ~ 

Taxable year (use a separate l ine 

for each full or short taxable year Principal place of business Net income beginning in 1973, 1974, or 1975) (enter name of U.S. possession or country) per books 

Beginning Ending · ./ 

~~~~(~m~o~n~th~/~d~a~y~/~y~ea~r~>~~~·l-~(m~on~t~h~/~d~ay~/~y~e~a~r>~-l-~~~~~~~~~~~~~~~~~~~~~~~i--------------- . ..... .... ...... ___ _ .. ... ----------------------------------------------------------------------· ------------------- ___ .............. .. 

__ .. ... ........ .. 

---------------------------------------· --------------------------- ---------------------------------------------------------------------- --- -- -------- ~ 

Who 

as Po 

Whe 

begi 

lion 

'Nh 

~~~~~~~~~~~~~~~~~~~~~~-;--u_._s__in_c_o_m_e~ta_x~re_t_ur_n_s_f_il_e_d_:~~~~~~~~~~~~~,.-~~~~~ I If corporation filed separately: If corporation joined in filing a consolidated 'return: 

Taxable income or {loss) shown on return 

Amount of gross income excluded under section 931 

Name and employer identification number of corporation filing return 

~ 

Internal Re11 e~~~ 

--------------1----------1------------------------1 __ _ ... -···· 

-------... -------------------------------- . -------------------------- -------... -........... --------------------.. -... ------.. -.. --------------------... ---... . . ---------------- ,; .. 

-------------------------------------------------------------------·---------------------------------------------------------------------- --- --- -- -- --- ~ I - t~· ~ Under penalties of perjury, I declare that I have been duly authorized by the above named corporation to make this election and that the statements made are to 

of my knowledge and belief, true, correct, and complete. 

·sig-riati"ire -aiil:i-iiHe-oTottiC:ei-------------------------------------------------------------------------------------------------------- oaie __ ____ __ ____ _ 

Form 
Instructions 

Who Can Elect 

a Only domestic corporations can elect to be treated 

s Possessions corporations. 

!..-/ When to File 

__./ b . Form 5712 must be filed within 90 days after the 

tieg1~ning of the first taxable year for which such elecon 1s made. 

Where to File 

c File this form with the Internal Revenue Service 

y~nter, Philadelphia , PA 19255. File separately from 

, Ur regular income tax return. 

U.s. Possessions 

incl For purposes of section 936, U.S. possessions 

Ude Puerto Rico but not the Virgin Islands. 

Period of Election 

ckof wh· hThe election applies to the first taxable year for 

dole s.uch election has been made and for which the 

rnest1c corporation qualifies under section 936(a). 

-- 1 

r 

be . T~is election may be revoked for any taxable year 

foi~n~ing before the expiration of the 9th taxable year 

appl~ing the taxable year for which such election first 

ta~a ies only with the consent of the Secretary. For any 

ta~a~:e Year beginning after the expiration of such 9th 

cons e year, this election may be revoked without the 

ent of the Secretary. 

Form 5735 

For every year for which an election under section 

936(e) is in effect, you must complete Form 5735, Computation of Possessions Corporation Tax Credit Under 

Section 936, and attach it to your income tax return. 

Consolidated Returns 

A corporation may not join in filing a consolidated 

return for any year for which an election under section 

936(e) is in effect. 

Business Classification 

Refer to the Codes for Principal Business Activity 

and Principal Product or Service in the Instructions for 

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 individuals is their 

social security number. For all others it is their employer 

identification number. 

Signature 

This form must be signed by the president, vice 

president, treasurer, assistant treasurer, chief accounting officer, or other corporate officer (such as tax officer) 

who is authorized to sign. 
Form 480.20 Dec.3,1974 

Common-aHb of Puato Rleo 

DEPARTMENT OF THE TREASURY INTERNAL REVENUE ADMINISTRATION 

BUREAU OF INCOME TAX 

Serial Nwnl><1 

Auditor Reviewer RECEIPT 

Field Audited by: 197 CORPORATION INCOME TAX RETURN 

FOR CALENDAR YEAR 197 

OR OTHER TAXABLE YEAR BEGINNING 

197 

_______ 197 __ AND ENDING _______ _, 197 __ 

Corporation's Name I Employer's Account Number I C.D. 

Ponal Addre• "Zip Code" 

LocaUon of Principal Industry or Buaine.......Street, Number and City MUD. Code 

Kind of Principal Industry or Buainea Ind. Code 

Does this Corporation have exempt activities other than under the Industrial Incentive Act? Yes 0 No 0 

1--..... u_n_d_e_r_w_h_a_t_A_c_t_o_r_A_c_u_? ______________ ,::_-_-_-_-_-_-,::_-,::_-,::_-_-_-_-_-_-_-_-::_-::_-::_-_-::_-_-_-::_-::_-::_-_-_-_-::_-_-_-::_-_-_-_-_-_-_-_-_-_-_-_____ ._, ____ -.----~------~~ 

1 T tal G I (F S h d I 4 ) 11()\ (01) $ ........................... :.• .. 1111 

llll :z M 0 :::> 0 Q 

llll ~ ::c t-

~ w 

z 

N 

llll Cl) 

5 tQ i5 w w ::c II: 

0 0 Cl) 

• o ross ncome rom c e u e ........................................................................................................... .'$.7. 

2. Less: Total Deductions (From Schedule 5) .............................................................................................................. (02) _______ _. .. Y 

3. Net operating income (or loss) for the year .............................................................................................................. (03) $ ...................... ·····~ 

4. Less: Net operating loss deduction for the preceding year (submit statement) ........................................................ (04) ______ __.., ~ 

5. NET INCOME (or Loss) ........................................................................................................................................... (05) $ -:::;::::.. 

6. Dividends or profits received from corporations or partnerships (See booklet of instructions) ............................ ~ (06) $ ........................... ~ 

7. Net income subject to normal tax ............................................................................................................................ (07) .............................. ./ 

8. Less: Surtax net income credit (See booklet of instructions) .................................................................................... (08) $ ~~ 

9. Net income subject to surtax ......................................................................................................................... (09) ~ 

10. 

11. 

12. 

Normal tax (22% of net income subject to normal tax, line 7) ............................................................................ ~ (10) 

Surtax (See booklet of instructions)......................................................................................................................... (11) 

Total Tax (normal tax and surtax) ..................................................................................................................... (12) 

13. Alternative tax (line 28 of Annex "B") ..................................................................................................................... (13) 

14. TAX DETERMINED (Item 12 or 13, whichever is lower) .............................................................. : ................... (14) 

····························" 

$ ......................... . 

~·~~~:::::~::::::::::;~ 15. Crediu: Tax Paid: (a) At Source ........................................................................................... (15) I $ 

(b) Allowable proportion of the tax paid to U.S. or its possessions or,__ ,--------1 __.V 

foreign countries (See booklet of instructions and submit details) ....... (16) ._-"'-S ______ +-"$'-----~ 

16. THIS IS YOUR TAX LIABILITY (Subtract item 15 from item 14. Enter difference here) .............................. (17) 

17. Less: Estimated tax paid: Current year $ ........................... Excess of previous years$ ....................................... @ (18) 

$ ........................... . 

······························ 18. Balance of tax payable (Enter here the difference, if item 16 is larger than item 17) .......................................... (19) ······························ 19. Less: Amount paid with tentative return $ ........................... With this return$ ......................................................... (20) 

20. Balance of tax due ............................................................................................................................................... ( 21) 

21. Amount of tax overpaid to be credited to estimated tax for 197 ............................................................................ (22) 

22. Amount of tax overpaid to be refunded .................................................................................................................... ( 23) 

......................... •""l/1 

$ __..,.l/ 

$ _........... V, 

$ __ ---:::;:V' 

l, 

2.Ao 

I 

3.No 

4. In 

5.In 

6. D 

s. 

6. 

1

2

0 AT H 11 a 

.. ~' 

NOTARIAL 

SEAL 

WE, the undersigned, president (or vicepresident, or other principal officer) and treasurer (or assistant treasur~r). ~:~ the corporation for which this return is made, being severally duly sworn, each for himself deposes and says that thJ.S retJief,' ~ ding any accompanying schedules and statements) has been examined by him and is, to the best of his knowledge and be 54 ,od 

corrP.Ct, and complete return, made in good faith, for the taxable year stated, pursuant to the Income Tax Act of 19 

Regulations issued thereunder. 

.~ ......................... A&~~i ............................ . 

Affi::;r: ~~~ .. ~~~ .. ~ .. ~;~re me bY----------------------. of '"" .,., ~ -------------------- and resident of ; and by ~~~ of legal age, occupation •nd resident of , per_:'~:/ to me at __________________ , Puerto Rico, this _______ day of 

··································o;iiclai'Tiiie............................... ···············silD&iUN'C>f'oiiiC:er'~·;;a·iJi·········· A RETURN NOT PROPERLY FILLED OUT WILL NOT BE CONSIDERED 

AS MEETING THE ST ATtrl'ORY REQUIREMENTS 
COMPARATIVE BALANCE SHEETS 

ASSETS Total 

1

· Cub on band and in banka .................... @ l 01) 

Amount 

Beclnninl of Tazable Year 

Total 

I (30) End of Taxable Year 

I Amount 

$ •....•..••.•.•••.••...•........ (01) $ ............................ .......• 

$ •.....................•............. (02) $ ................................ . 2

· Account& receivable ...........•.............•......•... (02) 

LEsS: Reserve for bad debta ·················- (03) 

L-/ :: ~:::~~~:~:::::::::::::: ::::::::::::::::::: :::::: ::: ~ 6

· Depreciable a.saeta •••....•.....•.•......•........... ~ (07) 

LESS: Reserve for depreciation ••....... ~. (08) 

---------······························· .... (03)._,__ ________ ~--+· ·· ······· ·· ···· ·············· .............................•. ... . (04) 

•.....•........................... . (05) 

.................................. (06) 

........ 

······ 

······ 

······ 

....... 

/ 

······ ./ 

······ / 

······ 

..... 

$ .......................... . (07) $ ........................ ....... . 

~: ~~·~~ ....................... ~ .................................................................. ~:: ~~~~ 

----------···-·· .. ·······-·••"'''"'' .... (081,_ ________ _. ..... .. ...................... .. 

(09) 

---------! (10) 

TOTAL ASSETS ............................. -•. (11) $ .......................... . (ll) $ ................................... . I==============="~ 

LIABILITIES AND NET WORTH 

1 Liabilities @ ~· Accounts payable •. .........................••....• !!. (12) 

12• Bonda, notes and mortgages payable .•......... (13) 

$ .......................... . (12) $ ........................ ....... . 

(13) ................. ......... . 

$ la: ~:;:::i~~ . .'.".'.'.".".'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.'.".'.·. ~~:~ $ I (14) .......................... . 

............................... ·········i--------~-1(15) .......................... . I 

1 ~et Worth 

4. C.pital stock : 

(a) Preferred stock .........................•... @.(16) 

15 (b)Commonstock .........................•.......•. (17) 

16. C.pitaI surplua .............................................. (18) 

17. Earned surplus ............................................. (19) 

· Surplua 18 reserves··········································· (20) 

'--..!otal Liabilities and Net Worth ........... (21) 

$ ................................... . 

........................................ 

........................................ 

(16) $ ........................ ....... . 

(17) ........................... ....... . 

(18) ........................... ....... . 

...... ··_····_···_···_···_····_···_···_····_·· __ .. ·_···-···.-_____ ,_g~~ ..... ··_···_··_···_···_···_· .._····-1. · ·_···_····+· -----+--'-

$ .............................. (21) $ ............................ i ....... . RECONCILITATION OF INCOME PER BOOKS WITH INCOME PER RETURN 

~· iet income per books ................................. . @ (01) 

a· tllcorne tax.................................................... (02) 

$ ............................... . 

4· 'l' ll:cesa of capital losses over capital gains...... (03) 

· 'll:able income not recorded on books this 

Year Citernized) ............................................ . 

···································································· i·~~ ·· ···· ··· ···· ····· ··· ··· ·· ·· ··· ········ ············· d n&es recorded on books this year not den:cted in this return (itemize. use rider if ceSSary) 

(&) •••••••••••••••••••••••••• $ •....................•..•..•... 

(b) ......... .. .. .... . ........ $ ..••.•......••..........•...•.• 

6. 'l'o~;·~~~~: ~·~~~:;·~·;::::::::: ::: :::::::::::::: 

(04) ··•······················· ........ . 

(05) 

(06) $ 

7. Income recorded on books this year not included in this return (itemized, use rider if necessary) 

(a) Tax-exempt interest$ .................................. . 

::::::::::::::::::::::::::::::::::::::: ::: ::::::: :: :::::::::: ~.@: (01) $ ....................... ········· 

8. Deductions in this tax retun not charged against 

book income this year (itemize, use rider if 

necessary) 

(a) Depreciation .....•..... $ ................................. . 

(b) Depletion ........•...... $ ................................. . 

9 .Total of lines 7 and 8........................................ (03) $ 

10. Income (Line 5 page 1)- Line 6 less Line 9 ....... (04) $ 

ANALYSIS OF UNAPPROPRIATED RETAINED EARNINGS PER BOOKS 

l. J)alance at be . . .@ 2. Net In &mnmg of year ....................... 3 (01) 

a. Qth ~Orne per books.... ............................. (02) .~.::::::::::::::::::::::: ::::::::: 5. Distributions: ~:~~;:ck :::::::::::::::: :::::::::~~ ~~~~ .~:: :::::: :::::::::::: : :::::::::. llec er Increases (itemize, use rider if eslllry) 

................................................................... 

.. ~~~:.i~:~:~.:~.:~~~:~~:.·· .. ·.:.-::::· .. :::.:::.::. 

(03) 

(04) 

(05) 

(06) 

(c) Property............................. (03) ................................... . 

6. Other decreases (itemize, use rider if necessary) (04) 

7. Total of lines 5 and 6 ........................................ (05)~$------+---

$ 8. Balance at end of year (Line 4 less Line 7)........ (06) $ 

1• lnco 

QUESTIONAIRE 

2.1-i. 11>oration date: a C8ofin -------------------- • lteliatr corporation: ------------------- 4· hidi Y Number in the Department of State __________ _ 

~te the accounting method used by the corporation. 

Caab method. 

0 Other: 

5, hico 

6, N rne (or deficit) as per return for procedin& year $ --------

"ll!nber of controlled corporations 

(See · J l.Dstructions). 

• 5-()735 

-40 ,000-29-PRGPD. 

7. Is this corporation engaged in Trade or Business within Puerto Rico? 

Yes 0 No 0 

8. Did the corporation file the following documents? 

(a) Annual informative Return (Forms 480.5 and 480.6) 

Yes O No 0 

(b) Withholding Statements (Forms 499 R-2). 

Yes O No 0 

9. The corporation's books are in care of: 

Name---------------------~ 

Address---------------------~ 
Form 5735 

(Rev. January 1978) 

Department of the Treasury Internal Revenue Service 

Computation of Possessions Corporation 

Tax Credit Allowed Under Section 936 

.... Attach to your tax return. 

For calendar year 19 ........ or other taxable year beginning ........................ . 19 ......... , and ending ....... .. .................. , 19 .. 

Ins 

(Ref 

A .

Name 

I Employer identification num:Jer Com 

elec 

tion •:1.nl- GrQss Income in Applicable Period 

Taxable year (Use a separate 

line for each taxable year ending with or within your applicable period, starting Name of U.S. possession 

with the earliest such taxable in which trade or 

year. See instruction B.) business was actively 

conducted 

Beginning Ending 

(a) (b) (c) 

Gross income during periods shown in columns (d) and (e) 

Gross income from the active conduct of a 

trade or business in a U.S. possession Gross qualified 

posssession From source sources From sources From all other From sources investment within within U.S. sources with· within income U.S. possessions out the U.S. the U.S. possessions 

(f) (g) (h) (I) O> 

"' I ! 

~ 

1 Total gross income in applicable period (add totals of columns (f) through (I)) 

_./ 

busi~~~i~~a~n a~~i;:l;r~~~d ~cted in a U.S. possession 

(Dates are inclusive) 

From-

(d) 

All other gross income 

From all 

other 

sources 

without 

the U.S. 

(k) 

_/ 

To-

____./' 

~ 

____./' 

Fro f1'1 

es 

n sou re withi 

the 

u.s. 

(I} 

2 Gross income in applicable period from sources within U.S. possessions (add totals of columns (f), (i), and (j)) . 

3 Line 2 divided by fine 1 (if less than 80%, do not complete Part If) 

4 Gross income in applicable period from the active conduct of a trade or business within a U.S. possession (add 

totals of columns (f), (g), and (h)) 

5 Line 4 divided by line 1 (if less than 50%, do not complete Part If) •:iF.r.•1- Computation of Section 936 Credit 

6 Qualified gross income in current year: 

(a) From sources without the U.S. from the active conduct of a trade or business within a 

U.S. possession . 

(b) Gross qualified possession source investment income 

(c) Less: Amounts received in the U.S. 

(d) Total (add fines 6(a) and 6(b) and subtract line 6(c)) 

7 Applicable deductions (attach schedule): 

(a) Definitely allocable deduction~ 

(b) Ratable part of deductions not definitely allocable 

(c) Total (add fines 7(a) and 7(b)) . 

8 Qualified taxable income before loss adjustments (line 6(d) less fine 7(c)). ff loss, do not complete Jines 9 

through 14 . 

9 Loss adjustments (attach schedule): 

(a) Current year losses from non-qualified sources 

(b) Recapture of prior year overall foreign losses 

(c) Total (add fines 9(a) and 9(b)) . 1-1· 

10 

11 

Qualified 

Total taxable 

taxable 

income 

income 

from 

(line 

all sources 

8 less line 

(enter 

9(c)) 

taxable income from your tax return) 

~I 12 Line 10 divided by fine 11 

13 Total U.S. income tax against which section 936 credit is allowed (see Instruction E) 

14 Section 936 credit (fine 12 multiplied by line 13). Enter here and on your tax return 

Form 

~ I 

I' 

5735 (Re" 

8. 

G 

Or 

th 

c 

a 

w 

( 
19 .. 

umber 

Instructions 

(References are to the Internal Revenue Code) 

A.. Corporations Required 

to File Form 5735 

Form 5735 must be completed and attached to the income tax return of any domestic corporation for which an 

election to be treated as a possessions corporation under section 936(e) is in effect. 

B. Qualifications for Section 

936 Credit (Section 936(a)) 

To qualify for the section 936 credit, a corporation must: 

(1) make a valid election under section 936(e) on 

Form 5712, Election to be Treated as a Possessions 

Corporation Under Section 936; 

(2) have derived 80 percent or more of its gross income 

from sources within a U.S. possession during the 

applicable period immediately preceding the close 

of the taxable year; and 

(3) have derived 50 percent or more of its gross income 

from the active conduct of a trade or business within 

a U.S. possession during the applicable period immed iately preceding the close of the taxable year. 

~enera lly , the " appl icable period " is the lesser of 36 months 

t~ the ~er od during which the corporation was engaged in 

P

e active conduct of a trade or business within a U.S. 0ssession. 

C. Ineligible Corporations 

an A corporation is ineligible for the section 936 credit in 

Why ta~ab e year in wh ich it is a DISC or former DISC, or in 

(Sic~ it owns at any time stock in a DISC or former DISC. 

ection 936(f).) 

D. U.S. Possessions 

PuertFor _Purposes of section 936, U.S. possessions include 0 Rico but not the Virgin Islands. (Section 936(d)(l).) 

E. Taxes Against Which 

Credit is Allowed 

irnpo The section 936 credit is allowed against income tax 

Sed by Chapter 1 but not against any: 

(1) nimum tax for tax preferences imposed by sec- tion 56; 

<

2> tax on accumulated earnings imposed by section 

531 ; 

(J) Personal holding company tax imposed by section 

541 ; 

(

4

) additional tax imposed for the taxable year under 

section 1351 (relating to recoveries of foreign expropriation losses); 

(S) ncre~se in tax under section 47 (relating to d1.., 

Pos1t1ons of investment credit property); 

(6) increase in tax under section 50A(c) (relating to 

early termination by an employer in a WIN program); and 

(7) tax on certain capital gains of electing small business corporations imposed by section 1378. 

F. Qualified Possession 

Source Investment Income 

Qualified possession source investment income is gross 

income (less applicable deductions) from sources within a 

U.S. possession in which a trade or business is actively conducted which you establish to the satisfaction of the Secretary is attributable to investment in such possession (for use 

therein) of funds derived from the active conduct of a trade 

or business in such possession, or from such investment. 

(Section 936(d)(2).) However, income derived from any 

source outside the U.S. from investment of such funds is 

"qualified possession source investment income" if you establish to the satisfaction of the Secretary that the income was 

earned before October 1, 1976. 

See temporary income tax regulation 7.936-1 concerning certain deposits in Puerto Rican banks and other 

financial intermediaries which may earn qualified income. 

G. Computation of 

Qualified Taxable Income 

(1) General Source Rules.-The determination of gross 

income, applicable deductions, and taxable income within and 

without the U.S., and within a U.S. possession must be made 

in accordance with sections 638 and 861 through 864. 

(2) Amounts Received in the U.S.-Gross income received in the U.S., regardless of source, may not be taken into 

account as income from sources without the U.S. (Section 

936(b).) 

(3) Certain Foreign Taxes.-No deduction (or foreign 

tax credit) is allowed for any tax paid or accrued to a foreign 

country or U.S. possession with respect to qualified taxable 

income. (Section 936(c).) 

(4) Current Year Losses.-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 limitation applies, allocate the loss 

to qualified taxable income in proportion to the ratio of qualified taxable income to total taxable income (excluding the 

loss). 

(5) Recapture of Prior Year Overall Foreign Losses.-

If in any taxable year beginning after December 31, 1975 you 

sustain an overall foreign loss, the loss is recaptured in succeeding taxable years by treating some portion of your taxable income from sources without the U.S. as income from 

sources within the U.S. (Section 904(f).) 

H. Coordination with 

Foreign Tax Credit 

Qualified taxable income is not taken into account in 

computing the foreign tax credit limitation. (Section 904(b).) 

I. Where to File 

Attach Form 5735 to your tax return and file it with the 

Internal Revenue Service Center, Philadelphia, PA 19255. 
~=.n!!V. Tr•sury Employer's Annual Federal Unemployment Tax Return ~®76 _1ntt __ m_•l_R_w_~_u~•-S_•m_·_ce ______ ..._~------------~------------------~--...,...----...,..----------------------------,.._----___.,, Sbite r1portln1 number Experience 111t1 period Name of State as shown on emploYer'a Ta~able 111yroll 4 Experl· Contributions hid Contributions PIY· Additlon1l Contributions enc1 r1t1 been 2.7% 1bl11texperience r1te credit actually p1id r1te (col. 3 X 2.7%) (col. 3 X col. 5) (col. 6 minus col. 7) to State 

1 State contribution 2 returns (As defined 3 

In Sbite eel) 1-----,____..,.,__,__ Fro~ To-_____ 1 

5 6 7 8 ~ 

_.., _________ ...... ' 

-------·----·· .. ............... ......................... --......... ........ ·----------------------- ·--------------- ---------------- ·------- ·-----------------··-------------.................... ------------------- ---- _________ .... . 

.............................................................. ·--------------- ---------------- ................. - -----------------· -------·-------------- ----...... ..... -----· ----- __ ,.. _____ ........... ---· 

··------------ ......... --..... ............................................... ........................................ ............................. ---------------- ---------------- ..................... ·------------------·-·---................................... ·-·- .... ----------------- ----------

__ ....... 

------............................................................................................. -----·-----------·--·--- ---------------- ---------------- ...................... ------------------ ·--------------····--- ------------------- --------------·· 

------·---···· ··-·-----:r~i~i;·-~- 1----19'~ ~ -~ 1---1______.., 

10 Total tentative credit (Column 8 plus column 9). • • • • • • • • • • 1 _____ ,__ __ 

11 Total remuneration (including exempt remuneration) PAID during the calendar year for services of employees 

Exempt Remuneration 

12 Exempt remuneration. (Explain each exemption shown, attaching 

Approximate number of 1mploy11S Involved Amount 111ld 

add itio na I sheet if necessary):·----------------------------------------------------· ----------·-----------·---· --·-··-··-------· ·---· 

fa"Fie-mLirieration--fn--excess--01·$4:2oo:··cfiiiei-c;,;i}t--itie-exc-ess-ove·.=-itie-· ·--··-------------------··· ·-····---·-···-·-----· first $4,200 paid to individual employees exclusive of exempt 

amounts entered on line 12) . • • • • • • • • • • • 

14 Total exempt remuneration (line 12 plus line 13) 

15 Total taxable wages (line 11 less line 14) • • 

16 Gross Federal tax (3.2% of line 15) • 

17 Enter 2.7% of the amount of wages shown on line 15 

18 Line 10 or line 17 whichever is smaller • • • 

19 Amount, if any, of wages on line 15 attributable to the following States: 

(a) Vermont $............................... x .003 · 1·-·-·-·--·-·---·---··--·-··-·-···· (b) Washington $.......................... x .003 • ---------1 

(c) Total (add lines 19(a) and (b)) . 

20 Credit allowable (line 18 less line 19(c)) • 

21 Net Federal tax (line 16 less line 20) . 

Record of Federal Tax Deposits for Unemployment Tax (Form 508) 

Quarter Liability by period Date of deposit Amount of deposit 

First 

Second 

Third 

Fourth 

22 Total Federal tax deposited . 

23 Balance due (line 21 less line 22-this should not exceed $100). Pay to "Internal Revenue Service" . . ~ 

Datt .... 

(If incorrect 

make any llllli.. 

necessary ,.. 

change.) 

Signature IJ: 

I Name (as distinguished from trade n11111) 

Tflde name, If any 

L Addrlss and ZIP code 

Title (Owner, etc.) IJ: 

Calendar Yur 

1976 

Employer Identification No. 

_J 

Form 

Gen 
I 

General Instructions 

de Additional instructions for withholding, 

1 Positing, paying, and reporting Federal 

llcome tax, social security taxes, and Fed· 

Ital unemployment tax, are contained in 

~l'Cular E, Employer's Tax Guide, available 11 ee from any Internal Revenue Service 

Office. 

.... Refer to Circular E to find which employ-

··~ must file Form 940, the types of pay-

~ents defined by law as wages, and the kind 

~i services covered by the Federal Unem· 

~oYment Tax Act. 

th Purpose of Form 940.-This form is for 

U e annual reporting of tax under the Federal 

nernployment Tax Act. Federal unemploy-

~en~ tax is paid by the employer. It is not de· 

ra~ct1~1e from wages paid employees. The tax 

, ~ e 1s 3.2 percent on the first $4,200 of 

I 

an Res paid to each employee during 1976 

d 3.4 percent during 1977. 

In Who Must File.-Every employer who durPa~d the current or preceding calendar year 

da' wages of $1,500 or more in any calen· 

,; quarter, or at any time had ONE or more 

~leP~oyees in any 20 calendar weeks must 

end orm 9~0. Count all regular, temporary, 

'ho Part-time employees. A partnership 

Ch Uld not count its partners. If there is a 

bu:~ge of ownership or other transfer of the 

dur!ness during the year, each employer who 

~ea~ng ~he current or preceding calendar 

Cale Paid wages of $1,500 or more in a 

~lo ndar quarter, or had ONE or more em-

'fle::es at any time in each of 20 calendar 

"1ou~ must file Form 940, but neither 

It report wages paid by the other. 

•re You receive a preaddressed form and 

for ~i liabl~ for Federal unemployment tax 

Of th 6, write "Not Liable" across the front 

enuee~r":1 and return it to the Internal Revness rvice. If you are no longer in busi· 

line :~ the end of a year, write "Final" in 

If 

dulin You sold or transferred the business 

~e n~ the year, attach a statement showing 

~oil n Ille, address, and employer identifica00 Umber (if known) of the new owner. 

Ice w~~ You have filed a Form 940, the Servthe Clo send you a preaddressed form near 

teceivese of each calendar year. If you do not 

~evenu a form~ request one from any Internal 

due. e Service office in time to file when 

bue D 

endar Y ate of Return.-Form 940 for cal31, 197e;r 1976 is d~e on or before January 

Posits i · However, 1f you made timely de-

~ear, y~full payment of the tax due for the 

ebruary ~ay file the return on or before 'Ith • 1977. 

'' ere to File. n ~our 1.''a. OfftPrlnctpal busl-

~ 

loeatedcein or agency 

Use th~ddress 

t~~~•s' ~'r ~=u~ltJ Internal Revenue Service Center llStcJi-- Uffolk, Ind 1040 Waverly Avenue :~ ...... Holtsville, New York 11799 ltts) 'tor\ ( I ~ Conn:J.other coun- Internal Revenue Service Center ~•11111ih"'8tb'~· Maine, 310 Lowell Street 1

~ 

ll•nd hi111, Rhoe! ew Andover, Massachusetts 01812 

~~---"Of ~lurnbi;la,--~-------- 1\ayfvinia •ryland, ~n \'0la1R:::i; ~~~1:_~entar 

m~gelphla, Pennsylvania 

Alabama, Aorida, 

Georeia, Mississippi, South Carollna 

Michigan, Ohio 

Arbnsas, Kansas, 

Louisiana, New Mexico, Oklahoma, Texas 

Alaska, Arizona, Colo· rado, Idaho, Minnesota, 

Montana, Nebrnka, Ne- vada, North Dakota, Ora· eon, South Dakota, Utah, Washington, Wyoming 

Illinois, Iowa, Missouri, Wisconsin 

California, Hawaii 

Indiana, Kentucky, North Carolina, Tennessee, 

Virginia, West Virginia 

Internal Revenue Service Center 4800 Buford Hl&hway Chamblee, Geor1ia 30006 

Internal Revenue Service Center Cincinnati, Ohio 45298 

Internal Revenue Service Center 3651 S. Interregional Hwy. Austin, Texas 78740 

l nternal Revenue Service Center 1160 West 1200 South St. Ogden, Utah 84201 

I ntemal Revenue Service Center 2306 E. Bannister Road Kansas City, Missouri 64170 

I ntemal Revenue Service Center 5045 East Butler Avenue Fresno, California 93888 

Internal Revenue Service Center 3131 Democrat Road Memphis, Tennessee 38110 

If you have no legal residence or principal place of business in any Internal Revenue Service dis- trict, or if your principal place of business is in Puerto Rico, file Form 940 with the Internal Rev- enue Service Center, 11601 Roosevelt Boulevard, 

Philadelphia, Pennsylvania 19155. 

Deposit Requirements.-You must deposit Federal unemployment tax in an 

authorized commercial bank or a Federal 

Reserve bank. Deposits must be made in 

accordance with instructions on the reverse 

of Federal Tax Deposit Form 508 which must 

accompany each deposit. 

You must compute Federal unemployment 

tax on a quarterly basis. Deposit any amount 

due on or before the last day of the first 

month, following the close of the quarter. (If 

you do not qualify as an employer until the 

second or third quarter, your deposit requirements do not begin until the end of the second or third quarter, respectively.) 

To determine whether you must make a 

deposit for any of the first three quarters in 

19n, compute the total tax by multiplying 

by .007 that part of the first $4,200 of each 

of your employee's annual wages you paid 

during the quarter. 

If the amount subject to deposit (plus the 

amount subject to deposit for any prior quarter but not deposited) is more than $100, 

deposit it during the first month following 

the quarter. If the amount is $100 or less, 

you do not have to deposit it, but you must 

add it to the amount subject to deposit for 

the next quarter. 

If the tax reportable on Form 940 less 

amounts deposited for the year is more than 

$100, you must deposit the entire amount. 

If your tax for the year (less any deposits) is 

$100 or less, you may either deposit the tax 

or send payment with Form 940. 

If you deposited the proper amounts in 

accordance with these rules, the balance due 

on line 23 will not exceed $100. 

How to Make Deposits.-Fill in a preinscribed Federal Tax Deposit Form 508 in 

accordance with its instructions. 

Send the Federal tax deposit form and 

your tax deposit to a commercial bank qualified as a depository for Federal taxes, or to 

a Federal Reserve bank, in accordance with 

instructions appearing on the reverse of the 

Federal tax deposit form. Make your check 

or money order payable to that bank. 

The timeliness of deposits is determined 

by the date the commercial bank depository 

or Federal Reserve bank receives them. A 

deposit received after the due date will be 

considered timely if you establish that you 

mailed it two or more days before the due 

date. 

Employer's Name, Address, and ldentifi· 

cation Number.-Use the preaddressed 

Form 940 mailed to you. If you must use a 

nonpreaddressed form, type or print your 

name, trade name, address, and employer 

identification number on it. 

Penalties and lnterest.-Avoid penalties 

and interest by filing a correct return and 

paying the proper amount of tax when due. 

The law provides a penalty for late filing 

unless you show reasonable cause for the 

delay. If you file late, attach an explanation. 

There are also penalties for willful failure 

to pay tax, keep records and make returns, 

and for filing false or fraudulent returns. 

Taxpayers who willfully claim credit on the 

record of Federal tax deposits or on line 22 

for deposits not made are subject to fine 

and/or other criminal penalties. 

Credit for Contributions Paid into State 

Funds.-You are entitled to a credit against 

your Federal unemployment tax for contri· 

butions you pay into a certified State unemployment compensation fund on or before 

the due date of Form 940. 

The term "contributions" means payments required by a State law to be made 

into an unemployment fund by any person 

on account of having individuals in his or 

her employ, to the extent that such payments are made without being deducted or 

deductible from the remuneration of individ· 

uals employed. 

You may credit contributions against the 

tax whether or not you paid them with respect to "employment." You may not take 

credit for voluntary contributions or for penalties or interest you pay to a State. 

Credit for contributions you make after 

the due date (or extended due date) for filing 

Form 940 may not exceed 90 percent of the 

amount that would have been allowable if 

you had paid the contributions on or before 

the due date. 

Employers who have been granted an 

experience rate lower than 2.7 percent by a 

State for the whole or part of the year are 

entitled to an "additional credit." This is 

equal to the difference between actual contributions and the amount they would have 

been required to contribute at (1) the high· 

est rate applied by the State, or (2) 2.7 percent, whichever is lower. 

Section 3302(e) of the Code provides a 

special credit if an employer during any calendar year acquires substantially all of the 

property used in the trade or business (or in 

a separate unit of a trade or business) of 

another person who is not an "employer" 

and immediately after the acquisition the 

successor employs in the trade or business 

one or more individuals who immediately 

prior to the acquisition were employed in 

the trade or business of the predecessor. 

This special credit is not allowable to any 

successor employer whose predecessor also 

is an "employer," nor is it allowable to a 

corporation acquiring the trade or business 

of another corporation in a statutory merger 

or consolidation. The amount of the special 

credit is based on the amount of remunera· 

tion, subject to the unemployment compensation law of a State, paid by the predecessor to those employees who were employed 

by the predecessor immediately before the 

transfer of the trade or business (or separate 

unit thereof) and who also were employed 

by the successor immediately after the 

transfer. 

The total credit allowable under Section 

3302 may not exceed 2.7 percent of taxable 

wages. 
Computation of Credit Against Federal Unemployment Tax 

Experience Rate.-lf a State has grant· 

ed you an experience rate lower than 

2.7 percent for all or part of the taxable 

year, use columns 1 through 9. If you 

have not been granted an experience rate 

use columns l, 2, 3, and 9 only. If you 

have been granted an experience rate 

of 2.7 percent or higher, use columns 

1, 2, 3, 4, 5, and 9 only. 

If a State has granted you an experience 

rate on part of your payroll, enter .separately in columns l, 2, 3, and 9, that part 

to which the experience rate does not 

apply. 

If you were granted an experience rate 

for only part of the year or your experience 

rate was changed during the year, show 

in the appropriate columns the period to 

which each separate rate applied, your 

payroll, rate of contributions, and required 

contributions for each period. 

Column 1.-Enter the name of the 

State or States (including Puerto Rico) to 

which you were required to pay contributions. 

Column 2.-Enter your State reporting 

number as shown on your State contribu· 

tion return. If you had a place of employment in more than one State, enter the 

reporting number assigned to you by each 

State. 

Column 3.-Enter the taxable payroll 

on which you must pay contributions to the 

unemployment fund of the State shown in 

column 1. If you have been granted an 

experience rate of zero, enter the amount 

on which you would have had to make con· 

tributions if that rate had not been granted. 

Column 4.-Enter the period(s) of the 

year to which the experience rate(s) 

applies. 

Column 5.-Enter the experience 

rate(s) the State(s) granted you for the 

period(s) shown in colum" 4. 

Column 6.-Multiply the payroll in column 3 by 2.7 percent and enter the result 

in column 6. 

Column 7.-Multiply the payroll in col· 

umn 3 by the "experience rate" in column 

5, and enter the result in column 7. 

Column 8.-Subtract the amount in col· 

umn 7 from the amount in column 6 and 

enter the result in column 8. If zero or less, 

enter zero (0). 

Column 9.-Enter in column 9 the 

amount of contributions actually paid into 

the State fund. 

Line 10.-Enter the sum of columns 8 

and 9. Also include any special credit as 

explained below. 

Line 19.-Enter in the appropriate 

line the amount (if any) of wages, as defined in the Federal Unemployment Tax 

Act, paid in 1976 which are subject to the 

unemployment compensation law of Vermont or Washington or are otherwise attributable to those States. (If in doubt, ask 

Computation of Taxable Wages 

Line 11.-Total remuneration (including exempt remuneration) PAID during the 

calendar year for services of employees.-

Enter on line 11 the total remuneration for 

services you paid employees during the 

calendar year, regardless of whether that 

remuneration is taxable. It should include 

salaries, wages, commissions, fees, bo· 

nuses, vacation allowances, salaries and 

wages paid to temporary or part-time employees, the value of goods, lodging, food 

and clothing, and all amounts deducted 

from employees' wages as employee tax 

or as deductions for other reasons. 

The basis on which you pay the remuneration is immaterial in determining 

whether it constitutes wages. Thus, you 

may pay it on the basis of piecework or a 

percentage of profits, and you may pay it 

hourly, daily, weekly, monthly, or annually. 

. .... 

You may pay the remuneration in cash 

or in some other medium, such as goods, 

lodging, food or clothing. Compute re· 

muneration paid in items other than cash 

on the basis of the fair value of the items 

at time of payment. 

Exempt Remuneration.-The terms 

"wages" and "employment" as defined 

for Federal unemployment tax purposes 

do not include every payment of remu· 

neration to an employee and every kind 

of service which an employee may per· 

form. In general, any remuneration which 

is excluded from "wages" and any remuneration for services which are ex· 

cepted from "employment," are not in· 

eluded in the total wages subject to the 

tax. These remuneration payments may 

be deducted from the total remunera· 

tion paid only if they a·re identified on 

line 12. 

your local Internal Revenue Service office.) 

Such amounts, multiplied by .003, are a 

credit reduction required by Internal Rev· 

enue Code section 3302(c)(3). If there 

were no wages paid attributable to these 

States, enter "none" or "O" in the appro· 

priate spaces on line 19. 

Special Credit.-lf you are claiming 

special credit as a successor employer, 

attach a statement showing (a) the name, 

address, and employer identification nurn· 

ber of your predecessor, (b) how you a~· 

quired your predecessor's trade or bus1

• 

ness (or a separate unit of it), (c) the date 

you acquired it, (d) each item in columns 

1 through 9 that applies to your precfeces· 

sor, (e) the number of individuals your 

predecessor employed immediately befor~ 

the acquisition, whom you also employe 

immediately after the acquisition, (f) the 

total remuneration subject to State unern; 

ployment compensation your predeces~0 

paid to the employees in (e) above during 

the calendar year. 

The amount of the special credit i~ d~ termined by (1) adding the "Addit1on~d 

Credit" and "Contributions actually • 

to the State" determined for your pr. e. 

cessor in step (d) above, and (2) mult1~~e ing this total by a fraction of which ·n 

numerator is the amount determin~d 1

6 step (f) above, and the denominator is th,, 

"Taxable Payroll (as defined in State Act~r paid to all individuals in the employ of ~~r· predecessor prior to your acquisition 

ing the calendar year. 

'telT1S Line 12.-Enter on line 12 such. 1 aY' as (1) agricultural labor, (2) benefr~ ~ 11 

ments for sickness or injury, un e nee workmen's compensation law, insura do· 

plan and certain employer plans, <

3i (5) 

mestic service, (4) family employmen 'ther 

certain fishing activities, and (6) any ~ore 

exempt payments or services. For hese 

detailed information with respect to.~ ra~ exemptions, see Circular E, Employer 

Guide. oxi· 

Line 13.-Enter on line 13 the apPryou 

mate number of employees to wh0111 year 

paid more than $4,200 during thexcess 

and the aggregate amount of the e em· 

above $4,200 paid to all of tho ~ you 

ployees. For example, assume th.~ each 

had 10 employees and that you par o ooO 

of them $5,000 during the year. d$is' ooO 

should be included on line 11 an ' 

on line 13 • 
Department of the Treasury 

Washington, D.C. 20220 

Official Business 

Penalty for Private Use, $ 300 

~\ NQ..>-

~ 0 

~ :z 

DC 

= FIRST-CLASS MAIL - POSTAGE & FEES PAIDTREAS. 

_ PERMIT No. G-52 ' 

, 

I 

·. 

•,