The Operation and Effect 

of the Possessions Corporation 

System of Taxation 

First Annual Report 

Department of the Treasury 

June 1978 
(.. 

t,pe Operation and Effect of the 

Possessions Corporation System of Taxation) 

First Annual Report~ 

De artment o_L_the Treasury. 

June 1978 

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

Washington, O. C. 20402 Stock No. 048·000-00315-0 

LIBRARY 

0Cf~ti1978 

ROOM 5004 

TREASURY DEPARTMEN 
THE SECRETARY OF THE TREASURY 

WASHINGTON 

JUN 2 9 1978 

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 first 

annual report entitled, "The Operation and Effect of the 

Possessions Corporation System of Taxation." 

I am sending a similar letter to Senator Russell B. Long1 

Chairman of the Committee on Finance. 

The Honorable 

Al Ullman, Chairman 

Committee on Ways and Means 

House of Representatives 

Washington, D.C. 20515 

Enclosure 

Sincerely, 

w. Michael Blumenthal 
THE SECRETARY OF THE TREASURY 

WASHINGTON 

JUN 2 9 1978 

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 first 

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 
Table of Contents 

Chapter I. Introducti on and Summary 1 

Chapter II. Puerto Rican and Federal Income 

Tax Law -- Past and Present 8 

A. Industrial Tax Exemption in 

Puerto Rico 8 

B. Section 931 of the U.S. Internal 

Revenue Code 9 

C. Section 936 of the U.S. Internal 

Revenue Code 11 

D. The Puerto Rican Tollgate Tax 

and the New Industrial Incentive Act 13 

E. Allocation of Income and Deductions 18 

Chapter III. Economic Impact 24 

A. Puerto Rican Economic Development 24 

B. Characteristics of Possessions 

Corporations 35 

c. Linkages and the Multiplier 43 

1. Backward Linkages 44 

2. The Multiplier 51 

3. Direct, Indirect and 

Total Effects 52 

4. Forward Linkages 55 

D. Impact of Changing from Section 931 

to Section 936 and of Restructuring 

the Tollgate Tax 55 

1. New Investment in Puerto Rico 57 

2. Repatriation of Dividends 63 

3. Financial Portfolios 64 

E. Possible Impact of the New Industrial 

Incentive Act 68 

Appendix A -- Operation of the Possessions 

Corporations System of Taxation in 

American Samoa, Guam, the Panama 

Canal Zone and the Virgin Islands 70 

Appendix B -- Sources and Limitations of the Data 

and Statistical Data for 1973 and 

1974 81 

Appendix C -- Tax Forms from which Data Included 

in this· Report was Obtained 91 
List of Figures and Tables 

Figure I: Total and Per Capita Gross National 

Product of Puerto Rico, 1948-1977 

(Constant 1974 Dollars} 

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, 

1960-1977 

Figure III: Current Status of 149 Exemption Decrees 

Granted Between 1960 and 1962 and 

25 

29 

Utilized by Recipient Firms 34 

Table 1: 

Table 2: 

Table 3: 

Table 4: 

Table 5: 

Table 6: 

Table 7: 

Federal Tax Expenditure Estimates 

and Projections, Possessions 

Corporation Provisions 

Federal Transfer Payments, Grants, 

"Covered Over" Taxes, and Tax 

Expenditure on Possessions Corporations 

in Puerto Rico, Fiscal Years 1968 and 

1977 

Total Manufacturing Employment in 

Puerto Rico, by Major Industry Group: 

Average for Calendar Years 1973 to 

1977 and April 1978 

Major U.S. Manufacturing Corporations 

Claiming a Reduction in Income Taxes 

in Excess of 2.4 Percent of Book 

Income Because of Section 931 or 

936 of the Internal Revenue Code 

Income and Estimated Tax Expenditure 

by Industry, 1975 

Tax Expenditure, Employment and 

Compensation of Employees by Industry, 

1975 

Tax Expenditure, Employment and 

Compensation of Employees by Size 

of Tax Expenditure Per Employee, 1975 

3 

28 

33 

36 

38 

41 

42 
Table 8: Expenditures on Materials, Labor, Plant, 

and Equipment as a Percent of the 

Value of Production by Manufacturing 

Establishments in Puerto Rico, 1972 

Table 9: Tax Expenditures as a Percent of 

Compensation of Employees, of Direct 

Expenditure in Puerto Rico, and of Direct 

and Indirect Expenditure in Puerto 

45 

Rico, for Manufacturing Industries 54 

Table 10: Destination of Shipments by Puerto Rican 

Manufacturing Industries, 1972 56 

Table 11: Income and Estimated Tax Expenditure by 

Industry, 1976 58 

Table 12: Tax Expenditure, Employment and 

Compensation of Employees by Industry, 

1976 60 

Table 13: Tax Expenditure, Employment and 

Compensation of Employees by Size of Tax 

Expenditure Per Employee, 1976 61 

Table 14: Elections under Section 936 by 

Industry 62 

Table 15: Estimated Composition of Financial 

Investments by 936 Corporations in 

Mid-1977 65 

Table 16: Sales of Bonds by the Government 

Development Bank for Puerto Rico, 

October 1976 - May 1978 66 

Table A-1: Income and Estimated Tax Expenditure 

by Possession, 1975 73 

Table A-2: Average Payroll and Employment for Tax 

Exempt Industries in the Virgin Islands, 

FY 1975 79 

Table A-3: Virgin Islands' Tax Incentive Program 

Subsidy Claims, Fiscal Years 1975 and 

1976 80 
Table B-1: Income and Estimated Tax Expenditure 

by Industry, 1974 85 

Table B-2: Income and Estimated Tax Expenditure by 

Industry, 1973 86 

Table B-3: Tax Expenditure, Employment and 

Compensation of Employees by Industry, 

1974 87 

Table B-4: Tax Expenditure, Employment and 

Compensation of Employees by 

Industry, 1973 88 

Table B-5: Tax Expenditure, Employment and 

Compensation of Employees by Size of 

Tax Expenditure Per Employee, 1974 89 

Table B-6: Tax Expenditure, Employment and 

Compensation of Employees by Size of Tax 

Expenditure Per Employee, 1973 90 
CHAPTER I. INTRODUCTION AND SUMMARY 

In 1975 and 1976, Congress considered a series of 

proposals to change Federal taxation of income from 

exporting and foreign investment. Having at first 

contemplated repeal of section 931, which exempted from 

Federal taxation the income of companies incorporated in the 

United States* but operating primarily in Puerto Rico, 

American Samoa, Guam, and the Panama Canal Zone, Congress 

~nstead passed a new section 936. The new section was 

intended to maintain tax incentives to invest in Puerto Rico 

and the possessions, but to encourage U.S. companies to 

bring money home to the United States if it could not be 

Profitably reinvested in the local economy. Replacing 

section 931 with 936 was expected to reduce the Federal tax 

expenditure attributable to the possessions corporation 

system of taxation by $10 million in calendar year 1977, 

roughly 4 percent of the then estimated total tax 

expenditure of $285 million.** 

The operation and effect of the possessions 

corporation system of taxation were not completely 

Understood. Thus, the staff of the Joint Committee on 

Taxation, adopting similar language to that used in the 

Reports of the House Committee on Ways and Means and the 

Senate Committee on Finance, stated in its General 

!xplanation of the Tax Reform Act of 1976: 

*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 

~nly the fifty states and the District of Columbia. The 

tanama Canal Zone was never a U.S. possession, but has been 

reated as such under the U.S. Internal Revenue Code. 

**See Special Analysis F, "Tax Expenditure," in Special 

~alyses of the Budget of the United States Government for 

!!seal Year 1977 (January, 1976), and "Estimates of Federal 

~ax Expenditures," Prepared for the Committee on Ways ~nd eans and Committee on Finance by the staff of the Joint 

Committee on [Internal Revenue] Taxation, (March 15, 1976). 

2sa-soa o - 78 - 2 
-2-

"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 

possessions. These reports, which are to begin with 

a report for calendar year 1976, are to be 

submitted to the Congress within 18 months 

following the close of each calendar year."* 

The body of this First Annual 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 the impact on Puerto Rico, and as indicated in 

Table 1, Puerto Rico accounts for over 98 percent of the tax 

expenditure associated with section 931 or 936 of the 

Internal Revenue Code. Appendix A of this Report describes 

the system of taxation as it affects American Samoa, Guam, l 

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 931 or 936, the taxation of U.S. 

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 tax 

laws of the United States and those of the Commonwealth. This 

Report first reviews those tax laws and then undertakes an 

economic analysis of their impact. The review begins with 

Puerto Rico's Industrial Incentive Acts, which have provided 

exemptions from income, property, and other taxes 

*Pages 277-8. 
;t 

id 

15 

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a 

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I • 

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_Year 

1973 

1974 

1975 

1976 

1977 

1978 

1979 

1980 

1981 

1Y82 

1983 

-3-

Table 1 

Federal Tax Expenditure Estimates and Projections, 

Possessions C.Orporation Provisions 1/ 

(millions of dollars) -

Reduction in Calendar Fiscal Year 

Year Tax Liabilities Recei;EtS Foregone y 

: Conpanies Operating in: : Conpanies Operating in: 

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

Total :Puerto Rico Possessions Total :Puerto Rico Possessions 

255 250 5 239 y 234 y sy 368 362 6 289 284 5 

440 437 3 390 385 5 

634 630 4 498 495 3 6~8 693 5 663 659 4 

673 668 5 687 682 5 

741 735 6 703 698 5 

814 808 6 774 768 6 

896 889 7 850 844 6 

985 978 7 936 929 7 

1,084 1,076 8 1,029 1,022 7 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

.!/ The 1973 through 1975 figures are estimates based on incane data taken primarily 

fran election form.s (Form 5712). The 1976 figures are estimates based on the 

1975 to 1976 growth rate of income by broad industry groups for those coapanies 

for which data for both years was available. The 1977 figures are estimates 

based on the 1976 to 1977 increase in manufacturing employment in Puerto Rico. 

Figures for 1978 and all subsequent years are projections based on an assumed 10 

percent growth rate. All figures are based on the assurrption that in the 

absence of the possessions corporation provisions, the income of possessions 

corporations would be subject to an effective Federal corporate tax rate of 40 

percent. For companies operating in Puerto Rico, the calendar year 1973 through 

1977 figures are net of estimated tax payments to Puerto Rico; the figures for 

l97b and subsequent years are net of an assumed 5 percent effective Puerto Rican· 

(corporate plus tollgate) tax rate. N:>te 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 tax credit, or with 

regard to Puerto Rican taxes, which are taken into account in computing the tax 

expenditure figures. 'Iherefore, the actual section 936 credit claimed will 

exceea the tax expenditure figure for the corresponding year. 

31 Calculated on the basis of normal relationships between calendar year corporate 

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

30 of the corresponding calendar year; thereafter on September 30. The 

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

that quarter is $95 million. 

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

to have been 10 percent lower than the estimates shown for 1973. 
-4-

for corporations manufacturing in Puerto Rico, passes to 

section 931 of the United States Internal Revenue Code, and 

then describes section 936. 

The Report next describes Puerto Rico's tollgate tax on 

dividends paid to U.S. parent corporations, a tax which was 

changed in 1976 in anticipation of the enactment of section 

936. The discussion then moves to the reform of the 

Industrial Incentive Act and the further modifications of 

the tollgate tax passed and signed into Puerto Rican law in 

June 1978. Finally, section 482 of the U.S. Internal 

Revenue Code, which guides the allocation of income and 

deductions between related entities is reviewed. Although 

section 482 has broader application than the possessions 

context, it is critical to the possessions corporation 

system of taxation. 

These Federal and Commonwealth tax provisions must be 

assessed against the backdrop of Puerto Rico's economic 

development. The economic growth of the Commonwealth from 

the late 1940's to the early 1970's has been termed an 

"economic miracle." Even after adjusting for price 

inflation, Puerto Rican income per capita grew at an average 

rate of 5 percent per annum. In the 1970's, however, real 

income per capita began to decline as the economy remained 

in a long recession, and many Puerto Ricans returned from 

the United States. The rate of unemployment, which had 

declined steadily through the 1960's to just over 10 percent 

of the measured labor force, went up to more than 20 percent 

in 1976 and 1977. And, were it not for the substantial 

increase in net Federal transfer payments to Puerto Rican 

individuals and Federal grants to Puerto Rican governments, 

the Puerto Rican recession of 1973-77 might have been much 

deeper. In late 1977 and the first half of 1978, the Puerto 

Rican economy has begun to recover; by April 1978 the 

unemployment rate had been reduced to 16.5 percent, its 

lowest rate since May 1975. 

The reasons for Puerto Rico's extended recession are 

many. The U.S. economy, to which Puerto Rican industry is 

closely linked, underwent a milder recession in 1973-74, and 

has not grown rapidly since. The Puerto Rican petrochemical 

industry suffered from the sharp increase in the price of 

foreign oil in 1973-74 and the consequent suspension of 

Federal oil import quotas. The construction industry has 

been hard hit by higher construction and interest costs and 
.o 

.d 

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j 

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l 

the sharp decline 

traditional Puerto 

apparel and shoes, 

increase in U.S. 

foreign countries. 

-5-

in demand for new condominiums. The 

Rican industries, such as textiles, 

have had to compete with the sharp 

imports of these goods from low-wage 

The increasing competitiveness of foreign exports to 

the United States has accelerated a change in the industrial 

composition of U.S. companies operating in Puerto Rico. At 

least prior to the recent effective dates of the Orderly 

Marketing Agreements limiting shoe exports from South Korea 

and Taiwan, and the Multifiber Arrangements limiting textile 

and apparel exports from eighteen developing countries, 

companies manufacturing such products in Puerto Rico were 

reluctant to keep existing plants open, much less to 

construct new ones. 

Because Congress in 1976 emphasized its desire to 

continue assisting Puerto Rico in obtaining ernploymentproducing investments, the Treasury has matched income tax 

return information with employment and payroll information 

for individual possessions corporations. For all 

manufacturing industries, the Federal tax expenditure per 

Puerto Rican employee averaged $7,428 in 1975, which was 

slightly larger than the average compensation (wages or 

salary plus other benefits), $7,300, of possessions 

corporations' employees. Tax expenditure per employee or as 

a percentage of total employee compensation varies 

substantially from industry to industry. For pharmaceutical 

companies the tax expenditure represents almost $35,000 per 

employee, or approximately three and a half times the total 

compensation of the comparatively well paid pharmaceutical 

employees. At the low end of the spectrum were many of the 

traditional labor-intensive industries where the Federal tax 

expenditure usually averaged less than $3,000 per employee. 

For all manufacturers other than pharmaceuticals, the tax 

expenditure averaged about $4,100, which was 50-60 percent 

of those employees' average compensation. 

In addition to the employment and payroll directly 

attributable to possessions corporations, Puerto Rico 

receives indirect benefits from this system of taxation. 

Manufacturing requires raw materials, intermediate goods, 

and services, a portion of which are supplied by the local 

economy. New investment in plant and equipment creates jobs 
-6-

in the construction and capital equipment industries. 

Workers in all industries spend their salaries on goods and 

services, which has a "multiplier" effect on the Puerto 

Rican economy. Including the estimated value of these 

"backward linkages" and multiplier effects significantly 

increases (and arguably overstates) the measure of the total 

benefit Puerto Rico receives from the possessions 

corporation system of taxation. Because all industries 

exhibit backward linkages and have a multiplier impact on 

the local economy, the ratio of this broader measure of 

Puerto Rican benefits to Federal tax expenditure varies from 

industry to industry, much as the narrower measures do. 

The impact of changing from section 931 to 936 is 

difficult to separate from the effects of changes in the 

Puerto Rican tollgate tax, which became effective on the 

same date, and from other contemporary events. The rate of 

new investment and of dividend payments was very slow 

throughout 1977. In early 1978, the Puerto Rican government 

approved a number of new applications for tax exemption, 

many of which may have been either delayed during 1977 or 

accelerated by the anticipated announcement of the new 

Industrial Incentive Act. Dividend payments have also 

accelerated in 1978; as of early June, more than $1.4 

billion in dividends have been declared, giving rise to $48 

million in Puerto Rican tollgate taxes. Several changes in 

1977 in the tollgate tax rules (especially the exemption for 

dividends paid out of non~Puerto Rican income) reduced the 

effective rate from the statutory 10 percent to less than 5 

percent. 

Because section 936 benefits are not available for 

income earned outside the possession where the corporation 

has a trade or business, but do apply to "qualified 

possessions source investment income," possessions 

corporations have had to restructure their substantial 

portfolios of financial assets. Eurodollar deposits have 

been replaced by substantial investments in Puerto Rican 

banks, Puerto Rican mortgages guaranteed by the Federal 

Government National Mortgage Association (GNMA), loans to 

other 936 companies, tax-exempt bonds (including Puerto 

Rican) and the preferred shares of U.S. corporations. To 

date, the special provision for "qualified possessions 

source investment income" does not appear to have had a 

material impact on long-term interest rates or credit 

conditions for the average Puerto Rican borrower. 
The June 1978 changes in the Puerto Rican Industrial 

Incentive Act and the tollgate tax are complex and will not 

become fully effective until 1979. Preliminary analysis 

suggests, however, that the combined efffective rate of 

income and tollgate taxation may be approximately 5 percent. 

If so, and if the level and composition of investment by 

possessions corporations and other aspects of their behavior 

are not materially affected by this tax increase, the 

Federal tax expenditure will be reduced in 1978 and the near 

future by one eighth (because the Federal taxes foregone 

Will represent 35 percent, rather than the currently 

estimated 40 percent, of pretax income). 
-8-

CHAPTER II. PUERTO RICAN AND FEDERAL INCOME 

TAX LAW PAST AND PRESENT 

A. Industrial Tax Exemption in Puerto Rico 

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 qualified firms an exemption 

from income, property, and municipal taxes, while the excise 

tax act exempted raw materials, machinery, and equipment 

used in rnanuf acturing for export or sold to other 

manufacturers in Puerto Rico. 

Originally, it was contemplated that the period of 

total 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. Tax exemption was restricted to items not produced on ' 

a commercial scale in Puerto Rico prior to 1948 and to 

certain other specified items, such as wearing apparel and 

processed food products. The 1948 legislation also provided 

for exemption from Puerto Rican taxes for a distribution of 

dividends to a parent outside Puerto Rico if the parent was 

unable to claim a foreign tax credit for the withholding 

tax. Finally, liquidation of an exempt company would be tax 

free, provided that the liquidating company was at least &O 

percent owned by its parent. 

Many firms established plants in Puerto Rico in the 

early 1950's in response to these incentives. Textiles were 

the fastest growing industry, but shoes and other leather 

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. 
-9-

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 sought to limit the ability of an 

old 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 exempted 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. 

As the 1950's drew to a close and some of the original 

grantees approached the end of their exemption periods, 

Pressure for further revisions in the Industrial Incentive 

Act began building. 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 

~ostpone the start of the exemption period for two years and 

0 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 1970's, Puerto Rico redefined the 

t(ax-exe~ption zones and lengthened some exempti~n periods 

exemptions of 10, 15, 25, or 30 years became available). An 

amendment was introduced classifying passive income from 

~ertain financial investments in Puerto Rico as "industr~al 

evelopment income," benefitting from the same tax exemption 

as trade or business income. This provision sought to 

enco~rage the possessions corporations to invest a larger 

Portion of their earnings in Puerto Rico. 

B. Section 931 of the U.S. Internal Revenue Code 

R The essential elements of section 931 of the Internal 

evenue Code of 1954 became part of U.S. law as section 262 

~f the Revenue Act of 1921. Proponents of this legislation 

ad sought exemption for any u.s. corporation deriving at 

2&8-so8 o - 78 - 3 
-10-

least 80 percent of its income from foreign sources. They 

stressed the competitive disadvantage of American firms in 

comparison to their British rivals. English law deferred 

taxation on foreign income until it was remitted to England, 

while the United States taxed the foreign income of U.S. 

corporations as it was earned.* The proponents settled 

ultimately for an exemption for firms deriving income from 

U.S. possessions. 

The reduction in the coverage of this legislation, from 

the whole world to the U.S. possessions, is not as 

astonishing as it might seem. The demand for exemption came 

primarily from a group of U.S. firms then operating in the 

Philippines (a U.S. possession in 1921). They argued that 

tax exemption would encourage export trade to the Far East 

from the U.S. base in the Philippines, while at the same 

time reducing the incentive for the 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; Puerto Rico was virtually ignored in the 

public debate. 

Under the terms of section 931 (as subsequently 

amended) a U.S. corporation deriving at least 80 percent of 

its gross income from sources within a U.S. possession 

(currently Puerto Rico, American Samoa, Guam, the Panama 

Canal Zone, and certain other areas) and at least 50 percent 

of its gross income from the active conduct of a trade or 

business therein could exclude from its gross income for 

Federal tax purposes all foreign-source income except that 

received within the United States. The corporation had to 

meet the 80 percent and 50 percent tests for the current and 

preceding two taxable years (or less if it was just 

initiating operations). Corporations that satisfied these 

requirements came to be called "possessions corporations," 

"931 corporations," or sometimes simply "93l's". Such 

corporations were usually organized as subsidiaries of U.S. 

parent companies in order to assure that 80 percent of gross 

income had its source in one or more possessions. 

*At the time, U.S. companies generally preferred 

incorporate subsidiaries under foreign laws; 

operations were initially conducted through either a 

of the U.S. parent or a u.s.-chartered subsidiary. 

not to 

foreign 

branch 
-11-

i A 931 corporation would often operate at a loss for the 

l first year or two. (Even an older corporation that had been 

j Profitable could suffer a loss from time to time.) In 1971, 

the Tax Court ruled that a company was not "receiving the 

benefits" of section 931 in a year in which it lost money, 

j so it could join its parent and other affiliated 

n corporations in filing a consolidated return for such a 

Year. The owner of a 931 thus avoided taxes in profitable 

¥ears but was able to offset any loss against other, taxable 

n income in unprofitable years. 

J 

r 

A 931 corporation usually avoided earning or receiving 

any taxable income within the U.S. and, thus, was wholly 

exempt from federal taxation on its earnings. In the 

majority of cases the 93l's were engaged in manufacturing 

activity that qualified them for exemption from Puerto Rican 

taxes as well. Thus, for the period of the Puerto Rican 

exemption (10 to 30 years) the 931 had a tax holiday. 

In the United States, however, the parent corporation 

could not claim a dividends-received deduction for dividends 

from a 931, so the dividend would be taxable upon receipt by 

the parent. To avoid payment of this tax, the typical 931 

accumulated its earnings, investing them (tax free) in the 

Eurodollar market. {Because the income was not taxable as 

earned, the company was not subject to the Federal 

accumulated earnings tax.) After a number of years (usually 

;t the end of its period of Puerto Rican tax exemption) the 

31 would be liquidated into its parent. If it was at least 80 Percent owned by a U.S. corporation (as was generally the 

~ase), the liquidation was free of any federal income tax. 

o, although the parent had to wait for the liquidation to 

~eceive the accumulated earnings, those earnings would be 

ree of either Puerto Rican or Federal income taxes. 

c. Section 936 of the U.S. Internal Revenue Code 

The Tax Reform Act of 1976 removed possessions 

corporations from section 931 and placed them in a newly 

~reated section 936. The primary differences between 

ections 931 and 936 are: 
-12-

1. The method of effecting the exemption changed: 

instead of excluding income, section 936 provides a 

credit to offset any U.S. tax on income from the active 

conduct of a trade or business in a possession, or on 

"qualified possessions source investment incomeu 

(interest, dividends, and other types of passive income 

earned on funds invested for use in a possession in 

which a trade or business is actively conducted). 

Because the section 936 credit offsets the U.S. tax 

liability on this income, a 936 corporation cannot also 

claim a foreign tax credit for taxes actually paid with 

respect to such income. A foreign tax credit offsets 

U.S. taxes only on income ineligible for the section 

936 credit. 

2. The dividends-received deduction can be 

claimed, so the parent pays no tax on dividends 

received from a wholly owned 936 subsidiary. This iS 

true not only for dividends paid out of current 

earnings, but also for dividends from earnings 

presumably accumulated while the subsidiary qualified 

under section 931. Because the parent is entitled to 

the dividends-received deduction, it cannot claim a 

foreign tax credit for a withholding tax on the 

dividend. 

3. 

section 

years. 

parent 

delay 

begin. 

The subsidiary must elect the benefits of 

936, and that election is irrevocable for 10 

During this period it cannot Join with itS 

in filing a consolidated return, although it can 

electing 936 status until profitable years 

Although most observers in 1976 appeared to believe 

that section 936 would make investing in Puerto Rico more 

attractive than it had been under section 931, the change 

had negative, as well as positive, components. On the one 

hand, section 936 does not allow possessions corporations to 

avoid Federal taxes on Eurodollar and other foreign income1 

as section 931 had. On the other hand, a primary obstacle 
a 

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ne 

LO 

~ . 

iX 

50 

:h 

:s 

)0 

-13-

to paying dividends (and, thus, an inducement to 

earnings) was removed by allowing the parent a 

received deduction.* 

accumulate 

dividends 

In explaining its motives, Congress cited its desire to 

leave undisturbed the tax exemption of earnings from a trade 

or business in Puerto Rico or from investments made with 

those earnings for use in Puerto Rico. At the same time, 

Congress desired to end the exemption for passive income 

from funds invested in foreign capital markets and to hasten 

their repatriation. Congress stated that it wanted to 

"assist the U.S. possessions in obtaining employmentproducing 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."** 

lt D. The Puerto Rican Tollgate Tax and the New Industrial 

JS Incentive Act ~d 

>f 

0 

:S 

tn 

·s 

e 

·e 

e 

e 

lO 

e 

Prior to October 1, 1976, the Puerto Rican government 

imposed a 15 percent tollgate tax on dividends paid out of 

Puerto Rican income from hotels, manufacturing and shipping 

to any corporation without significant business of its own 

in Puerto Rico, but only if that nonresident parent 

corporation could claim a foreign tax credit for the tollgate tax. In the United States a foreign tax credit was 

available until 1976, but because dividends were rarely 

Paid, the tollgate tax was rarely applicable, and the 

foreign tax credit little used. Anticipating the passage of 

section 936 and the other Federal provisions relating to 

--~-------------·-·--

*The dividends-received deduction eliminates the need to 

liquidate a possessions corporation to repatriate earnings 

free of Federal taxes; in the past liquidation was often 

accompanied by an actual cessation of operations and 

discharge of workers. The provisions of Puerto Rican law 

Which lead to this regretable practice were ameliorated, but 

not wholly eliminated, in the recent (June 1978) reforms of 

the Industrial Incentive Act. 

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

Representatives, on H.R. 10612, Report No. 94-658, 

November 12, 1975, pg. 255; and Report of the Committee on 

Finance, United States Senate, on H.R. 10612, Report No. 

94-938, June 10, 1976, pg. 279. 
-14-

possessions corporations, the Puerto Ricans in 1976 modified 

their 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. 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.* 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. 

Although the 10 percent tollgate rate 

1976 remains, the effective rate has been 

reduced by a series of amendments and rulings. 

instituted in 

subsequently 

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 percent, 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 

*The 10 percent tollgate tax does not apply to a resident 

parent corporatibn (e.g., a U.S. manufacturer which 

wholesales and retails its products in Puerto Rico). 

Dividend payments to such a corporation would, however, 

initially be subject to the regular Puerto Rican income tax, 

which has a maximum statutory rate of 45 percent. The 85 

percent dividends-received deduction in Puerto Rico would, 

however, reduce the effective rate on dividends from a 

possessions corporation to such a resident parent 

corporation to no more than 6.75 percent (45 percent of 15 

percent). Thus, a U.S. parent corporation resident in 

Puerto Rico is taxable in Puerto Rico on its dividend income 

from a possessions corporation, but the effective rate of 

taxation is less than the 10 percent tollgate tax applicable 

to dividends paid to nonresident U.S. parent corporations. 
l 

{ 

3 

n 

n 

r 

t 

n 

I 

5 

a 

t 

5 

n 

e 

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-15-

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 the designated 

Puerto Rican assets for a period of at least 8 years. 

3. Dividends paid out of income from interest on 

the 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. 

In December 1977, the Puerto Rican Treasury issued 

r~gulations clarifying the exemption paid out of non-Puerto 

Rican income earned outside 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 is deemed to consist of 50 percent exempt 

foreign-source income. That is to say, the tollgate tax in 

these instances equals 5 percent of the total dividend. 

In March 1978, Governor Romero Barcelo made his long 

~Waited proposals for restructuring the Industrial Incentive 

ct; after debate and minor revisions, the Puerto Rican 

~egislature enacted the Governor's program on June 2, 1978. 

he primary features of the new legislation 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 years, 65 percent in the eleventh 

to fifteenth years, and 55 percent the sixteenth to the 
-16-

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. 

3. The regular tollgate tax will be reduced 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. In the 

past, accumulated Puerto Rican income was exempt from 

the tollgate tax if distributed upon liquidation of the 

company. 

5. Export-oriented service industries (architectectural, insurance, engineering, management consulting 

firms, etc.), which had been fully taxable under prior 

law, will be able to exempt 50 percent of their 

export-service income, providing that 80 percent of 

their employees are residents of Puerto Rico and 80 
-17-

percent of the cost of the services was incurred in 

Puerto Rico. 

The new law also contains provisions permitting 

currently tax-exempt corporations to elect to move to a 

Partially exempt status. The election, which may apply to 

either the current or the coming fiscal year, 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 elect in April 1979 (the usual 

filing date) to become partially taxable for either 1978 or 

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

taxes actually due would be filed in April 1980. 

The election is subject to the following 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 2u years 

:Maximum Effective 

:Exemption Tax Rate 

:Percentages: 

73.3 

77.7 

85.5 

90.0 

91.0 

93.3 

(percent) 

12.0 

10.0 

6.5 

4.5 

4.0 

3.0 

After the period of original exemption has ex~ired, 

the companies electing this option are autom~tically 

entitled to operate partially_exempt_frorn taxation for 

ten more years. During the first five of th~se ten 

Years, 50 percent of income will be exempt; during the 

second five years, between 35 perc~nt and 50 percent 

~depending on the location of the investment) of total 

income will be exempt. 

2. Companies with six or more years remaining on 

their current tax exemption may make an alternative 

268-so8 o - 78 - 4 
-18-

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 providing 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, providing 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. Finally, 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 add1t1onal five years. 

The probable effects of these changes are analyzed 

below. 

E. Allocation of Income and Deductions 

Under section 482 of the Internal Revenue Code, the 

Internal Revenue Service may reallocate income, deductions 

or credits among two or more corporations under common 

ownership so as to prevent evasion of taxes. Nowhere has the 

application of section 482 been more controversial than to 

transactions between a o.s. parent and its possessions 

corporation. 
-19-

Section 482 cases involving possessions corporations 

first surfaced in the 1950's. In determining what 

percentage of a subsidiary's income came from a possession 

rather than the United States, the Internal Revenue Service 

had initially ruled that exports from the subsidiary to the 

parent could be priced so as to attribute to the parent only 

the prof it margin normally earned by an independent 

distributor. In some, but not all, cases, the Service 

subsequently clarified its initial ruling to indicate that 

it applied only to the 50 percent and 80 percent tests of 

eligibility for section 931 benefits. Some other income 

allocation rule would be used under section 482 to determine 

the tax liability of the parent. 

In August, 1959, Governor Munoz Marin of Puerto Rico 

formally protested to the Secretary of the U.S. Treasury 

that Puerto Rico was not a tax haven, but that the Internal 

Revenue Service's 482 position was hurting Puerto Rico's 

ability to attract U.S. investment. Furthermore, because a 

few 931 subsidiaries of U.S. parents never had a Puerto 

Rican tax exemption, and because many exemptions would 

expire in the future, section 482 cases might diminish 

Puerto Rican tax collections. Although the Federal 

government never accepted the Governor's proposal that a 

Federal-Commonwealth unit (analogous to the competent 

authority procedures incorporated into many bilateral tax t~eaties) be established for resolving transfer-pricing 

disputes, pending section 482 cases were suspended from 1961 

to 1963 while the Internal Revenue Service reviewed its 

transfer pricing standards. 

In the early 1960's the Treasury and Internal Revenue 

~ervice were increasingly aware of transfer-pricing problems 

ln taxing foreign income, and Puerto Rico presented an acute 

case of a more general problem. Although the new rules set 

forth by the Service in early 1963 were applicable only to 

transactions between possessions corporations and their U.S. 

Parent, the 1963 rules became the foundation for the 

9enerally applicable section 482 regulations issued five 

Years later. 

. The 1963 guidelines noted four situations where an lm~roper shifting of profits might occur and a section 482 

adJustment would be appropriate. 
-20-

1. When the 931 subsidiary 

parent for exports. 

overcharged its 

2. When the 931 subsidiary sold to an 

third party, but derived a benefit from some 

asset belonging to the parent (e.g., a 

trademark) without paying an appropriate fee 

to its parent. 

independent 

intangible 

patent or 

or royalty 

3. When the parent undercharged its subsidiary for 

raw materials or component parts furnished by the 

parent. 

4. When the parent incurred 

on behalf of its subsidiary without 

to the subsidiary. 

a direct 

charging 

expense 

it back 

In determining appropriate transfer prices, the general 

standard was always to be the arm's-length price, that which 

would have applied to a comparable transaction between 

unrelated parties. In any given instance, the specific 

methods for applying the general standard were ranked as 

follows: 

1. Directly Applicable Independent Prices. In some 

instances, the subsidiary or the parent may sell the 

same product to, or buy the same product from, 

independent parties. If so, the price used in these 

transactions should also be used for the inter-affiliate 

transactions. 

2. Independent Prices for Similar Products. Even 

though the parent and the subsidiary deal 

exclusively with one another, the same or similar 

product may be bought and sold by others at an 

identifiable price. This price should be used only if 

the first method cannot be applied. 

3. Other Methods. If the two prior methods availed 

nothing, then the parent should establish how much the 

product would have cost if purchased from an independent 

U.S. manufacturer. This price would include all 

relevant U.S. costs of production plus a reasonable 

profit margin. 
s 

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-21-

Under this last method, if a product could be 

manufactured in Puerto Rico and shipped to the United States 

more cheaply than it could be manufactured in the United 

States (for example, because Puerto Rican labor is usually 

cheaper than mainland labor), the additional profit from 

manufacturing in Puerto Rico would be allocable to the 

subsidiary. If the opposite were the case (for example, 

because transport costs were higher), the Puerto Rican 

subsidiary would earn less than a U.S. manufacturer would. 

~ The most difficult and contentious cases, the 1963 

ruling noted, typically involve intangible property: 

patents, trademarks, brand names, access to established 

~ marketing and distribution channels, and goodwill with 

~ customers. For example, in the pharmaceutical industry, 

manufacturing and distribution costs are a small fraction of 

the selling price. The large profit margins reflect a 

return on valuable intangibles, such as a patent on the 

product. The value of a patent may, in turn, reflect 

substantial outlays for past research and development. If 

R&D is to be economical, the ultimate profits must cover not 

only the cost of the projects yielding commercial products 

but the losers" as well. Regardless of whether current 

Profits represent a low, reasonable or high return on past 

R&D, the tax saving of assigning those profits to a 

tax-exempt subsidiary can be substantial. 

Because the total profit margin (i.e., that on 

manufacturing and distribution) often includes an implicit 

return on patents, trademarks, goodwill, etc., appropriate 

transfer prices can be established only by first determining 

~hether the mainland parent or the 931 affiliate owns the 

intangibles. In some instances, an intangible asset could 

not possibly be owned by the affiliate (for example, 

90odwill with customers based on the parent's own marketing 

ana distribution effort). In others, the intangible could 

have been transferred (for example, exclusive patent 

rights), but for one reason or another was not, so the 

Parent, not the subsidiary, was still entitled to the return 

0 n it. Only if the intangible property truly belongs to the 

Subsidiary could the transfer price appropriately allocate 

the return on the intangible to the subsidiary. 

These 1963 guidelines did not fully 

companies and the Puerto Rican government. 

satisfy the 

The companies 
-22-

had not engaged in careful tax planning in the past and had 

not taken care to transfer ownership of relevant intangibles 

to the subsidiaries. The Internal Revenue Service's 

guidelines would have resulted, in many cases, in 

substantial reallocations of income to the parent. An 

Internal Revenue Service Manual Supplement implementing the 

1963 guidelines was held in abeyance from 1965 to 1968, and 

section 482 cases involving possessions corporations were 

again suspended. Finally, in 1968, comprehensive 

regulations implementing, section 482 were issued, as was a 

revenue procedure allowing companies to follow the 1963 

revenue procedure instead of the 1968 regulations (with 

respect to Puerto Rican transactions only) if the results 

were more favorable. Although at least one major case 

dating back to the 1950's remains unresolved twenty years 

later, the logjam of unresolved cases was really broken in 

1968. 

Section 482 has, however, remained a problem. The 1963 

revenue procedure did not necessarily preclude parents from 

allocating substantial income to their possessions 

corporations, but did force the companies to lay a careful 

legal foundation for those allocations. After 1963, the 

creation of the subsidiary was usually accompanied by the 

execution of legal documents irrevocably assigning exclusive 

patent and other rights to the newborn company. 

Seeing that the 1963 revenue procedure and the 1968 

regulations did not materially reduce profit shifting, the 

Internal Revenue Service has brought a case against Eli 

Lilly involving a possessions corporation established to 

manufacture Darvon. Because Eli Lilly executed the legal 

documents purporting to effect the transfer of intangibles, 

the argument that the Service has traditionally used in such 

cases, that the parent and not the subsidiary is entitled to 

the return on the intangible, will be much more difficult to 

make. The Service must either argue that the original 

transfer of the patent was a sham and can be disregarded or 

find a new legal basis for denying the company the tax 

benefits it has claimed. 

Concerned by the transfer-pricing disputes, the current 

Governor of Puerto Rico, Carlos Romero Barcelo, has recently 

written the Secretary of the U.S. Treasury to protest that 

the Internal Revenue Service's practices are inhibiting 

Puerto Rico's ability to attract new investments through its 
-23-

tax exemption program. Furthermore, because some~ companies 

do not have a complete exemption, and because all are 

subject to the tollgate tax, the Governor maintains that the 

Internal Revenue Service's position could erode the Puerto 

Rican tax base. The Governor urges that the Treasury review 

the Service's practices and reaffirm its 1963 guidelines. 

In summary, then, the allocation of income between a 

U.S. parent and its tax-exempt possessions corporation has 

been a source of contention for the last twenty years. 

Because the income in question has usually been exempt from 

Puerto Rican taxation, the threat of double taxation has 

until recently been remote. Successive Puerto Rican 

Administrations have argued, however, that the Service's 

Proposed reallocations would seriously jeopardize the Puerto 

Rican industrial development program. With the recent 

changes in the Industrial Incentive Act and the tollgate 

~ax, the potential for double taxation will become more 

immediate. 
-24-

CHAPTER III. ECONOMIC IMPACT 

A. Puerto Rican Economic Development 

Although a full review of Puerto Rican economic 

development since 1947, the year of the initial Industrial 

Incentive Act, is beyon~ the scope of this study, a summary 

is useful in placing the possessions corporation system of 

taxation in perspective. 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 in 

dollar and per capita terms (adjusted for price inflation) 

from 1947 to 1977.* 

The population statistics used in determining national 

product 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 mainland). Between 1947 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.** 

*In interpreting these and other statistics on Puerto Rico, 

the reader should be aware of the distinction between gross 

national product and gross domestic product. Gross domestic 

product equals gross national product plus Puerto Rican 

income earned by foreign residents, such as possessions 

corporations, less income earned by Puerto Rican residents 

from foreign sources (the primary example being wages paid 

to Puerto Rican employees of the Federal Government). Gross 

domestic product is a measure of the total value of all 

goods and services produced in Puerto Rico in a particular 

year, whereas gross national product is a measure of the 

value of the production and income earned by residents of 

Puerto Rico. Largely because of the growth of high-profit 

possessions corporations, the ratio of gross national 

product to gross domestic product has declined from 99 

percent in 1960 to 90 percent in 1972 and to 81 percent in 

19 77. 

**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. 

$M

a,o

7,o 

s.o

5.o

4,

3

2

1
$Millions 

a.ooo 

7.ooo 

6,ooo 

s.ooo 

4.ooo 

3.ooo 

2.000 

1.000 

-25-

FIGURE I 

Total and Per Capita Gross National Product of Puerto 

Rico, 1947-1977 (Constant 1974 Dollars) 

'50 '52 '54 '56 '58 '60 '62 '64 '66 '68 '70 '72 '74 '76 '77 

Source· p . · uerto Rrco Planning Board 

268.508 o - 78 - 5 

2,400 

2,200 

2,000 

1,800 

1,600 

1,400 

1,200 

1,000 

800 

600 
-26-

Explanations for this success are many. In the late 

1940's and 1950's, Puerto Rican labor was very cheap by U.S. 

standards: per capita incomes were low, unemployment and 

underemployment were high, and federal minimum wage 

standards did not fully apply. U.S. manufacturers found 

Puerto Rico attractive compared to low-wage foreign 

countries. Puerto Rico was inside the U.S. tariff wall and 

offered a more stable political and economic climate than 

countries in Latin America or the Far East. Puerto Rico's 

tax exemption was important not only in boosting U.S. 

investors' profits, but also in symbolizing the less 

tangible, but equally important, differences between Puerto 

Rico and developing countries. 

Several studies have concluded that tax exemption has 

been crucial in inducing firms to locate one or more of 

their operations in Puerto Rico during the past 30 years. 

Company surveys conclude repeatedly that the attraction of 0 100 percent tax exemption" was the leading factor in most 

firms' decision to locate in Puerto Rico. Such findings can 

be overstated, for some firms now operating under an 

exemption probably would have been operating even without 

one. Nevertheless, while it would be difficult to determine 

how much manufacturing investment would have gone into 

Puerto Rico had a tax exemption not been available, the 

level and composition of Puerto Rican manufacturing 

investment surely reflects three decades of tax exemption. 

Puerto Rico's remarkable economic growth decelerated 

sharply in the 1970's. As one can see in Figure I, real GNP 

slowed its growth in 1974, declined in 1975, remained more 

or less stagnant in 1976, before increasing in 1977. Because 

of the influx of native Puerto Ricans returning from the 

United States, Puerto Rican GNP per capita declined steadily 

from 1973 to 1977. The traditionally high rate of 

unemployment in Puerto Rico, which had been gradually 

reduced to just over 10 percent in the late 1960's, started 

edging up in the early 1970's, and went to 21.5 percent in 

April 1977. As explained more fully below, the Puerto Rican 

economy began a · recovery in late 1977 and early 1978, and in 

April 1978, the unemployment rate was back down to 16.5 

percent. 
-27-

The prolonged recession in the Puerto Rica~ economy 

would have been deeper had it not been for offsetting 

expenditures by the Federal and Commonwealth governments. 

Total Federal transfers to Puerto Rico increased almost 

tenfold beween 1968 and 1977 -- see Table 2. By 1977, net 

Federal transfers directly to individuals (the bonus value 

of food stamps, net social security and medicare payments, 

veterans benefits, etc.) of $1.2 billion represented 15 

percent of personal income, which was two and a half times 

the 6 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 

1977, also two and a half times the 10 percent U.S. 

average. 

The efforts of the Commonwealth government to cushion 

the recession on the Puerto Rican economy are reflected in 

Figure II. Total spending by the Puerto Rican government 

~lus 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 gove~nment 

has taken over the telephone company, the sugar industry, 

and other private enterprises, and investment spending by 

P~blic enterprise has become an instrument of public 

finance.) Until 1968, total public sector borrowing 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 

b?rrowing was down to $300 million, and the premium Puerto 

Rico has paid to market its bonds has been pared. 

The reasons for the prolonged recession of the Puerto 

Rican P economy are many. F' irs t d t b an mos o v1ous · 1 y, the 

Uerto 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 1974-75, are 

transmitted to Puerto Rico. Puerto Rico's ability to offset 

eco~omic fluctuations through its own monetary or fiscal i 0 licy is limited. With the dollar as its currency and a 

R:ee flow of capital between San Juan and New York, Puerto 

ico has no real control over local interest rates or the 
-28-

Table 2 

Federal 'I'ransfer Payments, Grants, "Covered Over" 

Taxes, and Tax Expenditure on Possessions Corporations in Puerto Rico, 

Fiscal Years 1968 and 1977 1/ 

(Millions of dollars) -

Het Federal transfer payments to individuals, total 2/ 

Food stamps -

Old age, survivors, and disability insurance 

Veterans benefits 

Unenployment conpensation 

All other 

Federal grants to Puerto Rican Comnnnwealth and 

.cwnicipal govermnents, total 

Child nutrition and special milk programs 

Hwnan developnent 3/ 

Off ice of Education programs 

Public assistance 

Conmmity developnent block grants 

low rent public housing 

E'inployment and training programs 

All other 

Federal taxes "covered over" to Puerto Rican 

treasury, total 

Custoos duties 

Alcoholic beverage and tobacco excises 

Federal tax expenditure on possessions corporations 

'IOTAL 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

FY 1968 FY 1977 

68 1,235 

--no 

1 295 

59 185 

1 87 

7 5~ 

129 716 

-5 fil 

6 48 

67 

31 59 

15 49 

11 48 

7 150 

54 214 

93 223 

27 60 

66 163 

99 659 

389 2,833 

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

1977, and the Statistical Appendix to the Secretary's Annual Report 

for 1968; Office of the Governor, Cormonwealth of fuerto Rico, 

Economic Report of the Governor (various years); and U.S. Department 

of the 'Ireasury estimates. 

1/ 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 changed, beginning on October 1, 1976 

and ending 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 1977 is based on the Federal fiscal year. 

2/ All transfer payments are net of associated payments by or on behalf of - current or future recipients, such as employer, employee, and 

self-enployment contributions for OASDI. 

Y Fonnerly, "child" developnent. 

$ 

4, 

3 

3 

2 
-29-

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, 1960-1977 

$Millions 

4,000 

3,500 

3,00Q 

2,500 

2,000 

1,500 

1,000 

500 

250 

0 

·25o 

-----

Total government expenditures plus 

net investment of public enterprises 

• 

Own source revenue 

plus federal taxes covered over 

~ii" .,., 

, ____ , ,---- ,' -...... _ .... -----... ,, '~,, '~ ,,-------------------------------------

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

Source : Puerto Rico Planning Board 
-30-

availability of credit. Government and pub~ic enterprise 

spending was increased to mitigate the recession, but the 

impact was dissipated by the high propensity to import. In 

recent years, more than 75 percent of Puerto Rican gross 

national product 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 policy has been frustrating. 

The roots of Puerto Rico's economic problems go, 

however, deeper than recent U.S. recessions. Two important 

industries, petrochemicals and construction, have been 

depressed. In the late 1960's 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 U.S. oil import quotas (which allowed imports of foreign 

oil, which before 1973 was cheaper than domestic oil) rather 

than to low wages, locational advantages, or other real 

factors. 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. 

The Puerto Rican construction industry has also been 

hit by events of the last four years. From 1969 to 1973, 

construction spending, especially on apartment houses and 

condominiums, boomed. But in 1973, interest rates increased 

as the Federal Reserve tightened the money supply to fight 

inflation. High borrowing and construction costs and the 

general economic downturn choked off new condominium demand 

and left a large stock of unsold units. Between 1974 and 

1977, employment of highly paid construction workers dropped 

by 50 percent to 40,000 jobs. Although the backlog of unsold 

units is being worked off and other sectors of the 

construction industry show some new signs of life, full 

recovery for the construction industry is still a long way 

off. 
-31-

Puerto Rico has also been hurt by the~ growing 

competitiveness of foreign imports in U.S. markets. Its 

traditional advantages, cheap labor and no tariffs on 

exports to the U.S. market, have been undermined by a series 

of changes. Throughout the 1950's and 1960's (but not the 

1970's) Puerto Rican wage rates rose not only in dollar 

terms but also relative to wages paid in the United States 

and foreign countries. To some extent, Puerto Rico was the 

victim of its own economic success: as per capita incomes 

rose, so did the wage at which labor would work. Higher 

Puerto Rican wages are also the product of Commonwealth and 

Federal government policies. By the end of 1977, almost 

two-thirds of non-government employees were subject to the 

U.S. minimum wage, $2.30 per hour, and over 90 percent were 

subject to a minimum wage of at least $2.00 per hour. 

Furthermore, 37 percent of Puerto Rican employees work for 

the Federal or Commonwealth governments (the U.S. figure is 

18 percent), both of which pay higher than average salaries. 

Food stamp, unemployment insurance, and other income support 

Programs have discouraged many Puerto Ricans from taking 

unpleasant jobs paying a low wage. 

The competitiveness of Puerto Rican production has been 

further undercut by structural changes in the world economy. 

After the Kennedy round of tariff negotiations in the 

l960's, U.S. tariff rates were cut by 40-50 percent on 

average. As Japanese and other competitors utilizing 

low-wage foreign labor penetrated the U.S. market, U.S. 

companies lost their inhibitions about manufacturing in 

low-wage countries and exporting back to the United States. 

The difference in labor costs between these countries and 

Puerto Rico is striking. For example, in the Dominican 

Republic and Haiti, two countries sharing an island closer 

to the United States than Puerto Rico, unskilled labor earns 

roughly 33 cents per hour, a seventh of the minimum wage in 

Puerto Rico. Such countries' exports are subject to U.S. 

tariffs and non-tariff trade barriers, but they can be 

transported in ships flying foreign flags and using cheaper 

foreign labor, which Puerto Rican exports cannot. 

The increasing competitiveness of foreign imports is 

Clearly reflected in the level and composition of Puerto 

Rican employment. Between 1973 and 1977, total Puerto Rican 
-32-

manufacturing employment dropped from 152,100 to 145,400, or 

4.4 percent -- see Table 3.* This drop, which was much 

sharper in Puerto Rico than in the United States, was due to 

a decline in the traditional labor-intensive industries 

(tobacco, textiles, apparel, and leather products (including 

footwear)), and the petrochemical sector. By contrast, 

employment grew in the chemical (including pharmaceutical), 

non-electrical machinery, and professional and scientific 

industries. Because these industries taken together employ a 

fourth of manufacturing workers, their gain offered a 

partial offset to the others' loss. 

An unfortunate side effect of the possessions 

corporation system of taxation in the past has been 

tax-induced plant closings. Until 1976, a U.S. parent was 

subject to Federal tax on dividends received from a 

possessions corporation, but not on the distribution upon 

the liquidation of that corporation. Accordingly, 

liquidation of the subsidiary into the parent was the final 

step in realizing the full tax benefit of the possession 

corporation system of taxation. Although Puerto Rican 

operations could be continued after corporate liquidation as 

an unincorporated branch of the U.S. parent, high Puerto 

Rican and Federal taxes applicable to non-exempt income 

discouraged companies from continuing operations as taxable 

establishments. 

Although the available evidence is rather meager, a 

recent study by Fomento, the Puerto Rican agency charged 

with promoting new investment in Puerto Rico, provides 

information on this point (see Figure III for source). The 

Fomento study examined 149 cases in which companies were 

granted tax exemption between 1960 and 1962 and actually 

established operations. Because the grants apply to 

specific products, not to all the operations of the company 

obtaining the grant, the current status of operations in 46 

of the 149 cases could not be determined. Of the 103 cases 

remaining, 62 operations had apparently been discontinued, 

*The statistics in Table 3 for April 1978 represent a 

increase in manufacturing employment over the March 

sharp 

level. 
Table 3 

Total Manufacturing Employment in Puerto Rico, by Major Industry Group: 

Average for Calendar Years 1973 to 1977 and April 1978 

Industry Group 

:April 1978 

All Manufacturing Industries 

Nondurable goods 

Food and kindred products 

Tobacco products 

Textile mill products 

Apparel 

Paper and allied products; Printing 

and publishing 

Chemicals 

Petroleum refining; Rubber products 

Leather and leather products 

Durable goods 

Lumber and wood products; 

Furniture and fixtures 

Stone, clay and glass products 

Primary metal products; Fabricated metal products 

Machinery, except electrical; 

Transportation equipment 

Electrical and electronic equipment 

Scientific instruments 

Miscellaneous manufacturing industries 

Off 1ce of the Secretary of the Treasury 

Off ice of Tax Analysis 

151. 5 

102.l 

26.3 

3.2 

4.7 

36.7 

4.4 

15.l 

6.1 

5.6 

49.3 

3.7 

5.4 

5.7 

5.3 

13.9 

12.l 

3.2 

1977 

145. 4 

98.3 

23.7 

3.8 

4.4 

36.3 

4.4 

14.l 

6.3 

5.2 

47.l 

3.5 

5.2 

5.2 

5.0 

13.9 

11. 6 

2.7 

Total Employment (000) 

Average for Calendar Year: 

1976 : 1975 1974 

142. 5 

97.7 

24.l 

4.9 

4.6 

37.5 

4.1 

11. 4 

5.9 

5.2 

44.9 

3.7 

5.6 

5.4 

4.4 

11.8 

10.9 

3.0 

135. 2 

93.5 

23.8 

5.1 

5.1 

34.6 

4.0 

10.4 

5.5 

5.0 

41. 7 

3.9 

6.1 

5.8 

3.5 

9.6 

10.l 

2.8 

150.9 

103.9 

24.l 

5.4 

7.4 

38.l 

4.2 

11. 6 

6.6 

6.2 

46.9 

4.4 

7.3 

5.6 

2.3 

13.9 

9.3 

3.0 

1973 

152.l 

105.3 

24.0 

5.5 

7.6 

40.3 

4.3 

10.6 

6.7 

6.4 

46.8 

4.9 

7.3 

6.8 

1.9 

14. 0 

ts. 6 

3.2 

Percentage 

Change 

1973-B77 

-4.4 

-6.6 

-1.3 

-30.9 

-42.l 

-9.9 

+2.3 

+33.0 

-6.0 

-lts. !j 

+0.6 

-28.6 

-28.8 

-23.5 

+163.2 

-0.7 

+34.9 

-15.6 

Sources: Economic Development Administration, Commonwealth of Puerto Rico; 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 Societ"<y, 

June 1977, Table III-A-4, p. 166; and U.S. Department of Commerce. 

I 

w 

w 

I 
-34-

FIGURE Ill 

Current Status of 149 Exemption Decrees Granted 

Between 1960 and 1962 and Utilized by.Recipient Firms 

·.;::; 

rJ) 

cJ> 

E. 

..... 

·--

6 Exemptions held 

by taxable firms 

reporting profits 

4 Exemptions held 

by taxable firms 

reporting losses 

\ I 

\ 

\ \<2.7%) 

(4.0%) \ 

' ' ' ' ' ' ' ' ' ' ' ' 31 Exemptions extended ' ' ' ' ' ' ' (20.8%) 

' \ 

' 

46 Exemptions not 

fully accounted for 

(30.9%) 

62 Exemptions received 

by firms no longer in 

operation 

(41.6%) 

Source: Government of Puerto Rico, Economic Development Administration, Economic Analysis 

of the Industrial Incentive Program of Puerto Rico, February 1978. 
-35-

and 31 were still operating under an exte~sion or a 

modification of the original tax exempt grant. Ten 

operations were continuing in a taxable status; six were 

Paying taxes, and four were reporting losses. 

As noted below, the Tax Reform Act of 1976 eliminated 

the Federal tax incentive to liquidate operations, and 

recent changes in the Puerto Rican Industrial Incentive Act 

ease the transition from exempt to taxable status. 

B. Characteristics of Possessions Corporations 

The characteristics of the possessions corporations 

reflect the unique features of Puerto Rican and Federal tax 

laws. Because most of the statistical analysis below is 

~asea on tax returns, the identities and characteristics of 

h

lndividual taxpayers are confidential. Companies must, 

0 wever, file 10-K returns with the U.S. Securities and 

Exchange Commission, and these returns, which are available 

to the public, provide information on the importance of 

section 936 to individual companies. To explain why 

corporate income tax payments are often less than 48 percent 

bthe maximum statutory tax rate in the United States) of 

~k income, the S.E.C. requires corporations to indicate 

~h1ch provisions of the Internal Revenue Code reduced their 

.ax liability by more than 2.4 percent of pre-tax book 

~~come. A survey of recent 10-K forms, most of which cover 

iscal years ending in 1976 or the first half of 1977, 

Provides the information shown in Table 4. 

In interpreting these data, two caveats should be kept 

clearly in mind. First, because specific procedures for 

estimating the dollar value of various tax preferences have 

~ever been set forth by the S.E.C., the statistics presented 

~n Table 4 should be regarded as only rough estimates of the 

importance to the companies of the possessions corporation 

:Ys~em of taxation. Second, companies for whom the tax 

av1ngs may be large in dollar terms, but less than 2.4 

~ercent of book income before taxes, need not and generally 

5 ° ~ot report this item separately. Third, even when tax cavi~gs exceed 2.4 percent of book income, companies may 

omb1ne the tax savings attributable to possessions 

~~~Porations with lesser items (e.g., deferral or sometimes 

T bC). Companies following this practice were excluded from 

a le 4. 
Table 4 

Major U.S. Manufacturing Corporations Claiming a Reduction in Income 

Taxes in Excess of 2.4 Percent of Book Income 

Because of Section 931 or 936 of the Internal Revenue Code 

:Estimated Tax Saving : Estimated Tax Saving 

Corporation Industry :(millions of dollars):(Percent of Book Income Before Taxes) 

Esmark 

H.J. Heinz 

Pepsico 

Blue Bell 

Hanes Corporation 

Rohm & Haas 

Abbott Laboratories 

Baxter Travenol 

Merck 

Pfizer 

Richardson-Merrell 

Schering-Plough 

G.D. Searle 

Smith-Kline 

American Hospital Supply 

Johnson & Johnson 

Eli Lilly 

Squibb 

Upjohn 

Becton Dickinson 

Chesebrough-Pond's 

Digital Equipment 

Motorola 

Gould 

Perkins-Elmer 

Insilco 

Food products 

Food products 

Beverages 

Textile & Apparel 

Textile & Apparel 

Chemicals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Pharmaceuticals 

Toiletries 

Off ice Equipment 

Electronics 

Automotive Equipment 

Instruments 

Miscellaneous Manufactures 

Sub-total - 14 pharmaceuticals 

Total - 26 manufacturers 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

$ 5.6 4.9% 

7.2 4.6 

7.0 2.8 

3.6 3.4 

3.1 10.6 

0.6 3.0 

16.2 11.8 

12.1 14.3 

22.9 5.5 

35.6 15.1 

5.8 5.3 

37.0 15.1 

32.5 38.5 

24.5 22.9 

7.2 6.7 

12.7 3.6 

13.9 4.2 

21.9 14.6 

10.0 8.0 

2.9 5.1 

3.5 3.3 

11.l 6.3 

6.2 8.2 

1.1 1.1 

1. 7 4.5 

2.3 10.8 

255.2 

308.2 

Source: Summary of 10-K Reports filed.with U.S. Securities and Exchange Commission in Tax Analysts and 

Advocates, Tax Notes, recent issues. 

I 

w 

°' I 
-37-

To gain as complete a picture of possessions 

corporations ' operations as possible, inform§tion from 

Federal and Puerto Rican income tax returns was matched with 

Payroll and employment data from companies' Federal 

unemployment insurance tax returns. This section summarizes 

the results based on information for 1975*, the most recent 

Year for which relatively complete data are available. 

Section D below summarizes the less complete, but 

essentially similar information for 1976, and Appendix B 

sets forth comparable information for 1973 and 1974. 

Table 5 indicates that 595 companies were apparently 

eligible for the section 931 exclusion in 1975**, the book 

income (net of losses) of these subsidiaries was $1.1 

billion, and their estimated tax saving was $447 million. 

~his total tax saving is estimated by multiplying book 

income (before deducting losses) by 40 percent and then 

subtracting any income taxes paid to the Puerto Rican and 

foreign governments.*** The tax-saving calculation ignores 

companies with losses because in 1975, under section 931, 

*Tables 5, 6 and 7 are based on the returns for corporations 

Whose fiscal years ended between July 1, 1975 and June 30, 

1976. Because most possessions corporations have calendar 

Year accounting periods, the data correspond closely to 

calendar year 1975 operations. See Appendix B for details. 

**That is to say, the companies excluded income under 

section 931 in 1973, 1974 or 1975 and reported a profit or a 

lo~s in 1975. Included in these 595 companies are those 

~h1ch may not in fact have excluded income under section 931 

~n 1975 because they reported a loss or failed to qualify in 

975 for the section 931 exclusion. 

***The conventional practice of measuring tax savings or 

expenditures by calculating the tax consequences of changing 

the Internal Revenue Code, but assuming that corporations 

and individuals behave as they did before, may need 

~~Planation. The reason for the current practice is that ~ tax expenditure defined in this way may be estimated 

~si~g available information on existing law and behavior. 

st1mating the behavioral change requires additional e~onomic analysis of what would happen if tax policy were 

c anged, and knowledgeable observers may differ in their 

assessment of what would indeed happen. 
-38-

Table 5 

Income and Estimated Tax Expenditure 

by Industry, 1975 .!/ 

Industry Group 

All Industries 

Manufacturing industries 

Number of 

Corporations 

595 

394 

Food and kindred products 22 

'Ibbacco products 7 

Textile mill products 8 

Apparel 88 

Chemicals, total 69 

Pharmaceuticals 47 

All other chemicals 22 

Rubber products 14 

Leather and leather products 14 

Stone, clay, and glass products 7 

Fabricated metal products 26 

Machinery, except electrical 7 

Electrical and electronic equipment 76 

Transtx>rtation equipment 5 

Scientific instruments 27 

All other manufacturing 24 

Nonrnanufacturing 201 

Transtx>rtation, camunications, 

and utilities 9 

Wholesale trade 12 

Retail trade 101 

Apparel 83 

Finance, insurance, real estate 26 

Savings and loans 9 

Services 16 

Miscellaneous and not available 37 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

Book Income 

($000) 

1,109,567 

1,055,462 

71, 747 

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 

26,110 

54,104 

30,006 

3,144 

12,541 

2,082 

1,284 

808 

-107 

7,236 

Estimated 

Tax 

Expenditure 

( $000) __, 

447,059 

425,369 

28,652 

10,744 

265 

17,669 

246,470 

218,210 

28,260 

572 

2,910 

3,384 

10,114 

759 

79,164 

430 

13,627 

10,609 

21,689 

10,062 

1,258 

5,250 

1,123 

588 

307 

1,623 

2,908 

1/ Includes data for fX:>SSessions corporations operating in American Samoa, - Glarn, 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 1). 
~e 

-39-

they could JOln affiliated U.S. companies in filing a 

consolidated Federal return. The 40 percent re~resents the 

Treasury's necessarily rough estimate of what the effective 

rate of taxation would have been in the absence of a tax 

Provision such as this.* (Another way of interpreting this 

40 percent is that it is the effective rate which would 

apply if Puerto Rico were treated the same way as the fifty 

States and the District of Columbia.) The effective rate is 

less than 48 percent, the maximum statutory rate, because 

~ther provisions of the Internal Revenue Code (e.g., the 

investment tax credit and accelerated depreciation) would 

have reduced the tax buroen by an estimated 8 percentage 

Points. Puerto Rican and foreign taxes, which amounted to 

$6.2 million overall, would also have been creditable 

against the Federal income tax liability and, thus, further 

reduce the net saving of U.S. taxes. 

Several important conclusions can 

tables in the text and Appendix B and 

statistics: 

be drawn 

from the 

from the 

underlying 

The Federal tax expenditure in 1975 was $447 

million, compared to $258 million in 1973. 

If all the possessions corporations of each U.S. 

parent are consolidated, the benefits of the 

possessions corporation system of taxation were 

concentrated among all U.S. parent corporations 

as follows in 1975: 

Number of 

Parent Corporations 

Top 5 

Top 10 

Top 20 

Top 30 

Percent of Total 

Tax Benefits of All 

Corporations 

27.3% 

46.2 

70.0 

80.2 

Just under 50 percent of the total tax saving 

from 1973-1975 was realized by pharmaceutical 

subsidiaries. The concentration of tax benefits 

for parent corporations indicated above is 

largely attributable to its concentration in the 

pharmaceutical sector. 

*See Department of the Treasury, Effective Income Tax Rates 

~id by United States Corporations in 1972, May 1978. 
-40-

Tables 6 and 7 are based on 280 possessions 

corporations for which 1975 employment and payroll data 

could be obtained from the Federal unemployment tax returns. 

While the coverage represents less than half the number of 

companies included in Table 5, the combined book income of 

the sample, $860 million, represents four fifths of the book 

income of all possessions corporations. For no apparent 

reason, information for companies in the high-profit 

industries was more frequently available than. that for 

companies in the labor-intensive industries. 

The first three columns of Table 6 present information 

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

number of employees and the total employee compensation, 

respectively, in each industry in 1975. Finally, the last 

three columns indicate the tax expenditure per employee, the 

tax expenditure as a percent of total compensation, and 

average compensation. 

Table 6 highlights the relationship between Federal tax 

expenditures and Puerto Rican employment. For the 

manufacturing companies covered, the tax expenditure per 

employee averaged $7,428, which was slightly larger than the 

average compensation per worker, $7,300. Table 6 also 

indicates that the 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 and a half times the total 

compensation of the comparat~vely well paid Puerto Rican 

pharmaceutical employee. By contrast, in the rubber 

industry, the tax expenditure per employee was $760, or 11 

percent of the average wage. The tax expenditure per 

employee in all manufacturing corporations except 

pharmaceuticals was $4,061. 

Table 7 is based on the same 280 possessions 

corporations shown in Table 6, but ranked according to the 

Federal tax expenditure per employee. At the top of the 

ranking was a company for which the Federal tax expenditure 

represented more than $500,000 per Puerto Rican employee; at 

the low end were the companies which incurred losses and, 

thus, derived no immediate tax benefit from section 931. 

According to Table 7, the top five possessions corporations 

had tax savings per employee in excess $100,000; together 

they accounted for 8.4 percent of the total tax savings and 

0.5 percent of the total employment, of the 280 companies 

for which employment information was available. The top 58 

possessions corporations, those for which tax savings per 

employee exceeded $10,000 in 1975, collectively accounted 
0 

... 

... 

Industry Group 

'.Zable 6 

'.lax Expenditure, .Employment and Conpensation of .Employees by Industry, 1975 

: Tax Expenditure Enployees 

: Number of :Book Incane: .Amount :Percent :Percent 

:Corporations: ($000) ($000) :of Total Nurrt>er :of Total 

COnpensat1on of :Tax Expendi- Tax EXpenchture 

Enployees .!/ _: ture Per as Percent of 

.Amount :Percent : &nployee Coni>ensation of 

($000) :of Total: ($) &tployees 

~ All industries 280 858,961 

824,816 

342,212 100.0 43,174 

328,863 96.1 31,812 

100.0 345,234 100.0 5,229 y 

7,428 y 

2,469 

2,638 

1,723 

1,255 

67.7 y 

Manufacturing industries 

Food and kindred products 

'lbbacco 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 equipment 

Scientific instruments 

All other manufacturing 

Nonmanuf acturing 

Transportation, cannunications 

and utilities 

Wholesale trade 

!Etail trade 

Finance, insurance, real estate 

Savings and loans 

Services 

Miscellaneous and not available 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

237 

14 

5 

3 

46 

49 

35 

14 

8 

9 

4 

18 

3 

46 

3 

21 

8 

43 

4 

5 

3 

12 

8 

8 

11 

37,173 

5,487 

281 

14,007 

562,306 

507,126 

55,108 

1,173 

6,011 

4,530 

21,156 

963 

128,423 

734 

26,085 

16,487 

34,145 

27,975 

1,756 

2,346 

950 

785 

-991 

2,108 

13,138 

2,271 

143 

5,847 

224,734 

202,054 

22,680 

438 

2,404 

1,835 

8,578 

392 

51,651 

293 

10,479 

6,660 

13,349 

9,249 

702 

876 

390 

298 

1,331 

801 

3.8 

.7 

.1 

1. 7 

65.7 

59.0 

6.6 

.1 

.7 

.5 

2.5 

.1 

15.1 

.1 

3.1 

1.9 

5,321 

861 

83 

4,658 

7,838 

5,794 

2,044 

576 

1,477 

414 

1,248 

71 

6,958 

109 

1,627 

571 

3.9 11,362 

2.7 4,430 

.2 340 

.3 2,400 

.1 861 

.1 799 

.4 2,061 

.2 1,270 

73.7 250,149 72.5 

12.3 

2.0 

.2 

10.8 

18.2 

13.4 

4.7 

1.3 

3.4 

1.0 

2.9 

.2 

16.1 

.3 

3.8 

1.3 

26.3 

10.3 

.8 

5.6 

2.0 

1.9 

4.8 

2.9 

38,920 

4,600 

527 

25,508 

84,390 

58,127 

25,075 

3,959 

8,381 

2,775 

10,412 

457 

51,580 

898 

11,235 

7,696 

95,084 

37,792 

3,283 

21,944 

7,509 

6,913 

15,031 

9,525 

11.3 

1.3 

.2 

7.4 

24.4 

16.8 

7.3 

1.1 

2.4 

.8 

3.0 

.1 

14.9 

.3 

3.3 

2.2 

27.5 

10.9 

1.0 

6.4 

2.2 

2.0 

4.4 

2.8 

28,672 

34,873 

11,096 

760 

1,628 

4,432 

6,IS73 

5,521 

7,423 

2,688 

6,441 

11,664 

768 y 

2,088 

2,064 

365 

452 

373 

646 

631 

l/ Compensation of employees was canputed by multiplying 1.189 times payroll. 'lhe additional 18.9 percent reflects the . - employer-paid portion of social security, unemployment insurance, and other non-payroll labor costs. 'lhe 18.9 pe~cent is the 

average for all U.S. manufacturing industries in 1975; see the U.S. Department of Comnerce, Survey of Current Business, July 

1977, Tables 6.5 and 6.6. 

2/ Compensation of employees and number of employees used to canpute these aroc>Unts were weighted by industry using the ratio of 

- tax expenditure in Table 5 and tax expenditure in this Table. 

101. 7 y 

33.8 

49.4 

27.1 

22.9 

266.3 

347.6 

90.4 

11.l 

28.7 

66.1 

82.4 

85.8 

100.1 

32.6 

93.3 

86.5 

8.9 y 

24.5 

21.4 

4.0 

5.2 

4.3 

8.9 

8.4 

Average 

Employee 

Cont>ensation 

($) 

7, 729 y 

7,300 y 

7,314 

5,342 

6,346 

5,475 

10,766 

10,032 

12,300 

6,872 

5,674 

6,702 

8,342 

6,43i 

7,412 

8,239 

6,905 

13,478 

8,597 y 

8,530 

9,656 

9,143 

8,720 

8,651 

7,292 

7,500 

I 

..... ""' 

I 
Table 7 

Tax Expenditure, Employment and Compensation of Employees by Size of Tax Expenditure Per Employee, 1975 

Tax Compensation of :Tax Expendi- :Tax Expenditure 

Size of Tax E~nditure Enplo,l'.:ees E!!J210,l'.:ees y _: ture Per : as Percent of 

Expenditure Number of :Book Income Amount :Percent :Percent Amount :Percent : Employee :Compensation of 

per Enplo,l'.:ee :Co~rations: ($000) ($000) :of Total Number :of Total: ($000) :of Total: ($) Enplo,l'.:ees 

All Corporations 280 858,961 342,212 100.0 43,174 100.0 345,234 100.0 5,229 y 67.7 y 

$100,000 or more 5 72,950 29,180 8.4 227 .5 2,442 .6 128,546 1,194.9 

$ 50,000 under $100,000 11 266,912 106,760 30.9 l,5ll 3.5 16,289 4.3 70,655 655.4 

$ 10,000 under $ 50,000 42 274,257 108,529 31. 7 4,851 11.2 44,863 11.8 22,373 241.9 

$ 5,000 under $ 10,000 39 128,198 51,266 15.0 6,810 15.8 67,322 17.7 7,528 76.2 

$ 1,000 under $ 5,000 91 114,456 41,535 12.4 15,972 37.0 117,558 30.9 2,600 35.3 

$ 500 under $ 1,000 28 6,695 2,636 .8 3,640 8.4 24,145 6.3 724 10.9 

$ 100 under $ 500 26 5,615 2,246 .7 6,607 15.3 49,392 13.0 340 4.5 

$ 1 under $ 100 6 438 59 896 2.1 5,574 1.5 66 1.1 

Loss Corporations 32 -10,561 2,660 6.2 17,650 14.0 

Office of the Secretary of the Treasury 

Off ice of Tax Analysis 

1/ Compensation of employees was computed by multiplying 1.189 times payroll. The additional 18.9 percent reflects the 

employer-paid portion of social security, unemployment insurance, and other non-payroll labor costs. The 18.9 percent is 

the average for all U.S. manufacturing industries in 1975; see the U.S. Department of Commerce, Survey of Current Business, 

July 1977, Tables 6.5 and 6.6. 

2/ Compensation of employees and number of employees used to compute these amounts were weighted by industry using the ratio of - tax expenditure in Table 5 and tax expenditure in Table 6. 

Average 

Employee 

Compensation 

($) 

7,729 y 

10,757 

10, 779 

9,248 

9,885 

7,360 

6,632 

7,475 

6,220-

6,635 

I 

~ 

I\) 

I 
-43-

for 71 percent of the total tax expenditure and 15.2 percent 

of total employment. Because the coverage of~ employment 

and payroll statistics is not complete, possessions 

corporations with tax savings exceeding $10,000 per employee 

may in fact have realized a somewhat smaller percentage of 

the total tax savings and a significantly smaller percentage 

of the total employees of all possessions corporations than 

was the case for the 280 companies represented in Table 7.* 

Both Tables 6 and 7 indicate a direct relationship 

between the 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 

woul~ have been paid by other Puerto Rican employers. 

Finally, the industries in which tax savings per employee 

were the highest (pharmaceuticals, electrical and electronic 

equipment, scientific instruments, non-electrical machinery) 

tended to be the same industries in which total employment 

has been growing since 1973; conversely, industries in which 

tax savings per employee were the lowest (tobacco products, 

textiles, apparel, leather products) tended to be those 

Whose employment was declining -- see Table 3 above. While 

taxation is not the only factor shaping the development of 

Puerto Rican industry -- the growth in U.S. demand for the 

Products, international trade considerations and other 

factors play an important role -- the evidence does suggest 

that tax incentives may bring investment to Puerto Rico. 

C. Linkages and the Multiplier 

The preceding Section related the tax cost of the 

Possessions corporation system of taxation to the employment 

~nd payroll of those companies. In addition to creating 

Jobs directly, this system of taxation may bring indirect 

benefits to Puerto Rico. Manufacturing requires raw 

materials, intermediate goods, and services, a portion of 

Which are supplied by the local economy. Investment in 

Plant and equipment creates jobs in the construction and 

capital equipment industries. Workers in all industries 

spend their salaries on goods and services, which has a 

*These inferences are based on the assumption that tax 

savings per employee for companies missing from the sample 

equal the average tax savings per employee for companies in 

the same industry see Table 6. Because the 

Pharmaceutical companies tend to be over represented in the 

sample, the biases indicated in the text may have occurred. 
-44-

"multiplier" effect on the Puerto Rican economy.* In 

addition to these "backward linkages", the development of 

one industry may encourage the growth of downstream 

customers, a phenomenon called "forward linkage." For 

example, the building of a petroleum refinery facilitates 

the growth of the petrochemical manufacturers. This Section 

summarizes the evidence currently available on the 

importance of these indirect benefits. 

1. Backward Linkages 

The usual method of evaluating backward linkages begins 

by examining industries' expenditures on various inputs. In 

order to compare linkages in one industry to those in 

another, each industry's expenditures on labor, capital, 

locally purchased materials and on imports are expressed as 

a percentage of the total value of its production. The sum 

of the shares of all expenditures measured in this way, plus 

the rate of return on invested capital, is 100 percent. 

The costs of materials, labor and other inputs as a 

percentage of the total value of production by Puerto Rican 

manufacturing industries in 1972 are depicted in Table 8. 

The primary statistical source on which Table 8 is based 

does not differentiate between possessions corporations and 

locally owned companies or between imported and locally 

produced materials. Because the operations of a possessions 

corporation are often integrated with those of its u.s. 

parent, the linkage of possessions corporations with the 

local economy may be somewhat weaker than the linkage for 

all Puerto Rican manufacturers, as measured in Table 8. 

To estimate how much possessions corporations purchase 

from the local economy, one must first determine how total 

purchases are apportioned between Puerto Rican and imported 

inputs. Unfortunately, neither the 1972 Census of 

Manufactures nor any other recent study provides up to date 

information on this point. Rather than assuming that every 

industry's propensity to import was the same as that of the 

Puerto Rican economy as a whole, each industry's 1972 

expenditure was apportioned using data from a recently 

*As a general practice, the Treasury does not estimate the 

linkage and multiplier impacts of specific tax provisions. 

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 section 931/936, 

both in total and by industry, on Puerto Rico alone, not on 

the U.S. and Puerto Rico taken together. 
Table 8 

Expenditures on Materials, Labor, Plant, and Equipment as a Percent of the Value of Production by Manufacturing Establishments in Puerto Rico, 1972 

Cost of Materials 

from All Sources !I 

Cost of Materials 

from Puerto Rico ±I 

Value Added !I 

Labor Costs .Y 

Return on Capital and 

Overhead Costs ii 

Expenditures on 

New Plant !I 

Expenditures on 

New Equipment !I 

Expenditures on Used Equipment !I 

Total Expenditures on Materials, Labor, Plant, 

and Equipment in 

Puerto Rico ii 

Ratio of Labor Costs to 

Total Expenditures in 

Puerto Rico 

All Manufacturing 

Industries 

54.3 

26.8 

45.7 

17.0 

28.4 

2.1 

2.2 

* 

45.9 

.370 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

*Less than 0.05 percent. 

Food and 

Kindred Products 

64.7 

49.8 

35.3 

14.5 

20.6 

1.1 

3.2 

.3 

66.2 

.219 

Tobacco Textile 

Products :Mill Products: Apparel 

59.3 60.8 46.l 

19.0 16.4 14. 8 

40.7 39.2 53.9 

16.3 18.9 30.8 

24.l 20.0 22.7 

.1 .1 .1 

2.2 .9 . 8 

. 5 * • 4 

36.3 35.6 46.3 

.449 . 531 .665 

Lumber and 

Wood Products 

56.3 

18.0 

43.7 

30.0 

12.8 

.2 

I 

1.0 ~ 

I.Tl 

I 

* 

48.4 

.620 
Cost of Materials 

from All Sources ll 

Cost of Materials 

from Puerto Rico ~/ 

Value Added l/ 

Labor Costs ll 

Return on Capital and 

Overhead Costs ii 

Expenditures on New Plant .. !/ 

Expenditures on New Equipment l/ 

Expenditures on Used Equipment l/ 

Total Expenditures on Materials, Labor, Plant, 

and Equipment from 

Puerto Rico ~/ 

Ratio of Labor Costs to 

Total Expenditures in 

Puerto Rico 

Furniture 

and Fixtures 

46.3 

24.5 

53.7 

27.5 

25.7 

3.7 

1. 2 

. 2 

55.4 

.496 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

*Less than 0.05 percent. 

Table 8-continued 

Paper and Printing and 

Allied Products Publishing 

57.8 34.2 

24.9 20.9 

42.2 65.8 

22.4 30.3 

19.5 35.1 

3.3 3.0 

8.1 3.9 

• 2 

51. 7 54.4 

.433 .557 

Chemicals Petroleum 

Total :Pharmaceuticals: Refining 

42.3 16.4 75.4 

19.0 7.4 31. 7 

57.7 83.6 24.6 

8.7 6.9 6.4 

48.9 76.6 18.1 

4.3 4.0 5.5 I 

O'I ""' 

3.0 3.5 .2 I 

* * * 

31.8 18.1 42.5 

.274 .381 .151 
Rubber Products 

Cost of Materials 

from All Sources !/ 

Cost of Materials 

from Puerto Rico ~/ 

Value Added !/ 

Labor Costs ll 

Return on Capital and 

Overhead Costs ii 

Expenditures on 

New Plant !/ 

Expenditures on 

New Equipment !/ 

53.5 

17.1 

46.5 

27.5 

18.6 

. 2 

• 2 

Expenditures on 

Used Equipment !/ 2.2 

Total Expenditures on 

Materials, Labor, Plant, 

and Equipment from 

Puerto Rico 21 

Ratio of Labor Costs to 

Total Expenditures in 

Puerto Rico 

45.3 

Office of the Secretary the Treasury 

Off ice of Tax Analysis 

*Less than 0.05 percent. 

.607 

Table a-continued 

Leather and :Stone, Clay and: 

Leather Products :Glass Products 

51. 2 45.3 

9.7 38.5 

48.8 54.7 

29.3 25.3 

19.0 29 .• 0 

* 1.6 

• 5 4.2 

* • 2 

39.1 66.2 

.749 .382 

Primary Fabricated Machinery 

Metals :Metal Products:Exce t Electrical 

58.4 50.l )4.1 

31.5 16.0 10.9 

41. 6 49.9 65.9 

17.8 21. 9 26.1 

23.5 27.7 39.4 

1.1 1.4 .2 I 

~ 

~ 

I 

5.4 2.4 1.6 

.1 * 

51. 2 39.2 37.5 

.348 .558 .696 
Table 8-continued 

Cost of Materials 

from All Sources ll 

Cost of Materials 

from Puerto Rico ~/ 

Value Added .!/ 

Labor Costs 1/ 

Return on Capital and 

Overhead Costs ii 

Expenditures on 

New Plant .!/ 

Expenditures on 

New Equipment .!/ 

Expenditures on 

Used Equipment .!/ 

Total Expenditures on 

Materials, Labor, Plant, 

and Equipment from 

Puerto Rico ~/ 

Ratio of Labor Costs to 

Total Expenditures in 

Puerto Rico 

Electrical and 

:Electronic Equipment: 

42.5 

13.6 

57.5 

19.8 

37.4 

2.7 

1. 3 

. 2 

36.1 

.548 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

*Less than U.U~ ~e~cent. 

Transportation 

Equipment 

46.6 

14.9 

53.4 

28.9 

24.1 

* 

.9 

.1 

44.3 

.655 

Miscellaneous 

Scientific Manufacturing 

Instruments Industries 

36.2 54.6 

11.6 17.5 

63.8 45.4 

25.5 21.0 

37.9 24.1 

I 

.i:::. 

.5 1. 2 co 

I 

1.8 • 6 

.1 .1 

38.0 39.8 

• 671 .530 
~Less nan G.G~ ~e~cent. 

Table 8-continued 

Notes: 

ll Based on U.S. Department of Commerce, 1972 Economic Census of Outlying Areas, Manufacturing, Puerto Rico, October 1974, 

Chapter 2, Table 2. All statistics are expressed as a percentage of value added plus cost of materials. 

±I Percentage of cost of materials from Puerto Rico is estimated by multiplying the cost of materials from all sources by the 

share of intermediate imports in total intermediate inputs. This latter share was estimated by Richard Weisskoff and Edward 

Wolff, "Development and Trade Dependence: The Case of Puerto Rico, 1948-1963," Review of Economics and Statistics, November 

1975, Table 2, p. 474. These import shares are based on 1963 data; more recent information is unavailable. Whether the 

degree of dependence on imported inputs for individual industries decreased between 1963 and 1972 is impossible to 

determine, but the ratio of Puerto Rican imports of capital goods, raw materials and other intermediate goods to the value 

of shipments for all industries decreased only slightly over this interval. 

~/Labor costs are estimated by multiplying total payroll, as reported by the U.S. Department of Commerce, op. cit., by 1.16. 

The additional 16 percent reflects the employer-paid portion of social security, unemployment insurance and other 

non-payroll labor costs. The 16 percent is the average for all U.S. manufacturing industries in 1972; see the U.S. 

Department of Commerce, The National Income and Product Accounts of the United States 1929-74: Statistical Tables, 1976, 

Tables 6.5 and 6.6. 

ii Value shown equals the differential between value added and labor costs. The return on capital includes not only profits, 

but also interest expenses, depreciation, expenditures on accounting and legal services, and any other overhead costs. 

~/ Value shown equals the sum of the cost of materials from Puerto Rico, labor costs, 80 percent of expenditures on new plant, 

21 percent of expenditures on new equipment and total expenditures on used equipment. The 80 percent of expenditures on new 

plant corresponds to the estimated ratio of expenditures on Puerto Rican inputs to total expenditures by the construction 

industry, as reported in Weisskoff and Wolff, op. cit. The 21 percent of expenditures on new equipment corresponds to the 

ratio of the value of shipments of machinery except electrical with a Puerto Rican destination to total expenditures for new 

equipment by all manufacturers. 

I 

~ 

~ 

I 
-sopublished study based on 1963 data (see footnote 2 to Table 

8). Because Puerto Rico's total imports of capital 

equipment, raw materials and intermediate products as a 

percentage of either aggregate manufacturing shipments or 

gross domestic output decreased only slightly between 1963 

and 1972, applying the 1963 apportionment ratios to the 1972 

data may produce reasonable results. Between 1972 and 1977, 

however, the ratio of imported capital equipment, raw 

materials and intermediate products increased substantially, 

so the statistics in Table 8 may overstate possessions 

corporations dependence on the local economy.* 

With these caveats in mind, Table 8 indicates that for 

all manufacturers the cost of materials represented 54.3 

percent of the value of production. Just under half of 

these materials (26.8 percent of the value of production) 

were estimated to have been obtained in Puerto Rico, and the 

rest were imported, primarily from the United States. Labor 

costs, which include the employer-paid Social Security 

contribution and the cost of other non-wage benefits, 

constituted 17.0 percent of the value of production. The 

return on capital plus overhead costs (interest, 

depreciation of existing capital, accounting and legal 

costs, etc.) accounted for the remaining 28.4 percent of the 

value of production. Although the source on which Table 8 

is based does not estimate the cost of existing capital used 

in production, it does report new investment in plant and 

equipment, be it for replacement or expansion. New 

investment represented 4.3 percent of the value of 

manufacturing production, roughly a seventh of the current 

return on capital plus overhead costs. 

The last two rows in Table 8 show estimated expenditures on all Puerto Rican inputs (labor plus locally 

purchased materials, plant and equipment) as a percent of 

the value of production, and labor costs as a percentage of 

estimated expenditures on all Puerto Rican inputs, respectively. The former statistic is useful in comparing one 

*A group of 12 pharmaceutical companies indicated in an 

April 19, 1978 submission to the Treasury that their own 

recent annual purchases in Puerto Rico of materials and 

services totaled $89.9 million, which was 11 percent larger 

than their own total payroll in Puerto Rico. By comparison, 

Table 8 estimates the cost of materials from Puerto Rico for 

all pharmaceutical manuf acterers was 7 percent larger than 

the cost of labor in 1972. In this one industry, at least, 

the use of 1963 data has produced a result close to that 

based on more recent and presumably more accurate data. 
-51-

industry's use of Puerto Rican inputs to another's, while 

the latter will be used below to translate the Federal tax 

expenditure as a percent of compensation of employees into 

tax expenditure as a percent of Puerto Rican income 

associated directly or indirectly with possessions 

corporations. 

The second to last row in Table 8 indicates that some 

Puerto Rican manufacturers depend much more than others on 

locally produced inputs. For example, food, furniture, 

paper, printing, stone, clay and glass, and primary metal 

manufacturers' expenditures on Puerto Rican inputs represent 

more than half of the total value of their own production. 

At the opposite extreme, the pharmaceutical manufacturers 

spent less than a fifth of the value of production on Puerto 

Rican inputs. The low pharmaceutical percentage reflects a 

high return on capital plus overhead costs, not a heavier 

than average dependence on imported versus locally purchased 

materials. (The pharmaceutical companies are estimated to 

import approximately 55 percent of their total inputs, which 

is slightly higher than the 51 percent average for all 

manufacturers.) Finally, Table 8 also indicates that the 

pharmaceutical companies reinvested 7.6 percent of the value 

of their current production in additions to plant and 

equipment, more than the 4.3 percent for all manufacturers. 

As Table 3 above indicated, the chemical sector, which 

includes pharmaceuticals, has expanded rapidly since 1972. 

2. 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 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 

in GNP which-is saved or is spent on imports, 

an increase 

respectively. 
-52-

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 is dissipated, and the smaller the multipler is. 

In Puerto Rico, the propensity to save appears to be 

small, and the propensity to import high. In 1976, imports 

equaled 72 percent of gross national product; between 1974 

and 1976 the increase in the dollar value of imports equaled 

79 percent of the increase in the dollar value of gross 

national product. 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 additional $.33 in local spending will be 

subsequently generated, so the total increase in income is 

$1.33.* 

3. Direct, Indirect and Total Effects 

Information on total employee compensation of 

possessions corporations was presented in Section B above. A 

broader measure of Puerto Rican benefits can be obtained by 

adding to employee compensation estimates of the companies' 

purchases of Puerto Rican materials, new plant and 

equipment, and then incrementing that total spending on 

Puerto Rican inputs by the multiplier. The final result 

would be a measure of the total Puerto Rican income 

associated directly and indirectly with possessions 

corporations. 

An assumption implicit in this new, broader measure is 

that all Puerto Rican resources used by the possessions 

corporation in their production have no alternative economic 

use -- they would be unemployed but for the possessions 

corporations. Although this may be a resonable assumption 

for the Puerto Rican labor used, other Puerto Rican factors 

may be scarce. Capital must be diverted from other 

productive uses. water and land are scarce in Puerto Rico; 

their use by possessions corporations 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. 

*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 matching amount, the "leakage" will be greater, and the 

multiplier will be smaller, than this simple analysis 

indicates. 
-53-

Sewage treatment, solid-waste collection and disposal and 

other government services may also have economic costs. If 

employee compensation by possessions corporations is too 

narrow a measure of the benefits they bring Puerto Rico, the 

total income associated directly or indirectly with those 

corporations is probably too broad a measure. 

Table 9 below 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 to that in Table 6 above, the second 

is obtained by multiplying the first by the percentage in 

the last row of Table 8, and the third by dividing the 

second by the multiplier. Finally, the fourth column is 

simply the inverse of the third 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 

~uerto Rican expenditures or income than in other 

lndustries. The average for all manufacturing is 3.5. In 

some industries (e.g., food products, rubber products), the 

ratio is between 15 and 20, reflecting a low level of 

tax-exempt income and/or substantial purchases of goods and 

services from the Puerto Rican economy. In other 

industries, the ratio is quite low, 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 of taxation. And 

While the measured cost-benefit ratios are reduced, they 

continue to vary widely from one industry to another.* 

*Note that a benefit-cost ratio of 1.0 does not mark the 

boundary between a "good" program and a "bad" one. For the 

r~asons indicated above, the total income associated 

directly or indirectly with possessions corporations may 

overstate the benefits to Puerto Rico. More importantly, 

~he benefit-cost ratio of one program should be compared not 

0 some fixed benchmark, but rather to the ratio for 

alternative programs. For example (and only for example), a 

~Ublic-works program funded by the Federal government would, 

ecause of the multiplier effect, have a benefit-cost ratio 

of 1.3. The alternative program could, of course, be a 

restructured tax incentive. 
Table 9 

Tax Expenditures as a Percent of Compensation of Employees, of Direct Expenditure in 

Puerto Rico, and of Direct and Indirect Expenditure in Puerto Rico, for Manufacturing Industries 

Tax Expenditure:Tax Expenditure :Tax Expenditure as Percent Total Direct and 

as a Percent :as Percent of of Total Direct and Indirect Expenditures 

of Compensation:Direct Expenditures Indirect Expenditures in in Puerto Rico Divided 

~~~~~~~~~~~~~~~~~~~~o_f~E_m_p_l_o~y~e_e~s !/:in Puerto Rico~/ Puerto Rico ll by Tax Expenditure!/~ 

Manufacturing industries 

Food and kindred products 

Tobacco products 

Textile mill products 

Apparel 

Chemicals, total 

Pharmaceuticals 

Rubber products 

Leather and leather products 

Stone, clay, and glass products 

Fabricated metal products 

Machinery, except electrical 

Electrical and electronic equipment 

Transportation equipment 

Scientific instruments 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

1/ From Table 6, column (10). 

2/ Column (1) times Table 8, line (10). 

3/ Column (2) divided by 1.33. !I Inverse of column (3). 

101. 7 

33.8 

49.4 

27.1 

22.9 

266.3 

347.6 

11.1 

28.7 

66.1 

82.4 

85.8 

100.1 

32.6 

93.3 

37.6 

7.4 

22.2 

14.4 

15.2 

73.0 

132. 4 

6.7 

21. 5 

25.3 

46.0 

59.7 

54.9 

21.4 

62.6 

28.2 

5.6 

16.7 

10.8 

11.4 

54.8 

99.3 

5.0 

16.1 

19.0 

34.5 

44.8 

41. 2 

16.1 

47.0 

3.5 

17.9 

6.0 

9.3 

8.8 

1.8 

1.0 

20.0 

6.2 

5.3 

2.9 

2.2 

2.4 

6.2 

2.1 

I 

l11 

""' I 
-55-

4. Forward Linkages 

Forward linkages are usually evaluated by examining the 

percentage of total sales to various types of customers. 

Table 10 shows the percentages of manufacturing industries' 

shipments in 1972 to Puerto Rico, to the United States and 

to foreign countries, respectively. For manufacturing as a 

whole, 41.2 percent went to individual and industrial 

consumers in Puerto Rico, 54.2 percent to buyers {including 

parent companies) in the United States, and 4.5 percent to 

foreign purchasers. If indirect exports {i.e., goods sold to 

other Puerto Rican manufacturers who, in turn, were 

exporting to the United States or foreign countries) could 

be estimated separately, Puerto Rico's dependence on export 

markets would appear larger than what Table 10 indicates. 

Table 10 indicates that some industries' forward 

linkages with other sectors of the Puerto Rican economy are 

stronger than others'. The lumber and wood industry sells 

its limited output to Puerto Rican users, and its primary 

customers -- the furniture and paper industries -- also sell 

almost exclusively to the local market. By contrast, the 

pharmaceutical industry derived 1 percent of its total sales 

from the Puerto Rican market. Sales to Gnited States 

buyers, many of whom may be parent corporations, accounted 

for 76 percent of total sales. The remaining 23 percent of 

pharmaceuticals' sales were to foreign purchasers {many of 

whom may have been affiliated foreign subsidiaries), a 

larger percentage than the corresponding figure for any 

other industry. The machinery industry, which exported 15 

percent of its total shipments to foreign buyers, was second 

in terms of non-u.s. exports. Because possessions 

corporations sell mostly outside Puerto Rico, their 

operations were not depressed by the 1973-77 recession in 

the local economy. 

D. Impact of Changing from Section 931 to Section 936 and 

of Restructuring the Tollgate Tax 

This Section reviews the available evidence on the 

impact of the Federal Tax Reform Act of 1976 and of the 

Commonwealth's restructuring of its tollgate tax on 

dividends paid by possessions corporations. Because the 

tollgate tax changes became effective on the same date 

{October 1, 1976) as section 936, and because the entire 

Puerto Rican Industrial Incentive Act has been under close 

scrutiny and its reform anticipated, the impact of shifting 

from section 931 to section 936 cannot be completely 

disentangled from the impact of the tollgate tax or the 

Uncertainty about the future of the tax exemption program. 
Table 10 

Destination of Shipments by Puerto Rican 

Manufacturing Industries, 1972 

(Percentage of Total) 

Industry Group 

All manufacturing industries 

Puerto Rico United States !/~~F_o_r_e_i~g_n __ C_o_u_n_t_r_i_e_s~ 

Food and kindred products 

Tobacco products 

Textile mill products 

Apparel 

Lumber and wood products 

Furniture and fixtures 

Paper and allied products 

Printing and publishing 

Chemicals 

Pharmaceuticals 

Petroleum refining 

Rubber products 

Leather and leather products 

Stone, clay and glass products 

Primary metal products 

Fabricated metal products 

Machinery except electrical 

Electrical and electronic equipment 

Transportation equipment 

Scientific instruments 

Miscellaneous manufacturing 

industries 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

41. 2 

59.2 

15.5 

28.7 

21.8 

100.0 

97.9 

87.5 

78.2 

18.9 

1.0 

64.2 

47.8 

15.6 

91. 7 

87.1 

77.1 

35.2 

10.7 

72.7 

3.9 

12.3 

54.2 

37.2 

84.5 

71. 3 

78.0 

2.1 

s.o 

18.2 

66.5 

76.0 

32.7 

52.2 

83.1 

8.3 

9.7 

22. 2· so.a 

87.9 

9.1 

94.6 

87.7 

4.5 

3.7 

* 

* 

* 

* 

7.5 

3.6 

14.6 

23.0 

3.3 

* 

* 

* 

3.2 

1.4 

14.8 

.2 

9.1 

2.3 

* 

Source: u.s. Department of Commerce, 1972 Economic Censuses of Outlying Areas, 

Manufactures, Puerto Rico, October 1974, Chapter 2, Table 3. 

!/ Includes shipments to the Virgin Islands. 

* Less than 0.05 percent. 

I 

U1 

°' I 
-57-

1. New Investment in Puerto Rico 

The Puerto Rican economy remained sluggish throughout 

1977, but has been picking up speed in 1978. To a large 

extent these recent gains represent a welcome, if long 

overdue, recovery from the recession which began in 1973-74. 

In addition, Puerto Rico is a primary beneficiary of recent 

changes in the international economy. The recent 

depreciation of the dollar against many foreign currencies 

has helped Puerto Rican goods and services compete with 

foreign producers for U.S. markets. The Orderly Marketing 

Agreements limiting Korean and Taiwanese exports of shoes to 

the U.S., and the Multifiber Arrangements limiting eighteen 

developing countries' exports of textiles and apparel to the 

U.S., have lessened the competitive pressure on Puerto Rican 

manufacturers in these industries. The winter of 1977-78 

was apparently the best ever for Puerto Rico's tourist 

industry. As the dollar depreciated and foreign vacations 

became more expensive, Puerto Rico seemed more attractive. 

In addition, the Tax Reform Act of 1976 imposed 

record-keeping and other requirements on Americans attending 

foreign conventions, but exempted those attending 

conventions in Puerto Rico and the possessions from those 

limitations. 

The combined Federal and Commonwealth tax changes 

enacted in 1976 apparently made investing in Puerto Rico 

somewhat less attractive for most U.S. companies. The 

Federal tax change added new incentives and disincentives to 

investing in Puerto Rico. Those companies anxious to bring 

money home from Puerto Rico as soon as possible benef itted 

from the dividends-received deduction made available in 

1976; those who felt no pressing need for domestic use of 

accumulated Puerto Rican income might have preferred to keep 

~ection 931 because of the exemption for Eurodollar interest 

lncome. But when the Puerto Rican tollgate tax rules and 

rates were also changed to make the dividends taxable, the 

9ains U.S. investors expected from the Tax Reform Act of 

1976 were diminished and, perhaps, reversed. 

Table 11 below is based on 394 corporations claiming 

section 936 benefits for fiscal years.ending before July 1, 

1977 (most of which were for the calendar year 1976). The 394 corporations included in Table 11 accounted for 

approximately 80 percent of the income excludable under 

section 931 in 1975 (as shown in Table 5 above). For 

corporations included in both the 1975 statistics of Table 5 

ana the 1976 statistics of Table 11, total book income and 

total Federal tax savings increased by 43 percent and 44 

Percent, respectively. Accordingly, the estimated tax 

~Xpenditure for sections 931 and 936 in calendar year 1976 

f

ls $634 million, a 44 percent increase over the $440 million 

or 1975. 
-58-

Table 11 

Income and Estimated Tax Expenditure by Industry, 1976 1/ 

Industry Group 

All industries 

Manufacturing industries 

Food and kindred products 

'lbbacco 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 

:Estimated Tax 

Number of :Book Incane: Expenditure 

:Corporations: ($000) ($000) 

394 1,325,963 532,996 

301 1,217,482 489,579 

18 79,205 31,882 

6 15,989 6,396 

6 -272 192 

67 47,462 19,072 

52 758,401 303,360 

36 654,540 261,816 

16 103,861 41,544 

7 l,56l) 626 

6 5,818 2,327 

3 9,242 3,697 

15 15,475 6,199 

7 2,012 808 

Electrical and electronic equipment 67 224,057 89,772 

Transportation equipment 

Scientific instruments 21 44,174 17,670 

All other manufacturing 26 14,359 7,578 

ltmmanufacturing 93 108,482 43,417 

'lransportation, communications 

and utilities 9 97,948 39,179 

Wholesale trade 11 1,881 753 

Retail trade 39 2,056 840 

Finance, insurance, real estate 9 1,065 434 

Services 10 743 297 

Miscellaneous and not available 15 4,787 1,915 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

.!./ Preliminary statistics. See text. Includes data for possessions 

corporations operating in American Samoa, G.larn, 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 1). 
-59-

Tables 12 and 13 present information for the 209 

possessions corporations included in Table 11 for which 1976 

employment and payroll· data are available. Comparing Table 

12 to Table 6 above suggests that between 1975 and 1976 the 

Federal tax expenditure increased not only in dollar terms, 

but also relative to Puerto Rican employment and payroll. 

This increase appears to be attributable as much to higher 

tax expenditure per employee or per dollar of employee 

compensation in the high-profit industries as to an increase 

in the relative importance of these industries. For the 143 

manufacturing corporations included in both Table 6 and 

Table 12, tax expenditure as a percentage of total employee 

compensation increased from 138 percent in 1975 to 149 

percent in 1976. (As noted above, employment and payroll 

data were, for no apparent reason, more often available for 

high-profit companies.) 

Because Tables 11, 12, and 13 are based largely on 

operations for calendar year 1976, they do not capture the 

effect of the Puerto Rican tollgate tax, which was passed 

and signed into law in the second half of 1976, much less 

the uncertainty of 1977 about the future investment climate 

in Puerto Rico. A better indicator of the impact of those 

developments may be the number of new tax exemptions applied 

for or granted over the last few years. Throughout 1977, 

each was low by historical standards, but this may have been 

due more to broader political and economic factors than to 

the technical changes in Federal and Commonwealth tax laws. 

As the outlines of the Puerto Rican Administration's 

Proposals for reforming the Industrial Incentive Act became 

apparent, investors realized that the days of total tax 

exemption were about to end. The large number of exemptions 

9ranted just before the new program was announced presumably 

included both a backlog of those that might have applied 

earlier and a rush of those that would have applied later. 

As of May 1978, 711 corporations had filed a section 

936 election form -- see Table 14. Taken together, these 

711 companies accounted for 99.5 percent of the income 

excludable under section 931 in 1975. Of these, 635 were 

included in one or more of the tables for 1973 to 1976 in 

this Report. The remaining 76 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, 

~977. Thirty-five of these 76 new companies were 

~ncorporated in 1977 or 1978, while the remaining 41 were 

incorporated prior to 1977. This last group includes 
Table 12 

Tax Expenditure, Employment and Conpensation of Employees by Industry, 1976 .Y 

COnpensati.on :Tax Expendi.-

Tax E~nditure E!!J2lO:ieeS of E!!J2lO:ieeS y_: Industry Group ~rof :Book Incane Amount :Percent of :Percent of: Amount :Percent of :Co~rations: ($000) ($000) Total Nwrt>er Total ($000) Total 

All industries 209 815,305 328,627 100.0 32,912 100.0 266,223 100.0 

Manufacturing industries 192 811,909 327,271 99.6 31,697 96.3 255,590 96.0 

Food and kindred products 10 38,557 15,621 4.8 4,239 12.9 30,199 11.3 

'lbbacco products 5 12,158 4,863 1.5 1,882 5. 7 13,276 5.0 

Textile mill products 4 -454 119 212 .6 1,449 .5 

Apparel 42 30,099 12,066 3.7 7,938 24.1 46,390 17.4 

Chemicals, total 35 549,315 219, 722 66.9 6,220 18.9 76,707 28.8 

Pharmaceuticals 25 478,329 191,329 58.2 4,428 13.5 48,691 18.3 

All other chemicals 10 70,986 28,393 8.6 1,792 5.4 28,016 10.5 ~ber products 5 1,069 430 .1 180 .5 1,407 .5 

Ieather and leather products 5 5,550 2,219 .7 995 3.0 6,362 2.4 

Fabricated metal products 12 11,141 4,465 1.4 522 1.6 4,232 1.6 

Electrical and electronic equi?llE!nt 38 110,042 44,160 13.4 6,147 18.7 47,934 18.0 

Scientific instruments 18 38,466 15,386 4.7 1,792 5.4 13, 721 5.2 

All other manufacturing y 18 15,966 8,220 2.5 1,570 4.8 13,913 5.2 

Nonmanufacturing 17 3,396 1,357 .4 1,215 3.7 10,633 4.0 

Ofhce of the secretary of the Treasury 

Office of Tax .Analysis 

1/ Preliminary statistics. See text. ~/ Conpensation of employees was C'QlilUted by nultiplying 1.195 times payroll. '!he additional 19.5 percent reflects the - employer-paid ix>rtion of social security, unemployment insurance, and other ron-payroll labor costs. '!he 19.5 percent is the 

average for all U.S. manufacturing industries in 1976; see the U.S. Department of Conrnerce, Surve:i of Current Business, July 

1977, Tables 6.5 and 6.6 

y Compensation of employees and number of employees used to canpute these amounts were weighted by industry using the ratio of 

tax expenditure in Table 11 and tax expenditure in this Table. 

y Includes manufacturing industries where data were available for less than 3 corix>rations. 

ture Per 

Employee ($) 

5,127 y 

7,522 y 

3,685 

2,584 

562 

1,520 

35,325 

43, 209 

15,844 

2,386 

2,230 

8,553 

7,184 

8,586 

5,236 

1,118 

: Tax Expendi. ture Average :as Percent of Employee 

:Compensation of Conpensation : E!r()lo:iees ($) 

71.1 y 7,208 y 

119. 7 y 6,287 y 

51. 7 7,124 

36.6 7,054 

8.2 6,834 

26.0 5,844 

286.4 12,332 

392.9 10,996 

101.3 15,634 

30.6 7,816 

34.9 6,393 

105.5 8,107 I 

C'I 92.1 7,797 0 

112.1 7,656 I 

59.1 8,862 

12.8 8,751 
Table 13 

Tax Expenditure, Employment and Compensation of Employees by Size of Tax Expenditure Per Employee, 1976 .!/ 

Compensation of :Tax Expend1- :Tax Expenditure: Size of Tax Tax E~nditure E!!Elo:tees E!!Elo:tees y __ : ture Per :as Percent of 

Expenditure Number of :Book Income: Amount :Percent :Percent Amount Percent Eniployee :Compensation of: ~r E!!Elo:tee :Co~rations: ($000) ($000) :of Total: Nurrt>er :of Total: ($000) : of Total ($) :E!!Elo:tees 

All Corporations 209 815,305 328,627 100.0 32,912 100.0 266,223 100.0 5,127 y 

$ 50,000 under $100,000 9 339,728 135,889 41.4 1,721 5.2 20,121 7.6 78,959 

$ 10,000 under $ 50,000 50 314,304 125,719 38.3 6,291 19.1 72,339 27.2 19,984 

$ 5,000 under $ 10,000 28 64,402 25,761 7.8 3,780 11.5 29,038 10.9 6,815 

$ 1,000 under $ 5,000 64 95,374 38,136 11.6 14,567 44.3 100,039 37.6 2,618 

$ 500 under $ 1,000 29 6,314 2,522 .8 3,588 10.9 22,364 8.4 703 

$ 100 under $ 500 16 1,460 584 .2 1,780 5.4 11,691 4.4 328 

$ 1 under $ 100 3 33 13 224 .7 1,242 .5 58 

Loss Corporations 10 -6,309 961 2.9 9,389 3.5 

Office of the Secretary of the Treasury 

Off ice of Tax Analysis 

1/ Preliminary statistics. See text. 

2/ Compensation of employees was computed by multiplying 1.195 times payroll. 'Ihe additional 19.5 percent reflects the - employer-paid portion of social security, unemployment insurance, and other non-payroll labor costs. 'Ihe 19.5 percent is 

the average for all U.S. manufacturing industries in 1976; see the U.S. Department of Commerce, Surve:t of Current Business, 

July 1977, Tables 6.5 and 6.6. 

71.1 

675.4 

173.8 

88.7 

38.l 

11.3 

5.0 

1.0 

3/ Compensation of employees and number of employees used to compute these amounts were weighted by industry using the ratio of 

- tax expenditure in Table 11 and tax expenditure in Table 12. 

y 

Average 

Eniployee 

Compensation 

($) 

7,208 y 

11,691 

11,498 

7,682 

6,867 

6,232 

6,568 

5,545 

9,770 

I 

O'I 

I-' 

I 
Table 14 

Elections under Section 936 by Industry 

Total :Included: New Elections 

as of in Date of IncorEoration 

Industrx: :Mal 1978: ReEort Total :1977 or 1978:Before 1977 

All industries 711 635 76 35 41 

Manufacturing industries 546 491 55 27 28 

Food and kindred products 32 28 4 1 3 

Apparel 126 114 12 6 6 

Chemicals, total 95 87 8 4 4 

Pharmaceuticals 65 61 4 2 2 

All other chemicals 30 26 4 2 2 

Fabricated metal products 35 31 4 2 2 

Electrical and electronic equipment 106 97 9 5 4 I 

Scientific instruments 36 32 4 1 3 °' I\.) 

All other manufacturing 116 102 14 8 6 I 

Nonmanufacturing 165 144 21 8 13 

Wholesale and retail trade 70 65 5 2 3 

Finance, insurance, real estate 29 23 6 1 5 

All other nonmanufacturing 66 56 10 5 5 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 
-63-

several companies incorporated in the last five years, but 

which presumably had start-up losses making an earlier 

section 936 election disadvantageous. Table 14 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 14 indicates that the 

new 936 corporations have very much the same industrial 

composition as the old ones do. 

2. Repatriation of Dividends 

In denying a tax exemption for income earned outside 

the possession in which the corporation had a trade or 

business, and in making a dividends-received deduction 

available to the parent, Congress hoped to speed the 

repatriation of dividends. Because of the Puerto Rican 

tollgate tax, however, dividend payments were slow 

throughout 1977. With the entire 936 community seeking 

repeal or substantial modification of the tax, most 

companies waited to see what would happen. Because the 

tollgate tax does not apply to a liquidating distribution, 

the incentive to wait until the income tax exemption expired 

and then liquidate the subsidiary into the parent remained, 

albeit with diminished force and for Commonwealth, rather 

than for Federal, tax reasons. Finally, some companies 

initially wondered whether they could pay any tollgate tax 

Without being required by their accountants-to establish a 

reserve to provide for future tollgate taxes on all 

~ccumulated earnings. Creating such a reserve could depress 

income in financial statements in the quarter in which the 

reserve was established. Accounting firms have, however, 

tak~n the position that a reserve for taxes on accumulated 

earnings need not be established, providing the company 

commits itself to repatriating only current earnings. 

In the first six months of 1978, the rate of dividend 

hayments increased appreciably. As of early June, companies 

~ve committed themselves to paying in excess of $1.4 

billion in dividends and $48 million in tollgate taxes. The 

effective rate of taxation of 3-4 percent reflects the 

Puerto Rican Treasury Department's ruling in December 1977 

(clarifying the exemption for dividends from income earned 

outside Puerto Rico from the 10 percent tollgate tax and 

a~lowing a company to designate up to 50 percent of a 

~ividend as coming from undistributed foreign income). The 

increased flow of dividends reflects not only the lowering 

~f the effective rate of the tollgate tax from 10 percent to 

ess than 5 percent, but also the investors' recognition 

that further reductions in the tollgate tax are unlikely. 
-64-

3. Financial Portfolios 

As of mid-1977, accumulated retained earnings of 

possessions corporations were estimated to be between $5 

billion and $6 billion and growing at a rate of $1.6 billion 

annually. (The increase in dividend payments in 1978 has cut 

the growth of accumulated retained earnings.) Under section 

931, a portion of the accumulated funds found their way to 

the Eurodollar market through banks in Guam. Interest on 

Guam deposits was not only exempt from Guam and Puerto Rican 

taxes, but under section 931 was possessions source income, 

and, therefore, helped the recipient to remain qualified for 

the section 931 exclusion. Subsidiaries whose Eurodollar and 

other passive income was about to exceed 50 percent of their 

total income and, thus, stood to lose their· 931 exemption on 

this account often invested in tax-exempt municipal bonds, 

Puerto Rican and U.S., because the interest was not counted 

as income in determining the eligibility for section 931 

benefits. 

The tax exemption for interest on Eurodollar 

investments generally and Guam certificates of deposit in 

particular was terminated by section 936, which provided a 

tax credit only for income earned in the possession where 

the 936 company had a trade or business. The estimated 

composition of financial investments by 936 corporations as 

of mid-1977 is shown in Table 15. The nearly $3 billion 

invested in Puerto Rican assets represents a substantial 

·increase over earlier years and reflects the section 936 tax 

credit for "qualified possessions source investment income." 

Despite the apparent infusion of 936 funds, long-term 

interest rates in Puerto Rico have not been appreciably 

reduced for the average borrower. As indicated in Table 15, 

established 936 companies are willing to make construction 

loans to new 936 subsidiaries of established U.S. companies, 

but not to less credit-worthy Puerto Rican borrowers. Under 

temporary federal tax regulations, Puerto Rican banks 

(including the Puerto Rican branches of mainland banks) can 

"warehouse" 936 deposits in New York for up to six months, 

so much of the 936 bank deposits shown in Table 15 has led 

to increased investment outside of Puerto Rico. 

The substantial increase since 1976 in purchases of 

Puerto Rican government bonds and the contemporaneous 

reduction in interest rates on these bonds is sometimes 

attributed to the 936 credit for qualified possessions 

source investment income -- see Table 16. In fact, this is 

not the case -- such interest is tax-exempt under the Puerto 
-65-

Table 15 

Estimated Composition of Financial Investments 

by 936 Corporations in Mid-1977 

$ billions 

1.6 

.6 

.4 

.3 

2.9 

.6 

.3 

.4 

1.3 

. 6 

.5+ 

5.3+ 

Asset 

Deposits in Puerto Rican Banks 

Puerto Rican source GNMA mortgages 

931-936 loans 

Puerto Rican Government bonds 

Total invested in Puerto Rico 

U.S. municipals 

U.S. project notes 

Preferred stock 

Total invested in the U.S • 

Canada and Europe 

Unaccounted for 

Total 936 funds 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 
Table 16 

Sales of Bonds by the G:>vernment ~veloprnent Bank for Puerto Rico 

October 1976 - May 1978 

Average :Net Interest:Bond Buyer's: 

Issuing Agency Date 

(1) 

Water Resources Authority 10-13-76 

G:>vernrnent D:velopment Bank 2/ 12-06-76 

Aqueduct & Sewer Authority - 12-10-76 

Highway Authority 2-18-77 

Conunonwealth Series 1977 4-14-77 

G:>verrunent D:velopnent Bank 2/ 7-13-77 

Highway Authority 8-10-77 

Ports Authority 11-17-77 

Public Buildings Authority 2-14-78 

Puerto Rico Industrial Development 3-31-78 

G:>vernrnent D:veloprnent Bank 2/ 5-05-78 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

y Bond Buyer Index, 'Ihe Weekly Bond Buyer. 

l:J Issued directly to 936 cor{X>rations. 

Amount . . : ($ millions): 

(2) 

60.0 

85.0 

35.0 

62.5 

300.0 

so.a 

75.0 . 

29.5 

110.0 

40.0 

50.0 

Source: G:>verrunent Developrnent Bank for Puerto Rico. 

Life Cost Index of 

(Years) (percent) 20 Bonds y: 

(3) (4) (5) 

18.13 8.23 6.25 

8.65 7.75 5.96 

15.40 7.88 5.96 

13.66 7.61 5.83 

24.24 7.89 5.70 

6.21 6.15 5.64 

22.38 6.99 5.63 

20.06 7.33 5.45 

14. 71 7.72 5.61 

16.80 7.98 5.69 

7.64 7.04 5.89 

Point 

Spread 

(4-5) 

(6) 

1.98 

1. 79 

1.92 

1. 78 

2.19 

.51 

1.36 

1.88 

2.11 I 

2.29 "' 1.15 "' I 
-67-

Rican Relations Act.* Like interest on U.S. state and 

municipal bonds, interest on Puerto Rican government 

obligations was not counted in determining eligibility of 

section 931 and is similarly treated under section 936. By 

contrast, "qualified possessions source investment income" 

helps a possession corporation establish that 80 percent of 

its gross income is possessions-source. Thus, the increased 

demand by the 936's for Puerto Rican government bonds is 

attributable to several other factors: 

(1) the recent progress the former and the current 

Puerto Rican Administrations have made in 

reducing their borrowing requirements (see 

Figure II above) and thereby increasing the 

appeal of their bonds; 

(2) the tollgate tax reductions obtainable by 

investing in government bonds; 

(3) the increased demand for tax exempt bonds 

generally (because income earned outside a 

possession where the corporation has a trade 

or business i~ no longer tax exempt); 

(4) the "jawboning" of the Puerto Rican government 

to induce the 936's to reinvest more of their 

earnings in Puerto Rico; and 

(5) banks buying government bonds and reselling 

them to the 936's with a guarantee that the 

bank will repurchase the bonds as specified at 

the time of the original sale, should the 

936's wish to sell them back. 

* In 1970, the Internal Revenue Service ruled (Rev. Rul. 

70-219) that Puerto Rican Government Bonds were exempt under 

the Act of March 2, 1917, as amended by the Puerto Rican 

Relations Act, rather than under section 103 of the Internal 

Revenue Code (which exempts interest on bonds on States, 

Territories, Possessions and political subdivisions thereof) 

The effect of this ruling was to exempt Puerto Rico from the 

additional restrictions in section 103 of the Internal 

Revenue Code on industrial development bonds, arbitrage 

bonds, and so forth. 
-68-

To date, the section 936 credit for "qualified possessions 

source investment income" has allowed the 936's an additional 

source of tax-exempt income and permitted certain borrowers 

(other 936 companies, GNMA mortgage holders, the banks) to 

obtain funds at reduced interest rates, but apparently has 

not had a measurable impact on total new investment in Puerto 

Rico. 

Investments in tax-exempt U.S. municipals and in U.S. 

preferred stocks (which are entitled to an 85 percent 

dividends-received deduction for Federal tax purposes) by 

possessions corporations have also increased sharply. One 

company went so far as to obtain a letter ruling from the 

U.S. Internal Revenue Service that a 936's purchase of its 

own parent's common stock would not be treated as a 

constructive dividend for Federal tax purposes. But when the 

Puerto Rican Treasury declined to issue a comparable ruling 

for tollgate tax purposes, the planned purchase was 

abandoned. 

E. Possible Impact of the New Industrial Incentive Act 

The newly enacted reforms in the Puerto Rican Industrial 

Incentive Act are exceptionally complex, and the companies 

themselves will need some time to weigh the options before 

determining their own course of behavior. Because April 1979 

is the soonest a company must decide whether to convert to 

partial income taxation for its current fiscal year, several 

years may pass before the impact of the recent changes can be 

assessed with any precision. Nonetheless, some basic features 

of the recent changes can be considered now: 

For some companies, especially those with only a 

few years remaining on their exemption grants, 

the best option may still be to keep their total 

exemption from income taxes, repatriate no 

dividends, and when the tax exemption expires, 

liquidate tax-free into the parent. 

For those who do convert, the effective rates of 

taxation will be quite low, perhaps averaging 5 

percent of pretax income, in the near future. The 
s 

1 

s 

0 

s 

,0 

l e 

e 

te 

:s 

a 

1e 

tg 

tS 

-69-

low effective rates would reflect the provision 

allowing 50 percent of tollgate taxes paid on 

income earned prior to conversion to be credited 

against the post-conversion income tax, the 

"progressive" structure of the Puerto Rican 

corporate income tax rates, and the prov1s1ons 

allowing two-thirds of income taxes paid by some 

companies to be credited against post-conversion 

tollgate taxes. 

To alleviate unemployment, three declining 

industries -- textiles, apparel and shoes 

will be able to extend their tax exemption 

grants on terms more favorable than other 

industries can. In addition, export-oriented 

service industries, which heretofore have been 

fully taxable, but might bring high paying jobs 

to Puerto Rico, will qualify for grants of 

partial tax exemption. 

The tax incentive to liquidate companies and 

close plants will be lessened. New grants will 

exempt a large, but declining;- fraction of 

income from taxation, thereby easing companies 

into paying taxes. A primary incentive existing 

companies have to convert to partial tax 

exemption is an automatic extension of the 

partial exemption grant. 

How much of an economic impact will the new changes 

have? The measured Federal income tax expenditure will be 

reduced by any income and tollgate taxes paid in Puerto Rico, 

but an effective Puerto Rican rate of 5 percent is one eighth 

of the 40 percent rate which this Report has assumed would be 

applicable in the absence of section 936. If the new 

~ffective tax rates are low enough not to have a measurable 

lmpact on the volume or industrial composition of investment, 

0 r on inter-affiliate transfer prices or other features of 

Possessions corporations' behavior, the measured Federal tax 

expenditure (in dollar terms or relative to employment, 

employee compensation, total Puerto Rican income generated, 

and so forth) will be reduced by one eighth (because the 

Federal taxes foregone will represent 35 percent, rather than 

40 percent of pretax income). Accordingly, the Federal tax 

expenditures for 1978 and thereafter, as shown in Table 1, 

above, have been reduced by one eighth of the value they 

Otherwise would have taken. 
-70-

Appendix A -- Operation of the Possessions Corporation 

System of Taxation in American Samoa, 

Guam, the Panama Canal Zone and the 

Virgin Islands 

American Samoa, Guam and the Panama Canal Zone 

1. Federal and Possessions Taxation 

The income tax laws in effect in Guam are a mirror of 

those in force in the United States, i.e., the word "Guam" 

is substituted for the *ords "United States" wherever they 

appear in the United States Internal Revenue Code. This 

mirror system is provided for under section 31 of the 

Organic Act of Guam (48 u.s.c. section 1421). In contrast 

to Guam and the Virgin Islands, whose income tax laws were 

the result of Federal enactment, the U.S. Internal Revenue 

Code was enacted by American Samoa as the American Samoa 

Income Tax Act. The Act, effective January 1, 1963, 

established the "mirror system" for American Samoa. 

Under this "mirror" system, the U.S. and the 

possessions are separate tax jurisdictions and a taxpayer's 

status, whether resident or nonresident, alien or citizen 

for individuals, or whether domestic or foreign for corporations, is determined by reference to the jursisdiction 

invol~ed. The mirror system also means that any amendments 

.to the U.S. Code automatically change the tax law in effect 

in the possession. In contrast, the tax laws operative in 

Puerto Rico are based on the 1939 U.S. Internal Revenue Code 

and are not automatically amended with cha~ges in the U.S. 

Code. 

u.s.-chartered corporations operating in American 

Samoa and Guam are considered foreign corporations for 

purposes of the income tax laws of these possessions. 

Similarly, a corpoiation chartered in American Samoa or Guam 

is considered a foreign corporation for purposes of the 

Federal income tax. However, Code sections 881 and 1442 

provide an exception to this foreign corporation treatment 

for purposes of imposing the 30 percent withholding tax on 

fixed determinable, annual or periodical U.S. source income 

earned by a Guamanian corporation. Under these sections and 

applying the mirror concept, Guam and the U.S. are not 

considered foreign and no withholding tax is imposed. 
-71-

U.S. corporations operating in American Samoa, Guam, 

and the Panama Canal Zone may qualify for special tax 

treatment under section 936 in the same manner as U.S. 

corporations in Puerto Rico, if they satisfy the 80 and 50 

percent source rules. (The Virgin Islands are not treated 

as a possession for purposes of section 936). Corporations 

qualifying under section 936 are allowed a credit to offset 

any U.S. tax on income from the active conduct of a trade or 

business in the possession as well as for "qualified 

possessions source investment income". Also, the U.S. 

parent corporation of a 936 subsidiary operating in American 

Samoa, Guam, or the Panama Canal Zone is entitled to a 

dividends-received deduction. Finally, the 936 election is 

irrevocable for 10 years and during that period the 

subsidiary cannot join the parent in filing a consolidated 

return. 

Under the industrial incentive program of Guam, 

corporations that meet minimum investment and certain other 

requirements (such as increasing employment, replacing 

imports , or creating vitally needed facilities) can qualify 

for reba t es of corporate income taxes and income taxes on 

dividends, and exemption from taxes on income derived from 

the lease of land, buildings, machinery and equipment, 

Property taxes and gross receipts taxes on petroleum and 

alcoholic beverages manufactured in Guam. The rebate for 

corporate income taxes is allowed for up to 20 years, up to 

5 years for taxes on dividends and up to 10 years for all 

Other tax exemptions. The company has the option of 

doubling the allowable time period for the rebates or 

exemptions by electing to enjoy half the rebate or 

exemption. 

The government of American Samoa grants temporary 

exemptions from the payment of all or some taxes, duties, 

and business license fees for the establishment or expansion 

Of qualifying industrial or business enterprise. In order 

to qualify, the business must be owned by a resident of 

American Samoa. In addition,, 75 percent of the work force 

of the exempt firm must be residents of American Samoa. The 

~ax exemption can be for a period up to 10 years, although 

lt may be made to terminate earlier if the cumulative amount 

~f taxes forgiven equal 200 percent of the net current 

investment. 
-72-

The Panama Canal Zone, although treated as a possession 

under section 936, differs from the other possessions in 

several respects. It is operated by a federal agency (the 

Canal Zone Company) and government officials are appointed 

by the President rather than elected locally. It has few ..__ 

private businesses except for oil, shipping and insurance 

companies which assist in operating the Canal. Most of the 

expenditures of the Canal Zone government and Company are --

financed through toll collections. Although the President !\mi 

has the authority to impose taxes, it has never been used. 

Finally, as a result of the new Panama Canal Treaties, the Gu 

Canal Zone will no longer be considered a possession for 

U.S. tax purposes. Pa 

2. Statistical Data 

Table A-1 shows for 1975 the number of corporations in 

each possession which qualified for the benefits of section 

931, their book income, and estimated tax saving (i.e., 

Federal tax expenditure). The data show that 13 companies 

with book incomes of $7 million accounted for a tax saving 

of almost $3 million under section 936. These figures 

compare with 1975 book incomes of $1.1 billion and tax 

savings of $447 million for 595 companies oerating in Puerto 

Rico. Payroll and employment data were unavailable for the 

companies operating in American Samoa, Guam and the Panama 

Canal Zone. 

Virgin Islands 

1. Virgin Islands and Federal Taxation 

Under the Naval Appropriations Act of 1921, the income 

tax laws of the Virgin Islands are those currently in force 

in the United States; i.e., the U.S. Internal Revenue Code 

is transformed into a Virgin Islands Internal Revenue Code 

by substituting the words "Virgin Islands" wherever "United 

States" appears in the Code. In addition, under section 

28(a) of the Revised Organic Act of 1954, "inhabitants" of 

the Virgin Islands are taxed on their worldwide income by 

the Virgin Islands and are exempt from any income tax 

liability to the United States Treasury, even on their 

United States source income. The question of whether a 

corporation is an "inhabitant" of the Virgin Islands is an 
-73-

Table A-1 

Income and Estimated Tax Expenditure 

by Possession, 1975 

Number 

of 

-- Possessions : Coq~or at ions: 

l\rnerican Samoa 4 

Guam 3 

Panama Canal 6 

'l'otal 13 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

Book 

Income :Tax 

($000) 

4, 10 2 

1,086 

2,034 

7,222 

Estimated 

Expenditure 

($000) 

1,641 

434 

814 

2,889 
-74-

unsettled one. Corporations organized in the Virgin Islands 

are considered "inhabitants" of the Virgin Islands. 

Corporations organized outside the Virgin Islands may also 

be considered "inhabitants" of the Virgin Islands, although 

the precise conditions under which they will be so 

considered are not clearly defined. 

Foreign (including U.S.) corporations which do not 

qualify as inhabitants of the Virgin Islands are subject to 

taxation as foreign corporations under the "mirrored" Virgin 

Islands Code. Thus, they are taxed on a net basis on all 

income which is effectively connected with the conduct ·of a 

trade or business in the Virgin Islands. Although fixed or 

determinable annual or periodical income (such as interest, 

rents, dividends, wages) which is not effectively connected 

with the conduct of a trade or business is generally subject 

to taxation at a flat 30 percent rate, recent court 

decisions have raised questions as to whether and in what 

circumstances this income is subject to withholding by the 

Virgin Islands. The Virgin Islands tax administrators have 

in recent years assumed that such income is subject to 

withholding, and have imposed the withholding taxes. 

However, a 1977 decision of the United States Court of 

Appeals in the Third Circuit has cast serious doubt on 

whether the withholding taxes may be imposed upon payments 

to United States persons under the "mirrored" Virgin Islands 

Code. If withholding taxes are imposed, the taxes are 

creditable (subject to limits) against United States tax 

liability. 

During the post World War II period, many developing 

countries (including the Virgin Islands) enacted legislation 

providing tax incentives to encourage business investment. 

The Virgin Islands' first Tax Incentive Act was pas&ed in 

1948 (the same year the Puerto Rican Industrial Incentive 

Act was enacted), and was amended several times thereafter. 

In 1975, a new industrial incentive program was enacted by 

the Virgin Islands Legislature. The program established 

significant new incentives (tax exemptions and subsidies) 

for businesses to establish operations in the Virgin 

Islands. However, in order to receive the tax benefits under 

the industrial incentive program, the corporation must 

qualify not only under the industrial incentive program, but 

must also qualify under section 934 of the Internal Revenue 

Code. 
-75-

Enacted by the Congress in 1960, section 934 aims to 

Prevent the Virgin Islands from granting tax rebates or 

subsidies for taxes attributable to income derived from 

sources within the United States. The Virgin Islands are 

Permitted to make rebates and subsidies to a U.S. or Virgin 

Islands corporation on tax liability based on income from 

sources without the United States, but only if the 

corporation meets the so-called "80-50 tests." These are: 

(1) that 80 percent or more of the corporations income 

for the 3-year period preceding the close of the taxable 

Year must be from sources within the Virgin Islands; and, 

(2) that 50 percent of the corporation's income for the 

Period must have been derived from the active conduct of a 

trade or business in the Virgin Islands. 

Under the current Virgin Islands Industrial Incentive 

Program, U.S. corporations which meet the requirements of 

section 934 and certain other requirements (including 

minimum investment, employment, and ecological standards) 

are eligible for the two types of benefits: 

(1) total exemption from property taxes attributable to 

the exempt business, gross receipts taxes, and excise taxes 

on materials, appliances, and supplies used in the 

construction, alteration, reconstruction, or extension of 

the facilities of the exempt business; 

(2) tax refunds for (a) 90 percent of the customs 

d~ties on raw materials or component parts imported into the 

Virgin Islands used to produce, create or assemble articles, 

90ods or commodities; (b) 90 percent of the income tax paid 

to the Virgin Islands on income derived from V.I. sources. 

These exemptions and subsidies are permitted for 10 

Years, but the beneficiary has the option of electing 

Partial benefits for up to 20 years provided that the 

Percentage of the benefits taken multiplied by total number 

of Years equals 10. The percentage subsidy available for 

each term chosen by the taxpayer is given in the following table: 
Term 

10 years 

11 years 

12 years 

13 years 

14 years 

15 years 

16 years 

17 years 

18 years 

19 years 

20 years 

-76-

Percent of Subsidy 

or Exemption 

100.0% 

90.9 

83.3 

76.9 

71.4 

66.7 

62.5 

58.8 

55.5 

52.6 

50.0 

Although tax exemptions and subsidies do not have to follow 

the same time schedule, the dates of election must be within 

the first five years of the operation of the business. 

Moreover, an additional five years of benefits (or up to 10 

years of no less than 50 percent of the benefits) may be 

obtained by locating in certain economically depressed 

areas. 

A U.S. corporation which qualifies as an "inhabitant" 

of the Virgin Islands, meets the 80-50 tests, and elects a 

10 year subsidy pays a maximum effective corporate income 

tax rate in the Virgin Islands of 4.8 percent, assuming the 

corporation is taxed at a 48 percent and 90 percent of the 

tax is refunded. The actual effective V.I. tax rate is 

probably less if the impact of other tax provisions, such as 

the investment tax credit and accelerated depreciation, is 

taken into account. For example, the effective tax rate on 

domestic income of U.S. manufacturing corporations is about 

40 percent after taking into account other provisions in the 

law which reduce taxes. 1/ Therefore, U.S. corporations 

which do business in the V:I. may pay effective rates in the 

V.I. as low as 4 percent, if they take advantage of these 

provisions. 

A United States corporation which qualifies as an 

inhabitant of the V.I. is treated as a domestic corporation 

!/ Department of the Treasury, Effective Income Tax Rates 

Paid by United States Corporations in 1972, May 1978. 
-77-

for U.S. tax purposes. Like 936's in Puerto Rico, dividends 

paid by a U.S. subsidiary in the V.I. to its U.S. parent 

qualify for a dividends-received deduction. If the 

subsidiary is 80 percent or more owned by the parent, the 

U.S. subsidiary in the V.I. may be liquidated, and its 

assets distributed to its parent, without recognition of 

gain or loss upon the liquidating distributions. In 

addition, other corporate organizations and reorganizations 

involving the subsidiary do not require a section 367 ruling 

or toll charge, because no foreign corporation is involved. 

Unlike section 936 companies, the U.S. subsidiary may be a 

member of an affiliated group for purposes of filing a 

consolidated return. Finally, under section 28 of the 

Revised Organic Act, the U.S. subsidiary which qualifies as 

an inhabitant of the V.I. satisfies its U.S. tax liability 

by reporting and paying taxes to the Virgin Islands. Not 

only does it escape U.S. tax jurisdiction, but it may also 

qualify for a reduced V.I. tax liability if it meets the 80 

and 50 percent source of income rules under section 934 of 

the Code. 

Although dividends paid by the U.S. subsidiary 

operating in the V.I. qualify for the dividends-received 

deduction for purposes of computing the parent's United 

States tax liability, the Virgin Islands may seek to impose 

a 30 percent withholding tax on these dividends (as 

discussed above). If withholding taxes are imposed, the 

United States would allow the parent corporation to credit 

these taxes (subject to limits) against its U.S. tax 

liablity. Puerto Rican possession corporations are also 

allowed a dividends-received deduction, but are not allowed 

a foreign tax credit for withholding taxes. 

If the parent wishes to "repatriate" the earnings 

Without paying the V.I. withholding tax, it may permit the 

Subsidiary to accumulate its earnings and then liquidate the 

Subsidiary. The United States would not recognize a gain or 

loss on the transaction (although the earnings might be 

Subject to the accumulated profits tax). The Virgin Islands 

Would treat the liquidation as a capital transaction not 

Subject to the withholding tax. 
-78-

2. Statistical Data 

At the end of the 1975 fiscal year, 92 firms held 

certificates of tax exemption and subsidy in the Virgin 

Islands. The average wage and payroll distribution for the 

tax exempt industries is presented on Table A-2. These 

firms employed about 4,800 persons and had a payroll of 

approximately $34 million. Employees of firms in the 

chemical (including pharmaceuticals) and hotel industries 

alone accounted for almost 66 percent of total employment in 

tax exempt industries and 20 percent of total private 

employment in the Virgin Islands. 

Table A-3 shows the subsidy payments received by tax 

exempt businesses during fiscal year 1975. According to the 

figures on Table A-3, subsidy payments of almost $137 

million have been made during fiscal year 1975. This amount 

is large when it is compared to total operating revenues of 

only $294 million for the Virgin Islands. Subsidy claims 

increased to $146 million for fiscal year 1976, probably 

reflecting the enactment of the new industrial incentive 

program in October 1975. Moreover, it should be noted that 

most of these businesses also enjoyed exemption from license 

fees, excise taxes or building materials and real property 

taxes. 

Published data are inadequate for estimating the tax 

loss from the tax exemptions and subsidies permitted by 

section 934. The income tax subsidies presented on Table 

A-3 do not accurately reflect the U.S. tax loss because the 

data include both U.S. and V.I. corporations and represent 

actual payments rather than claims. !/ 

!/ The published data for 1975 show both pending certified 

claims and actual payments of $18,651,249 and $4,432,365, 

respectively. 
Table A-2 

Average Payroll and Employment for Tc:lx Exempt Industries in the Virgin Islands, FY 1975 

:Average Number Percent of Annual : Percent of 

Indus tr~ of Enplolees :Total Enplo~ees: Avera9e Payroll :Total Payroll 

Hotels, Q.iest !buses and Motels 1,117 23.1 $5,249,000 15.5 

Watches and Related Products 589 12.2 3,055,000 9.0 

Costume Jewelry and Related Products 18 0.4 95,000 0.3 

Knitting, Weaving, Spinning, 

Laminating and Shower-Proofing Woolens 186 3.8 1,170,000 3.4 

Chemicals and Related Products 2,071 42.7 19,362,000 57.0 

Housing Projects 31 0.6 248,000 0.7 

All others 832 17.2 4,778,000 14.1 

'lbtal 4,844 100.0 $33,957,000 100.0 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

Source: 1975 and 1976 Annual Reports of the Q)vernor of the Virgin Islands to the Secretary of the 

Interior for the fiscal years ended June 30. 

I 

.......i 

~ 

I 
-80-

Table A-3 

Virgin Islands Tax Incentive Program Subsidy Claims, 

Fiscal Years 1975 and 1976 

FY 1976 

Customs Duties $122,495,822 

Excise Tax 87,731 

Income Tax 

(Business) 23,245,850 

Total 145,829,557 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

FY 1975 

$132,408,111 

86,062 

4,352,717 

136,848,890 

Source: 1975 and 1976 Annual Reports of the Governor of the 

Virgin Islands to the Secretary of the Interior for 

the Fiscal Years ended June 30. 
-81-

Appendix B -- Sources and Limitatioris of the Data and 

Statistical Data for 1973 and 1974 

Introduction 

This Appendix includes tables covering data for 1973 

and 1974, similar to text Tables 5, 6, and 7 covering data 

for 1975 and Tables 11, 12, and 13 covering 1976, and a 

discussion of the sources and limitations of the data. All 

of the data in these text and Appendix tables are based on 

910 corporations that either excluded income under section 

931 in one or more of th~ years 1973, 1974, and 1975, or 

made an election under section 936 for 1976. 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. 

§...ources and limitations of the data 

The primary source of income data was Form 5712, 

hElection to be Treated as a Possessions Corporation Under 

Section 936". (Appendix C contains copies of all tax forms 

from which data included in this Report was obtained.) If 

the corporation filing Form 5712 or any other member of its 

controlled group excluded income under section 931 for any 

~axable year beginning in 1973, 1974, or 1975, the net 

lncome per books of that corporation for each year 1973-1975 

Was reported on the Form. One problem with this data is 

that the income for all three years, 1973-1975, was reported 

even though the corporation may not have excluded income 

Under section 931 all three 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, 

~nd does not affect the tax expenditure estimates which are 

ased on the income of profitable firms only. 
-82-

In addition to Form 5712, some income data and all of 

the Puerto Rican tax data were obtained from income tax 

returns (Forms 480.20) filed with the Puerto Rican 

Government. Most of the 1976 income data were derived from 

Form 5735, "Computation of Possessions Corporation Tax 

Credit Allowe~ Under Section 936". 

The employment and payroll data was taken from Form 

940, "Employer's Annual Federal Unemployment Tax Return". 

These returns are filed on a calendar year basis; for 

companies 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 (line 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 (line 11, Form 940) by a factor representin9 

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 items, such as 

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 
-83-

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 (910) included 

in at least one year for several reasons. Some corporations 

were organized after 1973, in some cases as late as 1976, 

and therefore do not appear in tables for the years prior to 

their establishment. Similarly, some firms were liquidated 

{or became inactive) before 1976, 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 was 

not available for all years 1973-1975. 

The number of corporations included in text Tables 11, 

12, and 13 covering 1976, is considerably less than the 

number included in Tables 5, 6, and 7, covering 1975, for 

several reasons. The 1976 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 benefited from section 931 in at least one of the 

Years 1973-1975. These corporations, for various reasons, 

~ave not themselves made an election under section 936 and 

1 n most instances will therefore not appear even in complete 

~976 data. For example, there were 115 corporations 

~ncluded in the 1975 tables that did not elect under section 

36, compared with only 10 in 1976. (These 10 had 

~~counting periods beginning before January 1, 1~76, and 

T erefore could still claim the benefits of section 931. 

1

hey may elect under section 936 for subs~quent yea:s:) _ A 

arge portion of the section 931 corporations classified as 

~~n-manufacturing did not make an election under sect~on 6• As a result, relatively few non-manufacturing 

corporations are present in the 1976 data. 
-84-

Statistical Data for 1973 and 1974 

Tables B-1 and B-2 correspond to Tables 5 and 11 in the 

text and provide data for 1974 and 1973, respectively. 

Similarly, Tables B-3 and B-4 correspond to Tables 6 and 12 

in the text, and Tables B-5 and B-6 to Tables 7 and 13. 

Table B-1 indicates that 594 corporations had income of ~ 

$852 million and tax savings of $372 million in 1974. Table 

B-2 presents data for 563 corporations with income of $651 M

million and tax savings of $258 million in 1973. 

Tables B-3 through B-6 are limited to those 

corporations for which both income and employment data were 

available. Although these tables present data for less than 

half the number of corporations included in Tables B-1 and 

B-2, their coverage in terms of income and tax expenditure 

exceed 60 percent for 1974. The coverage for 1973, however, 

is much more limited because employment data were less 

readily available. 

Table B-3 presents data for 243 corporations with 

42,000 employees and income of $541 million in 1974. The 

tax expenditure per employee ranges from $55 for textile 

mill products to $36,050 for pharmaceuticals. 

The 1973 data presented in Table B-4 is considerably 

weaker than the data for other years, as noted above. 

Although the number of corporations (187) is only slightly ~ 

lower than for 1974, the book income ($143 million) is only 

one-fourth and the number of employees (16,000) about 40 

percent of the corresponding 1974 figure. 

Tables B-5 and B-6 present tax expenditure, income and 

payroll data classified by size of tax expenditure per 

employee. None of the 243 corporations included in Table 

B-5, covering 1974, had tax savings greater than $100,000 

per employee. The 7 corporations with tax expenditure per 

employee in excess of $50,000 in 1974 had average tax a 

savings per employee of $67,370, compared to $78,216 for the 

18 corporations in the same group in 1975. Data for 1973 is 

shown in Table B-6. ! 
-85-

Table B-1 

Income and Estimated Tax Expenditure by Industry, 1974 1/ 

Industry Group 

All industries 

Manufacturing industries 

Food and kindred products 

'Ibbacco 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 

:Estimated Tax 

Number of :Book Income: Expenditure 

:Corporations: ($000) ($000) 

594 852,092 372,362 

398 813,056 352,759 

25 65,123 26,517 

6 12,472 4,938 

8 -66,071 624 

94 42,052 17, 515 

65 478,329 190,683 

44 405,355 161,341 

21 62,974 29,342 

14 2,150 922 

14 7,080 2,689 

6 8,684 3,418 

27 28,017 11,221 

7 2,281 908 

Electrical and electronic equipment 76 167,389 66,750 

Trans_portation equipment 5 1,100 440 

Scientific instruments 25 27,452 11,044 

All other manufacturing 26 36,998 15,090 

tbnrnanufacturing 196 39,035 19,602 

Trans_portation, corrununications 

and utilities 7 16,701 6,750 

Wholesale trade 10 1,709 704 

Retail trade 105 12,154 5,057 

Finance, insurance, real estate 19 2,035 893 

Services 14 -457 580 

Miscellaneous and not available 41 6,893 5,620 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

l.! Includes data for possessions corporations operating in America Samoa, 

Guam, and the Panama Canal Zone. 'Ihese non-Puerto Rican operations 

account for less than 2 percent of total tax expenditure in any year 

(see Table 1). 
-86-

Table B-2 

Income and Estimated Tax Expenditure by Industry, 1973 ..!./ 

Industry Group 

:Estimated Tax 

: Number of :Book Income: Expenditure _______________ :_Co_rpo ___ rations: ( $000) ( $000) 

All industries 563 650,759 258,316 

Manufacturing industries 382 591,721 242,064 

Food and kindred products 22 60,937 21,960 

Tobacco products 8 15,265 6,089 

Textile mill products 16 -4,539 l,lYO 

Apparel 93 36,991 15,240 

Chemicals, total 57 268,868 110,380 

Pharmaceuticals 39 251,897 103, 533 

All other chemicals 18 16,971 6,847 

Rubber products 14 1,606 1,149 

leather and leather products 19 4,283 1,853 

Stone, clay and glass products 8 6,272 2,505 

Fabricated metal products 24 15,465 6,828 

Machinery, except electrical 4 1,830 732 

Electrical and electronic equipment 64 116,277 46,734 

Transportation equipment 3 601 240 

Scientific instruments 23 22,176 8,794 

All other manufacturing 27 45,689 18,370 

Norunanufacturing 181 59,038 16,252 

Transportation, cormm..mications 

and utilities 6 6,952 2,843 

Wholesale trade 10 29,834 541 

Retail trade 98 10,901 4,506 

Finance, insurance, real estate 16 2,601 1,081 

Services 17 -6,923 423 

Miscellaneous and not available 34 15,671 6,858 

Off ice of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Includes data for possessions corporations operating in America Samoa, - G.lam, and the Panama Canal Zone. 'lhese non-Puerto Rican operations 

account for less than 2 percent of total tax expenditures in any year 

(see Table 1). · 
Table B-3 

Tax Expenditure, frnployment and Compensation of Employees by Industry, 1974 

Compensation of Tax ExpendiTax E~nditure E!!J2lol'.ees E!!J210l'.ees y __ : ture Per 

Industry Group Number of Book Income Amount :Percent :Percent Amount Percent Einployee 

CoE}22rations ($000) ($000) :of Total Number :of Total: ($000) of Total ($) 

All industries 243 540,975 245,197 100.0 42,394 100.0 308,337 100.0 4,033 y 

Manufacturing industries 207 525,413 235,652 96.1 32,118 75.8 225,741 73.2 5,424 y 

Food and kindred products 15 30,062 12,124 4.9 4,764 1L2 32,298 10.5 2,545 

'lbbacco products 6 12,472 4,938 2.0 1,435 3.4 9,215 3.0 3,441 

Textile mill products 3 -67,294 135 .l 2,472 5.8 19,132 6.2 55 

Apparel 44 19, 717 8,580 3.5 5,993 14.1 32,202 10.4 1,432 

Chemicals, total 28 372,565 146,741 59.8 5,066 1L9 50,554 16.4 28,966 

Pharmaceuticals 21 323,048 126,931 5L8 3,521 8.3 31,675 10.3 36,050 

All other chemicals 7 49,417 19,810 8.1 1,545 3.6 18,879 6.1 12,822 

Rubber products 9 1,987 752 .3 531 L3 3,268 Ll 1,416 

Leather and leather products 10 3,813 1,568 .6 1,025 2.4 5,494 L8 1,530 

Stone, clay and glass products 3 6,603 2,586 Ll 466 Ll 2,997 LO 5,549 

Fabricated metal products 17 17,453 6,981 2.8 1,120 2.6 7,827 2.5 6,233 

Electrical and electronic equipment 37 76,250 30,317 12.4 6,302 14.9 42,453 13.8 4,811 

Transportation equipment 3 474 189 .1 113 .3 855 .3 1,673 

Scientific instruments 18 20,169 8,058 3.3 2,063 4.9 12,040 3.9 3,906 

All other manufacturing y 14 31,142 12,683 5.2 768 L8 7,406 2.4 16,514 

Nonmanufacturing 36 15,562 9,546 3.9 10,276 24.2 82,595 26.8 718 

Transportation, COIMUnications 

and utilities 3 14,744 5,967 2.4 4,138 9.8 36,906 12.0 1,442 

Wholesale trade 3 716 286 .1 179 .4 1,642 .5 1,598 

Finance, insurance, real estate 6 835 367 .l 238 .6 2,087 .7 1,542 

Services 7 -475 431 .2 981 2.3 6,991 2.3 439 

Miscellaneous and not available !I 17 -258 2,495 LO 4,740 11.2 34,969 1L3 526 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

Y Compensation of employees was computed by multiplying 1.178 times payroll. '!he additional 17.8 percent reflects the 

employer-paid portion of social security, unemployment insurance, and other non-payroll labor C'OSts. '!he 17.8 percent is 

the average for all U.S. manufacturing industries in 1974; see the U.S. ~partment of Conunerce, Survey of Current Business, 

July 1977, Tables 6.5 and 6.6. Y Compensation of employees and number of employees used to compute these amounts were weighted by industry using the ratio of 

tax expenditure in Table B-1 and tax expenditure in this Table. Y Includes manufacturing industries where data were available for less than 3 corporations. !I Includes nonmanufacturing industries where data were available for less than 3 corporations. 

y 

:Tax Expenditure: Average 

: as Percent of : Employee 

:Compensation of:Compensation 

Ercplol'.ees ($) 

56.1 y 7,184 y 

77.8 y 6,973 y 

37.5 6,780 

53.6 6,422 

.7 7,739 

26.6 5,373 

290.3 9,979 

400.7 8,996 

104.9 12,219 

23.0 6,154 

28.5 5,360 

86.3 6,431 

89.2 6,988 

7L4 6,736 I 

22.l 7,566 co 

-..J 66.9 5,836 I 

17L3 9,643 

9.3 y 7,688 

16.2 8,919 

17.4 9,173 

17.6 8,769 

6.2 7,126 

7.1 7,377 
Table B-4 

Tax Expenditure, Employment and Compensation of Employees by Industry, 1973 

Conpensation of Tax Expend1-

Industry <Coup N..unber of :Book Incane: 

Tax E~nditure 

Aroount : Percent of 

E!!J210::Lees Enplo::Lees y __ :Percent of Amount :Percent of 

:Corporations: ($000) ($000) Total Nunt>er Total ($000) Total 

All industries 187 143,448 51,846 100.0 16,339 100.0 97,226 100.0 

Manufacturing industries 157 110,587 49,842 96.l 14,578 89.2 84,162 86.6 

Food and kindred products 6 3,700 1,416 2.7 673 4.1 4,611 4.7 

'lbbacco products 4 2,338 918 1.8 444 2.7 2,285 2.4 

Textile mill products 10 -7,084 128 .2 2,919 17.9 14,588 15.0 

Apparel 44 6,943 3,206 6.2 4,265 26.l 22,668 23.3 

Chemicals, total 18 83,031 35,731 68.9 1,265 7.7 9,113 9.4 

Pharmaceuticals 12 79,686 34,393 66.3 1,057 6.5 7,680 7.9 

All other chemicals 6 3,345 1,338 2.6 208 1.3 1,433 1.5 

Rubber products 9 1,949 740 1.4 533 3.3 3,026 3.1 

leather and leather products 9 2,255 896 1. 7 749 4.6 3,876 4.0 

Fabricated metal products 12 1,841 727 1.4 350 2.1 2,070 2.1 

Electrical and electronic equipnent 20 9,197 3,488 6.7 2,347 14.4 15,401 15.8 

Scientific instruments 11 4,911 1,887 3.6 405 2.5 2,510 2.6 

All other manufacturing y 14 1,506 705 1.4 628 3.8 11,046 11.4 

Nonmanufacturing 30 32,861 2,003 3.9 1,761 10.8 13,063 13.4 

Wholesale trade 5 29,345 343 .7 338 2.1 2,655 2.7 

Finance, insurance, real estate 5 1,427 571 1.1 198 1.2 1,585 1.6 

Services 9 534 378 .7 566 3.5 4,279 4.4 

Miscellaneous and not available !I 11 1,555 711 1.4 659 4.0 4,545 4.7 

Office of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Conpensation of enployees was conputed by ITllltiplying 1.172 times payroll. 'Ihe additional 17.2 percent reflects the - enployer-paid portion of social security, unemployment insurance, and other non-payroll labor costs. 'Ihe 17.2 percent is 

the average for all U.S. manufacturing industries in 1973; see the U.S. Department of Corrmerce, Surve:r'. of Current Business, 

July 1977, Tables 6.5 and 6.6. 

2/ Compensation of enployees and number of enployees used to conpute these anK>Unts were weighted by industry using the ratio of - tax expenditure in Table B-2 and tax expenditure in this Table. 

3/ Incllrles manufacturing industries where data were available for less than 3 corporations. !/ Incllrles nonmanufacturing industries where data were available for less than 3 corporations. 

ure Per 

Employee 

($) 

1,740 y 

1,810 y 

2,104 

2,068 

44 

752 

28,246 

32,538 

6,433 

1,388 

1,196 

2,077 

1,486 

4,659 

1,123 

1,104 y 

1,015 

2,884 

668 

1,079 

:Tax Expenditure: Average : as Percent of : Employee 

:Conpensation of:Conpensation 

~lo::Lees ($) 

19.3 y 9,013 y 

19.6 y 9,236 y 

30.7 6,851 

40.2 5,146 

.9 4,998 

14.l 5,315 

392.1 7,204 

447.8 7,266 

93.4 6,889 

24.5 5,677 

23.1 5,175 

35.1 5,914 I 

22.6 6,562 CX> 

75.2 6,198 CX> 

I 

6.4 17,589 

15.8 6,988 y 

33.8 7,855 

36.0 8,005 

8.8 7,560 

15.6 6,897 
Table B-5 

Tax Expenditure, Employment and Compensation of Employees by Size of Tax Expenditure Per Employee, 1974 

Tax Compensation of Tax Expendi- :Tax Expenditure: 

Size of Tax E~nditure E!!J2loyees E!!J2loyees !/ __ : ture Per : as Percent of : 

Expenditure N.lmber of Book Income: Amount :Percent :Percent Amount Percent Employee :Compensation of: 

~r E!!J2loyee Co~rations: ($000) ($000) :of Total: Number :of Total ($000) : of Total ($) Enployees 

All Corporations 243 540,975 245,197 100.0 42,394 100.0 308,337 100.0 4,033 y 

$ 50,000 under $100,000 7 149,057 59,623 24.3 885 2.1 8,127 2.6 67,370 

$ 10,000 under $ 50,000 35 291,488 115,661 47.2 5,261 12.4 52,376 17.0 21,984 

$ 5,000\under $ 10,000 29 49,775 19,884 8.1 2,725 6.4 20,836 6.8 7,296 

$ 1,000 under $ 5,000 91 116,875 46,405 18.9 19,099 45.1 127, 471 41.3 2,429 

$ 500 under $ 1,000 14 3,650 1,460 .6 1,811 4.3 10,364 3.4 806 

$ 100 under $ 500 26 5,822 2,107 .9 6,577 15.5 46,599 15.1 320 

$ 1 under $ 100 8 3,700 58 1,150 2.7 7,070 2.3 50 

loss Corporations 33 -79,392 4,886 11.5 35,492 11.5 

Off ice of the Secretary of the Treasury 

Off ice of Tax Analysis 

1/ Cornpensation of employees was computed by multiplying 1.178 times payroll. 'lbe additional 17.8 percent reflects the - employer-paid portion of social security, unemployment insurance, and other non-payroll lal:x>r costs. 'lbe 17.8 percent is 

the average for all U.S. manufacturing industries in 1974; see the U.S. Department of Comrrerce, Survey of Current 

Business, July 1977, Tables 6.5 and 6.6. 

2/ Compensation of employees and number of employees used to compute these amounts were weighted by industry using the ratio - of tax expenditure in Table B-1 and tax expenditure in Table B-3. 

56.1 y 

733.6 

220.8 

95.4 

36.4 

14.1 

4.5 

.8 

Average 

Employee 

Cornpensation 

($) 

7,184 y 

9,183 

9,956 

7,646 

6,674 

5, 723 

7,085 I 

00 6,148 "° I 

7,264 
Table B-6 

Tax Expenditure, Employment and Compensation of Employees by Size of Tax Expenditure Per Employee, 1973 

Compensation of : Tax Expendi :Tax Expenditure Size of Tax Tax E~nditure E!!J210:t:ees E!!J210:t:ees .!/ _: ture Per : as Percent of 

Expenditure ~r of :Book Income Amount : Percent :Percent Amount :Percent : Employee :Compensation of ~r E!!J210:tee :Co~rations: ($000) ($000) :of Total: Number :of Total: ($000) :of Total: ($) E!!J210:tees 

All Corporations 187 143,448 51,846 100.0 16,339 100.0 97,226 100.0 1,740 y 19.3 y 

$ 50,000 under $100,000 5 68,559 27,423 52.9 410 2.5 3,372 3.5 66,885 813.3 

$ 10,000 under $ 50,000 14 20,479 8,106 15.6 413 2.5 2,833 2.9 19,627 286.1 

$ 5,000 under $ 10,000 12 13,566 5,395 10.4 707 4.3 4,441 4.6 7,631 121.5 

$ 1,000 under $ 5,000 60 21,647 8,474 16.3 3,944 24.1 23,684 24.4 2,149 35.8 

$ 500 under $ 1,000 22 4,272 1,701 3.3 2,288 14.0 13,474 13.9 743 12.6 

$ 100 under $ 500 25 1,979 708 1.4 2,525 15.5 14,645 15.1 280 4.8 

$ 1 under $ 100 12 28,820 38 .1 935 5.7 5,226 5.4 41 .7 

loss Corporations 37 -15,873 5,117 31.3 29,550 30.4 

Of flce of the Secretary of the Treasury 

Office of Tax Analysis 

1/ Compensation of employees was computed by multiplying 1.172 times payroll. 'Ille additional 17.2 percent reflects the - employer-paid portion of social security, unemployment insurance, and other non-payroll labor costs. '!he 17.2 percent is 

the average for all U.S. manufacturing industries in 1973; see the U.S. ~partment of Co~rce, Survey of Current Business, 

July 1977, Tables 6.5 and 6.6. 

2/ Compensation of employees and number of employees used to compute these amounts were weighted by industry using the ratio of - tax expenditure in Table B-2 and tax expenditure in Table B-4. 

Average 

Employee 

Compensation ($) 

9,013 y 

8,224 

6,860 

6,281 

6,005 

5,889 I 

5,800 ID 

5,589 0 I 

5,775 
-91-

Appendix C -- Tax Forms from which Data Included 

in this Report was Obtained 
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 Employer identification number 

Number and street Date of incorporation 

City or town, State and ZIP code Place of incorporation 

Business code number I Principal business activity Principal product or service 

Description of each class of stock 

Number of shares of each class issued and outstan~ 

:::: ::: :::::::: :::::::: : :: :: :: : : : : :: : : : : : :: :::: :: : : :: :: : : :::: :: :::::::::::::: :::::: :: :: ::::::::: :: :: ::::::: ::::::::::::::::::::::::::: 1:::::::::-_:: ::::::::::::::::::::: 

The following information must be submitted for each shareholder owning 10% or more of the issued and outstanding stOC~ of 

any class: 

Name of shareholder Identifying number Address Class of stock Number of shares o~ 

------------------------------... --------- ·----------------... .,.________ ----------------------------------------------- ·----------------------· ------------------ ___________ ...... ,,· 

------------------------- ______ ...... '' 

--------------------------· ----------------------------------------------· ----------------------- ·---------------------________ ...... .... ' 

Election is made for the taxable year beginning (month, 

day, year) 

Date corporation commenced busi· 

ness in a U.S. possession 

Annual return will be filed for the taxable year 

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? . [J ~o D Yes 

If "Yes," for each such corporation (attach additional schedules if required): 

(1) Enter the corporation's name and employer identification number .... ·--------------------------------------------------------------------------_.., 

(2) Complete the following schedule-- ___./ 

Taxable year (use a separate line for each full or short taxable year beginning in 1973, 1974, or 1975) 

Beginning Ending (month/day/year) (month/day/year) 

Principal place of business (enter name of U.S. possession or country) Net income per books 

____ .. 

---------------------------------------· --------------------------- --------------------------------------------------------------------- ---------------------------- ___ ............ 

~~~~~~~~~~~~~~~~~~~~~~~.,..__u_.s_.~in_c_o_m_e~ta_x~re_t_u_rn_s~fi-le_d_:~~~~~~~~~~~~~~~~~~~~~____.-/ 

~~~~~~lf~c_o_rp_o_r_a_ti_o_n_f_il_e_d_s_e_p_a_ra_t_e_IY_~~~~~-i.~~~~~~~~-lf~co_r_p_o_ra_t_io_n~jo_i_n_e_d_i_n_fi_•_lin_g~a~co_n_so~l-id_a_te_d~r-et_u_r_n_:~~~~~____..--/ 

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 Revenue Service Center in d which return was~ 

--------------------------. . ---------------------------------------------------------------------- -------------------------_ ... ___ .......... 

-------------------------- ---------------------... ------------------------------------------------· ----------------------------____ , ... 

----------------------------.. __ ...... · 

Under penalties of perjury, I declare that I have been duly authorized by the above named corpo111tion to make this election and that the statements made are to tll• 

tiof my knowledge and belief, true, correct, and complete. 

·s18iiatu-re-anC:i-iitie-cifotticer------------------------------------------------------------------------------------------------------- oaie-------------------:=::.; 

g--18 Form 5712 (Re"· 

'Nho 

as po 

\Vhe 

begir 

tion i 

'Nhe 

Centi 

Your 

U.s. 

inclu 

Peri 

Whic 

darn 

begi 

follo 

app1 

taxa 

taxa 

cons 
~o 

... 

I 

Instructions 

'Nho Can Elect 

Only domestic corporations can elect to be treated 

as possessions corporations. 

When to File 

Form 5712 must be filed within 90 days after the 

bt.eginning of the first taxable year for which such elec1on is made. 

'Nhere to File 

C File this form with the Internal Revenue Service 

enter, Philadelphia, PA 19255. File separately from 

Your regular income tax return. 

U.s. Possessions 

. For purposes of section 936, U.S. possessions 1

nclude Puerto Rico but not the Virgin Islands. 

Period of Election 

. The election applies to the first taxable year for 

Which such election has been made and for which the 

domestic corporation qualifies under section 936(a). 

. This election may be revoked for any taxable year 

feg1nning before the expiration of the 9th taxable year 011owing the taxable year for which such election first 

applies only with the consent of the Secretary. For any 

~axable year beginning after the expiration of such 9th 

axable year, this election may be revoked without the 

consent 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 

Auditor I Reviewer 

Field Audited by: 

........ 

197 

Commoa-itla °' hmto IUeo 

DEPARTMENT OF THE TREASURY INTERNAL REVENUE ADMINISTB ATION 

BUREAU or DfCO)IJC TAX 

CORPORATION INCOME TAX RETURN 

FOR CALENDAR YEAR 197 

OR OTHER TAXABLE YEAR BEGINNING 

Sedal Number 

Rl:CEJPT 

197 

r-~~~~~~--~-------------1_9_7====-A_N_D_E_N_D_IN_G ______ ~~~-~-~---1_9_7;;:::::::::--r==-""T"'""--~~----_/ Corporation's Name 1 l!:mplo7er'a Account Number I C.D. I 

"Zip Code" I Mun. Code 

Pociel Addrea 

LocaUon of Principal lnd\utry or B~treet, Number and Cit)' 

Does ttw Corporation have exempt activities other than under the Industrial Incentive Act? Yes 0 No D 

UnderwhatActorActa?--------------------------------

Ind. Code 

1. Total Grou Income (From Schedule 4 ) ........................................................................................................... ~ (01) $ ·-······· ....................... .. 

2. Lea: Total Deductiona (From Schedule 5) .............................................................................................................. (02) 

3. Net operating income (or loaa) for the year .............................................................................................................. (03) $ •.•.••••••••••.••.......•.. ··""' 

4. Lesa: Net operating loaa deduction for the preceding year (submit statement) ........................................................ (04) 

5. NET INCOME (or Lou) ........................................................................................................................................... (05) $ 

6. Dividends or profits received from corporatiom or partnerabipa (See booklet of instructiona) ....•••.•.......•........•.• @ (06) 

7. Net income subject to normal tax ............................................................................................................................ (07) 

$ ................................... .. 

•••••••••••••••••••••••••••••• ....... 1 

8. Lea: Surtax net income credit (See booklet of inatructiona) ............................•.........................•............................. (08) 

9. Net income subject to surtax ....................................................................................... -................................ (09) $------r::__,/_ 

10. Normal tax (22% of net income subject to normal tax, line 7) ....................•.......••..........•...•••..........................••. ~ (10) $ ··············•·•·•······· ·····' 11. Surtax (See booklet of instructiom) ......................................................................................................................... (11) 

12. 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. Credita: Tax Paid: (a) At Source ........................................................................................... (15) I $ 

(b) Allowable proportion of the tax paid to U.S. or ita poaaeaiom ort--,--------1 fQreign countries (See booklet of instructions and submit details) ....... (16) L..;z._ s ______ +-"S'--------1-

16. THIS IS YOUR TAX LIABILITY (Subtract item 15 from item 14. Enter difference here).............................. (17) $ ................................... .. 

17. Lea: &tirnated tax paid: Current year$ •.......••.•..•.•••..•••••. Excess of previoiu years$ ....................................... @ (18) .... / 

18. Balance of tax payable (Enter here the difference, if item 16 is larger than item 17) •..••.••.•••••..•....•.............••..... (19) 

19. Lea: Amount paid with tentative return $ ........................... With this return$ ...•......•.•.......... - ...•...•••.•.•.•••.•••.....••.•• (20) .... ,.,; 

20. Balance of tax due .......................................................................................... , .•.......•..••.•.•.•...•••...••••...••.....••.•..••. (21) 

$ _____ .,.....L/ 

21. Amount of tax overpaid to be credited to estimated tax for 197 .....•.•...•..•••..•...•..••.•.....•...•.•...•...•...••....•.•.•.•.......••• (22) $ L/ 

22. Amount of tax overpaid to be refunded •.........•..•.•...•••.•.....••..•....••.•.....•....................•••..•.......•••.•.•.•.....•.......•.•..•....... (23) $ ~ 

NOTARIAL 

SEAL 

OATH 

WE, the undersigned, precident (or ricepresident, or other principal officer) and treasurer (or ..Utan& treasurer), or ag~ll~ the corporation for which thia return ia made, being severally duly sworn, each for hirmelf depo- and says that this return (iJl fll't 

ding any accompanyine lcbedulea and statements) baa been examined by him and is, to the beat of his knowledge and belief, • t Ill' 

corrl!ct, and complete return, made in 1ood faith, for the taxable year stated, pursuant to the Income Tax Act of 1954 and 

Retiulatk>na iaued thereunder. 

·-···--~.;·~,~·<s~~·uu;.·>··········· 

·-·························~;i····························· 

Affi:::: ~·-~;~::;;··~··;;;;~re me bY-----------------------. of legal age, occuP'*;o' ---------------and resident of _________ ; and by 

of lepl ace, occupation resident of peraonally knO-' to me at ____________ , Puerto Rico, &his _______ day of _____________ , 19_.../ 

.................................. Oiftdai'Tiue................................ ···············SiCD&iiift·;;;-c;;tic;a·~·;;a·ib····"····"·"· 

A RETURN NOT PROPERLY FILLED OUT WILL NOT BE CONSIDERED 

AB MEETING THE STATUTORY REQUIREMENTS 
........ 

........ 

·····"'* 

.... ~ .. 

...... ~ 

··""' 

······" 

.... _,. 

.... .-

COMPARATIVE BALANCE SHEETS 

Beclnnln& of Taxable Year I 30) End of TaI&ble Year 

ASSETS Amount Total I Amount Total 

1 ~h . @ · on hand and m bank.a······················-· {01) $ •.•.......••..•................ (01) $ ................................... . 

2. Accounta receivable ••.......................•.....•.... (02) 

LESS: ReaerTe for bad debta ·················- (03) 3• Notes receivable .......................................... (04) 

4. Inventoriea ..................•......................•..•...• (05) 

S. Jnveatmenta ................................................ (06) 6· Depreciable aueta. ................................. ;Qi (07) 

LESS: Reserve for depreciation ......... ~. (08) 

~: ~:~·~~ ...................... ·.-.·.·.· ........................................................... ~:: ~~:~ 

$ .......................... . (02) $ ............................... .. 

----------+ ................................... (03)1--------+---+·· ............................ . 

.................................. ,(04) 

................................... (05) 

.................................. (06) 

$ ......................... .. (07) $ ............................... . 

...--------+-~···-···· .. ·-... -................ (08\----------+··· .......................... .. 

.................................. (09) 

.,._ _____ --+--4 (10) 

TOTAL ASSETS ....•.... - .................. - •• (11) $ ............................... (ll) $ ................................... . 

LIABILITIES AND NET WORTH 

Liabilities !

0

• Accounts payable ................................. @. (12) 

1

1

· Bonda, notes and mortp.gea payable ...•.•..•.. (13) 

i!: ~7;~=~:: ............................................................................... ~~:~ Net Worth 14• Capital stock: 

(a) Preferred stock ............................. @.(16) 

1 (b)Commonstock ................................... (17) 

$ .................................. . (12) $ ............................... . 

............................... , ........ (13) .......................... . 

...................................... , I (14) ......................... .. 

....................................... +---------'--! (15) .......................... . $ I 

$ .................................. . (16) $ .............................. . 

(17) ................................ .. 

(18) ................................... . 

::: ::::~ =s::::::::::::::::::: :::: :::::::::::::::::::::: i ~ Total Liabilities and Net Worth ........... (21) 

...... _ ... _ .. _ ... _ ... _ .. ... _ _ ... _ ... _ .. _ ... _ .. _._ ..._ ... ______ ... 1_g~~+-·_· .. _ ... _ .. ... _ _ ... _ ... _ .. ... _ _ ........ --+------t--'-

$ .............................. (21) $ ............................ ········ 

RECONCILITATION OF INCOME PER BOOKS WITH INCOME PER RETURN 

!·Net income per books .................................. ~ (01) 

3. Income tax.................................................... (02) 

$ ............................... . 

4 I!:xcess of capital losses over capital &&ins...... (03) 

· Taxable income not recorded on books this 

Year (itemized) ............................................ . 

···································································· s .................................................................. .. · Expenses recorded on books this year not de· 

ducted in this return (itemize, use rider if 

necessazy) 

(•) .......................... $ .............................. . 

(b) .......................... $ .............................. . 

6 ............................................................. .. 

· Tota1(Lines1 tbrou&h 5) ........................... . 

(04) .................................. . 

(05) 

(06) $ 

7. Income recorded on books this year not includ· 

ed in this return (itemized, use rider if necessary) 

(a) Tax-exempt interest $ .................................. . 

::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::~:@: (01) $ ............................... . 

8. Deductions in this tax retun not char&ed a&ainst 

book income this year (itemize, use rider if 

necessary) 

(a) Depreciation ........... $ ................................. . 

(b) Depletion ............... $ ................................ .. 

9.Totaloflines7and8 ........................................ (03) $ 

10. Income (Line 5 pace 1)-Line 6 less Line 9 ....... (04) $ 

ANALYSIS OF UNAPPROPRIATED RETAINED EARNINGS PER BOOKS 

!·:&lance at be&innin& of year ...................... .@ (01) 

· et income per books................................. (02) 3

' Other increases (itemize, use rider if 

neceuary) 

··································································· 

··································································· 

··································································· 

(03) 

(04) 

(05) 

(06) 

.~::::::::::::::::::::::: ::::::::: 5. Distributions: ~:~ ~::k:::::::::::::::::::::::::::::~~ ~~~~ .~::::::::::::::::::::::: :::::::::. 

(c) Property............................. (03) ................................... . 

6. Other decreases (itemize, use rider if necessary) (04) 

7. Total of lines 5 and 6........................................ (05) 1--*-----+--- $ 8. Balance at end of year (Line 4 less Line 7)........ (06) $ 

QUESTION AIRE 

!: ~ncorporation date: --------------------

a lace of incorporation: ------------------ 4. · llect.try N lndi umber in the Department of State __________ _ 

C:.te the accountin& method used by the corporation. 

0 Cub method. 

0 Other: 

&. Income (or deficit) u per return for procedin& year $ -------

S. !>f ll.mber of controlled corporations 

(See instruction.a). 

J. &-0 735 -40,000-29~RGPD. 

7. Is this corporation encased in Trade or Business within Puerto Rico? 

Yes 0 No 0 

8. Did the corporation file the followin& documents? 

(a) Annual informative Return (Forms 480.5 and 480.6) 

Yes O No O 

(b) WiUiholdin& Statements (Forms 499 R·2). 

Yes 0 No 0 

9. The corporation's books are in care of: 
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 

Name 

....................... , 19 .......... , and ending ....... ...... ........... , 19 ... :.;.:_.;.; 

•:1.T:I- Gross 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 8 .) 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 

from sources within U.S. possessions 

(f) 

from all other sources with· 

out the U.S. 

(g) 

from sources within 

the U.S. 

(h) 

Gross qualified 

posssession source 

investment 

income 

(I) 

From 

sources 

within 

U.S. possessions 

(j) 

I Employer identification number 

Periods in which trade or business was actively conducted in a U.S. possession 

(Dates are inclusive) 

From- To-

(d) (e) 

All other gross income 

From all 

other 

sources 

without 

the U.S. 

(k) 

From 

sources 

within 

the 

U.S. 

(I) __...-

~~~~~~~~~~1-~~~~~~-1-~~~~~~-11-~~~~~~-1-~~~~~~-1~~~~~~~-I-~~~~-___..­

~~~~~~~~~-,1-~~~~~~-1-~~~~~~-1~~~~~~~-1-~~~~~~-1~~~~~~~·l-~~~~------­

-:-:-.-~~~~~~~11~~~~~~-1-~~~~~~·1-~~~~~-1~~~~~~-1-~~~~~~1-~~~--____.,,, 

i1 

~-'---------=---------'-------"----------''---------!-------l·---------- 1 Total gross income in applicable period (add totals of columns (f) through (I)) ----

2 Gross income in applicable period from sources within U.S. possessions (add totals of columns (f), (i), and U)) . , _____ ____.,,,_ 

3 Line 2 divided by line 1 (if less than 80%, do not complete Part II) ----

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 II) __,., ;;iiiiiinmiii---;:;-:=:~:-;;:-::-"'-:-;-~~-=--~;:--;:;::-:;;;-----''----~~~~~~~~~~~.;__;__;__;__;......!._~~~ •:F.Ti•I- 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 lines 6(a) and 6(b) and subtract line 6(c)) 

7 Applicable deductions (attach schedule): 

(a) Definitely allocable deductions 

(b) Ratable part of deductions not definitely allocable 

(c) Total (add lines 7{a) and 7(b)) . 

8 Qualified taxable income before loss adjustments (line 6(d) less line 7(c)). If loss, do not complete lines 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 lines 9(a) and 9(b)) . 

10 Qualified taxable income (line 8 less line 9(c)) 

,_,. 

______,,,, 

______,,,, 

11 Total taxable income from all sources (enter taxable income from your tax return) ___-/ 

12 Line 10 divided by line 11 ___-/ 

13 Total U.S. income tax against which section 936 credit is allowed (see Instruction E) ___-/ 

14 Section 936 credit (line 12 multiplied by line 13). Enter here and on your tax return . • __.....-::: ~~~~~~~__;~~~~--~~~~....;.~~~~~~~--~~~~~~~~~~~~.;._...:.....~~--- 78) 

Form 5735 (Re"· lInstr 

(Reter1 

~. Cc 

to 

Fe 

Corne t 

!lectior 

lion 93 

b. 

iillp 
--

E 

t 

t 

t [ 

lnstr~ctions 

r~eferences are to the Internal Revenue Code) 

~. Corporations Required 

to File Form 5735 

Form 5735 must be completed and attached to the in-

~rn~ tax return of any domestic corporation for which an 

~ction to be treated as a possessions corporation under seen 936(e) is in effect. 

a. 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 immediately preceding the close of the taxable year. 

G 

~~erally, the "applicable period" is the lesser of 36 months 

lhe he ~eriod during which the corporation was engaged in 

Do active conduct of a trade or business within a U.S. 

ssession. 

C. Ineligible Corporations 

a~Y A corporation is ineligible for the section 936 credit in 

ifhi ~a~able year in which it is a DISC or former DISC, or in 

(Se\. it owns at any time stock in a DISC or former DISC. C IOn 936(f).) 

b 

· lJ.s. Possessions 

Pwe/0 r _Purposes of section 936, U.S. possessions include 0 Rico but not the Virgin Islands. (Section 936(d)(l).) 

t 1' 

axes Against Which 

Credit is Allowed 

'llip0 lhe section 936 credit is allowed against income tax 

Sed by Chapter 1 but not against any: 

0) minimum tax for tax preferences imposed by section 56; 

<

2

> tax on accumulated earnings imposed by section 

531; 

(l) 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) increase in tax under section 47 (relating to dispositions 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 l, 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 re· 

ceived 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, Phil~delphia, PA 19255. 
Form 940 

Dlplrtm111t of the Tl'llSlll'J Internal R1m1ue Semce 

Employer's Annual Federal Unemployment Tax Return ~®76 Name of State S~;~i:tbnulnUfomn:fn:tu::rm.as (•- d!;~'!le1:'Y!!'t'1' ...... ) Experience4rate period ~~~- ~tr~,~0~~1'9r .~~\"e~~~~~te Ad~!:s~~al ~~i~t:i: ..... ....,,.,, - Sta' ..,, •----------• rate (col. 3 X 2.796) (col. 3 X col. 5) (col. 6 minus col. 7) to Stat• 1 2 3 From- To- 5 6 7 8 ~ 

------- -------------·' 

-------------------------------------- ----... ---·--·------------ ---------------- ---------------- ---............ . .................................. -............................................ --- ------------------- ----- ______ ........ .. 

________ ....... ---' 

-------------. . ..... --------------------- -................ ---------------.... ---------------- ---------------.. ----.. ---·-----------....... ---- -----.......... -----... --.. ... ....... ---... -----..... -------. --------..... _ ........ . 

------------ ------------------------ ·--------------... -------... ·--... ------------ ---------------- ..................... ·-----------------· ·--------------------- ... ----------------... -------------

-------------- ·------------------·---- ------------------------ ---------------- ---------------· -------· ------------------ ............................................................. ------------------- ---------------' 

-----------------------i~is--~- ·----·~ ~ ~ ~ ~~·---•___.., 

10 Total tentative credit (Column 8 plus column 9). • • • • • • • • • • • • • • • • • i--------

11 Total remuneration (including exempt remuneration) PAID during the calendar year for services of employees 

12 Exempt remuneration. (Explain each exemption shown, attaching 

1fl~e-rilt.-.;e-iatioii--f.;--e>ccess-or$4.-200.--ce:-iite-.=--c,-.;iy--iiie-exC:ess-o-ve-.:-iti_e __ ·-------------------------- ---------------------- I ......... ··---!::: 

first $4,200 paid to individual employees exclusive of exempt 

amounts entered on line 12) • • • • • • • • • • • • • •---------l:.-------1: 

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 • ---------• 

(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" . • ~ 

24 If no longer in business at end of year, write "FINAL" here .... ~ 

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 it is true, correct, 1 

complete, and that no part of any payment made to 1 State unemployment fund, which is claimed IS 1 credit on line 20 above, was or is to be deducted from the remuneration of employees· 

(If incorrect 

make any lllr... 

necessary ,.. 

change.) 

Sllllllurl ~ 

I "-(Is di1tfnplshld from trade n11111) 

Tnide nine, if 111J 

L ...... -s ZIP code 

Cllendar Yur 

1976 

Employer ldentificeUon No. 

Title (Owner , etc.) ~ 

I 

_J 

T _,.,., FF _,.,., FD _,.,., FP _,.,., I _,.,., T L/ 

1976) Form 940 ( 

Ge 
~ I 

I I 

I 

' 

General Instructions de~i~ional instructions for withholding, 

lrico •tang, paying, and reporting Federal 

era rne tax, social security taxes, and FedCir 1 unemployment tax, are contained in 

fr~Ular E, Employer's Tax Guide, available 

Offi from any Internal Revenue Service Ce. 

ers, Refer to Circular E to find which employIlle rnust file Form 940, the types of payof ~ts~efined by law as wages, and the kind 

Ployerv1ces covered by the Federal Unemrnent Tax Act. 

thePu'l>Ose of Form 940.-This form is for 

One annual reporting of tax under the Federal 

lllen rnplo~ment Tax Act. Federal unemployduct~;sx is paid by the employer. It is not del'llte 1

. le from wages paid employees. The tax 

Wage is 3:2 percent on the first $4,200 of 

and~ Paid to each employee during 1976 

. 4 percent during 1977. 

lng~o Must File.-Every employer who durPaid e current or preceding calendar year 

dar q Wages of $1,500 or more in any calenernpi Uarter, or at any time had ONE or more 

file r:0Yees in any 20 calendar weeks must 

and 0rrn 9~0. Count all regular, temporary, 

ShouiJ>art-t1me employees. A partnership 

Chan not count its partners. If there is a 

businge Of ownership or other transfer of the 

durin ess during the year, each employer who 

Year g ~he current or preceding calendar 

Calen Paid wages of $1,500 or more in a 

Ploye~ar quarter, or had ONE or more emWeeks s at any time in each of 20 calendar 

'houici must file Form 940, but neither 

If report wages paid by the other. 

are u. receive a preaddressed form and 

for 19i liable for Federal unemployment tax 

Of the f

6• Write "Not Liable" across the front 

eou8 S or°.1 and return it to the Internal Rev-

~ess a erv1ce. If you are no longer in busihne 24~ the end of a year, write "Final" in 

If 

dulin~~~ sold or transferred the business 

~e na e Year, attach a statement showing 

~on 0:e, address, and employer identificaOnc mber (if known) of the new owner. 

Ice Wil~ You have filed a Form 940, the Servthe Clo send you a preaddressed form near 

receivese 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 

l'lue o 

endar ate of Retum.-Form 940 for cala1, 1?.,e;r 1976 is due on or before January 

Posits i · However, if you made timely de-

~ear, Y~ full payment of the tax due for the 

ebruary u

1 may file the return on or before 

\a/ti 0, 1977. 

tr .. ere to File. ~ •Our 1,"'· OffiPrlnclpal busl· 

'Ocatedcein or agency ~ _ Use this address 

~ .. ~ ..... ~ r' New Yort Cif,y Internal Revenue Service Center •es of Nassau 1040 Waverly Avenue ;uffolk, aoo' Holtsville, New Yort 11799 

~'l),\'~~ 11 other coun. Internal Revenue Service Center ~ th~'cut, Maine 310 Lowell Street 

~~~:_ Rhod_ew ' Andover, llassichusetts 01812 

b~~~ P~~rt01 ~lu::-rn bi'""a,---,n-tema--l-R_even_u_e_Se_rv_i_ce_Cen_tu_ 

~vtni aryland, 11601 Roosevelt Boulevard ............_ .• .,,a Philadelphia, Pennsylwnia --------------......!1~91~5~5 ______ __ 

Alabama, Florida, 

Geor&ia, Mississippi, South Carolina 

Michigan, Ohio 

Arbnsas, Kansas, 

Louisiana, New Mexico, 

Oklahoma, Texas 

Alaska, Arizona, Colo· rado, Idaho, Minnesota, 

Montana, Nebraska, Ne- wda, North Dakota, Ore· eon, South D1kota, Utah, Washington, Wyoming 

Illinois, Iowa, Missouri, Wisconsin 

California, Hawaii 

Indiana, Kentucky, North Carolina, Tennessee, 

Virginia, West Virginia 

lntem1I Revenue Service Center 4800 Buford H iatrway Ch1mblee, Georai• 30006 

Internal Revenue Service Center Cincinnati, Ohio 45298 

1 nternal Revenue Service Cent1r 3651 S. Interregional Hwy. Austin, Texu 78740 

!ntemal 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 de· 

posit 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 sec· ond or third quarter, respectively.) 

To determine whether you must make a deposit for any of the first three quarters in 

1977, 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 quar· 

ter 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 prein· 

scribed 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 un· 

employment compensation fund on or before 

the due date of Form 940 . 

The term "contributions" .~a11s pay· 

ments 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 pay· 

ments 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 re· 

spect to "employment." You may not take 

credit for voluntarY ccntributions or for pen· 

alties 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 con· 

tributions and the amount they would have 

been required to contribute at (1) the high· 

est rate applied by the State, or (2) 2.7 per· 

cent, whichever is lower. 

Section 3302(e) of the Code provides a 

special credit if an employer during any cal· 

endar 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 compen· 

sation 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 granted 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 1, 2, 3, and 9 only.- If you 

have been granted an experience rate 

of 2.7 percent or higher, use columns 

l, 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 contribution 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 contributions 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. 

your local Internal Revenue Service office.J 

Such amounts, multiplied by .003, are a I 

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 app!'O' 

priate spaces on line 19. 

Special Credit.-lf you are claiminS 

special credit as a successor employer, I 

attach a statement showing (a) the name, 

Column 6.-Multiply the payroll in col- address, and employer identification nurn· 

umn 3 by 2.7 percent and enter the result ber of your predecessor, (b) how you a~: in column 6. quired your predecessor's trade or bll ~ ness (or a separate unit of it), (c) the d81

5 you acquired it, (d) each item in column. 

1 through 9 that applies to your predecesr 

sor, (e) the number of individuals yo~ 

predecessor employed immediately befo~ the acquisition, whom you also emploY e 

immediately after the acquisition, (f) t~. total remuneration subject to State unertlr 

ployment compensation your predeces~ 

Column 7.-Multiply the payroll in column 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 paid to the employees in (e) above durinS 

amount of contributions actually paid into the calendar year. 

the State fund. 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~ . 

cessor in step {d) above, and (2) mult•P1

Y6 ing this total by a fraction of which t~~ numerator is the amount determined 1

8 step (f) above, and the denominator is t~ .• ''Taxable Payroll (as defined in State Act) r 

paid to all individuals in the employ of yo~. predecessor prior to your acquisition dll 

ing the calendar year. 

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 Line 12.-Enter on line 12 such itert1~ or in some other medium, such as goods, as (1) agricultural labor, (2) benefit paY3 lodging, food or clothing. Compute re- ments for sickness or injury, under ce 

muneration paid in items other than cash workmen's compensation law, insura0 O' 

on the basis of the fair value of the items plan and certain employer plans, (3) 1s) 

at time of payment. mestic service, (4) family employment, er 

Exempt Remuneration.-The terms certain fishing activities, and (6) any ot~ re 

"wages" and "employment" as defined exempt payments or services. For nio se 

for Federal unemployment tax purposes detailed information with respect to th~a~ do not include every payment of remu- exemptions, see Circular E, Employer's 

neration to an employee and every kind Guide. ~i· of service which an employee may per- Line 13.-Enter on line 13 the appr~~ 

form. In general, any remuneration which mate number of employees to whorn ar 

is excluded from "wages" and any re- paid more than $4,200 during the Y

6

55 muneration for services which are ex- and the aggregate amount of the exce,,,. 

cepted from "employment," are not in· above $4,200 paid to all of those ~ 

eluded in the total wages subject to the ployees. For example, assume that Y c~ 

tax. These remuneration payments may had 10 employees and that you paid ~oO be deducted from the total remunera- of them $5,000 during the year. $50, rjJ 

tion paid only if they are identified on should be included on line 11 and $8,0 

line 12. on line 13. 

(For General Instructions, see back of your coPY.) 

U. S, GOVERNMENT PRINTING OFFICE : 1978 O - 268-508 
Department of the Treasury 

Washington, D.C. 20220 

Official Business 

Penalty for Private Use, $ 300 

Postage and Fees Paid 

Department of the Treasury 

TREAS-551 U.S.MAIL 

\.. ® ......