Source: https://franklindelanolopez.com/2015/09/29/background-data-information-from-the-federal-senate-finance-committee-on-pricos-crisis/
Timestamp: 2019-04-23 23:55:05+00:00

Document:
The Senate Committee on Finance has scheduled a public hearing for September 29, 2015, entitled, “Financial and Economic Challenges in Puerto Rico.” This document,1 prepared by the staff of the Joint Committee on Taxation, provides an overview and analysis of Federal tax laws relating to the Commonwealth of Puerto Rico and other U.S. territories, summarizes recent prominent changes in Puerto Rican tax law, and describes the economy of Puerto Rico, in part by comparison to economic measures for the United States as a whole.
Puerto Rico is one of 13 territories of the United States under the jurisdiction of the Department of the Interior.2 Puerto Rico and two other territories, Navassa Island and the U.S. Virgin Islands, are in the Caribbean Sea. Ten territories – American Samoa, Baker Island, Guam, Howland Island, Jarvis Island, Johnston Atoll, Kingman Reef, Midway Atoll, the Northern Mariana Islands, and Wake Atoll – are in the Pacific Ocean.
Puerto Rico became a territory in 1898 and a commonwealth 1952.3 Puerto Rico is represented in the U.S. Congress by a non-voting resident commissioner in the House of Representatives. Residents of Puerto Rico are generally U.S. citizens.
1 This document may be cited as follows: Joint Committee on Taxation, Federal Tax Law and Issues Related to the Commonwealth of Puerto Rico (JCX-132-15), September 28, 2015.
2 The source of information about the territories included in this paragraph and the paragraph that follows is the website of the Office of Insular Affairs of the Department of the Interior: http://www.doi.gov/oia/index.html.
3 The Northern Mariana Islands are also a commonwealth. Commonwealth status typically involves a legal relationship with the United States that is embodied in a written mutual agreement. The 11 territories other than Puerto Rico and the Northern Mariana Islands generally have less developed legal relationships with the United States. Their governments are generally constituted by U.S. Federal statutes referred to as organic acts.
5 Unless otherwise noted, section numbers in this document are sections of the Code.
territory of which the individual is a resident, and not with the United States. American Samoa and Puerto Rico, by contrast, are non-mirror Code possessions. These two territories have their own internal tax laws, and a resident of American Samoa or Puerto Rico may be required to file an income tax return with both the territory of residence and the United States.
Federal tax rules apply to the territories in a manner that is different from their application in relation to both the States and foreign countries. Broadly, an individual resident of a territory is exempt from U.S. tax on income that has a source in that territory but is subject to U.S. tax on U.S.-source and non-possession-source income. A corporation that is organized in a territory is generally treated as a foreign corporation for U.S. tax purposes. On the other hand, a number of Code provisions have effect in one or all of the territories as if the territories were States. For example, the tax credit for research and experimentation has been available for research conducted in a territory. Historically, the Federal tax rules also have included preferences for territory activities. Until its expiration in 2006, the section 936 possession tax credit permitted qualifying U.S. corporations a credit against their U.S. tax liability in respect of possession-source income.6 After section 936 expired, a similar, temporary provision was enacted for American Samoa activities, and the section 199 domestic production activities deduction was expanded temporarily to include production activities conducted in Puerto Rico. These temporary rules for American Samoa and Puerto Rico were extended multiple times but most recently expired at the end of 2014.
Questions related to the Federal tax rules’ application to Puerto Rico and the other territories include whether the application should be uniform across the territories; whether the application should be based on a single principle such as State treatment or foreign country treatment; and whether U.S. bilateral income treaties should in any cases include the territories in their scope.
6 The section 936 credit was phased out during the 10-year period starting in 1996. During this phase-out period, the Puerto Rico economic activity credit of section 30A was available for trade or business activity in Puerto Rico.
Puerto Rico differs from the United States along a number of demographic and economic dimensions.7 Table 1, below, provides a demographic overview of the United States and Puerto Rico. The Puerto Rican population is generally older than the U.S. population and is experiencing greater population outflows than inflows. In 2015, 17.5 percent of Puerto Ricans are ages 65 and over, while a smaller percentage, 14.9 percent, of the U.S. population is in that age range. In contrast, 17.7 percent of Puerto Ricans are ages 14 and younger in Puerto Rico, while a larger percentage, 19.0 percent, of the U.S. population is in that age group.
Population flows also differ between the United States and Puerto Rico. While approximately four people, per 1,000 people on net, migrated to the United States in 2015, approximately three people, per 1,000 on net, migrated out of Puerto Rico.
Source: U.S. Census International Database.
7 In this section, the United States encompasses the 50 States and the District of Columbia.
Workforce compensation is generally lower in Puerto Rico than in the United States. As Table 2, below, shows, median and mean wages in the United States were greater than that in Puerto Rico in May 2014.
8 The GDP figure for Puerto Rico comes from the World Bank, and the GDP figures for the United States and Mississippi are from the Bureau of Economic Analysis. Population figures are from the U.S. Census Bureau.
9 Bureau of Labor Statistics.
be considered possessions of the United States for political purposes but are not generally accorded special status under the Code or by Treasury. But see, e.g., section 274(h)(3)(A) (defines “North American area” to include the United States, its possessions and the Trust Territory of the Pacific Islands, as well as Canada and Mexico) and Rev. Rul. 2011-26, 2011-1 C.B. 803 (explains the current status of the entities that were part of the Trust Territory when 274(h) was enacted, and rules that “possessions” includes, in addition to the five discussed in this pamphlet, Baker Island, Howland Island, Jarvis Island, Johnston Island, Kingman Reef, the Midway Islands, Palmyra Atoll, Wake Island, and any other United States islands, cays, and reefs that are not part of the 50 states or the District of Columbia).
14 The 1950 Organic Act of Guam, 48 U.S.C. sec. 1421i(h) (2012).
15 Covenant to Establish a Commonwealth of the Northern Mariana Islands in Political Union with the United States of America (“Covenant”), Act of March 24, 1976, Pub. L. No. 94-241, 48 U.S.C. sec. 1801 (note) (2012); President Ronald Reagan, “Placing Into Full Force and Effect the Covenant With the Commonwealth of the Northern Mariana Islands, and the Compacts of Free Association With the Federated States of Micronesia and the Republic of the Marshall Islands,” Proclamation No. 5564, 51 Fed. Reg. 40,399-400 (Nov. 3, 1986).
16 Act July 12, 1921, ch 44, 42 Stat. 123, popularly known as the Naval Service Appropriation Act, 1922, codified at 48 U.S.C. sec. 1397 (2012).
17 For example, 48 USC 1421i(d) specifies that for Guam, the mirrored sections include most of subtitle A (income tax), chapters 24 and 25 (withholding tax), and subtitle F (administrative) as applicable to the income tax.
19 The special effective date for the revision of section 931 and repeal of section 935 is provided in section 1277(b) of the 1986 Act, stating “The amendments made by this subtitle shall apply with respect to Guam, American Samoa, or the Northern Mariana Islands (and to residents thereof and corporations created or organized therein) only if (and so long as) an implementing agreement under section 1271 is in effect between the United States and such possession.” Tax Reform Act of 1986, Pub. L. No. 99-514, sec. 1277(a), (b), 100 Stat. 2085, 2600 (1986).
The United States generally imposes income tax on the worldwide income of U.S. citizens and residents. Thus, all income earned by a U.S. citizen or resident, whether from sources inside or outside the United States, is taxable whether or not the individual lives within the United States. All U.S. citizens and residents whose gross income for a taxable year is not less than the sum of the personal exemption amount and the basic standard deduction are required to file an annual U.S. individual income tax return.
The taxable income of a U.S. citizen or resident is equal to the taxpayer’s total worldwide income less certain exclusions, exemptions, and deductions. A foreign tax credit, with limitations, may be claimed for foreign income taxes paid or accrued, or, alternatively, foreign taxes may be treated as a deduction. Income taxes paid in a U.S. possession are generally creditable taxes for these purposes.
Generally, special U.S. income tax rules apply with respect to U.S. persons who are bona fide residents of U.S. possessions and who have possession-source income or income effectively connected with the conduct of a trade or business within a possession.20 The term bona fide resident means a person who meets a two-part test with respect to American Samoa, Guam, the U.S. Virgin Islands, Puerto Rico, or the Northern Mariana Islands as the case may be, for the taxable year. First, an individual must be present in the U.S. possession for at least 183 days in the taxable year.21 Second, an individual must (1) not have a tax home outside such possession during the taxable year and (2) not have a closer connection to the United States or a foreign country during such year.
Individual residents living in U.S. possessions generally are subject to either a single- or double-filing system with respect to their income. Individual residents subject to section 931 or 933 (that is, bona fide residents of American Samoa and Puerto Rico) operate under a double- filing system. Under a double-filing system, income that is not exempt from U.S. tax under section 931 or 933, and meets certain filing thresholds, must be reported to the United States on a U.S. return. An individual resident of a territory with a double-filing system who has income from sources outside the territory of which the individual is resident (for example, a Puerto Rican resident individual with non-Puerto Rican-source income) must file a U.S. tax return and may also be required to file a return with the territory of residence. Income reported on a U.S. return by a bona fide resident of a U.S. possession is generally subject to the same U.S. tax treatment that applies to individuals resident in the United States.
20 For more detail about these special rules, see generally, Joel D. Kuntz and Robert J. Peroni, U.S. International Taxation, “U.S. Taxation Relating to Possessions” (Warren Gorman and Lamont-RIA, 2005), Part D.
21 Sec. 937(a). Treasury regulations provide guidance related to meeting the presence test, including exceptions for certain extended absences from the possession. Treas. Reg. sec. 1.937-1.
In contrast, an individual subject to section 932(c) or 935 (that is, a bona fide resident of the U.S. Virgin Islands, Northern Mariana Islands, or Guam22) generally are subject to a single- filing system. Under a single-filing system, income is reported in one jurisdiction, based on bona fide residency. A bona fide resident of a territory with a single-filing system generally files a tax return only with that territory and not with the United States. In a single-filing system, income is typically allocated between the U.S. possession and the United States through a cover-over mechanism. Cover-over generally refers to the collection of certain taxes and fees by the U.S. Treasury and subsequent payment of such taxes and fees to the governments of the territories as specified.
22 The repeal of section 935 is not yet effective for Guam or the Northern Marianas, due to failure to meet the condition in the special effective date provided in section 1277(b) of the 1986 Act, which states, “The amendments made by this subtitle shall apply with respect to Guam, American Samoa, or the Northern Mariana Islands (and to residents thereof and corporations created or organized therein) only if (and so long as) an implementing agreement under section 1271 is in effect between the United States and such possession.” Tax Reform Act of 1986, Pub. L. No. 99-514, sec. 1277(a), (b), 100 Stat. 2085, 2600 (1986).
24 Treas. Reg. secs. 1.911-2(g),(h).
U.S. corporations are subject to U.S. income tax on their worldwide income, whether derived in the United States or abroad. Income earned by a domestic parent corporation from foreign operations conducted by foreign corporate subsidiaries generally is subject to U.S. tax when the income is distributed as a dividend to the domestic corporation. Until such repatriation, the U.S. tax on such income is generally deferred. However, certain anti-deferral regimes may cause the domestic parent corporation to be taxed on a current basis in the United States with respect to certain categories of passive or highly mobile income earned by its foreign subsidiaries. The main anti-deferral regimes in this context are the controlled foreign corporation rules of subpart F28 and the passive foreign investment company rules.29 A foreign tax credit is generally available to offset, in whole or in part, the U.S. tax owed on this foreign- source income, whether earned directly by the domestic corporation, repatriated as a dividend, or included under one of the anti-deferral regimes, subject to certain limitations.
Foreign corporations with U.S.-source income generally are subject to U.S. tax on a net basis at graduated rates on income effectively connected to a U.S. trade or business. U.S.-source passive income paid to a foreign corporation is generally taxed on a gross basis at a withholding rate of 30 percent. With limited exceptions, the United States generally does not tax foreign- source income of foreign corporations that are not owned by U.S. shareholders.
Corporations formed in the U.S. possessions generally are treated as foreign corporations for U.S. tax purposes. The United States therefore generally does not impose tax on the business income of possessions subsidiaries of domestic corporations, but subpart F may cause passive and mobile income to be taxed currently. Corporations organized in the U.S. territories and not owned by U.S. shareholders generally are not subject to U.S. tax on territory-source or other foreign-source income.
27 See section 1277(e) of the 1986 Act. Under this special source rule, gains from dispositions of certain property held by a U.S. person prior to becoming a resident in American Samoa, the Northern Mariana Islands, or Guam are treated as income from sources within the United States for all purposes of the Code.
foreign corporations for purposes of the 30-percent gross-basis tax on passive income and the branch profits tax. Under this rule, U.S.-source fixed or determinable annual or periodical income such as a dividend, interest, rent, or royalty received by a corporation created or organized in American Samoa, Guam, the U.S. Virgin Islands, or the Northern Mariana Islands is not subject to the 30-percent gross-basis tax provided that certain local ownership and activity requirements are met.30 Those possessions similarly provide a zero rate of gross-basis tax on territory-source payments made to corporations organized in the United States.
30 Sec. 881(b)(1). The local ownership and activity requirements are that (A) at all times during the taxable year foreign persons own directly or indirectly less than 25 percent in value of the stock of the corporation; (B) for the three-year period ending with the close of the taxable year, at least 65 percent of the corporation’s gross income is shown to the satisfaction of the Secretary to be effectively connected with the conduct of a trade or business in the territory of residence or the United States; and (C) no substantial part of the income of the corporation is used directly or indirectly to satisfy obligations to persons who are not bona fide residents of the territory of residence or of the United States. Ibid.
(indexed for inflation). The estate tax rate is 40 percent.
34 Sec. 2503(b). The annual gift tax exclusion amount for 2015 is $14,000.
The estate of a nonresident alien generally is taxed at the same estate tax rates applicable to U.S. citizens, but the taxable estate includes only property situated within the United States that is owned by the decedent at death (and certain property transferred during life subject to reserved interests or powers). This estate generally includes the value at death of all real and personal tangible property situated in the United States and certain intangible property, such as stock of a domestic corporation, considered to be situated in the United States.37 The estate of a nonresident alien is allowed a unified credit of $13,00038 and under treaty may instead be allowed a pro rata portion of the generally applicable unified credit.
Nonresident alien individuals are subject to gift tax with respect to certain transfers by gift of U.S.-situated property under the same tax rate schedule applicable to U.S. citizens. The tax applies only where the value of the transfer exceeds the annual exclusion amount.39 Such property includes real estate and tangible property located within the United States. Nonresident aliens generally are not subject to U.S. gift tax on the transfer of intangibles, such as stock or securities, regardless of where such property is situated.
35 The unified credit (with a basic exclusion amount of $5.43 million in 2015) is allowed in computing the gift tax on lifetime transfers and transfers at death. Just as the unified credit is a single credit against tax and gifts and bequests, the 40-percent tax rate applies to both gifts and bequests.
36 Secs. 2208 (estate tax) and 2501(b) (gift tax).
37 For these purposes the United States means the 50 States and the District of Columbia.
38 Sec. 2102(b). This credit shelters the first $60,000 of the taxable estate from Federal estate tax.
39 The annual exclusion amount is $14,000 for 2015 (indexed for inflation).
40 Sec. 2209 (estate tax) and 2501(c) (gift tax).
Employees and employers in the United States are subject to payroll taxes for the Federal Insurance Contributions Act (“FICA”) that fund Social Security and certain Medicare benefits, Federal unemployment insurance payroll tax (“FUTA”), and the withholding tax for Federal income tax.42 FICA imposes tax on employers based on the amount of wages paid to an employee during the year. The tax imposed is composed of two parts: (1) the old age, survivors, and disability insurance (“OASDI”) tax as a percentage of covered wages; and (2) the Medicare hospital insurance (“HI”) tax amount, also a percentage of covered wages. In addition to the tax on employers, each employee is subject to FICA taxes equal to the amount of tax imposed on the employer. The employee-level tax generally must be withheld and remitted to the Federal government by the employer. Certain categories of services and employment are often exempt from FICA, including foreign agricultural workers with appropriate visas.
42 Secs. 3121(a) and 3402(a).
Samoa, and the Commonwealth of the Northern Mariana Islands (Publication 80 Circular SS), 2012.
44 Under section 3401(a)(8), most wages paid to U.S. persons for services performed in one of the possessions are excluded if the payments are subject to withholding by the possession, or, in the case of Puerto Rico, the payee is a bona fide resident of the possession for the full year.
45 Section 3306(j) provides that for purposes of the FUTA tax, the term State includes both Puerto Rico and the Virgin Islands.
46 While the gross FUTA tax rate was 6.2 percent (until July 2011), the net rate was 0.8 percent. The credit is not available to employers who are delinquent in repaying a Federal loan.
In addition to the U.S. and foreign statutory rules for the taxation of foreign income of U.S. persons and U.S. income of foreign persons, bilateral income tax treaties limit the amount of income tax that may be imposed by one treaty partner on residents of the other treaty partner. For example, treaties often reduce or eliminate withholding taxes imposed by a treaty country on certain types of income, such as dividends, interest, and royalties paid to residents of the other treaty country. Treaties also include provisions governing the creditability of taxes imposed by the treaty country in which income is earned in computing the amount of tax owed to the other country by its residents with respect to that income.
drawback claimant upon the exportation, or destruction of eligible articles upon which the duties, taxes and fees have been paid. The purpose of drawback is to place U.S. exporters on equal footing with foreign competitors by refunding most of the duties, taxes and fees paid on imports used in domestic manufacturing intended for export.
51 Sec. 103. Section 103(c)(2) defines State to include any possession of the United States.
foreign research to be research conducted outside the United States, the Commonwealth of Puerto Rico, or any possession of the United States.
53 Sec. 42. Section 42(h)(8)(B) defines State to include a possession of the United States.
54 See, e.g., Agreement between the Government of the United State of America and the Government of the Republic of Panama for Tax Cooperation and the Exchange of Information Relating to Taxes Tax Information Agreement between United States and Panama, entered into force April 18, 2011.
55 See section 1.02 of Rev. Proc. 2006-23, 2007-1 C.B. 900.
56 See, for example, Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (JCS-10-87), May 4, 1987, pp. 999-1000, available at http://www.jct.gov/jcs-10-87.pdf.
57 39 Stat. 951 (1917).
In general, a corporation organized under the laws of Puerto Rico is a foreign corporation for U.S. tax purposes. The United States taxes foreign corporations only on income that has a sufficient nexus to the United States. This taxation includes a 30-percent tax on the gross amount of a foreign corporation’s fixed, determinable, annual, or periodic income from U.S. sources and taxation under the corporate income tax on net income that is effectively connected with the conduct of a U.S. trade or business.
60 Determined under the principles of sec. 911(d)(3).
61 Determined under the principles of sec. 7701(b)(3)(B)(ii).
64 See sec. 881(b)(2)(A)(ii). The requirements are listed at sec. 881(b)(1)(A), (B), and (C).
66 Secs. 3121(e) and 3306(j).
definition of wages for amounts under an educational assistance program or a dependent care assistance program67 do not apply because the exceptions are by reason of specific Code sections (i.e., sections 127 and 129) that are not applicable in the case of Puerto Rico employers and employees.
Revenues collected by the United States from the excise taxes imposed on certain articles coming into the United States from Puerto Rico generally are covered over to the Puerto Rico Treasury.70 With respect to otherwise eligible excise taxes imposed on articles not containing distilled spirits, revenues are covered over to Puerto Rico only if the cost or value of materials produced in Puerto Rico plus the direct costs of processing operations performed in Puerto Rico equal at least 50 percent of the value of the article at the time it is brought into the United States. Moreover, no cover over is permitted on such articles if Puerto Rico provides a direct or indirect subsidy with respect to the article which is of a different kind or in an amount greater than the subsidies which Puerto Rico generally offers to industries producing articles not subject to Federal excise tax.
With respect to Federal excise taxes imposed on articles containing distilled spirits that are manufactured in Puerto Rico and shipped into the United States, revenues are covered over to the Puerto Rico Treasury only if at least 92 percent of the alcoholic content of such articles is attributable to rum. The amount of excise taxes covered over to Puerto Rico from such articles cannot exceed $10.50 per proof gallon. This limitation was temporarily increased to $13.25 for articles brought into the United States after June 30, 1999, however the increase in the limitation does not apply to articles brought into the United States after December 31, 2014.
67 Secs. 3121(a)(18) and 3306(b)(13).
A provision of the Code added by the Caribbean Basin Economic Recovery Act provides a special rule for excise taxes collected on rum imported into the United States from any country.71 Such excise taxes are covered over to the treasuries of Puerto Rico and the U.S. Virgin Islands, under a formula prescribed by the Treasury Department for the division of such tax collections between Puerto Rico and the U.S. Virgin Islands.72 The formula for division of excise tax collected from other countries is roughly based on the relative market share of rum produced in Puerto Rico and the U.S. Virgin Islands. The law stipulates that the Puerto Rico share not exceed 87.626889 percent and not fall below 51 percent. This formula resulted in approximately 88 percent of revenues from rum excise taxes being covered over to Puerto Rico in fiscal year 2014.
The generally applicable section 199 deduction for income from domestic production activities was expanded temporarily to include production activities conducted in Puerto Rico.73 For purposes of computing the wage limitation for the deduction, wages include wages paid for services performed in Puerto Rico. This provision is not applicable to tax years beginning after December 31, 2014.
71 Present law section 7652(e), enacted as part of Pub. L. No. 98-67, August, 5, 1983.
for articles imported into the United States before 2015) limitation described previously.
74 This description of the tax laws of Puerto Rico relies largely on the following secondary source: Ríos- Méndez and Alemar-Escabí, 2650-3rd T.M., Business Operations in Puerto Rico. The description is intended to serve as a general overview; many details have been omitted and simplifying generalizations made. All citations to the Laws of Puerto Rico Annotated (L.P.R.A.) are current as of the year of the most recent English translation available on Lexis. This description generally does not include changes made by tax legislation enacted in May 2015, other than the value-added tax described below.
75 Ríos-Méndez and Alemar-Escabí, 2650.05(B).
76 13 L.P.R.A. § 30071 (2011).
77 13 L.P.R.A. § 30073 (2011).
79 13 L.P.R.A. § 30441(a) (2011).
80 13 L.P.R.A. § 30085 (2011).
81 Ríos-Méndez and Alemar-Escabí, 2650.08(A).
82 The IRS and Treasury Department are evaluating the excise tax and have concluded that the IRS will not challenge a taxpayer’s position that the excise tax is a tax in lieu of an income tax under section 903 (and therefore creditable). See Notice 2011-29, 2011-16 I.R.B. 663 (April 18, 2011).
83 Ríos-Méndez and Alemar-Escabí, 2650.10(A).
84 13 L.P.R.A. § 30061 (2011); P.R. Act No. 72, effective May 29, 2015.
85 13 L.P.R.A. § 30062 (2011).
86 13 L.P.R.A. § 30086 (2011).
87 13 L.P.R.A. § 30085 (2011).
88 13 L.P.R.A. § 30082 (2011).
89 Ríos-Méndez and Alemar-Escabí, 2650.10(A).
10832(a) (2012). 10831(f) (2012). 10831(g) (2012). 10831(m) (2012). 10831(m) (2012). 10832(a) (2012).
Benefits under the EIDA are available with respect to enumerated business activities, such as commercial manufacturing, science and medical laboratories, renewable energy production for consumption in Puerto Rico, recycling, investment banking, electronic data processing, public relations, commercial software development, hydroponic agriculture, strategic public-private partnerships, purifying and bottling water (tax credits only), and construction of affordable public housing.
Qualifying businesses generally are eligible for a reduced income tax rate of four percent on income related to exempt activities and a withholding tax rate of 12 percent on royalty payments, or they may elect to pay an eight-percent income tax rate and a two-percent withholding rate on payments of royalties for use of intangibles in Puerto Rico. There is also a 90-percent exemption from property taxes and 100-percent exemption from municipal license taxes during the initial period of operations and an exemption of at least 60 percent thereafter. Eligible funds and financial institutions receiving passive income derived from exempt businesses and other designated investments are fully exempt from income and municipal license taxes.
Ríos-Méndez and Alemar-Escabí, 2650.15(Q); 13 L.P.R.A. § 10833(a) (2012). 13 L.P.R.A. § 10836 (2012).
Ríos-Méndez and Alemar-Escabí, 2650.15(R). P.R. Act No. 73, § 2(d)(1) (May 28, 2008).
residents for the right to use intangible property in exempt operations, credits for strategic projects such as the construction of dams and reservoirs, and industrial investment credits.
Businesses engaged in eligible tourism-related activities may qualify for 90-percent or 100-percent exemption from tax on income tax for tourism-related activities, 100-percent exemption from dividend and profit distributions, 90-percent exemption from property taxes, and 100-percent exemption from municipal license and excise taxes. There is a 50 percent credit for qualifying tourism industry investment. Interest from financing tourism projects paid to financial institutions is exempt from income tax.
Bona fide farmers may qualify for a 90-percent income tax exemption on earnings derived directly from agriculture. There are 100-percent exemptions from property tax, municipal license taxes, and excise taxes. Interest earned on investment in agriculture is exempt from income tax.
Qualifying hospital facilities are eligible for a 50-percent exemption for net taxable income derived from rendering hospital services, 100-percent exemption from property tax, 100- percent exemption from excise taxes on equipment expressly designed for medical diagnosis and treatment, and 100-percent exemption from municipal taxes. There is a 50-percent exemption for interest from investment in operating or modernizing hospital units.
Income derived directly from film projects may qualify for a flat four-percent rate of tax. Qualifying businesses receive a 90-percent property tax exemption, 100-percent municipal license tax exemption, 100-percent excise tax exemption, and tax credits for expenses. There are similar preferential rates, exemptions, and credits for entities that obtain grants to develop studios or other permanent facilities to carry out film projects.
102 P.R. Act No. 74 (July 10, 2010).
103 13 L.P.R.A. § 10408 (1997).
104 P.R. Act No. 168 (June 30, 1986).
105 P.R. Act No. 27 (Mar. 4, 2011).
On sale of a qualifying housing unit, there is an exemption of up to $5,000 of the gain from the sale of each unit of social interest housing, and an exemption of up to $2,500 of the gain from the sale of each unit of middle class housing. On leasing housing units to low or moderate income families there is an exemption for rental income up to 10 percent of the yield on capital investment in the housing unit. There are also exemptions from property taxes for qualifying businesses.
There are tax exemptions for businesses engaged in production and sale of green energy on a commercial scale for consumption in Puerto Rico. Businesses that qualify are eligible for a reduced income tax rate of four percent and a withholding tax rate of 12 percent on royalty payments to non-Puerto Rico resident companies. There are also exemptions for property taxes, municipal license taxes, excise taxes, and sales and use taxes. Gain from sale of shares by shareholders in corporations engaged in such businesses are taxed at a rate of four percent.
106 P.R. Act No. 47 of June 26, 1987, as amended; 17 L.P.R.A. §§891–901.
107 13 L.P .R.A. § 8412A(2).
108 13 L.P .R.A. § 8422(b)(47).
109 13 L.P .R.A. § 8422(b)(47).
110 P.R. Act No. 83 (July 19, 2010).
U.S. Federal tax rules related to the U.S. territories vary from one territory to another. Under Federal law, Guam, the Northern Mariana Islands, and the U.S. Virgin Islands have mirror Code tax systems, while American Samoa and Puerto Rico have their own tax systems. The Internal Revenue Code and other Federal laws also include more specific rules that treat U.S. territories differently from (or, in some cases, the same as) one another. A broad question for consideration is whether this disparate treatment advances traditional tax policy goals of fairness to U.S. persons and general economic efficiency.
A related question is, regardless of whether there is variation or uniformity in the U.S. Federal tax rules that apply to the U.S. territories, what broad principles, if any, should underlie the U.S. rules? For example, should U.S. tax rules related to the territories be guided by the principle that the territories are similar to States of the United States? Or, by contrast, should the U.S. tax rules operate as if the territories were more like foreign countries?
A specific application of the question whether U.S. territories should be viewed as similar to States or foreign countries is in the context of bilateral income tax treaties. U.S. income tax treaties generally do not include the U.S. territories in the definition of United States and generally do not treat territory residents as U.S. residents. Consequently, among other things, in the absence of specific treaty or internal law rules to the contrary, treaty reductions in source- basis withholding tax rates do not apply to payments made by or to a corporation organized in one of the U.S. territories and individual residents of the territories do not benefit from treaty reductions in source-basis taxation. A question is whether this general approach to the scope of U.S. income tax treaties is appropriate.
The Code and other Federal laws also include more specific rules that treat U.S. territories differently from – and in some cases, the same as – one another. For example, following the expiration of the section 936 possession tax credit, two temporary, but different, rules were enacted for activities in American Samoa and Puerto Rico. The generally applicable section 199 deduction for income from domestic production activities, which in its original form did not apply to activities in a U.S. territory, was made available in respect of production activities carried out in Puerto Rico.115 A credit similar to the possession tax credit was enacted only for activities in American Samoa.116 These two rules originally expired at the end of 2007 but were extended in subsequent public laws through the end of 2014.
111 See 48 U.S.C. secs. 1397 (U.S. Virgin Islands), 1421(i) (Guam), and 1801 (the Northern Mariana Islands).
112 See secs. 932(c), 935(b).
113 As described previously, however, American Samoa’s income tax rules largely parallel the U.S. rules.
For a description of the tax rules of the Commonwealth of Puerto Rico, see Joint Committee on Taxation, An Overview of the Special Tax Rules Related to Puerto Rico and an Analysis of the Tax and Economic Policy Implications of Recent Legislative Options (JCX-24-06), June 23, 2006, pp. 22-36.
114 See secs. 931(a) (American Samoa), 933(1) (Puerto Rico).
116 Pub. L. No. 109-432, sec. 119 (which also expired at the end of 2011).
A question is whether the variation in the tax rules applicable to the U.S. territories – both in the general distinction between mirror and non-mirror Code systems and in narrower Federal rules that often distinguish among the territories – is appropriate. The variation might be viewed as appropriately reflecting different historical, economic, legal, and political considerations among the territories. As a recent example, it might be argued that the expiration of the possession tax credit, which had been allowed for activities in any possession, would have disproportionately affected economic activity in American Samoa and Puerto Rico had the special temporary rules described above not been enacted for those territories. It might be difficult to verify this claim empirically even if the claim has had anecdotal support.
The mirror and non-mirror Code arrangements between the United States and the territories represent resolutions of a particular issue in the historical relationships of the territories and U.S. governments and are part of an overall legal structure for the territories. Moreover, the economies of the territories differ greatly from one another, and these differences could be considered to justify differences in taxation. On the other hand, States of the United States differ from one another in their economic, historical, and political circumstances, but the U.S. Federal tax rules for the most part do not explicitly distinguish among the States. Moreover, uniform treatment of the territories might be expected to reduce aggregate administrative and compliance costs. This result, though, might depend on the particular sort of uniformity adopted.
121 Sec. 7701(a)(4), (5), (9), (10).
proposal related to the refundable child tax credit for residents of Puerto Rico, see Joint Committee on Taxation, An Overview of the Special Tax Rules Related to Puerto Rico and an Analysis of the Tax and Economic Policy Implications of Recent Legislative Options (JCX-24-06), June 23, 2006, pp. 78-82.
The U.S. tax rules applicable to the territories could be modified so that the rules as a whole reflect the principle that the territories are like States or the principle that the territories are like foreign countries. It is not clear, however, whether either of those principles or another principle would be an improvement over present law. Territories are much poorer than States, and their economies are different from the economies of States. These observations may argue against an overarching principle of treating the territories as States. They do not, however, necessarily favor the principle of treating the territories as foreign countries. The economies of the territories differ from the economies of both the States and some foreign countries. In other areas of the law – trade, for example – territories are generally treated as part of the United States. In part because the territories are subject to the authority of the Federal government, the Federal government has an interest in the welfare of territory residents that contrasts with the Federal government’s stance toward residents of other countries. Given these considerations, and given the unique histories of the U.S. territories’ relationships with the United States, it is understandable that neither foreign country treatment nor U.S. State treatment – nor any other single principle – underlies the U.S. Federal tax regime for the territories.
127 See Pub. L. No. 111-5 (Feb. 17, 2009), sec. 1001; Pub. L. No. 111-147 (Mar. 18, 2010), sec. 102(d); Pub. L. No. 112-56 (Nov. 21, 2011), sec. 261(f).
U.S. bilateral income tax treaties generally define the United States as not including the U.S. territories and generally do not treat territory residents as residents of the United States.128 Consequently, in the absence of rules to the contrary, treaty reductions of source-basis taxation do not apply to individuals resident in, or corporations organized in, the territories.
It is understandable that U.S. income tax treaties do not cover the U.S. territories: Individuals resident in the territories are generally taxed in the United States in a manner more similar to non-U.S. residents than to U.S. residents, and corporations organized in the territories likewise are subject to U.S. tax in a manner more similar to foreign corporations than to domestic corporations. Moreover, territory residents may benefit from favorable tax regimes in the territories, such as the U.S. Virgin Islands’ economic development incentives and the more recently enacted Puerto Rican tax incentives described previously. If U.S. income tax treaty benefits were conferred on territory residents, consideration would need to be given to whether those benefits should be restricted in any way as a result of preferential tax regimes in the territories. Restrictions on treaty benefits as a result of territory tax preferences would be consistent with the long-standing U.S. treaty policy against tax sparing.
On the other hand, the exclusion of territory residents from treaty benefits such as reductions in source country taxation may be in tension with the goals of some U.S. internal laws applicable to the territories. For example, the possession tax credit was intended to encourage economic activity in the territories. Economic activity might be discouraged, though, if, because they are not eligible for the benefits of U.S. income tax treaties, territory residents with cross- border income must pay more in source country income taxes on that income than their peers in the United States or foreign countries would face on the same income. Economic development similarly might be hampered if potential foreign investors in mirror Code territories face 30- percent gross-basis withholding tax on dividends and other payments from those territories rather than the lower treaty rates that would apply to U.S.-source payments.
128 For examples of a typical definition of the United States and a typical definition of resident, see United States Model Income Tax Convention of November 15, 2006, Article 3(1)(i) (excluding U.S. territories from the definition of United States) and Article 4(1) (excluding from the definition of a resident of a contracting state “any person who is liable to tax in that State in respect only of income from sources in that State”).
The concern that imposition of the mirror Code 30-percent withholding tax might discourage inbound investment also underlay the Guam Foreign Investment Equity Act.130 Under that law, the rate of gross-basis withholding tax imposed on a Guam-source payment to a nonresident individual or a foreign corporation is generally the same as the rate of tax that would apply if Guam were treated as part of the United States for purposes of U.S. income tax treaty obligations. Because Guam is a mirror Code territory, in the absence of this law, the generally applicable U.S. withholding tax rate of 30 percent would apply to Guam-source cross-border payments. By permitting treaty reductions of withholding tax to apply to these payments, the law extends mirror Code treatment to the treaty context. One question is whether enactment of the same or a similar rule for the other mirror Code territories (the Northern Mariana Islands and U.S. Virgin Islands) merits consideration. By contrast, American Samoa and Puerto Rico have the discretion under their non-mirror Code tax systems to reduce or eliminate source-basis taxation of American-Samoa-source and Puerto-Rico-source payments to foreign investors. A special rule like the one enacted for Guam therefore is unnecessary.
129 The 2013 protocol has been signed, transmitted to the Senate, and reported favorably to the full Senate by the Foreign Relations committee, but it has not been ratified.
130 Pub. L. No. 107-212 (Aug. 21, 2002). See also H.R. Rep. No. 107-48, Apr. 24, 2001; S. Rep. No. 107- 173, June 24, 2002.

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