Incentives are net positive, but watch the fine print

Vicente Feliciano

The San Juan Star, May 14, 2008

In the final analysis, the proponed incentives are a positive step for the Island, as long as the fine print in the law is appropriately addressed.

The vision that comes out is to prudently increase taxes for the tax exempt firms, maintaining competitive levels. Thus, the 4% minimum tax when at present many firms are paying below this threshold.

The 4% is the result of some haggling. It was mentioned that Ireland had rates of 12.5%. On the other hand, Ireland offers grants and incentives that result in actual taxes below 12.5%. Individuals close to the exempt companies stated that the effective tax rate is 4%, even though there is no official document or in-depth study to support it. The committee accepted this on faith.

The proposed law has a vision of competitiveness that goes beyond tax rates. We understand that tackling issues of transaction, energy and labor costs is an important precedent. The decline in our manufacturing base and the difficulties of our local industry has more to do with high operational costs than with high taxes. To oppose flexi-time and the like is to embrace a failed model.

Another positive element is that it expands on the definition of exempt company, incorporating activities within the value chain that were not previously included. Also, the law advances the concept of clusters by offering credits for purchases to local manufacturers. In addition, it assigns resources to the Science and Technology Trust.

However, the devil is in the details. Unless the fine print is taken care of, the law would not be beneficial for Puerto Rico.

The definition of minimum tax is not consistent with the agreement of the Steering Committee of a 4% effective tax rate. As written, the effective tax rate would be lower than 4% and in some cases Hacienda could end up paying money to the exempt corporation.

The length of the exemption decree ought to be 10 years instead of 15 years. The proposed law entails such a major shift from the present law, that it is bound to have mistakes that would be addressed over time. It is like a software program that needs the bugs to be worked out, with the additional complication that we cannot run the program beforehand to see how it works.
It would be imprudent to tie Puerto Rico to 15 year commitments knowing that the law will require modifications. On the other hand, a 10 year decree gives us a brutal advantage over other jurisdictions. Neither Ireland nor the United States offer a single day of guaranteed income tax rules. There is no technical analysis that justifies 15 years instead of 10 years.
We are concerned that the law does not have an expiration date. The proposed law is the result of the “sunset clause” in the previous law by which the law expired after ten years. It is reasonable that every ten years we take stock of where we are and where we should be going. It would be somewhat like the census. Over nine years estimates are used, but every ten years is necessary to perform an actual census.

The credit for royalties is equal to the royalty payments, which we understand is too high. If one company pays royalties equivalent to an effective tax rate of 4% then there is no incentive to perform any of the activities that the law intends to advance.

If a company has a standing tax decree with income tax rates below 4% or royalty payments below 12%, it would keep this rates under the new law. It is not a matter of respecting the present decrees for which the government of Puerto Rico has a commitment, but that when these decrees expire the new decrees would maintain the tax rates of the old law. If the tax rates in the proposed law are good enough to attract new investment, they are good enough to retain existing investment.

The proposed law exempts from taxes income from financial investments (Section 2J) instead of treating it like any other income. There is no technical analysis to justify this policy. In the case of Ireland, income from financial investments has a higher tax rate than other operating income.
In the big picture the law is positive because the legislature, with a previous record which is less than stellar, forced the private sector to get to work. Instead of waiting for two years we have a proposed law that is better than the existing one and in only six months. Our shared government was able to come together in a controversial and potentially divisive issue.
For those of us who are married to this Island, the potential of this law reaffirms our conviction that there is a future right here in Puerto Rico.

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