Carveouts from overseas profits tax sought for US territories

Puerto Rico, Virgin Islands, others hurt by treatment as foreign jurisdictions under US tax code

Puerto Rico Capitol building in San Juan on June 18.  (Jinitzail Hernández/CQ Roll Call)
Puerto Rico Capitol building in San Juan on June 18. (Jinitzail Hernández/CQ Roll Call)
Posted July 27, 2021 at 2:37pm

Sen. Bob Menendez is urging fellow Democrats to cushion the blow for Puerto Rico and other U.S. territories if they raise taxes on multinational corporations’ foreign profits.

Menendez, a New Jersey Democrat, and others want to lighten the taxes owed on income that U.S.-controlled corporations generate in Puerto Rico, the U.S. Virgin Islands, Guam, American Samoa and the Northern Mariana Islands, which are currently treated like foreign countries under the tax code. He reintroduced legislation Tuesday with Sen. Roger Wicker, R-Miss., that the duo offered in the last Congress to give tax breaks to qualifying firms.

The Biden administration has proposed effectively doubling a minimum tax that multinationals pay on lightly taxed foreign income from mobile assets like patents — prevalent in the pharmaceutical industry that has a large presence in Puerto Rico, for instance — which advocates worry could undercut efforts to spur investment in the territories.

Menendez said that if Democrats raise the tax rate on “global intangible low-taxed income,” known as GILTI, or include other new taxes on multinationals’ profits in a $3.5 trillion budget reconciliation package, he wants the bill to include some relief for companies operating in the territories. Menendez, a member of the tax-writing Finance Committee, has not committed to back the deal, and Democrats will need every vote they have in the Senate to approve it.

“The three-and-a-half million citizens who live in Puerto Rico are U.S. citizens, and they deserve to be treated in every respect as every other U.S. citizen,” Menendez said. “So if GILTI has a disproportionate effect on the economy on the island of Puerto Rico, then ultimately that’s simply not fair, so we have to think about how that gets managed in the context of the greater goal.”

International tax changes

In their 2017 tax law, Republicans changed how the U.S. taxes foreign income of multinationals, getting rid of a system that allowed companies to delay paying taxes on profits until they’re repatriated to the U.S. Instead, multinationals are subject to an effective minimum tax rate of 10.5 percent, half the corporate tax rate of 21 percent for income earned within the United States. The tax was meant to target corporations’ use of tax havens, particularly moving intellectual property abroad to avoid taxes.

Citing continued tax avoidance by multinationals, the Biden administration initially proposed effectively doubling the minimum GILTI rate to 21 percent alongside other crackdowns on overseas profits coupled with a higher statutory corporate income tax rate of 28 percent.

Democrats’ proposals on corporate and international taxes are likely to be considered in the filibuster-proof $3.5 trillion budget reconciliation package. They’re planning to raise taxes on corporations and wealthier Americans to offset the plan to expand child care, clean energy, education, housing and other benefits.

The Treasury Department has estimated the administration’s proposals to overhaul corporate taxes could raise about $2 trillion over 10 years. But that figure seems likely to be whittled down in the Capitol Hill bargaining. For example, in international negotiations the administration has endorsed a lower 15 percent GILTI rate, and they’ve also signaled wiggle room on the headline corporate tax rate.

The changes could still impact corporations operating in Puerto Rico and other territories, including those with tangible assets like manufacturing plants, that were already hit with higher taxes under the initial 2017 law.

Companies who reported lobbying on Puerto Rico and international tax issues, and implementation of the 2017 law, include pharmaceutical giants AbbVie Inc., based in Illinois; Amgen, headquartered in California; and Johnson & Johnson, based in Menendez’ home state of New Jersey.

The life sciences industry represents half of manufacturing in Puerto Rico, 30 percent of the country’s gross domestic product and about 94,000 jobs, according to Invest Puerto Rico, a nonprofit.

Menendez has also been a strong voice urging caution when it comes to restrictions on prescription drug pricing, another key offset Democrats are eyeing for their reconciliation package. His home state is also home to the third-largest number of Puerto Ricans as a share of their overall populations after Florida and New York, by some estimates.

To shield companies in Puerto Rico and elsewhere from some multinational taxes, the Menendez-Wicker bill would create a tax credit for U.S. parent corporations with branches or subsidiaries in the territories, based on wages and tangible investments, according to a summary from Menendez’s office. Firms would have to source at least 80 percent of their income from a territory and three-quarters from an active trade or business there to qualify.

A company’s credit would be worth 40 percent of wages and benefits paid to employees in the territory, up to the Social Security contribution base — currently $142,800 — and 25 percent of tangible investments. It could be used to offset a multinational’s GILTI liability for a territory in a given year, but anything above that could be carried back one year or forward for 10.

“Upon enactment, the legislation will provide for significant job opportunities and critical investments in Puerto Rico’s manufacturing sector,” wrote Puerto Rico’s Senate President José Luis Dalmau in a letter to Menendez. “It will also help address the reshoring of vital supplies of pharmaceuticals and medical devices and other advanced manufactured products critical to U.S. national security.”

Puerto Rico's House Speaker Rafael Hernandez Montanez said in a separate letter to Menendez that the tax credit would help boost manufacturing jobs in Puerto Rico. The territory has lost more than 100,000 manufacturing jobs since 2006 when a separate tax incentive for U.S. companies operating in Puerto Rico ended, he wrote.

Menendez isn’t alone in pushing to change how the tax code treats corporations doing business in the territories. New York Democratic Reps. Tom Suozzi, a Ways and Means member, and Nydia M. Velázquez, who was born in Puerto Rico, introduced the House version of the Menendez-Wicker bill last year.

'Constructive approach'

Del. Stacey Plaskett, a Democrat representing the U.S. Virgin Islands, raised the issue in June when Treasury Secretary Janet L. Yellen appeared at a House Ways and Means hearing. Yellen told Plaskett she would work with her to “find a constructive approach” on her concern about a higher GILTI rate’s impact.

Jeff Nowill, Plaskett’s legislative director, said the current GILTI system has created problems in the Virgin Islands by making it harder to attract new business and has made U.S. programs meant to incentivize investment in the territories less attractive.

The Virgin Islands is currently conducting an analysis with an independent firm to determine the exact impact the tax has had on its economy. Plaskett is particularly concerned about a higher tax rate on foreign earnings.

“If we don’t get a fix to this for cases of U.S. investment in active trade or business in U.S. territories, this would be disastrous and it would really kill the prospect for U.S. investment in these island territories,” Nowill said in an interview. “It’s already caused some of that.”

With tourism — a main component of the Virgin Islands’ service-based economy — hampered by the COVID-19 pandemic and multiple hurricanes since 2017, higher business taxes would be “kicking the territories when they’re down,” Nowill said.

The changes that Biden and other Democrats have proposed would exacerbate the problem for Puerto Rico and other territories, said Kyle Pomerleau, a senior fellow who has studied GILTI at the American Enterprise Institute, a conservative think tank.

“The U.S. tax system has to play a balancing act,” Pomerleau said. “It needs to on the one hand protect the U.S. tax base to prevent companies from using offshore or foreign jurisdictions to reduce U.S. tax liability," while also "making sure that the rules do not discourage too much outbound foreign direct investment because that activity is important for U.S. companies, and it’s important for the countries in which they operate.”

Plaskett’s bill would exempt income earned in the territories from being taxed by the U.S. It would have the same threshold as Menendez's bill of 80 percent of income to be from sources in a territory and 75 percent connected with an active trade or business.

Nowill said Plaskett prefers her proposal because it’s simpler and because Menendez’s bill would give a bigger boost to manufacturing, a major plank of Puerto Rico’s economy that isn’t as significant in the Virgin Islands.

Menendez said that while he would seek to address the territories’ situation if GILTI changes are in the budget deal, it would not alleviate his other concerns with the potential package.

“For me, it’s about the people of Puerto Rico and the rest of the territories,” he said.

Lindsey McPherson, Lauren Clason and David Lerman contributed to this report.