The Puerto Rico corporate tax question
The Government Accountability Office published a report estimating the economic advantages and costs Puerto Rico would have if it enters statehood. The biggest cost would be that Puerto Rico citizens would be required to pay federal income tax on their domestic earnings. Currently they pay federal income tax on income they earn outside of Puerto Rico.
The GAO estimates that If Puerto Rico had been a state in 2010, the estimated income tax paid by individual taxpayers would have ranged from $ 2.2 to $ 2.3 billion. The report also estimates changes in federal entitlement benefits that would flow to the island. In many cases there would be additional federal funds for the island.
The critical piece of the puzzle would be the change in income taxes for Puerto Rico corporations and subsidiaries of U.S. corporations that do business on the island. These corporations are a big contributor to Puerto Rico general fund revenues. Puerto Rico corporations are currently treated as foreign corporations under U.S. tax law. Here is what the report says (page 115):
Now, here is where Microsoft comes in:
Based in Humacao, Puerto Rico, Microsoft Operations Puerto Rico (MOPR) is responsible for producing all optical media sold by Microsoft in the Americas. This fast-growing complex has a complement of 250 employees and produces 250,000 disks a day.
El Nuevodia lays out what this means:
In 2012, the Senate Chairman of the Subcommittee on Investigations, Democrat Carl Levin (Michigan), presented a report stating that between 2009 and 2011, Microsoft was able to keep out of the hands of the U.S. Treasury about $21 billion by transferring certain property rights to their intellectual subsidiary in Puerto Rico.
The $21 billion, according to Levin, account for almost half of Microsoft sales revenue in the United States. Microsoft is then saved about $1.5 billion a year in sales taxes in the United States of products attributed to its subsidiary in Puerto Rico.
From Business Insider:
To review: An American buys a copy of Microsoft Office at Best Buy in Manhattan. Best Buy bought that copy of Office from a Microsoft distributor. The regional distributor bought that copy of Office from Microsoft Operations Puerto Rico. Microsoft Operations Puerto Rico is owned by MACS Holdings, which itself is owned by Round Island One, which itself is owned by Microsoft Corp.
The reason for that convoluted supply chain — the reason why that copy of Office wasn’t just shipped from Microsoft Corp in Redmond, Washington to Manhattan — is that 47 percent of the profits from that sale go to Puerto Rico, untaxed by the U.S. federal government.
Those profits were taxed by Puerto Rico at an effective rate of 1.02 percent in 2011, a massive savings from the U.S. corporate tax rate of 35 percent. Over three years, Microsoft saved $4.5 billion in taxes on goods sold in the U.S. alone. The company saved $4 million per day by routing domestic operations through Puerto Rico.
Microsoft is parking a lot of cash offshore, as detailed in its 2012 10K (page 36). It is unclear how much of it stayed in the Puerto Rico banking system:
Of the cash, cash equivalents, and short-term investments at June 30, 2012, approximately $54 billion was held by our foreign subsidiaries and would be subject to material repatriation tax effects.
It’s impossible to discern exactly how much Microsoft and other U.S.-based corporations are paying into Puerto Rico’s general fund, but the GAO report suggests what might happen if Puerto Rico is accepted for statehood and U.S. tax treatment would apply (page 115):
Essentially the U.S. Treasury is saying that if corporate tax treatment is equalized between Puerto Rico and the mainland, corporations would leave the commonwealth for lower tax jurisdictions. This is what happened when Congress ended the last round of tax preferences in 2006 and Puerto Rico began its eight-year recession.
In the two years that I have written about Puerto Rico I have stayed away from the statehood discussion. But with the new GAO report detailing how the revenues of Puerto Rico’s general fund could be altered by changes to the federal tax treatment of corporations, I’ll start paying attention. Puerto Rico bondholders should too.