Tuesday, April 05, 2005

Outsourcing & layoffs

Received the news today that ~4% of the company will be laid off due to outsourcing to Puerto Rico. Was curious about the tax advantages of locating in Puerto Rico so looked up a very nice update from the Puerto Rico Herald:

Congressional Advisors: Exempt "Foreign" Dividends from Income Tax

The staff of the Congress’ Joint Committee on Taxation Thursday recommended exempting dividends earned by "foreign" subsidiaries of U.S. companies from income taxation.

The proposal could have major implications for Puerto Rico’s economy and its future political status. Forty-two percent of the economy is attributable to manufacturing by operations of companies based in the States. Most of the operations are, or are planning to be, organized as foreign subsidiaries.

The recommendation came in a package of options, others of which would also have substantial implications for Puerto Rico’s economy. The Joint Tax Committee staff act as advisors to the congressional committees that determine taxes, the House of Representatives Ways and Means Committee and the Senate Finance Committee.

Earnings from "foreign" subsidiaries -- including those in Puerto Rico and other U.S. territories -- are currently subject to U.S. income tax when "repatriated" to parent companies. Until then, income tax is "deferred."

The recommendation to exempt foreign dividends from the income tax did not note that income from Puerto Rico and other U.S. territories is considered to be "foreign." If the proposal is applied to income from Puerto Rico -- as it would be under current law, in addition to economically affecting companies operating or locating in the territory, it could be used as an argument in the debate over Puerto Rico’s status as a U.S. territory.

At the same time, by applying to dividends from foreign countries, the proposal would not provide Puerto Rico with a competitive advantage over foreign countries as a location for subsidiaries. Many foreign countries offer companies lower labor and other costs of doing business. They have posed increased competition to Puerto Rico as a location for manufacturing as the U.S. has lowered or eliminated tariffs on their products.

The exemption would not apply to income from: "passive" investments, such as interest from bank deposits; royalties subsidiaries pay parent companies for assets such as patents; and intra-company sales. It would also be accompanied by tightened rules on shifting of income from taxed U.S. companies to untaxed foreign subsidiaries. These limitations would also likely affect companies in Puerto Rico which have used such devices to avoid U.S. income tax.

The proposal would go beyond a one-time, one-year 85 percent cut in taxes on income that companies in the States receive from "foreign" subsidiaries enacted into law last year. That tax cut is expected to encourage companies to repatriate hundreds of billions of dollars of income, including income from Puerto Rico.

The new proposal would tax some companies more and some companies less. Overall, it would increase domestic income, which would be taxed. It was estimated that the proposal would generate $54.8 billion for the federal treasury, including $2.7 billion next year and $5.3 billion in 2007.

Manufacturers that have operated in Puerto Rico since 1996 and have not become foreign subsidiaries currently enjoy one of two expiring tax advantages over manufacturers in the States as well as foreign countries. One that engendered overwhelming opposition in the federal government, provided by Internal Revenue Code (IRC) Section 936, exempts 40 percent of income attributed to Puerto Rico from the income tax.

The other advantage, provided by IRC Sec. 30A, gives companies a tax credit for wages, investments in plants and equipment, and local taxes in Puerto Rico. Both advantages expire this year, although there have been proposals to extend Sec. 30A for a few more years.

Puerto Rico’s last governor, Sila Calderon proposed tax exemption for earnings that "foreign" subsidiaries in U.S. territories -- but not foreign countries -- "repatriated" to their parent companies in the States. One goal was to provide Puerto Rico with a competitive advantage as a location for manufacturing over foreign countries. But the proposal was rejected by the federal government for reasons that included the fact that the proposal would also have given Puerto Rico a substantial advantage over the States.

Puerto Rico’s Resident Commissioner in the States, Luis Fortuno has proposed that Sec. 30A be extended for a few years and that tax benefits for underdeveloped areas of the States be extended to Puerto Rico.

Another Joint Tax Committee staff proposal Thursday that could affect Puerto Rico would consider companies to be U.S. or "foreign" depending upon where their active management is conducted. Currently, businesses avoid income taxation by establishing "shell" corporations in foreign locations, especially foreign tax havens that impose no or few taxes and, sometimes, allow companies to hide information from U.S. tax authorities. The shell corporations primarily exist on paper with all real operations conducted in the States.

According to a tax expert, most if not all of the foreign manufacturing subsidiaries in Puerto Rico have been organized in foreign tax havens so that companies can avoid Puerto Rico income tax as well as defer payment of U.S. income tax.

Here is another article on the tax code including this item:

Certain industrial projects that are considered as core pioneer industrial activities by PRIDCO could be eligible for a corporate income tax rate ranging from 2% to 0%. Core pioneer industries are those that employ innovative technology never used in Puerto Rico before January 1, 2000.

Hmmm. I guess we could argue that we are a core pioneer. Not a bad tax rate.

Not very comforting information. Of course what's a bit odd is that the 4% laid off are having their jobs outsourced to Chicago & not Puerto Rico.


Some folks of course fear the worst - that the entire plant will be shut down. I can't see that anytime soon - we still generate revenue, though no income - but I'm not going to find out any answers from "all hands meetings" that don't allow Q&A.

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