Puerto Rico to Lose Tax Advantages Under GOP Plan, Expert Says

(Bloomberg) -- The final version of the Republican tax plan would end some of the tax advantages companies with operations in Puerto Rico have long enjoyed, potentially delivering an economic blow to the territory still reeling from Hurricane Maria and a record setting bankruptcy, according to an expert who reviewed the plan Friday.

Gabriel Hernandez, the head of the tax division at BDO Puerto Rico, said that under the new rules subsidiaries of U.S. companies based on the island would be treated as foreign, subject to a tax from income derived from intangible assets held offshore. Although the final plan did not include the House’s proposed 20 percent excise tax, as many local officials feared, it still likely signaled sweeping changes for the commonwealth’s economy, he said.

"All planning related to Puerto Rico essentially has changed," Hernandez said in a telephone interview Friday evening. "It’s so complicated, it’s not even funny. And I’m a tax guy’

The treatment of Puerto Rico as a foreign jurisdiction undercuts the central platform of Governor Ricardo Rossello, who lobbied against that status this week in Washington. Rossello wants Puerto Rico to become a state -- the consideration of the island as foreign runs counter to his party’s main policy.

Hernandez, who has been a Puerto Rico tax expert for more than 25 years, said the plan released Friday seemed like deja vu for the embattled territory. In the nineties, Congress voted to end certain tax incentives then enjoyed by pharmaceutical and other companies with Puerto Rican manufacturing plants. When the rules lapsed completely in 2006, the island entered its years-long recession that culminated ultimately in its record-setting bankruptcy earlier this year. He said the changes released today could be as dramatic.

"That’s the feel, at least for me as a tax adviser," he said.

Still, he said, all was not lost as there may be mechanisms companies can use to rearrange their affairs.

"Whenever you have tax changes, businesses tend to reorganize and restructure. This will be no different," he said. "But I have to keep working. It will certainly be an interesting weekend."

After the incentives lapsed in 2006, many of the companies that kept operations in Puerto Rico reconfigured their businesses there as foreign subsidiaries, now in the cross hairs of the Republican plan. Until now, however, this was one of the island’s central draws for mainland firms. About a third of its output is powered by the pharmaceutical and medical device industry alone, which at present does not pay federal taxes on the income derived there as long as it’s kept offshore. In return, drugmakers have created thousands of high-paid, skilled jobs -- the types lawmakers claim the corporate tax cut will help create.

"At the end of the day, this bill is about creating American jobs and that’s what jobs in Puerto Rico are," said Carlos Mercader, executive director of the Puerto Rico Federal Affairs Administration, in an interview before the final version was released. Mercader, based in Washington, was a part of the Puerto Rico government’s talks with lawmakers.

Puerto Rico’s Treasury Secretary Raul Maldonado said earlier this month that the island could lose as much as a third of its revenues if the reform passed as then written, when the House’s excise proposal was still under consideration, and the large manufacturers were to leave. The local government has already said it doesn’t have the money to pay even a portion of the $74 billion it owes creditors, especially in light of the near $100 billion of damage caused by Hurricane Maria. Less revenues could complicate what is already one of the most complex bankruptcy cases in U.S. history and may mean bondholders would have to take even deeper losses.

Despite officials’ fears, no drugmaker has said it would leave the island if Puerto Rico were to lose some of its advantages and may be weighing an exit for other reasons. Many pharmaceutical factories were left to rely on temporary generators after Hurricane Maria wiped out the island’s electric grid, which the U.S. Army Corps of Engineers said wouldn’t be completely repaired until next May. The Food and Drug Administration raised concerns about potential drug shortages in the aftermath of the storm.

Taxes are "only one element in the analysis of doing business," said Ben Procer, a consultant with PricerwaterhouseCoopers. "It’s just one factor in the overall analysis."

--With assistance from Jared S. Hopkins

To contact the reporter on this story: Rebecca Spalding in New York at rspalding@bloomberg.net.

To contact the editors responsible for this story: Christopher Maloney at cmaloney16@bloomberg.net, William Selway

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