How tax reform affects Puerto Rico, explained

As of the passing of the Tax Cuts and Jobs Act by the Senate on Friday, December 5, major overhauls would be made to US taxation policies. Several of these are predicted to directly affect Puerto Rico’s economy, to an immediately negative effect.

Some sections of the bill will keep things the same as they have been throughout 2017 in Puerto Rico. Sections 4401 and 4402 of the bill provide for the laws on domestic production activities and extend tax cover over rum taxes, respectively. This is nothing new under the sun.

The great change that threatens to cause harm to Puerto Rico’s economy is Section 4403, which states that “under the provision, payments (other than interest) made by a US. corporation to a related foreign corporation that are deductible, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset would be subject to a 20 percent excise tax, unless the related foreign corporation elected to treat the payments as income effectively connected with the conduct of a U.S. trade or business.” Puerto Rico, for all American taxation purposes, would be treated as a foreign country.

Boiled down, what this means is that US-based companies making payments to Puerto Rico would need to accept a 20% tax to their payments, reducing the amount that the territory received, or the affiliated businesses in Puerto Rico would have to make its profits susceptible to all US tax laws. This is problematic because, due to its territory classification, there are many tax laws to which Puerto Rican businesses are exempt.

In the context of an already-depressed economy, this would most likely mean that the financial damages to Puerto Rico would be in the millions of dollars, resulting in the dropping of life expectancy, standard of living, and government programs. Lobbyists unveiled multiple plans to stop the Tax Cuts and Jobs Act, as well as to modify certain sections of the bill, but the ultimate outcome remains indeterminate; how much of this becomes part of a more permanent legislative culture in the US is still unclear.

One of the likely outcomes of Section 4303 having been passed within the Tax Cuts and Jobs Act is that companies will relocate their Puerto Rican branches to nearby, more financially viable locations. Those businesses which can either not afford to do this or are unwilling will be subject to increased taxations, making it more difficult for companies in Puerto Rico to exchange goods and services with those in the US. Though amendments are needed to the Tax Cuts and Jobs Act to mitigate these likely future damages, the prospect of changes being presented in the near future seems slim.