Section 936 of the U.S. Internal Revenue Code (IRC) is widely believed to have been the driving force behind the phenomenal growth of U.S.-based manufacturing companies establishing and operating in the U.S. Commonwealth of Puerto Rico.
The primary financial benefit offered to U.S.-based companies under Section 936 was the ability to repatriate Puerto Rico source income free of U.S. federal taxes. In other words, you could bring money earned in Puerto Rico back to operations in the US mainland with no tax penalty.....Absolutely, incredible.
Then, in the Clinton Presidential years in 1996, Section 936 was considered precisely what it is...corporate welfare. Thus, the economic stimulus legislation passed by the U.S. Congress that year precluded any companies not already operating under Section 936 from doing so, and also instituted a 10-year phase-out for existing Section 936 companies.
The phase-out of this investment incentive was widely forecast to be the death of manufacturing in Puerto Rico. However, this didn't happen. Manufacturing in Puerto Rico continued to flourish
One reason for this continued manufacturing growth in Puerto Rico is that although Section 936 was sunseted, another section of the Internal Revenue Code found new life.....the section concerning Controlled Foreign Corporations (CFCs). The section on CFCs had been part of the tax code for years, but the benefits under Section 936 were so good that many tax professionals simply ignored CFCs.
While Puerto Rico is part of the U.S. (as a commonwealth), it is outside the federal income tax jurisdiction. Companies in Puerto Rico can qualify as CFCs and enjoy the same legal protections as those on the U.S. mainland, while at the same time having their profits deferred from U.S. federal taxes until repatriated to the parent company. Also, manufacturing and export service entities on the island pay a maximum income tax of only 7%.
Those Puerto Rico earnings taxed at such low rates, will ultimately be taxed at the U.S. federal level when repatriated to the U.S., but the company can choose the most tax-advantageous time to bring it home. Most, if not all Section 936 companies operating in Puerto Rico have converted to CFCs.
This is why US multinational corps operating in Puerto Rico are lobbying so hard for a foreign earnings repatriation tax holiday in the US. They got one in 2004, and would really like to have another one.
My recommendation would be for the US Government to disallow deferral of earnings of Puerto Rico Controlled Foreign Corps.
Also, the US Government should give due consideration to this incredible CFC corporate tax loophole in deciding how to wisely implement a foreign earnings repatriation initiative.
