Puerto Rico: Life after Section 936

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Until a few years ago, the little roadside 936 Pub & Grill was doing a brisk business, serving lunch and drinks at the nearby multinational pharmaceutical and garment factories lining Highway 2 on the northern coastal town of Manati in Puerto Rico. But today the joint has faded into history-along with Section 936 of the Internal Revenue Code, for which the place was named.

Under the terms of 936, US companies were exempt from paying federal income tax on profits earned by their Puerto Rican manufacturing subsidiaries. The idea was to generate year-round employment in Puerto Rico-and that it did. In the late 1980s, nearly 170,000 inhabitants of this US commonwealth had factory jobs, making everything from brassieres to birth-control pills.

In 1995, however, Congress approved a 10-year phase-out of the tax subsidy grandfathering companies already in Puerto Rico but denying the benefit to newcomers. The program will end completely on December 31 2005. Xavier Romeu, Puerto Rico's secretary of economic development and commerce, says that New Economy investments will take the place of Old Economy investments under 936. "Nothing has taken the place of 936, yet contrary to all the predictions that we were going to lose hundreds of thousands of jobs, the opposite has been true," he says. "We're experiencing another expansion in manufacturing, particularly in high-tech contract manufacturing and R&D:'

Romeu, who also oversees Puerto Rico Industrial Development Company (Pridco), points to the recent announcement by Hewlett-Packard that it will make a $100 million investment in a new R&D division in Aguadilla, as an example of the new trend in Puerto Rico high-tech investment.

"Federal tax incentives have very little to do with hightech operations nowadays. Most of these companies are profit centers; Romeu says. "Companies came to Puerto Rico because they were able to shield their profits through 936. But other considerations-such as location, labor costs, infrastructure, logistics, and training-have since become more important," he says.

Antonio J. Colorado Jr, the island's resident commissioner in Congress, is concerned, nonetheless. "This is a crisis as far as manufacturing is concerned. The only reason the companies that are here have stayed here is that they've changed to controlled foreign corporations [CFCs]," he says. CFC status is particularly attractive to drugmakers, since they generally have massive capital investments in Puerto Rico as well as other international operations. These companies can use untaxed Puerto Rico-generated earnings for investments at plants in countries outside the United States.

Still, President Clinton's recent signing into law of the new Caribbean Basin Trade Partnership Act could hurt Puerto Rico in the long run, particularly in low-wage sectors, such as mass apparel production and tuna canning, open to competition from neighboring countries with lower wage rates. But if Puerto Rico becomes a US state, treatment under such treaties would be moot.

Puerto Rico's perennial status debate is always an issue, and with gubernatorial elections in November, this year is no different. The latest polls give Carlos Pesquera of the pro-statehood New Progressive Party 40% of the vote, followed by 35% for Sila Calderon of the Popular Democratic Party, which favors continued Commonwealth status.

"Puerto Rico has tried to overcome all this by changing its investment law and making it more attractive, and that has been helpful in maintaining some employment," says Peter Holmes, executive director of the Puerto Rico-USA Foundation in Washington. "We're still work ing very closely with the govern ment of Puerto Rico to persuade Congress to reverse its attitude and at least continue wage credits beyond the 936 termination date of 2005; he says.

The wage credit is an issue of critical importance, says Holmes. In 1993 Congress enacted legislation that took the former income credit and set up a wage tax credit,known as 30A, which will remain at 60% until its scheduled demise in 2005. …