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'Backdoor bailout' boosts Puerto Rico's revenues

Monday, 10 Feb 2014 | 4:50 PM ET

WASHINGTON, Feb 10 (Reuters) - The second-largest revenue source for Puerto Rico last month was an excise tax that has been labeled a "backdoor bailout" for the struggling territory, preliminary estimates released on Monday showed.

The federal government has stated repeatedly that it will not come to the rescue of the territory, whose credit rating was cut to junk last week by two of the three major rating agencies. But the island has few financial life preservers left as its population declines and its bills mount.

Puerto Rico brought in $142.5 million last month through the excise tax, representing more than 20 percent of the territory's $664 million general fund revenues in January. Only individual income tax collections were greater, at $175.3 million, according to the territory's preliminary revenue report.

The excise tax is levied on multinational manufacturers doing business in Puerto Rico, primarily pharmaceutical and medical device companies such as Johnson & Johnson and Pfizer, according to Martin Sullivan, chief economist for the publication Tax Analysts.

Under a reform plan enacted in 2011, some corporations can take a credit on their federal taxes for the Puerto Rico tax, known as "Act 154." The Internal Revenue Service has said it will not challenge taxpayers taking the credit, which effectively created a federal subsidy for taxes paid to financially hobbled Puerto Rico.

For three years, the IRS and Treasury Department have been assessing the legality of the credit. The evaluations continue, a Treasury Spokesperson said on Monday, adding that any final decision will be "prospective." That means corporations will not have to pay retroactively for taking the credit if it is ultimately deemed unconstitutional.

"Until the IRS issues a ruling, Puerto Rico can collect the tax and companies can take the credit," said David Kotok, chief investment officer for Cumberland Advisors, calling the scheme a "backdoor bailout."

"Puerto Rico gets a transfer of a couple of billion a year below the radar," he said.

The territory expects to keep relying on Act 154 collections. It increased the tax's rate last year to 4 percent and also extended the tax through 2017.

Revenues from Act 154 will likely total $1.956 billion for the fiscal year that started in July, compared with $1.67 billion in fiscal 2013, according to a financial statement released in October.

Those totals are roughly equal to the interest costs on Puerto Rico's $70 billion in outstanding debt, said Kotok.

"Imagine what would happen if it didn't get the subsidy," he said, calling the arrangement uncertain. "How can you expect anyone to make an investment?"

For the first half of fiscal 2014, Act 154 provided $1.04 billion to Puerto Rico's treasury, close to the $1.054 billion that came from individuals and less than the $1.02 billion paid by corporations, according to Monday's report.

In November, Act 154 collections were the top revenue source, at $135.3 million, followed closely by individual income taxes of $132 million. In December they totaled $176.5 million, second only to corporate tax collections of $305.5 million.

"This look-the-other-way approach to the credit-ability of the tax may be questionable procedure and policy, but it has furthered the Obama administration's goal of maximizing assistance to Puerto Rico under current law," wrote Sullivan, who first highlighted the growth of Act 154 last month. "It is unlikely in these times of extremely tight budgets that the administration could obtain congressional approval for financial benefits of similar magnitude."