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Nov 10, 2010

Puerto Rico Blindsides Manufacturers

Industry is lobbying against new tax rules, expected to raise $6 billion over six years.

Puerto Rico Blindsides Manufacturers

Kheng Guan Toh - Fotolia.com

  • Puerto Rico is losing its biopharma-friendly environment. When the government of Puerto Rico passed Law 154 on October 25, imposing a 4% tax on companies that manufacture on the island but are headquartered elsewhere, it came like a thief in the night. The bill was written, introduced, and passed in 72 hours, without public comment. That, in fact, is what worries the biopharma industry most.

    Lilly’s statement on the new law is plain-spoken:  “The manner in which this legislation was developed, considered, and approved is troubling. The legislation was passed without the benefit of hearings or analyses, and it does not consider the likely impact on the economy of Puerto Rico or U.S. companies doing business there. Given our long-standing relationship with Puerto Rico, the quick and secretive approach to approving this law is disappointing.”

  • Law 154

    The law takes effect January 1 and for the first year imposes a 4% tax on products produced in Puerto Rico by manufacturers located elsewhere. That tax rate declines to 3.75% in 2012, 2.75% in 2013, 2.5% in 2014, 2.25% in 2015, and 1% in 2016 before expiring at the end of 2016. It affects manufacturers with $75 million or more in gross receipts from products being shipped from the Commonwealth.

    Law 154 is an amendment to the Internal Revenue Code of 1994. It was passed “to benefit the workers and employees and to do the work of social justice that the people entrusted to us,” according to Senate president Thomas Rivera Schatz. Likewise, Senator Migdalia Padilla, president of the Senate treasury committee, remarked that this bill “fulfills the promise of tax justice for all Puerto Ricans,” calling the tax “fundamental to the economic future of Puerto Rico.”

    The intent was to close loopholes in the tax code involving local affiliated corporations. Senators in the minority Popular Democratic Party say, however, that the legislation is plagued by errors and faulty assumptions. As Lilly wrote, “While the government of Puerto Rico believes the tax can be addressed through U.S. foreign tax credits, the legislation erroneously assumes all sales from Puerto Rican operations come into the U.S. It also wrongly assumes that companies can fully utilize the incremental paid foreign taxes as credits.”

  • Repercussions

    BIO’s Patrick Kelly, vp of state government relations, estimates the tax will raise approximately $6 billion from the biotech companies with major manufacturing operations on the island during the six years it is in force. “It’s a significant tax, and an unforeseen business expense.” It is particularly troubling because “it came out of the blue,” Kelly remarked to GEN.

    “We have no idea where Puerto Rico stands regarding the industry. If this can be done, it doesn’t bode well,” he stressed. Once companies assess the situation, they may conclude that there are too many unknowns and that the business climate is too risky for continued investment in Puerto Rico.

    One year ago Governor Luis Fortuño flew to New York in the wake of the Pfizer/Wyeth merger to attempt to mitigate the effects of that merger on local pharmaceutical jobs. One year later Law 154 passed, calling into question the future of what has been a mutually beneficial relationship between Puerto Rico and the biopharmaceutical industry. “This new tax will be overly burdensome for U.S. companies doing business in Puerto Rico, putting jobs at risk,” Lilly noted.

    For Puerto Rico, the consequences could be severe. In a letter to the governor dated the day before the law was passed, John Murphy III, director of state government relations for BIO, wrote, “These proposed taxes…will not only ensure that Puerto Rico’s ability to attract new business investment will be constrained, but they will also lead to decreased innovation in the established Puerto Rico life sciences sector and possibly even the migration of high-quality and high-wage jobs out of the area.”

    The U.S. Chamber of Commerce, writing its counterpart in Puerto Rico, stated, “A strong incentive is created for foreign companies to look elsewhere for their biomanufacturing and distribution. This new tax increase will profoundly affect the decision-making of foreign corporations as they consider whether to continue to do business and deploy their capital in Puerto Rico.

    “An ad hoc tax passed without notice, after the start of the fiscal year, which takes effect in less than three months, will wreak havoc on the business and tax planning of companies in a time of increasing uncertainty in the global economy, creating a hostile tax environment in Puerto Rico. To say that this new tax increase is ill-timed is an understatement.”

    PhRMA was similarly concerned, noting that Law 154 will dramatically hinder (biopharmaceutical) companies’ positive efforts within Puerto Rico and could significantly reduce the ability of PhRMA’s members to operate in the Commonwealth.

    Lilly agreed. “This tax will likely affect our Puerto Rican operations.” Pfizer is more sanguine.  Although it foresees a negative financial effect, the company said that there will be no impact to its 2012 financial target of an approximately 30% effective tax rate on adjusted income as a result of this change.

    BIO’s Kelly told GEN, “The affect upon the industry may take several years to play out.” Companies may react, at least in the short run, by decreasing staffing or shifting some production volume to other facilities when practical. In the long term, it must cause corporations to reassess the relative risks and benefits of manufacturing in Puerto Rico. “Critical mass may leave the island,” Kelly speculated.

  • Local Perspective

    Amid the furor from the biopharmaceutical industry, Puerto Rico’s economic development officials at PRIDCO are puzzlingly quiet. However, Representative Antonio Silva (New Progressive Party), chair of the House Treasury Committee, was quoted in the Puerto Rico Daily Sun saying he could understand manufacturers’ concerns regarding the way in which Law 154 was passed. “But those industrialists are the same ones who took away more than $60 million in incentives last year.”

    Meanwhile, there is a bill in the legislature to make the island a medical tourist destination. Legislators also are pushing forward forms that streamline the tax code, eliminate many deductions, and reduce the personal income tax rates. Puerto Rico Chamber of Commerce president Roland Lopez, commenting on those proposed reforms in the same Puerto Rico Daily Sun article, remarked that the chamber had “no idea what would be the effect on job creation. We did not contemplate this in our study.” The recommendation to the legislature is that any future discussion of tax reform be open to scrutiny by all sectors involved, unlike the situation with Law 154.

  • Options

    Manufacturers began lobbying the government of Puerto Rico soon after the law passed. Options are to repeal the law or delay the implementation to allow manufacturers time to budget for the tax.

    Although the law sounds good for Puerto Rico from a revenue-generating standpoint, it’s possible that lawmakers will rethink this approach once they consider the long-term consequences of this measure. Another catalyst to repeal the law may come from Puerto Rico citizens themselves who fear the repercussions on their jobs. “We expect a groundswell of concern from employees,” Kelly remarked.


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