hen Puerto Rico’s Law 154 was enacted by Gov. Luis Fortuño’s government in October 2010, one anonymous pharmaceutical executive called its excise tax “the last nail in the coffin” for his industry’s investment on the island.
But in this era of vampires and zombies, coffins aren’t as final as they used to be.
At least that’s what some Puerto Rico leaders hope, as their island emerges from an election that saw voters elect a new governor by the slimmest of margins (over the pro-statehood Gov. Fortuño), yet also vote for statehood in a plebiscite on the same ballot.
One glimmer of that hope comes courtesy of the Internal Revenue Service, which, pending resolution of some questions, considers the island’s new excise tax as fundamentally a replacement tax for the generally imposed income tax, and therefore eligible for a foreign tax credit for amounts paid.
Another comes straight from the lips of Governor-elect Alejandro Garcia Padilla, says Roberto Monserrate, vice president of legal and legislative affairs for the Puerto Rico Manufacturers Association, who heard Garcia Padilla address the island’s pharmaceutical industry association convention earlier this week.
“He was keen to emphasize that he will make sure that companies start believing again,” says Monserrate by phone. “He said ‘I want to bring back confidence in Puerto Rico, and in the Puerto Rico tax system.’ And he said he would do anything and everything to make sure that the tax laws could not be changed as easily. He said that several times, and I think that’s a good message to send out, and exactly what we need. What’s done is done, but we can certainly learn from what’s happened, and bring back confidence to investors.”
The governor-elect has also pledged to stand behind a previously-agreed-to US$2.5-billion public private partnership agreement to privatize Luis Muñoz Marín International Airport.
It’s not as if the island were moribund: Bristol-Myers Squibb recently announced a 100-job expansion, and new incentives are encouraging investment in renewable energy projects and film projects. But the life sciences momentum of the 1990s and early 2000s is, if not a fond memory, then at least a fading one.
Monserrate says Law 154 has been “a major concern when trying to attract additional multinational companies or making sure we have expansions. It’s still a big issue. Some of the companies have told us they’re not beginning to forget Law 154 yet. When investors lose confidence, this is what happens. You have to prove to them that they can believe in you again. One of he most damaging parts of that law was it was enacted ‘over the weekend’ without due legislative process. That’s what companies want — a chance to talk about it. The fact they were not given the chance was probably the most damaging.”
Figures and Fortunes
According to Commonwealth of Puerto Rico financial information and operating data released in June, “the increase in General Fund total revenues for fiscal year 2011, compared to fiscal year 2010, were mainly due to an increase of $170.1 million in tax withholdings from non-residents and the collection of $677.6 million as a result of the new temporary excise tax and the expansion of the taxation of certain foreign persons adopted as Act No. 154 … which the Government began collecting in February 2011.”
For fiscal year 2011 (from February 2011 through June 2011), the collections from the excise tax were $677.6 million. For the first nine months of fiscal year 2012, says the document, the collections from the excise tax were $1.379 billion.
Though some of the new taxes are offset by gradual cuts in corporate and individual income tax rates, the figures associated with the excise tax are large. Elsewhere in the June document, the government estimates that “this excise tax will affect foreign corporations or partnerships that are principally engaged in the manufacturing of pharmaceuticals and electronics. The Government expected to raise approximately $1.4 billion from the excise tax during the first year of implementation of Act 154 and expects to raise $5.6 billion for the six-year period that the excise tax is in place.”
Monserrate says it will take time to make amends. But meanwhile, despite the work accomplished by Fortuño in reining in fiscal profligacy, the ratings agencies now are threatening to downgrade Puerto Rican bonds to junk status. The Government Development Bank for Puerto Rico on Nov. 8 released net revenue figures that showed September general fund net revenue figures to be down by $58 million to a total of $612 million from Sept. 2011.
Fortuño was considered the pro-business candidate. The first Republican governor of Puerto Rico in 35 years, he cut government jobs and corporate and income tax rates significantly, and got unemployment down from 16.4 percent three years ago to under 14 percent. But analysts have said fundamental challenges in the island’s economy — perhaps led by its overweening dependence on the U.S. mainland — have kept unemployment (13.6 percent in September) and poverty rates higher than they should be.
Essentially, all those laid-off government employees didn’t have enough private-sector job opportunities to turn to. And according to recent reports by The Wall Street Journal and the Wharton School, the labor non-participation rate — those who’ve given up trying to get a job — is well above the U.S. average, at 60 percent.
Some circumstances have been beyond government’s control, however: In 2006, Section 936 of the IRS code, which had allowed big pharma and other multinationals tax-free income, was phased out. Then, even as Puerto Rico was dealing with increased competitiveness from other Latin American territories, the Great Recession struck. And pharma was suffering its own transformation in any case.
“It’s been a perfect storm for some multinationals, with patent expirations, and not enough new approved drugs in the pipeline,” says Monserrate. “Then there are issues of logistics, and how to get more production through the Asian countries. And there have been acquisitions and mergers. All of that has an effect on production.
“It is a very complex situation in terms of attracting new investment everywhere,” observes Monserrate. “There is a lot of competition around the world. It’s unfair to say that Law 154 is the only reason we haven’t seen a lot of major companies come to Puerto Rico. But it would not be far-fetched to say it’s one of the things that contribute to the fact we have not had a lot of newcomers.”
The excise tax, which starts at 4 percent, goes to zero in 2016. Monserrate says companies are still doing their numbers to project tax implications after that year. Some, he says, might have a liability of more than 4 percent. “That, again, is a complex calculation,” he says. “Every single company will have a different set of values.” And even if the IRS ruling seems favorable to some firms, it certainly doesn’t apply to European companies. “Many companies could use that,” he says, “but a lot of them couldn’t.”
Despite it all, however, biopharma in Puerto Rico remains a $10-billion business.
“It’s a world-class representation,” says Monserrate. “By no means do we think it’s the end of multinationals. Some are still investing in Puerto Rico. I‘m positive we’ll get more and more of that as we can prove to the companies that Puerto Rico is a serious competitor in terms of manufacturing, and we want to remain that way.”
Monserrate thinks such measures as Law 154 may have contributed to the election results, which saw Garcia Padilla win by a mere 16,000 votes out of approximately 1.6 million ballots cast. At the same time, statehood proponent Pedro Pierluisi, Puerto Rico’s Resident Commissioner to the U.S. Congress (with a seat but no vote) won re-election.
“He has been adamant in saying we need more incentives for manufacturing in Puerto Rico,” says Monserrate of Pierluisi. “He’s pro-statehood, from the New Progressive Party. He’s said when that comes, we’ll deal with it. But in the meantime we need to do many things — we’re still in a recession, and manufacturing is one of the ways we should get out of it.”
Last year Pierluisi presented the Puerto Rico Investment Promotion Act (PRIPA) of 2011 (H.R. 3020). Section 933A of that bill would authorize, but not require, Puerto Rico corporations that earn at least 50 percent of their income on the island to choose to become domestic U.S. companies.
Then there was the plebiscite. A U.S. territory since 1898, Puerto Rico is now home to 3.7 million U.S. citizens who cannot vote for president, are not represented in the Senate, and elect one non-voting member to the House. As Puerto Rico law experts at McConnell Valdés documented in a Nov. 13 memo, “In the first referendum question, 54 percent of all voters expressed that they did not want to remain under the ‘current territorial political relationship’ with the United States. With regards to the status options question, Statehood was able to garner 809,652 votes, Sovereign Commonwealth obtained 441,505 votes, Independence 73,362 votes, while 472,674 ballots were left blank for this question.”
Like the path back to trustworthiness among corporations, a switch to statehood will not happen fast, says Monserrate.
“It will take a transition time,” he says. “All of the tax issues would have to be dealt with in that transition state — for instance, right now we don’t pay federal taxes. Life as we know it would have to be transitioned. It’s a complex issue, and the Congress has to accept it. So that’s a big step, and we know it’s not going to happen overnight.”