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Puerto Rico Tax Law Update - September 2016

January 13, 2017

Puerto Rico originally enacted an Alternative Minimum Tax (AMT) regime to prevent multistate corporations doing business in Puerto Rico from shifting profits out of Puerto Rico via the purchase of goods and services from related US mainland affiliates at artificially inflated prices. As part of the AMT, a 2 percent flat tax was imposed on interstate transfers of tangible property between related companies or different offices of the same company. The AMT also included a 20 percent flat tax on expenses for interstate services between those entities.

In May 2015, in response to its fiscal crisis, Puerto Rico enacted a new tax law (Act 72-2015) which introduced modifications to the AMT regime, including an increase of the corporate AMT rate on intercompany purchases. The amended AMT increased AMT's tangible-property tax rate from 2 percent to 6.5 percent. The amendments also eliminated a provision that had exempted a tangible-property transfer from the tax if the transfer price was proved to be an arm's length price.

The US District Court for the District of Puerto Rico declared these AMT changes unconstitutional and issued an injunction immediately prohibiting Puerto Rico from levying, collecting or enforcing this portion of the AMT regime. Puerto Rico’s Treasury Department promptly appealed the decision. In a recent ruling, the US Court of Appeals for the First Circuit has affirmed the District Court opinion invalidating Puerto Rico's corporate alternative minimum tax (AMT).

Basis for US Appeals Court Ruling
The US Court of Appeals concluded that the Court had jurisdiction for the present pre-payment proceeding because Puerto Rico's tax-refund process could not be counted on to provide the taxpayer with speedy and efficient remedy for the payment of an invalidated tax, given Puerto Rico's insolvency and legislative and regulatory changes.

The US Court of Appeals also concluded that the AMT violated the dormant Commerce Clause of the US Constitution, which precludes US states from discriminating between transactions on the basis of some interstate element, i.e. a US state may not tax a transaction or incident more heavily when it crosses a US state line than when it occurs entirely within the US state. The US Court of Appeals noted that the dormant Commerce Clause applies to Puerto Rico in the same way that it applies to the US states. The Circuit Court stated that the AMT was facially discriminatory because it taxed only cross-border transactions between a Puerto Rico corporate taxpayer and a home office or related entity outside of Puerto Rico.

Finally, the US Court of Appeals concluded that the AMT did not meet the heightened level of scrutiny required to survive under the dormant Commerce Clause because Puerto Rico's Treasury Department failed to show that there was no other means to advance the legitimate local purpose of targeting profit-shifting. The US Court of Appeals identified narrower alternatives, such as a unitary tax system that uses a formula to distribute multistate corporations' income to different jurisdictions and a traditional transfer-pricing audit of interstate transactions between related parties under the existing regulations.

The US Court of Appeals accordingly affirmed the decision of the US District Court and continued the injunction against enforcement of the Puerto Rico AMT against the taxpayer. 

Recommendation
Taxpayers subject to the AMT on intercompany/branch charges and intercompany purchases related to operations in Puerto Rico should determine if they need to account for the invalidated AMT provisions in determining their taxable income. A similar determination should be made with respect to the calculation of estimated tax payments for the taxable year 2016.