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SECTION 936 COST-SHARING MEHTOD FOR ALLOCATING INTANGIBLES TO PUERTO RICAN SUBSIDIARIES WOULD BE ELIMINATED UNDER REP. ROSTENKOWSKI TAX PROPOSAL

Executive Summary

The Section 936 cost-sharing option for allocating income derived from intangible property transferred to a Puerto Rican subsidiary would be eliminated under a tax plan proposed by House Ways & Means Cmte. Chairman Rostenkowski (D-Ill.) Sept. 26. According to a summary of the Rostenkowski plan, prepared by the staff of the Joint Cmte. on Taxation and released Sept. 26, the possessions tax credit provision currently in place under Section 936 would be retained "with certain modifications. With respect to income generated from intangibles transferred to the possessions, the optional cost-sharing method of allocating intangible income would be repealed." The summary adds that "the credit allocable to passive income of the corporation would be limited to one-half of the U.S. tax on such income." The Rostenkowski proposal takes a middle ground with respect to Section 936 between the positions of the drug industry and the Puerto Rican govt. on one side and the Reagan Administration on the other. Industry has lobbied hard for retention of Section 936 in its present form, while the Administration, in a tax revision plan drawn up earlier this year, proposed a wage-based tax credit as an alternative to the present system. The Ways & Means staff summary notes that the "wage credit proposed by the President would not be adopted." Under the cost-sharing option currently open to Section 936 companies, part of the R&D costs for a class of related products manufactured in Puerto Rico can be charged against island operations. The cost-sharing method is one of two options by which companies can derive tax credits by assigning the rights to manufacturing intangibles such as patents, processes, and know-how to their Puerto Rican subsidiaries. lf the Rostenkowski tax plan is adopted, the calculation of tax credits based on allocation of intangible property to Puerto Rican subsidiaries would be done under the second current option, a profit split method. Under that option, a 50%-50% profit split on worldwide sales to third parties or foreign affiliates would be the basis for tax calculations. The calculations would be done on a product-by-product basis. In comments on the Rostenkowski plan, PMA said: "We were encouraged by the Joint Cmte. staff's rejection of the Treasury proposal to phase out Section 936 of the tax code. We remain convinced, however, that the best interests of the people of Puerto Rico, the Caribbean region, and the mfrs. who build and operate plants there would be served by retaining 936 in its present form. We will continue to work with the Ways & Means Cmte. to make our views known."

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