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Executive Summary

The treatment of dividends from Puerto Rican earnings to U.S. parent companies under the minimum corporate tax provisions of the Senate Finance Cmte. tax reform bill may reduce the benefits of the Sec. 936 tax credits. While Sec. 936 benefits per se have emerged relatively unscathed from the tax code rewrite, the inclusion of dividends from Puerto Rican subsidiaries into a corporation's minimum tax liability could have the practical effect for some companies of taxing sheltered island earnings. The loophole in Sen. Packwood's (R-Ore.) tax reform bill weakens what had been perceived as a victory for the drug industry and for other companies making use of Sec. 936 tax credits. Rather than jeopardize what is otherwise a favorable piece of legislation for the drug industry, the Sec. 936 lobby will probably bring up the minimum tax issue in conference cmte. after the bill passes the Senate. The full Senate began consideration of the bill on June 4. Senate Majority Leader Robert Dole (R-Kansas) has said publicly that he would like to have the work on the bill finished by the time Congress recesses Aug. 15. Dole's plan is to have the tax reform legislation, the Administration's top priority item for this Congress, on the President's desk for signing by Labor Day. Under the stricter minimum corporate tax provisions in the Packwood tax plan, corporations must figure out both a regular tax liability, based on the 33% effective corporate tax rate in the bill and any preferences taken by the filing company, and an alternative minimum tax. If a company's alternative minimum tax liability is higher than its regular liability, the filing company would be required under the new tax plan to pay the amount of the alternative minimum tax. The cmte. report specifically excludes Sec. 936 corporations from the computation of the alternative minimum tax. "The alternative minimum tax does not apply to any corporation that validly elects the application of Sec. 936," the cmte. reports states. "Thus, a Sec. 936 corporation is exempt from the alternative minimum tax, even to the extent that it has preference income that is not qualified possession source income." In addition, income retained by a possessions corporation is exempt from the minimum tax provisions in the Senate tax plan. However, dividends to the U.S. parent company from Puerto Rico subsidiaries would be included in the computation of net book income under the tax plan now on the Senate floor. The cmte. report notes that a "taxpayer is required to record as an item of book net income the amount of any actual or deemed distribution (as measured for tax purposes) from another corporation if the other corporation is not included in the taxpayer's consolidated group for the year." Under the Senate plan, a company's minimum tax liability is computed by finding the median point between an alternative minimum taxable income figure -- based on the taxable income figure in the company's filing with IRS increased by the taxpayer's tax preferences for the year and adjusted by computing certain deductions to negate acceleration of those deductions -- and a company's net book income, generally reported as the pretax income figure in a company's financial statement to the Securities & Exchange Commission. The median point between the alternative minimum tax figure and the net book income figure is then used as the tax base to compute the minimum tax liability using a tax rate of 20%. Explaining its reasons for including financial reports to shareholders in computing the minimum tax, the cmte. contended that a minimum tax will be fair only when "there is a certainty that whenever a company publicly reports substantial earnings . . . that company will pay some tax." Aside from the minimum tax provision, the Sec. 936 provisions in Packwood's tax plan are unchanged from the House bill ("The Pink Sheet" May 19, p. 5). Generally, the passive income limitation would be reduced from 35% to 25%; the cost-sharing payment under that method of accounting Sec. 936 tax credits would be increased by 10%; and the R&D expense allocated to a possessions corporation in computing the tax credit under the profit-split method would be increased by 20% as a way of concurrently raising a company's tax liability from either method by 10%.

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