Walmart and Puerto Rico

By: David J. Herzig

Everyone knows by now the dire financial problems facing Puerto Rico.  (My co-blogger Shu-Yi Oei wrote about the default in Surly here.)  In order to generate liquidity to pay debt and run government operations, Puerto Rico began to look to the deepest pockets for help.  If you are looking for a deep pocket, look no further than Walmart.  The question facing Puerto Rico was how to get more money out of Walmart without actually targeting the corporation (that would be unconstitutional.)

The territory, instead, tinkered with an old law to created a tax hikes which on the face seemed neutral.  However, the law, according to Walmart, targeted primarily the large retail corporation. The after-tax effect of the corporate alternative minimum tax change was to raise Walmart’s Puerto Rican tax liability to over 90% of its income.

How did we get here? Last year, Puerto Rico enacted Act 72-2015 (Act 72) into law. The key component of the act was an increase in the Tangible Property Component (TPC) of the corporate AMT.  According to prior reporting, “The TPC piece of the AMT imposes a tax on the value of property transferred to an entity doing business in Puerto Rico from a related party outside of Puerto Rico.”

Then last December, Walmart filed suit styled, Wal-Mart Puerto Rico Inc. v. Zaragoza-Gomez, 15-cv-3018, U.S. District Court, District of Puerto Rico (San Juan) challenging Act 72.  According to Walmart, the tax was unconstitutional violating the commerce clause.  Moreover, the new tax raised the company’s estimated income tax to “an astonishing and unsustainable 91.5% of its net income.”

In March of 2016, the District Court agreed with Walmart and in a 109 page opinion stated, “Puerto Rico’s AMT, on its face, clearly discriminates against interstate commerce.”  Part of the story told by bond holders, is that in the course of the trial, it came to light the government of Puerto Rico might have been misleading their bond holders and this law was a kind of hail-mary.  Per the UBS report, “In the course of the trial, senior officials of the García administration were obliged to provide sworn testimony. Judge Fusté’s subsequent written opinion provided information that had been either knowingly or inadvertently withheld from investors by the Government Development Bank.”  So, yes, the tax was targeted at Walmart.  Also, the government of Puerto Rico was also not disclosing to its bond holders the true economic conditions.

Late last week, the 1st Circuit agreed with the District Court.   The 1st Circuit concluded, “As to the merits of the Commerce Clause challenge, the AMT is a facially discriminatory statute that does not meet the heightened level of scrutiny required to survive under the dormant Commerce Clause.”

Continue reading “Walmart and Puerto Rico”

Church or Family Business? Puerto Rico Wants to Know

By: Sam BrunsonHacienda

On Friday, Shu-Yi posted an overview of Puerto Rico’s financial problems, and described the centrality of the island’s tax regime to those problems. Today, I’m going to dig into one particular aspect of Puerto Rican taxation: tax-exempt churches.

Last year, the Puerto Rican Treasury department launched an ambitious pilot program[fn1] under which it planned on auditing more than 40 tax-exempt organizations. Juan Zaragoza, Puerto Rico’s Secretary of Treasury, announced that this month the program moves to Phase 3: auditing churches.

As in the U.S., the Puerto Rican tax law exempts some nonprofit organizations from tax. Puerto Rican tax law explicitly exempts

Churches, church conventions or associations, as well as religious and apostolic organizations, including corporations and any community chest, fund, or foundation, organized and operated exclusively for religious purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.[fn2]

Some tax-exempt churches, Zaragoza asserted, aren’t really churches, but rather family businesses. They make annual profits, just like a shoe store (and yes, his example was a shoe store), but, because they claim to be tax-exempt churches, they don’t pay taxes on their profits. Continue reading “Church or Family Business? Puerto Rico Wants to Know”

Tax Policy and Puerto Rico’s Fiscal Crisis: An Insolvency Primer and Some Tax Things to Read

By: Shu-Yi Oei

I’ve been following the story of Puerto Rico’s default on its public corporation debt repayment obligations, which has been unfolding over the last several months. The latest happened on Monday, May 2 (well, technically Sunday), when Puerto Rico missed a major debt payment that was due to the bondholders of its Government Development Bank (GDB).

The topic has been well covered from the sovereign debt/insolvency angle over on Credit Slips, so I won’t go into that in detail here. As I understand it, the main points are these:

(1) Puerto Rico owes around $70 billion total outstanding debt to its creditors, of which a significant chunk is public corporation debt. Public corporations are corporations owned by the government of Puerto Rico. For example, the GDB is a public corporation.

(2) Unlike U.S. municipalities such as Detroit, Puerto Rico entities aren’t considered debtors for purposes of Chapter 9 of the U.S. Bankruptcy Code. They therefore don’t have access to the Chapter 9 municipal bankruptcy process. See 11 U.S.C. § 101(52). This is a bit of a head scratcher.

(3) In 2014, Puerto Rico’s legislature passed a law, the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which created a mechanism analogous to Chapter 9 bankruptcy by which Puerto Rico public corporations can restructure their debt. See Puerto Rico Passes New Municipal Reorganization Act: Puerto Rico Public Corporation Debt Enforcement and Recovery Act, 2014 P.R. Laws Act. No. 71, 128 Harv. L. Rev. 1320 (2015).

(4) Some bondholders filed a lawsuit, contending that Chapter 9 of the U.S. Bankruptcy Code preempts the Recovery Act. The First Circuit ruled that the Recovery Act is preempted. Franklin California Tax-Free Trust v. Puerto Rico, 805 F.3d 322 (1st Cir. 2015). The Supreme Court granted cert and heard oral arguments on March 22, 2016. No decision yet. For one scholar’s take on the issue, see Stephen J. Lubben, Puerto Rico and the Bankruptcy Clause, 88 Am. Bankr. L.J. 553 (2014).

(5) In light of all this, some have called for U.S. Congressional action, and there’s been legislation drafted to address Puerto Rico’s fiscal crisis that will allow for both restructuring and reform going forward. The House Committee on Natural Resources put forth a draft bill, the Puerto Rico Oversight, Management & Economic Stability Act (“PROMESA”). See also here for a helpful executive summary that accompanied an earlier draft. So far, that legislation has stalled, but they’re still trying.

There are many important issues in play, about which various stakeholders and commentators disagree. Some big ones are: (a) whether the draft PROMESA legislation raises retroactivity issues that make it unfair to bondholders (including mutual funds and their investors) who may be subject to restructuring ex post without having had notice of that possibility ex ante; (b) relatedly, whether creating a bankruptcy-like restructuring process for Puerto Rico is bad for bondholders because it prevents holdout creditors from holding up restructuring negotiations, (c) how much oversight and sovereignty Puerto Rico should cede (for example, different stakeholders feel differently about the installation of an oversight board); (d) the extent to which austerity measures are feasible and should be imposed [fn1], and (d) and what substantive reforms should be put enacted going forward.

So where does tax come in?

Continue reading “Tax Policy and Puerto Rico’s Fiscal Crisis: An Insolvency Primer and Some Tax Things to Read”