TheDC Exclusive: A secret $6 billion bailout for Puerto Rico?

The Obama administration is eying a secretive tax deal critics charge is an indirect bailout for Puerto Rico to the tune of billions of taxpayer dollars.

The U.S. territory, desperate for revenues in the midst of the recession, surprised industry with a $6 billion tax on foreign firms – including a significant bloc of U.S. pharmaceutical firms – late October in a rare weekend legislative session without any public debate in advance.

But now U.S. taxpayers, not the firms, could end up footing at least a significant chunk of the bill.

Gov. Luis Fortuño signed the new tax into law Oct. 25. That day, the Washington, D.C.-based whiteshoe law firm Steptoe & Johnson issued him a legal brief arguing U.S. firms should receive money from the U.S. government to offset the Puerto Rico tax increase, which Fortuño sent to the Internal Revenue Service, where a decision is pending.

The international tax law in question is complicated, but experts agree the tax, and the request, are an unusual use of portions of the tax code intended to avoid double taxation on U.S. firms in countries that have reciprocity treaties with the U.S.

“We would call it creative,” said James Hines, an expert on international tax issues and the L. Hart Wright Collegiate Professor of Law at the University of Michigan Law School. “It’s an unusual tax for sure.”

It’s an “indirect bailout,” said Dan Mitchell, an international tax expert and senior fellow at the Cato Institute.

Factions within the IRS are fighting over the decision.

“The IRS is very careful about giving away U.S. taxpayer dollars,” said Roberto Monserrate, assistant executive vice president for the Puerto Rico Manufacturers Association. “This is big money we’re talking about.”

Fortuño promised worried businesses the matter would be decided by Dec. 24 but the IRS had not made up its mind late Monday.

The IRS could deny the request by deeming the tax increase a “soak up” tax designed to prey only on firms that could offset the increase with tax credits from the U.S. government.

Hines explained the credits are different from how state tax increases are treated, though Puerto Rico is an American territory and receives federal funding.

“It’s a difference, but it’s only a difference of degree,” he said. Taxes paid by U.S. firms to U.S. states can be subtracted from the income level by which those firms are taxed by the federal government. For instance, a firm with $1 million in income that paid $100,000 in state taxes would be taxed by the federal government for $900,000 worth of income.

In this case, some firms could receive a dollar-for-dollar credit for the increase in Puerto Rico taxes. For instance, a firm with $1 million in income that paid $100,000 in the new Puerto Rican tax would have its U.S. tax burden reduced by $100,000.

Monserrate said his organization estimated that if international firms with subsidiaries in Puerto Rico did not change their business structure to additionally benefit from the credit they could offset $3.5 billion of the $6 billion tax.