Wal-Mart Transfer-Pricing Tax Declared Unconstitutional

It’s common sense that one cannot, for long, spend more than their income.  Doing this for long time periods is destructive and irresponsible.  Our leaders in PR and the USA Federal Government have failed us, we the people.  Discriminatory taxation is unjust.  Puerto Rico created a law to single out WalMart of Puerto Rico, to charge them a high tax rate to help fund Puerto Rico’s financial shortfall.  Such an unfair and vindictive system  would cause targeted companies to leave and shut down.  People and companies need to be treated fairly.  Demonizing the rich is a misguided approach because it punishes people and corporations for being successful.  One only need look to our neighbor to the South, in Venezuela, to see how punishing companies who provide merchandise, causes them to stop providing that merchandise.  As a result, the citizens of Venezuela suffer with hours long lines and empty shelves.  See here to read about what happens when the government demonizes businesses, as happened in Venezuela.


Wal-Mart Transfer-Pricing Tax Declared Unconstitutional

By on March 28, 2016

“It gives us no pleasure, under these circumstances, to enjoin a revenue stream that flows directly into Puerto Rico’s general finances.  For we, too, are citizens of this island, and we, too, must suffer the consequences of the financial disarray on the horizon. But, we are in this position precisely because the Commonwealth’s insolvency has left the plaintiff, Wal-Mart Puerto Rico, Inc., with nowhere else to turn. Now that we are here, we cannot shield ourselves from what we have learned, but must rule on the issues presented and order the relief required by law. In doing this, we agree wholeheartedly with the conclusion reached by one of the expert witnesses at the hearing we held: ‘[A]t the end of the day, the Commonwealth should not rely on revenue that it’s not entitled to, to try to pay for essential services,’” the judge ruled.

Wal-Mart Puerto Rico had filed a lawsuit against the commonwealth government after local officials implemented the transfer-pricing tax hike last year through the signing of Act 72 of 2015. The law effectively increases the rate in which corporate property coming from outside Puerto Rico is taxed, specifically from 2% to 6.5%, on entities that generate more than $2.75 billion in business annually on the island.

In their suit against the P.R. Treasury Department, Wal-Mart Puerto Rico execs alleged government officials were singling out the retail giant for inequitable tax treatment. They also argued the unconstitutionality of such a practice, citing the U.S. Constitution’s Commerce Clause—which gives Congress the power to regulate commerce with foreign nations and among the states—as well as equal protection laws.

While legal experts questioned the ability of federal courts to interfere with tax collections, Wal-Mart has argued that the new law violates the aforementioned Commerce Clause because it places the 6.5% tax on property bought outside the commonwealth, but not if said property is bought in Puerto Rico.

The plaintiffs also dismissed claims by the commonwealth government that Wal-Mart Puerto Rico had used transfer pricing to evade its proper tax burden. They also alleged that the new tax rate would amount to more than 91% of Wal-Mart’s net income in Puerto Rico, with Iván Baez, corporate affairs director, even saying the company would leave the island if the tax hike were to take effect.

In their questioning of the limits that federal courts have in interfering with state taxes, local officials stated that the Butler Act, a close relative of the federal Tax Injunction Act, prevents lawsuits that seek to restrain the collection of any tax imposed by the laws of Puerto Rico. The commonwealth government contended that a more valid way to challenge a tax is to pay it first and then sue to get the money back.

Eleven witnesses participated in the trial, including Government Development Bank (GDB) President Melba Acosta and Puerto Rico Treasury Secretary Juan Zaragoza.

Fusté noted in his ruling that the commonwealth is insolvent and no longer able to pay its debts as they become due. The Treasury Single Account, which functions as the commonwealth’s main operating account, will reach almost a $1 billion negative balance by the end of June 2016.

The Financial Institutions Commissioner’s Office has found the Government Development Bank of Puerto Rico insolvent as well, which means it may need to go into receivership.

When, in 2015, the commissioner approached the [GDB] about conducting a liquidity review, the bank dragged its feet and took more than six months to disclose “the minimum necessary information to produce” the review. The commissioner later described the “flow of information” from the bank as “extremely slow and inadequate.”

The commissioner was still able to evaluate the bank’s internal financials, however, focusing “particular attention on the adequacy and sustainability of [its] liquidity levels.” What the commissioner discovered may explain why the bank was so slow to cooperate. Based on the bank’s internal information, the commissioner found that the bank’s “[l]iquidity levels are critically deficient in relation to [its] weakened financial conditions caused by an elevated debt exposure and obstructed access to capital markets,” rendering “[t]he continued viability of [the GDB] questionable,” the judge said.

The GDB’s “risk tolerance limits” are “too liberal in light of [its] liquidity risk profile” and “do not provide any cushion for unexpected liquidity events or contingent liabilities that require additional disbursements of cash.” The bank does not properly account for “off balance sheet items,” like its “$1 billion [in] unfunded loan commitments” and “$1.3 billion [in] standby letters of credit,” Fusté said, quoting the commissioner.

The Treasury Department harbors significant doubt about the commonwealth’s very ability to persist as a going concern. And, in response to this dire situation, Puerto Rico has enacted laws and regulations that effectively ensure that a large taxpayer, if forced to challenge a patently unconstitutional tax by first paying it and then suing for a refund worth several tens of millions of dollars, will not see the full refund for decades, if at all, the judge added.

Wal-Mart’s lawsuit came about as Puerto Rico struggles under a crippling debt crisis. The island’s efforts to address the situation have mostly proven fruitless, among them a local bankruptcy law that would have allowed the territory’s utilities to restructure $20 billion in debt. The law was thrown out in court shortly after signed.

Fusté’s ruling comes as yet another blow for Puerto Rico’s coffers, with revenue projections slated to be significantly affected. Recently, island officials warned about the negative impact of the litigation as it updated projections for fiscal years 2016 to 2020 to account for year-to-date actual results. In response to creditor requests for additional information, projections were further extended until fiscal 2025.

“General fund inflow assumptions do not account for the potential risk of a material negative impact [$115 million in fiscal 2016] from the ongoing Wal-Mart litigation,” according to a footnote in an update issued Jan. 18 to the Puerto Rico Fiscal & Economic Growth Plan.

Wal-Mart PRFusté noted contradictions in the chain of events in the case. After his appointment to Treasury in late 2014, Juan Zaragoza wrote a letter to House Rep. Rafael Hernández Montañez, chairman of the Treasury and Budget Committee, advising the Legislature to modify the commonwealth’s alternative minimum tax (AMT) to “minimize its impact.” In the letter, dated Feb. 18, 2015, the Zaragoza acknowledged the AMT’s “purpose” at the time was to recapture some of the income that certain “multinational chains doing business in Puerto Rico” were suspected of exporting off the island by purchasing goods and services from “related entities” at such a high price that these chains “report year after year net operating losses in their subsidiaries or branches in Puerto Rico, even though their sales in Puerto Rico exceed the sales in other countries.”

To make the AMT more accurately reflect the “fair portion of the taxes” these chains were allegedly “evad[ing],” Zaragoza wrote that the Legislature needed to cut by 25% the 2% flat tax on interstate transfers of tangible property between related companies or different offices of the same company and eliminate the 20% flat tax on expenses for interstate services between the same.

“The Legislature had other plans, however, because Puerto Rico needed to raise $125 million in new revenue quickly to close a budget gap. Treasury, under Secretary Zaragoza, who did not agree with the Legislature’s plan, was tasked with developing an amendment to the AMT that would raise the necessary revenue.

After crunching the numbers, Treasury proposed new graduated rates for the AMT’s tangible-property tax–whose new top rate of 6.5%, a 325% increase, was designed to capture Wal-Mart PR, the biggest fish in the pond–and also the elimination of a provision that had allowed the Secretary to exempt a tangible property transfer from the tax upon proof that the transfer price was equal or similar to the price paid in an arm’s-length transaction between unrelated parties,” the ruling says.

Wal-Mart Puerto Rico is the largest private employer on the island. Comprising Walmart Supercenters, Walmart Discount Stores, Supermercados Amigo, Sam’s Clubs, and, until earlier this year, Super Ahorros, the multinational retail store currently operates 48 stores on the island, employing some 14,300 residents. Each store employee receives a minimum wage of at least $10 an hour, $2.75 higher than the minimum wage set by law in Puerto Rico.

Wal-Mart Puerto Rico sells about $3 billion worth of merchandise each year and remits more sales tax to the commonwealth than any other retailer. It buys around $1.6 billion in inventory from local vendors and suppliers each year. It also buys more than $700 million in inventory from its parent company, Wal-Mart Stores Inc., and related affiliates in mainland United States.

“The Puerto Rico Treasury Department neither believes, nor suspects, that Wal-Mart PR uses these related party purchases to shift income or profit off of the island to avoid payment of Puerto Rico income tax. In fact, Wal-Mart PR regularly pays around $20 million in income tax each year and is now paying more than $40 million,” the judge said.

In response to the ruling, Senate President Eduardo Bhatia said the “transfer pricing has to stop because it hurts Puerto Rico.”

He said the tax hike’s intention was to combat the alleged evasion of local taxes by the mega-store chains. He insisted on continuing legislation to prevent the practice.

“What we tackled with this legislation was the problem of accountants transferring prices, changing the price of a product so a product that does not make earnings in Puerto Rico, can make an earning in another jurisdiction where it does not pay. That is very funny; they buy among themselves. We have to avoid that and this legislation was the first serious attempt, a responsible attempt to deal with that. If the first attempt fails, we will attempt it a second time,” he said.

Wal-Mart Puerto Rico, however, hailed the ruling, contending that the island’s 14,000 associates, suppliers and farmers depend on the firms. “This unconstitutional tax was damaging to our business because it seized more than 100% of our profits. Because we wish to continue to do business in Puerto Rico and be part of the solution to the fiscal crisis is the reason we are grateful that the court acted fast in considering this and repealing the tax,” the store said.

Treasury Committee Chairman Rafael Hernández said the ruling will not have an effect on the  budget because the government plans to appeal. “If there is an erosion of revenues, we will see it in the last trimester of the budget if we have to return any money. But we are going to appeal,” he said.

Dennis Costa contributed to this report.

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