A temporary excise tax recently enacted in Puerto Rico will have a significant impact on U.S.-based multinational groups conducting, or considering conducting, manufacturing activities in Puerto Rico. Companies should consider the creditability of the excise tax for U.S. purposes and, even if the excise tax is creditable, whether their current organizational structure allows them to fully utilize the foreign tax credit.

Overview

On October 25, 2010, Puerto Rico enacted a temporary excise tax on related party purchases of products manufactured in Puerto Rico or services performed in Puerto Rico. The tax is imposed on the value of the products or services purchased. The rate of the tax will decrease during the years of its existence from 4 percent in 2011, to 3 percent in 2012, to 2.75 percent in 2013, to 2.5 percent in 2014, to 2.25 percent in 2015 and down to 1 percent in 2016, when it will expire on December 31. The tax will have a significant impact on U.S.-based multinational groups that engage in manufacturing activities in Puerto Rico.

Currently, many U.S. companies manufacture products in Puerto Rico that are subsequently sold throughout the world by affiliates. By way of example, assume a U.S. corporation (USP) owns the stock of a Dutch company (BV) that constitutes a controlled foreign corporation. Through a branch in Puerto Rico (PR Branch), BV engages in the manufacture of Product A. PR Branch sells Product A to an affiliate of USP (Purchaser), that in turn sells Product A to customers throughout the world.