United States

Puerto Rico: U.S. District Court Enjoins Treasury from Enforcing the AMT

Apr 04, 2016
From KPMG TaxWatch

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Recently, the United States District Court for the District of Puerto Rico permanently enjoined the Secretary of the Treasury from enforcing a component of the Commonwealth’s Alternative Minimum Tax or AMT. Notably, in the court’s view, the AMT imposed on tangible property and services transferred from an out-of-Island entity to a Puerto Rico affiliate discriminated against interstate commerce and also violated the Equal Protection Clause.

In 2015, Puerto Rico adopted certain changes to its AMT regime that gave rise to the action before the court. These changes were aimed, in large part, to raise revenue in light of the Commonwealth’s looming—and ongoing—fiscal crisis.  Specifically, for purposes of the instant case, Act 72 of 2015 adopted increases in the tangible property tax component of the corporate AMT. Similar to the federal income tax AMT, the Commonwealth’s AMT is owed whenever the taxpayer’s “tentative minimum tax” exceeds the taxpayer’s “regular” income tax. In other words, a taxpayer calculates tax under both regimes and pays tax that results in a higher amount. There are two components of the “tentative minimum tax.” One applies to income- subject to certain adjustments. The other applies to the gross value of goods and services sold or otherwise provided to the corporate taxpayer by a related party or home office located outside of Puerto Rico. The second measure was comprised of two parts: an expenses component and a tangible property component. The expenses component imposes a 20 percent tax on services provided to the taxpayer by a related party or home office outside Puerto Rico. The tangible property component imposes a 2 percent tax on the gross value of goods sold or transferred to the taxpayer by a related party or home office outside of Puerto Rico.

Act 72 increased the tangible property rate from a flat 2 percent to a graduated rate ranging from 2.5 percent to 6.5 percent. For the taxpayer, Wal-Mart Puerto Rico, the result of Act 72 was that it was required to pay a 6.5 percent tax on each item of inventory transferred to Wal-Mart Puerto Rico from the U.S. parent company. To get a sense of the economic effect of the revised AMT, the court noted that the taxpayer had paid $40 million in estimated income taxes for the year ending January 15, 2016 and $30 million of that was related to the new AMT.

In December 2015, Wal-Mart Puerto-Rico filed an action against the Secretary of the Treasury seeking an injunction against the enforcement of the AMT and a ruling that the AMT violates various clauses of the U.S. Constitution.

In a lengthy option, the court first addressed the Commonwealth’s fiscal challenges and in great detail outlined the burdens and hurdles facing taxpayers seeking a refund of erroneously-collected corporate income taxes. The court concluded that, if Wal-Mart Puerto Rico had to vindicate its federal rights by means of a tax-refund action, it would have to keep paying several tens of millions of dollars in AMT to Puerto Rico. However, under present circumstances and law, Puerto Rico would not fully refund that money for decades, if at all. Thus, the court rejected the Secretary’s claim that Wal-Mart Puerto Rico could obtain a “plain, speedy and efficient remedy,” by filing a tax refund action. Notably, the court noted that the Commonwealth cannot provide a remedy if it is unable to pay a refund.

Next the court addressed the constitutionality of the AMT, holding that on its face, the AMT clearly discriminates against interstate commerce. The tangible property and expenses taxes applied only to “cross-border” transactions with out-of-state entities. Thus, in the court’s view, by design, the AMT does what it is not supposed to do—it taxes a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State.” The Secretary even conceded that the tax applies only to transactions “between Puerto Rico taxpayers and their cross-border affiliates.” Because the AMT facially discriminated against interstate commerce, the court concluded that it was “virtually per se invalid.” The court also held that the AMT violated the Equal Protection Clause because its facial discrimination against multistate businesses engaging in controlled interstate transactions was arbitrary and served no legitimate state purpose. The mere generation of tax revenue could not be a legitimate state purpose under an equal protection analysis because “acceptance of [that] contention . . . would eviscerate the Equal Protection Clause in this context.” Given the Commonwealth’s fiscal situation and the likelihood that a refund would take years, the court permanently enjoined and declared invalid the sections of the law comprising the second measure of “tentative minimum tax,” which consisted of the tangible-property tax and the expenses tax. For more information Wal-Mart Puerto Rico, Inc., v. Juan C. Zaragoza-Gomez, please contact Rolando Lopez at 787-622-2765.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.