May 3, 2005 Gov. Charles W. Turnbull took the EDC bull by the horns last week in a letter addressed to John W. Snow, Treasury secretary.
"Although my administration will provide you with detailed comments on the regulations within the prescribed comment period, at this early date I want to make an urgent request that you personally review the regulations and consider appropriate changes in order to avoid serious damage to our economy and fiscal stability," Turnbull wrote.
The regulations referred to are those that will determine which V.I. companies and individuals can benefit from tax breaks under the Economic Development Commission's tax incentive program.
The program was swimming along bringing tens, if not hundreds, of millions of dollars to the V.I. coffers when the U.S. Treasury Department issued a warning last June that was the beginning of the end of the program as it had been known and understood.
The notice said, in part, that the V.I. government could not offer tax breaks to "U.S. citizens or residents who are not bona fide residents of the USVI." And for those who are bona fide residents, "it may reduce their tax liability only with respect to income from sources in the USVI or income effectively connected with the conduct of a trade or business within the USVI." (See "IRS Stance on Tax-Break Program Causes Concerns").
At that point the scramble began in Washington, D.C. to mitigate any potential damage from the Treasury's unexpected notice. But the efforts of V.I.'s Washington lobbyists and Delegate Donna M. Christensen amounted to less than nothing a few months later when amendments to the American Jobs Act emerged from a joint House and Senate Ways and Means Conference Committee. Much to the shock of those who thought they had struck a deal with key committee members, amendments to the tax laws governing residency and source income threatened to gut the program for one large segment of the beneficiaries financial services companies. And the gutting was to be swift. The source income changes went into effect when President George W. Bush signed the bill a few weeks later. The residency changes became effective Jan. 1, 2005.
Designated Service Business, as the financial services companies are also known, are mostly money managers and investment firms.
The fundamental questions are how much time do the principals spend in the territory, and is the money they make "effectively connected" to their V.I. businesses.
Under the former rules governing the program, investors relied upon a facts-and-circumstances test to determine residency. Did they vote in the V.I.; do they own a home in the V.I.; do their children go to school in the territory; do they have other connections like membership in local organizations and other non-EDC businesses in the USVI?
The new rules which keep getting tighter and tighter with each new definition require that a person reside 183 days a year in the territory to be considered a bone fide resident. It surfaced recently that individuals could not spend even one day as a resident of the U.S. in a year and be considered a resident of the V.I. that year under the new tax laws.
And source income now applies only to money actually made as the result of business activities in the V.I.
A white paper accompanying Turnbull's April 28 letter, drafted by a combination of Washington lobbyists to support the governor's request for clemency, says in the absence of clear guidelines from Treasury or the Internal Revenue, the Government of the Virgin Islands and "EDC participants did the best they could under the circumstances." The Internal Revenue Code of 1986 laid the groundwork for the EDC program. Since then the V.I. has received no clear regulations or interpretation of the law from the federal agencies.
Along with the V.I. government, private tax advisors to the EDC companies interpreted the source income to mean "that if an EDC business operated mainly through an office in the Virgin Islands and met the hiring, investment, and other requirements imposed by the EDC, the income realized by the business from clients outside the territory should be eligible for EDC tax benefits," the paper says.
In his letter to Snow, Turnbull implores the Treasury secretary to "grandfather" the previous tax laws to "legitimate investors who relied on the tax law as they and we understood it when the investors made the decision to risk their time and money in starting businesses in the V.I."
Memorandums of Understanding Signed in Secret
As V.I. government officials and consultants were putting their heads together with federal officials last summer and fall in attempts to come up with compromises to the impending law that would ease the fallout from the new guidelines, other V.I. government executives were secretly hammering out memorandums of understanding between the local Bureau of Internal Revenue and the IRS.
Four memorandums of understanding were signed by officials of the local BIR in September 2004, a month before the joint Congressional committee came up with the new amendments.
Informed sources have confirmed that neither Turnbull nor his consultants have seen the documents, which remain under lock and key at the BIR.
One source said the secrecy could be related to strict federal privacy guidelines. But as no one except a few BIR insiders have seen the documents, it's anybody's guess why they have been kept secret.
There has been speculation that the agreements contain a revenue-sharing agreement that would allow the V.I. government to cash in on monies collected from federal audits being conducted on EDC beneficiaries and others. But one source said that BIR officials have been emphatic that no such revenue-sharing agreement exists relative to money that might be collected in the future due to the audits.
However, it is likely money already collected by the BIR will be allowed to stay in the V.I. treasury, under the agreements, since the BIR has agreed to cooperate fully with the IRS investigations.
BIR director Louis M. Willis did not return a call placed Tuesday seeking information on the MOUs.
IRS audits being conducted
While local officials have been meeting with and writing letters to the federal officials in charge of the destiny of the program, the IRS has been conducting audits of approximately 65 companies that have paid taxes in the V.I. Most but not all of them are designated service businesses receiving EDC benefits. In general, the EDC certificate grants eligible companies a 90 percent tax break on most taxes. The first round of audits was to establish residency for tax purposes. The second round will look at source income. If the IRS determines the companies have erroneously paid their taxes in the V.I, they will be forced to pay their taxes in the U.S., as well. Several people have said it is far less costly to pay their taxes twice than to engage in a legal battle with the IRS.
At a pow-wow held days after the April 15 tax deadline, Willis reportedly said $100 million had been lost due to the changes in the tax laws. He later said it was more like $50 – $60 million.
In his letter to Snow, Turnbull wrote, "With April 15 having just passed, it appears that what we had feared might happen has, in fact, occurred; the revenues generated by our Economic Development Commission program have been significantly impacted by at least seven companies that have departed the territory, or that have now provided legal notice of their intent to depart. Several more are expected to follow suit in the near future."
One person said at least nine more have already told employees they are closing shop.
As the audits and confusion continue, more and more companies are expected to pay their taxes in the U.S. whether or no
t they are V.I. residents and whether or not they intend to stay leaving the two tax collection entities to work out who gets what.
One such business reportedly paid $24 million to the IRS this month instead of to the BIR.
Local lawmakers to consider their own rules
Senate President Lorraine L. Berry has postponed a Senate session scheduled for Wednesday morning and instead convened a Committee of the Whole meeting to take testimony on and consider the drafting of amendments to the local EDC law.
In a letter to stakeholders and EDC and BIR officials requested to testify, Berry said the mounting cost-of-living increases for locals pointed to the need for "further investment in the territory."
There was no indication from Berry's letter dated May 2, but sent to the media May 3, if the call for the meeting was the result of Turnbull's most recent letter to Treasury.
Invited to testify are: Marjorie Rawls Roberts, tax attorney; Hurdle Trip Lea III, chief executive officer of Margate Management; Frank Schulterbrandt, chief executive officer of the Economic Development Authority; and BIR director Willis.
In his release to the media accompanying his letter to Snow, Turnbull said the V.I. would "redouble" its efforts to get Treasury to reconsider the recently released rules and regulations that many think will drive investors out of and away from the Virgin Islands.
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