Puerto Rico's Underground Economy And Tax System - Essay Example

Puerto Rico Puerto Rico’s Underground Economy and Tax System The United s holds five major commonwealths and possessions. The key possessions are U.S. Virgin Islands, Guam and that of American Samoa. On the other hand the key commonwealths of the United States are the Northern Mariana Islands as well as Puerto Rico. In the five major commonwealths and possessions, four of these are under a non-voting representative in the United States Congress. Individuals who reside in the United States possessions are all considered citizens of the country except for those individuals residing in American Samoa who are already taken into account as nationals of the United States, however they are still not considered citizens for that matter. Generally, all U.S. Federal statutory laws are applicable to the whole of the U.S. possessions save for certain exemptions. These rules also cover the condition in using US flagships as well as the minimum wage standard. Income coming from other U.S. possessions or Puerto Rico is generally considered as foreign-source income. On the other hand, entities which are instituted other U.S. possessions or Puerto Rico, are usually considered as foreign persons. Special Tax Rules Related to Puerto Rico As a consequence of the hybrid domestic-foreign conduct of individuals in Puerto Rico, the common ideology of U.S. taxation are qualified by numerous particular rules pertinent to U.S. citizens and inhabitants of, and U.S. persons who are conducting business in the said territory. Puerto Rico’s 2 For the majority of the cases, these particular rules have the necessary influence of separating tax control between the government of Puerto Rico and the U.S. Federal government Other rules on the other hand are intended to put off U.S. Federal tax laws from opposing tax incentives applied by Puerto Rico to draw investors. The United States has also placed in tax incentives to help Puerto Rico when it comes to acquiring employment producing investments particularly from companies in the US. The demand for these particular tax incentives could be traced in part, to the extra costs placed on investing in Puerto Rico mainly since it holds such status as a U.S. possession. When taking into account the earlier U.S. law, definite domestic corporations with operations in U.S. possessions could vote for under Code section 936 to commonly do away with the U.S. tax, which also includes the alternative minimum tax, on particular foreign source income which was associated to their processes in the specified regions. The advantage awarded to corporations under section 936 is generally pertained to as the possession tax credit. A bulk of the companies that profited from the possession tax credit instituted operations in Puerto Rico. Corporations with important operations in Puerto Rico functioned by means of a Puerto Rico division of a domestic U.S. corporation. These companies were generally to as “section 936 companies.” Income that was not included to U.S. tax under this provision took in income that was acquired from either the active system of a business or trade in a U.S. possession or from particular investments in the specified regions of possessions or in particular Caribbean Basin countries which created competent possession source investment income (“QPSII”). Puerto Rico’s 3 The advantage of the possession tax credit was that it secured the choosing corporation U.S. tax whether or not it remunerated income tax to the region On the other hand, the Small Business Job Protection Act of 1996 (“Small Business Act”) revoked the possession tax credit for tax years starting from December 31, 1995. In such case, the Small Business Act presented grandfather regulations that permitted for a 10-year transition phase. The Small Business Act provided another section 30A to the Code in reference to the qualified income grossed in Puerto Rico. This section permitted an economic action credit that could also be applied for tax years starting from December 31, 1995 and prior to January 1, 2006. Tax Structure The taxes in Puerto Rico are functional at both the state as well as municipal levels. Definite federal (U.S.) payroll taxes are also applicable in this respect. The U.S. Internal Revenue Code (USIRC) is in general not valid to residents of Puerto Rico, in both cases whether the individual is a U.S. citizen or an alien. In the case of U.S. citizens that are classified as residents, income received coming from sources external to Puerto Rico is placed under the U.S. income tax. On the other hand, those aliens with residence in Puerto Rico and who also acquire U.S. source income could be placed under the income tax which is subject under the USIRC. In this case, value added taxes (VAT) or sales taxes are not enforced. Taking the International Law into consideration, Puerto Rico could not partake into any agreements with other countries. Consequently no tax agreements subsist. Apart from the provisions concerned with payroll tax, if any, Tax Treaties involving foreign countries and the US do not apply in Puerto Rico. Puerto Rico’s 4 Income Tax Law In this case, it is essential to establish that Puerto Rico do have a tax system of its own. The conceptions of taxable income and deductions come in the same manner as observed in both US and Puerto Rico tax systems. The income tax laws in Puerto Rico could be found under the Puerto Rico Internal Revenue Code of 1994, as amended (PRIRC). The regulations on income tax are provided through the P.R Department of the Treasury. They are also taken into account as the PRIRC’s government interpretation. The tax system of Puerto Rico could be traced back on self-assessment. Individual taxpayers are mandatory to have their own annual income tax return provided that the minimum-income thresholds are already reached. The taxpayers file the taxable income and deductions, they put into comparison their final tax accountability to any income tax withheld or expected tax paid. Apart from this they also identify any balance due or overpayment of tax due from the Treasury. The PRIRC is applicable to persons, companies, estates and trusts, associations as well as partnerships. The PRIRC could be traced back fundamentally from the U.S. Internal Revenue Code of 1939 which was accompanied by countless additions and modifications. In this case, it is multifaceted in organization and could be noted as ever changing. The primary reason for the intricacy is attributed to the many extremely technical alterations and exceptions, regulations as well as qualifications intended to reduce tax evasion and newer accompaniments tailored from the U.S. Internal Revenue Code of 1986, as amended. Puerto Rico’s 5 The Code is applicable to individual residing in Puerto Rico. It also applies to non-residents with Puerto Rico source income. Apart from this, domestic entities (for example Puerto Rico corporations and partnerships) as well as resident foreign entities are subject to this code. The foreign institutions are taxed solitary on income acquired from Puerto Rico sources. In this case, every payer should be able to keep back the tax from the wages and salaries, as well as from additional payments granted to each individual being paid. Individuals who receive other types of income, that is in the form of investment income and non-wage income are not overruled, this means that withholding at source should make quarterly expected payments of tax. Estimated Tax Every company or partnership that is involved in trade or business in Puerto Rico, and is placed under the regulations of tax, is mandated to file an Estimated Tax Declaration. The taxpayer should be able to file Declaration on 15th day of the fourth month of the taxable year, which is essentially succeeds after the start of the taxable year. Expected tax payments should be filed on the fifteenth day of the fourth, sixth, ninth and twelfth months of the taxable year Withholding Taxes on salaries and wages Withholding is in general valid to all of an employees wages for services accomplished or an employer. In the case of non-cash wages, these are calculated through their fair market value during the period of transfer. Payment of taxes withheld should be forwarded to the Puerto Rico Treasury Department subsequent to the similar deposit regulations. Puerto Rico’s 6 Reporting Periods Taxpayers should be able to submit their returns depending on a twelve-month year foundation. The majority of taxpayers file in reference to the calendar year basis. Tax returns are supposed to be submitted by the fifteenth day of the fourth month following the end of the taxpayers taxable year, for taxpayers filing in reference to a calendar year basis, the date is April 15. All taxpayers are entitled to extensions; however they have to file a request on or before the due date. The maximum extension that is given is usually 90 days on calendar basis. The appeal for extension of time in submitting the tax return should be attended by any tax due. Tax Rates on Individuals, Estates and Trusts Trusts are different taxable entities that come along with the PRIRC. The tax rates for a trust apply in the same manner for individuals. On the other hand, business, commercial and investment trusts are in general taken into account to be organizations instituted to carry on profit-making activities and are taxed as companies. The tax is compulsory on taxable net income. Taxable net income pertains to the gross income less permissible deductions as well as personal exemptions. Particular rules are applicable to married couples who are residing together and are submitting separate returns. Puerto Rico’s 7 The current tax system At present, numerous sectors of Puerto Rico’s civil society have put forward the proposal of substituting Puerto Rico’s current income-tax system with a consumption tax. This includes retail sales tax or a European-style value-added tax.  There is an immense and diverse literature concerning the issue of consumption taxes. A discussion on this current issue on the tax system of Puerto Rico would be discussed. Effect on Puerto Rico’s Underground Economy   There are is an apparent commonality that could be observed from a lawyer, a drug lord and even a simple street vendor. Even though they partake in fundamentally different activities, these individuals are all providing important goods and services to paying customers. Additionally, it comes to the point where in they do not file a report on some and from time to time even all of the income they have acquired from their customers. Ultimately they are able to avoid or evade their share of tax accountability.  This subdivision of a country’s economy, where tax evasion is out of control, is most of the time pertained to as the “underground economy.”  A number of commentators opted using the terms “informal,” “hidden,” or “parallel” economy instead.  On the other hand this term is defined, the dilemma is similar: tax evasion. Puerto Rico’s 8 The magnitude of Puerto Rico’s underground economy is extremely large.  As presented by the Puerto Rico Treasury Department, Puerto Rico’s underground economy acquires about two billion dollars every year which no less than 17% of Puerto Rico’s Gross Personal Income. In the case of the figures justification, more questions are now raised in the name of the Puerto Rico’s economy. Particularly there is the idea of why is the extent of the country’s underground economy is massive. Eventually, another concern is raised, why do so many individuals in Puerto Rico avoid their liability to pay their taxes? Either tax evasion has turned out to be a socially-acceptable act in Puerto Rico or tax accountability is basically so immense that the majority otherwise law-abiding citizens are obliged to evade taxes in order to survive in the industry.  For purposes of this essay, on the other hand, we shall limit the discussion on the effect of the consumption tax on the underground economy of Puerto Rico. There is the certain agreement that the present system of direct taxation of income generates inefficiencies that consent to evasion as well as avoidance to thrive and there is also the apparent observation that to be able to reach into the underground economy, a more well-organized auditing system should be imposed.  However, there is the question of whether a consumption tax instead an income tax would be able to lessen the underground economy in Puerto Rico. The obvious answer for that matter is that it is not an easy feat. Puerto Rico’s 9 The implementation of a consumption tax in substitute of the present income tax would offer new opportunities as well as incentives for tax evasion and avoidance.  Essentially, the income acquired by black-market activities like that of drug marketing and prostitution would not be arrested under any tax system period. In simpler terms, a drug lord’s reason to avoid both consumption taxes and income taxes is similar.  Through the payment of taxes, the drug lord would unreservedly be acknowledging the act of a crime save for he goes to the difficulty and price of laundering the income acquired by his illegal actions. Additionally, the majority of black-market activities have a tendency to be barter or cash dealings. Particulalry because these kinds of dealings eave no paper trail, they are difficult to find especially following after the fact which makes it even easier avoid tax. Consequently, a consumption tax would not just lead to a zero net increase in tax revenues for the state; it would also have the paradoxical effect of increasing the tax evader’s income. Nonetheless, a consumption tax system could still have affirmative psychological effects that could lead to a lower rate of tax avoidance in comparison to the existing system.  Taxpayers would take into account the expense of consumption taxes as a loss of a mere prospect.  Apart from this, a consumption tax could generate the insight or false impression among taxpayers that those who partake in the underground economy are paying their reasonable share of taxes.  Puerto Rico’s 10 Conclusion Considering consumption tax to replace an income tax includes numerous trade-offs.  First, a consumption tax which is set to replace the existing system might not able to spawn additional tax revenues and it could also include extra administrative expenses, however there is also the concept that people would recognize a broad-based consumption tax as more reasonable in comparison to the existing system.  Apart from this, a consumption tax has a tendency to increase cross-border shopping; however it would have the prospective affirmative effect of encouraging savings as well as investment in the Island’s economy.  Lastly, even though a consumption tax would most likely not lessen the extent Puerto Rico’s underground economy, people could be keener to pay their contribution of taxes provided that they are able to have that notion that everyone else is paying their fair share.  References: Guerra, F. E. and Ramos, J. B. (2003). Analysis of the Effects of a Consumption Tax in Puerto Rico. Volumen 42: Num. 2 de 2003 Joint Committee on Taxation. (2006). An Overview of the Special Tax Rules Related to Puerto Rico and an Analysis of the Tax and Economic Policy Implications of Recent Legislative Options. Morris, N. (1995). Puerto Rico: Culture, Politics, and Identity. Praeger/Greenwood, Read More