Puerto Rico Tax Under IRS Review Penalizes Debt

Puerto Rico, whose debt was cut to junk by two ratings companies last week, pays a penalty when it borrows because of the uncertainty created by U.S. scrutiny over whether an excise tax on non-residents qualifies for a federal credit, according to Cumberland Advisors Inc.

The U.S. territory’s excise tax on companies and others that do business there generates $2 billion a year, or about one-fifth of its general-fund budget, according to a report by David Kotok, chairman of Sarasota, Florida-based Cumberland. Those who pay take a credit on their federal income tax, according to the report, though legal questions about the levy have yet to be resolved.

The U.S. Internal Revenue Service is reviewing whether the tax, enacted in 2010, qualifies for the credit, the Treasury Department confirmed today in an e-mail.

The Tale of Puerto Rico's Slide

“The whole thing just sits there because the IRS is refusing to rule on the issue,” said Kotok, whose fund manages $2.3 billion of assets, in a phone interview. “They have spent three years studying it.”

In mid-January, a Puerto Rico general-obligation bond maturing in 2019 traded at a yield of about 10.9 percent, which compares with a lower-rated Guam bond trading at 4.9 percent.

Ratings Cuts

Puerto Rico Governor Alejandro Garcia Padilla and lawmakers are working on legislation to authorize as much as $3.5 billion of general-obligation debt to balance its budget, Representative Rafael “Tatito” Hernandez said this month.

Alix Anfang, a spokeswoman for the commonwealth’s Government Development Bank at SKDKnickerbocker, didn’t immediately respond to an e-mail seeking comment.

Puerto Rico was cut below investment grade by Standard & Poor’s on Feb. 4 and by Moody’s Investors Service three days later. Its general-obligation bonds maturing in July 2041 traded today with an average yield of 8.15 percent, down from 8.24 percent on Feb. 7 and the lowest level since November, according to data compiled by Bloomberg. The securities yielded about 5 percent a year ago.

To contact the reporter on this story: Darrell Preston in Dallas at dpreston@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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