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Charlotte Amalie
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HomeNewsArchivesANALYSIS: THE TERRITORY'S TAXING RELATIONSHIPS

ANALYSIS: THE TERRITORY'S TAXING RELATIONSHIPS

Editor's note: The following analysis tracing the evolution of the territory's present tax relationship with Congress and the U.S. Treasury is by Dr. Richard Moore, Ph.D., a V.I. economist/consultant and former chief economist for the V.I. government and director of its Bureau of Economic Research.
May 30, 2003 – Should the recent and apparently unannounced "arrival" of U.S. Treasury officials to "investigate" at least one V.I. taxpayer turn out to be more than just a training exercise for new recruits, a new and ominous chapter in V.I. relations with Congress and the Treasury Department may be unfolding.
For that reason, a short history using just a few examples of the often-contentious, mostly transparent, yet always interactive relationships between the V.I. government and both Congress and the Treasury Department on the use of tax policy to support economic development may shed some light on the complexity of these relationships.
Although much remains to be seen, the last eight years have witnessed a clear structural deterioration in the relationships between the Virgin Islands and these institutions regarding this issue.
Our story begins with Congress 'way back on June 21, 1921, when the need to generate local funding for public services in the newest U.S. possession was most urgent. The Danish West Indies had been purchased from Denmark in 1917 for $25 million to establish a U.S. Navy submarine base; hence, it was natural to assign the Navy to administer the renamed U.S. Virgin Islands. The Naval Service Appropriations Act of 1922 included the following provision creating the "mirror code" regarding taxation:
"The income-tax laws in force in the United States of America and those which may hereafter be enacted shall be held to be likewise in force in the Virgin Islands of the United States, except that the proceeds of such taxes shall be paid into the treasuries of said islands."
Residency and forgiveness
After decades of economic stagnation during the Great Depression and spirited economic growth during World War II, the 1950s were a time of debilitating quiet for the Virgin Islands, with the territory's population falling to its lowest level in modern times — 32,099 in 1960.
However, the 1950s also were a time when the seeds of our tourism industry were germinating, and investment in this industry prompted local use of tax forgiveness to attract investment as an intermittent exercise using neither publicity nor promotion.
At this time, two issues brought the Virgin Islands, Congress and the Treasury Department together: who was to be considered a V.I. resident for tax purposes, and how much freedom the territory should have in using tax forgiveness to attract investment.
Notwithstanding enactment of the Revised Organic Act of 1954, provisions of U.S. law regarding just who is and who is not a bona fide V.I. resident for tax purposes have remained ambiguous. Although I'm aware of several local professionals with standing who have requested clarification and regulations on the residency issue numerous times in the last decade, the Treasury Department has remained strategically silent and has not yet clarified this issue. This differs from the long-standing close cooperation that had generally functioned to resolve such matters whenever they occurred in the past.
In fact, language found in The Tax Reform Act of 1986, section 1274 (c) directs that: "The Secretary of the Treasury or his delegate shall prescribe such regulations as may be necessary or appropriate for applying the Internal Revenue Code of 1986 for purposes of determining tax liability incurred to the Virgin Islands."
"Determining tax liability to the Virgin Islands" is a reference to 26 USC Sec. 932, which provides the rules for taxing residents and non-residents of the Virgin Islands and to Sec. 934.
The "Blue Book" for the above act — the explanation of the act provided by staff of Congress's joint committee on taxation — states: "Congress expressed the desire that the Secretary of the Treasury consult as appropriate with officials of the Virgin Islands in formulating regulations for the purposes of determining tax liability incurred to the Virgin Islands."
Clearly, any post-1986 confusion over the determination of tax liability between the U.S. and V.I. governments lay with the Treasury Department's failure to act on this directive. Even with the passage of 17 years, no such consultations have ever taken place and no such regulations exist.
The tax forgiveness issue was ostensibly settled by Congress in 1960 to abate concerns that mischievous application of the practice might occur. With enactment of 26 U.S.C. Sec. 934, formal definitions set out the conditions under which income taxes could be forgiven by the local government. As an aside, there was a costly 25-year distraction, ending in 1986, over residency and income tax obligations derived from misinterpretation of Sec. 28a of the Revised Organic Act. Yet throughout this period the V.I. government and the Treasury Department worked diligently to sort out these jurisdictional tax obligations.
As the last government crop of sugar was harvested in 1964 at Estate Bethlehem on St. Croix, Harvey Alumina and Hess Oil Virgin Islands Corp. were preparing to begin production and visitor arrivals by air and on cruise ships were growing at double-digit rates. To clearly and convincingly attract the largest investment in the territory's history, it appeared that accommodations were necessary.
Some taxpayers saw a need for "special" local legislation to accommodate their special circumstances. In 1966, the V.I. attorney general issued an opinion that the V.I. Legislature was not prohibited from enacting local laws granting specific corporations tax exemptions and subsidy benefits otherwise prevented by 48 U.S.C. Sec. 1471. This opinion was overturned by a U.S. Court of Appeals in 1967. However, over the years, it became painfully obvious that special legislation was, in fact, being enacted for individual taxpayers in spite of the above.
In 1983, Congress repealed this section of federal law. At least for the territories, the prohibition against special legislation was lifted.
Currently, more than 30 states prohibit the enactment of special law where general law may suffice. Yet relations between the Virgin Islands and the Treasury Department and Congress clearly warmed to meet an apparent need for the territory to be free of this burden. Whether or not public policy is best served by the result is an entirely different question; what is important is that the parties worked closely together.
Tax takeover/reform, financial services save the day, maybe
Early in the first Reagan administration, the Treasury's assistant secretary for tax policy embarked on a quest for enactment of legislation to end V.I. administration of the mirrored tax code. The objective was to engage U.S. Internal Revenue Service personnel to administer the tax code for all V.I. taxpayers. We would send our tax forms and payments to the IRS with the understanding that all proceeds would be covered over to the V.I. treasury.
Under the leadership of Gov. Juan Luis (1978-86) and in the face of a highly publicized brouhaha, the Treasury Department abandoned this position.
In 1984, the second Reagan administration generated strong support for a complete overhaul of the tax code. Luis created a Federal Tax Council and I, as the appointed chair, worked on his behalf with our private sector, the Treasury Department and Congress to resolve the territory's interest in what has come to be known as the Tax Reform Act of 1986.
Early on, the Treasury Department sought to have the mirror code abandoned for both Guam and the Virgin Islands. The Virgin Islands fought hard and successfully to retain the mirror code. Guam, on the other hand, cooperated with the Treasury Department and organized the admin
istration of its own code. Within five years, however, the Treasury Department suppressed this ambition and worked with Guam to reinstate the mirror code.
Incidentally, another outcome of the Tax Reform Act of 1986 was to create federally sanctioned authority for the Virgin Islands to establish a non-discriminatory income tax system alongside the mirror code. To date, that option has not been exercised.
It was during this period that the Luis administration, with assistance from attorney William Blum, the governor's former legal counsel, and the V.I. Legislature sought to utilize tax reform awareness to expand the territory's application of tax forgiveness to attract new forms of investment.
Up until this time, the existing economic development program had aimed at investment generating the production and export of commodities. With hindsight, cooperation was perfectly timed between the Luis administration and the Legislature with support from the Treasury Department to offer tax forgiveness for firms investing in the territory, creating jobs and exporting designated business services.
The telecommunications boom had not yet begun, the computer was still a toy for geeks and the Internet was still below the horizon. This prescient effort culminated with the Legislature passing and Luis signing into law Act 5224, adding designated business services and, more generally, exempt companies as eligible entities for alternative forms of industrial development program support.
On Dec. 8, 1986, the territory's post-foreign sales corporation financial services era began with the signing of Act 5224. In fact, we negotiated an implementation agreement with the Treasury Department focused on this legislation so as to minimize misinterpretation in the administration of this new industrial development opportunity. It appears that the maintenance and upkeep of this agreement has failed, given the mysterious circumstances in which we now find ourselves.
Post-Hugo deterioration and finger pointing
Succeeding governors have done little to enhance this investment/employment vehicle, aside from a program name change, establishment of a list of fees and penalties, and moderate refinement of definitions, all enacted in 2001. Private-sector business development professionals have created the interest in and the implementation of what has become the strongest — in fact, the only — sector with significant employment growth in recent years.
However, since the late 1980s the collegial relationship of the Virgin Islands with Congress and the Treasury has fallen on hard times.
Following Hurricane Hugo in 1989, the V.I. economy sputtered and fell to deteriorating underperformance, exhibiting little capacity to grow. Yet inflation and growing household needs and expectations remained. This has left growing public expenditure outpacing public-sector revenue growth, financed by tax increases. Well, yes and no. The full $1.5 billion in tax increases are being assessed not on the current generation but on future generations — in the form of long-term debt to be repaid by future taxes.
In the midst of these hard economic times, the Treasury Department and the federal government in general appear to have taken a more stand-offish/interactive approach with the territory. Although interaction continues, the traditional federal personality of supportive encouragement has been replaced by the personality of a watchful disciplinarian.
A long list of threatened interventions precipitated by federal assertions of the Virgin Islands' failure to maintain public trust periodically surface and dominate federal/territorial relations. Aside from the tepid attempt by the Treasury Department to wrest local income-tax administration from the territory in the early 1980s, it is only in the last eight years that the threat of a federal takeover or lost support in so many areas has come to dominate federal/territorial relations.
The list of federally managed/disciplined V.I. programs today includes:
– Occupational health and safety
– Roads and highways
– V.I. Customs
– Public education
– Environmental protection
– Solid waste
– Liquid waste
– V.I. prisons
A new twist of focus involves federal intervention in what are clearly and exclusively local affairs: a District Court effectively manages local property-tax administration and the U.S. Attorney's Office files suit on the awarding of a local contract using local money. The Virgin Islands' defense against growing federal intervention to supplant its management for the territory's own is becoming very expensive.
Three recent events portend more problems
Finally, in the face of growing institutional contention among the Virgin Islands, Congress and the Treasury, three events of the last two weeks may generate a worsening of the downward spiral that defines the territory's overall economic condition.
First, on May 28, President Bush signed into law a bill to reduce federal taxes by $350 billion. This legislation will of course be mirrored in the territory and will likely result in lowered local tax collections. The new law also reduces the federal tax rate on dividends and capital gains to 15 percent, thereby vastly cutting the incentives for certain service-sector businesses to establish in the Virgin Islands.
Second, Gov. Charles W. Turnbull, facing a near $150 million deficit in the current account, saw fit on May 20 to propose the territory's largest increase in taxes and fees in recent memory.
Third, the Treasury Department's "intervention" on St. Croix with Kapok Management LP, also on May 20, shutting down one of the largest of the territory's financial services firms without public comment, has frozen the capacity of this industry to grow and currently holds many would-be investors as if "deer in the headlights."
The financial services industry is now responsible for an estimated one-third of all individual tax revenues collected in the territory, and the proportion is growing. The prospect of losing the economic benefits from this industry, should the discipline be too strong, is frightening.
For 70 of the last 80 years, V.I. tax policy has been managed in an arena of institutions — the territory, Congress and the U.S. Treasury Department — such that they were simultaneously battling and cooperating to stimulate full-capacity economic growth in the Virgin Islands. In the last 10 years, however, a new era has come to define local/federal interaction on tax policy management in which discipline has replaced cooperation, and silence and middle-of-the-night assaults have replaced transparency.
As is always the case in such matters, the big losers in this new, colder environment will be those who cannot defend themselves: children, losing full access to quality educational program support and losing a growing economy to employ them, and the elderly, losing full access to quality programs supporting housing, recreation and health care.

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