Sept. 19, 2004 – It is impossible to know what the fallout will be from a front-page article appearing in The New York Times Saturday edition about the territory's tax incentive program, known as the EDC (Economic Development Commission) program. It may bring even more federal scrutiny to potential abuses of the program and even prosecution. It may prevent potential businesses from setting up in the Virgin Islands. It could also force the U.S. Internal Revenue Service and the Treasury Department to get together with territorial officials in an effort to reach agreement about certain currently ambiguous definitions such as residency and "effectively connected income."
It had been widely known locally that Times reporters had been in the territory talking to people and collecting information. Some close to the EDC program had been holding their breath to see what tack the report would take. In the day following the publication, several were saying the story was fair, even tame, compared to what they were expecting.
The article, headlined "Tax Break Bringing Businesses, and Fraud, to the Virgin Islands," zeros in on the issue surrounding the program's nebulous residency requirement. The report does not mention that the residency requirement issue is being addressed by a bill that made it through the U.S. Senate in May.(See "U.S. Bill to Restrict EDC Firms Causing V.I. Concern").
The reporters, Stephanie Strom and Lynnley Browning, touch on the issue of partnerships developed in some of the EDC beneficiary companies that may not be appropriate or even allowed under the program's guidelines. For instance, one company was found to have 99 partners – a questionable practice that could allow all the partners to funnel income from businesses elsewhere through the local EDC certified company and thereby avoid paying up to 90 percent of their taxes. According to The Times, Frank Schulterbrant, chief executive officer of the Economic Development Authority, the umbrella over the EDC, didn't know the beneficiary was operating with that many partners. He told the reporters his records showed only three.
The EDC program, developed in the 1960s to bring new business to the economically challenged territory, came under attack from the Internal Revenue Service in June, when the IRS warned it was cracking down on abusers and misleading promoters. (See "IRS Stance on Tax-Break Program Causes Concerns").
However, the article barely touched on what may be the biggest conundrum for beneficiaries, legal analysts and local officials – the matter of "effectively connected income."
According to certificate holders in the category of designated service businesses, such as investment managers, software developers, business and management consultants and other international firms who serve clients outside the territory, those designated businesses can claim income and therefore exemptions under the EDC program on money made outside the territory. In fact, they are barred from competing locally with similar types of businesses.
But the IRS sees it differently. A notice issued in June stated that "it [the V.I. government] may reduce their tax liability only with respect to income from sources in the U.S.V.I. or income effectively connected with the conduct of a trade or business within the U.S.V.I."
Designated service businesses were newcomers to the program, having been designated eligible businesses in a 1986 act that expanded the program.
The long-awaited Times article speaks strongly about the benefits the expanded program brought to the territory, including a real estate boom, growth for local restaurants and professional services, employment and reversal of the islands' brain drain. Part of the program's requirement is local employment quotas. Because of that, many educated Virgin Islanders have returned home to work in the financial management businesses.
But because of the ambiguity, the IRS threat also caused at least one beneficiary to close up shop, displacing at least eight local employees. Consolidated National Corp. closed its doors in July. Fred Rice, CNC's vice president, told the Source he couldn't afford to wait around while officials on both sides of the water worked out their difference. Rice, who was also interviewed by The Times, said there was too much "indecison" and that nobody seemed to know what the rules were. (See "EDC Firm Closes Its Doors Citing Tax Rules Ambiguity").
Other businesses that were poised to open their doors here have plans on hold, according to several beneficiaries who didn't want to be named.
Government officials and EDC beneficiary representatives have made at least one trip to Washington, D.C., to talk to officials there, and Delegate Donna M. Christensen has vowed to resolve the issues facing the program. But so far no one has come back to the territory with any concrete resolutions.
With this latest spotlight on the program, which in the last few years has accounted for 25 percent of the territory's revenues, according to Louis M. Willis, director of the V.I. Bureau of Internal Revenue, the heat is on those in power to come to a swift resolution or face a perhaps substantial loss in revenue for the territory.
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