By permanently enjoining Puerto Rico’s minimum alternative corporate income tax, a federal district judge underscored the urgency for the Supreme Court or Congress to give the island access to chapter 9 municipal bankruptcy.
The tax, referred to as the AMT, was aimed at Wal-Mart Puerto Rico Inc., the largest private employer and largest retail taxpayer in Puerto Rico. District Judge Jose Antonio Fuste in Puerto Rico held in his March 28 opinion that Wal-Mart has no prayer of ever obtaining a refund of the AMT because the commonwealth “is insolvent and no longer able to pay its debts as they come due.”
The opinion lays out Puerto Rico’s financial problems in excruciating detail. Judge Fuste said that “not a single witness even attempted to argue that the Commonwealth can still pay its debts,” which exceed $70 billion, or more than the island’s gross national product. As the “first step of a disorderly default,” the judge said that Puerto Rico is projected to default on a $700 million general obligation bond payment in June.
Puerto Rico’s legislature enacted the AMT in May 2015 in 12 days. In his 109-page opinion written after a four-day trial in early February, Judge Fuste concluded that the AMT “is a legislative money grab pure and simple.” He held that the tax violates the dormant Commerce Clause in the U.S. Constitution, as well as the Equal Protection Clause and the Federal Relations Act. He enjoined the tax “immediately.”
The Supreme Court heard argument on March 22 in Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust and Acosta-Febo v. Franklin California Tax-Free Trust. If the high court reverses the First Circuit, Puerto Rico will be better able to deal with its debt crisis by utilizing a local law to restructure debt in a manner akin to chapter 11 reorganization. As a better solution for dealing with the island’s financial ills, bills are pending in Congress to give Puerto Rico’s municipalities and instrumentalities access to chapter 9. To read ABI’s report about the Supreme Court appeal, click here.
Under the prior version of the AMT before it was amended last year, Wal-Mart paid the tax at the rate of 2%. At the new rate of 6.5%, Judge Fuste said the retailer will pay “far more than it earns in net taxable income” in Puerto Rico. The tax, which the judge called “confiscatory,” was aimed at Wal-Mart, the “biggest fish in the pond.” No other retailer pays the tax at that rate.
Unless enjoined, the AMT obliges Puerto Rico to pay the tax in installments of $10 million a quarter. Puerto Rico law requires Wal-Mart to pay the tax, file an annual tax return, and claim a refund on the ground that the tax is illegal. Only after the commonwealth denies the refund would Wal-Mart be entitled to sue for a refund in the local courts.
Therefore, years would pass before Mal-Mart could have any hope of obtaining a judgment voiding the tax and winning the right to a refund. Given Puerto Rico’s insolvency, Wal-Mart would be “without any hope” of being reimbursed, the judge said.
Before deciding that the AMT is unconstitutional, Judge Fuste relied on an exception to the Butler Act, which deprives federal courts of jurisdiction to enjoin the collection of taxes in Puerto Rico. The Butler Act is an analog to the federal Tax Injunction Act.
Judge Fuste invoked an exception to the Butler Act, created by the First Circuit, which allows injunction actions “when there exists no plain, speedy and efficient remedies in the local forums.”