For some time now, the V.I. government has recruited industry and new businesses through its Economic Development Program. We have induced businesses to relocate from more expensive areas by extolling the benefits of the EDP tax-incentive program. The strategy has worked, at least to attract new businesses.
Recently the Internal Revenue Service published a warning addressing both residency and promoting issues. Aside from the sourcing issue, there are other two significant issues:
– Bona-fide residency of the EDP beneficiaries.
– Conduct that has been viewed as unethically promoting the EDC tax benefits.
Since these issues have been the subject of conversation and debate for well over two years in the stateside tax community, the IRS warning should have come as no surprise. For example, on May 22, 2003, a letter authored by an unidentified practitioner directed to Pamela Olsen, assistant secretary for tax policy, called for a crackdown of what he called the U.S. Virgin Islands' tax shelters. The writer submitted a memorandum that he reported was presented to him "from a group selling the Virgin Islands as a tax shelter." He was particularly "outraged" by the group's position that an audit was highly unlikely and called for the disbarment for practitioners communicating this type of advice. Further, he questioned the credibility of the group's claims of residency.
In response to the residency issue, one local commentator has suggested that the federal government enact a law allowing an individual to qualify as a Virgin Islands resident if he or she is present in the Virgin Islands 122 days over the course of three years. Even if the federal government enacted such a low threshold for residency, the majority of the states also impose a day-counting mechanism, often 183 days, as the basis for their taxing jurisdiction. Thus, an individual will still be vulnerable to challenge and costly litigation under those state laws.
Finally, similar to the lobbying efforts that resulted in the repeal of Puerto Rico's tax benefits under Title 26, section 936, it would simply be a matter of time before states banded together to lobby the federal government to either modify or repeal the federal statute empowering the Virgin Islands to offer these tax incentives.
Although day counting need not necessarily be conclusive, the beneficiary should be required to demonstrate effectively that he or she has, in fact, relocated his/her primary residence to the Virgin Islands. Nevertheless, the local government may have lost the opportunity to have much of an impact, since the federal government has stepped in.
There is another practice that has been subject to intense scrutiny in the United States. In an effort to avoid hiring 10 Virgin Islands residents as employees, established EDP companies are offering limited partnerships for a price. This practice is simply one method of franchising the EDP tax benefits. The promoter issue more than likely will prove to be more challenging to resolve than the residency issue. It will be difficult to discern what factors signify legitimate attempts to attract capital investment from those "franchising" efforts where the primary intent is to avoid a local statutory requirement.
Although the residency issue has come under the domain of the federal government, instead of keeping a low profile or waiting for the federal government to act, the Virgin Islands government should be proactive and address the promoter issue before it, too, becomes subject to federal regulation.
The local government should begin problem-solving the unethical promoter conduct by identifying and articulating factors supporting legitimate capital investment through partnership, shareholder or member capital contributions. Further, the V.I. government should consider whether there are viable alternatives to some of the local statutory requirements.
In this way, the government would neutralize the incentive for potential investors to "buy into" an existing company without a common legitimate business purpose. For example, in lieu of an employee commitment, the government could allow the beneficiary to commit to providing a scholarship for a V.I. resident to a credible academic or vocational program. Another alternative may be to base the employee requirement on sliding scale that parallels the company's annual income flow.
If we are unable to provide a work force with the skills needed by today's businesses, our economic development success will be limited. Studies critiquing stateside tax-incentive programs have been conducted, and the findings reflect that offering tax incentives alone often prevents jurisdictions from raising their economies, their educational systems and the quality of life of the local population. Unless a jurisdiction simultaneously improves the sophistication of its local labor pool and educational systems, the sole offering of tax incentives often creates a cycle of low-wage, low-skill industry begetting more low-wage low-skill industry.
The scholarship in lieu of a statutory employee requirement would break the cycle of low-wage, low-skill patterns of employment and provide uneducated and/or unskilled V.I. residents a meaningful opportunity to rise above their circumstances while greatly minimizing the allure of the unethical marketing ploys of certain franchising promoters.
It is high time that the old adage "Discipline yourself, so others don't have to…" is abandoned. We need a local government official to step up to the plate, risk being labeled "anti-business" and admit "yes, we have problems, but give us the opportunity to fix them" — and then make a wholehearted attempt to do so. Otherwise, the legitimacy of the EDP program is compromised.
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