Hearing: Hearing On Members Proposals On Tax Issues Introduced In The 109th Congress
Mr. Chairman and Distinguished Members of the Subcommittee, I am pleased to have this opportunity to appear before you in support of H.R. 273, legislation I introduced last year to repeal the cap, under Section 7652(f) of the Internal Revenue Code ("Code"), on the rate of excise tax on Virgin Islands and Puerto Rico rum shipped to the United States and returned, or "covered-over," to the treasuries of the Virgin Islands and Puerto Rico, respectively. This legislation would eliminate the need for Congress to periodically extend the current cover-over rate as is now the case. I am not aware of any policy objections to this legislation, and I respectfully ask that this Committee act on it at the earliest practicable time.
At the same time, I would like to take this opportunity to bring an issue to the attention of the Subcommittee that is having an extremely damaging impact on the Virgin Islands economy.
As you know, residents of the Virgin Islands, as citizens of the United States, are required to pay Federal income tax like any other citizen living outside the United States. However, section 932 of the Internal Revenue Code ("Code") states that bona fide residents of the Virgin Islands are not required to file an income tax return with the IRS. They are required instead, to file their income tax return and pay the applicable tax to, the Government of the Virgin Islands.
The amount of the liability to the Virgin Islands, determined under the "mirror code" system, in most cases is exactly the same amount that they would otherwise have been required to pay to the Federal Government. The only exception is a provision under Section 934 of the Code which permits the Virgin Islands to provide economic development incentives through tax credits or tax rate reductions for income from sources in the Virgin Islands or income effectively connected with the conduct of a trade or business in the Virgin Islands.
Pursuant to this authority, the government of the Virgin Islands established, almost 50 years ago, an economic development program that was intended to diversify the local economy, create jobs for its citizens, and to lessen its dependence on the Federal Government.
Under this program, the VI government provided tax incentives to qualified businesses that established operations and invested in the Virgin Islands, and that met the program's criteria for creating jobs and economic opportunity for Virgin Islanders.
In response to concerns that some U.S. citizens claimed tax benefits who neither lived nor worked in the Territory, Congress two years ago tightened the income and residency rules as part of the American Jobs Creation Act of 2004 ("Jobs Act"). With respect to the rules for determining residency in the Virgin Islands, the Jobs Act replaced a "facts and circumstances test" similar to that previously used for determining the tax residency for aliens with a physical presence test, a closer connection test, and a tax home test.
At around the same time, the U.S. Internal Revenue Service ("IRS") initiated a comprehensive series of audits not only of individuals who participated in the Territory's Economic Development Commission ("EDC") program, but also of many taxpayers who had moved to the Virgin Islands years earlier and who did not participate in the EDC program as well as taxpayers who were born in the Virgin Islands but who had spent periods of their working life outside the Territory due to the lack of opportunities in the Virgin Islands.
Neither the VI government nor most responsible members of our EDC community have any objection to properly conducted IRS audits with clear audit guidelines in place at the outset.
However, it appears that the IRS has used the subjective nature of the pre-Jobs Act legal standard for determining bona fide V.I. residency as a "hunting license" for challenging anyone who claimed EDC benefits as a potential participant in an abusive tax shelter, rather than as a participant in a lawful economic development program duly authorized by the Congress.
Indeed, I have been informed by many of my constituents who have been the subject of such audits that some IRS agents have taken the position that anyone who moved to the Virgin Islands for the principal purpose of taking advantage of EDC benefits, by definition, cannot be a bona fide V.I. resident, even if the individual meets all generally accepted tests of residency under pre-Jobs Act law.
Such a position not only stands the law, on which the EDC program is based, on its head, but has served unfairly and improperly to influence and distort IRS's entire approach to the ongoing audits of V.I. taxpayers.
Rather than facilitating and ensuring tax compliance and, if the facts warrant, ferreting out wrongdoers, the IRS audits have instead become a vehicle for undermining a Congressionally sanctioned and authorized economic development program through punitive and heavy-handed techniques, including repetitive, intrusive, and burdensome data and document requests. Unfortunately and unfairly, the IRS audit presumption seems to be that the taxpayer engaged in tax fraud unless he or she can prove otherwise.
The IRS tactics, however, go far beyond intrusive and burdensome data requests. In the course of these audits, the IRS has reversed its long-standing administrative practice and published position, and now claims that the statute of limitations never runs for V.I. taxpayers who reasonably and in good faith file their tax returns with, and pay their tax to, the Virgin Islands Bureau of Internal Revenue ("BIR"), as the law requires them to do.
In a recent General Counsel Advisory Memorandum, the IRS announced its new position that it has the right to audit the returns of a V.I. taxpayer as far back as they like and, if they determine under the subjective pre-Jobs Act test that the taxpayer was not a bona fide V.I. resident, that it can assess full tax and penalties even if the taxpayer has paid the correct amount to the Virgin Islands.
Because the Virgin Islands statute of limitations will have run in many of these circumstances, the taxpayer will be precluded from seeking a refund of tax paid to the Virgin Islands, and thus be subject to double taxation. Moreover, since the IRS position reverses a previously issued IRS advisory memorandum and also runs counter to the general rule that persons can be audited for up to three years after filing a return, many taxpayers who are being audited no longer have the records to defend themselves.
Similarly, at least some IRS agents may now be taking the position that even a bona fide V.I. resident who underpays his tax to the Virgin Islands by even one dollar (even if this is a result of a good faith error) may now be subject to full taxation by the United States without regard to, or credit for, any payments made to the Virgin Islands.
Such a position is not only not without legal support, but it operates perversely as a disincentive for the BIR to audit and seek any underpayments of tax from its own V.I. taxpayers.
These heavy handed practices have been damaging to the Territory's EDC program, raising the specter of guaranteed and endless audits of virtually anyone who moves to, and invests in, the Virgin Islands.
This is not, I would respectfully submit, what Congress had in mind when it enacted the Virgin Islands tax incentives at issue as part of the 1986 Tax Reform Act, or when Congress acted to include more objective factors in the determination of residency and sourcing of income as part of the Jobs Act in 2004.
Representatives of the VI government, including the BIR, are working with Treasury and IRS officials in an effort to minimize the burdens and intrusiveness of the audit process. There needs to be published reasonable and precedent-based IRS audit guidelines for the determination of bona fide V.I. residency under pre-Jobs Act law in order to avoid IRS audit abuse. The IRS needs to state up front that the EDC program is a legitimate, congressionally sanctioned economic development program and that participation in the EDC program does not create a rebuttable presumption that the taxpayer/investor is not a bona fide V.I. resident, engaged in tax fraud, or unlawfully participating in a tax shelter.
Most importantly, if not soon reversed by IRS or Treasury administrative action, Congress needs to clarify that, consistent with the language and legislative intent of the 1986 Tax Reform Act, the filing of a tax return by a bona fide resident of the Virgin Islands with the BIR starts the running of the statute of limitations in both the Virgin Islands and the United States and that a person who filed his return with the Virgin Islands as a bona fide resident of the Virgin Islands in good faith for years that are now closed for Virgin Islands purposes should be credited for any tax paid to the BIR, even if the person is subsequently determined not to have been a Virgin Islands resident by the IRS.
And finally, to the extent that a bona fide Virgin Islands resident underpays his tax liability to the Virgin Islands, any residual tax liability should be payable to the Virgin Islands and not the United States.
Mr. Chairman, I look forward to working with you and Members of this Subcommittee to resolve these important issues which are so critical to the economic development and well-being of the United States Virgin Islands. Thank you.