Article: Tax Haven Wants Its Welcome Mat Back

Tax Haven Wants Its Welcome Mat Back
U.S. Virgin Islands Says Crackdown Deals
Blow to Local Economy, Government Revenue
By ROBERT GUY MATTHEWS
December 27, 2006

For decades, the U.S. Virgin Islands was a friendly place for business owners looking to skirt U.S. taxes. Too friendly, Congress declared back in 2004, changing the relevant statute. Since then, the Treasury Department and Internal Revenue Service have been cracking down.

Now, elected officials and business leaders in the U.S. territory are complaining that the federal government has gone too far and the tax crackdown is threatening the local economy and government revenue. They are lobbying Congress to ease up.

"While these changes were aimed at preventing tax abuse by persons who neither lived nor worked in the Virgin Islands, the changes went too far, forcing many legitimate businesses to close their doors," Charles Turnbull, governor of the Virgin Islands (population about 109,000), told a Senate committee this year.

The controversy is a reminder that what looks like an odious tax dodge to the Treasury and IRS can look like a well-justified tax break to individuals and communities that benefit from it. The tension comes as the Treasury is under pressure to collect more of the taxes that are legally owed. The IRS estimates about 17% of all taxes owed -- about $290 billion every year -- go unpaid.

Forty miles east of Puerto Rico in the Caribbean, the U.S. Virgin Islands -- not to be confused with the British Virgin Islands -- include the islands of St. Croix, St. John and St. Thomas, and about 50 small islets and cays. They were named in 1493 by Christopher Columbus in reference to the legendary beauty of St. Ursula of Cologne and her 11,000 virgins. The U.S. bought them from the Danes for $25 million of gold in 1917 to improve military positioning during World War I.

Per capita income is just $14,500, less than that in Mississippi, the poorest state. The hilly islands have little room to grow food; many goods have to be flown or shipped in. About 80% of the territory's 43,000 jobs are tied to tourism.

In 1986, as part of a sweeping overhaul of U.S. tax laws, Congress opened the door to tax breaks to spur economic development in the territory. One of the biggest allowed the Virgin Islands to offer a deal to Americans who moved there to set up a business. Companies and individuals would pay the same taxes they paid in the U.S. -- minus 90%. By law, Virgin Islanders pay U.S. tax rates, but the money goes to the local government, not Washington.

To qualify, companies had to invest at least $100,000; hire at least 10 people, 80% from the Virgin Islands; and contribute $50,000 or more to local charities. The rules have since been eased in some cases.

In later years, as Washington began to crack down on tax abuse of all sorts, the Virgin Islands came under scrutiny. "Something had to be done," said Benedetta Kissel, deputy international tax counsel at the Treasury Department. "We were getting reports that people were living and working in the U.S. but claiming 90% discounts on their tax returns."

In June 2004, the IRS warned companies in what is known as the Economic Development Commission program to avoid manipulating residency and income rules to qualify for the tax break. The Treasury and IRS also began implementing new regulations that significantly lengthened the time a person seeking the tax break had to live in the Virgin Islands. The old rule required a resident to be on the Islands for 122 days a year on average, over three years, to qualify. The new ones required a resident to spend at least 183 days, or roughly six months, every year.
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The Treasury and IRS began enforcing the new regulation in earnest in early 2005, and -- to the consternation of some on the Islands -- the IRS asserted that it had authority to go back as far as it wanted without regard to the statute of limitations. IRS spokesman Terry Lemons wouldn't estimate how many audits are in the works, saying only that the Virgin Islands is facing increased scrutiny. "Basically, we have tried to figure out who was a bona fide resident who could claim these tax incentives," says Treasury's Ms. Kissel.

In the Virgin Islands, this is seen by some as overkill. "I don't think that there is any question that there were bad guys, but we here on the island are feeling the effects from the IRS," said Theodore Skolkus, a partner at Clearwater Consulting LLC. Four years ago, Mr. Skolkus, a tax attorney, set up a Virgin Islands consulting firm after moving from Arkansas to take advantage of the tax breaks. Because of new rules, he says, he has laid off two employees because one of his partners decided to leave the firm, taking away the extra business income to support existing staff.

Business owners say residency rules are a hardship because they have to leave the islands, often for long stretches to drum up clients.

In 2005, the Virgin Islands government spent at least $1.38 million lobbying the federal government on tax-related issues, according to Opensecrets.org. Included is a $140,000 fee to hire former Texas Republican Rep. Richard K. Armey. Mr. Armey, now with the law firm of DLA Piper, didn't return messages.

The number of financial firms that make the Virgin Islands their corporate home has fallen to less than 60 from 100 two years ago. One of the biggest to pull up stakes is a subsidiary of Chicago-based Driehaus Capital Management -- a retirement-planning outfit -- which expects to be gone by the end of the year. A Driehaus spokesman declined to give the reason for the company's departure.

Applications to sign up for the 90% tax breaks have fallen to zero, said Frank Schulterbrandt, chief executive officer of the Virgin Islands Economic Development Authority, which runs the program. He said the program created 3,000 high-paying jobs and generated about $114 million of tax revenue to the islands. The crackdown has chilled economic growth and scared away future investment, even though the agency has jettisoned those who were improperly claiming the tax break. "We have been blindsided and we didn't have time to negotiate," he said.

Firms that remain in the program are asking for permission to employ fewer locals than previously required.

Gov. Turnbull and Donna M. Christensen, a Democrat who is the territory's nonvoting delegate in Congress, insist they aren't looking to make the Virgin Islands a tax haven. But they argue that the U.S. government should balance cracking down on tax cheats with helping the islands to become more self-sufficient and its economy more diversified.

To buttress their argument, the territorial government hired PricewaterhouseCoopers to assess the effect of the tax breaks. That report said the islands could lose $80 million, or more than a tenth of the $633 million of corporate and individual tax receipts, if the economic-development program's tax incentives end.