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Pay to the Order of Puerto Rico

By Alexander Odishelidze and Arthur Laffer

(Complete work below in “Must Axxess Files” box.)

Vignette 2: A New Friend of Commonwealth

Jose Fernandez Antonsanti is a Puerto Rican entrepreneur. He comes from one of the oldest and best-known families in Puerto Rico, a family that can trace its roots to the 18th century and, before that, to Spain and Corsica. His early education was from one of the best private schools in San Juan. Later, he received an engineering degree from MIT and an MBA from Harvard.

Although the family was prominent in Puerto Rico, agricultural products have not been a hot property for the making or keeping of fortunes for almost a century. The Antonsantis have survived by living off the real estate investments their ancestors made with their long-gone plantation profits. As a matter of fact, there was barely enough cash flow to keep Jose in college. But Jose was a bright and imaginative young man and, with the help of scholarships and federal assistance (he was considered a “minority,” though he was anything but that on the island), he managed to keep his financial head above water and graduate with honors.

His lucky stroke was to have as his roommate at MIT one Juan Luis Cabral, a young man from a wealthy family in Cali, Colombia. Juan’s family had properties and businesses all over the world and especially in their home country, in Medellin.

Juan introduced his new friend Jose to his family in Colombia and he became like another son to the Cabrals. When Jose graduated from Harvard he took his newfound engineering and business skills and went to work for the largest building contractor in Puerto Rico. After a few years there, he tried his luck as a developer, but lacking strong financial backing made the going very tough. Although the Antonsantis still had a significant net worth, all of Jose’s aunts and uncles were so dependent on the rental cash flow from the crumbling buildings they owned in San Juan that it was impossible for Jose to tap that equity for new ventures.

One day Juan invited a frustrated Jose to his family home in Cali and made him an offer he could not refuse. Jose was tendered full financial backing for major real estate developments in Puerto Rico. Jose was enthralled. This was the fulfillment of Jose’s dream, the focus of all his schooling.

There was a catch. Even though on the surface Jose would appear to be the sole owner of a real estate development company, he would have no say in the disposition of the resulting cash flow.

Nor would he be privy to all the financial transactions related to those projects. Yet he would have to sign-off as the chief executive officer of the corporation on all its tax returns. Jose would run the business, but Juan’s family would run the money.

Jose recognized immediately that it was not his nickel that was on the line. He had everything to gain and nothing to lose. He said “yes” immediately.

The biggest challenge for any successful drug production and smuggling operation is that its proceeds are in cash and most of its expenses are also in cash. The profits that accrue to the higher-level drug producers and importers have to be converted into legitimate investments. Otherwise, this perishable paper would rot in their suitcases. Most small-time dealers find ways to dissipate their income. It’s not that difficult to process into legitimate businesses hundreds of thousands or even one or two million a year in cash.

When you are talking about tens and hundreds of millions of dollars a year, you now have a serious problem. To launder money in these amounts and bring it into the mainstream of business activity in the industrialized world, a cooperative bank willing to accept suitcases full of cash is needed. This bank will be of little use if it is within a jurisdiction where banks must report and bank regulators routinely scrutinize unusually large cash transactions. Moreover, tax agencies can make matters truly difficult for businesses with cash flows out of all proportion to other size or their character.

In Puerto Rico, money launderers have a good half of what they desire. Even though the Puerto Rican banking system is part of the U.S. system and is subject to comparable regulatory oversight, there is no equivalent of the Internal Revenue Service to monitor the income of local businesses with local income. The result is that the island is a magnet for Caribbean Basin drug profits, a funnel that, properly managed by its manipulators, can disperse drug proceeds into sheltered accounts all over the world.

If you are one of big drug dealers, you can always pull up a boatload of cash to a sandy beach in the Cayman Islands, the Bahamas, or any other remote jurisdiction that specializes in bank secrecy and has not signed a U.S. cooperation agreement. You can easily dispose of this cash by depositing a few dozen suitcases of the stuff into a local bank, using a numbered account issued to a shell corporation, which you control. You can now shuffle this money all over the world via wire transfer from one shell corporation to another. Eventually, tracing the money becomes all-but-impossible.

Now suppose you want to invest part of this money in the United States. Your primary business is risky enough; you don’t want to have comparably risky investments so you want the safest financial markets on the globe. The moment your money hits a corporate or individual account in the United States, you have a law enforcement periscope fastened on your stern. You ponder your options. Someone tells you about Internal Revenue Code Section 933.

Under this provision, all income generated in Puerto Rico by U.S. citizens living on the island, or by corporations domiciled in Puerto Rico, is not reportable to the Internal Revenue Services for U.S. income tax purposes.

Bingo! A license to launder.

So long as Puerto Rico remains a territory of the United States, whatever name is assigned to that territorial status, this condition will apply. Jose now learns the lessons of his new financial partnership. If he wants to build a $100 million shopping center in San Juan, he has access to all the capital he wants. He can have a Swiss shell corporation, as an investor, guarantee a loan through his local bank. Thus, a Puerto Rican bank provides the cash for a mammoth business development backed by deposits in another part of the world. The best part is that the Internal Revenue Service will never ask where the money came from and why a Swiss has so much confidence in a novice developer in Puerto Rico. It’s a financial global village, no? As long as Section 933 is in force, the IRS has no interest in the income generated on the ground in Puerto Rico.

For local people, Jose’s success, sudden as it may be, isn’t newsworthy. They will say, “Ah, it’s young Fernandez Antonsanti. He’s from a leading family and I knew his grandfather personally.

How hard they worked!” So no questions asked. Once a business is opened on U.S. soil, the Commonwealth of Puerto Rico included, millions of dollars can be poured into it, expanding property, building hotels, shopping centers and office buildings, without the Internal Revenue Service making a single inquiry. Territorial income is isolated income, and practices that would subject your business in Seattle or Peoria to intense examination trigger nothing when your business is in San Juan or Ponce. Consider the impact of this windfall on Jose Fernandez Antonsanti’s politics. Suddenly he is a champion of territorial status.

He will support a local political party that advocates maintaining the status quo, and he will make contributions from his windfall to U.S. politicians (he can do so because, though he does not vote for president or a voting member of the Congress, he is still a U.S. citizen) who will work to resist Puerto Rico’s transition to statehood or independence. He may even become a local civic leader for the cause, rallying his fellow Puerto Ricans for a cause that serves his pocketbook in the short term and compromises theirs forever.

All of this he will do, not with his own money, but with the cash supplied by the Cabral family of Cali. If Jose were ever to take a close look at the books of the company he heads, he would see income that he is unable to explain and expenses and loans that are a complete mystery. It is better for him if he does not look, even though the Internal Revenue Service will never ask about lapses in the conduct of a prosperous CEO.



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