SECTION 2. BACKGROUND

The Treasury Department and the IRS are aware that certain U.S. taxpayers with operations in Puerto Rico (including operations conducted indirectly through subsidiaries or other affiliates) have negotiated long-term tax agreements with Puerto Rico, known as tax decrees, that provide more favorable tax treatment than under the generally applicable Puerto Rico tax laws. Among other benefits, these tax decrees provide for reduced rates of tax levied on U.S. taxpayers and their affiliates performing certain activities in Puerto Rico. However, the tax decrees do not modify the application of the modified effectively connected income rules (Modified ECI Rules) of section 1123(f)(3)(B) of the Puerto Rico Internal Revenue Code of 1994, as amended (1994 PR IRC) and incorporated by reference into the Puerto Rico Internal Revenue Code of 2011, as amended (2011 PR IRC), by section 1035.05 of the 2011 PR IRC. The Modified ECI Rules impose a tax on income deemed to be earned in connection with a Puerto Rico trade or business (Modified ECI Tax). Similarly, the tax decrees do not modify the application of the excise tax (Excise Tax) on the acquisition of certain

personal property manufactured or produced in Puerto Rico and amounts paid for certain services performed in Puerto Rico that is imposed by sections 2101 through 2106 of the 1994 PR IRC and incorporated by reference into the 2011 PR IRC by section 1035.05 of the 2011 PR IRC.