14 ASIA-PACIFIC TAX BULLETIN
NORTHERN MARIANA ISLANDS
New Legislation Eliminates Second-Tier
“Earnings Tax” on Passive Income
By Gregory J. Koebel
Gregory J. Koebel is the resident tax partner of the
Saipan, Commonwealth of the Northern Mariana
Islands office (fax: +1 670 234-5683; e-mail:
odb.law@saipan.com) of the Micronesia-wide law firm
of O’Connor Berman Dotts & Banes, which also has
offices in Guam (fax: +1 671 477-4366), the
Federated States of Micronesia (fax: +1 691 320-
5450) and the Republic of Palau (fax: +1 680 488-
4579). Mr Koebel received a Master of Laws Degree
in Taxation from New York University in 1992.
I. BACKGROUND INFORMATION AND INCOME
TAX
The Commonwealth of the Northern Mariana Islands (the
“CNMI”) is a self-governing Commonwealth in political
union with the United States. It consists of a chain of
islands, three of which are inhabited, beginning about 75
miles north of the US Territory of Guam.
The CNMI’s political status is defined in the Covenant to
Establish a Commonwealth with the United States
(adopted as US Public Law 94-241). Under this Covenant,
most of the Internal Revenue Code (the “IRC”) is adopted
as the local “mirror image” income tax regime, adminis-
tered and enforced by the Commonwealth Division Rev-
enue and Taxation.
CNMI resident individuals, partnerships and corporations
file yearly income tax returns, which are in most ways
identical to their US counterparts.1 Income tax, as well as
all other locally imposed taxes paid by CNMI taxpayers,
are retained by the CNMI Government. However, FICA
and FUTA taxes are still payable by CNMI residents to the
Internal Revenue Service.
The major advantage to the CNMI income tax system is
the rebate provision built into the legislation. Under 4
Commonwealth Code §1708, every taxpayer is entitled to
a rebate of income taxes paid on CNMI-sourced income
during the prior tax year.
The rebate for both individuals and corporations is at pre-
sent graduated from 90% of CNMI-source income tax
paid for the first USD 20,000 paid in, to 70% of the next
USD 80,000 paid in to 50% of any amount paid over USD
100,000.
Consequently, an individual whose CNMI-sourced
income tax liability (calculated in accordance with the
© 1999 IBFD Publications BV
Exported / Printed on 20 July 2019 by niluh.wulandari@pajak.go.id.
JANUARY 1999
IRC) in year 1 is USD 50,000 will receive USD 39,000
(i.e. USD 18,000 + [70% x USD 30,000]) as a rebate after
filing his or her form 1040CM on or before 15 April of
year 2. Similarly, a corporation with a CNMI-sourced
income tax liability in year 1 of USD 2,080,000 will
receive USD 1,074,000 (i.e. USD 74,000 + [50% x USD
2,000,000]) as a rebate after filing its form 1120CM on or
before 15 April of year 2.
There are no sales, VAT or property taxes imposed in the
CNMI.
II. ADDITIONAL TAXES
In addition to the mirror-image income tax, the Covenant
authorizes the CNMI to impose other taxes. Aside from
peripheral taxes such as Excise Taxes and User Fees, the
only significant additional taxes, before 1995, were:
– a wage and salary tax; and
– a business gross revenue tax.
Both of these taxes are gross taxes imposed at graduated
rates. The wage and salary tax is imposed upon all of the
gross wages earned in the CNMI by CNMI residents. The
rate is graduated at nine levels, starting at no tax for wage
earnings under USD 1,000 to 9% on all wage earnings
over USD 50,000.
The business gross revenue tax is imposed on all gross
receipts of a business, whether in the corporate, individual
or partnership form. The business gross revenue tax is
applied at different rates depending on amount and type of
revenue received. For instance, banks and wholesalers are
taxed at a lower rate than retailers, construction companies
and hotels. By and large, the rate fluctuates between 3%
and 5% of gross receipts.
Although both the wage and salary tax and the business
gross revenue tax are allowed as a non-refundable credit
against the CNMI income tax, they do represent a signifi-
cant liability as an addition to the CNMI income tax for
resident individuals and businesses. This is primarily
because the credit against the CNMI income tax is taken
before the rebate calculation is made, thus dramatically
reducing, and in some cases eliminating, the value of the
rebate. For instance, a corporation with an income tax lia-
bility of USD 50,000 and gross receipts liability of USD
1. For instance, the Commonwealth corporate tax return is form 1120CM
while the basic personal return is the form 1040CM.
JANUARY 1999 ASIA-PACIFIC TAX BULLETIN
35,000 has only USD 15,000 of income tax paid which is
subject to the rebate.
Before January, 1995, there were no flat taxes similar to
the business gross revenue and wage and salary taxes on
the passive income and non-real-estate-based capital gains
of CNMI resident individuals and businesses. Provided
that the passive income of CNMI residents was CNMI-
sourced, such passive income and capital gains were sub-
ject only to the income tax, at least 50% (and up to 95%)
of which income tax paid was rebated to the resident tax-
payer. Non CNMI-sourced passive income is not rebat-
able, and so CNMI residents must pay at the same rate as
they would in the United States on such non-CNMI-
sourced income. This system had the effect of encouraging
CNMI residents to invest in the CNMI.
III. PELLEGRINO V. SECRETARY OF FINANCE
In 1994, the CNMI Department of Revenue and Taxation
(the “Department”) levied an assessment of approximately
USD 250,000, consisting of unpaid gross revenue tax,
penalties and interest, upon Anthony and Eileen Pelle-
grino, a local couple who own and operate a number of
CNMI corporations.
The Department based its assessment on a finding that the
Pellegrinos should have paid business gross revenue tax
on dividends received from their shareholdings in local
corporations and interest received from local bank
accounts. This was the first time that the CNMI Govern-
ment had tried to impose any sort of gross tax on passive
income, other than gain from the sale of real property,
which is specifically provided for in the business gross
revenue tax legislation.
After an administrative appeal where the Department’s
Administrative Hearing Officer found for the Department,
the Pellegrinos filed a law suit in the CNMI Superior
Court for a Declaratory Ruling. The Superior Court found
for the Pellegrinos, ruling that passive income such as div-
idends and interest is not subject to the business gross rev-
enue tax.2
The Department appealed to the CNMI Supreme Court,
where the issue was briefed and argued. At the time this
article was written, no decision had yet been issued by the
CNMI Supreme Court.
IV. THE EARNINGS TAX
In January 1995, while the Pellegrino case was pending,
the CNMI Legislature enacted, and Governor Froilan C.
Tenorio signed, Public Law 9-22, commonly referred to as
the “Revenue Act of 1995” (the “1995 Act”). Two major
features of the 1995 Act were:
– the lowering of the rebate percentage on CNMI-
sourced income tax paid; and
– the addition of a new “Earnings Tax”.
This Earnings Tax applied a “second-tier” flat tax on,
basically, all CNMI-sourced income not already subject to
the business gross revenue tax or the wage and salary tax.
© 1999 IBFD Publications BV
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15
“Earnings” in the 1995 Act was defined in a number of
separate subsections. §1202(b)(4) of the 1995 Act set forth
that “earnings” included:3
[I]nterest, dividends, rents, royalties, or similar income
earned in and derived from a person in the Commonwealth
and received by a resident not in the course of carrying on a
business.
The Earnings Tax was applied at the same graduated rate
as the Wage and Salary Tax, and similarly allowed as a
non-refundable credit against the CNMI income tax.4
This new Earnings Tax, combined with the reduced rebate
percentage on the income tax, had a significantly adverse
effect on taxpayers with CNMI-sourced capital gains from
sales of personal property and passive income. For
instance, an individual taxpayer who had USD 50,000 of
CNMI-sourced personal property capital gains/passive
income in 1995 would have approximately USD 9,750 of
income/earnings tax liability; only a year earlier, the lia-
bility would have been about USD 1,500, solely in income
tax. Naturally, this had an extremely adverse effect on
CNMI-based investment.
V. REPEAL OF EARNINGS TAX AND
REINSTATEMENT OF HIGHER REBATE
In late 1987, the Commonwealth Legislature passed the
Public Laws 10-74 and 10-80, collectively known as the
“Taxpayer Relief Act of 1997”.
Public Law 10-80, signed into law by Governor Froilan C.
Tenorio on 6 January 1998, applied retroactively to 1 Jan-
uary 1997.
Public Law 10-80 Act repealed §1202(b)(4) of the 1995
Act,5 effectively eliminating passive income from the def-
inition of “earnings” for Earnings Tax purposes.
Capital gains continue to be subject to the Earnings Tax,
although only 50% of the gain from the sale or long-term
lease of real property is so subject.6
Public Law 10-74, which was signed by the Governor
Tenorio on 19 December 1997, applied retroactively to 1
October 1997 and raised the rebate amount available to
resident individuals on the CNMI-sourced income tax paid
to the same levels as corporate entities. At present, both
individuals and corporations receive a rebate of:
– 90% of the first USD 20,000 of CNMI-sourced
income tax paid;
– 70% of the next USD 80,000 paid; and
– 50% and all amounts over USD 100,000 paid.
Consequently, the only tax to which CNMI-sourced pas-
sive income is presently subject is the CNMI income tax,
which is greatly reduced by the rebate mechanism. This
2. Superior Court of the Commonwealth of the Northern Mariana Islands
Civil Action No. 96-533.
3. Commonwealth of the Northern Mariana Islands Public Law 9-22
§1202(b)(4).
4. Commonwealth of the Northern Mariana Islands Public Law 9-22 §§1204,
1205(a).
5. Commonwealth of the Northern Mariana Islands Public Law 10-80 §2.
6. Commonwealth of the Northern Mariana Islands Public Law 9-22
§1202(b)(1), (b)(2).
16 ASIA-PACIFIC TAX BULLETIN JANUARY 1999

creates significant tax saving opportunities for locally Japan, Taiwan, South Korea and other Asian nations who
based asset-management trusts, as well as for individual are taking advantage of the attractive tax benefits afforded
investors. The CNMI is now experiencing a slow but them in the US Commonwealth.
steady trickle of retirees from the US mainland, as well as

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