Puerto Rico is a self-governing territory of the United States located in the Caribbean Sea. In order to bolster its economy, the government of Puerto Rico has created an aggressive economic and tax incentives program with the purpose of establishing Puerto Rico as an international service center by helping operations on the island become more profitable to those companies who establish themselves in Puerto Rico. Likewise, Puerto Rico is trying to stimulate its economic development by offering 100% tax exemptions on all interest, all dividends, and all long-term capital gains to investors that become bona-fide residents of Puerto Rico. These benefits are possible because income generated within Puerto Rico is generally not subject to U.S. federal taxation.
Puerto Rico is a self-governing territory of the United States located in the Caribbean Sea. In order to bolster its economy, the government of Puerto Rico has created an aggressive economic and tax incentives program with the purpose of establishing Puerto Rico as an international service center. Likewise, Puerto Rico is trying to stimulate its economic development by offering 100% tax exemptions on interest, dividends, and capital gains to investors that become bona-fide residents of Puerto Rico. These benefits are possible because income generated within Puerto Rico is generally not subject to U.S. federal taxation. Puerto Rico has its own hybrid tax system outside of Federal Code, where is explicit that the Puerto Rico sourced income are excluded from Federal Taxation through Internal Revenue Code: 26 U.S. Code s 933. In addition, it is important to consider that Puerto Ricans are US citizens and have a US passport, as well as the same currency tan in US, the US Dollar.
On January 17, 2012 Puerto Rico (PR) enacted Act No. 20 of 2012, as amended, known as the “Export Services Act” in order to promote the exportation of services and allure outside service entities to relocate to the Island for the purposes of stimulating economic growth. The Act provides attractive tax incentives and tax credits to entities that establish their export services in the Island. In order to avail from such benefits, the business needs to apply for a tax concession and obtain a tax exemption decree.
Act 20 applies to any entity with a bona-fide establishment in Puerto Rico that is engaged in an eligible service for export (from Puerto Rico to clients outside Puerto Rico). Eligible services include but are not limited to: consulting services on matters relating to any trade or business; investment banking and other financial services; research and development; advertising and public relations; economic, scientific, environmental, technological, managerial, marketing, human resources, engineering, information systems, auditing and consulting services; services performed by electronic data processing centers; call centers; professional services (such as medical, legal, tax and accounting services), and centralized managerial services, among others. An eligible service must also qualify as an export service. An eligible service done by a foreign entity or non-resident individual that does not relate to business activities within Puerto Rico qualifies as an export service.
A business that renders eligible export services can request the issuance of a tax exemption decree under Act 20. Pursuant to such decree, the export services business will only be subject to:
4% Fixed Income Tax Rate: A 4% fixed income tax rate on income generated from export services.
3% Fixed Income Tax Rate: A 3% fixed income rate in case of services considered strategic.
0% Taxes on Earnings and Profit: The exemption includes a 100% tax exemption of earning and profit distributions on income generated from export services.
0% Real Property Tax: 100% property tax exemption for the initial 5 years of operation for certain export services including corporate headquarters, call centers, shared service centers for accounting, finance, marketing, human resources, and other centralized management services. After the 5-year period expires, a 90% tax exemption will apply for the remainder of the Tax Exemption Decree. The taxable portion will be subject to the regular tax rate, which currently can be up to 10.83%. Therefore, after considering the 90% exemption, the effective tax rate would be up to 1.083%.
0% Personal Property Tax: 100% property tax exemption for the initial 5 years of operation for certain types of businesses. After the 5-year period expires, a 90% tax exemption will apply for the remainder of the Tax Exemption Decree. The taxable portion will be subject to the regular tax rate, which currently can be up to 8.83%. Therefore, after considering the 90% exemption, the effective tax rate would be up to .883%.
60% Tax Exemption on Municipal Taxes (90% tax exemption if business operates in industrial development zones constituted by Vieques and Culebra): Any taxable portion will be subject to regular tax rate, which currently can be up to .5%. Therefore, after considering the 60% exemption, the effective tax rate would be up to .02%.
Tax Exemption Decree
Eligible export services businesses that request the benefits of Act 20 are subject to a $750 filing fee that is payable upon filing the petition for the grant. Once the Act 20 grant is issued, grantee must file an annual report showing its compliance with the terms and conditions of the grant during such year, together with an annual fee of $300.
An eligible service provider’s exemption decree will endure for a term of 20 years and may be renewed for an additional 10 years. The tax exemption decree constitutes a contract between the service provider and the Puerto Rican Government that is immune to any future legislation.
On January, 2012, along with Act 20, Puerto Rico enacted Act No. 22 of 2012, as amended, which is known as the “Act to Promote the Relocation of Individual Investors”. This Act helps stimulate Puerto Rico’s economic development by offering bona-fide residents of Puerto Rico 100% tax exemptions on interests and dividends on PR sourced income and all long-term capital gains when they relocate to Puerto Rico. This Act combined with US Internal Revenue Code (“US-IRC”) provisions dealing with Puerto Rico and its residents, provide extraordinary income tax benefits to an individual that:
Did not reside in Puerto Rico at any time from January 16, 2006 through January 16, 2012.
Becomes a bona fide resident of Puerto Rico after January 17, 2012.
Obtains a Tax Exemption Grant under Act 22.
As per the U.S. Internal Revenue Code (Sections 933 and 937), a bona-fide resident of Puerto Rico is a person who meets the following tests:
1) Presence test. The individual must meet any of the following: (1) be present in Puerto Rico for at least 183 days during the calendar year; (2) be present in the United States for no more than 90 days during the calendar year; (3) have no earned income from sources within the United States (that is, compensation for labor or personal services rendered by the manager in the United States exceeding $3,000) and be present in Puerto Rico for more days than in the United States; (4) be present in Puerto Rico for a minimum of 549 days during the three-year period that includes the cur- rent tax year and the two preceding calendar years, as long as he is also present in Puerto Rico for a minimum of 60 days during each of those three years; or (5) have no ‘‘significant connection’’ to the United States.
2) Tax Home Test. The individual’s regular (or principal, if more than one) place of business that he claims for purposes of determining income tax deductions for traveling expenses while away from home in the pursuit of a trade or business must be in Puerto Rico. Thus, to meet the tax home test, the individual must spend substantially more time working from his office in Puerto Rico than from an office in the United States or a foreign country.
3) Closer Connection Test. The individual must have a closer connection to Puerto Rico than the U.S. or any other foreign country. The closer connection is determined by a variety of factors including but not limited to the following: (1) the location of the individual’s permanent home; (2) the location of the individual’s family; (3) the location of the individual’s personal belongings, such as automobiles, furniture, clothing, and jewelry; (4) the location of social, political, cultural, or religious organizations with which the individual has relationships; (5) the location where the individual conducts routine personal banking activities; (6) the location where the individual conducts business activities (other than those that constitute the individual’s tax home); (7) the location where the individual holds a driver’s license; (8) the location where the individual votes; and (9) the country of residence designated by the individual on all official government forms, documents, and tax returns. The significant connections analysis can also take into account similar factors that attempt to show that the individual is no longer living in the United States.
The “Eligible Individual” must be certain to qualify as bona-fide resident of Puerto Rico, as defined in US-IRC §937. Bona fide residency in Puerto Rico must be for the entire calendar year. Accordingly, the individual must meet the tax home and closer connection tests on or before December 31 of the year preceding the calendar year for which the individual intends to qualify as a bona fide resident and must meet the presence test during the calendar year for which he/she wishes to qualify as a bona fide resident. If the individual is not a bona fide resident of PR during the entire calendar year, the individual may nonetheless qualify as a bona fide resident of PR as long as he/she (1) was not a bona fide resident of PR for any of the three calendar years immediately preceding the year of the move to Puerto Rico; (2) meets the presence test for the calendar year; and (3) complies with the tax home test and the closer connection test for at least each of the last 183 days of the calendar year in which he/she moved to Puerto Rico. However, under this alternative, the individual must continue qualifying as a bona fide resident of PR for each of the three calendar years immediately following the calendar year of the move to Puerto Rico. If the individual fails to qualify as a bona fide resident of PR in the following three calendar years, the individual will not qualify as a bona fide resident of PR for the year of the move to Puerto Rico, and will be subject to U.S. federal income tax for that year.
Generally, Act 22 provides the following income tax benefits to the new Puerto Rico bona-fide residents on qualified investments:
100% Tax Exemption from Puerto Rico income taxes on dividends from all sources. The US-IRC generally provides US income tax exemption on Puerto Rico source dividends and interest earned by a “bona-fide Puerto Rico resident”. However, dividend and interest income from non-Puerto Rico sources (i.e., US or foreign sources) will be subject to US income taxation;
100% Tax Exemption from Puerto Rico income taxes on interests from all sources; and
100% Tax Exemption from Puerto Rico income taxes on all short-term and long-term capital gains accrued after the individual becomes a bona-fide resident of Puerto Rico. The long and short term capital gains derived from appreciation of securities after the individual becomes resident of Puerto Rico are exempt from Puerto Rico income tax and will not be subject to US income tax if the securities were not owned prior to becoming a Puerto Rico resident. If the securities were owned prior to becoming a Puerto Rico resident, the gains will be considered Puerto Rico source income (as per the US Internal Revenue Code) when sold after 10 years of Puerto Rico residency. Long-term capital gains prior to becoming a resident of Puerto Rico are subject to a 10% tax rate if realized within 10 years of residency or 5% if realized after 10 years of residency. Under U.S. tax law, long-term capital gains prior to becoming a bona-fide resident of Puerto Rico that are realized within 10 years are subject to 20% tax rate. If the long-term capital gains are realized after 10 years, the U.S. tax rate is 0%.
Tax Exemption Decree
In order for the individual investor to benefit from these exemptions, an application to obtain a tax exemption decree must be submitted and it is conditioned on requisites such as the bona-fide Puerto Rico resident acquiring a residential property in Puerto Rico within the two years of becoming a resident of Puerto Rico and opening a deposit account (personal and/or business) in a bank or cooperative operating in Puerto Rico.
Individuals that request the benefits of Act 22 are subject to a $750 filing fee payable upon filing the grant’s petition and a $5,000 fee upon the issuance of the tax decree. Eligible Individuals must file an annual report supporting their compliance with the terms and conditions of the decree during such year, together with an annual fee of $300.
Once the individual investor obtains the tax decree, the benefits will be secured during the term of the decree, irrespective of any changes in Puerto Rico tax laws.
Note: The above summary is intended for information purposes only. It should not be considered a legal or tax opinion. Neither it may be considered as relevant to every particular person, entity or circumstance. Qualified counsel should be consulted based on individual circumstances. To ensure compliance with requirements imposed by the IRS, we inform you that any United States federal tax advice contained in this presentation is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code; or (ii) promotions, marketing, or recommending to another party any transaction or matter addressed herein.