Puerto Rico Tax Exemptions Acts
In an attempt to stimulate domestic economic growth, the government of Puerto Rico enacted two laws (in 2012) that provide generous tax incentives for individuals and businesses. While such Acts are not unusual for smaller island states, these two Acts are unique in that they potentially provide US citizens with a significant tax advantage.
The general rule is that all U.S. citizens are ordinarily subject to US tax on their worldwide income and gains – irrespective of where they live. Thus, for example, a US citizen that has been living and working in the UK (and thus paying UK taxes on their income) is also required to continue to file US tax returns on a similar basis. This requirement of US tax law is unique.
The attraction of the new Puerto Rican rules for high net worth US citizens is Puerto Rico’s constitutional status as regards the US. Puerto Rico is a commonwealth of the US (but not, constitutionally a US state) and thus enjoys a certain local autonomy. As such, it is possible for Puerto Rico to have a separate Constitution (and flag) despite being subject to the purview of the American Congress. Of most relevance for present purposes is that Section 933 of the US Internal Revenue Code (IRC) provides that Puerto Rican residents are not subject to US federal tax on their income generated in Puerto Rico.
The two laws the Puerto Rican government is actively promoting are Act No.20 (Export Services Act for businesses) and Act No.22 (Individual Investors Act). US citizens who become residents of Puerto Rico (and who would then be liable to Puerto Rican tax only on local source income) will be entitled to the benefits of Act No.22 (described below). The result is that, when combined with the section 933 IRC exemptions, Act No.22 allows a 100% tax exemption on all interest, all dividends and all long-term capital gains to US citizens (for their Puerto Rico source income) who become bona-fide residents of Puerto Rico.
Prior to the passing of these two new Acts, it was almost impossible for a US citizen to take advantage of inpatriate regimes (i.e. tax incentives offered by countries to attract highly skilled individuals) because of the requirement to file a US tax return on a worldwide basis. Traditionally, expatriation (i.e. giving up US citizenship) was the only (drastic) measure US citizens could adopt to remove themselves from the scope of US tax. However the passage of Act 22 and Puerto Rico’s unique constitutional status with the US means that expatriation is not the only option for US citizens seeking to reduce their tax liability. The only real barrier to entry is that individuals will have to live in Puerto Rico.
The Individual Investors Act provides tax exemptions to eligible individuals residing in Puerto Rico. The individuals will not qualify if they were resident in Puerto Rico at any time during the 15-year period preceding the enactment of the Act on 12 January 2012.
By definition, a bona-fide resident of Puerto Rico is a person who:
- is present for at least 183 days during the taxable year in Puerto Rico; and
- does not have a tax home outside of Puerto Rico during the taxable year. A tax home is taken to be the individual’s regular or main place of business, employment, or post of duty regardless of where the family home is maintained; and
- does not have a closer connection to the US or a foreign country than to Puerto Rico. A closer connection is determined by a variety of factors including, but not limited to, the location of the individual’s permanent home, family, personal belongings and voting district.
Even though Puerto Rico is a territory of the US, Section 933 IRC, as amended, provides that bona fide residents of Puerto Rico are not subject to US federal income tax on Puerto Rican source income. They were, however, liable to Puerto Rican income tax at progressive rates up to 33% plus surcharges for high earners. With the introduction of Act 22 and the 100% exemption, this is no longer the case.
The Act provides a 100% exemption to new Puerto Rico residents on:
- all dividends;
- all interest; and
- all short-term and long-term capital gains accruing after the individual becomes a resident of Puerto Rico.
The tax exemptions granted by Act 22 will expire on 31 December 2035.
The Export Services Act provides tax exemptions and tax credits to businesses established in Puerto Rico that are engaged in eligible activities provided from Puerto Rico to outside markets.
Eligible activities include:
- research and development (R&D);
- advertising and public relations;
- consulting services for any trade or business;
- call centres; and
- shared services centres.
In order to qualify as an eligible activity, the service must not have a nexus with Puerto Rico (Promoter services are the only exception to this general rule – see below). The following services will be considered to have a nexus with Puerto Rico and will not be eligible for benefits provided by the Act:
- services provided to businesses that are or have been performed in Puerto Rico;
- services related to the sale of any property for the use, consumption or disposition in Puerto Rico; and
- legal services relating to the laws, regulations and administrative decisions of the Government of Puerto Rico.
Promoter services are services:
- provided to non-resident individuals and/or foreign entities; and
- are related to the establishment of a New Business in Puerto Rico.
Eligible activities benefit from the following incentives on income derived from customers located outside of Puerto Rico:
- 4% corporate tax rate (the ordinary corporate tax rate in Puerto Rico is comprised of a base rate of 20%, plus a graduated surcharge). This 4% rate may be reduced to 3% when more than 90% of the Eligible Business’s gross income is derived from export services and such services are considered strategic services;
- 100% exemption on dividends or profit distributions from export services businesses;
- 100% exemption on property taxes for certain export service businesses services; and
- a 20 year guarantee (renewable for an additional 10 years).
In order to benefit from the above mentioned tax incentives, the business must apply to the Office of Industrial Tax Exemption of Puerto Rico.
The incentives are still relatively new and have not been widely publicised by the Puerto Rican government. Nevertheless it is anticipated that many investors will take advantage of these incentives in the coming months and years.
For more information, please contact Miles or Andy.