In a previous article, “Investment Destination: Puerto Rico, New Tax Incentives to Lure Business and Individual Investment,” which was published in 2012, we discussed how Puerto Rico is an unincorporated territory of the U.S. This status establishes a special relationship in which Puerto Rico is subject to U.S. federal laws unless locally inapplicable. Thus, Puerto Rico uses U.S. currency, intellectual property is protected under U.S. laws, the island has access to federal funds, our banking system is regulated by the U.S. Federal Deposit Insurance Corp., and U.S. citizens do not need a passport to visit.
Puerto Rico Source Income
This unique relationship is reflected in the U.S. tax code. Puerto Rico entities are not included in the definition of U.S. persons under tax code Section 7701(a)(30). Pursuant to such exclusion, entities organized in Puerto Rico or outside of the U.S. are not subject to U.S. income taxes unless they are engaged in trade or business within the U.S. or derive investment income from U.S. sources. For individuals, Puerto Rico sourced income derived by Puerto Rico bona fide residents during the entire taxable year is exempt from U.S. federal taxation. Therefore, despite being located in a U.S. territory, local income taxes may be the only relevant income taxation for entities operating in Puerto Rico and bona fide Puerto Rico residents. In turn, any local incentives regarding those local taxes are a key factor when choosing to invest in Puerto Rico.
Act 60, the New Incentives Code
Puerto Rico has a long history of using tax incentives and tax credits as tools for economic development and recovery after economic crises. The territory had around 76 laws or programs that promote investment through the granting of tax incentives.
Most recently, the government went through the effort of codifying the incentives and credits that have existed for different industries throughout the decades into a single law to bring uniformity to benefits and streamline the administrative framework of the application process, making their implementation and management more efficient. The Incentives Code, P.R. Act No. 60 of July 1, 2019, consolidates and codifies most of the existing tax incentives into a single code, derogates what will not be known as “previous laws,” and provides the following uniform tax incentives:
- Flat 4% income tax rate applicable to exempt income generated by an exempt business.
- Distributions to shareholders and members are exempt from income tax.
- 75% exemption on personal and real property taxes, with specific provisions for construction periods.
- 50% exemption on municipal license tax, municipal excise taxes, or any other municipal taxes, plus a 75% exemption on construction excise taxes that applies to contractors and subcontractors.
- Tax exemption decree terms are standardized to 15 years, with an additional 15 year extension, for a potential total of 30 years, giving the exempt business the option to choose the taxable years to be covered by such decree.
- Employment requirements are only applicable for eligible businesses with an annual projected or actual business volume of more than $3 million with one employee for export services and three employees for industrial incentives. All other activities under the Incentives Code do not have employment requirements. The employment requirements for a projected $3 million business volume will begin the year after such threshold is reached. Current decree holders may request amendments to reduce their employment requirements.
- Requirements for exempt businesses to file income tax returns with the Secretary of the Treasury regardless of its gross or net income amounts, to maintain separate accounting books for its exempt operations, and to electronically file an annual compliance report with the Office of Incentives. For Resident Individual Investors, this annual compliance report must be accompanied by evidence of the $10,000 annual charitable donation.
Beginning on Jan. 1, 2020, the following persons and industries may request and obtain tax benefits and certain tax credits under the Incentives Code:
1. Individuals (qualified medical physicians and resident individual investors);
2. Export (services and goods);
3. Financial and insurance services;
4. Visitor’s economy and tourism;
5. Manufacturing, including the research and development;
6. Infrastructure and green energy;
8. Creative industries and film;
9. Entrepreneurship; and
10. Other industries including air carriers, maritime, and cruise ships.
Based on the above, all Puerto Rico source income generated by Puerto Rico entities or Puerto Rico bona fide residents will only be subject to Puerto Rico taxation at a very low tax rate, which in most cases is 4%. Therefore, a relocation to Puerto Rico of a currently profitable business or of an individual who take advantage of these incentives may achieve significant tax savings.
Other Business Opportunities
Puerto Rico, with support from the federal government, is still in the process of reconstruction after hurricanes Irma and Maria impacted the island on September 2017. In relation to this recovery process, the federal government allocated approximately $41 billion to improve Puerto Rico’s infrastructure through the U.S. Department of Housing (HUD) Community Development Block Grant Disaster Recovery Program (CDBG-DR) and around $8 billion in Community Development Block Grant Mitigation (CDBG-MIT).
In addition, the opportunity zones legislation and regulations apply to approximately 98% of the island’s territory. Taxpayers may be able to combine local incentives with opportunity zones and other federal benefits and grants provided to low income jurisdictions such as Puerto Rico. Small business credits, energy credits, minority owned businesses, and women-owned businesses.
Moreover, the local government made adjustments to the Puerto Rico Internal Revenue Code and the Incentives Code, mentioned above, to assure that these benefits can be maximized on a local level. This crossroad provides a unique opportunity to invest in Puerto Rico NOW.
More recently, Puerto Rico’s profile as a jurisdiction with many opportunities has been highlighted as part of the economic and health emergency caused by the Covid-19 pandemic. Being a U.S. territory with close geopolitical and economic ties to the contiguous states, as well as an industrial and tax incentives history, the revitalization of Puerto Rico’s industrial capacities and workforce has been presented as an option to assist the U.S. in the fight against Covid-19.
Renowned economists have testified before Congress as to the U.S.’s dependence on China for its supply of medical supplies and medicines. Members of Congress have introduced legislation to have better control of the pharmaceutical supply chain by moving it from China to Puerto Rico, reducing the U.S.’s dependence on China for antibiotics and other lifesaving drugs (H.R. 6690, the BEAT CHINA Act), and other legislation to secure the national supply chain by providing incentives, by means of tax credits, to distressed zones in the U.S., including Puerto Rico (H.R. 6443, Securing the National Supply Chain Act of 2020).
Additionally, Congresswoman Stacey E. Plaskett (D.-V.I.) has introduced the Territorial Economic Recovery Act (H.R. 6648) to treat qualified investments in Puerto Rico by companies that have an active trade or business as domestic, rather than foreign, for the purpose of the global intangible low-taxed income (GILTI) introduced in the Tax Cuts and Jobs Act of 2017.This could mean the return to Puerto Rico of many pharmaceutical and manufacturing companies, bringing them back to a U.S. jurisdiction with economic and tax incentives for their operations.
Although the territory is going through the biggest governmental bankruptcy in U.S. history, was hit by two historical hurricanes in 2017, suffered a swarm of earthquakes in the beginning of 2020, and is currently fighting the Covid-19 pandemic, Puerto Rico seems to be in the middle of a perfect storm. A well planned and executed tax strategy can result in significant tax savings, while investing in one of the areas of the U.S. that has huge economic development potential and needs it greatly.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jeanelle Alemar-Escabí and Paola Medina-Prieto are partners at JACE LLC, a boutique law firm in San Juan, Puerto Rico, with practice areas in international, federal, and local taxation and tax incentives, among other corporate matters, and can be reached at email@example.com and firstname.lastname@example.org, respectively. The authors are members of the Board of Directors of the Tax Incentives Association Inc., a local non-profit that is working towards having Puerto Rico’s tax incentives, and their unique formula, be recognized as a trust-worthy program that adds value for bona fide residents and businesses.
Taxpayers are urged to consult their tax advisers regarding specific questions as to U.S. federal or Puerto Rico taxes or as to the consequences of doing business in Puerto Rico and the application of these laws to their particular circumstances. The content of this article has been prepared for educational purposes. Its intention is not, and it does not constitute, legal advice. It is recommended to everyone who reads this article to seek advice from his/her lawyer and/or financial advisor before carrying out any transaction described here.
Circular 230: This article was not written to be used, is not intended to be used and cannot be used by any taxpayer for purposes of avoiding United States federal income tax penalties that may be imposed. This material is written not to support the promotion or marketing of any transaction. We are providing the foregoing disclaimer to satisfy obligations we have under Circular 230, governing standards of practice before the IRS.