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  • August 13, 2017
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A DETAILED ANALYSIS OF PUERTO RICO’S TAX INCENTIVE PROGRAMS

A DETAILED ANALYSIS OF PUERTO RICO’S TAX INCENTIVE PROGRAMS

BELOW IS AN UPDATED REVIEW OF PUERTO RICO’S TAX INCENTIVES FOR 2017. MAJOR CHANGES WERE MADE TO ACT 20 AND ACT 22 ON JULY 11, 2017 (THE MOST POPULAR OF PUERTO RICO’S TAX INCENTIVES). IN ADDITION, SOME OF THE TAX INCENTIVES HAVE BEEN ADDED AND OTHERS HAVE BEEN AMENDED. BELOW IS A COMPLETE LIST OF THE TAX HOLIDAYS AVAILABLE IN PUERTO RICO AS OF AUGUST 2017.

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A new business friendly government has been elected in Puerto Rico and they’re making you a tax deal you can’t refuse. Move a business to the island and pay only 4% in tax, move yourself to Puerto Rico and pay zero in capital gains, set up a bank or hedge fund and pay only 4% tax, etc. The list of tax incentives in Puerto Rico has become very impressive.

And only Puerto Rico can offer you these tax incentives. We US citizens are taxed on our worldwide income. The ONLY exception to this is residents of the US territory of Puerto Rico.

Residents of Puerto Rico don’t pay US taxes on Puerto Rico sourced income. They pay only Puerto Rico tax on local profits and capital gains (including stock gains in publicly traded companies). See US Tax Code Section 933.

This means that Puerto Rico is free to set whatever tax rates it wants. In years past, the government would charge residents about the same as the US IRS, so there was no benefit to relocating.

Today, Puerto Rico has many tax incentives for business and high net worth individuals. The government is very motivated to attract quality businesses to the island and has pulled out all the stops with these updated tax incentives. For more, see How to benefit from Puerto Rico’s bankruptcy.

Puerto Rico’s tax incentives have turned this territory into a tax haven on steroids. Whether you’re a high net worth individual, a one man shop, or a multinational, there’s a tax incentive for you.

Few places in the world offer a better return on investment than Puerto Rico. With a growing variety of services and emerging industries, the island’s success will be directly attributable to the incentives available. To diversify the economy, the local government has developed an aggressive economic stimulus package in the form of tax incentives to help make operations on the island more profitable for companies settling here.

Ranging from exporting services, practicing medicine, tourism, and manufacturing, there are a variety of tax incentives available in Puerto Rico. Below is an updated list of tax incentives the territory has to offer:

A List of Puerto Rico’s Tax Incentives for 2017

Act 20 Known as the law to promote the export of services, Act 20 offers attractive tax incentives for companies at fixed rate of 4% and minimal requirements that establish and expand the export services industry on the island. The tax incentive is guaranteed for 20 years. See below for more information.
Act 22 Law to Encourage the Relocation of Individual Investors to Puerto Rico seeks to attract new residents to the Island. It offers a total tax exemption on passive income generated or accumulated once the individual is a bona fide resident of Puerto Rico. Tax exemption on capital gains and much more.
Act 73 Known as the Puerto Rico Economic Incentives for Development Act, was established to provide an efficient environment and opportunities for the development of local industry, to offer an attractive contributory proposal, to attract foreign direct investment and to promote the economic and social development of Puerto Rico.
Act 273 Regulates the organization and operation of international financial institutions authorized by the Office of the Commissioner of Financial Institutions to operate in Puerto Rico, and grants tax exemption decrees, among other benefits. The export of services is an economic activity that has been identified as one of the key pieces for the economic development of Puerto Rico and financial services employ the largest number of people per business under the tax incentives. The IFE tax incentive is generally used by international banks, investment funds, hedge funds and family offices.
Act 399 International insurers and reinsurers act allows entities to organize a captive insurance in Puerto Rico. International insurers may incorporate a holding company for the interest in another company. Tax exemptions for insurers that qualify for an international insurer license are 100% exempt on all income (including liquidation and dissolution of its operations in PR) derived by the international insurer or international insurer holding company. Also, 100% tax exemption on municipal license tax, property tax, dividends, and distributions to its shareholders. Moreover, interest, dividends or distributions paid to foreign entities or non-residents, not engaged in business in Puerto Rico are tax free. Captive insurance in Puerto Rico facilitates business through alternative risk management strategies and as a vehicle to enter Latin America and US markets. Integrated insurance plans and segregated assets plans serving high net worth individual markets are the focus of most companies using this tax incentive.
Act 185 Private Equity Funds not only represent a proven alternative to investment, but also constitute a financing and economic propulsion tool that facilitates the pooling of private capital in order to finance the expansion of companies, restructure businesses at risk and to promote pioneering businesses in full development. In addition, by promoting this investment vehicle used by investors around the world, it promotes the creation of jobs for professionals in the field of securities and financial business in Puerto Rico, as well as the development of the securities industry on our Island. Private equity funds generally pay a 4% tax rate on gains.
Act 135 The Young Entrepreneurs Act was established for hard working young adults within the ages of 16 to 35. The subsections of this Act grants tax exemption for individuals (from ages 16 to 26 making under $40,000) and new business (from ages 16 to 35 until $500,000).
Act 74 The Act for Tourism Development, offered through the Puerto Rico Tourism Company, provides incentives for the development of world-class tourist industry. The benefits granted under this law will be valid for 10 years from the time that the eligibility of the tourism project is established and if they are eligible they can be extended to apply to the operational phase for an additional 10 years. Act 74 is most commonly used by large  hotel projects, but a variety of projects can qualify.
Act 14 The law for the retention and return of medical professionals hopes to keep and return some doctors to the island by offering them a tax deal. In order to establish a rate of contribution on income and dividends accrued in medical practice to doctors residing in Puerto Rico the law hopes to halt the mass exodus of the Puerto Rican medical class and encourage the return or transfer of medical professionals to Puerto Rico, especially medical specialists. As of July 11, 2017, Act 14 can be combined with the telemedicine components of the Act 20 tax incentive program.
Act  83 Establishes standards to promote renewable energy, in accordance with short, medium and long-term compulsory targets, known as the Renewable Energy Portfolio

These are benefits of the Puerto Rico Tax Incentives in 2017:

Act 20 Export Services from Puerto Rico attempts to create a “World Class International Service Center” in the Commonwealth of Puerto Rico. The Act 20 tax incentive is for businesses providing a service from Puerto Rico to companies or person’s outside of Puerto Rico. Just about any portable, online, or service business can qualify.

Remember that residents don’t pay US federal taxes on Puerto Rico sourced income(Section 933). Under the umbrella of the Act 20 tax incentive, the entity in Puerto Rico will pay 4% corporate tax for eligible export services and receive a 100% exemption on dividends for PR bona fide resident shareholders. That means the corporation will pay 4% on net profits and can distribute those profits to a residents of Puerto Rico tax free. You can exchange your US rate of 40% for a PR rate of 4% overnight.

In general, businesses providing eligible services in the categories of corporate headquarters, call centers, internet marketing, online businesses, and just about any portable business will pay 4% in corporate tax and enjoy 100% exemption from property taxes during the first five years of operations. After the 5 years period, a 90% exemption will apply to property taxes and the 4% rate is good for 20 years. The Act 20 decree is granted for a 20-year term, renewable for 10 additional years, provided certain conditions are satisfied. That is to say, the 4% Act 20 tax incentive is guaranteed for 20 years.

To obtain an Act 20 decree, the business must meet minimal requirements. For example, the entity should be a new entity incorporated and the owners must pass a background check (can’t have a criminal record). Local businesses may apply for the Act 20 tax incentive program.

As of July 11, 2017, there is no minimum number of employees of an Act 20 tax incentive. As you read articles on the web, note that the number of employees was 3 in 2012. It increased to 5 in December of 2015 and is now zero. For more information, see: Puerto Rico Eliminates 5 Employee Requirement.

There are a few exceptions to this rule. If the Act 20 tax incentive company offers a substantial amount of employment outside of Puerto Rico, the Secretary of DDEC may mandate reasonable ratios of local to non resident employees. For example, you have 100 employees in the Philippines and 2 in Puerto Rico. The government is likely to require you increase your PR workforce.

Also, the Act 20 tax incentive business must provide eligible export services specified under the regulations. You will find a list of those services below. Also, an Act 20 company is prohibited from offering services to locals.

That is to say, an Act 20 tax incentive company must be providing a service from Puerto Rico to companies or persons outside of Puerto Rico.

Only Puerto Rico sourced income qualifies for this 4% tax incentive. Puerto Rico sourced income is usually income generated by work done in Puerto Rico.

Likewise, income earned from work done in the United States is always US source income and taxable in the US. US source income is never Puerto Rico source income and doesn’t qualify for the tax incentive. For more, see: What is Puerto Rico Sourced Income for an Act 20 Business.

Eligible Activities For Act 20 Tax Incentive in Puerto Rico

  • Research and development;
  • Advertising and public relations;
  • Consulting services, including, but not limited to, economic, scientific, environmental, technological, managerial, marketing, human resources, computer and auditing consulting services; Advisement on matters of any industry or business;
  • Creative industries defined as any business with the potential to create jobs and income, principally on exportation of good and services in the following sectors: Design (graphic, industrial, fashion, interior) Art (music,visual art, performing arts, publications)
  • Media (app development, video games, online media, digital content and multimedia)
  • Creative Services (architecture and creative education);
  • Production of blueprints, architectural and engineering services, and project management;
  • Professional services such as legal, tax and accounting services;
  • Centralized management services, including, but not limited to, strategic direction, planning, distribution, logistics and budgetary services carried out by the headquarters or similar regional offices of an entity engaged in rendering such services;
  • Centers for electronic data processing;
  • Development of computer software;
  • Voice and data tele-communications between persons located outside of Puerto Rico;
  • Call centers;
  • Shared services centers, including, but not limited to, accounting, finance, tax, auditing, marketing, engineering, quality control, human resources, communications, electronic data processing, and other centralized management services;
  • Storage and distribution centers of businesses dedicated to transportation of products and articles pertaining to third parties, also known as hubs;
  • Educational and training services;
  • Hospital and laboratory services;
  • Investment banking and other financial services, including but not limited to, asset management, management of investment alternatives, management of activities related to private capital investment, management of hedge funds and high risk funds, management of pools of capital, management of trusts that serve to turn different types of assets into stocks, and management of escrow accounts;

New Eligible Activities for the Act 20 Tax Incentive as of July 2017

  • Hospital services and laboratories including medical tourism and telemedicine facilities.
  • Companies dedicated to international trading (known as trading companies) – Trading companies will mean any entity that produces no less than 80% of gross income from the following:
    • Sales to any persons or entities that are outside of Puerto Rico, for use, consumption or disposition outside of Puerto Rico, of products which have been manufactured inside or outside of Puerto Rico and have been bought by the eligible business for resale;
    • From commissions derived from sales of goods for consumption and use outside of Puerto Rico will be considered industrial development income. The property used for this income is not used for other activities not authorized under tax decree; and
    • Other eligible exportation services as described under this law.

Puerto Rico’s Act 22 Tax Incentive

The Act 22 tax incentive, also known as the Act to Promote the Relocation of Investors to Puerto Rico, provides a total exemption from tax on Puerto Rico sourced capital gains, interest, and dividends realized once the individual is declared a bonefide resident. Once the investor becomes a bona fide resident, Puerto Rico’s Act 22 tax incentive will also grant them a 100% tax exemption with respect to gains from the sale of Puerto Rico property acquired if the sale takes place before 1/1/2036 and after their bonafide residence status. In addition, 90%-100% exemption on short and long-term capital gains, and 100% exemption on passive income, and 100% exemption on federal taxes on Puerto Rico source income for bona fide residents.

Act 22 decree holders may also qualify for Act 20 and various other tax holidays.

If you’re already a resident of Puerto Rico, you can’t use the Act 22 tax incentive. To obtain decree, you must not have been a resident of Puerto Rico at any time during the 6-year period prior the effective date of the Individual Investors Act (Jan 11, 2012). (Amended to 6 years before 2012 – it was previously 15 years.)

A Puerto Rico bona fide resident is an individual who is domiciled in Puerto Rico. Physical presence in Puerto Rico for a period of 183 days during the taxable year will create a presumption of residency for tax purposes. Other requirements are the individual cannot have a tax home outside of Puerto Rico and can’t maintain closer connections to United States or any other foreign country than to Puerto Rico.

Also, you must purchase a residence in Puerto Rico within 2 years of applying for Act 22. I suggest you do this ASAP because you must prove to the IRS that Puerto Rico is your home and you’re not there on a temporary basis. Buying a home within 2 years is required under the law and buying a home as soon as possible will help you if you’re selected for audit in the United States.

Basically, Puerto Rico should be your home for the foreseeable future. The territory should be where you call home, where you return to when you travel, and where most of your business interests are located. On a similar note, you should break as many ties to the United States as possible and focus your life in Puerto Rico.

Annual reports with the Office of Industrial Tax Exemption including evidence of compliance of conditions and requirements of the grant for taxable year immediately before the filing date of report.

Government Fees

$5,000 fee is due upon the approval of decree under Act 22 in addition to fees due with filing of Grant application. These fees do not include legal and other fees associated with negotiating the decree.

New July 2017 amendment requires you to donate at least $5,000 per year to an official charity in Puerto Rico each year. See: Changes to Puerto Rico’s Act 20 and Act 22

To qualify for the full Act 22 incentives, individual must become a bona fide resident of Puerto Rico.

Again, applicants must acquire a residential property in the first 2 years since the date of the notification of residency. (2015 amendment). The presentation of the Deed of Purchase & Sale is mandatory.

The focus of the Act 22 tax incentive is to eliminate capital gains on assets acquired after you move to the island. It’s also possible to allocate gains on assets acquired before you move to Puerto Rico between the United States and Puerto Rico.

Puerto Rico Tax Incentive Allocations

Tax exemptions on capital gains for Act 22 has a 10 year rule.

  • If the gain is Puerto Rico sourced income, the 10 year rule doesn’t apply and you pay zero tax. This usually applies to gains on stocks purchased after you move to Puerto Rico.
  • For Non-PR sourced income, which is usually assets purchased prior to becoming a Puerto Rico bona fide resident, you pay 10% in capital gains to Puerto Rico if you sell before before 10 years of residency and 5% to Puerto Rico if you sell after 10 years residency but before 1/1/2036.
  • A US investor with a US source gain, that sells before the 10 year term, pays US capital gains tax on the sale. After the 10 year term, you pay no federal income taxes.

Let’s say you buy Microsoft stock in 2010. When you move to Puerto Rico in October of 2017 you have an accrued gain of $200 per share. You live in Puerto Rico for 5 more years and accrue another $100 in gains. So, your total appreciation in the stock from 2010 to 2022 is $300 per share.

You sell the stock in 2022 and allocate the $300 gain between the United States and Puerto Rico. $200 of the gain is taxable at standard US capital gains rates, or 20% (assuming Trump does away with the Obamacare tax).

You also pay 10% on the $100 Puerto Rico sourced gain – the gain that accrued while you were a resident of Puerto Rico.

Had you held the stock for 10 years in Puerto Rico, or until October of 2027, you would have paid only 5% in capital gains tax on the $300 gain. You would not have paid any tax to the United States.

It’s important to note that Puerto Rico’s tax incentive for investors applies to Puerto Rico sourced gains and not US sourced gains. So, real estate in the United States, and rental properties in the United States do not qualify for Act 22. These are always US sourced gains and taxable by Uncle Sam. The same applies to partnership income (K-1s), interest income from banks in the United States, and any other US source income.

Remember that only Puerto Rico can offer these tax incentives on capital gains.When a US citizen moves to a foreign country, they must pay US tax on their passive income. Only Puerto Rico is exempted from US tax on capital gains.

So, in the stock example above, if you were living in France or Panama, you would pay US capital gains tax on your stock sale. Regardless of whether you sold those Microsoft shares in 2022 or 2027, you would pay US long term capital gains on the transaction.

Only Puerto Rico can offer a zero percent tax on dividends to its residents under Act 20. Only Puerto Rico can offer a zero percent tax rate on capital gains. Only Puerto Rico can offer an offshore bank charter without all the headaches of Federal oversight (not to mention the 4% tax rate). Only Puerto Rico can distribute dividends to its residents under Act 20 tax-free.

Read the entire article on PremierOffshore.com

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