Insight

Tax Saving Opportunities under Puerto Rico Incentives

Puerto Rico offers a variety of attractive incentives packages that cover multiple industry sectors.

Tax Saving Opportunities
AG

Alexis R. González-Pagani

September 1, 2017 12:24 AM

Introduction

The Commonwealth of Puerto Rico is unlike any other island in the Caribbean. Its strategic geographical location, which grants it proximity to North, Central, and South Americas; its ability to enact laws and regulations similar or identical to those that are recognized and compatible with some of the most sophisticated jurisdictions in the world; its ample federal regulatory backbone; and its autonomy for certain aspects make it an ideal business environment for a variety of industries. Furthermore, its own history, coupled with its interaction with the United States for the last century, have continually molded the island into a location that has a unique set of characteristics that are unequal to any other U.S. jurisdiction. These factors, along with various tax incentive programs, provide an unmatched development ground for various business sectors.

Puerto Rican Individuals and Entities in General: Taxation

Puerto Ricans are, by law, natural-born citizens of the U.S. and may move freely between the island and the mainland. As a result, and as with all U.S. citizens, they are subject to federal taxation on their worldwide income. However, U.S. citizens that are also bona fide residents of Puerto Rico are allowed to exclude from federal taxation (933 Exclusion) all of their income, be it ordinary income, interest, dividends, or capital gains that are derived from sources within the island (known as P.R. source income). With regards to legal entities, the United States Internal Revenue Code (U.S. Code) excludes entities organized in Puerto Rico from the definition of “United States persons” and treats them as foreign, therefore not being subject to federal taxation, unless U.S. source income is earned.

Bona Fide Resident

As discussed above, the 933 Exclusion can only be used by (i) bona fide residents of Puerto Rico and (ii) for income that is considered P.R. source income. An individual will be considered a bona fide resident of Puerto Rico if such individual meets all of the following: (i) presence test, (ii) tax home test, and (iii) closer connection test, as provided in the U.S. code. If any of these three tests are not met, the individual will not be treated as a P.R. resident and will not benefit from the 933 Exclusion.

Economic and Tax Incentives

Puerto Rico offers a variety of attractive incentive packages that cover multiple industry sectors.

The vast majority of these incentives provide (i) a fixed low income tax rate; (ii) various tax exemptions and special deductions; and (iii) training expenses reimbursement and special tax treatment for pioneer activities. Some of the keystone tax incentive acts in Puerto Rico that are granted to the legal entities that operate in the island are (i) Act 73 of May 28, 2008, known as the Economic Incentives for the Development of Puerto Rico Act, as amended (Act 73), which is focused mainly on manufacturing operations, pharmaceutical industries, airplane and ship repairs, research and development, among others; (ii) Act 20 of January 17, 2012, known as the Act to Promote the Export of Services, as amended (Act 20), was designed to tap into the human capital of the island and develop it into an international export service center; it covers almost any type of exportable service that is provided to clients who do not have a nexus with Puerto Rico; and (iii) Act No. 185 of November 12, 2014, known as the Private Equity Funds Act, as amended (Act 185), developed to promote investment in entities that do not have access to public capital markets and attract capital investment to Puerto Rico (collectively the Corporate Exemptions).

In addition, there are certain tax incentive acts that are granted at the individual level. Some of the most recent and significant acts are (i) Act 22 of January 17, 2012, known as the Act to Promote the Transfer of Individual Investors to Puerto Rico, as amended (Act 22), which focuses on providing a preferential tax rate on certain forms of passive income derived from Puerto Rico sources to individuals that relocate to the island; and (ii) Act 14 of February 21, 2017, known as the Incentives Act for the Retention and Return of Medical Professionals (Act 14), which was enacted to offer an attractive tax incentive proposal for the medical professionals to stay in Puerto Rico, and at the same time, attract the setup of other professionals’ medical practice in Puerto Rico (collectively the Individual Exemptions, combined with the Corporate Exemptions, referred to as P.R. Exemptions). When the P.R. exemptions are combined with the 933 Exclusion, they result in significant tax savings to U.S. citizens either currently residing in Puerto Rico or that make a move to the island.

Specific Tax Incentives Rates

In general, Act 20 and Act 73 provide the following tax incentives to entities operating in Puerto Rico that have obtained a tax incentives grant: (i) 4 percent fixed income tax rate; (ii) 100 percent exemption on distributions; (iii) 90 percent exemption on property taxes; and (iv) 60 percent exemption from volume of business taxes, among other benefits. The aforementioned benefits extend for an initial period of 20 and 15 years, respectively.

Act 185 provides multiple benefits, and some of the incentives vary depending on the role the individual or entity plays in the private equity fund. Some of the main benefits under Act 185 are (i) deduction of 30 percent to 60 percent of the initial investment made in the fund; (ii) preferential tax rates on capital gains, dividend, and interest income; and (iii) special tax rates on the sale of ownership interests.

In the case of Act 22, it provides a 100 percent exemption on dividend, interest, and capital gain income that are derived from Puerto Rico sources. The benefits under Act 22 last until December 31, 2035. Lastly, Act 14 provides (i) a 4 percent fixed income tax rate on income from providing professional medical services; (ii) 100 percent exemption (including alternative minimum tax [AMT]) on up to $250,000 received from eligible dividends; and (iii) eligibility to contribute up to 25 percent of the net income to individual retirement plans (Keogh) or up to 25 percent of their salary in case of corporate retirement plans, as after tax contributions. The preferential tax rates under Act 14 are available for an initial period of 15 years.

Related Articles

Paying the Price in P.R.


by Best Lawyers

Isis Carballo-Irigoyen discusses discuss intergovernmental relations, opportunity zones, and why a move to Puerto Rico to ease your tax burden likely won’t be as simple as you might think.

An Interview With McConnell Valdés

Announcing the 2022 Best Lawyers® in the Puerto Rico


by Best Lawyers

The results include an elite field of top lawyers and firms.

2022 Best Lawyers® in the Puerto Rico

Announcing the 2021 Best Lawyers in Chile, Colombia, and Puerto Rico


by Best Lawyers

Find the top legal talent in Chile, Colombia, and Puerto Rico.

Best Lawyers in Chile, Colombia, Puerto Rico

Great Rebuild


by Best Lawyers

Néstor Méndez discusses labor peace, junk-bond repercussions, and the laudable resilience of those who call this storm-battered island home.

An Interview With Pietrantoni Méndez & Alvare

Baraona Fischer & Cia on the Changes Coming to Tax Law in Chile


by Best Lawyers

Juan Manuel Baraona of the 2019 "Law Firm of the Year" award-winner for Tax Law in Chile discusses forthcoming regulations, career highlights, and his secrets to success in an interview with Best Lawyers CEO Phillip Greer.

Baraona Fischer & Cia LFOTY

Lecher Pays


by Ann E. Evanko and Katherine L. Wood

Can social change be sped up via legislation? A key provision of the recent tax-law overhaul, clearly written with #MeToo in mind, suggests it can.

Social Change Amid #MeToo

Opening Pandora's Box in Portuguese Tax Law


by Best Lawyers

Diogo Ortigão Ramos discusses Cuatrecasas' 2019 "Law Firm of the Year" award for tax law in Portugal.

Cuatrecasas Law Firm of the Year Interview

Monica Biringer and Firoz Ahmed on Canada's Changing Tax Practice


by Best Lawyers

The attorneys from Canada's 2019 "Law Firm of the Year" winning Osler, Hoskin & Harcourt look at their achievements over the past year.

Osler, Hoskin & Harcourt Interview

What Spain’s Proposed ‘Google Tax’ Means for its New Economy


by Mariano Roca López

How the Spanish Stability Program is tapping new sources of tax revenue.

Will Spain Pass the 'Google Tax?'

A Master in Defending the Accused


by Best Lawyers

The relentless pursuit of justice when everything is on the line.

Patrick A. Mullin

Q&A with Konstantin Mikhel at Vlasova Mikhel & Partners


by Best Lawyers

A Q&A with Konstantin Mikhel of Vlasova Mikhel & Partners about his experiences and the legal field in Belarus.

Konstantin Mikhel

Recent Case Law on Cross-Border Reorganizations


by Marie-Hélène Raffin

The Euro Park decision is bound to facilitate the application of the French favorable tax regime to cross border mergers and spin-offs.

Cross-Border Reorganizations

Trending Articles

Announcing the 2023 The Best Lawyers in America Honorees


by Best Lawyers

Only the top 5.3% of all practicing lawyers in the U.S. were selected by their peers for inclusion in the 29th edition of The Best Lawyers in America®.

Gold strings and dots connecting to form US map

Announcing the 2022 Best Lawyers® in the United States


by Best Lawyers

The results include an elite field of top lawyers listed in the 28th Edition of The Best Lawyers in America® and in the 2nd Edition of Best Lawyers: Ones to Watch in America for 2022.

2022 Best Lawyers Listings for United States

2021 Best Lawyers: The Global Issue


by Best Lawyers

The 2021 Global Issue features top legal talent from the most recent editions of Best Lawyers and Best Lawyers: Ones to Watch worldwide.

2021 Best Lawyers: The Global Issue

The U.S. Best Lawyers Voting Season Is Open


by Best Lawyers

The voting season for the 31st edition of The Best Lawyers in America® and the 5th edition of Best Lawyers: Ones to Watch® in America is officially underway, and we are offering some helpful advice to this year’s voters.

Golden figures of people standing on blue surface connected by white lines

How To Find A Pro Bono Lawyer


by Best Lawyers

Best Lawyers dives into the vital role pro bono lawyers play in ensuring access to justice for all and the transformative impact they have on communities.

Hands joined around a table with phone, paper, pen and glasses

What the Courts Say About Recording in the Classroom


by Christina Henagen Peer and Peter Zawadski

Students and parents are increasingly asking to use audio devices to record what's being said in the classroom. But is it legal? A recent ruling offer gives the answer to a question confusing parents and administrators alike.

Is It Legal for Students to Record Teachers?

How Palworld Is Testing the Limits of Nintendo’s Legal Power


by Gregory Sirico

Many are calling the new game Palworld “Pokémon GO with guns,” noting the games striking similarities. Experts speculate how Nintendo could take legal action.

Animated figures with guns stand on top of creatures

The Best Lawyers in Australia™ 2024 Launch


by Best Lawyers

Best Lawyers is excited to announce The Best Lawyers in Australia™ for 2023, including the top lawyers and law firms from Australia.

Australian Parliament beside water at sunset

Best Lawyers: Ones to Watch in America for 2023


by Best Lawyers

The third edition of Best Lawyers: Ones to Watch in America™ highlights the legal talent of lawyers who have been in practice less than 10 years.

Three arrows made of lines and dots on blue background

Inflation Escalation


by Ashley S. Wagner

Inflation and rising costs are at the forefront of everyone’s mind as we enter 2023. The current volatile market makes it more important than ever to understand the rent escalation clauses in current and future commercial lease agreements.

Suited figure in front of rising market and inflated balloon

A Celebration of Excellence: The Best Lawyers in Canada 2024 Awards


by Best Lawyers

As we embark on the 18th edition of The Best Lawyers in Canada™, we are excited to highlight excellence and top legal talent across the country.

Abstract image of red and white Canada flag in triangles

8 Different Types of Criminal Defenses in Law


by Best Lawyers

Learn about the different types of criminal defenses available in law, including innocence, self-defense, insanity and more. Protect your rights today.

Silver handcuffs laying on finger printed papers

Wage and Overtime Laws for Truck Drivers


by Greg Mansell

For truck drivers nationwide, underpayment and overtime violations are just the beginning of a long list of problems. Below we explore the wages you are entitled to but may not be receiving.

Truck Driver Wage and Overtime Laws in the US

The Upcycle Conundrum


by Karen Kreider Gaunt

Laudable or litigious? What you need to know about potential copyright and trademark infringement when repurposing products.

Repurposed Products and Copyright Infringemen

Choosing a Title Company: What a Seller Should Expect


by Roy D. Oppenheim

When it comes to choosing a title company, how much power exactly does a seller have?

Choosing the Title Company As Seller

Unwrapping Shrinkflation


by Justin Smulison

Through the lens of the United States, we take a closer look at the global implication of companies downsizing products while maintaining and often raising prices.

Chocolate bar being unwrapped from foil