Through Act 20 and 22, Puerto Rico Offers World-Class Tax Incentives to Promote Investment
As an unincorporated territory of the United States with its own tax code, Puerto Rico has always enjoyed tax advantages. Throughout the years, incentives and tax credits have been created for certain manufacturing operations, hotel and tourism projects, film industry, agriculture, green energy, insurance and banking operations.
Most recently in 2012, the government of Puerto Rico passed two key pieces of legislation that provide dramatic tax incentives for businesses and individual investors. The first, Act 20 of 2012, also known as the Export Services Act, seeks to establish Puerto Rico as an international export services center. The second, Act 22 of 2012, also known as the Individual Investors Act offers new residents of Puerto Rico a 100 percent tax exemption on all interest, dividends and long-term capital gains accrued after the individual becomes a resident. Combined with other industry-specific tax incentives (see http://www.ddec.pr.gov/en/invest/), U.S. rule of law, a great lifestyle, and geographical and time-zone proximity to the U.S., Puerto Rico is becoming a world-class destination for investors to relocate to.
Puerto Rico as a Business Location
Puerto Rico is part of the United States’ political, monetary and legal system. Most federal laws apply, but income derived from sources within Puerto Rico by individuals who are bona fide residents of Puerto Rico is exempt from U.S. taxation. As such, Puerto Rico offers the benefits of operating within a U.S. jurisdiction while providing the tax benefits of a foreign tax structure.
Other benefits of doing business in Puerto Rico include:
- Investors are fully afforded intellectual property protection under U.S. laws
- Highly educated and trained workforce that is bilingual (Puerto Rico ranked 3 out of 142 countries in the World Economic Forum’s Competitiveness Report (2012-2013) in terms of availability of scientists and engineers)
- Access to federal funding for infrastructure, education, research and other programs.
- The Puerto Rico banking system is regulated by the Federal Reserve and deposits are insured Federal Deposit Insurance Corporation
- Puerto Rico is part of the U.S. free trade zones and customs system
- The official languages are Spanish and English, the currency is the U.S. dollar, and no U.S. passport is required for U.S. citizens traveling to the island
- Geographical proximity (2.5 hour flight from Miami and 3.5 hour flight from NYC) and Eastern Standard Time Zone (no daylight savings time)
- Superior Lifestyle (San Juan ranked 3 among 35 top US cities by Travel & Leisure magazine in terms of quality of life and visitor experience)
Export Services Act
Act 20 of 2012, also known as the Export Services Act, encourages existing service centers, operators and professionals from outside of Puerto Rico to relocate to the island, and supports local service providers in exporting their services to become participants in the global economy. The Export Services Act applies to any bona fide office or establishment located in Puerto Rico and engaged in “eligible businesses,” which include, but are not limited to: (i) research and development; (ii) advertising and public relations; (iii) consulting and advisory services; (iv) professional services, such as legal, tax and accounting services; (v) corporate headquarters; (vi) electronic data processing centers; (vii) call centers, (viii) technology services and development of computer programs; (ix) storage and distribution centers and (x) educational and training centers, among others.
The benefits of Act 20 certified businesses include:
- 4% flat income tax rate on export services income
- 100% tax exemption for distributions (earnings and profits derived from export services income)
- 90% exemption from property taxes (100% exemption during the first five years for certain eligible services)
The term of the Act 20 tax decree is for a period of 20 years, renewable for an additional period of 10 years if certain conditions are met. Certification under the Export Services Act must be done prior to December 31, 2020.
Individual Investors Act
Act 22 of 2012, also known as the Individual Investors Act, seeks to attract new residents and investment to the island by providing a total exemption from Puerto Rico income tax on all passive income realized or accrued after such individuals become bona fide residents of the island. The tax benefits of Act 22 apply to any individual that becomes a bona fide resident of Puerto Rico on or before the taxable year ending December 31, 2035 (the “Tax Exemption Period”), provided such individual has not been a resident of Puerto Rico at any time during the 15-year period prior to the effective date of the Act.
The benefits of Act 22 certified individuals include:
- 100% Puerto Rico tax exemption on all passive income realized during the Tax Exemption Period
- Passive income is considered to be Puerto Rico source income not subject to federal taxes (I.R.C. § 933 exclusion)
- 100% exemption of Puerto Rico taxes on short-term and long-term capital gains accrued after becoming a resident of Puerto Rico
- 100% exemption of federal taxes on long-term capital gains after 10-year period of becoming a resident of Puerto Rico
International Financial Entities
Subject to licensing requirements and regulatory powers of the Office of the Commissioner of Financial Institutions of Puerto Rico, International Banking Entities (IFE) and its owners are offered the following preferential treatment:
- 4% income tax on net income derived from an IFE from permitted activities
- 100% Puerto Rico tax exemption on dividends or other distribution of profits to non-Puerto Rico residents
- 100% exemption on municipal taxes
- 100% exemption on property taxes
What Does this all Mean?
Similar to residents of the United States, residents of Puerto Rico are subject to federal tax on their worldwide income. However, U.S. Code Section 933, for tax purposes, allows a bona fide individual resident of Puerto Rico to exclude Puerto Rico source income from his or her gross income. Furthermore, Puerto Rico entities not engaged in U.S. commerce are generally not subject to U.S. federal taxation.
Under the Export Services Act and the Individual Investors Act, service providers with an appetite to expand into foreign markets can significantly reduce their tax liability by establishing their businesses in Puerto Rico, since a Puerto Rico entity will generally not be subject to federal taxes and will benefit from a reduced tax rate in Puerto Rico, in addition to a full tax exemption on passive income.
As an example, investment and financial services providers rending services to clients outside of Puerto Rico, including, without limitation, asset management, investment advisory, private equity management, family offices, and managers of funds may relocate to Puerto Rico and be subject to a 4% income tax rate, instead of the current maximum tax rate of 35% applicable to U.S. corporations.
The following article does not constitute tax or legal advice and should not be relied upon when making any investment or tax decisions. Taxpayers are urged to consult their tax advisors regarding specific questions as to the consequences of doing business in Puerto Rico and the application of the foregoing laws to their particular circumstances.U.S. Treasury Circular 230 Notice. U.S. Treasury Regulations require us to inform you that any U.S. tax advice in this communication cannot be used by you (i) to avoid tax penalties or (ii) to promote, market or recommend to another party any transaction or matter addressed herein.