How Moving To Puerto Rico Can Become A Permanent GILTI Tax Deferral
US businesses have been known to defer taxation of their earnings through supply chain and intellectual property migration planning with jurisdictions outside the US. According the tax adviser due to US tax reform, including lower federal income tax rates and preferential tax regimes such as FDII (foreign-derived intangible income), many now consider keeping IP rather than following the typical IP migration route.
For those who are not falling for the allure of these tax benefits GILTI (global intangible low-taxed income) is a problem which makes it impossible to defer the US taxation of earnings of controlled foreign corporations (CFCs) in most situations (excluding a 10% carve-out for the CFC’s qualified business asset investment and certain other exceptions).
Apart from the above, IP migration is further exacerbated by charges on outbound transfers of appreciated assets under Sec. 367 as well as substance requirements in the EU. For many US businesses, global IP is often the most valuable revenue generator and the main trigger for corporate tax expenses. Under specific circumstances, Puerto Rico might offer one of the most significant opportunities for tax savings.
Puerto Rican Incentives
What is of specific importance for this article are the tax incentives afforded by Puerto Rico to individual resident investors and export services businesses. Those who are eligible can obtain a 100% Puerto Rican tax exemption until then end of 2035, including taxes on dividends, interest and capital gains accrued after becoming a bona fide resident of Puerto Rico. Even profits generated from commodities, coins, and digital assets based on blockchain technology are eligible. There are some requirements, though.
An annual contribution of $10,000 has to be made to a not-for-profit organization operating in Puerto Rico, and residential property has to be acquired within two years after the start of participation in the incentives. The new incentives are similar to those previously provided by Act No. 22 of 2012, the Act to Promote the Relocation of Investors to Puerto Rico.
A tax of 4% on income from eligible export service activities is included in the export services incentive. It will last until the end of 2035. Qualified services include service income from a network, cloud computing, blockchain, subscription, or licensing, among others. Similarly, income from dividends from eligible businesses are exempt from Puerto Rican income tax. Eligibility requirements include a commitment to appointing at least one employee for those businesses with a projected or actual volume of business of more than $3 million. This is also similar to previous incentives in terms of the 2012 Export Services Act (Act No. 20 of 2012).
These incentives are part of an incentive program to attract new businesses to Puerto Rico. For companies in technology and other industries where IP is a significant component can enjoy an attractive combination of preferential tax regimes while reaping the benefits of a first-class workforce and the benefits of the US legal system for IP protection.
There is a price for such a migration. For US companies, it might be an arduous process that includes the relocation of individual owners as the move of activities, employees, and functions to Puerto Rico while navigating the US tax consequences of migration.
From Us Standpoint
The US taxes citizens and permanent residents on worldwide income regardless of their residence. This includes US citizens and resident alien individuals who reside in Puerto Rico. Under Sec. 933, however, these individuals can exclude the Puerto Rico-source income from their US individual income tax returns when they determine their US income tax liability.
To determine whether income is considered sourced from Puerto Rico, Sec. 937(b) sets forth regulations and rules. AS for determination of income is sourced from Puerto Rico or is connected with the conduct of a trade or business in Puerto Rico -Secs. 861-865 apply. For example, dividend income paid by a Puerto Rican corporation from its Puerto Rican-source income is generally considered to be considered Puerto Rican in respect of Regs. Sec. 1.937-2(g)(1)(ii). The same goes for some capital gains sourced to Puerto Rico if derived by Puerto Rican residents.
Income from services delivered is sourced to Puerto Rico in so far as it was provided in Puerto Rico as a software service with substance and functions. Such a subscription income to worldwide customers can be sourced to Puerto Rico. With the proper planning income from eligible Puerto Rican activities can enjoy a preferential 4% tax rate while fully exempt from US taxation in the hands of a US owner who is a bona fide resident of Puerto Rico.
GILTI And The Subpart F Regime
Anti-deferral regimes such as these apply to persons who are US shareholders of a CFC. A US shareholder is defined to include US persons who own directly, indirectly, or constructively 2o% or more of the vote or value of the CFC.
In respect of Sec.957(c)(1), a bona fide resident of Puerto Rico is not treated as a US person, as defined in Sec. 7701(a)(30), and therefore are not subject to Subpart F and GILTI inclusions associated with stock ownership in a Puerto Rico subsidiary as long as dividends received by the individual from the foreign subsidiary is considered as a Puerto Rican source.
What is more, to qualify for the four percent preferential rate in Puerto Rico, the relevant income does not have to be derived directly from a Puerto Rican corporation. It can even be generated by a Puerto Rican branch or transparent entity. This allows for considerable flexibility from a planning standpoint.
US citizens that relocate to Puerto Rico do not fall under Sec. 877A, so no exit charge is imposed on built-in gains inherent in the individual’s assets (if any). Therefore a permanent exemption from US income tax can be obtained without the need to give up US citizenship. Sec. 367(a)(1) imposes taxation on outbound transfers of property by a US person to a foreign corporation in a transaction that would otherwise qualify for nonrecognition treatment. Also, in respect of Sec.367(d), certain typically tax-free transfers of patents, know-how, copyrights, trademarks, franchises, licenses, and other similar IP create a taxable deemed royalty to the US transferor. The TCJA added goodwill, going concern value and workforce in place to the list to further limit the ability of US taxpayers to move IP offshore.
For a standard IP holding company, such a significant exit charge would diminish and outweigh the potential benefits of any migration. The ability to obtain FDII rates (13.25% between December 31st, 2017 and January 1st, 2026 and 16.406% after December 31st, 2025) on export activities could make it a lot less attractive to migrate. Nevertheless, Puerto Rico remains by far the best alternative compared to all other jurisdictions. Puerto Rico offers some entity choice solutions that cannot be equal in traditional EU IP holding company structures. One example, some Puerto Rican business, and associated assets can be held via a Puerto Rican branch instead of a subsidiary corporation, which makes it possible to eliminate the exit charges under Sec. 367 while still qualifying for a preferential 4% tax rate in Puerto Rico on eligible income generated through the branch and a complete exemption from US taxation on the same income under Sec.933 in the hands of US owners who are also bona fide residents of Puerto Rico.
US IP holding structures do obtain the benefits of the FDII regime occurs fewer costs, but the FDII preferential tax rate is reserved for export activities income only. For Puerto Rican IP holding structures, the preferential tax rates may be available for export activities to US, EU and other customers located outside Puerto Rico.
The implementation of a Puerto Rican structure, careful consideration is required. All facts and circumstances play a role. It all depends on the sourcing of income that meets the Puerto Rican eligibility requirements for the tax exemption decree and US eligibility under Sec. 933, among other factors.
Typically Puerto Rican residents are not eligible for international tax treaty benefits, so additional planning may be required to mitigate the withholding tax exposures. Implementation may require changes, but for some enterprises, it may be advantageous. Now is the time to start exploring your options.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason. Click here to email us and start your project.
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