Tax Strategy To Move Your Company To Puerto Rico
FAS CPA & Consultants
How should you treat a private business property tax if you move the business to Puerto Rico?
In the case of PR, they have a tax law that gives this tax break for people who want to move to Puerto Rico, but they have to become permanent residents there. In PR there is this tax break and whenever a business owner from the continental US moves the entire operation to PR there is a minimum tax payment that the person will have of only 4%, but there is a catch. If you leave any operation in the continental USA, that will be separated and you will have to pay taxes according to the federal rates, that is customary for any company doing business in the US. So, the key to take this tax rate in PR is that you move the entire operation from the US including offices and personnel or hire new people in PR and you move residence to PR.
What are the requirements to enjoy the reduced rates for residents in PR and requirements to move my company to PR?
The first one is that you have to demonstrate that you live in PR, because there is an IRS for the entire continental US and there is an IRS exclusively for PR called Departamento de Hacienda, this department does not deal differently with the PR residents than the IRS deals with US Citizens, there are 2 separate institutions and most of the time they do not communicate with each other, PR is an associate state that’s why they have its own IRS. To transfer from one geographic place to another you have to physically move to the other state in PR, that is the only way you are under the authority in PR and buy a house, have kids in school, have a bank account. The requirement for the company is that you cut all the responsibilities in the continental US, and you open a company or register a new company in PR and place all your personal and business assets there, you can also close the company in the USA if you want it too. You must give a service from PR, transfer first yourself and later the business.
Having kids, paying for school, or buying property in PR can prove your current residence is there. That’s the ultimate proof of residence and you have to stay in PR at least 6 months, these are the basic rules to move to PR for anyone who wants to enjoy the tax rate in PR. Now for private business property tax there is this tax break, in US these taxes are customarily handled by the counties in each state, it could be personal or business property taxes, but that is responsibility for each state. Act 22 is the tax created that when you move operations you will be exempt and only the income tax you will pay 4%. If we are referring to private property taxes, considering the machinery and equipment and that is taxable in the counties that doesn’t apply in PR, at least for 10 years.
What about if I am part owner of the business, I have a company tax reporting business that’s in NY and I have an office in Florida. So, if I move to PR would I have the PR advantage?
Any move to PR includes the business and you. The ultimate beneficiary is by moving yourself to PR and your family, this is how you prove that you are a PR resident, that you have complied with the requirements of Act 22, that is the sole requirement. However, if you move there and you have business in NY and Florida, and they create revenue and make profits you are still bound to the IRS in the continental US because that business pertains to the US. If it’s an LLC you are bound only to the IRS because they don’t pay taxes to the state, but if it’s a corporation you are bound to the state taxes.
Move to Puerto Rico, slash your taxes to zero? Not exactly
Despite the tax cuts brought about by the TCJA of 2017, most Americans still feel over-taxed. State taxes add to the lamentations. New York and California’s state taxes were always a sore point, but now you can only deduct $10,000 from your federal tax return for the enormous taxes these states charge. Some see moving to tax-free states like Florida, Nevada, Texas, or Washington as the solution. Another solution is to avoid these high taxes by using trusts or renouncing your citizenship and suffering through the IRS and State Department’s exit procedure, but these are very drastic measures. And then there is Puerto Rico. According to the allure, you can keep your passport and pay a fraction of the taxes you pay now. It seems like a win-win, but is it really?
US Citizens are taxed on their worldwide income. What makes Puerto Rico different is its status as a US Commonwealth. This means it is part of the US but remains independent in some ways.
Puerto Rico’s tax system is a hybrid system, partly US and partly not. So, the short answer is yes, it is possible to move there and make dramatic cuts to your income taxes. But you have to be very careful.
The IRS and the Puerto Rican revenue service have a multi-layered relationship. Some Puerto Ricans have to file with the IRS, some have to file with the Puerto Rican Department of finance, and some residents have to file with both.
Puerto Rico offers an income tax rate of merely 4%. If you can legally avoid the federal top marginal tax rate of 37% and the 13.3% California rate, this sounds very tempting. Add that Puerto Rico does not tax dividends or capital gains, and things are beginning to look up.
There are some necessary disclaimers to keep in mind. You will probably not be able to avoid US tax on asset appreciation before you move away. Whether you move with appreciated stock, bitcoin, or other property and later sell the same, the pre-move appreciation is still subject to US tax. Only post-move appreciation is subject to Puerto Rican special tax rules.
The only way to escape US taxes on the pre-move appreciation is to wait for ten years after your move before you can sell. What is more, your US real estate remains a US source of income whether you move to Puerto Rico and wait for ten years or not.
Some Fundamentals:
⇒ You really have to move. You have to actually live in Puerto Rico.
⇒ Avoid any messy facts that dilute the appearance of a permanent move.
⇒ Sell your home, move your family, and sever your connections with local clubs and associations.
REMEMBER: If you are at any time ruled not to be a permanent resident of Puerto Rico, the IRS will reappear very fast, and you will be liable for back taxes, penalties, and interest.
To qualify:
⇒ You must not have been a Puerto Rico resident within the last fifteen years.
⇒ You have to become a Puerto Rican resident before December 31, 2035.
⇒ You have to reside in Puerto Rico for 183 days per year.
⇒ You have to file an application with the tax authorities in Puerto Rico.
Once your application is approved, you get:
⇒ Tax-free interest and dividends earned (after you became a resident).
⇒ Zero long-term capital gains taxes on appreciation (after you became a resident).
⇒ Five percent tax on long-term capital gain for appreciation before your move for any sales during your first ten years as a Puerto Rican resident.
⇒ Many incentives for business owners IF you move your company and employees to Puerto Rico.
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The Law That Made Puerto Rico an Offshore Paradise
The ACT 273
In terms of Act 273 of 2012, known as the International Financial Center Regulatory Act, eligible businesses engaged in Puerto Rico and licensed as International Financial Entities (IFE) in Puerto Rico can benefit from tax exemptions.
IFE Eligibility
Any person who is NOT AN INDIVIDUAL who is incorporated or organized under the laws of Puerto Rico, the US, or any other country, can be eligible for the exemptions.
Organize an IFE
⇒ Apply for a permit from the Office of the Commissioner of Financial Institutions.
⇒ Pay the non-refundable application fee of $5,000.
⇒ Comply with all the requirements of the Bank Secrecy Act where applicable.
⇒ When the permit is issued, organizing the IFE is subject to the following criteria:
⇒ Authorized Capital Stock (or initial paid-up capital) shall not be less than $5 million.
⇒ Of the above amount, the permit holder must pay a minimum of $250,000 at the time of application.
⇒ The Commissioner can waive the minimum requirement when interested parties negotiate a lower proposed or initial paid-in amount, and the circumstances warrant it.
⇒ The IFE must employ four or more people at its office or offices in Puerto Rico.
⇒ The IFE can request a discretionary waiver to lower the employment requirement.
⇒ After the organization of the IFE, the Puerto Rico State Department will provide it with its Organization Certification.
⇒ When the Commissioner receives the above certification, the IFE can apply for a license.
⇒ For the license to be issued, the IFE will have to provide Articles of Incorporation and all other corporate documents required.
⇒ The license will list all the transactions in which the IFE can participate.
Permitted Transactions
When approved, the IFE is allowed to participate in the following transactions:
⇒ Syndicated non-conforming loans with local banks for five years starting in 2012.
⇒ Acquisition of classified or distressed loans and any personal or real property that provides collateral for these loans from local banks.
⇒ This is allowed until December 31, 2018. The IFE may sell the collateral property for the loans after December 31, 2018.
⇒ Accept deposits from foreign persons.
⇒ Borrow duly secured money from the Governmental Development Bank and the Economic Development Bank
⇒ Accept adequately collateralized deposits from the Governmental Development Bank or the Economic Development Bank
⇒ Establish branches outside of Puerto Rico, in the US (mainland) and its possessions and other foreign countries,
⇒ Place deposits in and extend credit to the Governmental Development Bank, the Economic Development Bank, or any other bank or IFE.
⇒ Guarantee, procure, place, or provide loan servicing to certain foreign persons.
⇒ To issue, confirm, give notice, negotiate, or refinance letters of credit if the beneficiary requesting the letter of credit and the client is not a domestic person.
⇒ To issue, confirm, give notice, negotiate, or refinance letters of credit in transactions that finance exports regardless of whether the beneficiary is a domestic person or not.
⇒ To discount, rediscount, deal or otherwise trade in money orders, bills of exchange, and similar instruments, if the drawer and the original debtor is not a domestic person.
⇒ Invest in securities, stocks, notes, and bonds of the Government of Puerto Rico.
⇒ Carry out any permitted transaction in the currency of any country or gold or silver and take part in the trade of foreign currency.
⇒ Underwrite, distribute, and otherwise trade in securities, notes, debt instruments, drafts and bills of exchange issued by a foreign person for final purchase outside of Puerto Rico
⇒ Engage in any financial activity outside Puerto Rico, which is legal for bank holding company or a foreign subsidiary of a US Bank.
⇒ Act as a fiduciary (if a permit was issued to the same by the Commissioner) on condition that no such services will be offered or will incur domestic persons.
⇒ Acquire and lease personal property at the request of a lessee who is a foreign person.
⇒ Trade in securities outside of Puerto Rico on behalf of a foreign person.
⇒ Act as a clearinghouse for financial contracts and instruments from foreign persons.
⇒ Organize, manage, and provide management services to financial entities located outside of Puerto Rico, including investment companies and mutual funds as long as participation in the capital of these companies is not directly distributed to domestic persons (by the IFE).
⇒ Participate in granting & securing loans originated or guaranteed by the Governmental Development Bank and the Economic Development Bank.
⇒ Provide loans and financial securities to Puerto Rico’s Government’s prioritized projects designated as extraordinary projects by the Secretary of the Treasury and the Commissioner.
⇒ Provide financial services, including the following:
⇒ Asset Management.
⇒ Investment Alternative Management.
⇒ Management of Private Capital Investments.
⇒ Management of Coverage Funds.
⇒ Management of High-Risk Funds.
⇒ Management of Pools of Capital.
⇒ Trust Management to Convert Groups of Assets into Securities.
⇒ Escrow Account Management Services.
Prohibited Transactions
⇒ Accept deposits or borrow money from domestic persons who are not the Government Development Bank or the Economic Development Bank or another IFE.
⇒ Make, procure, place, secure, or provide loan servicing not expressly permitted by the Act when beneficiaries do not use all the loan proceeds outside of Puerto Rico.
⇒ To issue, confirm, or give notice of letters of credit when the beneficiaries are not foreign persons who use their proceeds outside of Puerto Rico.
⇒ To discount bills of exchange when the drawer and beneficiaries are not foreign persons who use their proceeds outside of Puerto Rico.
⇒ Purchase or hold any of its capital stock unless when expressly permitted to do so by the Commissioner.
⇒ To finance or provide credit of any type or form to employees or stockholders if not expressly permitted to do so by the Commissioner.
⇒ To – directly or indirectly – underwrite, insure, reinsure or place risks or objects residing in or located in or to be executed in Puerto Rico.
Tax Exemptions
⇒ Fixed Income Tax rate of 4%.
⇒ Interest, financing charges, and the participation in partnership benefits are 100% excluded and will not constitute gross income from Puerto Rico sources; hence it will not be subject to either taxation or withholding for nonresidents of Puerto Rico.
⇒ A tax rate of 6% on dividends and the pro-rata shares of the benefits of the corresponding IFE for shareholders or who are are residents of Puerto Rico.
⇒ A tax exemption of 100% on all real and personal property that belongs to an IFE.
⇒ A tax exemption of 100% on the payment of all municipal license taxes.
⇒ Seven and a half percent of all IFE taxes collected will go to a special fund to promote the growth of services and other eligible businesses in Puerto Rico.
Tax Exemption Decree
Upon submission of its license to the Department of Economic Development and Commerce of Puerto Rico, an IFE may request a tax decree providing the full details of the tax rates and conditions specified by the Act. This decree will constitute a contract between the Government of Puerto Rico and the IFE. The benefits granted in the order will be secured for the term of the decree irrespective of any changes in applicable tax laws. The valid period of the decree will be fifteen years, which may include two extensions of fifteen years each.
Puerto Rico Income Taxes
International financial entities operating in Puerto Rico via a Puerto Rican entity are not eligible for any taxes. This includes tollgate tax or any similar taxes on income from its permitted activities in Puerto Rico, besides rates established in the decree and charges imposed on dividends to exempt businesses’ shareholders that reside in Puerto Rico. Distributed income repatriated to the resident jurisdiction of the owners of the Puerto Rico entity is subject to the taxes imposed for that jurisdiction.
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Achieving Permanent GILTI Tax Deferral by Relocating to Puerto Rico
US businesses have been known to defer taxation of their earnings through supply chain and intellectual property migration planning with jurisdictions outside the US. 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 must 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 like 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 like 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 relates to 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.
Exit Charges
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.
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