McV tax attorneys have developed a strong Act 20 and Act 22 practice, counseling and advising clients seeking to learn more about these novel incentives.
Act 20, also known as the Puerto Rico Export Services Act, seeks to develop Puerto Rico as an international export service center by reducing income taxes and providing exemptions from property taxes, municipal license taxes, and taxes on dividend distributions for income generated and property used in the exempt operations. It creates an opportunity for investors to engage in business activities in Puerto Rico for customers located outside Puerto Rico with very low taxes, if properly structured.
Act 20 applies to legal entities that have a “bona fide” office or establishment in Puerto Rico and conduct eligible services either as an export service provider or as a promoter. Among the eligible services are the following:
- Advertising, marketing and public relations
- Call Centers
- Creative Industries (design, art, music, publications, development of apps and video games, creative education)
- Corporate Headquarters
- Development of computer programs
- Electronic Data Processing centers
- Engineering, architecture and project management
- Hospital and laboratory services
- International Trading companies
- Investment banking and other financial services (including investment advisory services and broker dealer operations)
- Professional services (law and accounting)
- Research and Development
- Shared Service Centers
- Voice and data telecommunications
- Education services and training
- Assembly, bottling and packaging of products for export
Export services are eligible services rendered to a foreign natural or juridical person located outside of Puerto Rico. To qualify for the exemption, the export services cannot have a connection with Puerto Rico. In general, the services will be considered to have a connection with Puerto Rico if they are, among others, related to (i) commercial or for-profit activities that have been or will be carried out in Puerto Rico; or (ii) advice regarding the laws and regulations of Puerto Rico, as well as procedures and administrative orders of the Government of Puerto Rico and its agencies.
Promoter services include eligible services that are related to the establishment of a new business in Puerto Rico, regardless of whether they have a connection with Puerto Rico.
Income Tax Benefits
Under Act 20, exempt businesses are generally subject to an income tax rate of 4% on the net income derived from the exempt operation, which can be reduced to 3% if certain conditions are met. The statute imposes a base period income limitation on the income tax benefits for businesses that were engaged in the eligible activity before filing the tax exemption application under Act 20.
Income Tax Exemption for Distributions
Distributions of dividends or benefits generated by the exempt operation are 100% exempt from Puerto Rico income tax.
Real and Personal Property Tax Exemption
Exempt businesses engaged in creative industries, centralized management services, call centers or shared service centers are entitled to 100% exemption from personal and real property taxes during the first five years of operations, and to 90% property tax exemption thereafter. Exempt businesses engaged in all other activities are not entitled to property tax exemption.
Municipal License Tax Exemption
Exempt businesses are entitled to 60% exemption from municipal license taxes during the tax exemption period. Exempt businesses operating in the Municipalities of Culebra and Vieques are entitled to 90% exemption from municipal license taxes.
Tax Exemption Period
The tax exemption period under Act 20 is 20 years, which may be extended for an additional 10 years.
To obtain the benefits of Act 20, the legal entity must request and obtain a grant of tax exemption. The grant is considered a contract between the legal entity and the government of Puerto Rico.
Act 20 does not impose a minimum employment requirement.
Act 22, also known as the Act to Promote the Relocation of Individual Investors to Puerto Rico, provides 100% tax exemption from Puerto Rico income taxes on all interest and dividend income and on certain capital gains realized or accrued after such individual becomes a bona fide resident of Puerto Rico. It applies to any individual investor who becomes a Puerto Rico resident (“Resident Individual Investor”) on or before the taxable year ending on December 31, 2035, provided that such individual was not a resident of Puerto Rico at any time from January 16, 2006 to January 16, 2012.
A Puerto Rico 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 residence in Puerto Rico for Puerto Rico income tax purposes.
Section 933 of the U.S. Internal Revenue Code of 1986, as amended (the “US Code”) provides that income derived from sources within Puerto Rico by individuals who are a bona fide residents of Puerto Rico during the entire taxable year is not included in gross income and is exempt from federal income taxation under the US Code (the “Section 933 Exclusion”). An individual is treated as a bona fide resident of Puerto Rico for purposes of Section 933 if the person (1) meets a physical presence test, (2) does not have a tax home outside of Puerto Rico during the taxable year; and (3) does not have a closer connection to the United States or a foreign country than to Puerto Rico.
Under Act 22, Resident Individual Investors will enjoy 100% tax exemption from Puerto Rico income taxes on interest and dividend income during the period of exemption. Moreover, pursuant to the Section 933 Exclusion, interest and dividends received by Resident Individual Investors that qualify as Puerto Rico source income will not be subject to federal income taxation under the US Code. Resident Individual Investors who are U.S. citizens or resident aliens, however, will be subject to U.S. federal income taxation on interest and dividends that do not qualify as Puerto Rico source income.
In certain circumstances, gains from the disposition of marketable securities acquired after an individual becomes a bona fide resident of Puerto Rico will not be subject to federal income tax if sold during the period of residence in Puerto Rico. Special rules apply for non-marketable securities and for marketable securities acquired prior to the establishment of residence in Puerto Rico.
The tax incentives granted under Act 22 will expire on December 31, 2035.
To obtain the benefits of Act 22, a Resident Individual Investor must request and obtain a grant of tax exemption. Such grant is considered a contract between the Resident Individual Investor and the government of Puerto Rico.
News & Publications
- McV NewsApril 7, 2017
- An McV Tax AlertNovember 3, 2017
- An McV Tax AlertJuly 19, 2017