Understanding Puerto Rico Business Tax Advantages
Starting a business and paying taxes in Puerto Rico can be very similar to operating in a typical US state. Since Puerto Rico is a US territory, you still pay tax to the IRS and, what amounts to a state tax, to Puerto Rico.
In 2012, however, Puerto Rico enacted legislation to make emigration from the US to Puerto Rico attractive for business owners. The legislation is basically split into two different acts. Act 20 and Act 22.
Below you will find thorough explanations of both Act 20 and Act 22. If you are interested in moving your business to Puerto Rico we offer Puerto Rico registered agent service, as well Puerto Rico foreign LLC and Puerto Rico foreign corporation services. However, you will need the help of a competent tax attorney should you decide to start doing business in Puerto Rico for tax purposes.
The Puerto Rico Business Tax Strategy
To implement a Puerto Rico tax strategy and move some or all of your business interests to the island, you’ll need to work within the bounds of Act 20 and/or Act 22. Here you’ll find an overview of both acts and how they are utilized by investors and business owners.
Puerto Rico Act 22
The Individual Investors Act
This Act provides:
- 100 percent tax exemption from Puerto Rico on all income taxes on dividends, interest, and capital gains taxes (both short and long-term)
- Additionally, residents of Puerto Rico (because there is “no taxation without representation” and Puerto Rico doesn’t have US respresentatives) automatically avoid federal US taxes on income derived from Puerto Rico.
The intent of this act is to attract individuals with a lot of money. However, there is a catch: you must become a Puerto Rico resident. The requirements of Act 22 are as follows:
- The Act 22 tax benefits include:The Act is only available to Puerto Rico residents who were not residents of Puerto Rico for the 6-year period preceding the enactment of Act 22 legislation on January 12, 2012.
- To be considered a resident of Puerto Rico, you must be present in Puerto Rico for 183 days a year
- You must not have a tax home outside of Puerto Rico for the taxable year
- You must have a closer connection to Puerto Rico than any other country including the United States
Essentially, this Act would be extremely useful for an individual set on lower the tax rates of their investment income. But becoming a resident with closer ties to Puerto Rico than the US is impractical for many individuals. Interestingly, if this setup sounds appealing to you and you qualify for Act 22, the agreement is seen as a contract between you and the Puerto Rico government and cannot be undone or altered once by legislation until 2035.
Puerto Rico Act 20
The Export Services Act
The Puerto Rico Export Services Act is designed to attract businesses to Puerto Rico and then export their goods and services to places and countries outside of Puerto Rico. Essentially, Puerto Rico wants businesses to offer services to the world outside of Puerto Rico from Puerto Rico. The Act doesn’t help businesses to avoid taxes on services offered to residents of Puerto Rico, only on services offered from Puerto Rico to those not living in Puerto Rico.
In short, a business in Puerto Rico would not qualify for any tax incentives under Act 20 for income gained from Puerto Rico sources. The same business could qualify for tax incentives on its income from non-Puerto Rico sources.
The Act 20 tax benefits include:
- Fixed income tax rate of 4 percent on export services income
- 100 percent tax exemption from Puerto Rico on dividends and benefits distributed out of export services income
- 90 percent property tax exemption (100 percent for the first five years) on both real and personal property taxes
- 60 percent tax exemption on local taxes (current rate is at 0.5 percent)
In order to qualify for Act 20, the business must be a “bona fide Puerto Rico business.” What does that mean?
The business must:
- Employ at least 5 full-time Puerto Rico residents within six months of beginning operations in Puerto Rico.
- In addition to employing at least five people (the owner can be one of the employees), the business has to be a Puerto Rico business. It can’t be incorporated in Wyoming, and registered as a foreign corporation in Puerto Rico, with no real physical presence. The business must be physically located in Puerto Rico. So, if your business is already in existence, you must move it to Puerto Rico.
Puerto Rico has also defined the types of businesses that can apply for the Tax Decree:
- Information systems
- International Trading companies
- Investment banking and other financial services (including investment advisory services and broker dealer operations)
- Managerial and human resources services and consulting, including centralized managerial services
- Professional services
- Research and Development
- Scientific consulting
- Shared Service Centers
- Technological services and consulting
- Advertising, marketing and public relations
- Call Centers
- Commercial Arts and Graphic Services
- Development of computer programs
- Electronic Data Processing centers
- Engineering, architecture and project management
- Environmental services and consulting
- Hospital and laboratory services
Recently, Puerto Rico also added manufacturing to the list, but the manufacturing would have to be export focused for the business to qualify.
Act 20 Application
To obtain the tax incentives the business must complete the Tax Incentives Application and pay the $750 application fee. To complete the application, you must include
- Legal business name and contact information
- Percentage of business dedicated to qualified exportation services
- Detailed description of qualified services
- Business entity type
- If part of a larger chain of companies or a holding company strategy, describe information of parent company and include an organizational chart depicting intermediate and related entities
- Stockholder/Member/Partner information for background check
- Indicate whether business is actively engaged in the qualified services, and if so, describe duration and commencement of operations in Puerto Rico
- Employment information
- Description of assets and capital investment
- Financial information and projections
You may need the help of a professional to complete the application. Puerto Rico has many CPA and tax attorney firms that would love to help you.
Why Puerto Rico Tax Strategy Appeals to US Citizens
As a US territory, Puerto Rico provides these simple benefits to investors and business owners moving to Puerto Rico:
- As a US Citizen, you can just move to Puerto Rico and become a resident without changing, altering, or renouncing citizenship status.
- You don’t have to pay a 23.8 percent exit tax on unrealized capital gains (things like stock and property that you own but haven’t sold yet)
That’s a much sweeter deal than having to give up citizenship and pay a big tax right off the bat.
Can I move my company to Puerto Rico for Act 20, but keep the US as my primary residence?
You certainly could base your company in Puerto Rico and keep the US territory as its home base, but without individual residence in Puerto Rico, the deal gets much saltier.
Puerto Rico residents have no representation by the US government, so even though they have US citizenship, they are not taxed by the IRS on income derived from sources in Puerto Rico. That makes being a resident there so tempting. You remain a US citizen, yet are not taxed on your income by the federal government because the source of income is from your business in Puerto Rico.
If you only move the company, though, on your personal tax income, you’ll be paying the federal government their fair share of your Puerto Rico sourced income. But the island of Puerto Rico will still give you all the same breaks. So, if you only move your company, you would have to think of Puerto Rico as your state. Their state corporate tax rate and incentives would be really nice, but your federal income taxes wouldn’t change.
In short, unless your state has a high corporate tax rate, it may not be fiscally prudent to move your company to Puerto Rico if you’re not moving with it.