by:

Richard Hartmann, J.D., CLU, ChFC, TEP (Auctoris)

Janira Beltrán, Esq. (Pellot-Gonzalez)

Marisel Valentin Marquez, Esq. CPA, LLM (Pellot-Gonzalez)

PURPOSE

• To illustrate the U.S. income and estate tax benefits U.S. citizens have available through Puerto Rico Economic Incentive Acts (known as Acts 20 and 22)
• To briefly outline the types of businesses that qualify
• To briefly state the simple qualifications that are required to realize the tax benefits

Example

A U.S. citizen owns a significant number of health care facilities in the U.S. They fall into three categories – memory care centers, rehabilitation centers and home health care businesses. For management efficiency and business succession purposes he created three LLC’s to own all the individual businesses.

Before Planning

• All net income was subject to U.S. Federal and State taxes
• The full value of all his businesses was included in his gross estate subject to the 40% estate tax

Planning

• G1 created three holding company LLC’s – one for each of type of business
• Sold 99% non-voting interest in each LLC to Multi-Generation Trusts for their family…at 35% discount
• Kept 1% (100% of voting interest) of each LLC
• Took up residency in Puerto Rico (183 days per year and closer connections in Puerto Rico)
• Started a Management Company (service company) under the Economic Incentive Acts in Puerto Rico
• Management Company manages all three LLC Holding Companies and all of the individual businesses in each of the LLC’s

Results of Planning

• Immediately reduced G1’s taxable estate by the 35% discount on all of the companies sold to the Trusts
• Transferred 99% of the growth of those companies out of their estates
• Qualifying as an Economic Inventive business, distributions from the management Company to the owners are FREE of U.S. Federal income taxes, state income taxes, and Puerto Rico income tax
• If G1 sells the Puerto Rico Management Company they may pay no tax on the gain, depending on the number of years the interest in the company is held before sale

Dollar results

• G1 gets distributions of $5M per year from the company – totally free of income tax! A savings of over $2M per year!
• The Management Company continues to grow and if sold (along with the individual businesses) G1 will have less gain and perhaps no gain on which they have to pay tax (depending on the number of years the company was owned before sale)

Another Planning Opportunity

• The owners of the Management Company who also own the notes from the sale of the three (3) holding company LLC’s, and have significant other assets, are still subject to U.S. 40% estate taxes of approximately $35M
• G1 could give or sell an interest in the Puerto Rico Management company (at a discount for lack of control and marketability) to the Multi-Generation Trusts that own 99% of the U.S. businesses
• Because the Trusts are Grantor Trusts, G1, who are residents of Puerto Rico, pay no tax on the pro-rata distributions paid to the trusts (neither does the trust)!
• Net profit from the Management Company will pass to the Multi-Generation Trusts free of income, gift, estate and GST taxes
• The trust will use some of the income tax-free distributions to pay premiums on $35M of life insurance on G1 to pay the estate taxes so 100% of the wealth created by G1 does not shrink by 40% as it passes for the use of all future generations

That is the power of utilizing the Puerto Rico Economic Incentive Laws for the benefit of successful privately held companies and their U.S. owners!

 QUALIFYING BUSINESSES

Act 20: Act to Promote the Exportation of Services

Purpose:

• To promote development of new Puerto Rico companies to export “services”
• To promote relocation of foreign companies to Puerto Rico that already provide “services” outside of Puerto Rico

Benefits:

• 4% income tax on net income to the company
• 60% exemption on municipal license tax
• 90% exemption on real and property taxes for creative industries, corporate headquarters, call centers, shared service centers, distribution of Puerto Rico manufactured products and trading companies
• 0% tax for shareholders/owners on distributions from “eligible services”

Eligible Services:

• Consulting services, marketing, public relations
• Back-office functions, corporate headquarters
• Arts, media, creative industries (architecture & creative education)
• Hospital services, labs, medical tourism, telemedicine facilities
• Call Centers
• Education and Training Services
• Center for Electronic Data Processing
• Development of licensable software
• Research & Development
• Commercial and Mercantile Distribution of products manufactured in Puerto Rico for export
• Assembly, bottling, and packaging operations for export
• Investment Banking and other financial services

Exemption Period:

• 20 years renewable for 10 more, if conditions met

Employer Requirements:

• No minimum employees
• If employees needed (in addition to the owner), it may be required to employ or subcontract Puerto Rican Residents
• Assignment of salary to owner/employee ($350,000 limit)
• Audit every two (2) years to review compliance

 

Act 22: Act to Promote the Transfer of Investors to Puerto Rico

Purpose:

• To promote the relocation to Puerto Rico of individuals who have not been residents

Benefits to Individuals:

100% tax exemptions (federal and state):

• Interest/Dividends/Distributions
• “After relocation” capital gain on securities

“Prior Relocation” capital gain on securities:

• 5% rate after 10 years
• 15% rate within 10 years
• Reinvest in Qualified Opportunity Funds

Eligible Persons:

• Non-resident U.S. citizens or
• Non-resident aliens
• That establish domicile in Puerto Rico, and
• Have not been domiciled in Puerto Rico at any time during the 6-year period ending on Jan 17, 2012

Exemption Period:

• Begins the date the the tax concession is filed
• Ends on Dec. 31, 2035
• Requires $5,000 annual contribution to certified Puerto Rico tax exempt charity
• Audited for compliance every two (2) years

Act 73: Economic Incentives Act for the Development of Puerto Rico

Benefits:

• 4% tax on income from eligible activities
• 1% tax on income from Novel Pioneer Activities (NPAs)
• 0% tax on NPAs that create or develop an intangible property in Puerto Rico
• 60% exemption on municipal license tax
• 90% exemption on real and personal property tax
• 0% tax for shareholders/owners on distributions

Eligible Activities:

• Manufacturing
• Research & Development
• Recycling
• Hydroponics and “Aquaculture”
• Software development
• Natural gas or renewable sources energy generation
• Certain services to manufacturing exempt businesses
• Production of bottled water
• Social interest and self-sustainable housing
•  Value added activities in designated ports
• Repair, maintenance and conditioning of airplanes
• Assembly of equipment for renewable sources energy generation

Exemption Period:

• 15 years

Additional Benefits – Tax Credit For:

• Purchase of products manufactured in Puerto Rico
• Job creation
• Investment in R&D, clinical tests, toxicology tests, infrastructure, renewable energy, and intangible property
• Technology transfer
• Investment credit or strategic projects
• Tax credit industrial investment credit (operation in process of shutting down)

Act 74: Economic Incentives for the Tourist Development Act of Puerto Rico

Benefits:

• 90% tax exemption on income from the tourist activity is tax free, the rest is subject to normal rates and distributions
• 90% tax exemption on the sale or exchange of stock/ownership interest, or substantially all assets. If the eligible activity continues for at least 24 months after such sale
• 100% tax exemption of gross receipts taxes for new projects, 90% for existing project

Eligible Activities:

• Hotels, including Casinos
•  Condo-hotels
• Puerto Rican “paradores”
• B&B and guest houses
• Timeshares and vacation clubs
• Theme parks
• Golf courses located within a tourist destination or resort
•  Nautical tourism
• Tourist marinas and docking facilities for tourists
• Agritourism and Agri-lodgings
• Medical tourism
• Natural resources that are useful as a source of active or passive entertainment or amusement
• Other facilities or activities constitute a stimulus to domestic or foreign tourists

Exemption Period:

• 10 years renewable for additional 10 years
• Remodeling or renovation of exempt business may allow renegotiation for additional 10 years

Additional Benefits:

• 100% exemption on municipal construction excise taxes
• 90% exemption on real and personal property taxes
• 100% exemption on sales and use tax on items acquired and used in a tourist related industry
• 100% exemption on excise taxes on petroleum derivatives and/or hydrocarbons for generation of energy

Tax Credits:

• Up to 40% of investment in eligible project
• Transferrable at approximately 90% of value*
• Tax-free transfers*

Note: The credit is like a tax voucher that is sold at a discount. Currently they are traded at around 90% of their face value, so the purchaser gets approx. 10% discount on their taxes and the seller gets cash in a tax free transaction.

Act for the Development of Economic Development Opportunity Zones in Puerto Rico

Benefits:

• 18.5% tax on income from eligible activities.
• 25% (up to 75%) exemption on municipal license tax
• 25% (up to 75%) exemption on real and personal property tax
• 0% tax for shareholders/owners on distributions
• No gain or loss recognition on capital gains (subject to U.S. Code reinvestment requirements for QOF)

Eligible Activities:

• Designated Priority Projects by an Opportunity Zones Committee (types of business to be determined, but cannot include businesses that are eligible for any of the other Puerto Rico Tax Incentives Laws)

Exemption Period:

• 15 years

Tax Credits:

• Up to 25% of the cash investment
• Transferrable at approximately 90% of value
• Tax-free transfers

 

This article was originally published on LinkedIn on June 19, 2019.