Productivity | Strategy | Profitability
Productivity | Strategy | Profitability
The Beauty of Business In Puerto Rico
Puerto Rico (which means “rich port” in Spanish) is officially named the Commonwealth of Puerto Rico. A Caribbean island, it is both US territory and yet unincorporated within the United States, reports Rachel Smith.
The island is located in the northeast of the Caribbean Sea, approximately 1,600 km southeast from Miami. It sits between the US Virgin Islands and the Dominican Republic, and Puerto Rico also includes the smaller islands of Culebra, Mona, and Vieques. Puerto Rico is in fact an archipelago of the main island, and some 143 smaller islands. With 3.2 million residents and a capital in San Juan (where most people live), Spanish predominates, although English is a close second. The islands were colonised by Spain following their discovery by Christopher Columbus, although for thousands of years prior, varying waves of various peoples had settled the country.
In 1898, after the Spanish–American War, Puerto Rico became a United States territory. While many complain of their secondary American citizen status, most Puerto Ricans trade it off against being largely independent of the mothership in other ways. From a business and investment point of view, Puerto Rico can offer the best of both worlds. There are catches, though, in spite of the fanfare around the country’s “Act 60” tax incentives.
COMPANY FORMATION IN PUERTO RICO
As a jurisdiction for business relocation and/or expansion, Puerto Rico is a dream come true, especially for many US businesses. It’s very individual though, as many companies’ architecture means there’s no gain in relocating there.
Act 60 is the legislative moniker that encapsulates Puerto Rico’s offer to foreign companies. In deconstructing Act 60 (formerly Act 20 and 22), which is the current gateway for evaluating business opportunities on the island for foreigners, it’s worth noting that US citizens are still liable to declare global income, no matter where it’s generated. As a US Territory, Puerto Rico is not going to be a solution to tax avoidance for many. That said, of course there are some tax incentives available to genuine expats, such as foreign earned income tax exclusion, foreign tax credits, and being able to operate a business by proxy, through a non-US company.
Foreigners who become bona fide residents of Puerto Rico will no longer be subject to US federal income taxes on their Puerto Rican source income. Instead, they’re only subject to Puerto Rican income tax on local income.
Company formation on the island is fairly simple and inexpensive. A registered agent needs to be appointed, a name chosen for the company, and a Certificate of Incorporation needs to be filed with the Department of State. Filing can happen online, and a cost of $150 accompanies the certificate. Limited liability companies (LLCs) are generally taxed as corporations. Businesses incorporated as an LLC in Puerto Rico are taxed as a domestic corporation, and those incorporated under foreign laws who wish to establish on the island, are taxed as foreign corporations.
Genuine residents (citizens and US visitors) of Puerto Rico who spend all or most of the tax year in Puerto Rico, are typically not required to file US federal income tax returns, assuming their income is derived of business within Puerto Rico. When Puerto Rico slashed its corporate tax rates to 4%, it gave thousands of (especially) US companies an incentive to look at residency. Another part of the incentive is that individuals will pay 0% tax on capital gains and certain other dividends while a bona fide resident of Puerto Rico.
A HARD LOOK AT THE AVAILABLE PUERTO RICO TAX BREAKS
While the points below are particularly pertinent for US companies and investors, much the same can be said of EU residents’ tax avoidance aspirations by leveraging Puerto Rican incorporation or investment. Online advice regarding incorporating in Puerto Rico- especially that aimed at US corporations, is generally misleading. A few realities are worth investigating in detail.
> The Puerto Rico incentives only work if you actually live in Puerto Rico. A common theme among offshore gurus is that US citizens can take advantage of the island’s Act 60 benefits while still resident in the US. The pitch is that US citizens form a Puerto Rican corporation, hire Puerto Rican employees, and run the business from a US home base. The stated aim of this fanciful architecture is that citizens will then only pay US taxes on a salary taken from the company, while the company’s tax liability is only 4% “back home” in Puerto Rico. This a false depiction, as it looks only at the glittering Puerto Rican tax consequences. It’s not cognisant of broader US tax consequences.
> For the purposes of US tax rules, a Puerto Rican corporation is seen as a non-US corporation. It is therefore subject to the same general US tax rules that apply to a corporation formed outside the US. A non-US corporation that is “engaged in trade or business within the US” (ETBUS) is indeed subject to federal taxes. Although a non-US corporation is defined as ETBUS typically only when it has its own (foreign) people on American soil, operating its business, a non-US corporation that’s ETBUS faces a tax liability on income that is “effectively connected” with business within the US.
> It becomes easier to see that the scenario of Americans running an almost tax-free Puerto Rican business from their laptop is indeed wishful thinking. Federal tax authorities would determine how much of the offshore company’s income is attributable to the US owner’s work on US soil. There would then be an allocation made by authorities, where they deem X% of the Puerto Rican income is derived from the owner’s efforts, and that percentage attracts 21% tax. Trying to remove that income from the US would attract branch profits tax at a rate of 30%. Ultimately, this boils down to the Puerto Rican corporation being ETBUS, and thus subject to US tax (at a very stiff rate) on at least part of its income.
To truly take advantage of the Purto Rican tax breaks, the owner would need to move to Puerto Rico to operate the business. In doing so, the corporation would no longer qualify as having “people on the ground” in the US, and therefore cease to pay federal taxes on its income. For many, physically relocating to Puerto Rico isn’t feasible.
OTHER CONSIDERATIONS AROUND PUERTO RICO’S OFFERING TO BUSINESS
Many gurus point to the fact that US citizens only need to spend the mandated 183 days per year within Puerto Rico to be deemed a “bona fide resident” of Puerto Rico. There are additional requirements though:
> You may not have a “tax home” outside of Puerto Rico.
> You may not have any “closer connections” to any place except Puerto Rico during that taxable year.
To pass the “closer connections” test, foreigners will need to show the following:
> The location of your permanent residence.
> The whereabouts of immediate family.
> The location of personal vehicles, furniture, jewellery, and clothing.
Moreover, to qualify for Act 60 tax benefits, a company must be concerned with research and development, consulting, PR, construction or engineering, graphic design, accounting, architecture, hospital and laboratory services, or coding and telecoms. There are a few other categories that qualify, but those that don’t include all e-commerce businesses, affiliate marketing, most SaaS business, and app businesses.
TO BECOME PUERTO RICAN, OR NOT
Tourism is big on the island, and it can’t be denied that the latest Act 60 efforts are attractive to many companies for individual reasons, thus boosting government efforts to diversify and fortify the local economy. In short, the nature of their business and company architecture make it sensible for some business owners to relocate. For many others, the benefits will be negligible.
Indeed, for any benefits to become real, company owners will need to be Puerto Rican residents for a year before benefits kick in the following year. Additionally, capital gains are not as easily pocketed sans tax as online gurus make out.
The island’s current attractiveness can also be altered by the stroke of a politician’s pen, and physically relocating is a big price to pay if the US starts to apply pressure to the local regime when it feels it’s losing too many tax dollars abroad.
American entrepreneurs like Peter Schiff, Mike Maloney and Harry Dent love Puerto Rico, and it’s no surprise, as each of them have found major benefits there for their personal endeavours. One size won’t fit all, though, and the extended fine print accompanying Puerto Rico has to be considered to determine genuine value. The grass might very well be greener in Puerto Rico, but it’s worth looking long and hard at the island’s latest offer to companies and investors before setting anything in motion. EG