Puerto Rico as a tax haven should not be overlooked. Special concessions called tax holidays were carved out by PR legislators permitting U.S. and foreign and businesses to reap large tax benefits. Puerto Rico is a U.S. controlled tax haven, having all the benefits of any State in the Union, but with an internal tax system all its own. One tax haven writer has said… “There is no place in the territorial limits of the United States that provides such an advantageous base for exporters.”
The United States Congress actually prompted the current unique relationship with PR when it enacted special legislation exempting PR based U.S. subsidiaries from the Controlled Foreign Corporation provisions, even if they are 100% owned (controlled) by the U.S. parent. The regulations governing the use of a Puerto Rican subsidiary are found under IRC §957(c) (Corporations organized in United States Possessions), IRC §931 (Income from sources within possessions of the U.S.). It is the combination of these laws, plus newer legislation under IRC §936, plus Puerto Rico’s own tax incentive legislation under the Industrial Incentives Act (IIA) that make for the tax breaks.
In 1963 PR enacted its Industrial Incentive Acts (IIA) (revising earlier Acts of 1954 and 1948) providing 100% exemption from PR’s income tax, property tax and municipal tax for up to 30 years if the company was a qualifying manufacturer or hotel operator. Later, in 1978, a New Act, the Industrial Incentive Act of 1978 amended the previous Act by cutting back on the degree of the tax exemption. Today U.S. companies can get a partial exemption of 90% for the first five years on income and property taxes. Qualified U.S. subsidiaries are allotted a 100% exemption from PR municipal taxes. Puerto Rico’s regular corporate income tax rate for 1988 was 45%, but under the tax holiday the effective tax rate is only 4.5%.
Qualified Companies with Approved Products and Services
Under the IIA any foreign or domestic manufacturer, hotel operator, and service industry is eligible for the partial exemption. For example, drug manufacturers and manufacturers of woman’s, men’s and children’s apparel, hosiery and gloves, rugs, leather goods can obtain the effective low 4.5% profits tax rate. Service industries, including but limited to, investment banking, international commercial distribution facilities, public relations services, economic, scientific or management consulting services, processing, editing and dubbing cinematographic films, commercial and graphic arts, insurance firms, mail order firms, computer service centers, maritime vessel and aircraft repair, and international banking operations can also obtain the tax exemptions.
Exemption Rate Schedule
||Years of Exemption
|| Tax Exemption
|II, III, IV
In addition, an IIA exempt business may apply for a 10-year extension of its grant within 12 months before the expiration date of its tax-exemption decree. Depending on the zone in receive a partial exemption, which varies from 50% for the first 5 years to a low of 35% for the remaining 5 years.
Predecessor – Successor Businesses:
Persons owning at least 25% of an exempt business (the “Predecessor” business). In addition, any integrated expansion requiring common facilities can obtain a separate exemption with approval from the Governor.
Dividends from Exempt Entity
Dividends paid by a corporation operating under the IIA grant are exempt from income tax in the hands of a PR domestic company or an individual resident in PR.
Dividends from an exempt corporation paid to nonresident individuals are partially exempt from Puerto Rico’s withholding tax (called a tollgate – normally 29%), if the individual can show he is either now taxable on the dividend elsewhere or that he is not allowed a tax credit in his home country.
Dividends paid by a PR subsidiary to its U.S. parent are generally subject to a PR withholding tax of 10%, but this is reduced to 7% if a specified percentage of the earnings are retained and reinvested in PR property. The PR tollgate (withholding tax) can be further reduced to 5% in some cases. In addition, the U.S. parent will not have to pay any U.S. income tax on the dividend it receives from its PR subsidiary under U.S. tax statutes. Indeed, the Tax Reform act of 1976 made it possible for U.S. possession corporations to return profits to the U.S. parent at any time 100% tax-free.
Puerto Rico lies within the customs territory of the United States. Goods, equipment and supplies can be transferred from the States duty free. PR based manufacturers can use the U.S. postal system, and pay the same postal rates as U.S. companies. In addition, PR and the U.S. observe identical immigration laws. U.S. citizens can travel to and from PR without passports, the same as they can within the States.
Puerto Rico’s Inhabitant Rule
U.S. citizens that pick up and take up permanent residence in PR are permitted tax privileges unfounded in any territory or state of the United States.
Puerto Rican residents (including relocated U.S. citizens) can receive dividends from their tax except corporations without paying any taxes – U.S. or Puerto Rican. This is nothing more than the same old inhabitant rule that was repealed in the USVI.
IRS Attacks Under IRC §482
U.S. subsidiaries operating in Puerto Rico have little difficulty following IRS tax policies relating to U.S. possession corporations. Occasionally, the IRS has launched an attack on a PR-U.S. subsidiary that manufactured a product in PR, and then shipped it back to the U.S. parent for resale in the United States, using the parent company’s distribution channels as a means to reap large tax-free profits. This scheme will be challenged under IRC §482 (transfer pricing rules), and the IRS has been successful in winning such cases in court.
In one 1970’s case, drug manufacturer Eli Lilly was challenged by the IRS, and the U.S. courts reapportioned Lilly’s PR subsidiary’s income to better reflect the true taxable income of the U.S. parent company. The amount in question was some $12,000,000.
It should be mentioned, in the case where a PR subsidiary sells its product to an unrelated U.S. company, there should be no IRS challenge under IRC §482 and no “reapportionment of profits” under current law.
(Courtesy of New Providence Press: Tax Havens of the World).
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