July 1, 2022
FIRST IMPRESSIONS | Puerto Rico enacts legislation allowing companies to replace 4% excise tax on foreign corporations with new, possibly creditable, tax on industrial development income
The Governor of Puerto Rico has enacted Act 52 of June 30, 2022 (Act 52-2022), which allows companies to elect a 10.5% tax on industrial development income from sales of goods and services instead of the 4% excise tax on foreign corporations, which the latest US foreign tax credit rules do not consider creditable. In addition to changing the excise tax regime, Act 52-2022 amends the incentives laws and other statutes, including the Puerto Rico Internal Revenue Code of 2011, as amended (PR IRC).
This Alert provides a high-level overview of the Act. A detailed Tax Alert on Act 52-2022 is forthcoming.
New tax regime to replace the excise tax
Businesses electing the 10.5% tax rate must ask the Department of Economic Development and Commerce (DEDC) to amend their tax exemption decree to reflect the new tax regime under which the 10.5% tax rate will apply. The legislation authorizes the DEDC to determine whether granting the election will be in Puerto Rico's best interests. If the DEDC grants the election, the taxpayer may request to have its decree extended for an additional 15 years, beginning on the day following the expiration of its existing decree.
If the United States amends the Internal Revenue Code to apply a corporate income tax rate of at least 15% to the income of a controlled foreign corporation, then a 15% rate will apply to the taxpayer's industrial development income, instead of the 10.5% rate. The industrial development income that will be subject to the opted 10.5% rate, or the automatically triggered 15% income tax rate, generally is eligible for various exemptions. Exemption eligibility depends on certain conditions, such as the amount of income, the number of employees, capital investments made, and the number of municipalities in which the business operates. Exemptions fall into the following tiers:
US adoption of a corporate income tax rate of at least 15% would reduce the average employment condition under Tier 1 from 1,000 to 100 direct employees.
The Act amends the Incentives Code (Act 60-2019), as well as the predecessor incentives laws as applicable (Act 135-1997 and Act 73-2008), to incorporate these tiers.
Credit for businesses remaining under excise tax regime
The Act also provides a new credit mechanism to be applied against the excise tax for tax years commencing after December 31, 2022, for taxpayers that remain under the excise tax regime. Among the requirements, the taxpayer must be part of a controlled group with manufacturing facilities in four or more Puerto Rican municipalities as of June 30, 2022. The credit equals $8 million per each of the operating facilities, with an annual maximum of $32 million. A minimum excise tax $500,000 payment rule applies to each municipality to which the credit relates.
Withholding tax on royalties
Generally, taxpayers that elect to be subject to the 10.5% rate or the automatically triggered 15% income tax rate must continue applying a 12% withholding tax to royalties paid to corporations, partnerships, or nonresident persons that are not engaged in a trade or business in Puerto Rico for the use, or right to use, patents, copyrights, formulas, technical know-how and other similar property in Puerto Rico. Act 52-2022, however, reduces the withholding tax rate to 7.5% under certain circumstances.
Companies with 100 or more direct employees may exempt 37.5% of royalties subject to the 12% withholding rate. This exemption will not apply to Tier 1 or Tier 4 businesses. A 13% withholding tax rate will apply to royalties paid by Tier 4 businesses, but may decrease to 12% if certain conditions are met.
New process for evaluating requests to amend tax exemption decrees
Act 52-2022 introduces a new process for evaluating taxpayer requests to amend their tax exemption decree to reflect the new 10.5% tax. The process seems to be aimed at expediting the evaluation of the request and DDEC's final determination on granting the amendment.
New system for administering tax credits
The Act authorizes the Puerto Rico Treasury Department (PRTD) to create a system to administer tax credits. The PRTD must publish regulations or other administrative guidance on the implementation date of the new system.
The Act distinguishes between pre and post system credits (i.e., credits granted before or after the system’s implementation). Taxpayers would have three years from the system’s implementation to use pre-system credits; after those three years, unused pre-system credits will expire.
Other tax changes
Act 52-2022 introduces multiple changes to the PR IRC’s provisions on income tax and sales and use tax, some of which are briefly addressed below.
The PR IRC now recognizes the tax status of a disregarded entity for tax years beginning after December 31, 2021, if the entity meets certain requirements. The changes seem to apply only to a limited liability company with a sole member who is a Puerto Rico individual resident. The owner of the disregarded entity will recognize the disregarded entity’s activity on its income tax return. Under Act 52-2022’s amendments, a disregarded entity is not required to file an income tax return, but its owner must report income and expenses using the same tax year and accounting methods as the disregarded entity.
The Act also amends the PR IRC’s definition of being engaged in trade or business in Puerto Rico to prevent remote workers in Puerto Rico from creating nexus for nonresident businesses for income tax purposes. Various factors and conditions must be satisfied for the remote worker not to create a trade or business in Puerto Rico. These rules apply to tax years beginning after December 31, 2021. Withholding taxes do not apply to wages paid after December 31, 2021, to a remote worker as defined under the PR IRC for services rendered. The remote worker must, however, pay estimated taxes on the income realized for the services rendered.
The Act requires Puerto Rico resident individuals with financial accounts maintained outside of Puerto Rico or United States to file a declaration detailing those accounts with their annual individual income tax return.