On January 17, 2012, Puerto Rico enacted Act No. 22 of 2012, also known as the “Individual Investors Incentives Act” (the “Act”). The Act provides tax exemptions to eligible individuals residing in Puerto Rico, and may have profound implications for the continued economic recovery of Puerto Rico. To avail themselves of such benefits, individual investors need to become residents of Puerto Rico and apply for a tax exemption decree.
Eligibility: The benefits of the Act are only available to bona-fide residents of Puerto Rico that were not bona-fide residents of Puerto Rico for the 15-year period preceding the enactment of the Act on January 12, 2012 (“Eligible Individuals”). Generally, a bona-fide resident of Puerto Rico is a person who: a) Is present for at least 183 days during the taxable year in Puerto Rico; b) Does not have a tax home outside of Puerto Rico during the taxable year; and c) Does not have closer connections to the U.S. or to a foreign country than to Puerto Rico.
Although Puerto Rico is a U.S. territory, pursuant to Section 933 of the U.S. Internal Revenue Code of 1986, as amended, bona-fide residents of Puerto Rico are not subject to U.S. federal income taxes on income derived from sources within Puerto Rico. Therefore, U.S. citizens that are bona-fide residents of Puerto Rico benefiting from the Act will only be subject to federal income taxation on income derived from sources outside of Puerto Rico.
Tax Exemptions: The Act is designed to primarily attract to Puerto Rico high net worth individuals, empty nesters, retirees who currently relocate to other States and individual investors from U.S. and other countries. The Act provides the following benefits to new Puerto Rico bona-fide residents on qualified investments: a) 100% tax exemption from Puerto Rico income taxes on all dividends; b) 100% tax exemption from Puerto Rico income taxes on all interest; and c) 100% tax exemption from Puerto Rico income taxes on all short-term and long-term capital gains accrued after the individual becomes a bona-fide resident of Puerto Rico (“Puerto Rico Gain”).
Built-in Capital Gains: Also, capital gains realized by an Eligible Individual, but accrued before the individual investor became a bona-fide resident of Puerto Rico (“Non-PR Built–in Gains”), will be subject to preferential Puerto Rico income tax rates. If such gain is realized and recognized within 10 years after the date residence is established in Puerto Rico, it will be taxed at the income tax rate for capital gains applicable for the tax year in which the gain is realized (currently the capital tax rate is 10%) and at a 5% income tax rate if such gain is realized and recognized after said 10-year period.
Pursuant to U.S. income tax regulations, U.S. residents moving to Puerto Rico will be subject to federal income taxes on any Non-PR Built-in Gains realized within 10 years after moving. However, Puerto Rico income taxes are creditable against such federal income tax, and therefore, U.S. residents moving to Puerto Rico and realizing Non-PR Built-in Gains within a 10-year period after moving will be subject to the excess of U.S. taxes over Puerto Rico taxes on such Non-PR Built-in Gains. In other words, under current law and tax rates, such individual investors will only pay income taxes for the Non-PR Built-in Gains in an amount equal to the federal income tax rate imposed on such Non-PR Built-in Gains.
Example 1 - For example, if stock from a publicly traded company is acquired by a U.S. resident in 2006 for $40 and is worth $100 just before moving to Puerto Rico in 2012, and then it is sold by the Puerto Rico resident on 2018 for $200, the individual investor will be subject to income taxes for the gain realized on the sale as follows:
Cost ($40) U.S. Tax (15%) PR Tax (10%) U.S. Tax (after PR credit) Net Tax (U.S. and PR) Non-PR Built-in Gains ($60) $9 $6 ($9 - $6) = $3 ($3 + $6) = $9 Puerto Rico Gain ($100) $0 $0 $0 $0
After 10 years of moving from the U.S. to Puerto Rico, the income tax on the Non-PR Built-in Gains will not apply and bona-fide residents of Puerto Rico will only be subject to a 5% Puerto Rico income tax on any portion of the Non-PR Built-in Gain realized after 10 years from moving to Puerto Rico.
Example 2 - If the stock acquired by the U.S. resident in Example 1 is sold by the Puerto Rico resident on 2023 for $200, the individual investor will be subject to income taxes for the gain realized on the sale as follows:
Cost ($40) U.S. Tax PR Tax (5%) U.S. Tax (after PR credit) Net Tax (U.S. and PR) Non-PR Built-in Gains ($60) $0 $3 $0 $3 Puerto Rico Gain ($100) $0 $0 $0 $0
Tax Exemption Decree: To benefit from the Act, the individual investor needs to submit an application with the Office of Industrial Tax Exemption to obtain a tax exemption decree signed by the Secretary of Economic Development and Commerce of Puerto Rico, which will provide full detail of tax rates and conditions mandated by the Act and will be considered a contract between the Government of Puerto Rico and the individual investor. Once the individual investor obtains the tax exemption decree, the benefits granted will be secured during the term of the tax exemption decree, irrespective of any changes in the applicable Puerto Rico tax laws. The term of the tax exemption decree will be until December 31, 2035.
Puerto Rico Income Taxes: An individual investor in Puerto Rico under the Act should not be subject to any Puerto Rico income taxes (such as a dividend, tollgate, capital gain or other similar taxes) on his or her exempted income (as described herein) from eligible activities in Puerto Rico, other than the Puerto Rico fixed income tax rate established in the tax exemption decree.