Overview of Puerto Rico Act 22 Tax Incentive Legislation
On January 17, 2012, the Legislative Assembly of Puerto Rico approved a new legislation to promote the economic development of Puerto Rico: (i) Act 22 to Promote the Relocation of Individual Investors to Puerto Rico (the “Individual Investors Act”) and (ii) Act 20 to Promote the Exportation of Services (the “Export Services Act”). In this post, we will discuss Puerto Rico Act 22 tax incentives: Individual Investors Act. Act 20 is exclusively related to businesses.
Puerto Rico Act 22: The Individual Investors Act, seeks to attract new residents to Puerto Rico with tax incentives providing a total exemption from Puerto Rico income taxes on all passive income realized or accrued after such individuals become Puerto Rico bona fide residents. This relocation should result in new local investments in real estate, services and other consumption products, and in capital injections to the Puerto Rico banking sector, all of which will accelerate the economy of Puerto Rico.
Applicability of Puerto Rico Act 22 Tax Incentive
The Individual Investors Act applies to any individual investor that becomes a Puerto Rico bona fide resident on or before the taxable year ending on December 31, 2035 (hereinafter referred to as “Resident Individual Investor”), provided that such individual was not a resident of Puerto Rico at any time during the 6-year period preceding the effective date of the Individual Investors Act. (Amended to 6 years, it was previously 15 years.)
A Puerto Rico bona fide resident is an individual who is domiciled in Puerto Rico. Physical presence in Puerto Rico for a period of 183 days during the taxable year will create a presumption of residence in Puerto Rico for tax purposes.
Special Tax Rule under the US Code for Puerto Rico Bona Fide Residents
Pursuant to Section 933 of the Internal Revenue Code of the United States of 1986 (the “US Code”), income derived from sources within Puerto Rico by individuals who are a bona fide residents of Puerto Rico during the entire taxable year is not included in gross income and is exempt from taxation under the US Code. (the “Section 933 Exclusion”).
The term bona fide resident of Puerto Rico means a person who: (1) is present for at least 183 days during the taxable year in Puerto Rico, (2) does not have a tax home outside of Puerto Rico during the taxable year; and (3) does not have a closer connection to the United States or a foreign country than to Puerto Rico.
Tax Exemption on Interest and Dividend Income
Under the Individual Investors Act, Resident Individual Investors will enjoy a 100% tax exemption from Puerto Rico income taxes on interest and dividend income derived during the Tax Exemption Period (as defined below).
Pursuant to the Section 933 Exclusion, interests and dividends received by Resident Individual Investors that qualify as Puerto Rico source income will not be subject to federal income taxation under the US Code.
Resident Individual Investors may be able to reduce the tax rate applied on interest and dividend income coming from sources outside of Puerto Rico (including the source country taxation) to 0% or 10%, respectively, by investing through certain Puerto Rico investment vehicles.
Tax Exemption on Capital Gains
Capital gains (“CG”) derived by Resident Individual Investors for investment appreciation accruing after becoming a Puerto Rico resident will be 100% exempted from Puerto Rico income taxes, if such gain is recognized prior to January 1, 2036.
On the other hand, CG derived by Resident Individual Investors will be subject to preferential income tax rates in certain circumstances, as follows:
- CG for investment appreciation that accrued prior to becoming a Puerto Rico bona fide resident (the “Non-PR Gain”) will be taxed at: (i) 10%, if such gain is recognized within 10 years after the date residence is established in Puerto Rico and prior to January 1, 2036, and (ii) 5%, if such gain is recognized after said 10-year period but prior to January 1, 2036.
- A similar rule applies under the US Code with respect to United States Investors, regardless of the Section 933 Exclusion, since any Non-PR Gain recognized within said 10-year period by investors formerly subject to the United States taxing jurisdiction (the “United States Investor”) will be taxed in accordance to the applicable provisions of the US Code. The United States Investor may elect to apportion to Puerto Rico any part of the CG related to investment appreciation that accrued after becoming a Puerto Rico resident and, therefore, be entitled to the Section 933 Exclusion for such portion.
- The United State Investor qualifying as a Resident Individual Investor which recognizes a Non-PR Gain after 10 years of becoming a bona fide Puerto Rico resident would not be subject to federal income taxation on any portion of the Non-PR Gain and to a 5% tax in Puerto Rico. As stated before, any part of a CG attributable to the period of Puerto Rico residence would qualify for 0% United States federal income taxation and 0% Puerto Rico income taxation, if recognized prior to January 1, 2036.
Any CG for investment appreciation not described above will be taxed in accordance with the applicable provisions of the Puerto Rico Internal Revenue Code of 2011, under which CG derived by Puerto Rico residents is subject to a 15% preferential income tax rate.
In light of the above, Resident Individual Investors may be able to reduce the tax rate applied on CG in their former domicile to 0%, 5% or a maximum 10%.
Tax Exemption Period
The Puerto Rico tax incentives granted under the Individuals Investors Act will expire on December 31, 2035 (the “Tax Exemption Period”).
The Amendment of Act 22 established fees for those applying and accepting the approval of the tax decree. Application fee for Act 22 incentives remains the same, but the acceptance fee, once the tax decree is approved, will be 5,000.00 USD.
A recent amendment requires the new resident to acquire residential real estate in the island, as well as opening an account at a Puerto Rico bank or “cooperativa” (which is similar to a savings & loans institution).
Myths and False Claims
Myth #1: All your income will be tax exempt. This is not accurate. Only income from passive sources will be exempt. Income streams that would qualify:
- Dividend income
- Interest income
- Long Term Capital Gains (for the regular Joe portfolio and investor)
- Short Term Capital Gains (for the active / day trader and hedge fund manager)
Any income derived from active sources, like consulting work or salaries (even for remote workers, teleworkers or online consultants) is not exempt under Act 22. Anyone claiming that this is possible is incorrect.
Myth #2: If you have rental income from real property located in the United States, this income will be tax exempt. No, this is not correct. While yes, you won’t pay taxes in Puerto Rico, you will still be taxed at the Federal level. Why? Because real property is taxed at the location of the property. If this is a huge portfolio, there are some ways to use Act 20 to manage the properties, but by no means the rental income will be exempt under the US IRC.
Myth #3: You can benefit from Act 22 without relocating to Puerto Rico. No, there is not way around this. Act 20 business owners are not require to relocate, as long as they have 5 employees doing all the work in the company, but Act 22 investors cannot enjoy the tax savings without relocating to Puerto Rico. That said, Puerto Rico is an amazing place to reside.
We had to add this “myth section” because some clients have been told otherwise. The above myths would include any claims that income from retirement funds, 1031 exchanges (real estate), W2 salaries or consulting engagements, real estate developments, retail business owners with a physical presence in the US, and anything with a physical presence in the United States are exempt from taxation through Act 22. There might be some ways to relocate some consulting business through Act 20, but no business / consulting income can benefit from Act 22, except trading of investment assets.
Disclaimer: The content of this Summary of New Puerto Rico Act 22 Tax Incentives Legislation in Puerto Rico has been prepared for information purposes only. It is not intended as, and does not constitute, either legal advice or solicitation of any prospective client and Porto Capital, Inc. nor its affiliates have any obligation to update any of the information contained herein.