Puerto Rico Pours On Tax Incentives For Investors
Robert A. Green, CPA , Contributor
Puerto Rico’s tax incentive acts are tailor-made for traders, investors, investment managers and financial institutions.
Enacted in 2012, Puerto Rico’s Act 22 allows investors and traders with bona fide residence in Puerto Rico to exclude 100% of all short-term and long-term capital gains from the sale of personal property accrued after moving to PR. Act 22 exclusions include day trading and it does not require investment in Puerto Rican stocks and bonds; trades can be made with a U.S. broker or on any exchange around the world.
Americans with residence in PR report “non-PR source” income on U.S. Form 1040, and PR-source income on a PR income tax return filed with Hacienda (PR’s tax authority).
IRS Pub 1321 shows how to treat different types of income (see “Source of Income Rules”). Other than the “sale of personal property” (stocks, bonds, futures) which is sourced in the “seller’s tax home” (presumably in Puerto Rico), other types of income are sourced from to location of the real property (home or office building) or payer (interest and dividends), or where the services or pension were earned. Special rules provide for capital gains on the sale of personal property purchased before moving to PR to be treated as U.S. source income.
Traders will go from paying U.S. federal and state income taxes on capital gains to paying zero taxes on capital gains as a bona-fide resident of PR. That’s a huge savings!
Act 20 for investment managers
Investment managers charge advisory fees to investors. They export their services to investors outside of PR and can qualify for Act 20 tax incentives for “export service businesses.”
The Act 20 tax incentive is a 4% flat tax rate on export service net income. The owner receives Act 22 100% exclusion on PR-source dividends received from the PR export service entity. Companies retaining some operations in the U.S. will have “effectively connected” trade or business income subject to U.S. tax.
Many owners and employees of investment management operations have significant capital gains income generated from their investment portfolios, including investments in their own funds and profit allocations of capital gains in their managed hedge funds. These capital gains can be excluded under Act 22.
Bona fide residence tests
You must pass all three different tests – the presence test, tax home test and closer connection test – for individual bona fide residence. Plan to live more than half the year in PR and move your family, domicile, connections and legal matters to PR.
If you’re young and single or an empty nester, this type of move may work well for you. If you trade for your own account with no investors or employees, it’s easier to move. But, for some investment managers it may be difficult to move an investment management business to PR. You have to change documents with investors, hedge funds and counterparties to reflect the PR company name and address and carry on your business from PR.