Indirect Tax Alert. Puerto Rico approves technical amendments to SUT and VAT and Treasury Department issues transitionperiod.

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1 16 October 2015 Indirect Tax Alert News from Americas Tax Center EY Americas Tax Center The EY Americas Tax Center brings together the experience and perspectives of over 10,000 tax professionals across the region to help clients address administrative, legislative and regulatory opportunities and challenges in the 33 countries that comprise the Americas region of the global EY organization. Copy into your web browser: Services/Tax/Americas-Tax- Center---borderless-clientservice Puerto Rico approves technical amendments to SUT and VAT and Treasury Department issues transitionperiod guidance Executive summary On 30 September, 2015, the Governor of Puerto Rico signed into law Act 159 (Act 159). This piece of legislation has been dubbed the technical amendments to Act 72 of 29 May 2015 (Act 72). Among the most notable changes introduced by Act 72 were the phasing-out of the central government sales and use tax (SUT) and its replacement with a value added tax (VAT). 1 Although Act 159 also introduced some changes to the Puerto Rico income tax, this Tax Alert focuses on the SUT and VAT provisions. The SUT changes introduced by Act 159 were intended to expand and clarify certain Act 72 provisions that went into effect on 1 October Namely, it modifies the definition of the terms services rendered to other merchants, designated professional services and taxable services for purposes of the transition SUT rules in place from 1 October 2015 through 31 March 2016 (Transition Period). 2 The Puerto Rico Treasury Department (PRTD) issued Administrative Determinations of 31 August 2015 (AD 15-17) and of 5 October 2015 (AD 15-21), providing guidance on the application of the SUT on services during the Transition Period. Although both administrative determinations are related in terms of subject matter, the discussion in AD is circumscribed to the changes introduced by Act 159. The Act 159 provisions dealing with VAT are principally aimed at harmonizing the expanded SUT service exemptions with the VAT provisions, once it comes into effect on 1 April As of the publishing of this Tax Alert, the PRTD has not issued guidance on the upcoming VAT implementation. 3

2 Lastly, the PRTD announced changes to the IVU Loto program through a series of administrative pronouncements. For purposes of this overview, this Alert refers to the 4% tax on services rendered to other merchants and designated professional services as the special 4% SUT and to the 11.5% combined sales and use tax imposed by the central government and municipal government as the basic 11.5% SUT. Detailed discussion Sales and use tax transition period rules Exempt services The Puerto Rico Internal Revenue Code of 2011, as amended (Code), subjects all designated professional services and services rendered to other merchants that are not considered taxable services to the special 4% SUT during the Transition Period, as long as the service is not exempt from the SUT. Additionally, all services, including taxable services, designated professional services and services rendered to another merchant, performed by a person not resident in Puerto Rico will be subject to either a 10.5% or 4% SUT, depending on the transaction, for the duration of the Transition Period. Under AD 15-17, in the case of taxable services, the 1% municipal SUT portion of the basic SUT would not apply since the service is rendered outside of Puerto Rico. Repair and maintenance services Circular Letter of 20 August 2013 (CL 13-13) discusses which repair and maintenance services are subject to the 11.5% basic SUT. Specifically, Circular Letter states the following services are not repair and maintenance services and, thus, covered by the businessto-business SUT exemption: Repair and maintenance of vehicles, as defined in the Code The removal of machinery, equipment or other types of tangible personal property, as well as the demolition of real property Computer software maintenance services The inspection or validation of equipment or machinery, elevators and fire alarm systems Capital repair services Although the listed services have been exempt from the basic SUT under the business-to-business exemption, AD clarifies that, starting on 1 October 2015, they will be subject to the special 4% SUT, provided the services are rendered between merchants that are registered in the SUT Merchant Registry. Bank fees Administrative Determination of 13 September 2013, lists the bank fees that are subject to the SUT. In addition, it lists bank fees that are not subject to the SUT if they are deemed charges for financial services described in Section (nn)(2)(E) of the Code. AD clarifies that those bank fees will also be exempt from the special 4% SUT. Telecommunication services AD clarifies that telecommunication services, as defined in Section (kk) of the Code, are subject to the basic 11.5% SUT, even when the services are performed for other merchants. Although some telecommunication services are exempt from the basic 11.5% SUT, those exempt services will be subject to the special 4% SUT beginning 1 October 2015, if the services are performed between registered merchants. Charges for internet services and fees for services required by local or federal law, however, will remain exempt from both the basic and special SUT. Exported services AD clarifies that the exemption for exported services applies to services rendered to other merchants, designated professional services and taxable services when a merchant performs services in Puerto Rico for another person that has done business in Puerto Rico or is doing business in Puerto Rico and the services performed are unrelated to the business activities in Puerto Rico. If the services performed by the merchant are related to the business activities of the other merchant in Puerto Rico, those services will be subject to the special 4% SUT. AD provides examples to illustrate the application of this exemption. Legal services Act establishes that fees paid to licensed attorneys regulated by the Supreme Court of Puerto Rico or a similar entity in a foreign jurisdiction for services related to legal representation before the Commonwealth of Puerto Rico or US Federal Courts are exempt from the special 4% SUT. Services rendered by members of the Puerto 2 Indirect Tax Alert Americas Tax Center

3 Rico bar that can be performed by other professionals, however, such as financial consulting and certain types of work before government agencies and lobbying, will be subject to the special 4% SUT. The scope of the legal services exemption was limited further under AD to exclude the following: expert opinions, arbitrator services, consulting work related to human resources, offering seminars, presentations and courses, business consulting and all types of tax consulting work. Tax consulting work is defined as the preparation of tax returns, handling of refund claims, the clarification of debts before governmental agencies, representation before governmental agencies in tax matters, administrative determination requests, tax exemption requests and pension plan assistance, among others. AD contains examples to illustrate what services will be considered legal services. Construction services Under Act 159, the sales price of construction services rendered to other merchants is determined by multiplying the total amount of the bill by 35%. AD clarifies that, for purposes of determining the construction services that will be subject to the special 4% SUT, the merchant should multiply the total amount of the bill issued to another merchant by 35%. This provision will not apply to construction services performed for persons that are not merchants. Merchant with volume of business of $50,000 or less Services performed for merchants with a volume of business that does not exceed $50,000 will be exempt from the basic and special SUT. This exemption includes merchants that are dedicated to the performance of designated professional services. Eligible merchants must ensure their Merchant Registration Certificate indicates the merchant has a volume of business of $50,000 or less and, thus, is not required to withhold the SUT. AD contains several examples illustrating how the volume of business should be determined. Services performed by a person not resident in Puerto Rico Under the Code, a person resident in Puerto Rico who receives services from a person not resident in Puerto Rico will be responsible for self-assessing and remitting the corresponding SUT. The tax rate will depend on the type of service received. In accordance with Act 159, AD clarifies that services rendered to other merchants, designated professional services and taxable services performed by a person not resident in Puerto Rico for a person resident in Puerto Rico will be subject to a tax of 10.5% or the special 4% SUT, regardless of where the services are performed, provided the services are directly or indirectly related to the activities or operations of the person resident in Puerto Rico. AD contains examples to illustrate this provision. Services performed between related entities Generally, services performed between controlled group members or related parties that are engaged in a trade or business in Puerto Rico are exempt from the basic 11.5% SUT and the special 4% SUT. When an entity with a business in Puerto Rico receives services from a related entity without a business in Puerto Rico, however, AD clarifies that those services will be subject to the special 4% SUT. The entity doing business in Puerto Rico will be responsible for remitting the SUT to the PRTD. Services performed between related entities with business activities covered under a tax exemption decree under Acts , or Under Act 159, services performed between members of the same controlled group or related parties whereby one party that is not engaged in a trade or business in Puerto Rico provides services for an entity whose operations are covered by a tax exemption decree under Act 73 of 28 May 2008, (Act 73), Act 83 of 19 July 2010 (Act 83), Act 20 of 17 January 2012 (Act 20) or the National Bank Act, among other similar laws, will be exempt from the SUT. AD contains one example to illustrate this provision. Toll manufacturing or contract manufacturing Act 159 provides that toll manufacturing or contract manufacturing will be exempt from the SUT, as long as the service provider obtains a Collection Waiver Indirect Tax Alert Americas Tax Center 3

4 Certificate from the Secretary of the Treasury. According to AD 15-21, the PRTD will establish a procedure to request this certificate. Subcontracted services Under Act 159, subcontracted services will be exempt from the SUT, as long as the subcontracted service is related to a construction project or telecommunication services hired by a merchant dedicated to providing telecommunication services. As provided in AD 15-21, a construction project will include labor and services related to obtaining permits, but excludes designated professional services and services related with the administration and sale of properties. AD contains examples to illustrate this provision. Breakdown of items and reimbursed expenses AD requires all service providers to break down the different services performed and reimbursed expenses in their bills. Under AD 15-17, the following expenses will not be subject to the special 4% SUT: Expenses incurred, including the payment of the SUT, in purchasing tangible personal property used in the performance of the service, such as a part purchased for installation Expenses directly attributable to the service that are paid by the service provider and reimbursed by the client, such as fees paid to a government agency The following items will not be considered reimbursed expenses for purposes of determining the applicable SUT and will be subject to the SUT, provided the items are included in the bill: Additional charges that do not result from a direct expense related to the service, such as out-of-pocket expenses or administrative recovery fees Expenses indirectly related to the service performed, even if the expense is separately itemized in the bill Services performed by employees Services subcontracted and services provided by other merchants, whether or not subject to the basic or special SUT The basic or special SUT paid for subcontracted services or services provided by other merchants Accounting method The accounting method rules set forth in Section of the Code should be used by merchants for purposes of remitting the SUT to the PRTD. AD clarifies that such rules will also apply for purposes of the special 4% SUT. It also states that, for purposes of the basic and special SUT, merchants should use the same accounting method that they use to report income on their income tax returns. Merchants providing designated professional services, however, can elect to be cash-basis taxpayers for purposes of remitting the special 4% SUT for services. The merchant should make the cash-basis accounting method election on the Monthly Special SUT Return (discussed below) for October 2015, which should be filed no later than 20 November Merchants that begin doing business after October 2015 should make the election on their first Monthly Special SUT Return. As provided in AD of 24 June 2015, services rendered to other merchants and designated professional services performed before 1 October 2015, will not be subject to the special 4% SUT, provided the services are billed no later than 20 October Monthly Special SUT Return AD introduced the Monthly Special SUT Return. This new filing applies to merchants rendering services to other merchants or designated professional services that must withhold the special 4% SUT. This filing also applies to other merchants that must make SUT filings and merchants receiving services from other merchants or designated professional services outside of Puerto Rico. The Monthly Special SUT Return should be filed through the electronic system known as PICO ( comerciantes.hacienda.pr.gov/). Merchants should file the return no later than the 20th of the month following the month in which the special 4% SUT is collected. The first Monthly Special SUT Return should be filed for October 2015 no later than 20 November Other provisions AD provides rules for: Certificates for exempt purchases The credit for taxes paid by a reseller 4 Indirect Tax Alert Americas Tax Center

5 Preexisting contracts for services that will be rendered to other merchants or designated professional services Updating the Merchant Registration Certificate AD also contains rules for: Services provided by condominium and homeowner associations Publicity services Services provided by employment agencies Agricultural services Services performed by tax-exempt entities Designated professional services performed for unions Value added tax technical amendments As noted previously, most of the VAT amendments introduced by Act 159 are aimed at ensuring a degree of consistency after the conclusion of the Transition Period. As a result, some of the previously mentioned SUT amendments are similar to those adopted under Act 159 for VAT purposes. Following are some of the transactions that will be exempt from VAT under Act 159: Description of Transactions Exempt from VAT Retail sale of electric solar equipment Services rendered to an entity dedicated to repair, maintenance and reconditioning (RMR Services) of aircraft RMR Services of aircraft Toll manufacturing or contract manufacturing services Services provided to a person engaged exclusively in the storage (including the leasing of tanks) and processing of gasoline, jet fuel, aviation fuel, gas oil, diesel oil, crude oil, crude oil derivative products and any other hydrocarbon mixture Services provided to a merchant engaged in the generation and sale of electricity on a commercial scale Comments Retail sales refers to sales to merchants for use in their business. The entity receiving the services must be a grantee of a tax exemption decree under Act 73 or a similar law. The entity providing the RMR services must be a grantee of a tax exemption decree under Act 73 or a similar law. The RMR Services must be covered as an eligible activity under the tax grant. This exemption applies to toll manufacturing or contract manufacturing services if the provider of those services obtains a Collection Waiver Certificate from the Secretary of the Treasury. The storage and processing service must be performed in a Foreign Trade Zone. Guidance may be issued to address the scope of services covered under this exemption. Indirect Tax Alert Americas Tax Center 5

6 The Code defines a service for VAT purposes as any business conducted by a merchant that is not the sale of goods. The Code also excludes certain activities from this definition, which was expanded by Act 159 to include: Legal Services, as discussed above for SUT purposes, but it is still undetermined if the PRTD will issue guidance tailored to the VAT Rights to the use of intangibles Services performed among members of the same controlled group or related parties whereby one party that is not engaged in a trade or business in Puerto Rico provides services for an entity whose operations are covered by a tax exemption decree under Act 73, Act 83, Act 20 or the National Bank Act, among other similar laws Maritime, air and ground transportation services, including charges directly related to such services Services performed for any public or private entity formed under a statute that provides they will be exempt from all taxes Zero-rated services and articles The definition of services for export was expanded to include services covered by Act 20 and Act 73, as long as such services do not have nexus to Puerto Rico. In addition, the definition of manufacturing articles now includes machinery and equipment, including parts, tools, and components, used in RMR Services of aircraft, by the grantee of a taxexemption grant under Act 73 or a similar law. VAT credits Input VAT paid in relation to exempt items under the Federal Nutritional Assistance Federal Program or the Special Supplementary Nutritional Program for Women with Infants (WIC) will be deemed as paid in relation to a taxable operation; thus, allowing recovery of the corresponding input VAT. Merchants mainly engaged in the sale of certain fuel products or automobiles that are subject to excise taxes will be allowed to take a credit for input VAT paid or accumulated during the corresponding month. Penalties Act 159 added a new subchapter under the Code dedicated to VAT penalties and fines. The approved provisions are similar to those that currently apply under the Code for SUT purposes. The end of the IVU Loto program but not the end of the fiscal terminal During 2011, the PRTD rolled out the IVU Loto program. The main objective of the IVU Loto program was for merchants making sales in customer-present environments to issue sales receipts through fiscal terminals that transmitted sales information to the PRTD and issued a participation number that made the holder of the receipt eligible to win prizes in one of several monthly drawings. The premise behind IVU Loto was that, by providing an incentive for consumers to demand the sales receipt at the time of making a purchase, the PRTD would have access to real-time sales information for registered merchants and in turn improve SUT compliance and collections. Administrative Determination (AD 15-20) of 28 September 2015, established new requirements for fiscal terminals. AD provides that merchants with a sales volume of $125,000 or less and merchants that only provide designated professional services subject to the special 4% SUT are not required to have fiscal terminals, among other merchant types. Moreover, merchants with gross annual sales of more than $1 million must possess one of the following: (i) a fiscal terminal that is integrated to each one of its point of sales, or (ii) cash registers with the capacity of transmitting electronic data or information to the PRTD. It also states that, effective 30 October 2015, merchants will be responsible for the acquisition and maintenance of fiscal terminals and for any costs related to their operation. The PRTD also issued Informative Bulletin (IB 15-14) of 28 September 2015, which announced the cancellation of the IVU Loto drawings. IB also provided that merchants no longer had to include the IVU Loto numbers in their sales receipt. Thereafter, on 5 October 2015, the PRTD issued Tax Policy Circular Letter (CL 15-13) whereby it revoked the provision in IB requiring that merchants no 6 Indirect Tax Alert Americas Tax Center

7 longer had to include the IVU Loto numbers in the sales receipt, because the IVU Loto number identifies each individual transaction and the PRTD wants to continue receiving this data. The only information to be eliminated from the receipt is the number and date of the IVU Loto drawing. CL 15-13, however, requires the word IVU Loto in the sales receipt be replaced with the word Control. For independent processors, CL allows 60 days from 5 October 2015, to incorporate these changes. Under the SUT and VAT provisions of the Code, the Secretary of Treasury is authorized to require the use of fiscal terminals. Thus, although the recent guidance eliminates the IVU Loto program, it appears that its backbone, the fiscal terminal enforcement mechanism, will continue in effect under the SUT and as part of the upcoming VAT implementation. Endnotes 1. See EY Global Tax Alert, Puerto Rico becomes first US jurisdiction to adopt VAT system, dated 2 June The Secretary of the Treasury has discretion to extend the SUT sunset provisions by 60 days to 31 May See EY Global Tax Alert, Puerto Rico continues efforts to become a VAT jurisdiction, dated 16 April Indirect Tax Alert Americas Tax Center 7

8 For additional information with respect to this Alert, please contact the following: Ernst & Young Puerto Rico LLC, State and Local Taxation Group, San Juan Teresita Fuentes Rosa M. Rodriguez Pablo Hymovitz Pedro Mercado-Reyes Noeliz Suarez Archilla Ernesto A Rivera ernesto.rivera@ey.com Ernst & Young LLP, State and Local Taxation Group, New York Gino Dossche gino.dossche@ey.com Ernst & Young LLP, State and Local Taxation Group, Atlanta Peter Molnar peter.molnar@ey.com 8 Indirect Tax Alert Americas Tax Center

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