Latest Amendments to the Puerto Rico Internal Revenue Code of 2011

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Nigel Walton
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1 O N E I L L & B O R G E S LLC Latest Amendments t the Puert Ric Internal Revenue Cde f 2011 Octber 2015 TAX ALERT On September 30, 2015, the Gvernr f Puert Ric signed int law Act 159 f 2015 ( Act 159 ) which, in general, cntains varius amendments bth f a technical and nn-technical nature t Act 72 f May 29, 2015, cmmnly knwn as the 2015 Tax Refrm Act ( Act 72 ). The fllwing is a summary f the amendments intrduced by Act 159. Sales and Use Tax ( SUT ) Certain exclusins frm the definitins f prfessinal designated services, services rendered t ther merchants and taxable services were intrduced. Befre the enactment f Act 72, certain services, classified as taxable services, were subject t SUT at 7%. Act 72 increased the SUT n taxable items (including the taxable services) t 11.5% (10.5% Cmmnwealth SUT and 1% Municipal SUT) and established a 4% Special SUT, effective Octber 1 st, 2015, with respect t services that were classified as prfessinal designated services and as services rendered t ther merchants. Act 72 als established an bligatin t self-assess the SUT with respect t services rendered by persns that are nt engaged in a trade r business in Puert Ric (hereinafter nn-residents ). Act 159 intrduced certain exclusins frm the definitins f prfessinal designated services, services rendered t ther merchants and taxable services, s that services described in such exclusins are nt subject t SUT. Act 159 als clarified the scpe f the applicatin f SUT with respect t services rendered by nn-residents. Self-Assessment f SUT with respect t services by nn-residents Services prvided by a nn-resident persn t a persn lcated in Puert Ric, directly r indirectly related t the peratins r activities f such persn in Puert Ric, regardless f the place where the service is rendered, are subject t SUT at a 4% r 10.5% depending n the nature f the service rendered. That is, designated prfessinal services and services rendered t ther merchants are subject t the 4% Special SUT and taxable services are subject t 10.5% SUT, bth payable t the Puert Ric Treasury Department ( Treasury ) by the recipient f the service. N Municipal SUT is applicable t such services. Services that are nt subject t SUT The fllwing services were added t the list f services that are nt subject t SUT, in accrdance with Act 72, as amended by Act 159. Unless therwise specified, the belw list f services that are nt subject t SUT refers t services excluded frm any r all f the categries O Neill & Brges LLC 2015

2 Octber 2015 Page 2 Legal and ntarial services are nt subject t SUT f prfessinal designated services, services rendered t ther merchants and taxable services. Legal services Legal services prvided by members f the legal prfessin authrized by the Puert Ric Supreme Curt t practice law in Puert Ric, r by the crrespnding entity in a freign jurisdictin, are nt subject t SUT. The exclusin applies with respect t fees fr services related t legal representatin befre the General Curt f Justice, the Federal District Curt f Puert Ric, the U.S. Curt f Appeals fr the First Circuit and the U.S. Supreme Curt, r administrative agencies f the Gvernment f Puert Ric, and legal advisry services and ntarial services. Hwever, SUT applies t services prvided by law prfessinals authrized by the Puert Ric Supreme Curt that can be prvided by any ther prfessinal, including, but nt limited t, financial cnsulting, lbbying, and administrative prcessing services ( servicis de gestría ). Services rendered by members f the same grup f cntrlled crpratins in the fllwing situatins are nt subject t SUT: Services rendered by nn-resident affiliates t certain grantees f tax exemptin are exempted frm SUT. Services prvided by members f the same grup f cntrlled crpratins r grup f related entities, including insurance cmpanies, if bth the entity rendering the service and the ne receiving it are engaged in trade r business in Puert Ric; and Services prvided by a persn engaged in trade r business utside f Puert Ric t an entity that perates with a tax incentives decree under Act 73 f 2008, knwn as the Ecnmic Incentives fr the Develpment f Puert Ric Act ( Act ), Act 83 f 2010, knwn as the Puert Ric Green Energy Incentives Act ( Act ), r Act 20 f 2012, knwn as the Act t Prmte Exprt Services ( Act ), r any analgus previus r subsequent acts, entities subject t the prvisins f Act 55 f 1933, knwn as the Bank Act, r entities rganized r authrized under the Natinal Bank Act, if bth the entity rendering the service and the entity receiving the service are members f the same grup f cntrlled crpratins r grup f related entities. Tll / Cntract Manufacturing Services are exempted frm SUT Manufacturing services (tll manufacturing/cntract manufacturing), if the prvider f such services btains a Cllectin Waiver Certificate frm the Secretary f Treasury; Maritime, air, and grund transprtatin services, including charges directly related t the maritime, air and grund delivery. Services prvided t hme wners assciatins r cuncil f cndminium wners fr the cmmn benefit f their residents, and t husing cperatives rganized pursuant t Act ; if the assciatin, cuncil, r cperative units are used, at least, 85% fr residential purpses are exempt frm SUT. Services prvided t scial interest husing prjects that receive federal r state rental subsidies.

3 Octber 2015 Page 3 Subcntracted cnstructin and telecmmunicatins services are nt subject t SUT. Other subcntracted services are subject t SUT. Services prvided t a persn engaged exclusively in the strage (including the leasing f tanks) and prcessing f gasline, jet fuel, aviatin fuel, gas il, diesel il, crude il, crude il derivative prducts and any ther hydrcarbn mixture in a Freign Trade Zne r Sub-zne; excluding any persn engaged in distributin and transprtatin f such prducts. Services prvided t bna fide farmers. Services prvided t labr unins r syndical assciatins rganized under Act and , as amended. Services prvided t a public r private entity that enjys full exemptin frm all types f taxes under their Organic Law. Rights t the use f intangibles. Prductin services prvided by any prducer f radi r televisin prgrams r cmmercials prduced in Puert Ric. Advertising, prmtin and advertising time in any media. Services rendered by a persn with an annual vlume f business f $50,000 r less. Subcntracted services, but nly with respect t cnstructin and telecmmunicatins services. Other subcntracted services are subject t SUT, unless the subcntracted service falls within anther SUT exemptin. Emplyment agency services, but nly with respect t the grss salary f emplyees prperly identified as such in the invice. Determinatin f sales price in the cntext f cnstructin services In the case f services rendered by ther merchants fr cmmercial, industrial r residential cnstructin prjects directly related t the prject, the sales price f such services, fr SUT cmputatin purpses, is 35% f the inviced ttal cst. This amendment des nt apply t designated prfessinal services (e.g., services prvided by engineers and architects) directly related t the cnstructin prject. Tangible persnal prperty and services related t the maintenance, repair and recnditining f aircrafts (MRO peratins) Act 159 amends the definitins f machinery and equipment used in manufacturing and manufacturing plant t exempt frm SUT the machinery and equipment, including parts, tls, and cmpnents, used in the repair, maintenance, and recnditining f aircrafts by cncessinaries f a tax incentives decree under Act , r any analgus previus r subsequent act.

4 Octber 2015 Page 4 Als, services prvided t an entity engaged in the business f repair, maintenance, and recnditining f aircrafts cvered by a tax incentives decree issued under Act , r a previus r subsequent analgus act are nt subject t SUT. Finally, repair, maintenance, and recnditining f aircrafts services prvided by a cncessinary with a tax incentives decree issued under Act , r a previus r subsequent analgus act, and such services are cvered under said act; are nt subject t SUT. Other SUT amendments The exemptin limited t text bks is substituted by a brader exemptin fr printed bks. This exemptin des nt include peridical publicatins. The SUT grandfather prvisins fr pre-existing cntracts and biddings, t which included cnstructin prjects cmmenced as f May 31, 2015, were amended t, amng ther things, include the certificates t be issued by the Secretary f Treasury under such prvisins, and t establish that in the case f cnstructin prjects fr turism and hspital units, the SUT grandfather will be fr the term f the prject. Value Added Tax ( VAT ) Transactins that will nt be subject t VAT The fllwing transactins were added t the list f transactins that will nt be subject t VAT, in accrdance with Act 72, as amended by Act 159. The belw list refers t transactins, either, excluded frm the definitin f services r included as an exempt transactin fr VAT purpses. Services rendered by nn-resident affiliates t certain grantees f tax exemptin are exempted frm VAT. The fllwing services r transactins will nt be subject t VAT: Legal services Legal services prvided by members f the legal prfessin authrized by the Puert Ric Supreme Curt t practice law in Puert Ric, r by the crrespnding entity in a freign jurisdictin, will nt be subject t VAT. The exclusin applies with respect t fees fr services related t legal representatin befre the General Curt f Justice, the Federal District Curt f Puert Ric, the U.S. Curt f Appeals fr the First Circuit and the U.S. Supreme Curt, r administrative agencies f the Gvernment f Puert Ric, and legal advisry services and ntarial services. Hwever, VAT will apply t legal services prvided by law prfessinals authrized by the Puert Ric Supreme Curt that can be prvided by any ther prfessinal, including, but nt limited t, financial cnsulting, lbbying, and administrative prcessing services ( servicis de gestría ); Services rendered by members f the same grup f cntrlled crpratins in the fllwing situatins will nt be subject t VAT:

5 Octber 2015 Page 5 Services prvided by members f the same grup f cntrlled crpratins r grup f related entities, including insurance cmpanies, if bth the entity rendering the service and the ne receiving it are engaged in trade r business in Puert Ric; and Services prvided by a persn engaged in trade r business utside f Puert Ric t an entity that perates with a tax incentives decree under Act , Act , r Act , r banks, if bth the entity rendering the service and the entity receiving the service are members f the same grup f cntrlled crpratins r grup f related entities. Tll / Cntract Manufacturing Services are exempted frm VAT. Manufacturing services (tll manufacturing/cntract manufacturing), if the prvider f such services btains a Cllectin Waiver Certificate frm the Secretary f Treasury. Maritime, air, and grund transprtatin services, including charges directly related t the maritime, air and grund delivery. Services t hme wners assciatins r cuncil f cndminium wners fr the cmmn benefit f their residents, and t husing cperatives; if the assciatin, cuncil, r cperative units are used, at least, 85% fr residential purpses. Services t scial interest husing prjects that receive federal r state rental subsidies. Services prvided t a persn engaged exclusively in the strage (including the leasing f tanks) and prcessing f gasline, jet fuel, aviatin fuel, gas il, diesel il, crude il, crude il derivative prducts and any ther hydrcarbn mixture in a Freign Trade Zne r Sub-zne; excluding any persn engaged in distributin and transprtatin f such prducts. The sale f articles and services fr the agriculture t bna fide farmers. Services prvided t labr unins r syndical assciatins. Services prvided t a public r private entity that enjys full exemptin frm all types f taxes under their Organic Law. Rights t the use f intangibles. The retail sale f electric slar equipment. Maintenance fees paid under a Timeshare and Vacatin Club Plan, pursuant t Act 252 f 1995, r any analgus previus r subsequent act. Services prvided t a merchant engaged in the generatin and sale f electricity in a cmmercial scale.

6 Octber 2015 Page 6 Medical devices Medical devices acquired by hspital units were included under the definitin f articles fr the treatment f health cnditins, this means, in general, that the imprtatin and sale f medical devices will be cnsidered an exempt article and exempt transactin, respectively, fr VAT purpses and als, merchants engaged in the sale f medical devices will be able t take a credit fr the VAT paid n their inputs, as an exceptin t the credit allcatin rules. Articles and services related t the maintenance, repair and recnditining f aircrafts (MRO peratins) Machinery and equipment, including parts, tls, and cmpnents, used in the repair, maintenance, and recnditining f aircrafts by cncessinaries f a tax decree under Act 73 f 2008, r any analgus previus r subsequent act, will nt be subject t VAT upn imprtatin. The sale f these articles t a Manufacturing Plant will be subject t a zer VAT rate (0%). As in the case f SUT, services prvided t a Act grantee engaged in the repair, maintenance, and recnditining f aircrafts will be exempt frm VAT. Such repair, maintenance, and recnditining services will als be exempt frm VAT if cvered by a grant under Act , r a previus r subsequent analgus act. Exprt Services Act 159 clarifies that exprt services cvered by a tax incentives decree issued under Act r Act , r any analgus previus r subsequent acts, will be subject t the zer VAT rate (0%), prvided that such services d nt have a nexus with Puert Ric. Administrative fines and penalties fr the nn-cmpliance with VAT prvisins and bligatins were added. VAT Credit Merchants mainly engaged in the sale f gasline, aviatin fuel, gas il r diesel il, crude il, unfinished ils, and end prducts derived frm il, and any ther hydrcarbns mixture, will be able t take a credit fr the VAT paid in their inputs, as an exceptin t credit allcatin rules. VAT fines and penalties Act 159 establishes administrative fines and penalties fr the nn-cmpliance with the VAT prvisins and bligatins. Excise Tax The excise tax exemptin fr nn-fr prfit institutins n the first $5,000 f a nn-luxury vehicle, is limited t nly tw (2) vehicles per calendar year, except fr vans and minivans (fr which the limitatin f tw vehicles per year des nt apply).

7 Octber 2015 Page 7 Incme Tax Alternative Minimum Tax (AMT) The AMT cmputatin remains the same but Act 159 clarifies that the waivers f the 20% n expenses paid t related parties r hme ffice will be fr a maximum f three years, with the ptin f requesting a new waiver after that perid. Fr taxable years cmmencing after December 31, 2014, waivers will be limited t 60% f such expenses, except in the case f banks. Since May 28, 2015, the Secretary f Treasury des nt have the authrity t reduce the AMT rate n purchases f persnal prperty frm related parties fr taxable years cmmenced after December 31, % Special tax n dividend distributins and prepayment f deemed distributins A special tax f 8% is available fr actual r deemed dividend distributins between Octber 1, 2015 and December 31, Any dividend distributin made during the perid between Octber 1, 2015 and December 31, 2015 r any amunt designated as a deemed distributin fr which an electin and payment is made within the referred perid will be subject t a special tax f 8% f the ttal amunt distributed r deemed distributed. In the case f actual distributins, the special tax will be in lieu f any ther tax impsed by the 2011 Internal Revenue Cde (the 2011 Cde ), including the AMT and the alternative basic tax, but in the case f deemed distributin, the special tax will nt be applicable t taxpayers that are subject t the AMT related t the purchases f persnal prperty frm related parties. This special tax is nt applicable t dividends paid by public crpratins. Net perating lss Carryvers fr taxable years cmmencing after December 31, 2014 cntinue t be limited t 80% f net incme, but Act 159 clarifies that, in the determinatin f the net perating lss, n deductin will be allwed fr expenses incurred by a taxpayer and paid r payable t related persns r hme ffice nt resident f Puert Ric, except in the case f peratins cvered by a tax exemptin grant. Disallwance f expenses The waivers r reductins against the 51% deductin disallwance fr regular tax purpses regarding payments t related persns fr services rendered utside Puert Ric and nt subject t Puert Ric incme taxes will be limited t a maximum f three years, with the ptin f requesting a new waiver after that perid. Fr taxable years cmmencing after December 31, 2015, waivers will be limited t 60% f the expenses fr such services, except in the case f banks. Act 159 clarifies that the disallwance f the deductin fr expenses related t services and the deductins fr the cst f prperty r depreciatin when the applicable sales and use tax r value added tax has nt been paid des nt apply when the taxable item is subject t an exceptin r exclusin frm SUT r VAT.

8 Octber 2015 Page 8 New tax credit fr purchase r transmissin f televisin prgrams made in Puert Ric. Lng Term Cntracts Entities engaged in the develpment f land r structures will be cnsidered as deriving incme frm lng-term cntracts, but may nly use the percentage f cmpletin methd r ther methd authrized by the Secretary f Treasury thrugh regulatin, circular letter r administrative determinatin. They may nt use the cmpleted cntract methd. Tax Credits Act 159 clarifies that the tax credits under mratrium may be used t reduce either the incme taxes impsed under the 2011 Cde r under any ther special law. Act 159 intrduced a new tax credit f 15% f the expenses paid by a televisin channel fr the purchase r transmissin f a televisin prgram made in Puert Ric by independent prducers where 90% r mre f artists emplyed are Puert Ric residents. The payments t related entities will nt be cnsidered in the determinatin f the amunt f the credit and this credit will nt be available fr a prgram cvered by the tax benefits under the Puert Ric Film Industry Ecnmic Incentives Act. This credit will be available t reduce up t 15% f the incme tax liability f the televisin channel and any remaining balance will nt be carried ver t future years. Financial Statements As part f the Supplementary Infrmatin that accmpanies the Financial Statements, the auditrs will have t cnfirm if the exempt sales and the aut-cnsumptin f inventry are duly reprted by the merchants fr sales and use tax purpses. Act 159 prvides a list f agreements that will be prhibited under the Clsing Agreements between Treasury and the taxpayers. Nnprfit Entities N entity will be cnsidered a nnprfit entity unless it can prve t the satisfactin f the Secretary f Treasury that it pursues a public interest. Fr this purpse, there will be a rebuttable presumptin that the entity has a private interest. Incurring in extravagant expenses; expenses that are nt clearly related t the exempt purpse f the rganizatin; expenses that represent a fr prfit purpse f the directrs, fficers r emplyees; r persnal r family expenses f the directrs, fficers r emplyees is prhibited and will be cnsidered a cause fr the revcatin f a tax exempt determinatin if incurred. Crpratin f Individuals A crpratin f individuals that vluntarily revked its electin fr taxable years cmmencing after December 31, 2010 and availed itself f the benefits f the prepayment f the deemed dividend at the special tax will nt have t wait 5 years t reelect the crpratin f individuals status.

Octber 2015 Page 9 Clsing Agreements Act 159 prvides a list f agreements that will be prhibited under the Clsing Agreements between Treasury and the taxpayers, including prepayment f tax debts,

Other Amendments The Cperative Savings and Credit Unins Act f 2002, Act 255 f 2002, as amended, and the Puert Ric General Cperative Assciatins Act f 2004, Act 239 f 2004, as amended, were amended t

9 Octber 2015 Page 9 Clsing Agreements Act 159 prvides a list f agreements that will be prhibited under the Clsing Agreements between Treasury and the taxpayers, including prepayment f tax debts, extensin f statutes f limitatin, waiver f interest and surcharges, and waiver f filing f tax returns. Other Amendments The Cperative Savings and Credit Unins Act f 2002, Act 255 f 2002, as amended, and the Puert Ric General Cperative Assciatins Act f 2004, Act 239 f 2004, as amended, were amended t establish that the cperatives and credit unins authrized under such acts, respectively, are nt exempt frm the SUT increases and the VAT. Act 42 f 2015 is amended t prvide that ne f the tw payment mechanisms that prfessinal services prviders must ffer t their custmers has t be debit r credit card, electrnic fund transfer, internet payment r direct payment. Criminal and administrative fines fr the nn-cmpliance with the prvisins f Act 42 f 2015 are established. O Neill & Brges LLC 250 Muñz Rivera Ave. Suite 800 San Juan, Puert Ric Tel.: Fax: Because f the general nature and infrmative purpse f this newsletter, nthing herein shuld be cnsidered as legal advice r a legal pinin. Fr further infrmatin abut the cntents f this newsletter, r shuld yu need further assistance in cnnectin with these matters, please cntact any f the attrneys f the firm s Crprate Tax Grup. O Neill & Brges LLC CORPORATE TAX GROUP Members Walter F. Chw Ivelisse Cllaz Giselle Flaqué Rsa M. Gnzález-Lug Amaya Iralagitia Michelle Marichal Cristina Mrazzani Samuel Rsad-Dmenech Ismael Vincenty Assciates Denisse Ortiz Rxanna Santiag Suhaily Sepúlveda Pala Medina O Neill & Brges LLC 2015

Latest Publications Issued by the PR Treasury Department Regarding the Sales and Use Tax TAX ALERT

Latest Publications Issued by the PR Treasury Department Regarding the Sales and Use Tax TAX ALERT O N E I L L & B O R G E S LLC Nvember 2015 Latest Publicatins Issued by the PR Treasury Department Regarding the Sales and Use Tax TAX ALERT Since ur last abut the enactment f Act 159-2015, the PR Treasury