(H. B. 4794) (No. 404) (Approved September 22, 2004) AN ACT To add clause (11) to subsection (a) and amend clauses (1), (2) and (3) of subsection (b) of Section 1165 of Act No. 120 of October 31, 1994, as amended, known as the Internal Revenue Code of 1994, to provide that, except in cases of a trust created or organized outside of Puerto Rico that has a paying agent in Puerto Rico, the qualified retirement plan trusts must be created or organized in Puerto Rico and the trustees of the qualified retirement plan trusts must be residents of Puerto Rico; to clarify that the rules for distributions of qualified retirement plan trusts shall apply to the distributions made to the beneficiaries of the participants; to provide that total distributions in a single year shall be taxed at a preferential rate of ten (10) percent in certain cases and to defer the taxation of qualified retirement plans distributions in stock belonging to the employer. STATEMENT OF MOTIVES It is the public policy of the Commonwealth of Puerto Rico to promote savings and investments in our economy and to provide the mechanisms to achieve this purpose. For such effects, pension plans have become one of the most attractive benefits that employers can offer to their employees. As regards taxation policy, it is one of the areas in which the Government can modify the behavior of taxpayers by promoting savings and providing incentives for the creation capital markets. However, many pension plan trusts are managed and operated from outside Puerto Rico, and sometimes, the withholdings required by the law are neither made nor reported adequately to the Department of the Treasury. The Legislature deems it necessary to make certain changes to the provisions for pension plans in order to expedite the supervision of such instruments and to
promote the creation of local capital markets. Pursuant to said purposes, pension plan trusts shall be required to be located in Puerto Rico to expedite their supervision and collect the income that is currently not being reported into the treasury. Likewise, the trustee shall be required to be a resident of Puerto Rico, in other words, a juridical person with fiduciary powers under the laws of Puerto Rico. This would promote the trusts industry in Puerto Rico and extend the base of taxpayers. The Legislature recognizes that these requirements may be onerous and difficult for certain companies in important sectors of Puerto Rico s economy, so the Secretary of the Treasury may exempt from such requirements a trust created or organized under the laws of the United States, and that is part of a pension plan that appoints a financial institution or trustee (regulated by the Commissioner of Financial Institutions, or any other entity duly authorized by the Secretary) as paying agent of the trust which shall be responsible for making all the distributions or payments of the trust to the participants or beneficiaries that are Puerto Rico residents and comply with all the laws of Puerto Rico requiring the filing of any type of return, informative return, declaration or form in the Department of the Treasury, or in any other agency of the Government of Puerto Rico, as well as making all the payment withholdings required by the law. Furthermore, the Secretary may exempt from the requirement of creation or organization in Puerto Rico when the trust has a trustee who is a Puerto Rico resident and who acts as paying agent responsible for making all the trust distributions or payments to the participants or beneficiaries that reside in Puerto Rico, and complies with all the laws of Puerto Rico, as described above. The aforementioned requirements shall be accompanied by a 20% to 10% tax rate reduction applicable to lump sum distributions of stock bonuses, pensions, profit sharing or annuities in which the participant or beneficiary is fifty-five (55)
years or older at the time of the distribution and an average of ten (10) percent of all contributions to the trust have been invested in property located in Puerto Rico, as the term is defined in Section 1014(e)(3) of the Puerto Rico Internal Revenue Code of 1994 ( the Code ), as amended. On the other hand, the Code currently grants a tax deferment to the distribution of employer stock to employees as part of an options plan to acquire stock under Section 1046 of the Code and as part of a stock ownership plan for employees under Section 1165(h) of the Code. Therefore, the Legislature deems that a tax deferment should be granted to employer stock distributions, including the stock of a controlled group of a corporation (i.e. parent company), in qualified retirement plans. To determine income or loss in the future disposition of said stock, the base of distributed employer stock (or of a corporation that is a member of the same controlled group) shall be zero. Finally, it is hereby clarified that the rules for retirement trust distributions shall also apply to the beneficiaries of the participants of the plan. The Legislature of Puerto Rico, aware of the importance of promoting savings, investments, the creation of capital markets and the supervision of pension plans, deems it necessary to approve laws in order to provide: that qualified retirement plans must be created or organized in Puerto Rico and that the trustees of qualified retirement plan trusts must be Puerto Rico residents; clarify that the rules for retirement trust distributions apply to distributions made to the beneficiaries of the participants; to provide that the total distributions in a single year shall be taxed with a 10% preferential tax rate in certain cases; and to defer the taxation of qualified retirement plan distributions in stocks belonging to the employer. BE IT ENACTED BY THE LEGISLATURE OF PUERTO RICO: Section 1.- Clause (11) is hereby added to subsection (a) and clauses (1), (2) and (3) of subsection (b) of Section 1165 of Act No. 120 of October 31, 1994, as
amended, are hereby amended to read as follows: Section 1165.- Employee Trusts (a) Exemption (1)... (10) (11) The trust must be created or organized under the laws of the Commonwealth of Puerto Rico and the trustee shall be a resident of Puerto Rico. For purposes of this clause, a trustee that is a domestic corporation or a foreign corporation engaged in business or industry in Puerto Rico and authorized to do business in Puerto Rico is considered to be a resident of Puerto Rico. The Secretary, by regulations, circular letter or administrative determination, shall exempt from compliance with both requirements trusts created or organized under the laws of the United States and that are part of a pension, profit sharing, stock bonuses or stock ownership plan for employees and that designate a financial institution regulated by the Commissioner of Financial Institutions, or any other entity duly authorized by the Secretary as paying agent of the trust. In the event that the trust created or organized under the laws of the United States and that is part of a pension, profit sharing, stock bonuses or stock ownership plan for employees has a trustee that is a resident of Puerto Rico and said trustee is the paying agent of the trust, the Secretary shall exempt said trust from the requirement of creation or organization in Puerto Rico by regulations, circular letter or administrative determination. The paying agent shall be responsible for making all the
trust distributions or payments to the participants or beneficiaries that are Puerto Rico residents and complying with all the laws of Puerto Rico requiring the filing of any type of income tax return, informative returns or declarations or forms with the Department of the Treasury or any other agency of the Commonwealth of Puerto Rico, and for making all payment withholdings that the tax laws, family laws or any other law in Puerto Rico may impose. Employers whose employees are beneficiaries of the trust shall be severally responsible for noncompliance with these legal obligations of the paying agent. A term of three (3) years as of the date of effectiveness of this Act is hereby granted for the trusts existing at the time of the date of effectiveness of this Act to comply with these provisions. (b) Taxation of beneficiary.- (1) In General.- The amount actually distributed or placed at the disposal of any participant or beneficiary by any of said trusts shall be taxable to said participant or beneficiary in the year in which it is thus distributed or placed at his/her disposal under Section 1022(b)(2) as if it were an annuity whose price or consideration are the amounts contributed by the participant, except for those sums contributed by the participant based on a cash or deferred contribution agreement under subsection (e). If the total distributions payable with regard to any participant or beneficiary are paid to the participant or beneficiary in one single taxable year due to the participant s separation from service, the amount of said distribution, in the amount that
exceeds the amount contributed by the participant, on which taxes have already been paid by the participant, shall be deemed for the purposes of Section 1014 as a long-term capital gain. For purposes of Section 1014(b), and in the case of distributions made after the date of effectiveness of this Act, if the participant or the beneficiary is fifty-five (55) years old or more at the time of the distribution and an average of ten (10) percent of all contributions to the trust have been invested in property located in Puerto Rico, as the term is defined in Section 1014(e)(3), during the current fiscal year of the trust and two fiscal years of the trust preceding the date of the distribution, this long-term capital gain shall be deemed as derived from the sale or exchange of property located in Puerto Rico. The investment requirement shall not apply to those distributions made between the date of effectiveness of this Act and December 31, 2005, to participants or beneficiaries entitled to avail themselves of the preferential rate of ten (10) percent. In the case of defined contribution plans in which a separate account is held for each participant or beneficiary, the requirement of investment in property located in Puerto Rico may be met with respect to the contributions credited to the account of the participant or beneficiary. The Secretary shall provide the manner in which the requirement of investment in Puerto Rico shall be met through regulations, circular letters or administrative determination. (2) Exception and Special Rule.- (A) The provisions of clause (1) of this subsection, shall not
apply to an amount of a qualified trust paid or distributed to a participant or beneficiary if the total amount received (in money or any other type of property) is paid into an individual retirement account or annuity under the provisions in Section 1169, or a non-deductible individual retirement account, or a retirement plan qualified under the provisions in this Section in benefit of said participant or beneficiary not later than sixty (60) days after having received said payment or distribution. In the case of a rollover into a non-deductible individual retirement account, the exception referred to this clause shall apply only to those distributions described in Section 1169B(d)(5)(A). Notwithstanding the above, contributions by rollovers into non-deductible individual retirement accounts shall be subject to the taxes set forth in Section 1169B(d)(5) and, for purposes of this clause, it shall be deemed that it complies with the requirements of said section if an amount equal to the total amount received by the participant or beneficiary from the qualified trust reduced by the tax imposed in Section 1169B(d)(5) which has been withheld as provided therein is contributed into the non-deductible individual retirement account. (B) If a total distribution as described in clause (1) of this subsection includes stock belonging to the employer, that part of the total distribution that consists of stock belonging to the employer shall be excluded from the total distribution for purposes of the calculation of the
contribution provided in clause (1) of this subsection. To determine income or loss in the future disposition of this stock, the base of the stock belonging to the employer so distributed shall be zero, increased by the amount contributed by the participant whose tax has already been paid by him/her and has not been taken into consideration under clause (1) above when calculating the tax of other trust distributions. The terms stock belonging to the employer and controlled group shall have the same meaning provided in clause (2) of subsection (h) of this section. The withholding agent shall not have to perform the withholding required in clause (3) of subsection (b) of this section from the part of the total distribution that consists of stocks belonging to the employer. (3) Obligation to Deduct and Withhold.- Every person, regardless of the position he/she holds, who performs total distributions payable with respect to any participant or beneficiary within a single tax year due to the severance from service of the participant, which under the provisions in clause (1) are deemed a longterm capital gain subject to the provisions of Section 1014, shall deduct and withhold from such distributions an amount equal to twenty (20) percent of the total thereof in excess of the amounts contributed to the plan by the participant that have been paid by the same. This deduction and withholding shall be of ten (10) percent if the
participant or beneficiary is fifty-five (55) years old or more at the time of the distribution and ten (10) percent average of all contributions to the trust have been invested in property located in Puerto Rico, as said term is defined in Section 1014(e)(3), during the current fiscal year of the trust and two fiscal years of the trust preceding the date of the distribution. The investment requirement shall not apply to distributions made between the date of effectiveness of this Act and December 31, 2005, to participants or beneficiaries who are entitled to the ten (10) percent preferential rate. Any employer whose employees participate in the plan or the administrator of the plan shall certify to the person that makes the trust distributions that the participant or beneficiary is fifty-five (55) years old or more at the time of the distribution and the requirement of investment in property located in Puerto Rico has been met. Once the certification issued by the employer is received, the person who makes the trust distributions shall not be responsible for the payment of the tax, interest or penalties in case there has been noncompliance with these requirements, but he/she shall be responsible for the ten (10) percent deduction and withholding. (4) Section 2.- This Act shall take effect immediately after its approval.
CERTIFICATION I hereby certify to the Secretary of State that the following Act No. 404 (H.B. 4794) of the 7 th Session of the 14 th Legislature of Puerto Rico: AN ACT to add clause (11) to subsection (a) and amend clauses (1), (2) and (3) of subsection (b) of Section 1165 of Act No. 120 of October 31, 1994, as amended, known as the Internal Revenue Code of 1994, to provide that, except in cases of a trust created or organized outside of Puerto Rico that has a paying agent in Puerto Rico, the qualified retirement plan trusts must be created or organized in Puerto Rico and the trustees of the qualified retirement plan trusts must be residents of Puerto Rico; etc, has been translated from Spanish to English and that the English version is correct. In San Juan, Puerto Rico, today 15 th of October of 2008. Francisco J. Domenech Director