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Puerto Rico Tax Compliance Guide By Torres CPA Group CifrasPR Puerto Rico Understanding the Puerto Rico tax system and its interrelation with United States is crucial for individuals and entities doing business in Puerto Rico. Puerto Rico is not a state; it s a territory, with its own Business and Payroll laws and regulations. The following White Paper is designed to give an insight Tax Issues in Puerto Rico. It provides relevant background information, which will be of assistance to organizations considering establishing business in the Island. Nonetheless, it is highly recommended to seek advice and counsel from qualified professional sources before undertaking any business. Certain exclusions and exemptions may apply and when specific problems occur in practice, it will often be necessary to refer to the laws and regulations of Puerto Rico, and to obtain appropriate accounting and legal advice. It is understood that the following overview does not constitute any formal rendering of either legal, accounting, tax or professional services. If legal advice or other assistance is required, an attorney, CPA or tax adviser should be consulted. Torres CPA Group is an Advice Certified Public Accounting Firm offering Audit, Tax, Consulting and Financial Outsourcing services for over 33 years. If you require any further information or help, please do not hesitate to contact us. CPA William Torres Torres 787-508-4545 CPA Saudhi Soto Pagán Page 1 of 7
PERSONAL SOURCE OF INCOME As per the approval and enactment of Act 22, known as the Act to Promote the Relocation of Individual Investors Act, those taxpayers with incomes from sources form Puerto Rico can benefit from the tax incentives and exemptions provided by this law. To determine the eligibility for these exemptions, the place in which a business originates its income is used to define the source of revenue. Act 22 applies to any individual who becomes a bona fide resident of Puerto Rico. The source rule applies irrespective of the residence of the payer, the place in which the contract for service is performed, or the location or time of payment. The place where the deposit of money is made has no bearing on the Source of Income determination. Tax liability is driven by the source of income, not the place where cash is deposited. The three main issues used to determine the source of income are: the character of the activity, the location of performance and identification of all statutory and regulatory exceptions. SUMMARY OF SOURCE OF INCOME RULE ON EARNED INCOME Working at a job, Owning a small business, Consulting, Gambling and any other activity for remuneration is received base on time/effort spent. Salaries, wages, and personal services Salaries, wages and personal services are source income attributed to the location where the services are performed. Income earned by a Puerto Rico resident that provides services of Puerto Rico or outside the US is considered Puerto Rico source income. Income earned by providing services in the United States is US based income. Non-US residents (not living in US mainland) who stay in the US for 90 or fewer days and earned services income in Puerto Rico is considered Puerto Rico source income. SELF-EMPLOYED INDIVIDUALS If you are self-employed, you determine the source of compensation for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income. In many cases, the facts and circumstances will call for an apportionment on a time basis. Page 2 of 7
CONTACT FOR SERVICES INSIDE AND OUTSIDE THE US If you are an employee and receive compensation for labor or personal services performed both inside and outside the US, special rules apply in determining the source of the income. Compensation is source of income established either on a time basis or on base on cost and value of services. TIME BASIS Use a time basis to figure your source compensation. Do this by multiplying your total compensation by the following fraction: Number of days your performed services in the US during the year. Total number of days you performed services during the year You can use a unit of time of less than a day, if appropriate. The period for which the compensation is made does not have to be a year. AGENTS, BROKERS & CUSTODIAN Apportionment on a time basis in acceptable in many cases, but providing they come from example exceptions for trading in stocks and securities and certain commodities through a resident broker, commission agent, custodian or independent agent as well, that are trading stocks and securities and certain commodities. Compensation for labor or personal services, including fees, commissions, fringe benefits, and similar items performed wholly within the US if gross income for sources is within the US. NEGOTIATION COMMISSIONS Negotiation commissions are determined to be those performing services and source of fees that follow the analogy of services performance, the source of rendering the service. Page 3 of 7
NOT TO COMPETE COMPENSATION Determines the place in which you agree not to perform. Services should be considered to have been performed in the US may not always be apparent, especially given the rise of electronic transactions. Still, as a general rule, an enterprise is not considered to have performed services in the US without some physical presence in the US. PENSIONS AND ANNUITIES The source of income is determined on where the services were provided to earn the right of Pension and Annuities. If you receive a pension form a domestic trust for services performed both in and outside the US, part of the pension payment comes from the US sources. That part is the amount attributable to earnings of the pension plan and the employer contributions made for services performed in the US. These apply whether the distribution was made under a qualified or nonqualified stock bonus, pension, profit-sharing, or annuity plan (whether or not funded). If you performed services as an employee of the US Government, you might receive a distribution form the US Government under a plan, such as the Civil Service Retirement System that is treated as a qualified pension plan. Your source of income is US taxable as well as the amount of the distribution that is attributable to your total US Government basic pay and in addition to any tax-exempt or pay for services performed outside the US. SCHOLARSHIPS, GRANTS, PRIZES AND AWARDS The source of scholarships, fellowship grants, grants, prizes, and awards is established by the residence of the payer regardless of who distributes the funds. Payments for research or study in the US made by the US, a US resident or a US domestic corporation are US sources. Similar payments from a Puerto Rico government agency or from a Puerto Rico company or a non-us resident are Puerto Rico source payments even through the funds are disbursed through a US agent. Payments made by an entity named as a public international organization under the International Organizations Immunities Act are from Puerto Rico sources. Page 4 of 7
Activities performed outside the US: Scholarships, fellowship grants, targeted grants, and achievement awards received by a nonresident for activities performed, or to be performed, outside the US are not US Source Income. INTEREST INCOME This is source of revenue is determined by the location of the payer. So, if the Corporation site is in the US, it is considered US source income. If the Corporation s location is Puerto Rico or worldwide, it is Puerto Rico source income. The place or manner of payment is irrelevant in determining the source of income. Interest income is sourced in the US if it comes from the US government, District of Columbia, or from non-corporate US residents of US Domestic Corporations. However, if a US company s earnings of 80% or more of its active business income are made in Puerto Rico over the 3-year period previous to the current tax year, any interest earned from the corporation is considered as Puerto Rico sourced income. Interest earned from a Puerto Rico branch of a US commercial bank is also Puerto Rico sourced. A substitute interest payment made to the transferor of security in a securities lending transaction or a sale-repurchase transaction is considered as the source in the same manner as the interest on the transferred security. DIVIDEND INCOME The source of revenues for dividends is determined by the location of the payer of the dividend. So, if the corporation s location is Delaware, it is US source income. If the corporation s site is Puerto Rico, it is Puerto Rico source income. Dividends paid by US corporations are US income. Dividends paid by Puerto Rico companies or foreign corporations are considered Puerto Rico income. If a Puerto Rico company is 50% or more owned by US persons and it pays dividends attributable to US source income, it will be considered US source income. Page 5 of 7
SUBSTITUTE DIVIDENDS A substitute dividend payment made to the transferor of security in a securities lending transaction or a sale-repurchase transaction is considered as the source of income in the same manner as a distribution on the transferred security. Dividend equivalent payments: US source dividends also include all dividends equivalent to payments. Currently dividend equivalent payments include (1) substitute dividends, and (2) payments made under a specified contract that, directly or indirectly, are contingent on, or determined by reference to the payment of a dividend from the US sources. GUARANTEE OF INDEBTENDNESS Amounts received, directly or indirectly, for the provision of a guarantee of indebtedness are considered US source income if they are paid by: A non-corporate resident or US corporation, or By any Puerto Rico person if the amounts effectively connects to the conduct of a US trade or business. REAL PROPERTY AND LEASING INCOME These are: Income earned form the rental of tangible assets in the country of the property s location: intangible assets, such as patents, copyrights, and other intellectual property, are attributed to the country where it is used or its right is protected. Real Estate is land and buildings and anything built on, growing on, or attached to land. The source of income for a real estate property sale is based on the location of the property. Rental income earned form property located in the US is considered US income. Installments yielding from interest payment gains on the sale of property are the source of income of the location of the payer. Page 6 of 7
PERSONAL PROPERTY SALES The source for personal tangible property sales depends on: Whether the sale of the property is made by the seller; It is the residence of the seller; What type of assets are sold, such as whether it was inventory or a capital asset. Income earned from sale or purchase of inventory is established by the country where the transfer of title takes place. Revenues from the disposal of the non-inventory personal property including personal property capital assets are sourced to the seller s residence unless depreciation was claimed on the personal property; in which case the depreciation recapture comes from the country where the depreciation took place, and any excess in gain is the sourced to the country of sale. INTAGIBLE ASSETS The sale of intangibles are treated in a similar fashion to amortizable personal property in such a way that any gains are the source of the country where prior amortization deductions were taken, buy any remaining profit is the origin of the country where the property is used. However, the source of contingent payments are considered as royalty income. COMMUNITY INCOME If you are married, and you or your spouse are subject to the community property laws of a Puerto Rico, a US state, or a US possession, you generally must follow those rules to determine you or your spouse s income for the US tax purposes. However, you must disregard certain community property laws if: Both you and your spouse are nonresident aliens, or One of you is a nonresident alien, and the other is a US citizen or resident and both of you do not choose to be treated as US residents. Page 7 of 7
EARNED INCOME Earned income of a spouse, other than a trade or business income and a partner s distributive share of partnership income is treated as the income of the spouse whose services produced the income. That spouse must report all of its earnings on a separate return. Trade or business income: Trade or business income, other than a partner s distributive share of partnership income, is treated as the income of the spouse that carries the trade or business. That spouse must report all of its earnings on a separate return. PARTNERSHIP INCOME (OR LOSS) A partner s distributive share of partnership income (or loss) is treated as the income (or loss) of the partner. The partner must report this on separate return. Separate property income: Income derived from the separate property of one spouse (and which is not earned income, trade or business income, or partnership distributive share income) is treated as the income of that spouse. That spouse must report all of its earnings on a separate return. Use the appropriate community property law to determine what separate property is. Other community income: All other community income is to be treated as provided by the applicable community property laws. Page 8 of 7