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New Legislation in Puerto Rico to Affect Foreign Taxpayers
On 25 October 2010, Act 154 ("Act") was enacted to amend the 1994 Puerto Rico Internal Revenue Code, as amended ("Code"), as a revenue raising measure that imposes taxes on certain non-resident individuals and foreign entities ("Foreign Taxpayers") that were not taxed under the previously existing tax regime. From 1 January 2011, these Foreign Taxpayers will be taxed in Puerto Rico if certain relationship tests are met regarding a manufacturing or service providing an affiliate that is a resident of Puerto Rico (the "Resident Entity"). Taxand Puerto Rico addresses the changes applicable to foreign companies and how they should comply.
In general terms, Puerto Rico taxes non-resident foreign persons on their gross income from sources within their jurisdiction. Therefore, the existence of a domestic trade or business by a Foreign Taxpayer expands the types of income which are taxable in Puerto Rico by including the foreign source income which is effectively connected with a PR trade or business and changes the taxation regime to one where income is taxed on a net basis.
Changes applicable to Foreign Taxpayers
Under the Act, a Foreign Taxpayer not otherwise considered engaged in a trade or business in Puerto Rico, at least under the traditional minimum contact standards, will be considered as such ("Deemed Resident Taxpayer") to the extent it has a manufacturing or service providing affiliate operating in Puerto Rico, and the level of certain commercial transactions between both entities exceeds pre-established thresholds.
Deemed Resident Taxpayers will be taxed based on 2 mechanisms depending on the gross receipts level of the Resident Entity for any of the 3 preceding taxable years. If in excess of $75 million purchases by the Deemed Resident Taxpayer from the Resident Entity will be subject to an export excise tax of 4% (the applicable tax rate of 4% will be subject to a gradual phase out and will end with transactions completed after 31 December 2016). This excise tax must be withheld on the sum of the total charges for such property or services reflected in the commercial invoice (or on their fair market value in the absence of an invoice). For cases not meeting the $75 million threshold, a four factor test ("Commercial Transactions' Tests") is used to characterise a portion of the Deemed Resident Taxpayer's income generated outside Puerto Rico as a domestic source.
How the changes are accomplished
By expanding the scope of what is considered a Foreign Taxpayer's office or fixed place of business as follows:
1. the Resident Entity has the authority to negotiate and conclude contracts on behalf of the Foreign Taxpayer or has a stock of merchandise from which to fill orders on its behalf and regularly does so; except general commission, agent, broker or independent agent agreements.
2. the Resident Entity is a member of a controlled group (as said term is defined in the Act) of the Foreign Taxpayer and meets 1 of the Commercial Transactions' Tests for any of the 3 preceding taxable years:
- Sales: at least 10% of the gross receipts of the Resident Entity is derived from the sale of personal property manufactured in whole or part in Puerto Rico or services rendered in Puerto Rico by the Resident Entity for, or on behalf of, the Foreign Taxpayer.
- Purchases: the sales of personal property manufactured in whole or part in Puerto Rico or services rendered in Puerto Rico by the Resident Entity to the Foreign Taxpayer account for at least 10% (measured by cost) of the purchases of the Foreign Taxpayer.
- Commissions: the commissions earned by the Foreign Taxpayer with respect to transactions related to personal property manufactured in whole or part in Puerto Rico or services rendered in Puerto Rico by the Resident Entity, represent at least 10% of its total commissions.
- Facilitator: at least 10% of the total gross receipts of the Resident Entity are derived from the sum of the sales of personal property manufactured in whole or part in Puerto Rico or services rendered in Puerto Rico are facilitated by the Foreign Taxpayer and the gross receipts resulting from the transactions described in the Sales, Purchases and Commissions Tests referred to above.
The Act amends the effectively connected income rules under the Code (which up to this point had no pertinence in determining whether a Foreign Taxpayer was engaged in a trade or business in Puerto Rico), and expands the scope of what is considered a domestic source income, therefore having an impact on gains and profits of the Deemed Resident Taxpayer earned outside of their jurisdiction. As a result, certain Foreign Taxpayers that previously were not considered engaged in trade or business in Puerto Rico will now be considered as such. Certain income derived by such Foreign Taxpayers which was previously considered income from sources outside of their jurisdiction will now be treated as domestic source income and, therefore, subject to income tax. In addition, in the case of the excise tax, the seller of the products or services will have the responsibility to collect the tax and remit it to the PR Treasury on a quarterly basis.
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