The Made-in-America versus “Made-in-Puerto Rico” tax breaks

The Made-In-America tax break has been the object of much discussion since the IRS issued the final regulation on July 9, 2020.  The tax break creates an effective reduction in the federal corporate tax rate from 21% to 13%.  However, it has two problems: (1) the 13% effective tax rate only lasts until 2025, then increases to 16% effective tax rate; and (2) the tax break is only for goods and services produced in the U.S. and sold overseas, missing your U.S. customer base.

The “Made-In-Puerto Rico” tax break results in a total corporate tax rate of 4%.  Relative to the Made-In-America tax break, the “Made-in-Puerto Rico” tax break has significant advantages: (1) the 4% corporate tax rate has existed for decades and lasts potentially decades into the future; and (2) the tax rate is for goods and services produced in PR and sold anywhere in the world, including in the U.S.

Most U.S. companies are probably looking at the Made-in-America tax break as an incentive to produce goods in the U.S. rather than in foreign jurisdictions such as China, India or Ireland.  Operating overseas, outside of U.S. laws and regulations and in different currencies and languages, introduces complex issues that are more pronounced than ever after COVID-19.

The best of both worlds – is Puerto Rico.  Puerto Rico is a U.S. possession which has a unique status relative to the U.S.  It operates under U.S. laws, uses the dollar as its currency, speaks English, and has a large skilled labor force.  However, for tax purposes, it is considered foreign and sets its own tax rates.

Using the combination of long-standing federal legislation contained within the Internal Revenue Code (“IRC”) – IRC §§ 933, 7701(a)(4), 7701(a)(5), 7701(a)(30), 881(b)(2), 882, 1442(c)(2), and various pieces of tax incentive legislation that began in 2008 and were ultimately consolidated and replaced with Act No. 60-2019, known as the Tax Incentive Code (‘‘Tax Incentive Code’’), Puerto Rico has sought to establish itself as a business service and manufacturing center.  In general, the United States does not tax foreign source income that is retained in a foreign corporation (IRC §§881 and 882) such as a Puerto Rico corporation operating under the Tax Incentive Code.  Therefore, only the applicable Puerto Rico corporate tax rate of 4% would apply for Puerto Rican companies.

In addition to a 4% tax rate at the corporate level, under the Tax Incentive Code, there is a 100% tax exemption on dividend distributions by that corporation of its Puerto Rico earnings.  As such,  for a Puerto Rico resident, there is no tax on the distribution at the shareholder level, and, at most, a 4% tax at the corporate level.  See Tax Incentive Code §2032.01(a).  This allows corporations to operate on an extremely low tax basis (4%) while resident shareholders may withdraw dividends income tax-free.  Furthermore, Puerto Rican residency is NOT required in order to receive the benefits of the Tax Incentive Code!  Non-residents may accumulate dividends at a favorable tax rate until either residency is established (at which time dividends can be withdrawn without any US or Puerto Rican tax), or alternatively, can use other distribution strategies that enable non-residents to access their earnings in a tax-advantaged way.

If you are looking to reduce your tax liability without moving your business operations, allow TLS to perform a complimentary analysis of your financials.  Our team of experts’ design and implement tax plans that will both reduce your taxation and maximize your business and personal cash flow.