Establish Your Business

Tax Systems

A Familiar Tax Structure in the Caribbean

Perhaps the most dynamic economy in the Caribbean, Puerto Rico, follows the US Tax System with a few differences.

1. Individuals Residing in Puerto Rico

Like residents of the United States, residents of Puerto Rico are subject to federal income tax on their worldwide income. However, U.S. Code Section 933, for tax purposes, allows a bona fide individual resident of Puerto Rico to exclude Puerto Rico source income from his/her gross income.

The process for determining and establishing bona fide residence for income tax purposes hinges on the result of three tests found in U.S. Code Section 937:
  • The presence test
  • The tax home test and
  • Closer connection test

Of course, even bona fide residents of Puerto Rico will be subject to U.S. income tax on income from sources outside Puerto Rico.

The exclusion of gross income from Puerto Rico sources for U.S. income tax purposes does not apply to salary received by U.S. government employees working in Puerto Rico, who must include federal income from work done in Puerto Rico as part of their gross income for both, U.S. and Puerto Rico income tax purposes. However, income tax paid by U.S. government employees on their salary to the Puerto Rico Treasury Department, may be credited against their U.S. income tax liability, subject to limitations.

2. Puerto Rico Corporations

Puerto Rico corporations are treated as foreign corporations for U.S. income tax purposes. Thus, Puerto Rico corporations are subject to a 30% U.S. income tax withholding on, among others: interest, rents, wages, premiums, annuities, compensation, remuneration, emoluments and other fixed or determinable annual or periodical gains, profits and income from sources within the United States. Dividends received by a Puerto Rico corporation from a U.S. corporation, however and provided certain conditions are met, are subject to only 10% U.S. income tax withholding instead of the 30% rate applicable to other foreign corporations. The requirements for the 10% rate to apply are:

  • Foreign individuals must not own (directly or indirectly) 25% or more of the stock of the Puerto Rico Corporation at any time during the taxable year in which the dividend is distributed.
  • At least 65% of the gross income of the Puerto Rico corporation is effectively connected with the conduct of a trade or business in Puerto Rico or the United States for the three-year period ending with the close of the taxable year of the Puerto Rico corporation or for such part of said period that the corporation has been in existence.
  • No substantial part of the income of the Puerto Rico corporation is used (directly or indirectly) to satisfy obligations to persons who are not bona fide residents of Puerto Rico or the United States.

In spite of this, Puerto Rico corporations are subject to regular U.S. tax rates on their income effectively connected to a trade or business in the United States. When using a Puerto Rico corporation, care should be exercised as to the possible applicability of U.S. Internal Revenue Code provisions related to controlled foreign corporations, passive foreign investment companies, and foreign personal holding companies. Your legal advisor or accountant should help you make the best decision in this regard.

3. United States Corporations

U.S. corporations are taxable in the United States on their worldwide income. Therefore, U.S. corporations that derive taxable income from Puerto Rico sources must include such income as part of their gross income for determining their U.S. income tax liability.

If a U.S. corporation decides to establish its operations in Puerto Rico through a Puerto Rico subsidiary, the latter will not constitute part of the consolidated group for purposes of the filing of U.S. income tax returns, since a P.R. corporation is considered a foreign corporation for U.S. purposes.

4. The Puerto Rico Tax System

The Internal Revenue Code for a New Puerto Rico (‘Puerto Rico Internal Revenue Code’) is the main body of domestic statutory tax law. It covers income taxes, payroll taxes, gift taxes, estate taxes and more.

Contact us to learn more about Puerto Rico’s tax systems.