CLIENTS & FRIENDS TAX ALERT

I. Income Tax Provisions

Articles 2 & 14 – Big Taxpayers

A new definition of big taxpayers has been added to the Code to include: commercial banks or trust companies; private banks; brokerage houses; insurance companies; telecommunication entities; and entities with a volume of business of $50 MM. Big taxpayers are required to file their income tax returns at the office established by the Secretary of the Treasury or electronically.

Article 3 – Tax rates of Individual Taxpayers

The maximum individual tax rate is set to 33% on the excess over $61,500 plus $8,430, plus a gradual adjustment of 5% of the net income subject to tax in excess of $500,000, but limited to $8,895 plus 33% of the personal and dependent exemption.

Article 4 – Special income tax to individuals engaged in a trade or business is eliminated

The special tax of 2% imposed on all gross income generated by an individual engaged in the performance of services or engaged in a trade or business, when the gross income generated is in excess of $200,000, is eliminated for taxable years beginning after December 31, 2014.

Article 5 – Alternative Minimum Tax (“AMT”) Applicable to Corporations

1. With respect to the determination of one of the elements of the computation of AMT, a taxpayer may be able to exclude certain expenses incurred or paid to a related person or home office from the 20% AMT on related party expenses. The approval of the Secretary of the Treasury would be necessary and the exclusion is limited to 60% of the total expenses subject to the 20% AMT; and
2. Other of the elements in the determination of the AMT, the 2% tax applicable to the purchases of personal property between related persons is increased for taxable years beginning after December 31, 2014, based on the volume of business (“VOB”) of the purchaser from trade or business within Puerto Rico, as follows:
   • if VOB is more than or equal to $10 MM, but less than $500 MM, then 2.5%;
   • if VOB is more than or equal to $500 MM, but less than $1,500 MM, then 3%;
   • if VOB is more than or equal to $1,500 MM, but less than $2,000 MM, then 3.5%;
   • if VOB is more than or equal to $2,000 MM, but less than $2,750 MM, then 4.5%; and
   • if VOB is more than or equal to $2,750 MM, then 6.5%.

   Also, for purposes of this AMT element, for taxable years beginning after December 31, 2014, the discretion of the Secretary of the Treasury to take into consideration certain facts in order to reduce the tax percentage applicable to the purchases of personal property between related persons is eliminated.

Article 6 – Adjustments in the Computation of Alternative Minimum Net Income

Net Operating Loss Deduction for Alternative Minimum Tax Determination. – The deduction for net operating loss for alternative minimum net income was reduced from 80% of alternative minimum net income to 70% of alternative minimum net income for taxable years ended after December 31, 2014.

Article 7 – Expenses not related with the principal trade or business

For taxable years beginning after December 31, 2014, the amount of the deduction that a shareholder or partner may take for its proportional share of the losses of corporation of individuals, partnerships and special partnerships is limited to 80% of its participation on the aggregate net income of the corporation of individuals, partnerships and special partnerships.

Article 8 – Net Operating Loss Deduction

For taxable years beginning after December 31, 2014, the amount of the carry-over of the deduction for net operating loss was reduced from 90% to 80% of net income for taxable years beginning after December 31, 2014.

Further, in the determination of the net operating loss deduction, except in the case of entities with certain tax incentives grants, the following shall not be allowed:

1. Expenses incurred or paid to a related person not engaged in a trade or business within Puerto Rico, if said payments are attributable to the conduct of a trade or business within Puerto Rico and are not subject to income tax withholding at source under the Code for the taxable year in which incurred or paid; or
2. Expenses incurred or paid to a home office located outside of Puerto Rico, by a foreign corporation engaged in the conduct of a trade within Puerto Rico through a branch.
3. Expenses incurred or paid to a related person or home office that were excluded by the Secretary of the Treasury from the 51% expense disallowance related to expenses incurred or paid to a related person or home office.

Article 10 – Items Not Deductible

1. For taxable years beginning after December 31, 2014, and for purposes of the application of the authority granted to the Secretary of the Treasury to exclude certain expenses incurred or paid to a related person or home office from the 51% expense disallowance related to expenses incurred or paid to a related person or home office, the discretion of the Secretary of the Treasury to exclude said expenses is limited to 60%.
2. Expenses incurred or paid for the performance of services by a non-resident person if the taxpayer paying for the services has not paid the corresponding applicable sales and use taxes (“SUT”) or value added taxes (“VAT”), respectively, on said services.
3. The cost or depreciation of any good or taxable item, for SUT or VAT, respectively, even when said good or taxable item is considered an ordinary and necessary business expenses, if the taxpayer has not paid the SUT of VAT applicable to said good or taxable item.

Article 11 – Capital Gains and Losses and carry-over of capital losses

1. Corporations – for taxable years beginning after December 31, 2014, capital losses from the sale or exchange of capital assets are allowed only up to 80% of the gains derived from said sales.Expenses incurred or paid to a home office located outside of Puerto Rico, by a foreign corporation engaged in the conduct of a trade within Puerto Rico through a branch.
2. Other taxpayers – capital losses from the sale or exchange of capital assets during a taxable year are allowed against the gains generated from said sales during said taxable year, and any excess may be deducted against the lesser of the net income of the taxpayer or $1,000.
3. Carry-over of capital losses – for taxable years beginning after December 31, 2014, capital losses from the sale or exchange of capital assets may be carry-over up to 80% of the net capital gain generated for the taxable to which said capital losses are being carried-over.

II. Sales and Use Tax Provisions

Before discussing the amendments made by HB 2482 to the SUT provisions, it should be noted that current SUT provisions provide that the tax shall be separately stated on any receipt, invoice, ticket, or other evidence of sale, and said provisions were not amended. Similarly, under current SUT provisions commercial rent is not subject to SUT.

As it will be detailed in the VAT section of this memo, a new Section 4150.07 was enacted by Act 72-2015 allowing non-residents to request a refund with respect to the sale of articles that are going to be exported (tourist that will leave the island), provided they comply with certain requirements. Although there is no such specific provision for the SUT under Act 72-2011, Section 4030.03 of the Code provides an exemption from the payment of SUT for taxable articles purchased for exportation which may be applicable. It should be noted though that section 4030.03 was not necessarily designed with this in mind.

Pursuant to Section 4030.03 of the Code, taxable items that are sold for use and consumption outside Puerto Rico, even when the sale takes place in Puerto Rico shall be exempt from the payment of the SUT. In order for such taxable items to be exempt from the payment of the SUT, they must be exported within sixty (60) days from the date of sale of such article. Treasury’s SUT Regulation further provides that a taxable item shall be considered sold for use or consumption outside of Puerto Rico when the purchaser of such taxable item takes possession of it outside of Puerto Rico. Thus, if the purchaser takes possession of such taxable items in Puerto Rico the sale of such taxable item shall be presumed to be for use or consumption in Puerto Rico, and the seller shall have the obligation to collect the SUT in such sale. (Refer to Example 2 of the Regulation). However, said rule establishes a presumption that may be rebutted by coordinating a procedure with the Treasury Department (by way of a ruling) under which the seller can verify that the purchaser will use and/or consume the taxable item outside of PR. For example, the seller may request a copy of the license of the seller and a copy of the airline ticket departing Puerto Rico within sixty (60) days from the date of sale of such article.

Article 19 – SUT Amendments to definitions

1. Designated professional services – in addition to the previously determined activities, for period beginning after September 30, 2015, the definition includes services provided by a “returns, declarations or refund claims specialist”.
2. As a general rule services are considered taxable, thus, subject to SUT unless an exemption or exclusion applies. The exclusion from SUT for certain services after the amendments will be as follows:

1. For taxable events occurring before September 30, 2015, the following services will be excluded from SUT:
   1. Business to business (“B2B”) services, except for the following B2B services which will be subject to a SUT of 7% (6% state and 1% municipal) before July 1, 2015; and 11.5% (10.5% state and 1% municipal) from July 1, 2015 to March 31, 2016:
      1. Bank charges;
      2. Collection services;
      3. Security and private investigation services, except when provided to building or residence associations;
      4. Cleaning services, except when provided to building or residence associations;
      5. Laundry services;
      6. Maintenance and repair services, except when provided to building or residence associations;
      7. Telecommunications services;
      8. Waste disposal services, except when provided to building or residence associations; and
      9. Daily car rental services.
   2. Designated professional services. Designated professional services means:
      1. Agronomists;
      2. Architects;
      3. CPA’s;
      4. Brokers, sellers and real estate companies;
      5. Professional draftspersons;
      6. Professional real estate appraisers;
      7. Geologists;
      8. Legal services;
      9. Engineers and surveyors; and
      10. Returns, declarations or refund claims specialist services.
   3. Government provided services, including sewer services;
   4. Education services;
   5. Interest, other charges for the use of money and service charges by financial institutions;
   6. Insurance commissions and services;
   7. Insurance commissions and services;
   8. Health and hospitalization services; and
   9. Services provided by persons with a volume of business equal or less than $50,000.
2. For taxable events occurring before September 30, 2015, the following services will be excluded from SUT:
   1. B2B services and designated professional services, which will be subject to a special 4% tax;
   2. Government provided services, including sewer services;
   3. Education services;
   4. Interest, other charges for the use of money and service charges by financial institutions;
   5. Insurance commissions and services;
   6. Health and hospitalization services;
   7. Services provided by persons with a volume of business equal or less than $50,000; and
   8. Services between related persons or controlled group.
1. A new B2B definition is added – For taxable events occurring after September 30, 2015 up to March 31, 2016, B2B services will be subject to a special 4% tax, except:
   1. B2B services that are subject to a SUT of 11.5% (10.5% state and 1% municipal) until March 31, 2016;
   2. Government provided services, including sewer services;
   3. Education services;
   4. Interest, other charges for the use of money and service charges by financial institutions;
   5. Insurance commissions and services;
   6. Health and hospitalization services;
   7. Services provided by persons with a volume of business equal or less than $50,000; and
   8. Services between related persons or controlled group.

Articles 20, 21, 31 & 32 – SUT

1. Effective July 1, 2015 until March 31, 2016, the SUT state rate of 6% is increased to 10.5% on the sale of taxable items including tangible personal property and taxable services. The municipal SUT of 1% is maintained. Thus, effective July 1, 2015 until March 31, 2016, an 11.5% SUT rate shall apply on the sale of taxable items including tangible personal property and taxable services.
2. For taxable events occurring after September 30, 2015 and up to March 31, 2016, B2B services, except for the ones above mentioned, and professional designated services (legal, CPA, engineers, architects, etc.) will be subject to a new 4%. The B2B services and professional designated services that are subject to the new 4% tax will not be subject to the 1% municipal SUT.
3. The Secretary of the Treasury has been given the authority to extend the deadline of March 31, 2016 for the phase out of the state SUT into the value added tax (“VAT”) up to 60 days.

Article 22 – Person responsible for SUT payment

With respect to taxable services, B2B and professional designated services performed by a non-resident person to a merchant in Puerto Rico, the person responsible for the payment of the SUT to the Treasury Department will be the merchant in Puerto Rico receiving the services.

Article 23 – Accounting method

For taxable events occurring after September 30, 2015, merchants engaged in the performance of professional designated services may use the cash basis method for purposes of the obligations of collecting and remitting the SUT.

Article 24 – Time to remit the SUT

A new provision is added for merchants with a VOB for the immediately before taxable year equal or less than $1,000,000, the time to remit the SUT to the Treasury Department for the month of July 2015, would be as follows:

• 55% of the SUT collected shall be paid not later than August 20, 2015; and
• 45% of the SUT collected shall be paid in three equal installments on September 20, 2015, October 20, 2015 and November 20, 2015, respectively.

Article 25 – SUT Credit in sales for resale

SUT credit provisions are amended to allow merchants who hold a reseller certificate to take a credit for the SUT paid on purchases and importations. For periods commencing before Jun 30, 2015, the credit is limited to 75% of the merchant’s responsibility reflected in the SUT return, except that in the case of merchants dedicated principally to the sale of food and food ingredients, the credit may be up to 100% of the merchant’s responsibility reflected in the SUT return. For periods commencing after Jun 30, 2015, the credit is up to 100% of the merchant’s responsibility reflected in the SUT return.

It should be noted, that the SUT credit that could be taken is limited to the state SUT portion (6% before July 1, 2015, and 10.5% after July 1, 2015), and although not clear, but it seems that no credit could be taken under the SUT systems for the 4% tax being paid on B2B services and professional designated services.

Article 26 – Transition for pre-existing SUT transactions

For pre-existing SUT transactions as of July 1, 2015, the sale of taxable items under contracts or bids executed or granted before July 1, 2015 will be subject to the SUT rate applicable to the taxable item as of June 30, 2014. The same shall apply to contracts related to taxable services if said services were paid before July 1, 2015.

Article 31 – Municipal SUT

It is not clear what happens to the 1% municipal SUT after March 31, 2016, as approved under Act 72-2015 the 1% municipal SUT continues to exist when the VAT starts.

III. Value Added Tax Provisions

Article 27 – VAT

The following is a brief highlight of the most relevant VAT provisions, definitions and procedures.

Starting on April 1, 2016, unless postpone by the Secretary of the Treasury, as a general rule a VAT of 10.5% will apply on the importation and sale of goods and services, including services rendered by a non-resident person to a person in PR. In the case of services rendered by a non-resident person to a merchant in Puerto Rico, said merchant will be obligated to compute, pay, and disclose the applicable VAT on services in the VAT Monthly Return. Please note that as approved, the 1% municipal SUT continues to apply on the sale of taxable items.

Similar to the SUT provisions, under the VAT the commercial rent is not subject to tax, and under both systems the price of the items and the amount of the tax should be shown separately. Also, the concept of the importer bond is maintained. Bonded merchants do not have to pay upon introduction into Puerto Rico, they pay with their monthly declaration of imports on or before the 10^th day of the following month.

The following taxable transactions are subject to a zero (0) tax rate: sale of goods for exportation; sale of services for exportation; and the sale of raw material, articles for manufacturing and equipment used in manufacturing to a manufacturing plant with an exemption certificate.

As previously mentioned, with respect to the sale of article to non-residents for exportation (tourist that will leave the island), a new Section 4150.07 was enacted by Act 72-2015. Under Section 4150.07, a non-resident individual who acquires property in Puerto Rico over which they have paid VAT may request a refund of the VAT paid if he/she comply with the following requirements: (1) the individual leaves Puerto Rico within a period not exceeding 30 days from the date the goods are purchased, and (2) the total amount paid by one or more goods as reflected in a single receipt exceeds $500. Section 4150.07 provides that the Secretary of the Treasury, the Tourism Company and the Ports Authority shall set forth the procedure for the person to request the refund at his/her exit from Puerto Rico.

For purposes of the application of VAT, the following are not considered “goods”:

1. money, stocks, bonds, notes, and other securities or obligations;
2. intangibles (except computer programs);
3. blood, products derived from blood, and human tissue and organs;
4. electricity generated by the PR Power Authority or any other entity;
5. water supplied by the PR Aqueduct and Sewer Authority; and
6. any property of the Commonwealth of PR or of the U.S. Government.

Goods considered for exportation (zero tax rate) are:

1. Goods acquired in PR to be sent to an address outside PR, if exported within 60 days of the sale;
2. Tobacco or cigarettes sold to foreign or US flag ships for consumption outside PR;
3. Goods sold at air or maritime terminals to persons departing from PR, when the person selling the good has the appropriate license (duty free shops or terminals); and
4. Goods sold to cruise ships.

The following transactions will not be subject to VAT:

1. Financial and insurance services, except bank charges;
2. Sale of prescription drugs;
3. Sale of articles to make up for physical or physiological deficiencies;
4. Sale of goods and services acquired with funds from Medicare, Medicaid and the Government Health Plan;
5. Sale of goods and services to the Government, or importation of goods by the Government;
6. The sale or importation of gasoline products and products derived from crude oil;
7. The rent or lease of real property subject to the room tax imposed by the Tourism Company;
8. Sale of food or food ingredients;
9. Sale of goods acquired with funds from the Federal Nutrition Assistance Program and WIC;
10. Sale of real property;
11. Rent or lease of principal residence, students and senior citizens lodging;
12. Rent or lease of commercial real property;
13. Sale of goods by non-for profit organizations, only if the goods being sold were acquired by donation;
14. Sale of machinery and equipment used for the performance of healthcare services on humans;
15. Sale of articles used by bona-fide farmers;
16. Occasional sales by churches or religious organizations;
17. Education and child care services;
18. Sale of goods to a merchant engaged in a tourism business when the tourism business has an exempt purchase certificate, and only with respect to goods that are used in the tourism activity and are not inventory;
19. Sale of articles for manufacturing to a manufacturing plant;
20. Sale of printed books;
21. Sale of vehicles, boats and heavy equipment that are subject to excise taxes;
22. Performance of health and hospitalization related services to humans or animals; and
23. Legal services provided on contingency with respect to cases involving family law, domestic food support, tort medical malpractice, and tort physical and mental anguishes damages.

One of the important elements of VAT systems is the availability of the credit to be taken by the merchant importer or purchaser of goods and services on the subsequent resale. The credit is composed of VAT paid on the import of goods, the purchase of goods and services in Puerto Rico and the VAT paid by a merchant for services rendered by a non-resident person. Except in the case of merchants principally engaged in the sale of foods or certain provisions, and merchants principally engaged in the sale of prescriptions drugs, merchants engaged in the sale of taxable and exempt goods and services might not be able to take full credit for VAT paid, because they are required to make an apportionment of part of the credit between taxable and exempt transactions. To evidence and keep track of the credits and to account for adjustments, a system of fiscal voucher and credit/debit notes has been put in place, as follows

1. Fiscal Voucher: merchants that purchase goods or services may request that the seller provide a Fiscal Voucher evidencing the tax withheld;
2. Debit Note: if there has been an increase in the amount of the value of the sale transaction, compared to what was reported in the Fiscal Voucher (including any corrections to the invoice); or
3. Credit Note: if there has been a decrease in the amount of the value of the sale, compared to what was reported in the Fiscal Voucher (including any corrections to the invoice, returns, bad debts, additional discounts, or when the sale is canceled).

If a merchant has credits or adjustments in excess of the VAT it is required to remit to the Treasury Department during a month, a VAT overpayment results. VAT overpayments that do not exceed $10,000 must be applied in the following month and the months thereafter, until exhausted. However, if the overpayment exceeds $10,000, the merchant may request a reimbursement if it holds an Eligible Merchant Certificate (a merchant with an annual volume of sales exceeding $500,000 for the three immediately preceding years, or less applicable period if in operations for less than three years, and 80% of its total sales are subject to a zero VAT tax rate), or if is in an overpayment situation for three consecutive months.

This is a preliminary discussion of the most relevant provisions of Act 72-2015. We will keep you posted with further updates to reflect any technical amendments, issued guidance and further clarifications.