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Puerto Rico: Tax law changes affecting corporations, partnerships

Puerto Rico: Tax law changes

House Bill 1544—signed by the governor as Act 257 on December 10, 2018— introduces changes to the taxation of corporations and partnerships as well as definitions and information returns. Unless otherwise noted below, the changes will apply to tax years beginning after December 31, 2018.

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Related content

The legislative changes for the taxation of individuals are summarized separately in TaxNewsFlash.

Tax changes for corporations

Normal tax

The corporate income tax rate is reduced from 20% to 18.5%. Thus, including a surtax, the highest income tax rate will be 37.5% (instead of 39%).

Alternative minimum tax (AMT)

Corporations with a volume of business of $3 million or more will be subject to a 23% AMT rate instead of the 30% rate under the law in effect prior to 2019. For corporations with less than $3 million in volume of business, the AMT will be the greater of $500 or 18.5%.

There are new limitations on the allowable expenses to compute the alternative minimum taxable income. Only the payments that are directly related to the trade or business and that are duly reported in informative returns will be allowed as deductions. However, taxpayers that file audited financial statements or have an “agreed under procedure” with the filing of the income tax return may calculate the alternative minimum taxable income claiming all ordinary and necessary expenses.

Optional tax for corporations engaged in rendering services

Corporations whose source of income substantially arises from the rendering of services subject to withholding may elect to pay their income tax at a flat rate on gross income, as noted in the following table:

 

If gross income is:
The tax will be:
Not greater than $100,000
6%
In excess of $100,000 but not more than $200,000
10%
In excess of $200,000 but not more than $300,000
13%
In excess of $300,000 but not more than $400,000
15%
In excess of $400,000 but not more than $500,000
17%
In excess of $500,000
20%


Credits and deductions

Act 257 includes measures concerning the following changes for tax credits and deductions for corporate taxpayers:

  • Disallowance on intercompany expense allocation (51% disallowance): Amounts paid or incurred to related persons (including home offices) will continue to apply unless the taxpayer files with the Puerto Rico Treasury a transfer price study under the provisions of IRC section 482. If there are no operations in the United States by the related parties, OECD-compliant reports would be accepted.
  • Depreciation: An entity with a volume of business of less than $3 million may depreciate fixed assets (excluding real property and automobiles) using a useful life of two years.
  • Meals and entertainment: Expense deductions will be reduced to 25% of the amount incurred, rather than 50% under the law in effect before 2019.
  • Travel expenses will be subject to a 50% limitation rather than being fully deductible.
  • Indemnity payments due to harassment cases: Payments of damages on account of harassment claims, including legal fees, will not be deductible if the settlement includes a non-disclosure agreement.
  • Wages paid to college students: Private employers will be allowed a 150% deduction for salaries paid to college students if certain requirements are met. If the employee participated in the Puerto Rico Treasury internship program, the deduction increases to 200%.
  • Foreign tax credit: Taxpayers will be allowed to claim a foreign tax credit for income taxes paid to any U.S. state.
  • Net operating losses (NOL): The NOL carryover deduction limitation increases from 80% to 90% of net income. A corporate partner that owns 50% or more of the interest of a partnership may not claim the NOL deduction against its distributable share from the partnership.
  • Capital losses: The rate for carryforward losses increases from 80% to 90%.
  • Charitable contributions: Deductions will be allowed only if the contribution is made to a nonprofit entity that renders services to Puerto Rico residents.
  • Motor vehicles: Deductions can be made for the real costs incurred in the use and maintenance of motor vehicles, rather than using the standard mileage rate. 

Extension of time to file the income tax return

For tax years beginning after December 31, 2016, the automatic extension is expanded from three months to six months.

Audited financial statements (AFS)

Taxpayers required to file AFS will have to submit an “Uncertain Tax Positions Schedule” with the return explaining any uncertain tax position taken under U.S. GAAP.

 

Tax changes for partnerships

Net operating loss (NOL) limitation

The limitation percentage on the NOL carryover deduction is increased from 80% to 90%. A corporate partner holding 50% or more of the capital interest or profits from the partnerships cannot claim an NOL deduction against its distributable share of net income of such partnership. The limitation on the distributable net loss of a passthrough entity against the net distributable share of net income from other passthrough entities increases from 80% to 90%.

Limitation on allowance of partner’s share of loss—charitable contributions and foreign taxes

The amount allowed as a partner’s loss is limited to the adjusted basis of the partner’s interest in the partnership as of the close of the tax year in which the partnership loss occurred.  Under the new law, the determination of any loss will be made considering the partner’s allocable share of charitable contributions or foreign tax expenses. As an exception, in the case of a charitable contribution of property having a fair market value exceeding the adjusted tax basis, the basis limitation will not be considered over the partner’s distributable share of such excess. 

Technical termination

The sale or exchange of an interest in the partnership equal to 50% or more will no longer be considered a technical termination.

Substantial built-in loss in the transfer of partnership interest 

A prior provision in the Puerto Rico tax law allowed an adjustment to the basis of partnership property upon the sale or exchange of a partnership interest, provided that the partnership had a “Section 1075.04 election” in effect, or when the partnership had a substantial built-in loss. The prior tax law established that a partnership had a substantial built-in loss with respect to the transfer of an interest in a partnership if the partnership's adjusted basis in all of its property exceeded the fair market value of such property by more than $250,000.  

The new law (Act 257) expands the application of the substantial built-in loss by adding that a substantial built-in loss also exists if the transferee partner would be allocated a loss in excess of $250,000 upon a hypothetical disposition by the partnership of all the partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest.

Sale of partnership interest

Gain on the sale of partnership interests after December 31, 2018, will be treated as Puerto Rico-source income to the extent a deemed sale of all assets at fair market value, regardless of the residence of the selling partner, generates Puerto Rico-source income. If the selling partner is a non-resident individual or foreign corporation not engaged in trade or business in Puerto Rico, the purchaser will be required to withhold a 15% income tax from the portion of the gain constituting Puerto Rico-source income.

Definitions

Limited liability company (LLC)

Act 257 provides that only foreign LLCs that are treated as partnerships under foreign laws must be treated as partnerships for Puerto Rico income tax purposes. Thus, this allows Puerto Rico LLCs to be treated differently for Puerto Rico and non-Puerto Rico tax purposes. Also, the Act provides that the LLC election in connection with the tax treatment of the entity in Puerto Rico will be made at the time of the filing the income tax return of the year in which the LLC adopts the tax treatment.

Large taxpayer

Act 257 amends the definition of “large taxpayer” to include international insurers within the current requisite of insurance industry. Also, the Act clarifies that the aggregate volume of all related entities, as defined by the Puerto Rico Code, will be considered in determining whether an entity has a volume of business of $50 million or more for purposes of being considered to be a “large taxpayer.” Under a new measure, a taxpayer may request to be excluded from the category of “large taxpayer” by filing a petition for an Administrative Determination.

Engaged in industry or business in Puerto Rico

The term “engaged in trade or business in Puerto Rico” excludes the trading of securities by the taxpayer through a resident agent / broker / custodian or any other resident independent agent. The exclusion only applies if the taxpayer does not have an office in Puerto Rico to conduct such trading operations.

Group of related entities

Act 257 expands the definition of “group of related entities” to include LLCs, partnerships, special partnerships, and corporations of individuals.

Other

Extension of time to file returns

For tax years beginning after December 31, 2016, the Act increases the period for the automatic extension of time to file a corporation or partnership income tax return from three months to six months. The information returns for partners of a partnership will be extended to six months if the entity has been granted an automatic extension of time to file its partnership information tax return.

Withholding taxes and informative returns

  • Withholding tax on salaries:
    • Payments made after December 31, 2018, will be considered to be salaries for the following services:
      • Agriculture 
      • Domestic services at home, local collegial club, or local chapter of a fraternity or collegial sorority
      • Religious 
      • Compensation or indemnity paid to an employee due to dismissalo 
    • Salaries for services rendered in temporary or seasonal work
      • An employer will be allowed to withhold 2% on total salaries for payments made before January 1, 2019, and 5% for payments made after December 31, 2018.
  • Withholding tax on indemnity payments
    • Withholding tax for payments made before January 1, 2019, is 7%, but increases to 10% for payments made after December 31, 2018. 
    • The amount paid to a legal representative will also be considered taxable income subject to withholding tax.
    • The tax withheld is to be remitted to the Puerto Rico Treasury Department no later than the 15th day following the month in which the tax was withheld. 
  • Withholding tax on services rendered
    • Withholding tax for payments made before January 1, 2019, is 7% and increases to 10% for payments made after December 31, 2018. 
    • Commission payments made for an insurance premium paid to an agent will be subject to withholding tax. 
    • The exception for the withholding tax rules was revised to exclude:
      • Payments made under $1,500 before January 1, 2019, will not be subject to withholding tax. Payments of less than $500 made after December 31, 2018, will not be subject to withholding tax. 
      • Services payments made to individuals, corporations, and partnerships for their first three years of operations until December 31, 2018, will not be subject to withholding tax. However, payments made to an entity after December 31, 2018, for the first year of operations will be exempt. 
      • Payments made by a partnership, special partnership or “corporation of individuals” to an individual that is a partner, shareholder or owner of such entity for services rendered. 
    • The tax withheld must be remitted to the Puerto Rico Treasury no later than the 15th day following the month in which the tax was withheld. 
    • Withholding tax waiver will allow payments made after December 31, 2018, to be subject to a withholding tax of 6% (instead of 3%) if the entity submits audited financial statements and does not owe any taxes. If an entity’s volume of business exceeds $1 million and it provides audited financial statements, no withholding tax is required. 
    • Quarterly reconciliation return: Every person required to deduct and withhold the withholding tax on services rendered must file a quarterly return with details of payments made and the tax withheld and remitted to the Puerto Rico Treasury.
  • Withholding tax at source for nonresident individuals
    • If a taxpayer or person required to file an informative declaration does not file such declaration and does not remit payment to the Puerto Rico Treasury, that person will not be able to claim the payments as an ordinary and necessary expense in its operations. 
    • In the case of a sale of a partnership interest by a nonresident person, the seller must withhold 15% of the gain of the sale that constitutes income from sources within Puerto Rico.
  • Information at source
    • Payments in the amount of $500 or more made to individuals, trusts, or to entities for rents, salaries, wages, premiums, annuities, services, advertising, insurance premiums, telecommunication services, internet services, cable or satellite television services, compensation, remunerations or emoluments or other fixed or determinable gains, profits, and income must file an information return on or before February 28 of the following year. 
    • To be able to deduct the payment for purposes of the alternative basic tax for individuals or the alternative minimum tax for corporations, all payments must be reported in an informative declaration even if payment is less than $500. 
  • Information return on extension of credit transactions
    • After January 1, 2019, an information return must be filed for each approved requested transaction or extension of credit, including loans and motor vehicle financing of $100,000 or more ($250,000 or more for mortgages).
  • Reports on income subject to alternative minimum tax
    • Every taxpayer or person that has not filed its informative declaration at the time of filing its income tax return, will not be able to claim the payments as an expense for its operations. 
  • Informative declaration on transactions made by electronic means
    • For transactions made as of January 1, 2019, any entity engaged in the business of processing payments by electronic means will be required to report annually the total amount of payments processed and credited to the merchant participating in the processing of payments. 
  • Failure to file informative declarations will result in the taxpayer not being able to claim such payments as an ordinary and necessary expense. Taxpayers under the accrual method of accounting or having a fiscal year will be able to claim the deduction even though the amount is not reflected in the informative declaration if they include a reconciliation of the expense as claimed on return and the amount included in the informative declaration on its income tax return. 

KPMG observation

Note that the federally created Financial Oversight and Management Board (FOMB) has expressed concerns related to the fiscal balance of this measure as required by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA). Specifically, FOMB has requested that the government provide analysis regarding the impact of some provisions related to the licensing of video lottery machines (not discussed above) before certifying that the legislation is consistent with the approved fiscal plan. FOMB stated:

We reserve the right to take such actions as we consider necessary, consistent with Section 204(a)(5) [of PROMESA], including preventing the enforcement or the application of Articles 132 through 163 [related to the video lottery machines] of the New Tax Law. We will endeavor to keep you abreast of any implications on the applicability of this law resulting from any actions the FOMB takes in this respect.

 

For more information, contact a KPMG tax professional in Puerto Rico: 

Rolando Lopez | +1 (787) 622-5340 | rlopez@kpmg.com

Carlos Molina | +1 (787) 622-5311 | cmolina@kpmg.com

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