The Commonwealth of Puerto Rico (“PR”) is a self-governing territory of the United States of America (“US”) with approximately 3,750,000 inhabitants. Located between the Atlantic Ocean and the Caribbean Sea, PR governs its internal affairs in a manner similar to that of the other 50 states of the US. The US has jurisdiction over foreign relations and commerce, customs, immigration, nationality and citizenship, postal service, currency and military matters, among others. Generally, US federal trade and economic treaties, laws and regulations apply in PR. The US is PR’s main trading partner. The official languages of PR are Spanish and English.
Domestic Corporations. The PR General Corporations Act is modeled after the Delaware General Corporations Law. Any natural or juridical person, acting singly or jointly with others, can incorporate or organize a corporation by filing a certificate of incorporation at the PR State Department. Generally, this certificate grants the corporation legal existence as soon as it is filed with the PR Secretary of State.
Foreign Corporations. Foreign corporations (including US corporations) desiring to operate in PR must request a certificate of authorization to do business in PR by filing an application at the PR State Department. The application to conduct business in PR must be accompanied by a certificate of corporate existence (or any other similar document) issued by the Secretary of State or other official having custody of the corporate register in the jurisdiction where the foreign corporation was incorporated. If such certificate of corporate existence is in a foreign language, a translation must be attached, together with a sworn certificate of the translator.
Limited Liability Companies. Limited liability companies or LLCs are fast becoming the preferred method of doing business in PR. LLCs offer their owners the same limited liability protection granted by law to corporations and the flexibility to manage their internal affairs as a partnership, a corporation or a combination of both in accordance with their Operating Agreement. LLCs are organized by filing a certificate of formation at the PR State Department.
Foreign Limited Liability Companies. Foreign limited liability companies desiring to operate in PR must request a certificate of authorization to do business by filing an application at the PR State Department. The application to conduct business in PR must be accompanied by a certificate of existence (or any other similar document) issued by the Secretary of State or other official having custody of the company register in the jurisdiction where the foreign corporation was incorporated.
Other Entities. Both the PR Civil Code and the PR Commercial Code allow for the creation and/or authorization to do business of other types of business entities such as civil and commercial partnerships and limited partnerships. A commercial partnership must be registered in the Mercantile Registry of the Registry of Property where its property is located. In order to have access to the PR Registry of Property, the partnership agreement must be constituted in Public Deed.
For tax purposes, PR is a separate tax jurisdiction from the US.
Income Taxes. PR’s Internal Revenue Code of 2011, as amended, is modeled generally after the US Internal Revenue Code. All corporations, whether domestic or foreign which are engaged in trade or business in PR are taxed on their net income. Domestic corporations are taxed on their net income from all sources and foreign corporations are taxed on the income that is effectively connected with the conduct of a trade or business in PR. The maximum tax rate is 39%. Foreign corporations not engaged in trade or business in PR are subject to a flat withholding income tax rate of 29% on certain items of gross income received from sources within PR.
Municipal License Taxes. The Municipal License Tax Act imposes a license tax on the volume of business (gross income) on every person engaged in any business, including the sale of goods, the performance of services and any financial business, in any municipality in PR. The municipal license tax rate applicable to non-financial business businesses ranges from .27% to .5%. For financial businesses, the rate is usually 1.5%. Each municipality establishes its own rates.
Personal Property Taxes. Unless specifically exempted, every natural or juridical person engaged in a trade or business in PR is subject to the imposition of personal property taxes ranging from 4.33% to 6.58%, of the net book value of the taxable property. Taxable property includes cash on hand, inventories, materials and supplies, furniture and fixtures, and machinery and equipment used in a trade or business.
Real Property Taxes. Real property tax rates vary for each municipality and generally are 2% higher than the personal property tax rate. For tax purposes, real property means the land, the subsoil, the structures, objects, machinery, or implements attached to the building or fixed on the ground in a manner showing permanence.
Sales and Use Taxes. Every merchant engaged in the sale of taxable items, or which provides a service not specifically exempted, has the obligation to collect a sales and use tax (“SUT”) as a withholding agent. The SUT rate on the sales and use of goods is generally 11.5%. Although originally exempted, services provided to businesses generally will be taxed at a rate of 4% commencing on October 1, 2015 and 10.5% commencing on April 1, 2016. There is a possibility that the SUT will be replaced by a VAT in 2016.
Tax Incentives. PR is focused in promoting foreign investment primarily on manufacture, biotechnology, communications, information technology, tourism and export services. To achieve this goal, PR offers tax incentives and exemptions for qualifying companies and individuals. Some of the tax incentive programs available in PR are:
- Economic Incentives for the Development of PR Act, as amended (“Act 73”). Act 73 provides a fixed income tax rate of 4% with a withholding tax on royalty payments of 12%. There is an optional fixed income rate of 8% with a withholding tax on royalty payments of 2%. There is a fixed income tax rate of 1%, or of 0% for pioneer products (as such term is define in Act 73). Distributions of earnings or profits and liquidations are tax free. The taxable gain realized on sales of stock and/or of substantially all of the assets of the exempt business are subject to an income tax rate of 4%. Act 73 also provides a 90% exemption from property taxes and a 60% tax exemption from municipal license taxes. Act 73 provides tax credits for purchases of products manufactured in PR, job creation, investments in research and development and technology transfers, among others. Some credits are transferrable.
- The PR Export Services Act, as amended (“Act 20”). Act 20 provides a 4% fixed income tax rate on the net income generated from the operation of an eligible export service activity which may be reduced to 3% if more than 90% of the income generated by the entity is generated from qualified export services activities and the services are considered strategic services. Accumulated earnings and profits derived from the export service activity are 100% exempted from income tax upon distribution. Act 20 also provides a 90% exemption from real and personal property taxes if the qualified eligible business is engaged in management headquarters services, call centers, and shared services center. The businesses engaged in any of these three services will enjoy a 100% exemption from all property taxes during the first five (5) years. The Act also provides a 60% exemption from municipal license taxes. These benefits would be provided for a 20 year period, and may be extended for 10 additional years.
- Act to Promote the Transfer of Individual Investors, as amended (“Act 22”). Act 22 provides a 100% income tax exemption on interest income, dividend income, and short and long term capital gain, derived from any source, which is generated by an individual investor that becomes a resident of PR or transfers his residency to PR. The income must be generated between the date in which the foreign individual is considered a resident in PR (i.e. 183 days test) and before January 1, 2036. In general, a special tax rate of 5% applies to capital gains accrued prior to the individual becoming a resident of PR which are recognized within 10 years after the residency in PR is established.
- The Tourism Incentives Act of 1993. The Tourism Incentives Act provides eligible tourism activities with partial exemptions from income, property, and municipal license taxes for a period of up to ten years. Qualifying investments in tourism activities may receive tax credits.
Both federal and local laws apply to employers in PR. The Fair Labor Standards Act (FLSA) applies to employers in PR engaged in interstate commerce. The federal minimum wage applies automatically in PR to employees who work in companies covered by the FLSA. Companies not covered by the FLSA must pay a minimum wage equivalent to 70% of the prevailing minimum wage.
In PR, a regular work day consists of 8 hours of work and a regular work week consists of 40 hours. Employers covered by the FSLA must pay overtime at a rate of not less than 1 ½ times their regular rates of pay, after 8 hour of work per day and after 40 hours of work in a workweek.
The meal period must be no less than 1 hour, unless a shorter period is agreed to by the employer and the employee. The meal period may be reduced for certain types of employees. Work performed during the meal period, or any part thereof, must be compensated at twice the regular hourly rate.
An employer is also required to pay a Christmas Bonus to each employee who has worked 700 hours or more between October 1 of the previous year and September 30 of the current year.
In PR, employees are entitled to compensation and medical treatment for work-related accidents or illnesses. The employer is not liable to the employee for damages arising out of an occupational accident in those cases where the employer is fully insured through the State Insurance Fund. There is also a short term disability insurance to cover non-occupational disabilities. This plan covers the risks of sickness, total and permanent physical disability, or death. Both, the employers and employees, are required to make payments to this plan. PR and US unemployment acts provide for a coordinated US/PR Plan designed to provide economic security for employees during temporary periods of unemployment.
There are several statutes, both local and federal, that prohibit discrimination in hiring, promotions, discipline or otherwise treating differently in employment persons on account of age, race, color, national origin, religious or political beliefs or sex, among others. There is also legislation protecting qualified individuals who are disabled veterans, veterans of the Vietnam era, or individuals with disabilities. Sexual harassment is forbidden in the workplace. The law provides for strict liability for the employer for the actions of its agents and supervisors.
Employees employed for an indefinite period and discharged from employment without just cause, as defined in PR Act 80, are entitled to a severance payment based on years of service and the highest salary earned in the last 3 years of employment.
Other US laws such as COBRA, WARN, OSHA, Title VII, ADEA, ADA and IRCA apply to PR.
Intellectual (Industrial) Property
US federal protection, laws and regulations regarding Trademarks, Patents and Copyrights apply to PR. The PR Trademarks Act provides ample protection for the rights of the owners of locally registered trademarks, such as granting the prevailing registrant the right to always recover the costs, fees and expenses of an infringement lawsuit. It also allows the issuance of an ex-parte temporary restraining order to cease and desist of the use of the mark and the seizure of the articles on which the mark was affixed.