PUERTO RICO Law and Practice Contributed by: Dianette Rivera-Melendez, Oreste Ramos, Maria Trelles-Hernandez and Rosangela Sanfilippo, Pietrantoni Mendez & Alvarez LLC
non-Puerto Rican resident individual that is not a US citizen, or a Foreign Entity not engaged in trade or business in Puerto Rico. Capital gains from the sale of real property, on the other hand, constitute Puerto Rican source income and, therefore, a non-Puerto Rican resident or For - eign Entity will be subject to Puerto Rican income taxes on the gains. The buyer in the transaction that generates a Puerto Rican source capital gain (ie, real estate, conduit entity interest) is required to withhold the applicable Puerto Rican income tax and remit it to the Puerto Rican Treasury Department. Investments in Domestic Entities that are taxed as conduit entities or in any other flow-through Puerto Rican business are generally made through a Domes - tic Entity taxed as a corporation. This investment vehi - cle serves as a “blocker” for the foreign investor as it eliminates the requirement of the foreign investor to file Puerto Rican income tax returns. The “blocker” will file Puerto Rican tax returns, pay the applicable Puerto Rican income taxes, and distribute its earnings and profits to the foreign investor, net of the applicable Puerto Rican income withholding tax. On an exit, the foreign investor may sell the shares or ownership interest of the corporation or Domes - tic Entity and be exempt from Puerto Rican income taxes. The “blocker” may not necessarily result in a lower Puerto Rican income tax rate but simplifies the applicable Puerto Rican tax return compliance. If Puerto Rican operations are covered by a tax exemp - tion decree, the “blocker” treatment is the preferred option because the “blocker” pays a fixed 4% Puerto Rican income tax rate and may distribute the earnings and profits without any Puerto Rican income taxes. 9.5 Anti-Evasion Regimes The Puerto Rican Internal Revenue Code of 2011 (as amended) (the “PR Code”) contains several rules designed to prevent tax avoidance or abuse. The Sec - retary of the Treasury has the authority to impute or reassign items of income and expenses to properly reflect the tax liability of the parties. In this regard, Puerto Rico follows the US federal transfer pricing rules. For example, deductions for payments to relat - ed Foreign Entities that are not engaged in trade or
business in Puerto Rico are limited to 49%, unless a certification that a transfer pricing study prepared in line with US federal tax rules was obtained to confirm the amount of the payments. Interest paid to foreign- related entities not engaged in trade or business in Puerto Rico is also subject to a 29% withholding tax. Finally, the PR Code has specific rules designed to accelerate the tax on dividends by treating certain transactions with foreign affiliates as deemed divi - dends. The PR Code also has several rules disallowing cer - tain expenses deemed or presumed abusive, such as denying tax deductions for certain payments for which an informative return was not filed with the Puerto Rican Treasury Department. Beyond these specific rules, the Puerto Rican Treasury Department may also invoke judicially developed doctrines such as economic substance, substance-over-form and step transactions. These doctrines empower the Puerto Rican Treasury Department to disregard the form or steps of certain transactions in order to establish the appropriate tax treatment. 10. Employment and Labour 10.1 Employment and Labour Framework Puerto Rico is not an “employment at will” jurisdiction and the termination of employees is highly regulated. Puerto Rican law requires employers to have “just cause” for termination within the definition in Puerto Rico’s Wrongful Termination Act, Act No 80-1976 (“Act 80”). Terminations without “just cause” trigger the employer’s obligation to pay the terminated employee the discharge indemnity provided in the Act. Puerto Rico’s labour and employment relations are governed by a mix of US federal and Puerto Rican laws and regulations. Areas covered by the applicable labour and employment legal regime include: • wage and hour; • the hiring and termination of employees; • employment discrimination, retaliation and work -
place harassment; • leaves of absence; • labour and union laws; and
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