PUERTO RICO Law and Practice Contributed by: Miguel E Otero-Sobrino and Alexis R González-Pagani, Ferraiuoli LLC
through which it – and its investors and managers – enjoy preferential tax rates. Incentives Code The Incentives Code provides the general framework for (i) the eligibility requirements for a fund to be treat - ed as a PR-PEF or PEF; (ii) tax benefits available for PEFs and PR-PEFs, and their investors, sponsors and managers, (iii) and various other aspects. Deductions One of the incentives that the Incentives Code pro - vides for PEFs is allowing investors to take a deduc - tion of 30% of their initial investment in the PEF within a maximum period of ten years, provided that the maximum deduction does not exceed 15% of the investor’s net income prior to the deduction. Investors that invest in a PR-PEF are eligible to deduct 60% of their initial investment in the PR-PEF within a maximum period of 15 years, provided that the maximum deduction does not exceed 30% of their net income prior to the deduction. These deductions provide significant tax efficiencies for Puerto Rico residents. Dividends and interest Under the Incentives Code, an investor’s share of income derived by a PEF or PR-PEF from interest and dividends is subject to a fixed income tax rate of 10%. However, the distributive share of investors that are registered (or exempt) investment advisers, private equity firms or general partners in interest and dividends derived by a qualifying fund will be subject to income tax at a fixed rate of 5%. Capital gains Under the Incentives Code, an investor’s distributive share of income derived from capital gains realised by the qualifying fund is exempt from Puerto Rico income tax. Generally, the sale of units or shares of the fund’s portfolio companies are “sourced” to the residence of the investor (by way of a look-through of the fund). If the investor is a US tax resident, the source of the income is deemed to be the USA, whereas if the seller is a Puerto Rico resident, the income is gener - ally sourced to Puerto Rico. Therefore, Puerto Rico residents that invest in a qualifying fund may enjoy a
complete exemption on the capital gains realised by the qualifying fund. The general rule is that capital gains realised by an investor upon the sale of their ownership interest in a qualifying fund will be subject to Puerto Rico income tax at a rate of 5%. However, if the investor is a regis - tered (or exempt) investment adviser of the qualifying fund, a general partner, general member of the qualify - ing fund or a private equity firm, then the gain will be subject to income tax at a rate of 2.5%. As an exception, capital gains realised by investors upon the sale of their ownership interest in a qualify - ing fund will not be subject to the 5% or 2.5% tax (as the case may be) if the gross proceeds from the sale are reinvested in a PR-PEF within 90 days thereof, in which case the capital gains will not be subject to income tax. Investors that are not Puerto Rico resi - dents, and US citizens, would be subject to taxation at the applicable federal level. The exemption provided to a PEF or PR-PEF under the Incentives Code is covered under a contract between the government of Puerto Rico and the entity that requested the benefits. The initial term of the benefits under the Incentives Code is 15 years, which can be extended for an additional 15 years at the discretion of the government of Puerto Rico. Puerto Rico-based funds that export their services In addition to the benefits offered by the Incentives Code to PEFs, PR-PEFs and investors, under a sepa - rate section of the Incentives Code, certain investment advisers who are organised in Puerto Rico or establish operations in the country – and which provide advice to funds or other investment advisers located outside of Puerto Rico (ie, export their services) – may elect to be taxed as corporations to benefit from the 933 Exclusion and the Incentives Code, which provides a preferential tax rate of 4% for services rendered from Puerto Rico to persons or entities located outside of Puerto Rico such as funds, other investment advisers or investors. Dividends The Incentives Code provides a 0% rate on dividends distributed by the entity that is providing the export of
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