Investment Promotion Act Would Extend Domestic Tax Treatment to Puerto Rico Corporations

Congress is considering a bill that would allow certain corporations incorporated in Puerto Rico to elect to be treated as a domestic corporation for U.S. income tax purposes. H.R. 3020, the Puerto Rico Investment Promotion Act of 2011, was introduced by Resident Commissioner Pedro R. Pierluisi, a Democrat and the sole representative for Puerto Rico in Congress. (see http://pierluisi.house.gov/english/home.html).

Generally, a "Puerto Rico corporation", i.e., a corporation incorporated in Puerto Rico, is considered a foreign corporation for U.S. tax purposes. See JCX-24-06, Joint Committee on Taxation, "An Overview of the Special Tax Rules Related to Puerto Rico and an Analysis of the Tax and Economic Policy Implications of Recent Legislative Options" (June 23, 2006). H.R. 3020 seeks to add Section 933A (Election by Puerto Rico Corporations to be Treated as Domestic Corporations) to the Internal Revenue Code. Under Section 933A, a qualified Puerto Rico corporation can elect for any taxable year to be treated for such taxable year as a domestic corporation. [H.R. 3020, Sec. 2(a)].  Treatment as a domestic corporation for U.S. income tax purposes under Section 933A allows for the distribution of the Puerto Rico corporation's earnings to its U.S. parent corporation as a dividend under IRC Section 243, and a dividends received deduction is available to the U.S. parent corporation under Section 243. ( "Pierliusi Seeks Support on House Floor for Puerto Rico Investment Promotion Act," Sept. 21, 2011, http://pierluisi.house.gov/english/news/2010/09.21.2011%20PRP%20seeks%20support%20on%20the%20house%20floor.html). 

Section 933A defines a "qualified Puerto Rico corporation" as any corporation if:

  1. it is incorporated under the laws of Puerto Rico, and
  2. at least 50 percent of its gross income for the taxable year is derived from sources within Puerto Rico. [H.R. 3020, Sec. 2(a)].

As explained in Mr. Pierluisi's letter to the Joint Committee on Taxation, requesting a revenue estimate for the bill, a Puerto Rico corporation electing under Section 933A would be treated in the same way that an individual resident of Puerto Rico is treated under IRC Section 933. Under IRC Section 933, a U.S. citizen who is a resident of Puerto Rico for the entire taxable year may exclude from gross income amounts derived from sources within Puerto Rico, other than amounts received for services performed as an employee of the federal government or federal agency. (Lexis Tax Advisor -- Federal Code Explanations § 933). Income earned outside of Puerto Rico by a U.S. citizen who is a resident of Puerto Rico is subject to U.S. tax. (Lexis Tax Advisor -- Federal Code Explanations § 933). In addition, income earned during a year when the U.S. citizen was not a resident of Puerto Rico for the full taxable year is also subject to U.S. tax. (Lexis Tax Advisor -- Federal Code Explanations § 933).

Like the exclusion in Section 933 for Puerto Rico-sourced income, under proposed Section 933A, the gross income for the taxable year of a qualified Puerto Rico corporation that has elected to be treated as a domestic corporation for such taxable year will not include income derived from sources within Puerto Rico. [H.R. 3020, Sec. 2(a)]. As explained by Mr. Pierluisi in his letter to the Joint Committee on Taxation, "the electing corporation would be subject to federal income taxation on its worldwide income, with the exception that its Puerto Rico source income would not be included in gross income and therefore not subject to federal taxation." Other than this exception for Puerto Rico source income, as noted in Mr. Pierluisi's letter, "the electing corporation would generally be subject to the same rules and regulations that apply to any other domestic corporation."

Mr. Pierluisi pointed out that most U.S. companies that operate in Puerto Rico do so as controlled foreign corporations, and their income is not subject to U.S. taxation until that income is repatriated. Mr. Pierluisi hopes that the measure will lead to increased investment in Puerto Rico and job creation and believes that the measure should have bipartisan appeal. ("Pierluisi Introduces Puerto Rico Investment Promotion Act," Sept. 22, 2011, http://pierluisi.house.gov/english/news/2010/09.22.2011%20The%20PR%20investment%20promotion%20act%20of%202011.html). Mr. Pierliusi, who supports statehood for Puerto Rico, notes that Puerto Rico's territorial status has limited its potential for growth. (See "Pierliusi Seeks Support on House Floor for Puerto Rico Investment Promotion Act," Sept. 21, 2011, http://pierluisi.house.gov/english/news/2010/09.21.2011%20PRP%20seeks%20support%20on%20the%20house%20floor.html).

So far, the bill has only six co-sponsors. However, the bill does have bipartisan support in Puerto Rico and should be able to generate the same backing in Congress considering the potential benefits to Puerto Rico's economy along with the potential investment of repatriated earnings in the U.S. (See "Pierluisi Introduces Puerto Rico Investment Promotion Act," Sept. 22, 2011, http://pierluisi.house.gov/english/news/2010/09.22.2011%20The%20PR%20investment%20promotion%20act%20of%202011.html ). In general, I think that one of the obstacles to the bill in Congress could perhaps be the lack of strong interest among members regarding issues affecting Puerto Rico and the other U.S. territories. However, as noted in a recent Huffingtonpost article, passage of the bill does have political ramifications for the 2012 elections. (See Gretchen Sierra-Zorita, " A Convenient Arrangement: Puerto Ricans and the Republican Party in 2012", Huffington Post, Oct. 5, 2011, http://www.huffingtonpost.com/gretchen-sierrazorita/a-convenient-arrangement_b_994263.html?view=print&comm_ref=false). Specifically, as noted by Ms. Sierra-Zorita in the Huffington Post article, Republicans could gain politically from legislation that is popular with the Puerto Rican population in Florida, a key election state. More importantly for the long term, I think the potential for greater investment in Puerto Rico and the benefits to the Puerto Rican economy should motivate lawmakers to look seriously at the bill. Furthermore, greater investment in Puerto Rico by U.S. corporations could lead to increased trade and economic ties with Latin American and Caribbean countries and more inroads into their markets. The bill warrants serious consideration and debate by both parties.

RELATED LINKS: For further guidance on U.S. taxation issues relating to Puerto Rico, please see:

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