2013 Modifications to Income and Sales Taxes Regimes
Following is a summary of the salient provisions of Act No. 40-2013 "Tax Burden Redistribution and Adjustment Act" (originally House Bill No. 1073). Act 40-2013 makes significant changes to the income tax and sales tax regimes. The income tax provisions are effective for taxable years commenced after December 31, 2012.
A. Income Tax
Alternative basic tax – The maximum rate is increased to 24% (from 20%) for net income (subject to the ABT) in excess of $500,000. In addition, the ABT computation includes the individual’s distributable/proportionate share of the gross income tax (described below) from partnerships, special partnerships and corporations on individuals, as the case may be.
Self-employment tax – A new 2% additional tax is assessed on gross income earned by self-employed individuals from rendering services (other than as employees) or carrying on a trade or business if such gross income exceeds $200,000. Individuals that elected to be taxed under the 1994 PR IRC are also subject to this new tax. Gross income means net sales less cost of goods sold, if any. The tax must be paid on the due date for filing the return and is not deductible in computing the regular tax or the ABT.
Mortgage interest deduction – The deduction for qualifying interest is capped at $35,000 taking into consideration the 30% adjusted gross income limitations.
Income tax rates – The current surtax rates and income brackets are repealed and rolled back to the rates and brackets of the 1994 PR IRC. Thus the maximum tax rate is 39% for net income in excess of the $275,000. The surtax exemption is reduced to $25,000. Assuming a taxpayer is not a member of a controlled group, taxable income will be subject to a regular tax of 20% and the balance exceeding the surtax exemption will be subject to the following surtax:
|$75,001 - $125,000
||$3,750 plus 15% of excess over $75,000
|$125,001 - $175,000
||$11,250 plus 16% of excess over $125,000
|$175,001 - $225,000
||$19,250 plus 17% of excess over $175,000
|$225,001 - $275,000
||$27,750 plus 18% of excess over $225,000
|$275,001 - Over
||$36,750 plus 19% of excess over $275,000
For purposes of the regular tax, the net operating loss deduction is limited to 90% of the corporation’s net income subject to such tax.
Alternative minimum tax – Significant changes have been made to the tentative minimum tax on which the AMT is computed.
The tentative alternative tax is the greater of the following amounts:
- The sum of (i) 30% of the amount by which the alternative minimum net income exceeds the exempt amount, reduced by the alternative minimum tax credit for foreign taxes paid for the taxable year, and (ii) the gross income tax discussed below, except in the case of a financial business; and
- The sum of (i) 20% of the amount of expenses incurred or paid to a related person if such payments are not subject to Puerto Rico income or withholding taxes or the amount of transfer or allocation costs from a home office to a Puerto Rico branch if such
expenses are attributable to the conduct of a trade of business in Puerto
Rico and payments thereof are not subject to Puerto Rico income or withholding taxes; (ii) if applicable, the amount of personal property purchases from a related person or transfers from a home office located outside of Puerto Rico to a Puerto Rico branch equal to 2% (lower percentages for certain products); and (iii) the new gross income tax (described below), except for a financial business, or the distributable share of this tax from partnerships and special partnerships, as the case may be.
Treasury Department has issued guidance regarding the procedures to follow for requesting that services described in item b(i) are excluded from the AMT and for partial or full reduction of the applicable rates on property described on item b(ii).
In computing the AMT, the deduction for net operating losses is reduced to 80% (from 90%) of the alternative minimum net income. The disallowance of the deduction for expenses paid to a related person is repealed.
- Gross income tax
A new tax on gross income as part of the AMT is imposed on every corporation engaged in a trade or business in Puerto Rico, except financial
businesses and certain foreign corporations that are deemed to have income effectively connected with a Puerto Rico trade or business
or are subject to certain excise tax on goods or services acquired from
related persons. In the case of individuals the tax applies to the
distributable share or proportionate share of gross income from pass-thru
entities when computing their alternate basic tax. The applicable rates are:
|From $1,000,000 up to $3,000,000
|From $3,000,001 up to $300,000,000
|From $300,000,001 up to $600,000,000
|From $600,000,001 up to $150,000,000,000
|In excess of $150,000,000,000
The Secretary is empowered to issue regulations reducing the applicable tax rates, but never to less than 0.05%, upon showing undue hardship as a result of the tax representing a significant amount compared to the gross margin. Treasury Department has issued guidance regarding the procedures to follow for requesting such reduction.
In order for a reduction to be effective for taxable years commenced during
2013, the application must be filed not later than November 30, 2013.
Financial institutions are subject to a 1% tax rate on their gross income. Certain other special rules pertain to such institutions.
Pass-through entities must withhold at the source and remit to Treasury Department the higher of (a) the gross income tax or (b) the applicable income tax percentages on the distributive/proportionate share of the entity’s net income
and income items subject to preferential tax rates.
This new tax applies as well to taxpayers that elected to be taxed under
the 1994 PR IRC (see rates described above) but for said taxpayers it is an
additional tax separate from the regular tax and the AMT or the alternate
basic tax, as the case may be.
In the case of a controlled group of corporations or a related group of entities, a member corporation (other than a financial institution) must determine its tax rate taking into consideration the total gross income of each member of the controlled group or a related group that is subject to the tax.
As general rule, gross income means the gross income determined under Section 1031.01 of the 2011 IRC less exempt income under Section 1031.02 (e.g., interest on U.S. and Puerto Rico bonds).
In the case of sales of inventory, it means gross sales without deducting the cost of the goods sold. Special definitions are set forth for insurance companies, commission agents, gas stations, brokers, representative agents, ads agencies, contractors, and wholesalers and retailers of new automobiles.
Gross income excludes the following items among others:
- Gross income derived from operations covered by a tax exemption grant or concession pursuant to the provisions of the Economic Incentives for the Development of Puerto Rico Act, its predecessor and successors acts, the 2010 Tourism Development of Puerto Rico Act, the Green Energy Tax Incentives Act, the Export Services Development Act, and any analogous, predecessor and successors acts, and any other special act providing tax exemption on net income.
- Gross income derived by non-profit organizations specified in Section 1101.01 of the 2011 IRC to the extent said income is not subject to tax under the 2011 IRC.
- Dividends received from a domestic controlled corporation up to the amount allowed as a dividend received deduction.
- Gross income attributable to the conduct of a trade or business outside Puerto Rico.
- Deduction disallowance of certain payments and extension of NOL carryover period
Fifty-one percent (51%) of the deduction for expenses or payments made by
pass-through entities to partners or shareholders owning more than 50%
interest in such entities and payments or transfers to related parties not engaged in trade or business in Puerto Rico or to home office
is disallowed if payments are not subject to
withholding tax in Puerto Rico,
(e.g. payments for services rendered outside Puerto Rico by foreign persons). This disallowance is not applicable to entities with tax exemption grants under Act 73 and similar tax incentives laws that provide income tax exemption. The Secretary of Treasury is given discretion to waive this disallowance.
The carryover period of net operating losses (NOLs) incurred in taxable years commenced after December 31, 2012 is 10 years. For NOLs incurred in taxable years 2004 thru 2012 the carryover period 12 years.
- Moratorium on the use and the grant of tax credits
The use of certain tax credits purchased or granted before June 30, 2013 is subject to limitations during taxable years 2013 through 2015. Among the credits unaffected by this limitation are those granted under the Act No. 73 of May 28, 2008, the Tourism Development Acts and the Film Industry Development Act. Tax credits in general are subject to a reporting requirement by not later than July 1, 2013.
B. Sales and use taxes
- New taxable services – Commencing on July 1, 2013 the following services become taxable services even if provided by a business to another business: banking charges and fees to commercial clients related to account management, security and armored services, collection services, cleaning services, laundry services, repair and maintenance services related to real property and tangible personal property (unless cost must be capitalized), telecommunication services,
and waste collection services and daily rental of vehicles. However, the
foregoing services are not subject to sales and use taxes if performed
between members of a controlled group of related entities.
- Waiver of sales tax collection – Manufacturing plants that make sales to distributors can apply for a waiver of sales tax collection on such sales.
A registered wholesaler that makes sales to resellers or registered
resellers before July 1, 2014
can apply for a collection waiver if (a) at least 90% of the personal
tangible property has been acquired from local manufacturers or imported by
the wholesaler as importer of record, and (b) at least 80% of the personal
tangible property is sold to registered resellers that have reseller
certificates or certificates of exemption.
A registered wholesaler can also apply for the collection waiver if the following requirements are met:
- During the period of 3 years, or applicable period, before filing the application at least 90% of the personal tangible property has been acquired from local manufacturers or imported by the wholesaler as importer of record.
- During the period of 3 years, or applicable period, before filing the application at least 80% of the personal tangible property is sold to registered resellers that have reseller certificates or
certificates of exemption.
- It conducts wholesale operations using an accounting system that that segregates, details and identifies sales to registered resellers separately from retail sales.
- It files an Agreed upon Procedure report prepared by a CPA duly licensed in Puerto Rico, who is subject to a peer review program, with respect to certain items including (a) and (b) above.
- Reseller exemption – This exemption is repealed for sales made after
August 16, 2013. Accredited resellers can still benefit from this exemption on taxable items for sale that are purchased and paid before
August 16, 2013.
Merchants holding a reseller certificate will be entitled to claim a credit for sales taxes paid on taxable items purchased for sale. The credit cannot exceed 70% of the merchant’s sales tax liability reflected in the corresponding monthly sales and use returns. Any credit in excess of the tax liability may be carried over and used in subsequent returns until exhausted. The Treasury Department can establish credit percentages lower or higher than the 70% for specific industries. The credit will be 100% of the tax paid on taxable items purchased for sale once the merchant has fully complied with certain bank account requirement.
A merchant can be released from its obligation to collect the sales tax on taxable items sold to a holder of an eligible reseller certificate. An eligible reseller is a registered merchant that acquires taxable items primarily for sale to persons that can acquire such taxable items exempt from sales and use taxes or for export. Primarily means that during the preceding 3-year period 80% or more of the merchant’s inventory was withdrawn for sales to persons that acquired such taxable items exempt from sales and use taxes or for export.
- Payment Date for Use Taxes on Imported Taxable Items - Effective July
1, 2014, use taxes on taxable items imported into Puerto Rico by a merchant, other than through the U.S. Postal Service, must be paid before the merchant takes possession of the items. However, in the event of items introduced after June 30, 2014 by a bonded merchant the payment date will be the 10th day of the following month after taking possession of the items. A bonded merchant is a registered merchant that has applied for, and to whom Treasury has approved, the bonded status, and has posted a bond guaranteeing the payment of use taxes.
- Rate Reduction – Subject to the power of the Legislative to postpone the effective date, the municipal tax rate will be reduced to 1.0% (from 1.5%) effective December 1, 2013 for a total combined rate of 6.5%.