Tax residence and fiscal domicilei Corporate residence
Corporate residence is based on the place of incorporation, and not on where corporations are managed or controlled. Under the PRIRC, foreign corporations are deemed those not organised under the laws of Puerto Rico.
The PRIRC does not define the term 'engaged in trade or business'. However, the Regulations issued pursuant to the Puerto Rico Internal Revenue Code of 1994 provide that said term includes the rendering of services in Puerto Rico at any time during the taxable year, and does not include transactions in shares of stock, securities or exchange commodities through a resident broker, resident agent or resident custodian. It should be noted that the definition of 'engaged in trade or business' of the courts of the United States is used consistently by the Puerto Rico Department of the Treasury.
Any partner of a partnership engaged in trade or business in Puerto Rico shall be deemed engaged in a trade or business in Puerto Rico with respect to his or her distributive share of the partnership's income, gains, losses, deductions and credits.ii Branch or permanent establishment
As previously mentioned, foreign investors may conduct business in Puerto Rico through foreign or domestic entities. If they decided to conduct their business by establishing a branch in Puerto Rico, they may be subject to a branch profit tax (BPT).
A foreign corporation that derives less than 80 per cent of its gross income from sources within Puerto Rico and from income effectively connected to its trade or business in Puerto Rico, is subject to a BPT of 10 per cent of the dividend equivalent amount for the taxable year. This tax is imposed on the amount of earnings and profits not reinvested in activities in Puerto Rico. Net equity is equal to the excess of the basis of Puerto Rico assets owned by the foreign branch that are treated as effectively connected to its trade or business in Puerto Rico over the liabilities of the Puerto Rico branch effectively connected to its trade or business in Puerto Rico.
The dividend equivalent amount is equal to the earnings and profits of the foreign branch derived from the effectively connected income relating to the trade or business in Puerto Rico reduced, but not below zero, by the increase in Puerto Rico net equity, and increased by the reduction in Puerto Rico net equity. The increases and decreases are determined by comparing the Puerto Rico net equity at the beginning of the year with the Puerto Rico net equity at the end of the year.
To determine earnings and profits relating to ECI, the dividends distributed by a foreign corporation operating as a branch-out of earnings derived from sources within Puerto Rico are not taken into account. However, said earnings and profits include the excess of the accelerated depreciation deduction over the amount of the depreciation deduction that would result from application of the straight-line method, and certain interest excluded from gross income. Earnings and profits are reduced by the Puerto Rico income tax paid with respect to that year, excluding the BPT for the year, and business-related meals and entertainment expenses that were not deducted owing to the statutory limitation.
It is more advantageous to operate a subsidiary than a branch. First, the 10 per cent dividend tax is applied only when dividends are actually paid, while the BPT (when applicable) is automatically applied. Second, in the case of a subsidiary, the assets of the parent will generally not be exposed to possible claims originating from activities in Puerto Rico.