Businesses Operating in Puerto Rico Must Consider Pillar Two
Puerto Rico’s unique status as a US territory impacts its decision-making on the OECD’s global minimum tax, known as Pillar Two. If implemented in its proposed form, Pillar Two would impose a tax of at least 15% on all companies with consolidated revenue of at least 750 million euros ($814 million).
If Puerto Rico doesn’t adopt Pillar Two or chooses not to apply it to holders of Act 60 tax benefits, other countries where Puerto Rico-headquartered entities operate could impose tax on what, in effect, is Puerto Rico source income. Businesses concerned that Pillar Two might apply to them should consider whether and how to restructure their businesses to address or avoid its application.
US citizens who are bona fide residents of Puerto Rico are exempt from US tax on their Puerto Rico source income. Puerto Rico’s Act 60 (formerly Acts 20 and 22) provides tax incentives for certain US persons who become bona fide residents of Puerto Rico and earn certain types of income.
Any Puerto Rico adoption of Pillar Two likely would be irrelevant to most Act 60 decree holders. In our experience, few decree holders are participants in global businesses with revenue greater than 750 million euros.
Puerto Rico believes in the Act 60 incentives and has maintained—and even expanded—them in the face of stiff political headwinds. An influx of businesses, investors, and residents from the US has led to approximately 33,000 newly created jobs on the island.
Against this backdrop, it seems unlikely that the Puerto Rican government would wish to apply the Pillar Two minimum tax to Act 60 decree holders. Even if Puerto Rico were inclined to do so, it may not be possible to alter existing decrees. Act 60 describes the decree as “a contract between the Government of Puerto Rico, the exempt business, and its shareholders.” If Puerto Rico adopts Pillar Two, decree holders could be protected as a matter of contract law.
Businesses may want to consider strategies such as changing transactional flows to reduce booked revenue, moving their headquarters to the US, and operating through unrelated parties in jurisdictions beyond the US and Puerto Rico.
The goal of reducing revenue would be to fall out of scope (below 750 million euros in global revenue). Reducing revenue could be achieved by restructuring buy-sell arrangements to commissionaire arrangements. Instead of booking product sales, the business could be paid a commission on product sales, materially reducing top-line revenue without materially changing functions.
A second approach to reducing revenue would be simply to sell part of the business to unrelated persons.
Re-headquartering to the US would ensure a 15% effective tax rate applies both globally and at the parent level. A US holding parentship might be formed to own both operations, causing the US to be viewed as the headquarters jurisdiction.
Depending on the circumstances, some functions (and the associated profits) might be shifted to the US from Puerto Rico to achieve a combined tax rate of at least 15%. The benefits of Act 60 would be lessened, but not eliminated. The business would need to ensure that the shift of headquarters and operations to the US doesn’t produce unintended Puerto Rico “exit” taxes.
Operating through unrelated parties in jurisdictions other than the US and Puerto Rico might be the most effective way to preserve benefits. The approach here is simple if not easy—avoid conducting operations outside of Puerto Rico and the US.
Each business is different and might require a different approach. Some Puerto Rico-based businesses will be too large to avoid application of Pillar Two; others might be small enough to avoid any immediate application.
Even for smaller businesses, it seems necessary to gain an understanding of how Pillar Two operates and how it may affect tax rates in the future. Pillar Two—or something like it—is coming, and experience suggests that smaller companies will eventually be subject to its rules.
