Caplin & Drysdale Law Firm

Further to our alert below, the government of Puerto Rico has indicated that it does not intend to enact Pillar 2 rules that override existing tax decrees: “Angel Pantoja-Rodríguez, assistant secretary of internal revenue and tax policy at Puerto Rico's Treasury Department, said that . . . the government will not override [tax decrees with MNE groups]” because . . .[t]hese tax decrees ‘are essentially a contract between the government and the taxpayers,’ [and] . . . there’s a constitutional protection on [them].” Puerto Rico Will Not Override Tax Decrees with Pillar 2, Sarah Paez, Tax Notes International (Nov. 4, 2024).

The article refers only to tax decrees held by multinational corporations, which likely reflects that Pillar 2 applies (currently) only to companies with global revenues in excess of €750 million. While it seems likely to us that the same protections should apply for decrees held by individuals, interested parties should consult Puerto Rico counsel for confirmation.

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The Organization for Economic Cooperation and Development (OECD), of which the United States is a member, has proposed a 15% minimum global tax on business income. Over 140 countries have agreed to implement some form of the proposal (referred to as “Pillar II”). While the United States has agreed in principle to adopt Pillar II, it has not taken steps to do so and likely cannot do so for some years. Puerto Rico has gone further. It has agreed in principle to adopt Pillar II, has formed a commission and solicited applications from outside advisors on how best to implement Pillar II. If Puerto Rico implements Pillar II in its proposed form, it will impose a tax of at least 15% on all companies with consolidated revenues of €750 million and above.

U.S. citizens who are bona fide residents of Puerto Rico are exempt from U.S. tax on their Puerto Rico source income. If they hold an Act 60/20/22 Decree, they also pay low or no tax on certain Puerto Rico source income. What will happen to these decrees if Puerto Rico adopts Pillar II?

Our view is that any Puerto Rico adoption of Pillar II will be irrelevant to the vast majority of decree holders. While at least one country (Kuwait) intends to adopt a version of Pillar II that applies to companies with revenues well below €750 million, Puerto Rico is unlikely to follow suit. Puerto Rico believes in the Act 60 incentives and has maintained them in the face of stiff political headwinds. The incentives attract businesses, investors, and residents from the United States and stimulate the local economy. It seems unlikely that they would wish to apply the Pillar II minimum tax to Act 60/20/22 Decree holders.

Decree holders with global revenues in excess of €750 million should consult immediately with counsel about how certain permitted transition rules may apply to their business and how best to structure their operations going forward. Even if Puerto Rico ultimately decides not to adopt Pillar II, the OECD proposal allows any country where the taxpayer has operations to impose a top up tax to ensure that the taxpayer faces a global effective tax rate of at least 15%. In other words, if Puerto Rico fails to pass some version of Pillar II, some other taxing jurisdiction (perhaps eventually including the United States) may be able to claim the tax revenue that a Puerto Rico version of Pillar II would have raised.

Caplin & Drysdale has experience working with Act 60/20/22 decree holders on their U.S. income tax obligations. We understand how Pillar II operates and the possibilities allowed by its transition rules. Please contact the undersigned if you need assistance with these issues.