Act 22 – The Individual Investors Act

Act 22 offers individuals a 100% tax exemption on Puerto Rico sourced capital gains, interest and dividend income. Capital Gains are typically sourced to the residence of the taxpayer, however different treatment applies to property (real estate) where the income is sourced to the location of the property. Interest and Dividends are sourced differently, so even though these may be tax exempt in PR, you may still be subject to US taxation on these types of income. Interest is generally sourced to the location of the payor, while dividends are sourced to the domicile of the issuing corporation.

Yes, nonetheless it may be difficult to achieve. for such cases we would need to consider the applicability of certain provisions related to liquidating distributions, swaps, and the Portfolio Interest Exception (“PIE”). These may be used to implement structures which modify the Withholding at source requirements or sourcing provisions, in order to effectively source the income to Puerto Rico and to eliminate US taxation. Special treatment to Swap agreements as well as PIE where enacted to attract foreign investment into the US, since PR is treated as a foreign jurisdiction for tax purposes these benefits may be made available under the appropriate structure.
These strategies have been historically used by mutual funds or other institutional investment operations and normally awards a planning opportunity for Hedge Funds or the like looking to take advantage of Acts 20 and 22, nevertheless an individual would not be barred from implementing a similar strategy.

As discussed above, the exclusion is only true for income which is tied to PR sources. That being said, the answer to the question stems from the American Revolution and James Otis’s claim that “There shall be no taxation without representation”. Due to PR’s (and other US possession’s) particular political situation, the lack of delegates with the ability to elect a President and lack of representation in Congress with the ability to vote makes it essentially unconstitutional for the US to impose taxes to possession residents on income from possession sources.

While Act 22 is fairly new, established in 2012, tax incentives programs based on the same federal exclusions have been around for decades in both Puerto Rico and the USVI. Historically, there seems to be no incentive for the US and the IRS to specifically target against these programs. Nevertheless, since PR is treated as a foreign jurisdiction for federal tax purposes, changes in the US code that apply to foreign taxpayers that do not specifically exclude PR or the possessions will directly affect PR taxpayers.
Such was the case with the recent tax reform which did not exclude the possessions from provisions such as the Global Intangible Low Taxed Income (GILTI) tax. If PR were to become a state, this would modify the sourcing rules, however experts in the field see this as a remote possibility. Even if this were to happen, the process could take a decade to complete, and it has been suggested that a transition period would be allowed or required to phase out the incentives programs.

PR’s economy has included tax incentives for decades, Act 22 is the first incentives Act specifically addressing individual investors, nevertheless the principles stem from the same sources as its predecessors in taking advantage of PR’s unique political and taxation reality from a US perspective. Since its enactment, Act 22 has been amended and slightly modified on several occasions by different administrations. Amendments have included changes in compliance, the application process, and fees, as well as the recent requirement establishing a minimum charitable contribution to a PR Non-Profit Organization.
Nevertheless, the essence of the Act remains unaltered. More importantly, since each Act 22 Grant is a contract with the government it may not be unilaterally amended by PR, hence benefits and requirements set by your grant should remain consistent throughout the life of the grant (expiring on December 31st, 2035).

Establishing Bona Fide Residency in Puerto Rico
To avail from such benefits, once you relocate to PR, you will have to evaluate your circumstances in order to be certain that you comply with the IRC criteria related to the determination for being considered a PR resident. In order to be treated as a bona fide PR resident as defined in Section 937 of the IRC, an individual must comply with the Physical Presence Test, Tax Home Test, and Closer Connection Tests. If any of these tests are not met, the individual will not be considered a bona fide resident of PR and will be subject to U.S. taxation on PR sourced income.
The Presence Test can be met by complying with any one of the following options (note that these alternatives are listed as “or” – only one of them need be met in each taxable year:

1. being present in PR for at least 183 days during a tax year;
2. being present in PR for at least 549 days during the three-year period consisting of the taxable year and the two immediately preceding taxable years (in other words, an average of 183 days during a three-year period) in which the individual was present at least 60 days each year, it is important to note that this test includes a look back period so it may not be applied for the first year but rather may be used on or after the third year of presence in the island;
3. not being present in the U.S. for more than 90 days during the tax year (there is no minimum day requirement in PR under this alternative;
4. not earning income over $3,000 from sources within the U.S.; or,
5. having no significant connection to the U.S
   In order to have no significant connection to the U.S. the individual:
   1. Must not have a permanent home in the U.S
   2. Must not be registered to vote in any political subdivision of the U.S
   3. Must not have a spouse or child who has not attained the age of 18, whose principal home is in the U.S

1. The location of the individual's permanent home (determined in the same manner as under the presence test discussed previously);
2. The location of the individual's family;
3. The location of personal belongings, such as auto-mobiles, furniture, clothing, and jewelry owned by the individual and his family;
4. The location of social, political, cultural, or religious organizations with which the individual has a current relationship;
5. The location where the individual conducts his routine personal banking activities;
6. The location where the individual conducts business activities (other than those that constitute the individual's tax home);
7. The location of the jurisdiction in which the individual holds a driver's license;
8. The location of the jurisdiction in which the individual votes;
9. The country of residence designated by the individual on forms and documents;
10. The location where the individual holds insurance;

The tests above are established in the US Treasury regulations. A couple years back we were able to review guidance issued to IRS Auditors on matters relating to confirming Bona Fide Residency. As of 2017, around 1% of the Act 22 community in PR had been Audited by the IRS. Additionally, we have dealt with residency audits in possessions other than PR but applying the same rules.
Both the audit guidance and the information requests sent by the IRS to the audited individuals allowed us to gain further insight on IRS interpretation and stance on the rules.
A frequent misconception is whether the location of the spouse or children will determine whether or not an individual would qualify as a Bona fide Resident of a Possession. There are several matters to take into consideration in this case; the preambles of the regulations regarding bona fide residency discuss how all elements of the closer connections test will carry the same weight when compared to others; The IRS has issued guidance to its Auditors, clearly stating that a person may be deemed a bona fide resident while the spouse is a resident of a State or elsewhere, this is also sustained by the Fact that IRS form 8898 is required to be filed separately by each spouse.

Yes, you may. Although this would not be a deal-breaker on its own, it may weigh negatively against you in the closer connections test. A good pre-emptive alternative is to have the home leased, available for lease and/or on the market for sale.

No. This requirement was briefly set as part of the law but has since been removed. Nevertheless, for purposes of the IRS, you must have your principal permanent home in PR. This requirement could be fulfilled by a lease, but it is highly suggested that the lease be signed for at least 6 months at a time. There should be no gaps between leases as you will need a permanent home available to you at all times throughout the year.