The Act 22 - Individual Investors Act seeks to attract new residents to Puerto Rico
Act 22 is an economic development program. While almost all other economic development programs focus on incentives for businesses, this program is designed for individuals that relocate to the Commonwealth of Puerto Rico, a U.S. Territory. Act 22 provides a total exemption from Puerto Rico income taxes on all passive income realized or accrued after such individuals become bona fide residents of Puerto Rico. Incoming Act 22 participants has resulted in new local investments in real estate, services and other consumption products, and in capital injections to the Puerto Rico banking sector, all of which accelerate the economy of Puerto Rico. Act 22 complements Act 20 incentives, which are for active income from eligible services, and can be used in tandem by Act 20 participants. Very often, Act 22 is used stand-alone by individual investors that do not participate in Act 20 or other economic development programs.
Below is the description of the Act 22 program as provided by the Puerto Rico Department of Economic Development and Commerce (DDEC).
Act 22 - Individual Investors Act Overview
- PASSIVE INCOME
- EXEMPTION PERIOD
The Individual Investors Act applies to any individual investor that becomes a Puerto Rico resident on or before the taxable year ending on December 31, 2035 (hereinafter referred to as “Resident Individual Investor”), provided that such individual was not a resident of Puerto Rico at any time during the 6-year period preceding the effective date of the Individual Investors Act.
A Puerto Rico resident is an individual who is domiciled in Puerto Rico. Physical presence in Puerto Rico for a period of 183 days during the taxable year will create a presumption of residence in Puerto Rico for tax purposes.
Special Tax Rule under the US Code for Puerto Rico Bona Fide Residents
Pursuant to Section 933 of the Internal Revenue Code of the United States of 1986 (the “US Code”), income derived from sources within Puerto Rico by individuals who are a bona fide residents of Puerto Rico during the entire taxable year is not included in gross income and is exempt from taxation under the US Code. (the “Section 933 Exclusion”).
The term bona fide resident of Puerto Rico means a person who:
(1) is present for at least 183 days during the taxable year in Puerto Rico,
(2) does not have a tax home outside of Puerto Rico during the taxable year; and
(3) does not have a closer connection to the United States or a foreign country than to Puerto Rico.
Interest and Dividend Income
Under the Individual Investors Act, Resident Individual Investors will enjoy a 100% tax exemption from Puerto Rico income taxes on interest and dividend income derived during the Tax Exemption Period (as defined under Exemption Period).
Pursuant to the Section 933 Exclusion, interests and dividends received by Resident Individual Investors that qualify as Puerto Rico source income will not be subject to federal income taxation under the US Code.
Resident Individual Investors may be able to reduce the tax rate applied on interest and dividend income coming from sources outside of Puerto Rico (including the source country taxation) to 0% or 10%, respectively, by investing through certain Puerto Rico investment vehicles.
Long-term capital gains (“LTCG”) derived by Resident Individual Investors for investment appreciation accruing after becoming a Puerto Rico resident will be 100% exempted from Puerto Rico income taxes, if such gain is recognized prior to January 1, 2036.
On the other hand, LTCG derived by Resident Individual Investors will be subject to preferential income tax rates in certain circumstances, as follows:
1) LTCG for investment appreciation that accrued prior to becoming a Puerto Rico resident (the “Non-PR Gain”) will be taxed at: (i) 10%, if such gain is recognized within 10 years after the date residence is established in Puerto Rico and prior to January 1, 2036, and (ii) 5%, if such gain is recognized after said 10-year period but prior to January 1, 2036.
2) A similar rule applies under the US Code with respect to United States Investors, regardless of the Section 933 Exclusion, since any Non-PR Gain recognized within said 10-year period by investors formerly subject to the United States taxing jurisdiction (the “United States Investor”) will be taxed in accordance to the applicable provisions of the US Code. The United States Investor may elect to apportion to Puerto Rico any part of the LTCG related to investment appreciation that accrued after becoming a Puerto Rico resident and, therefore, be entitled to the Section 933 Exclusion for such portion.
3) The United State Investor qualifying as a Resident Individual Investor which recognizes a Non-PR Gain after 10 years of becoming a bona fide Puerto Rico resident would not be subject to federal income taxation on any portion of the Non-PR Gain and to a 5% tax in Puerto Rico. As stated before, any part of a LTCG attributable to the period of Puerto Rico residency would qualify for 0% United States federal income taxation and 0% Puerto Rico income taxation, if recognized prior to January 1, 2036.
Any LTCG for investment appreciation not described above will be taxed in accordance with the applicable provisions of the Puerto Rico Internal Revenue Code of 2011, under which LTCG derived by Puerto Rico residents is subject to a 10% preferential income tax rate.
In light of the above, Resident Individual Investors may be able to reduce the tax rate applied on LTCG in their former domicile to 0%, 5% or a maximum 10%.
Tax Exemption Period
The tax exemption granted under the Individuals Investors Act will expire on December 31, 2035 (the “Tax Exemption Period”).
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