Puerto Rico is a United States possession in the Caribbean Sea. Its political situation was unfamiliar for many U.S. citizens on the mainland until September 2017 when hurricanes Maria and Irma lashed the small island. The natural disaster and related aftermath caused by the storms emphasized the need of investment in the infrastructure and affordable and secure housing that the several years’ long economic crisis had left unattended.

While those born on the Island are U.S. citizens, for several provisions of United States law the Island is treated as a foreign country. For example, entities organized under the laws of Puerto Rico are considered foreign entities for United States federal income taxes, while Puerto Rico born U.S. citizens are considered nonresident aliens for U.S. estate and gift tax purposes. These complicated circumstances support the matchless position Puerto Rico has when investors are looking for alternatives for their next investment.

HOW ARE OZs IN PUERTO RICO DESIGNATED?

While states and other possessions were able to propose for designation as OZs up to 25% of their low-income census tracts, Puerto Rico, by disposition of law, was granted designation for 100% of its low-income census tracts. [1] Pursuant to this, Puerto Rico has over 800 designated OZs. Therefore, almost 100% of the island qualifies for OZ investments.

And even though the law requires that a Qualified Opportunity Fund (QOF) and the corporations and partnerships in which the QOF invests must be domestic entities, the term “domestic” when applied to a corporation or partnership means created or organized in the United States or under the law of the United States or of any state unless, in the case of a partnership, the Secretary provides otherwise by regulations, [2] and as explained above, entities organized in Puerto Rico are foreign for U.S. tax purposes. The first set of proposed regulations issued in October 2018 established an exception based on where the QOF and the invested in entities are organized: [3]

• A QOF organized in a possession and not in one of the 50 States or DC will be considered domestic only it is organized for the investment in qualified opportunity zone property that relate to a trade or business operated in the possession in which it is organized.

• If an entity is organized in a possession but not in one of the 50 states or DC, it will satisfy the domestic requirement if it only conducts a qualified opportunity zone business in the possession it was organized. [4]

For these purposes, a possession is defined as any jurisdiction other than the 50 states and DC where a designated qualified OZ exists. [6] Consequently, QOFs and entities organized in Puerto Rico are eligible to participate in the OZ program.[5]

A STRONG TAX INCENTIVES PROGRAM

For many decades, Puerto Rico’s robust and well-established set of tax incentives programs, has attracted the establishment of businesses in several industries like manufacturing, tourism, research and development, and services, to mention a few. On July 1, 2019, all these incentives laws were collected in a single document known as the “Puerto Rico Incentives Code.”[7] The different incentives were grouped by the economy segments or industries they target: individuals; export of goods and services; financial and insurance services; visitors’ economy; manufacturing (including R&D); infrastructure (green energy and housing); agriculture; creative industries; entrepreneurship; and priority projects in OZs.

In general, an eligible business (certain businesses like PYMES, Priority Projects and agricultural may enjoy different rates) will benefit of a flat 4% income tax rate on qualified income, 50% exemption on municipal license taxes, 75% exemption on real and personal property taxes, and distributions made by the eligible business are 100% exempt of Puerto Rico income taxes (see further below for the specific benefits applicable to priority projects.) The benefits are formalized by entering into a contract type of agreement with the government of Puerto Rico and substantiated by a 15-year grant that may be extended for 15 additional years.

In addition, and depending on the industry, the business and or its investors may obtain an investment tax credit that they may use against their tax liability or may sell or transfer. Examples of the investment tax credits are those granted to priority projects, tourism projects and film projects. The credits, in general are not reimbursable but may be sold, ceded or transferred. When sold, the proceeds are not taxable to the seller and the discount on the sales price is not taxable to the buyer.

THE CBDG-DR FUNDS

The Second Amendment to the Puerto Rico Disaster Recovery Action Plan for the use of CBDG-DR funds in response to 2017 hurricanes Irma and Maria, with effective date of Aug. 23, 2019, [8] shows that the estimated amount of funds to be received by Puerto Rico for the recovery efforts is $19.9 billion. Around $9.2 billion have been already allocated to Puerto Rico with 42% directed to housing. The plan details that the expected deployment of the first $1.5 billion of funds will extend until year 2025. [9] These funds will be administered by the Puerto Rico Department of Housing in close collaboration with the Central Office of Recovery, Reconstruction and Resilience [10] and allocated to 27 programs [11] in the following sectors:

• Planning

• Housing: home repair, reconstruction, or relocation, social interest housing, rental assistance, among others

• Economic recovery: small businesses programs, workforce training, businesses loans among others

• Infrastructure: FEMA coordination, critical infrastructure resilience, community resilience centers

• Multi sector: city revitalization program and Puerto Rico by Design

THE PUERTO RICO OZs DEVELOPMENT FRAMEWORK

The action plan acknowledges that the OZ program provides “a viable means to leverage federal funding to help facilitate recovery and economic development, as permitted.”[12] Also, the action plan recognizes that the OZs “represent a critical opportunity in the rebirth and revitalization of the Island…” Consistent with the applicable requirements, such support could range from discrete, stand-alone projects to broader facilitation of economic development initiatives, including job creation, blight removal, and infrastructure initiatives.”[13]

In order to effectively compete for the investment funds to be generated by the OZ program in the United States and to provide similar benefits to local investors that are not subject to federal income tax on their capital gains, the Puerto Rico legislature approved and the Governor signed into law, Act 21 of May 14, 2019. The provisions of Act 21 were later incorporated into the Puerto Rico Incentives Code previously discussed. Act 21 provides the following:

• conforming provisions to Sections 1400Z-1 and 1400Z-2,

• a new incentive program for priority projects that do not qualify for any other tax incentive program, and

• an expedite permit process for priority projects.

 

A seven-member committee is required to publish the list of projects that will be considered priority projects. The initial list was issued on Aug. 21, 2019 and included four activities which basically involve the development of residential, commercial and industrial real property for sale or rent. It is expected that additional activities will be incorporated to the list during the coming months. An eligible business may request a tax incentive grant that will include the following benefits:

• flat income tax rate of 18.5%

• a minimum 25% exemption on municipal taxes

• a minimum of 25% exemption on real and personal property tax

• 100% exemption on dividend distributions

• a minimum guaranteed 5% investment tax credit, which may be increased up to 25% of the eligible investment

It is no surprise that almost 50% of the first allocation of CBDG-DR funds is assigned to home repair, reconstruction and relocation and that the development of low-income housing and residential property for sale or rent is included as an eligible activity that qualifies as a priority project. According to the “State of the Housing Industry in Puerto Rico” published by the Puerto Rico Builders Association on March 28, 2018, Puerto Rico has a great need of housing, especially on the low- and moderate-income levels of the population due to accessibility or inadequate and overcrowded residences. The CBDG-DR funds provide the opportunity to remedy part of the safe and formal housing need in Puerto Rico produced by the high cost associated with it. [14] According to the report, since 2010 the amount of owners of houses has decreased while the amount of rented properties has increased in average 8,600 per year. This is mostly because the income levels of an increasing part of the population is not enough to qualify for a mortgage. Therefore, the rental of housing market, which has not been traditional in Puerto Rico, represents a great opportunity to contribute to the solution of the housing crisis.

 

PROMOTING ECONOMIC DEVELOPMENT

Puerto Rico finds itself today in a once in a lifetime position which it must capitalize on in order to promote the economic development needed to attract those who have left the Island and retain those that still live there. All the programs described above along with Puerto Rico’s skillful people, geographical position and natural resources are the motors that will initiate and promote the growth and the change. All this delivers OZ investors with the chance of obtaining unsurpassed tax benefits when combining the federal and local programs, while making impact in the reconstruction and revitalization of Puerto Rico. The combination of public investment, via the CBDG-DR funds and the incentive programs, with private investment through OZs and other programs, will generate returns on investment not comparable to any other place in the United States.

Notes:

[1] 26 U.S. Code § 1400Z–1(b)(3)

[2] 26 U.S. Code § 7701(a)(4) – The term “domestic”

[3] Section 1.1400Z-2(d)-1(e)

[4] Section 1.1400Z-2(d)-1(e)(1)

[5] Section 1.1400Z-2(d)-1(e)(2)

[6] Section 1.1400Z-2(d)-1(e)(3)

[7] Act 60 of July 1, 2019

[8] https://www.cdbg-dr.pr.gov/wp-content/uploads/2019/08/PRDOH_AmendmentTwo_Non-SubstantialAmendment_EFFECTIVE082319.pdf

[9] https://www.cdbg-dr.pr.gov/en/budget/

[10] https://www.cdbg-dr.pr.gov/wp-content/uploads/2019/08/PRDOH_AmendmentTwo_Non-SubstantialAmendment_EFFECTIVE082319.pdf

[11] https://www.cdbg-dr.pr.gov/en/programs/

[12] https://www.cdbg-dr.pr.gov/wp-content/uploads/2019/08/PRDOH_AmendmentTwo_Non-SubstantialAmendment_EFFECTIVE082319.pdf

[13] Idem

[14] “Situación de la Industria de la Vivienda en Puerto Rico”, Asociación de Constructores de Puerto Rico, 28 de marzo de 2018