Tax Incentive Programs in the Caribbean

By: Greg Bryant, CPA/Attorney

Imagine, if you will, you live in California or New York City where your income tax rate is over 40% (federal and state). However, imagine then that you could move to another state, keep your US citizenship, and lower your tax rate to under 4% (federal and state). Would that be interesting?  Well, here is how you can do it.

The United States territories offer special tax regimes designed to galvanize economic development, and to allow the territories to compete with neighboring nation islands that have no income taxes. There are 16 US territories, and these include Puerto Rico, US Virgin Islands, Guam, American Samoa and outlying islands Bajo Nuevo Bank, Baker Island, Howland Island, Jarvis Island, Johnston Atoll, Kingman Reef, Midway Islands, Navassa Island and Palmyra Atoll.

In this article, we are going to focus on the US Virgin Islands (“USVI”), with comparison to Puerto Rico. 

There is empowering law that allows Puerto Rico and the US Virgin Islands[1] to create special tax regimes for (1) its residents (2) whose resident business (3) has income “sourced” or “effectively connected” to the territory. The law does not allow the territory resident business to base erode the US treasury, only the territory’s treasury. There are 3 tax incentive regimes to review, Act 60 in Puerto Rico and the Economic Development Commission and RT Park regimes in the US Virgin Islands.

Puerto Rico

Puerto Rico is a much larger island than the USVI, and has a population of over 3 million, compared to the USVI population of approximately 90,000.  Puerto Rico has its own culture and is a much more urban, metropolitan lifestyle by comparison to the USVI. 

Puerto Rico has its own tax law.  It is not a mirror system like the USVI.[2] Today, their tax incentive program is under Act 60.[3]  Prior to 2019, it was governed under the rules of Act 20 and Act 21, but these were combined into Act 60.[4]

Puerto Rico has several tax incentive regimes:

– Act 27 – Film Industry
– Act 60 – Service based businesses
– Act 73 – Manufacturing (largely food processing)
– Act 273 – Financial Services (large capital requirements)

In this article we are focusing on the incentives available to businesses and individuals, and only referring in passing to the special incentives for the film and pharmaceutical industries. 

In July 2019, to be effective January 2020, Act 20 was repealed and replaced with Act 60 Export Services, which also incorporates Puerto Rico Act 22. This Act is intended to entice high-net-worth individuals and businesses to Puerto Rico. Read on for a better understanding about Act 60 and how individuals or businesses contemplating a transfer to Puerto Rico can benefit from doing so.

What is Act 60?
In short, Act 60 is a bundle of tax incentives for high-net-worth individuals and companies with operations in Puerto Rico. The goal of Act 60 is to promote investment to improve the Puerto Rican economy. To achieve this goal, investors are provided with magnificent tax incentives. In other words, Act 60 was designed to bolster Puerto Rico’s development via outside investment sources.

Act 60 for Individuals
Individuals who reside in Puerto Rico and make passive income do not have to pay federal or state taxes on that income. That’s because it becomes Puerto Rican sourced income. Section 933 of the Internal Revenue Service Code states, “bona fide residents of PR that have PR-sourced income are exempt from U.S. taxation.”

What is Passive Income?
Passive income is that which an individual is not actively involved in generating revenue. For example, savings, cash back rewards, and rental properties (if you aren’t a real estate agent).

How can I qualify?
To qualify as a resident of Puerto Rico, you must spend a minimum of 183 days per year there.

What are eligible businesses?
There are various eligible businesses under Act 60. Some of those are:

– Call centers
– Computer software development firms
– Business consulting services
– Advertising and PR firms
– Research and development firms
– Laboratory services
– Data processing centers
– Investment banking businesses

There are additional businesses that qualify. Puerto Rico has greatly broadened the list of qualifying services and activities, but like the incentive programs in the other territories, the company and its owner(s) must be resident in Puerto Rico. Tax incentives must be limited to residents, whose business has income sourced to the territory. 

Benefits
For individuals who qualify for an Act 60 decree, the benefits are:

– A 4 percent income tax rate;
– A 75 percent discount on property tax; and
– Zero tax on capital gains accrued while on the island.

Act 60 for Businesses
Under Act 60, eligible businesses in Puerto Rico that generate revenue from customers outside Puerto Rico can benefit from the following advantages for income generated:

– A corporate tax rate of 4 percent;
– A 50 percent tax exemption for the municipality;
– A 75 percent tax exemption from local and state property taxes;
– A tax exemption from taxes equal to 100 percent on all distributions from earnings and profits; and
– A tax exemption equal to 100 percent of income for the first five years for qualifying small and medium businesses.

Note that the product a business produces must be manufactured on Puerto Rican soil.

Like the USVI rules, Act 60 requires the beneficiary of the tax incentives to be resident in Puerto Rico. This is a threshold requirement of both programs. Only residents benefit. Second, the program benefits certain businesses and in general all revenue eligible for benefits must be from markets outside Puerto Rico. So, keeping a marketing presence in the major markets has to be maintained to drive revenue to Puerto Rico.

US Virgin Islands

The US Virgin Islands has two different regimes, one is run by the government (the EDC program) and the other is independent and connected to the University of the Virgin Islands (the RT Park program). Each program comes with its own requirements. 

Both the EDC and RT Park programs offer the same benefits. The headliner is the 90% tax credit (it is actually a deduction that acts like a credit). Although in our experience, companies come for the tax rate but stay because they fall in love with the people. Here is the rundown:

– 90% credit in corporate income tax on qualifying income (with VI surtax that makes a tax rate of 2.3%)
– 90% credit in personal income tax on qualifying income (that makes top income rate 3.7%)
– 100% exemption on gross receipts tax
– 100% exemption on business property tax
– 100% exemption on excise tax payments
– Exemption from withholding tax for interest payments and 4 % withholding rate on dividends to individual recipients (and 4.4 %
withholding on payments to corporate recipients).
– Reduction in the customs duty from the standard 6% to 1%
– Availability of rental space at below-market rates in the St. Croix and St. Thomas Industrial Parks

Economic Development Commission – EDC
The EDC program is run by the US Virgin Island Economic Development Authority (“EDA”) and is a government administered program.  It is focused on investments that will create jobs for the local population. Approved Industries/Business are listed as:

– Legacy Industries – dairy, rum, jewelry (Captain Morgan is in the program, for example);
– Product Assembly, Manufacturing, Repair and Maintenance (other than historic industries);
– Facilities, Tourism and Communications Developments – including hotels, healthcare, recreation and utilities;
– Designated Service Businesses (serving clients outside the USVI); and
– International Financial Services Entities (in connection with the Division of Banking, Insurance and Financial Regulation).

The “Designated Service Business” category offers a path to many kinds of businesses, especially where so many services can be delivered digitally.

RT Park
The RT Park program is connected to the University of the Virgin Islands. That means the UVI is providing a lot of resources in addition to great tax breaks, such as its Entrepreneur program, the Incubator program, UVI facilities and student interns, and the community of RT Park tenants (companies in the program are called “tenants”, which as of the date of this article is approximately 80 companies), and the talented RT Park staff who will all contribute to helping your company succeed. These are important intangibles you can only get from the RT Park program.

For this reason, the RT Park program is focused on technology and knowledge-based businesses such as:

– Financial Services & Technology
– Healthcare and Medical Services and Technology
– Sustainable Solutions
– Internet Advertising & E-Commerce
– Specialized Software Development
– Consulting and Investment Services
– Telecommunications/Infrastructure

It is not unusual for companies to qualify under both programs. This is very true for service-based companies that have all their clients off-island. 

A company can apply to either program directly. The RT Park has a very responsive and supportive team to assist applicants. The EDC program, by comparison, is government run and not quite as user friendly.  In either case, it is recommended to get a local attorney to assist in the application process. There are good attorneys on St Thomas and St Croix. 

The USVI uses a mirror system of taxation known as the “mirror code.” Under the mirror code, all the US tax laws are mirrored to the USVI. The US Congress has granted USVI the authority to allow a lowered tax rate to bona fide residents of the USVI.  Any income related to a USVI business is also taxed at a lower rate.

USVI bona fide residents file one Form 1040 with the Virgin Islands Bureau of Internal Revenue (“BIR”), regardless of source of income, and they do not ever file Form 1040 with the IRS.  In Puerto Rico, residents have separate filings.

The USVI is foreign to the United States for corporate tax purposes, so the rules for Controlled Foreign Corporations, Passive Foreign Investment Companies and Foreign Personal Holding Companies, and Global Intangible Low-Taxed Income apply.

USVI corporations file Form 1120 with the Bureau of Internal Revenue (“BIR”) and foreign corporations (including U.S. corporations) file Form 1120F with the BIR.  A USVI corporation doing business in the United States may also have a requirement to file Form 1120-F with the IRS. 

A question we hear frequently is “can I grow the company through acquisitions and bring the acquired company into my company’s program?” The answer is “yes, if the acquisition is consistent with your core business, and expands its product line, service, customer base, know-how, and in general revenue.” Growth can come from two paths, organic or acquisition. The RT Park does not tell companies which path to follow. Growth by acquisition is not the same as venture capital investing in that it must be consistent with the company’s business model. 

These amazing benefits are only available to residents. 

Who is a resident?
Bona fide residents of U.S. possessions must satisfy 3 tests: 

– Physical Presence Test, and
– Tax Home Test; and
– Closer Connection Test.                  

There are five alternative ways that a person can meet the physical presence component of the bona fide residency test for U.S. possessions:

– A person is present in a possession for at least 183 days during a tax year (with any part of a day spent in the USVI counting as a USVI day. For example, a person flying from the USVI to Miami on a Saturday morning and back on a Sunday night has not left the USVI for “day counting” purposes). 

– Special 30-day rule applies: can be outside USVI but not in the United States (50 states plus DC) 30 of the 183 days subject to certain requirements.A person spends no more than 90 days in the United States during the tax year.A person has no significant connection to the United States during the tax year (meaning no home available for full-time use, spouse or minor children, and voter’s registration).A person has no more than $3,000 of earned income from U.S. sources and is present for more days in the territory than in the United States during the tax year.

– A person is present in the possession for a simple, non-weighted 3-year average of 183 days per year (or 549 days for 3 years starting in the 3^rd year of residency), provided that a minimum of 60 days of presence is met in each of those 3 years.

There are many ways to meet the residency test, and special circumstances can impact the counting of days. 

Lastly, after having a (1) resident business, (2) that has a business model that qualifies for the program’s incentives, (3) the income must also be “sourced” to the territory, or “effectively connected” to the territory.  What does income “sourced” or “effectively connected” mean?

Specific rules, from the Internal Revenue Code, dictate the “sourcing” of income and expenses to determine what is US “sourced” and what is not.  We find that getting the business model right, and the invoicing correct, can be vital.  For example, if a USVI company makes loans to borrowers in the US, all that income would be “sourced” to the US, where the borrower is, not to the USVI where the lender is.  This is a specific rule.  The same goes for royalties and rent: they are sourced to where the property is, not to where the licensor or owner is.  So, getting your business model right is very important.

The following table provides a good overview: 

Subject	Notes
Services – Where performed	Services are ”sourced” to where they are performed.  This is the least complex, and controversial method, but not all business models are service models.   If services are performed in and out of the USVI they must be apportioned
Inventory sold – normal course of business – Where title passes	If yes, then that income is considered “sourced” in the Virgin Islands. Income received from the sale of purchased inventory in other locations will be considered sourced where sold.
Items produced/Manufactured – Where produced / made	If yes, then that income is considered “sourced” in the Virgin Islands as the sale of inventory which a business is produced is considered sourced where produced. Allocation may be necessary.
Sales of other property – Where seller resides	Sourced to location of seller.
Interest income (unless ECI) – Where Borrower is (not lender)	Sourced to where the borrower is located.
Rental Income (unless ECI) – Where property / renter is	Sourced to where the property is being used.  Not a good model for sourcing to the islands if you are renting on the mainland.
Royalties: Patents, copyrights, etc. (unless ECI) – Where property is being used	Sourced to where the intangible property is being used.  Not a good model for sourcing to the islands if you are renting on the mainland.

Closing thoughts

There are significant benefits available if you have the right business model and are interested in having a low tax rate and to live in paradise.  But paradise, comes with its challenges.

You need to have a way to market to the continental US and other markets, outside the USVI, from the USVI. This means your business already has a well-established brand, and channels to market or you have other infrastructure in markets outside the USVI that will drive revenue to your business. We have found that this factor can greatly narrow the class of companies that can succeed remotely.  Nonetheless, internet marketing consultants, tele-medicine, high end consulting, data processing and many other businesses will be successful. It also makes it challenging for start-ups to launch from a remote location. 

Among the many other factors to consider in making a move to the Caribbean, the major lifestyle change. We have found, however, that people come for the tax rate and fall in love with the lifestyle. For example, while speaking at a conference in St Thomas in June 2024, I spoke with many people who said things like this “I have more friends here after one year, than I did after 9 years in California”; “We have a great network of friends and we get together a lot.” After only a few days, people you’ve never met will greet you by name.  And, if you have the right business, and are ready to make the change, you get a tax rate of 4% or less.

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[2] “Internal Revenue Code for a New Puerto Rico” or “Puerto Rico Internal Revenue Code of 2011”.  https://bvirtualogp.pr.gov/ogp/Bvirtual/leyesreferencia/PDF/2-ingles/1-2011.pdf
[3] https://bvirtualogp.pr.gov/ogp/Bvirtual/leyesreferencia/PDF/2-ingles/0060-2019.pdf
[4] Ibid