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The Lowest Effective Corporate
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Recommended Tax Structures
Many companies have established their operations in Puerto Rico as profit centers to take advantage of special tax provisions. The goal is to allocate the maximum share of the revenue stream to the lowest tax jurisdiction in which the company can perform their functions effectively, thereby reducing worldwide taxation and enhancing profitability. It is recommended that companies transfer their intellectual property to the Puerto Rico facility (generally through a royalty agreement, but possibly as an outright purchase), and have the Puerto Rico facility assume the operational risks of inventory obsolescence because the control of these rights and risks is part of what determines the revenue split between headquarters, marketing, R&D, and manufacturing.
U.S. Parent
Under the Controlled Foreign Corporation (“CFC”) structure, the Puerto Rico subsidiary, which will generate a maximum corporate income tax rate of 7% with no withholding tax, may use these profits to fund their foreign operations (including the Puerto Rico operations). In order to avoid or postpone repatriation, the Puerto Rico operation can either invest or make loans to other subsidiaries of the parent company from Puerto Rico. Although the earnings of those investments or loans will be taxed as current income by the U.S. federal tax authorities (“Subpart F Income”), the principal will not be taxed until it is repatriated. However, when the funds are repatriated, the company will receive a foreign tax credit for the taxes paid in Puerto Rico.
Another alternative for the use of these funds is to invest in the company’s R&D. The company can perform the R&D in the U.S. mainland or anywhere else; but it is the Puerto Rico operation, which owns and funds the R&D. By investing from Puerto Rico the company will be generating its future tax stream at the lowest tax jurisdiction, i.e. Puerto Rico.
European Union Parent
Under the European parent model, the European Union (“EU”) parent has an affiliate in the Netherlands who in turn owns the Puerto Rico corporation. The profits generated by the Puerto Rico operation can be transferred tax free to the Netherlands based affiliate, since the Netherlands does not tax previously taxed income. Furthermore, the Netherlands based affiliate can dividend the profits anywhere in the EU without being further taxed, because the EU member countries do not tax dividends from other EU member countries. The net result is a total tax payment of 7% or less.
Other Non U.S. Parent
Non-US firms can generally benefit even more than domestic firms, as there are more tax-advantaged structures through which to retain profits even after repatriation from the Puerto Rico operation.
