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Tax Reform - Restated House Bill 2193

The House of Representatives filed on June 20, 2006 a Restated House Bill 2193, which substantially amends the original version filed last year. The Restated Bill was approved by the House of Representatives the next day and by the Senate (with no amendments) on June 25.  It replaces the general excise tax of 6.6% by a sales and use tax of 5.5% , as discussed below, and will make minor changes to the individual income taxes. None of the proposals of the Governor in the corporate income tax area were included in the Restated Bill.  Nevertheless, it is expected that the Governor will sign the bill into law as soon as he receives the bill from the Legislature.

The following summarizes the most important aspects of the Restated Bill approved on June 25 by the Senate:

Sales Taxes

Taxable items

Tangible personal property, taxable services, admission rights and combined transactions will be considered "taxable items" and will be subject to the sales and use tax, with a number of exceptions.

Tangible personal property

All personal property, including software and prepaid calling cards are considered tangible personal property.  The term excludes cash, stocks, bonds, notes, promissory notes, mortgage notes, insurance, securities or other obligations.  Water supplied by PRASA and electricity generated by PREPA or other cogenerator are also excluded.

Taxable services

The term "taxable services" includes storage or personal property (other than vehicles and food), leases, computer configuration ("programación"), installation and repairs of tangible personal property.

Services provided to businesses

Services rendered to persons engaged in a trade or business or for the production of income are excluded from the definition of the term "taxable services". Section 2301(pp)(2)(A).

Services provided by government

Services rendered by the Commonwealth of Puerto Rico will not be subject to sales tax.

Designated professional services

The following professional services will not be subject to the sales tax: legal services, architects, CPAs, real estate brokers and sellers, appraisers, geologists, agronomists, engineering and surveyors.

Other excluded services

Educational services (and tuition), health services, hospital services, interest and finance charges, insurance and services rendered by persons with annual gross income lower than $50,000 will be exempted from sales tax.

Tax rate

The combined sales tax will be 7.0% (5.5% payable to the Secretary of Treasury and 1.5% payable to the municipalities). The bill includes source of income rules to determine where the sale took place. The Governor will be authorized to impose a "special executive sales tax" of up to 1% pursuant to House Bill 2766 if the collections from the special taxes pursuant to the law do not reach $1,000 million dollars to cover the deficit. The executive sales tax can be collected for up to three (3) years from the date of approval of House Bill 2766.

Use tax

Retailers will have to collect the sales and use tax on mail orders or Internet sales. Section 2408.

Municipal Sales tax

As discussed above, municipalities are authorized to charge a sales and use tax of 1.5% with the same taxable base and exemptions as the Commonwealth. The sales will also be subject to the municipal license tax.

Sales price

The term "sales price" includes the total amount of consideration paid in a sale of a taxable item.

Telecommunication services

In general, these services will be subject to sales tax.

Export sales

Sales for use or consumption outside of Puerto Rico will be exempted under Section 2503.  In-transit taxable items (such as property used in a trade show or convention) will be exempted under Section 2504.

Government purchases

Purchases by agencies of the Commonwealth of Puerto Rico and the U.S. Government will be exempted from sales tax.

Jewelry

Sales of jewelry be subject to the 7% sales tax. The 5% sales tax on jewelry under the excise tax provisions of the Internal Revenue Code is repealed. However, the Bill keeps the requirement of a license to sell jewelry.

Commercial leases

Payments of rent for real property used for commercial purposes by a business, including payments for office space, warehouse and parking, will not be subject to the sales tax. Section 2513.

Residential leases

Payments of rent by a tenant to a landlord for property use as the principal residence of the tenant will not be subject to the sales tax.

Food

Unprepared food will be subject to the municipal tax but not the state level sales tax. Prepared food will be subject to both taxes. The term "prepared food" is defined in the Bill.

Return

The retailers will be required to file a return on or before the 20^th day of the month following the month the tax is collected. If the retailer is selling $500,000 or more per year it will have to file the return electronically and deposit the tax by wire transfer. It is not clear whether a separate return will be required to be filed at each municipality. When the merchandise is not delivered in the facilities of the retailer, the sale is deemed to take place at the municipality where it is received by the purchaser.

Business Registration

All businesses must file an application for registration as a merchant for every commercial space they operate. The Secretary will issue a Certificate of Registration. Section 2801.

Record Keeping

Retailers are required to keep all records for a period of six (6) years. Consumers also have to keep receipts for 24 hours or four years for purchases of $1,000 or more.

Existing Contracts

- Personal property - retail sales covered by contracts or bids executed or awarded before October 31, 2006 will not be subject to sales tax;

- Taxable services - these will be subject to sales tax if the services are rendered after October 31, 2006.

Effective Date

The sales tax and use tax (and the repeal of the 6.6% of the excise tax) will be effective on November 15, 2006. The municipal tax (1.5%) will be effective on July 1^st, 2006.

Transition rules

There are no transition rules. Accordingly, an article that paid the 6.6% excise tax could also be subject to sales tax.

Special excise taxes

Vehicles, trucks, fuel, diesel and other products subject to special excise taxes (except liquor) will not be subject to sales taxes.

Amendment to Puerto Rico Act No. 80  (Wrongful Termination Act)

On October 7, 2005, the Governor of Puerto Rico approved Act No. 128, which amended the severance formula established in the Puerto Rico Wrongful Termination Act, Act No. 80 of May 30, 1976 (29 L.P.R.A. §185 (a) et seq.). With this amendment, Act No. 80 now provides for the payment of an enhanced severance based on the amount of years the employee has worked.

Act No. 80 requires employers to have just cause to terminate employees hired for an undetermined period of time. Its purpose is to protect the employees’ rights to keep their job and to discourage all terminations without just cause.

The new severance formula is the following:

(1)  Employees with five (5) years or less of service - two (2) months salary plus an indemnity equivalent to one (1) week per year of service;

(2)     More than five (5) years and up to fifteen (15) years of service - three(3) months salary plus an indemnity equivalent to two (2) weeks per year of service;

(3)     Fifteen (15) years of service or more - six (6) months salary plus an indemnity equivalent to three (3) weeks per year of service.

The compensation will be determined using the highest salary paid to the employee during the three years preceding the date of termination.  The law also expedites the court proceedings to resolve wrongful termination claims and to secure payment bonds. This amendment entered into effect immediately, thus it will apply to all employment terminations that occurred on or after October 7, 2005.

Bar Association Designation

In recognition for his contributions to the profession in tax matters, Orlando has been recently designated by the President of the Puerto Rico Bar Association as a member of the Tax Law Commission.

Increase to Christmas Bonus

On September 29, 2005 Governor Acevedo Vilá approved a piece of legislation to amend the Christmas Bonus Act to increase the bonus of employees in the private sector in three stages.  Every employer that employs more than fifteen employees will be required to pay a bonus to each employee that works seven hundred (700) hours or more during the twelve month period between October 1^st and September 30, according to the following table:

Employers that employ 15 persons or less will be required to pay the following amounts:

    The amount paid should not exceed 15% of the net income of the employer for the 12- month period ending on September 30 of the corresponding year.  As under current law, employers with no earnings may request an exemption to the Secretary of the Department of Labor on or before November 30 and submit a profit and loss statement for the 12- month period ended on September 30, certified by a CPA, that supports the economic condition of the employer.

Commercial Registry

Act No. 159 of August 8, 2002 creates a Business Registry and provides that all businesses in Puerto Rico selling or rendering services in the amount of $50,000 or more per year shall be inscribed in the Registry. The following information should be  considered before submitting the registration to the Administration for Commercial Development (the "Administration").

The Administration issued Circular Letter No. 03-01-001 describing the preliminary guidelines that had to be followed to register a business in the Registry established by Act No. 159 of August 8, 2002 (the "Act"). The Registry was created to maintain an inventory of all businesses and the goods and/or services they provide to the local market, as well as those that have the potential of being exported. It also provides a mechanism for the collection of data that facilitates the study of commercial activity in Puerto Rico.

The registration should be made on or before January 15 of each year following the first year of operations (or the Company can request an extension of time, until April 15, to register). The Circular Letter provides that since 2003 is the first year that the businesses will be doing the registration, the registration fee will be waived and the due date for all businesses to file their applications was July 15, 2003.

Although the Circular Letter states that there will be an administrative fine for those businesses who did not apply by July 15, 2003, the Administration has announced that there will be an amnesty for those business that have yet to register. As part of the amnesty, those companies that have yet to register for the year 2003 will not be fined. Also, in order to promote registration for 2004, no fines will be imposed on businesses until April 15 of next year.

The Administration also approved Regulation No. 66142 (the "Regulation"), which provides the filing requirements for the businesses or persons that must be recorded in the Registry. In the Regulation, certain parameters are formulated to protect the confidentiality of the information required to those who will form part of the Registry.

The application should be completed and accompanied by the following documents:

1. Name of the Company;
2. Complete name of the Owner, President, or Highest Ranking Official of the Company;
3. Employer’s identification number (or social security number of officer);
4. Name of Contact Person and Position within the Company;
5. Street and postal address of the main office;
6. Telephone and fax numbers;
7. Email and web address;
8. Branches, if applicable;
9. Type of structure where the Company is located (building, mall, kiosk, etc.);
10. The area (in square feet) that the Company or branch occupies;
11. Brief business description of the Company;
12. Annual sales volume:

• In Puerto Rico
• In the United States
• In other countries (specify by country)

 13.   Year of commencement of operations;

 14.   Years under present management;

 15.   Type of business according to the NAIC and SIC classifications. If the business has this code, please provide;

 16.    Number and Type of employees;

• Full time
• Part time.

 17.   Annual Payroll;

 18.  Any other reasonable information that the Administration deems pertinent in order to perform statistical and/or commercial studies.

The registration form may be filed personally at the following address: San Juan Center, New San Juan Building, #159 Chardón Avenue, San Juan, Puerto Rico 00918, or through the Administration’s web page, www.fomentocomercialpr.com.

Non compliance with the annual registration after April of next year conveys an administrative fine of no less than $500 and no greater than $5,000, based on the volume of business. The fine must be paid within thirty (30) days upon notification of the fine.

Amendments to Puerto Rico Internal Revenue Code ("Code") :

Cafeteria Plans Are Now Part of the P.R. Internal Revenue Code

Act No. 277, approved on September 14, 2004 (the "Act"), amended Section 1022 of the Puerto Rico Internal Revenue Code, as amended (the "PR Code") to incorporate flexible qualified benefit plans, popularly known as "cafeteria plans", into the PR Code. The Act also exempts from an employee’s gross income the value of child care payments made by an employer as part of a cafeteria plan. Prior to the Act’s approval, if pay for services was in a form other than money, the fair market value of the property or services on the date received was included as part of an employee’s gross income. For example, the value of any child care payments made by an employer on behalf of any employee would be part of that employee’s gross income.

Cafeteria plans allow employers to give employees the opportunity to choose between cash benefits or qualified noncash benefits that are excluded from their gross income. Employees who elect to receive these noncash benefits, such as health insurance, life insurance, and child care benefits, will not be subject to income tax on the value of said benefits solely because, under the plan, they are allowed to choose between said benefits and their cash equivalent. However, the new Section 1022(l)(2) of the PR Code establishes an exception to the previous rule regarding "highly compensated employees" for tax years in which the plan discriminates in favor of this group of employees, whether it be with regards to eligibility to participate or contributions and benefits. The term "highly compensated employee" is defined in Section 1022(l)(4)(B) of the PR Code.

The Act also incorporates into the PR Code an exemption previously enjoyed under the Puerto Rico Income Tax Act Regulations. The Act indicates that any premiums paid by an employer for ordinary life insurance on the lives of his employees are not taxable to the employee even if the gross proceeds are payable to the employee’s beneficiaries. The Act exempts from an employee’s gross income the value of life insurance premiums for coverage of up to $50,000. The cost of coverage over $50,000 will be taxable to the employee in the tax year in which the premiums are paid. In order to qualify for the exemption, the life insurance premium payments have to fall under Article 14.010 of the Insurance Code of Puerto Rico, which regulates group-term life insurance policies.