Generations Fall 2023 - Unlocking the Potential: Redomiciling and Investing in Puerto Rico – A Family Office Perspective

On May 11 Peter Bilfield, Co-Chair of Day Pitney's Investment Management and Private Equity Group, led a panel discussion of the tax benefits and practical aspects of redomiciling to Puerto Rico. This discussion was part of Day Pitney's Palm Beach Family Office Forum. On the panel were Joseph Armisto, Senior Vice President and Director of Financial and Tax Planning for Shepherd Kaplan Krochuk, LLC; Juan Carlos Feliciano, a Member of JFC Legal, LLC; Carlos M. Fontán, Esq., Director of the Office of Incentives for Businesses in Puerto Rico, of the Department of Economic Development and Commerce; and Olivier Gillier, a Partner in Rio Blanco Capital.

Peter Bilfield: Thank you, everyone, for joining us for this panel on unlocking the potential of living and investing in Puerto Rico. Over the last couple of years, we've seen a migration of investment managers and family offices to Puerto Rico, and we've been involved in structuring to mitigate their U.S. tax liabilities and Puerto Rico tax liabilities by creating Puerto Rico structures for these investment managers. I've gone to Puerto Rico to visit clients and get exposure to the island and what's going on there. It's a very exciting time. There's lots of development going on there, particularly with real estate, with so many private equity investors and managers moving there.

We're going to focus on four topics. First, we're going to discuss redomiciling families. What are the tax incentives, and how does the "Act 60 decree" work? Second, we're going to talk about the process of actually moving, which can be very cumbersome. You need to figure out who the service providers will be and what the process is. Third, we're going to talk about advantages of investing in Puerto Rico, from the perspective of both persons domiciled in Puerto Rico and persons domiciled in the U.S. investing in Puerto Rico. Finally, there's the tax structuring, not only on the personal level but also with respect to investments. So with that, I'd like to introduce our panel.

Carlos Fontán is from the Office of Incentives for Business in Puerto Rico. Carlos has been an integral part of the drafting and implementation of Act 60, known as the Puerto Rico Incentives Code, and its regulations. Joe Armisto is a senior vice president and director of financial and tax planning at Shepherd Kaplan Krochuk LLC, where he is focused on meeting the financial and tax needs of high net worth individuals, families and family offices. Oliver Gillier is a founder at RioBlanco Capital, a private equity and real estate fund manager based in San Juan which provides liquidity and growth capital to underserved markets and assets. Juan Carlos Feliciano, with JFC Legal LLC, has over 10 years of experience in providing tax and legal services.

Carlos, can you describe some of the benefits that Act 60 provides for family offices and investment managers looking to relocate their businesses into Puerto Rico?

Carlos Fontán: Of course. At the Department of Economic Development and Commerce of Puerto Rico, our mission is to foster, diversify and solidify our economy. Puerto Rico has a rich history of incentive programs going back to the 1950s. In 2019, all of that changed. Basically, we combined all the previous incentive acts into one piece of legislation that is Act 60 and centered implementation into one agency, the Department of Economic Development and Commerce. The Puerto Rico Incentives Code has over 300 pages, so there is quite a lot there to digest.

So you can imagine how many incentives we have in this program. We have programs for individuals, export services, manufacturing. You may think of Puerto Rico for tourism and great weather, but 48.2 percent of our GDP comes from manufacturing. In Puerto Rico, there are 12 of the top 20 biopharmaceutical companies in the world, as well as many of the top medical device companies in the world. So Puerto Rico is a great jurisdiction to establish a manufacturing business.

We have a program for services for individual investors. The main objective of the program is to promote the relocation of individual investors to the island. If you were not a resident of Puerto Rico between January 2006 and January 2012, you can apply. Under this program, when you become a bona fide resident of Puerto Rico, you will not pay any taxes on dividends, interest or capital gains that derive from securities. All you have to do is apply and you get a decree that creates a contract with the government of Puerto Rico. That decree is going to be effective until December 31, 2035. It doesn't matter if the act gets amended or gets repealed. We have to honor that decree. That decree is protected under the Constitution of Puerto Rico and under the Constitution of the United States.

Once you get the decree, you have one year to move to Puerto Rico. You have two years to buy a home in Puerto Rico. To maintain that decree, you have to remain a bona fide resident of Puerto Rico. Basically, you have to spend 183 days a year on the island. Also, you have to comply with the different tests of the IRS. We not only want folks to move to Puerto Rico; we also want you to bring business to Puerto Rico. We have an expert services program to bring service providers to the island and for local operation around the world.

And basically, if you are an entity authorized to do business in Puerto Rico, it can be a domestic entity or a foreign entity. If you are an individual and move to Puerto Rico and start providing services, you can get that type of decree. Fifty percent of the decrees that they provide from Puerto Rico are for consulting services.

We also have marketing services, R&D services, financial services, you name it. Under the act, the secretary [of the Department of Economic Development and Commerce] can designate any eligible service that he wants to promote in Puerto Rico. For purposes of the expert services program, you will get a tax incentive decree which will be effective for many years, and it cannot be amended or repealed. What are the benefits? You will get a four percent tax rate for three years, you will get a 75 percent tax exemption on the property in which you are rendering those services, you will get a 50 percent tax exemption on municipal license taxes and the owners of that entity will not pay any taxes on dividends.

First, you have to start operations. So if you have a business idea, you can access our platform and apply for the decree. Once you get the decree, you have to start operating. That term of one year can be deferred up to five years. And as you can see, Puerto Rico's a great jurisdiction to do business.

Peter Bilfield: That's great, Carlos. I think that's a lot to digest. I think having someone that's knowledgeable about helping people take advantage of those tax incentives would be helpful. Joe, you have a lot of experience in that space. You know the traps for the unwary, what to do, what not to do and who the service providers are. What are some of the challenges that your clients have confronted when utilizing Act 60 tax incentives?

Joe Armisto: Thank you for having me as a panelist today. For everybody who is thinking of moving to Florida, you just have to keep going a little bit further. The incentive programs are there. I have a story to illustrate this. I had recently joined Shepherd Kaplan Krochuk and was talking with one of the partners, who had said, "Hey, I'm interested in Puerto Rico. Do you have any real experience with this?" And so my first impression was, OK, it's kind of like moving from New York to Florida or to Texas, right? You have to follow all those same protocols to establish residency, closer connection and the domicile rules.

This conversation started in the beginning of the year. And in May, he said, "Joe, I'm moving to Puerto Rico, and I want to meet the criteria to be a bona fide resident this year." And so he landed in Puerto Rico on June 4th, so there was not a lot more than 183 days to meet the residency test. I didn't have a network. I didn't have the resources that I do today. So a lot of my time was spent developing the connectivity to Puerto Rico to help implement and transition the partner. The second time I advised a partner who decided to go to Puerto Rico, it was much easier, because I had developed a network. I had gone through the process, applied for Act 60. It was a "learn on the fly" experience, which can be very challenging. Building out a network and having the resources in Puerto Rico really does make for an easier transition.

Now, the second part of that question, Peter, is how do you begin that dialogue? Today's panel and the presentation Day Pitney has put together offer everyone in the audience the opportunity to have access to resources to transition to Puerto Rico. I'd encourage you to talk to your legal team and your accountants, and figure out a way to start that dialogue to see if it really makes sense from a personal wealth perspective or from an operations perspective. Ultimately, we will be able to help you with that transitional program.

What I've been able to do in Shepherd Kaplan is design a program for somebody who has interest. We can evaluate the tax and entity structuring that's here in the U.S. We can talk about how to structure it in a way that qualifies for the incentive programs that Carlos has mentioned. And then begins the migration process. So what we've been able to do is develop a local partner in the accounting practice who can help with the tax compliance, creating the entity structure and the Act 60 application process. Someone going to Puerto Rico really needs to know what programs are available. I personally don't know all 300 pages of the code, but there are people there who do and can advise. We've established banking relationships. As Carlos has described, part of your contract with Puerto Rico is that you need to purchase a home within two years. So having banking and lending resources available is critical. Having local estate planning counsel is important too, because estate planning in Puerto Rico is far more complex than in the United States.

So you do need someone like Juan, who has experience on the estate planning and tax side, to coordinate with your U.S. estate plan. Hopefully that's your Day Pitney advisor. If it's not, we're going to recommend you see the team at Day Pitney for your professional services. I think the final part of that question is, what challenges did the clients face? I'm going to spin that a little bit and ask, "What challenges does the advisor face when transitioning a client?" The most common challenge we face is not the economics. We can help model out what the tax savings and incentive programs will be. But many times the biggest challenge is family or work. There is just too strong a connection to the U.S., making it difficult to meet the 183-day presence requirement or the tax home test. We've seen it before, where we've gotten to the point of submitting the application. One particular client was very excited about his projected tax savings. He went back to his partners at his firm, and they said no. So he did all this planning for nothing. So that's a hurdle.

Another issue that arises is whether people have to give up their current team of tax and estate planning advisors. If you have a very knowledgeable, highly competent tax and estate planning team, then you want a complementary set of advisors in Puerto Rico to help coordinate your planning. As we've seen, the IRS has been in the headlines announcing that they're going to start scrutinizing individuals and companies that are relocating to Puerto Rico, so loose and fast is not the way to do it. Make sure your structuring is tight. Make sure that you have the right team around you who is building the right program in coordination with the incentives.

I spent some time working with a client who was U.S. based. He wanted to reduce his U.S. taxes by moving to Puerto Rico, so we set up his entire program. He's part of the individual investor decree. We set up an export service company, and things were going fine. And then he wanted to go to a boat show in Fort Lauderdale and look at a yacht. He wanted to charter the yacht, which creates a whole new opportunity under the Act 60 program. There is actually a tourism incentive for this. So in a very short window, we had to create a legal entity and determine what incentive program it would fall under. The Puerto Rico part of that falls under the Jones Act, so it had to be either a U.S. flag or an outside flag, but we had to be careful of the crew that we were hiring. So we went through a lengthy process, about two weeks on it, day in and day out. The client decided ultimately that he didn't like the yacht, but he is going to buy one in the future. So I already did the planning. I know how to structure it, and we've created the program for him. He just has to find the right yacht for him.

And so, you know, what we're trying to communicate is that Puerto Rico is rich in incentives. The people are friendly, the culture is wonderful, the food is delicious. What we try to do is to create the education on how to make the move, and if there really is a desire to move to Puerto Rico, create the road map to an accountant, to the legal team, private security, car service, helicopters, the entire suite that ultimately you would appreciate having to facilitate the move and benefit from the incentive program.

Peter Bilfield: Thank you, Joe. I want to focus on the real estate piece. Both of you and Carlos are focused on that in terms of the timing of purchasing real estate in order to take advantage of the Act 60 decree. Oliver, you are a private equity real estate fund manager based in San Juan, doing a lot of development in Puerto Rico. You relocated from New York to Puerto Rico many years ago, so you have gone through that process, but you have also developed properties in Puerto Rico to meet the needs of people migrating to Puerto Rico to comply with the Act 60 decree requirements of owning real estate. Maybe you can touch on your personal experience relocating as well as some of the investments that your firm is involved in.

Oliver Gillier: Thank you, Peter. When I told my wife we were moving from New York to Puerto Rico, I thought it was going to be easy. She's Puerto Rican, born in New York, but I got some resistance. Then during tax season, I gave her the checkbook and the pen and asked her to write the check. Then she realized, "Oh, maybe it's time we should move." So I moved as one of the early adopters. About nine years ago, in 2014, there were not that many people that had used Act 60 (which at the time was called Acts 20 and 22).

I had to adapt a little bit, but the quality of life definitely went up, and it's a very business-friendly tax jurisdiction. That helped a lot in growing the business that I had from New York. In 2015, after I had been there a while, I saw a lot of opportunity with my local business partner, Gabriel Jimenez. We started a fund in 2016, investing in real estate and attracting capital from the Middle East, Europe, stateside U.S., and then eventually Puerto Rico itself and Latin America. Interestingly, it was right during the Puerto Rican debt crisis, which eventually became a bankruptcy. And so you can imagine how hard it was to convince people to invest. On the Puerto Rican side, it was very hard to convince Puerto Ricans to invest because they had suffered serious losses, and on the states side, there was some skepticism at the time. But funny enough, on the European side, there was a lot of interest. Somehow the Europeans realized that Puerto Rico was a beautiful island in the Caribbean. I call it the Hawaii of the East Coast. And they saw the opportunity. They saw that it was centrally located in the Americas, very well connected to the United States, connected to Latin America, to Panama, Colombia, all over. It has a bilingual population, which is very useful when you do international business, and then it has all these tax acts in an environment where all these nonofficial "tax havens" are being shut down. Puerto Rico was very smart in taking a position of saying, "Okay, we're on U.S. soil, let's create a tax-efficient jurisdiction that is very pro-business." And so in our thinking, we said, "Okay, we'll sell that to investors and say there's a huge opportunity here." It was very contrarian, especially with the debt crisis, and has proved to be a very good bet.

Our fund, which is opportunistic, now has three opportunity zone funds. We have two Act 60 funds, which provide investors with a lot of tax benefits, and we have investors from all over the world. The experience has been very good. The quality of life is great, and the taxes are great. One of the questions was, "How is the investment environment?" Nine years ago there was very little investing in Puerto Rico. It was negotiating debts and not much more. These days, the community of investments has grown a lot. We've seen a lot of capital flow in, and I don't believe we're at the end of it. We're more in the beginning of it. You have several funds that have been created, with some of the biggest players, like RioBlanco in real estate. You have very large growth funds, venture capital, Morro Ventures and Advent-Morro, which are big players, and then you have a plethora of other funds that have recently opened, in the last few years, in Puerto Rico under Act 60, thanks to the very business mindset of the Puerto Rican government.

Yesterday, somebody asked me if I thought Puerto Rico is at the end of its cycle. I think actually it's at the beginning. It's one of the first stages of the cycle where now you start an acceleration of capital coming in, you see development coming. You see large hotels looking to develop in Puerto Rico. Puerto Rico and its people have been through a rough patch with the credit crisis and the bankruptcy of Puerto Rico. You have some banks in Puerto Rico that failed, which the Federal Reserve rescued. With all the things Puerto Rico has gone through, the U.S. federal government has, in cooperation with the Puerto Rican government, come up with a lot of money that's going to flow into the Puerto Rican economy, about $90 billion. If you think about that: $90 billion over the next 10 or 15 years coming to an island of three million people. You can see how Puerto Rico is set for a relatively long boom, between capital injection and people moving there. We liked that setting. We have luxury developments in Puerto Rico now valued at over $200 million. We own office space, more than 600,000 square feet of office space. We have investments in entertainment parks, you name it.

Our participation was mainly in real estate, because real estate was not something that was booming nine years ago. People were very scared of touching Puerto Rico. If you look at the venture capital market, you have four incubators in Puerto Rico. Our two biggest ones are Parallel 18 and Grupo Guayacán. They've created an environment that is very conducive to local Puerto Ricans as well as venture capital investors. They provide financing. They provide a framework for these new startups to thrive, something that we didn't have earlier. It was difficult to find capital for startups. Now it's easy, and you get very good companies that come out of that, especially in the pharmaceutical world. So from a personal perspective, it was a great decision.

From a business perspective, it's probably one of my best decisions. I'm Belgian. I moved to New York. That was a great decision, but the move from New York to Puerto Rico was probably my best decision personally and financially. But I do recommend a couple of things. Joe touched upon it—that the first thing is to properly coordinate with your local legal team and a Puerto Rican legal team. You have to get your tax decree. There are other rules that you have to respect. Compliance with those rules is not difficult, but you have to respect them. The other thing I recommend, especially if you do business in Puerto Rico, is to learn the unique culture of Puerto Rico. New York has a different culture than California, and so does Puerto Rico. Puerto Rico has a Spanish cultural influence.

My biggest recommendation is that you find a local partner to accelerate the learning curve, so that when your business moves there, you have the right contacts, you know who to work with, you know who not to work with, you know which banks to contact. Having good banking relationships is essential.

I became partners with Gabriel Jimenez. He knew exactly what I had to do. We have to be careful, for he knew who to contact when we needed lending, and he knew what help we needed from the government. I'm very happy to be a new Puerto Rican.

Peter Bilfield: Thanks, Oliver. You touched on the tax piece, both on the Puerto Rico side and the U.S. side. That leads us to Juan Carlos, who has expertise with both U.S. tax and Puerto Rico tax. That's important because you have to think about both.

There are some traps for the unwary. If you bring appreciated property into Puerto Rico, what happens there? There's potential timing issues. Maybe you could touch on some of those issues for folks that are interested in redomiciling in Puerto Rico, and maybe we can get into a bit of the structuring for some of the investments that you've worked on with RioBlanco. Finally, because there's a significant private client overlay here, maybe you could touch on the nuances of the estate tax considerations both in Puerto Rico and the U.S.

Juan Carlos Feliciano: I will start with Peter's first question. What are the key issues that I see with my clients when they relocate to Puerto Rico? The first thing—and Carlos and Joe talked about it—you need to make sure that you are a bona fide Puerto Rico resident under U.S. tax rules, because that's what would give you the Puerto Rican income to qualify for the exclusion for U.S. federal tax purposes. The first test is physical presence. You have to be in Puerto Rico 183 days, which we've spoken about. But also your tax home has to be Puerto Rico, which means your principal place of business has to be in Puerto Rico and you have to have closer connections to Puerto Rico than to anywhere else in the world. I like to summarize the closer connection test as "Where are your things that are near and dear to you located?" If they're back in the States, you're going to have a big issue defending yourself before the IRS and claiming that you had a closer connection with Puerto Rico. So those are the things, as Joe was mentioning, that you have to plan for before you move to Puerto Rico.

Another question that I get asked very often is "When should I time my move? Can I move at any time during the year?" Well, the answer is, "it depends." But generally, no. You have to be a resident for the whole year. So meaning as of January 1st, you have to be in Puerto Rico and you have to meet those three tests that I just mentioned for the whole year. There is an exception for the year that you move, but you have to go by June 30th to qualify as a bona fide resident for that specific year. That would allow you to exclude any Puerto Rican-source income from taxation in the U.S., but there is a clawback provision. If you fail any of the tests in any of the following three years, then you have to go back and amend your tax return and pay tax to the U.S.

There are special rules under the U.S. tax code to determine what is Puerto Rican-source income. If you bring appreciated property into the island and dispose of it within 10 years after you relocate to Puerto Rico, there are rules that will require you to pay U.S. income tax on the appreciation.

Sometimes you might have a taxable event from a U.S. tax perspective but not from a Puerto Rican tax perspective. You might get into a situation where you're paying U.S. tax on the income without a tax credit in Puerto Rico, so you might end up paying double tax on the same gain. These are some of the rules concerning appreciated property, and timing should be considered before you move to Puerto Rico. You need to think about whether you could generate a taxable transaction under both the U.S. rules and the Puerto Rican rules before you move to Puerto Rico so you avoid paying Puerto Rican income tax on gain taxed in the U.S.

If you sell appreciated property before you become a bona fide resident of Puerto Rico and you get fair market value for your property, then you reset the clock. If you dispose of the new property after that, then you should be able to exclude the gain from U.S. tax and also from Puerto Rican income tax under Act 60.

I also want to highlight that the exclusion applies only for income taxes. Any United States citizen who is not born in Puerto Rico or naturalized in Puerto Rico will be a United States person for estate tax purposes. Puerto Rico has forced heirship rules. The estate tax planning that family offices undertake in the U.S. can be adversely impacted if you don't go through the issues in Puerto Rico. Because this became an issue a few years ago, Act 22 was amended to provide that if an individual resident in Puerto Rico creates a trust and transfers property into the trust, the property in that trust will not be subject to Puerto Rican civil law. So effectively what that would do is align your estate planning in the U.S. with rules in Puerto Rico for certain rules and effectively avoid any potential issues. Because otherwise, if you have children, half of your estate has to go to them, and the remaining 50 percent you can freely dispose of in your will.

Generally speaking, these are the biggest issues. It's tax timing. You have to plan your move and make sure that you're a resident of Puerto Rico for U.S. tax purposes. Another question that I get asked often is "How do I structure the business? Should I do an LLC, a corporation, a partnership?" It depends on the risks that are going to be undertaken from Puerto Rico, the frequency of traveling outside of Puerto Rico, and whether the business operations could be fully moved to Puerto Rico or not.

Peter Bilfield: This is choice of entity. Puerto Rico LLCs are corporations for U.S. tax purposes.

Juan Feliciano: Exactly. So typically, we use a Puerto Rican LLC. From a tax incentive standpoint, there is no tax on dividends, so there's no double taxation of the earnings from the business. The LLC pays the tax, and the dividends are tax-free. But if you're in a situation where you have employees traveling back and forth between the United States and Puerto Rico or anywhere else in the world, the LLC might not be the best structure, because that LLC is likely going to have to pay U.S. tax and it's going to become inefficient. We could, in that situation, recommend a partnership structure. The partnership doesn't pay the tax, and there's no "deemed dividend" tax either. The income from the business just gets attributed to the partners, and they pay U.S. tax on whatever share they receive that is non-Puerto Rican source. It is a highly complex area of the law. You know, tax law is never easy, but it's fun for me when I have helped clients relocate to Puerto Rico. I also help RioBlanco with most of their structures. They have investments in Puerto Rico and in Latin America.

Peter Bilfield: I would like to thank our esteemed panel. I appreciate everyone on the panel coming and speaking about Puerto Rico. Thank you!

‌ ‌

Would you like to receive our Day Pitney Generations Newsletter? Sign up here.