Domestic Corporations or Partnerships

A domestic Corporation or  Partnership is an organization created under the Laws of the Commonwealth of Puerto Rico.  For tax purposes, a domestic corporation or partnership is one of the most favored structures for foreign business since it provides certain  promotional benefits and operates as a separate legal entity for commercial law purposes.  U.S. corporations, for example, establishing a local presence through a domestic subsidiary will not, with some exceptions, be subject  to U.S. taxation until profits are distributed.

A domestic Corporation is subject to regular income taxes .  In determining taxable income, the Corporation or  Partnership will take into consideration all items of income on a worldwide basis regardless of whether or not the income is effectively  connected with the conduct of a trade or business in Puerto Rico.  The Corporation or Partnership will be allowed to deduct its expenses to the extent they are related to the Puerto Rico operations.  In addition, the Corporation would  be entitled to deduct in the Puerto Rico income tax return a reasonable allocation of overhead expenses incurred by the Parent Company or any Affiliate in a foreign country or the United States to the extent they are related to the  Puerto Rico operations.

Under this structure, the Corporation's dividends or Partnership's distributions are subject to a 10% withholding tax upon distribution.  However, dividends received by a domestic corporation or  foreign corporation engaged in a trade or business in Puerto Rico, qualify for an 85% to 100% dividend received deduction.  Therefore, a foreign Parent Company that establishes an office in Puerto Rico to provide management  services to the P.R. subsidiary avoids the 10% withholding tax generally imposed on dividends paid to a foreign corporation not engaged in trade or business in P.R.  Under these circumstances, the Parent Company income tax  burden will be limited to a 5.85%   tax on the P.R. subsidiary dividends or distributions.

To avoid triple taxation, said dividends are not being subject to branch profit tax in the hands of the Parent Company.  We may add that the dividends from the Foreign Parent to its ultimate stockholder would not be subject to P.R. income taxes to the extent than the Foreign Parent's Puerto Rico effectively connected income is less that 20% of the Foreign Parent total gross income for the three-year period ending with the close of the taxable year of the parent corporation preceding the declaration of said dividend or distribution, or for said part of said period as the corporation has been in existence.