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Has anyone offered you a tax credit or an investment in a tourism-related project? Most people hesitate to buy or acquire these types of tax shelters because they don't
understand how they work, the risks involved, and the advantages or disadvantages of this type of investments. The purpose of this article is
to present to you an investment mechanism that produces future benefits and reduces your tax liability. You will find out that, even when acquired after April 15, the return on your investment and the tax
savings can be significant. It will help you understand tax credits and will provide a framework to help you decide whether this type of investment works within your particular tax situation.
Background Puerto Rico has a number of tax incentives designed to encourage capital formation, attract foreign investment, and reduce the tax burden of those qualifying for the investments. As part of
the efforts to strengthen the Puerto Rico tourism industry and the economy as a whole, the legislature approved Act No.78 of September 10, 1993 known as the "Puerto Rico Development Act of
1993"(the Act). Even though we are going to limit our discussion to investments in the tourism industry, the mechanism used for channeling the investments and monitoring the tax
incentives for investors is similar to the capital investment funds created for other industries. Incentives The major players to consider under the Act can be divided in three categories: ¨ Those who contribute cash or land in exchange of an interest in the exempted business in a primary issuance (Called "Investors"). ¨ Those who invest in Securities of a Tourism
Capital Investment Fund in a primary issuance (Called "Participants"). ¨ Those who purchase tax credits directly from an Investor or a Participant that is not a Developer (Called
"Purchasers"). Under the first two categories, the tax credit is limited to 50% of the amount invested. The first half (i.e., 25%) can be claimed in the year the exempted business has obtained
financing for the construction of the project and the remaining balance in the following year. The investment can be made at any time prior to the filing of the income tax return, including any extension
of time granted to file the return. Even if acquired after filing the return, generated tax credits can be applied against estimated tax payments for the year in which they are first available.
An amended estimated tax declaration is normally necessary to adjust your income tax payable for the remaining of the year. Any credit that can not be used in two installments may be carried forward
indefinitely until exhausted. For example, in March 19X1 Investor A makes a cash contribution of $20,000 in exchange of an interest in a tourism project. Assuming the financing is completed before
the due date for Investor A to file his/her 19X0 income tax return, Investor A can claim a tax credit up to $5,000. The remaining $5,000 can be claimed in his/her 19X1 income tax return. If
he/she made the cash contribution after his/her return was filed, an amended estimated tax declaration is necessary to reduce his/her tax liability by $5,000 in 19X1. The third category is the most commonly
used among individual and corporate investors who do not want to become Investors or Participants of the tourism project. The benefit under this alternative is that credits are purchased at a discount
(between 80% to 95% of the tax credit amount), and the accretion or difference between the credit claimed and the amount paid is exempt from income taxes. The Act does not clearly specify whether it is
also exempt from municipal taxes, but based on unofficial communications we understand that it should be also exempt, as new tourism businesses are 100% exempt from municipal taxes. The Purchaser under this
alternative cannot transfer, sell or assign the credit to other persons because he/she is not considered an Investor or Participant. As for the first two players, the credit can be claimed over two taxable
years. The first half can be claimed in the year the exempted business has obtained financing for the construction of the project and the remaining balance in the following year. However, the 50% limitation
does not apply and the Purchaser may opt for not taking any tourism tax credit in the year in which it is first available, thus allowing him/her to use the entire tourism tax credit in the following tax year
or at any time thereafter. In addition, any excess credit that can not be claimed in the first available year may be used to satisfy the estimated tax liability for the subsequent year. The
amount paid to acquire such credits can not be deducted or capitalized under any circumstances. The timing of the usage of the tax credits will determine the return on your investment. For example,
assume that Purchaser B acquires in 19X1 from Investor A, in the example above, the remaining $5,000 in tax credits for $4,500 (discount of 90%). The return on the investment will depend on the time
required to apply the $5,000 against the estimated tax payments for the current year. For example, if you need only 3 months to use the tax credits, you will receive a return equivalent to 44.44% (500
/ 4500 / 3mo. X 12 mo.), or in the case you need 6 months, you will receive a return equivalent to 22.22% (500 / 4500 / 6mo. X 12 mo.). We have kept our example as simple as possible, but in the case
you have to borrow the money to purchase the tax credit, you must subtract from the $500 the cost of funds (interest) plus any legal fees paid. Below you will find a list of documents that must be
presented when purchasing any tax credit under the Act and filed with the Puerto Rico Treasury Department when filing the return:
- Transfer of Tourism Investment Tax Credit Agreement.
- Sworn Statement pursuant to Section 5(f)-4 of the Regulation.
- Sworn Statement by Seller in compliance with Section 5(a)-4 of the Regulation.
- Administrative Determination authorizing the sale of the Investment Tax Credits.
- Opinion from tax counsel to the Seller regarding the validity and transfer of Investment Tax Credits.
Risks
- Developer risk
The credit available to each Investor and Participant is determined at the beginning of the tourism project based on the cash contributed and the estimated cost of the project. If
the tourism tax credits taken by the investors and/or participants exceed the final credit available to the tourism project, as determined by the Director of the Puerto Rico Tourism Company, the
excess shall be paid as additional tax by the "Developer". For these purposes, a Developer means an investor or any other related person who is directly or indirectly responsible for
or is a participant in the construction, development or administration of the tourism project.
- Opportunity cost risk
Any loss suffered in the sale or exchange of an eligible investment by the Investor or Participant, who is not a Developer, is considered a capital loss (Alternatives
1&2). However, at his/her election, the Investor or Participant can claim a credit for said loss in the current year and/or in the next 4 subsequent years. The amount claimed
for each year may not exceed 1/3 of the loss. Although the statute provides for a recovery of the initial investment cost, the investors and/or participants will forgo any profits on
alternative investment opportunities.
- Transferability
An Investor, Participant, or Developer (with certain exceptions) may transfer the credits arising from a tourism investment (Alternatives 1 & 2). However, the Purchaser (Alternatives
3) may not transfer such credits, since he/she is not considered an Investor or Participant. If the credit can not be used for any reason (Alternatives 1, 2 & 3), the Regulations
specifically provide that no refund can be claimed from the Treasury Department. However, if the tax credit is used against a withholding tax, the taxpayer may request a reimbursement up to the
amount credited against this tax.
The use of this type of investment vehicle can provide significant tax savings and returns. These benefits vary from taxpayer to taxpayer depending on each individual's tax situation.
If you are interested in determining the benefits available to you, please contact Mr. Luis R. Lomba at: PERDOMO FERRER & COMPANY
Suite 227 PO Box 194000
San Juan, Puerto Rico 00919-4000
Tel. (787) 754-5530 Fax (787)282-7917
Web: www.pf-cpa.com
E-mail: lomba@pf-cpa.com |
