In general, a domestic corporation means a corporation organized under the Laws of the Commonwealth of Puerto Rico. Note that a limited liability company's default tax classification is a corporation. Thus, a limited liability company created under Puerto Rico laws is taxed as a domestic corporation, unless pass-through treatment is elected or otherwise mandated. For tax purposes, a domestic corporation is one of the most favored vehicles 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 are not, with some exceptions and most notably the Subpart F income regime, subject to U.S. taxation until profits are distributed or deemed repatriated.
Domestic Corporation’s Taxable Income
A domestic corporation is subject to regular income taxes at a maximum rate of 39% on taxable income in excess of $275,000. Assuming a taxpayer is not a member of a controlled group, taxable income will be subject to a regular tax of 18.5% and the balance exceeding the $25,000 surtax exemption will be subject to the following surtax:
|$75,001 - $125,000||$3,750 plus 15% of excess over $75,000|
|$125,001 - $175,000||$11,250 plus 16% of excess over $125,000|
|$175,001 - $225,000||$19,250 plus 17% of excess over $175,000|
|$225,001 - $275,000||$27,750 plus 18% of excess over $225,000|
|$275,001 - Over||$36,750 plus 19% of excess over $275,000|
In determining taxable income, the corporation must take into consideration all items of gross 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. A domestic corporation is allowed to deduct its ordinary and necessary expenses to the extent they are related to the operations. In addition, a domestic corporation would be entitled to deduct on the Puerto Rico income tax return a reasonable allocation of overhead expenses incurred and charged by the Parent Company or any Affiliate in a foreign country or the United States to the extent they are directly related to the domestic corporation’s operations and subject to arm’s-length standard requirements. This allocation is often challenged by the tax authority during an examination or audit. Nevertheless, when determining the net income subject to income tax, 51% of the deduction for expenses or payments made by pass-through entities to partners or shareholders owning more than 50% interest in such entities and payments or transfers to related parties not engaged in trade or business in Puerto Rico or to home office is disallowed if payments are not subject to income or withholding tax in Puerto Rico, (e.g. payments for services rendered outside Puerto Rico by foreign persons). Nevertheless, for taxable years commenced after December 31, 2018, the 51% disallowance shall not apply if the taxpayer submits to the Secretary, together with the income tax return, a transfer price study, which includes an analysis of the operations carried out in Puerto Rico prepared in accordance with and in compliance with the requirements established in Section 482 of the Internal Revenue Code of the United States of 1986, as amended and duly reviewed by the Federal Internal Revenue Service. For regular tax purposes, the net operating loss deduction is limited to 90% of the corporation’s net income subject to such tax. Related party charges will be disallowed in determining an NOL.
For taxable year commencing after December 31, 2018, an Optional Income Tax Computation (“OITC”) will be available for service provider entities. If the taxpayer elects the OITC, no deductions for expenses will be allowed. The OITC tax rates computed on gross income are as follows:
|$100,001 - $200,000||10%|
|$200,001 - $300,000||13%|
|$300,001 - $400,000||15%|
|$400,001 - $500,000||17%|
|$500,001 - Over||20%|
Regarding the alternative minimum tax, for domestic corporations the tentative alternative tax is the greater of $500 or 18.5% (23% if required to submit audited financial statements with the income tax return) of the amount by which the alternative minimum net income exceeds the exempt amount, reduced by the alternative minimum tax credit for foreign taxes paid for the taxable year In computing the AMT, only specified expenses are allowed. If the taxpayer submits audited financial statements with the income tax return, it can deduct all the expenses as claimed for regular income tax purposes. Also, the deduction for net operating losses is 70% of the alternative minimum net income.
Dividends distributed by a domestic corporation to nonresident individuals, foreign partnerships and corporate shareholders that are not engaged in a Puerto Rico trade or business are subject to a 10% withholding tax upon distribution. In the event of a shareholder that is a domestic corporation or a foreign corporation engaged in trade or business in Puerto Rico, no withholding is imposed on dividend distributions. Such corporate shareholders will qualify for a dividend-received deduction equal to 85% of the dividend received (100% in certain cases), but the deduction may not exceed 85% of the shareholder’s taxable income. Therefore, a foreign parent corporation that establishes an office in Puerto Rico to provide management services to the domestic subsidiary is not subject to the 10% withholding tax generally imposed on dividends paid to a foreign corporation not engaged in trade or business in P.R.
To avoid triple taxation, said dividends are not subject to branch profit tax in the hands of the foreign parent corporation. Dividends distributed by such foreign parent corporation to its foreign stockholder would not be subject to P.R. income and withholding taxes to the extent that the parent corporation’s Puerto Rico effectively connected income is less than 20% of its total gross income for the 3-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.
Long term capital gains recognized by a domestic corporation on the sale or exchange of capital assets qualify for a 20% tax rate.