IMPORTANT ASPECTS OF THE PROPOSED TAX REFORM OF 2015

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1 P E L L O T - G O N Z Á L E Z T A X A T T O R N E Y S & C O U N S E L O R S A T L A W, P. S. C. F E B R U A R Y, IMPORTANT ASPECTS OF THE PROPOSED TAX REFORM OF 2015 House Bill 2329 (Bill) Act to Transform Puerto Rico s Taxing System The following is a summary of the most important aspects presented in the Bill. RELEVANT INCOME TAX ASPECTS REGULAR TAX RATES SPECIAL TAX RATES IMPORTANT ASPECTS OTHER COMMENTS INDIVIDUAL MARRIED Tax rates will be between 15% to 30%, the tax will apply when the net taxable income is over $40,000. (First $40,000 are not taxable). Tax rates will be between 15% to 30%, the tax will apply when the net taxable income is over $80,000. (First $80,000 are not taxable). 1. Capital gains and dividend distributions: Proposed rate: 30% Current rate: 15% Dividends paid after March 31, 2015, will be subject to a 20% withholding. 2. Preferential rates on certain interest from deposits in banking institutions, amounts from Individual Retirement Accounts and Variable Annuity Contracts: Proposal repeals Preferential rates Current rates: 10% or 17% regarding interests, 17% regarding IRA, and 15% regarding variable annuity contracts. - The following deductions are allowed: 1.Medical expenses. 2. Charitable. Contributions (if the entity is engaged in trade or business in PR and qualified by the Secretary of Treasury as a charitable organization). 3. Casualty losses. 4. Contributions to governmental pension or retirement plans. 5. Contributions to individual retirement accounts. 6. Interest paid on student loans at university level. - Up to $100,000 of compensation in the event of dismissal without just cause will be exempt. - Up to $100,000 of compensation paid for unjust dismissal under Act 80 will be exempt. 1. Basic Alternate Tax will be eliminated. 2. Special tax applicable to individuals engaged in a trade or business (2%) will be eliminated. 3. A partial credit instead of a deduction will be granted for the mortgage interest paid, the amount varies according to the gross income. The amount of the credit will gradually phase out and the unused portion will not be reimbursed nor carried over. 4. The following will be eliminated: - personal exemption - dependent exemption - special deduction for certain salaried taxpayers. 5. The total exemption regarding the capital gain generated in the sale of the principal residence will be eliminated for sales on or after March 31, of 7

2 REGULAR TAX RATES SPECIAL TAX RATES IMPORTANT ASPECTS OTHER COMMENTS CORPORATION - Fixed 30% - Alternative Minimum Tax still applies, with a reduction in the tax rate (30% to 25%). Special rates for capital gains and dividends. Proposed rate: 30% Current rate: 20% - The only allowable method of depreciation after 12/31/14 with respect to tangible property, will be the straight line method with specified allowed recovery periods. -The deduction allowed for the use and maintenance of automobiles will be those incurred or paid, but the Treasury may allow a deduction based on a standard mileage rate, fixed by regulation or administrative pronouncement. - The "patente nacional" will be eliminated. - Charitable Contributions will be allowed (if the entity is qualified by the Secretary of Treasury as an exempt organization; donations to trusts, foundations or funds must be for use in Puerto Rico). CONDUIT ENTITIES An automatic statutory conversion to a flow through entity or conduit entity will apply for tax years beginning after 12/31/2014 to entities that have pass-through treatment prior to The entity is not subject to income tax. - The owners will be subject income taxes, at individual tax rates, on their distributive share and considering the type of income generated. -Generally, owners will be considered engaged in trade or business in PR. APPLICABLE ENTI- TIES: 1. Partnerships 2. Limited Liability Companies 3. Corporations with pass through treatment 4. Special partnerships 5. Corporations of individuals (N Corp.) -All conduit entities will be filing the same return. 2 of 7

3 Prepayment Prepayment options on certain assets, undistributed accumulated amounts of Individual Retirement Accounts, and undistributed accumulated amounts of variable annuity contracts, introduced by Act , will be, in general terms, extended until March 31, 2015 (please refer to our Newsletter issued in July, 2014). Nevertheless, the Bill introduces additional items that will qualify for prepayment. ADDITIONAL ITEMS SUBJECT TO PREPAYMENT (public companies do not qualify) Dividend distributions between 1/1/2015 and 3/31/2015 Dividend distributions between 1/1/2014 and 6/30/2015 (there appears to be an error in the Bill, we understand it should be between 4/1/2015 and 6/30/2015) Deemed Dividend distributions between 1/1/2015 and 3/31/2015 Deemed Dividend distributions between 4/1/2015 and 6/30/2015 Tax Rate 5% 8% 5% 8% Other comments Corresponding prepayment 3/31/15, along with the payment. Corresponding prepayment 6/30/15, along with the payment. No actual distribution is necessary. The corresponding prepayment 3/31/15, along with the payment. No actual distribution is necessary. The corresponding prepayment 6/30/15, along with the payment. There is also another bill under evaluation (House Bill 1299) which contemplates identical extensions to the prepayment periods and in the same manner includes dividends and deemed distributions, as well as establishes an amnesty program along with a voluntary disclosure initiative. We will provide further detail of this legislation as soon as it is approved. Moratorium on Tax Credits Reactivates the moratorium on certain tax credits for tax years beginning after December 31 st, 2014 and before January 1 st, No additional credits subject to the moratorium may be granted by any agency, public corporation, instrumentality, municipality or dependency during the moratorium period. Any taxpayer that has acquired or that has been granted credits subject to moratorium before June 30, 2013, can use such credits during the moratorium period according to their original limitations, but never to reduce its tax liability by more than 25%. 3 of 7

4 REPLACEMENT OF THE SALES AND USE TAX SYSTEM (SUT) WITH THE VALUE ADDED TAX (VAT) One of the most significant changes that the Bill contemplates is the replacement of the SUT with a VAT, effective January 1, The Bill establishes that for the remainder of 2015 the provisions pertaining to sales and use tax will continue as per the Puerto Rico Internal Revenue Code of 2011 (2011 Code). However, effective April 1, 2015 the SUT rate will increase to 16% and will be known as VAT, in the same manner the Municipalities will not be allowed to impose a Municipal SUT or similar tax. As opposed to the sales tax, VAT is imposed at different stages of production on goods and services. The contemplated VAT rate is 16%, applicable to all goods and services except: exportation of services, sale of goods for export, and imports of goods and items used in manufacturing (manufacturing plants that possess a Certificate of Exempt Imports) which are subject to a 0% tax rate. In addition, the following are exempt from VAT: Financial services (except bank charges). Sale and import of prescription medicines and goods for medical treatments. Sale of medical items and equipment designed to supplement the physical or physiological deficiencies to a person with a disability. Goods or services covered by Medicare, Medicaid and the PR Government health's insurance plan. Sale of goods or services to the United States Government, any of the States, the District of Colombia, or the Puerto Rico Government. Import and sale of gasoline, diesel, aviation fuel, gas oil, and derivatives, subject to excise tax, except propane gas and derivatives and other similar natured gases. Hotel rooms subject to the room occupancy tax established by the Puerto Rico Tourism Company. Food (unprepared) and food ingredients. Goods acquired under the Federal Nutritional Assistance Program (PAN) and WIC. Sale and certain leases of real property. Certain transfers of goods and services rendered by non-for profit organization. Sale of medical-surgical materials, equipment, items and technology to, and imports by a healthcare facility to be used in human healthcare services (the healthcare unit must have its corresponding Certificate of Exempt Purchases). Sale and import of goods for agriculture (must be bona fide farmer). Occasional sales of churches or religious organizations. Articles used in the tourist activity (not applicable to inventory, Certificate of Exempt Purchases needed). Import and sale of motor vehicles. Collection In general terms, all merchants (except, small businesses that possess a Small Business Merchant Certificate) must collect, as withholding agents, the VAT upon the sale of goods or upon rendering a taxable service. A Certificate of Exempt Purchases or Certificate of Exemption on Imports (for eligible manufacturing plants) may exempt certain merchants from collecting the VAT. Certificates The following Certificates and Certificates of Exemption will be available under the Bill: Merchant Certificate Any person who wants to conduct business in Puerto Rico must submit an Application for a Merchant Certificate. 4 of 7

5 The merchants will receive either the Merchant Certificate or the Small Business Certificate. Small merchants are merchants with less than $75,000 in gross sales. Any modification to the information originally submitted must be adequately notified within 30 days of the change. Certificate of Exempt Imports (for eligible manufacturing plants). The Certificate of Exempt Imports will be effective for 3 years. The application requesting this certificate must be submitted to the Department of the Treasury along with the required documents. This certificate allows manufacturing plants to claim the 0% rate upon the importation of goods for manufacturing. Certificate of Exempt Purchases. This certificate will be issued to eligible persons. Eligible persons for this purpose are: the US Government, any of the States, the District of Colombia and the Government of PR; hospital units; tourism business; and bonafide farmers. The certificate will allow merchants to acquire or import goods and services exempt from IVA. The merchant must submit the application along with the required documents to the Department of the Treasury. The certificate will be effective for 3 years. Eligible Merchant Certificate. A merchant whose annual gross volume exceeds $500,000 for the immediate prior 3 years or for the applicable period and 80% of its total sales are subject to a 0% IVA tax, qualifies to request an Eligible Merchant Certificate. The merchant must submit the application along with the required documents to the Department of the Treasury. This certificate allows the merchant to request a refund regarding certain overpayments of the VAT. Filing Requirements The following declaration and/or returns must be filed: Declaration of Imports This declaration must be submitted by anyone who imports goods to PR prior to the release of the property. IVA must be paid on introduction of the taxable goods. However, the goods imported will not be subject to VAT if the seller collected it in the sale. As with the SUT, merchants with a tax bond that cover the applicable tax will pay the tax along with the Tax on Imports Monthly Return. Tax on Imports Monthly Return This return must be filed by anyone who imports goods to PR through any means, including electronic means, postal service and air cargo. The Tax on Imports Monthly Return is due the 10th day of the month following the taxable event. IVA Monthly Tax Return All merchants, except merchants with a Small Business Merchant Certificate, must file the IVA Monthly Tax Return. The due date of the return is the 20th of the month following the collection of the tax. Small Business Informative Annual Return Merchants that possess a Small Business Merchant Certificate must file this return. The due date of the return is 60 days after filing the income tax return (including extensions). 5 of 7

6 IVA Credit In general terms, merchants (except Small Business Merchants) will claim a credit in the IVA Monthly Tax Return for the amount of the VAT paid during the month that is directly or indirectly related to the sale of taxable goods or services. Furthermore, a merchant that generates an overpayment for any month in excess of $10,000 may request a refund if during the same month in which it was generated: it is considered an eligible merchant (must possess an Eligible Merchant Certificate) or if it constitutes the third consecutive month in which an overpayment has been reflected in its IVA Monthly Tax Return. Regressivity Relief Eligible consumers may receive a payment (regressivity relief) on the last day of November, March and July (starting November 2015) to compensate for the regressivity of the IVA paid. In order to receive this payment, an eligibility application must be submitted, along with the required information and documents. The amount that will be received will be determined based on certain criteria. Transitional Rules Among the transitional rules the Bill establishes that the certificates issued under the 2011 Code will be effective until December 31, 2015, regardless of its prior expiration date. Nevertheless, applications to renew the certificates will not be accepted as of the effective date of the Bill, nor requests for new certificates under the Bill will be accepted until the official forms are issued. In addition, the SUT bonds effective as of April 1, 2015 will remain effective until its expiration date. Any credits available as of December 31, 2015, under the SUT provisions under the 2011 Code may be claimed as a credit in the subsequent IVA Monthly Tax Return. Moreover, the allowable credit to merchants with reseller's certificate for taxes paid on inventory or purchases for resale will be of 100% instead of the 75% limit, of the tax liability shown on the monthly return. In addition, the following exemptions that were applicable before will be eliminated effective April 1, 2015: funeral services, solar energy equipment, uniforms, and materials and text books. Note the Bill summarized above is currently under the legislative process and therefore it will be subject to changes. IRS Circular 230 Notice: To comply with several U.S. Treasury regulations, unless specifically stated otherwise in writing, any U.S. federal tax opinion that may be included in this communication and its attachments, is not designed or written to be used, and cannot be used, by anyone for the purpose of avoiding any tax penalties that may be imposed by the Internal Revenue Service (I.R.S.) or any other U.S. federal taxing authority or agency, or endorsing, advertising or recommending to another person any matter addressed herein. * Our opinion only considers tax aspects presented herein. Nevertheless, there can be additional factors to be considered in each particular situation. This publication is not intended to substitute advise of legal counsel. We encourage you to contact us or your tax advisor if you have any questions or need assistance regarding any of the matters presented herein. An attorney-client relationship with Pellot-González, P.S.C. cannot be formed by reading or responding to this communication. Such a relationship may be formed only by express agreement with Pellot-González, P.S.C. If you decide to contact us, please call (787) or by at taxes@pellot-gonzalez.com. This publication has been prepared for information purposes only and may constitute an advertisement under the law. Therefore, you may choose not to receive these messages from Pellot-González Tax Attorneys & Counselors at Law, P.S.C. by forwarding this message with the title Unsubscribe to gerena@pellot-gonzalez.com. 6 of 7

7 Luis M. Pellot-González, Esq. Janira Beltrán-Sellés, Esq., CPA Yadira Portalatín-Méndez, Esq., CPA, LLM Yaritza Portalatín-Méndez, Esq., CPA, LLM Marisel Valentín-Marquez, Esq., CPA, LLM Xiomara Del Toro-Díaz, Esq., CPA, LLM Valerie Beauchamp-Torres, Esq., CPA Neysha Natal-Castro, Esq. Ilia Pellot-Juliá, Esq. The Hato Rey Center, Suite Ponce de León Ave. Hato Rey, Puerto Rico Tel: (787) Fax: (787) Web site: * * * José Rivera Aquino, Tax Consultant 7 of 7