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Individuals that are United States citizens are subject to federal income taxes on their worldwide income. However, by virtue of Section 933 of the IRC United States citizens that are bona fide residents of Puerto Rico during the entire taxable year (the “933 Individual”) are exepmt from the federal income taxes imposed by the IRC with respect to income derived from sources within Puerto Rico. The AJCA made substantial changes to the provisions dealing with the residency requirements for 933 Individuals in order to be considered bona fide residents of Puerto Rico. The AJCA also conferred to the IRS and the Treasury regulatory authority to provide specific exceptions to the sourcing rules for the 933 Individuals.
A. Generally
The Temporary Regulations provide rules for determining whether an individual is a 933 Individual pursuant to the provisions of the AJCA. The Temporary Regulations went further and provided rules for determinig whether certain dividends, interest and gains are considered as derived from sources within Puerto Rico in addition to providing conduit rules to prevent the avoidance of United States federal income taxes through certain arrangements.
B. Residency in Puerto Rico
The Temporary Regulations specify that only a natural person may quality as a 933 Individual. Therefore, the exclusion under Section 933 of the IRC is not applicable to Puerto Rico corporation, partnerships, trust or estates.The AJCA amended the IRC to provided that in order to be considered a 933 Individual, the individual must satisfy the Presence Test, the Tax Home Test and the Closer Connection Test.
1. Prsence Test
Section 937 of the IRC provides that a 933 Indivdual must be present for at least 183 days during the taxable year in Puerto Rico. It also confers to the IRS and Treasury with the authority to provided exceptions and safe harbors in order to comply with the Presence Test.The Temporary Regulations allow that an individual would comlply with the Presence Test if he meets any of the following requirements:
(a) Was present in Puerto Rico for at least 183 days.(b) Was present in the United States for no more than 90 days.(c) Had no earned income in the United States and was present for more days in Puerto Rico than in the United States; or(d) purposes a “permanent connection” includes a permanent home an current registration no vote in the United States buy excludes a valid license conferred by a political subdivision or having relatives in the United States that are not spouse or dependents.
For purposes of complying with the Presence Test the following days are not taken into account: (1) any day an individual is prevented from leaving the United States because of a medical condition that arose while the individual was present in the United States; (2) any day that an individual is present in the United States as a professional athlete to compete in a charitable sports event; (3) any day that an indivual is in transit between two points outside the United States and is physically present in the United States for Fewer than 24 hours; (4) any day that an individual is temporarily in the United States as a student and (5) in the case of an individual who is an elected representative of Puerto Rico, or who serves full time as an elected or appointed official or employee of the governement of Puerto Rico any day spent serving Puerto Rico in such role.
2. Tax Home Test
The 933 Indiviual’s Tax Home may not be located outside of Puerto Rico. An individual’s Tax Home is considered to be located at the individual’s regular or principal place of business or the individual’s regular place of abode in a real and substantial sense.
3. Closer Connection Test
The individual mus not have a closer connection to the United States or a foreign country than to Puerto Rico. A facts and circumstances analysis is used in determining whether an individual has a closer connection to the United States or to foreign country than to Puerto Rico.
C. Income from Puerto Rico Sources
1. Conduit Arrangements
The Temporary Regulations provide that income derived pursuant to certain plan or arrangements will be cosidered from sources in the United States and thus, not excluded under Section 933. In order to be considered a Conduit Arrangement, the plan or arrangement must consist of the following (a) the income is received in exchange for consideration provided to another person; and (b) such person (or another person) provides the same consideration (or consideration of a like kind) to a third person in exchange for one or more payments constituting income from sources whithin the United States. These special conduit arrangement rules would apply in addition to any other applicable conduit rules under the IRC. 1
2. Gains from Dispositions of Certain Personal Property
Generally, gain derived from the sale or other dispositions of certein personal property by a 933 Individual is considered from Puerto Rico sources and therefore excluded for federal income tax purposes. Pursuant to the Temporary Regulations gains derived by a 933 Individual that for any of the preceding 10 years was a citizen or resident of the United States (other than a bona fide resident of Puerto Rico) will be considered from United States sources if the personal property was owned before such individual became a 933 Individual. 2
3. Dividends Souring Rules
Generally, dividens distributed by a corporation organized under the laws of Puerto Rico derived by a 933 Individual were treated as income from Puerto Rico sources. The Temporary Regulatons limit the amount of dividends from certain Puerto Rico corporations that may be treated as income from sources within Puerto Rico. The Temporary Regulations generally provide that dividends received by a 933 Individual that owns directly or indirectly at least 10% of the voting stock of Puerto Rico coporation will be treated as derived from sources within Puerto Rico only with respect to an amount equivalent to the ratio of income from Puerto Rico sources derived from sources within Puerto Rico sources derived by the corporation bears to the total gross income of the Puerto Rico corporation for the 3 year period ending with the end of the taxable year in which the dividend is paid.However, the Temporary Regulations provide that the total amount of the dividends received from a Puerto Rico corporation wil be considered from Puerto Rico sources if the following two conditions are met: (a) that 80% or more of its gross income is derived from Puerto Rico sources or was effectively connected with the conduct of a Puerto Rico trade or business and (b) 50% or more of the gross income of the Puerto Rico corporation was derived from an active conduct of a trade or business within Puerto Rico. The income derived by corporations where the Puerto Rico corporation directly or indirectly owns at least 255 of its stock will be taken into consideration for purposes of applying these rules.3
4. Interest Sourcing Rules
Generally, interest received from corporations organized in Puerto Rico was considered from sources within Puerto Rico. The Temporary Regulations provide that interest received by a 933 Individual from a Puerto Rico corporation where the 933 Individual owns at least 10% of the voting stock will be considered from sources within Puerto Rico to the extent that the interest received is allocable to assets that generate, have generated or could reasonably have been expected is allocable to assets that generrated or could reasonably have been expected to generate income from sources within Puerto Rico or effectively connected with the conduct of a Puerto Rico trade or business. However, the total amount of the interest derived from Puerto Rico corporation will be considered from Puerto Rico sources if the following two conditions are met: (a) that 80% or more of the Puerto Rico corporation’s gross income is derived from Puerto Rico sources or was effectively connected with the conduct of a Puerto Rico trade or business; and (b) 50% or more of the gross income of the Puerto Rico corporation was derived from an active conduct of a trade or business within Puerto Rico. 4
D. Reporting Requirements
1. Organization of a Puerto Rico Corporation
Section 6046 of the IRC generally requires that every United States person must file a return with the IRS upon the acquisition of stock in a foreign corporation equivalent to 10% or more or becomes an officer or director of a foreign corporation. The Temporary Regulations porvides that a 933 Individual will not be considered a United States person for purposes of Section 6046 reporting requirements to the extent that the total amount of the dividends derived from the Puerto Rico corporation are considered from Puerto Rico sources under the rules explained herein. 5
2. Change of status as a 933 Individual
The Commissioner will prescribe through a notice, form or other publications the time and manner of reporting a change to or from the status as a 933 Individual.