Puerto Rico’s Tax Benefits- ‘The Better Florida’

tax PRPuerto Rico promises to now do for Americans what Singapore and Hong Kong have done for bankers and businessmen from London. In this interview with The Gold Report, three experts with in-depth knowledge of the pros and cons of living and investing in Puerto Rico share what it is like on the ground for investors.  InternationalMan.com Senior Editor Nick Giambruno and Casey Research Chief Technology Investor and Puerto Rico resident Alex Daley join Sterne Agee’s Managing Director of Equity Research Todd Hagerman in clearing up some of the confusion about this “misunderstood” island and why the tax benefits for Americans make it “The Better Florida.”


Source:  The Gold Report

 

The Gold Report: Alex and Nick, you just co-authored a report on Puerto Rico titled “Pocket Enormous Tax Savings in Puerto Rico.” Can you give us a rundown on the tax incentives in Puerto Rico?

Alex Daley: Sure. The first thing your readers should understand is that for Americans, this is truly a unique option and a tremendous opportunity for the right people.

Puerto Rico recently passed what are known as Act 22 and Act 20, or the Individual Investors Act and Export Services Act. They allow new residents of Puerto Rico to be completely exempted from Puerto Rican taxation on their capital gain, dividend and interest income. And the Export Services Act levies a top 4% tax rate on earnings from businesses that perform services, like professional consulting, asset management, research and development, computer programming, and so forth, in Puerto Rico for clients outside of Puerto Rico.

Before Puerto Rico’s new laws, it was immensely difficult for Americans to take advantage of incentives like these. For decades, programs in countries like Panama and Singapore sought to attract investors with tax breaks—but Americans couldn’t take advantage of them. Unlike countries in Europe, Asia and Canada, American nonresident citizens are taxed on their worldwide income. The only exceptions have been in far smaller jurisdictions—never before in a country with the modern infrastructure and a deep labor pool that Puerto Rico offers.

Todd Hagerman: In addition to Acts 20 and 22, the International Financial Center Regulatory Act, referred to as Act 273, is specifically designed to attract foreign investment outside the U.S.

Nick Giambruno: When I first heard about these tax incentives, I thought for sure it had to be something that was too good to be true. This motivated me to dig deeper. After extensive research, it became clear that the benefits were not an illusion and were 100% legitimate. For many Americans, including individuals operating on a modest scale, they are a huge opportunity that could really be game-changing. They’ve already helped a couple of my colleagues at Casey Research, like Alex.

TGR: Alex, tell us your rationale for moving to Puerto Rico. How is life there working out for you?

AD: I was no stranger to Puerto Rico and had been to the island a number of times previously. I had long been considering relocating to the Caribbean. Of course, Act 20 and Act 22 were a huge draw, but so is the tropical weather, beautiful white sand beaches, lower cost of living and the adventure of all of it. Just like everywhere else, of course, Puerto Rico has its negatives. Make a decision like mine and inevitably you will hear something about the crime. But to extrapolate these statistics to the entire area is a mistake. It would be similar to not moving to Michigan because there is crime in Detroit. Like any state with a dense metropolitan area, there’s crime in some areas. If you steer clear of those areas or take the same precautions you would in any big city around the world, you’ll be fine. In fact, one of my colleagues lives right on the beach in the touristy Condado neighborhood and just loves walking to the nice restaurants. For me, the more far-flung areas of the large island were more of a draw.

TGR: What makes these incentives in Puerto Rico different from, say, the Cayman Islands or other low-tax jurisdictions?

AD: It has better infrastructure, more familiar goods from home and because the U.S. is the only country that taxes its nonresident citizens on their income no matter where they live and no matter where they earn their money, it has huge tax benefits. This means that while a Canadian could relocate to a place like the Cayman Islands and pay zero tax, an American could not. The American would still have to pay taxes anywhere in the world by virtue of his citizenship; for Americans there really was no escape. . .until now.

NG: Yes, that’s exactly right. Because Puerto Rico is an unincorporated territory of the U.S., it’s not quite a state and not quite a foreign country; it’s a commonwealth. This arrangement allows it to have a unique tax situation. Namely, Puerto Rican residents who derive their income from Puerto Rican sources do not pay taxes to the U.S. government—they pay them to the Puerto Rican government. The same is true of the U.S. Virgin Islands, for instance, in a state of affairs that has been all but unchanged since the 1950s. Combine this commonwealth status with the new tax incentives, and mainland American citizens have a window to legally lower some of the burdens of U.S. taxation. There isn’t another jurisdiction in the world that offers such an opportunity for Americans. You can obtain most of the tax benefits of renunciation without giving up your U.S. passport.

TGR: Why would Puerto Rico want to make such an attractive offer to new residents?

NG: Quite simply, the Puerto Rican economy needs it. The island needs to boost its economy to reduce its debt burden, and that’s what gave impetus to Act 20 and Act 22. So in that sense, Puerto Rico’s economic troubles are a blessing in disguise. Puerto Rico is no novice at sculpting tax rules to attract foreign investors and expatriates. For decades, the country has offered tax incentives to many types of businesses, especially manufacturers, which is why today you’ll find plants belonging to Praxair (PX:NYSE), Merck (MRK:NYSE), Pfizer (PFE:NYSE) and other big names dotting the island’s interior. However, after watching India attract knowledge workers and Singapore attract asset managers, it was glaringly obvious that it could up its game and bring in less environmentally impactful businesses. After all, the populace is better educated, speaks English more fluently as a whole and doesn’t have to man the graveyard shift to work with American customers due to time-zone differences. So, the government set out to attract service businesses.

TGR: Is it working? Are people taking advantage of the benefits, moving to Puerto Rico and opening businesses?

TH: The intended outcome hasn’t been realized to this point. I think that part of the challenge is that Puerto Rico has been having a difficult time publicizing and promoting the various tax incentives, and, at this stage of the game, while the incentives were clearly designed to attract foreign investment largely in the manufacturing sector and facilitate job creation, they really haven’t lived up to expectations. Those who have participated have been largely professional investors who put money into properties, assets and other types of alternative investments to take advantage of the act. Unfortunately, those investments, while they create tremendous tax incentives for the investors, don’t create the jobs.

TGR: So will the government keep the incentives in place?

TH: It will. The legislation has been extended several times, and I believe it will continue to be extended until the government feels it is on more solid ground from both an economic standpoint, as well as an employment standpoint.

TGR: Couldn’t the U.S. government force Puerto Rico to change its tax incentives?

AD: Of course the U.S. government could pressure the government here, but it likely wouldn’t affect those who have already obtained the benefits. Such an action would just close it off to new participants. But we believe that is unlikely. The U.S. government understands that Puerto Rico needs to boost its economy to help it address its debt problem. Act 20 and Act 22 help the island do just that. The last thing that the U.S. government wants is a disorderly default or to have come to the rescue in the form of an unpopular bailout. As of right now, it looks like Act 20 and Act 22 are here to stay.

NG: There’s also the issue of Puerto Rico becoming the 51st state or its legal status otherwise changing. That would also be something that would end the tax incentives. However, this issue has languished for decades; the Puerto Ricans themselves are divided—some want statehood, some want the status quo, and others want complete independence. I think it is very unlikely that Puerto Rico’s current commonwealth status will change any time soon.

TGR: Todd, you said in a recent industry report that Puerto Rico’s economic activity is stabilizing. What specific steps have had the most success in slowing the year-over-year decline in Puerto Rico?

TH: There are a couple of different things. Puerto Rico typically changes administration every four years and there is a strong correlation with declining economic activity post the election year. That is often the result of the incumbent increasing spending to improve chances of getting elected. As usual, after the last change in administration a couple years ago, we immediately saw a drop off in economic activity compared to the election year.

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TGR: Are some of the reform measures, like pension reform and passing a neutral budget, working to improve the economy?

TH: It remains to be seen. Clearly, part of the stabilization in the economy right now reflects the fact that the employment participation rate continues to tick higher. Revenues are exceeding government expectations, largely through the immediate implementation of the corporate tax hike in July. But we probably won’t see the full impact of austerity measures on consumers and small businesses until the latter part of 2014, after we’ve had a full year of the budget.

TGR: Are there any publicly listed stocks with exposure to Puerto Rico worth discussing?

NG: If you want to get exposure to Puerto Rican stocks through your brokerage account you don’t have many options. You are basically limited to investing in Puerto Rican retail banks listed in New York. There are four such banks that most investors look to for exposure to Puerto Rico: Popular Inc. (Banco Popular) (BPOP:NASDAQ), First Bancorp (FBP:NYSE), Doral Financial Corp. (DRL:NYSE) and OFG Bancorp (Oriental Bank) (OFG:NYSE).

If you wanted to make a bullish bet on Puerto Rico, Banco Popular is your safest choice. It’s by far the largest retail bank on the island. It will likely be a primary beneficiary from any economic activity spurred by Act 20 and Act 22. Banco Popular has a market cap of around $3 billion, ample liquidity, a healthy Tier 1 capital ratio of 19.2%, a relatively low nonperforming loan ratio of 2.5% and is trading at 68% of its book value.

If you are more of an extreme contrarian or crisis investor, you may want to check out Doral Bank. It is one of the island’s primary mortgage providers and took a huge beating last quarter as its loan book deteriorated in tandem with the general economy.

Doral’s stock is down around 45% year-to-date—near 10-year lows—and is only trading at a mere 15% of its book value. Its nonperforming loan ratio is 11.3% and its Tier 1 capital ratio is 9.7%. It’s definitely a very risky proposition, but it could be an interesting play for speculators looking to profit from a potential economic upturn in Puerto Rico.

TGR: Todd, you have three of Puerto Rico’s banks as Buys. What are the individual catalysts for each company?

TH: The banks on the island were some of the most troubled institutions as we went through the financial downturn a few years ago. The banks in Puerto Rico were treated differently during the bailout than their U.S. counterparts. After a six-year recession, we are finally starting to see an inflection point where the credit quality at these institutions is becoming more manageable, bank capital levels have reached all-time highs and liquidity levels have improved. The underlying financial footing of each of the banks in Puerto Rico is significantly stronger than where it was only a couple years ago.

That said, these banks continue to operate under pretty close supervisory scrutiny from the various banking regulators. But we’re at a point where, with credit quality becoming more manageable, companies such as Banco Popular and First Bank are in a position to exit their various regulatory agreements. Banco Popular also has Troubled Asset Relief Program (TARP) debt that was provided from the Department of the Treasury during the downtown, and it is now in a position to repay that debt. All of these issues would be positive not only for the individual banks but also collectively. It’s signaling to investors that the banking authorities are now more comfortable with the financial condition of these companies and Puerto Rico’s economy.

TGR: For Banco Popular, is the improvement in the credit quality the most important factor?

TH: It is. The biggest problem asset class that each of the banks has in Puerto Rico is residential mortgage assets. Similar to the U.S., Puerto Rico has been experiencing a modest rebound in housing, particularly at the lower end of the market. Puerto Rico lagged the U.S. both in the recovery, as well as the downturn. This is certainly not a surprise, but we are seeing ongoing housing improvement. Thus, the banks are becoming that much healthier as we go forward.

TGR: Oriental Financial Group is also processing a merger. How is that going?

TH: Oriental was able to do what we consider to be a transformational merger with Banco Bilbao Vizcaya Argentaria S.A. (BBVA:NYSE). That purchase from the Spanish parent company effectively doubled the size of Oriental, giving it a meaningful delivery channel in the form of branches that it didn’t have before. It also provided much-needed diversification to its loan portfolio and its balance sheet so it looks more like a commercial bank than what we’ve seen in Puerto Rico in the past.

TGR: Do you have a favorite of the three?

TH: I think each one has a fair amount of upside from current levels, but Banco Popular is the one name that stands out. It is now in a great position to move forward by exiting the regulatory orders and repaying the TARP funds. That could have a meaningful impact on the stock price to the positive in the very near term. Once that happens, it’s going to send a very positive message to investors as a whole and have a residual benefit to the other banks on the island.

TGR: Do you have any final advice for investors who are either thinking of moving to the island to take advantage of some of the tax benefits or investing in Puerto Rico?

TH: Puerto Rico has long been a very interesting market, but it is also a very misunderstood market because of its commonwealth status. Many U.S. investors are unfamiliar with the laws and how that may impact them as an individual or as a company. But it has a lot of potential, particularly from a manufacturing standpoint. It has a tremendous education system, infrastructure to support a fair amount of growth and programs that have been put in place to stimulate investment and the economy, and underlying job growth. So I think we’re in the early innings, but the base has been set for growth going forward. It’s just going to take some time.

TGR: Thank you all for your insights.

Learn more at the Puerto Rico Investment Summit April 24–25 or access The Casey Research Guidebook to the tax advantages of residing in Puerto Rico. To contact some of the investors who have made the move and ask questions, simply email QandA@streetwisereports.com.

Nick Giambruno is senior editor at InternationalMan.com. He has lived in Europe and worked in the Middle East. Most recently in Beirut and Dubai, where he worked as a research analyst covering Middle East and North Africa equities for an investment bank. Giambruno is a CFA charterholder and holds a bachelor’s degree in finance, summa cum laude.

Alex Daley is the senior editor of Casey’s Extraordinary Technology. In his varied career, he’s worked as a senior research executive, a software developer, project manager, senior IT executive and technology marketer. He’s an industry insider of the highest order, having been involved in numerous startups as an adviser to venture capital companies. He’s a trusted adviser to the CEOs and strategic planners of some of the world’s largest tech companies. And he’s a successful angel investor in his own right, with a long history of spectacular investment successes.

Todd Hagerman joined Sterne Agee in March 2011 to lead the firm’s research coverage of the commercial banking sector, primarily focused on U.S. multinational and regional banks. Prior to joining Sterne Agee, Hagerman was head of regional bank equity research at Credit Suisse Securities (USA), where he focused on the regional banking sector. Prior to joining Credit Suisse in 2007, Hagerman spent eight years as a senior banking analyst at Fox-Pitt, Kelton in New York and well more than a decade at the Federal Reserve Bank, which encompassed various roles in bank supervision and regulation at both the Federal Reserve Bank of New York and Federal Reserve Bank of San Francisco. His work at the Fed included various management positions in bank surveillance and review, bank examinations, and policy and special studies. Hagerman holds a Bachelor of Science in finance and economics from the University of Arizona and received his Master of Business Administration from the Marshall School of Business at the University of Southern California.

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4) Alex Daley: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.

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Comments

  1. Meh …. it’s still Puerto Rico. More corrupt than the States and crazy high crime rate.

    • I live in Puerto Rico ask me anything.

      The crazy crime rate is like anywhere in the world. If you go to the wrong places your probability of crime rate is HIGHER. The people killed here are because of ilegal drugs. If you don’t mess with ilegal drugs or go to places where they sell drugs. You will be MORE than fine.

  2. PR is crashing   $50 billion in debt, bond ratings junk. The government is so broke they are sending out tax nazis to check on businesses not collecting sales tax.  $20,000 fine for not collecting the tax.   25% of economy is underground.  Yeah, just what you want. Another tax gulag.  The banksters (you know who) have demanded that the taxes be raised to pay the bankers the interest on the debt.  Not a good situation  Puerto Ricans are moving to Florida to escape the tax gulag.
     
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    • The underground economy thrives here; I will give you that.
      The politicians are corrupt (where can I find a country with no corrupt politicians?).
      Loaded with debt, I agree… We have learned very well from you guys! ;)
      “Sending nazis to check on business not collecting tax”… I have yet to see these nazis… and I have lived here for all of my life. Born and raised.
      If you want a 7% discount on any **LOCAL** business… just say that you are paying cash… and 90% of the business will gladly take the cash and you will not have to pay the 7% sales tax (IVU it’s the sales tax name).

      As some people in Puerto Rico might say… “we have the best of both worlds”. No income tax, tropical island and the benefits of the American imperialist petrodollar.

      Until the music stops, Puertoricans are having a party and they have no idea.

      When the collapse happens, Americans are going to suffer but Puertoricans… HA. Wait till they hear that they have to start working.

      The real problem in Puerto Rico is that 40% live off the government WELFARE. Most news outlets talk about the bad puertoricans but the other 60%… they work really hard.

      You can trust what I say or trust the propaganda machine that spews out only the negative side of this American paradise.

      I will respond no BS, no filter if you want to know more about Puerto Rico.

  3. Whenever I think about Puerto Rico, an image of a can of spray paint comes to mind…

  4. I lived in PR for twelve years, and retired there.  Had to leave.  Why?  Because Uncle took my $$$$, Commonwealth took my $$$$ and finally, I said Adios. 
    Scott:  What you say is true.  One thing you don’t mention is the TRAFFIC.  It makes California look like a “walk in the park”.  Miserable with a capital M.  And as  for those walks in the park, that park better be adjacent to your house, street, or casario, or else you’ll need “something” to get you to and from.  And of course, in PR, the bad guys have the guns. Period.
    As for the percentage of the “folks” on the government teat, its a lot more like 80%, that’s one reason why the island is crumbling financially.  And the “takers” start much younger than in the U.S.  It seems like most have a “contact” in the SSA or VA, so its not a problem getting those checks rolling in when they are in their 20s and 30s.

    • I don’t know where you lived. You probably lived in the suburbs because if you live in the capital you don’t have any traffic problems.

      I don’t agree with your statistic but I respect your opinion.

  5. scott  thanks for the intel   the two points that i mentioned were taken from another subscription newsletter.  This paper reported the tax nazis hired 200 inspectors, some covert, going to businesses to try to get the business owner to accept a sale without the sales tax.  The AG prosecuting the business owners forces a min fine of $20,000.
    He said there was about $80 million in fines and taxes unpaid.  
    I much prefer to ask my local business owner if they want to have a conversation without the governor—aka the highest tax nazi in the food chain. When I hear about the gummint going after business people trying to make a living so that the gummint can overspend a country into bankruptcy. It sounds too much like Greece or Cyprus Bail ins and foreclosures.

    Nothing against the people. Alot against the state and its insolvency

    The banksters in NY are salivating over the prize of being paid on their loans to PR and probably getting a chunk of the inland if PR defaults on its $50 billion in debt.
    Whether it’s PR or Nevada, tax nazis are on the move.  The nevadan patriots straightarmed the BLM gestapo army by force of arms and sent them packing.  
    cheers scott   from what I’ve heard you live in a really beautiful place.

    • Fines are crazy here if you are proven to be evading taxes. $10,000 a day if I am not mistaken. For businesses anyway.

      The $80million in fines and taxes is probably a WAY WAY WAY understatement.

      The people here believe in “es mejor pedir perdón que pedir permiso”… which means that it’s better to say I’m sorry than to ask for permission.

      Every couple of years the government gives people a “I forgive you” incentive where they give discounts on the debts. This happens in almost all the taxes, fines for almost all industries etc etc.

      I have a friend that had over $3,000 in traffic tickets and waited for 5 years and then the government gave a 30% discount on traffic tickets + the interest accrued on that debt and THEN he paid.

      People in Puerto Rico are mostly very street savy and hustlers. A lot of sweet talking goes on. Which is why we can seduce any woman we want! HA. :)

      If you find a hard working Puertorican (which is rare) it can be the best blessing for any business. Go through the bullshit to get those gems. They are TOTALLY worth it!

  6. now you’re talking scott.   people power

  7. I have nothing against PR or any other place but… when the SHTF, is it a good idea to be on an island that imports a lot of things that make life there reasonably good?  Personally, I would not want to live on ANY island unless it was mostly self-sufficient.  I might make an exception for Australia, given its large size, small population, and considerable food production capacity.  Hawaii is beautiful too but will fare very poorly if imports stop coming in for any reason.  While no place is immune to a reduction in imports, a large country with a strong farming tradition will fare better than smaller ones that must import all of their fuel and most of their food.  I like them but can live without bananas, coconuts, pineapples, and mangoes.
     

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