Puerto Rico Treasury Department Issues Regulations for Controlled Groups of Corporations and Related Entities

The Puerto Rico Treasury Department has released regulations to provide guidance on the application of the new rules for controlled groups of corporations and related entities included in the Internal Revenue Code for a New Puerto Rico. The regulations also provide guidelines on how to compute the regular tax and surtax in the case of a group of related entities, the requirement to submit audited financial statements and to clarify which corporations are not considered part of a controlled group of corporations.

“Controlled Group” and “Related Entities” Defined1

Under Article 1010.04-1 of the regulations, “controlled group of corporations” is defined as a parent subsidiary controlled group (with 80 percent ownership), a brother-sister controlled group and a combined group. Furthermore, pursuant to Article 1010.05(a)-1 of the regulations, “group of related entities” is defined as a controlled group of corporations. However, for these purposes, a parent subsidiary controlled group is one or more chain of corporations related through stock ownership with a common parent corporation in which the parent corporation owns at least 50 percent of one member of the group and all members of the group are owned, at least 50 percent, by other members of the group. In addition, the regulations provide various examples on how to determine which corporations are members of a brother-sister controlled group. The regulations also provide guidance for those situations in which one corporation may be considered a component member of more than one controlled group.

Computation of Normal Tax and Surtax

As a general rule, Section 1022.01 of the Code imposes a normal tax and surtax on all regular corporations. The normal tax for corporations (20 percent) is computed on the “net income subject to normal tax.” However, the surtax of 5 or 10 percent for corporations is computed on the “net income subject to surtax” (the normal tax net income minus the surtax deduction of $750,000 provided by the Code).

It is important to note that flow-through entities such as special partnerships, corporations of individuals, partnerships and limited liability companies treated as partnerships are not included in the definition of regular corporations. Therefore, they are not subject to the normal tax and surtax and are not included as members of any controlled group.

The regulations provide that when there exists a group of related entities, at the time of determining the applicable surtax, there should be taken into consideration the total sum of the normal tax net income (as if they were a single entity) of each corporation member of the group that is required to file a Puerto Rico income tax return. Furthermore, these entities will have a limited benefit of taking the surtax deduction of $750,000 only once as a group.

Based on the above, the members of a group of related entities must agree on the distribution of the surtax deduction of $750,000 among them. If the related entities cannot agree on an allocation, the amount must be divided equally by the number of corporations that are component members of the group. The agreement must be reported to the Department through the electronic filing of Form SC 2652, Deduction Distribution for the Surtax Computation—Related Group of Corporations.

Requirement to Submit Financial Statements Postponed

As a general rule, Section 1061.15 of the Code requires every business engaged in a trade or business or engaged in the production of income in Puerto Rico to submit audited financial statements with its income tax return when the volume of business during the taxable year is greater than $3 million. The financial statements should be accompanied by an Auditor’s Report issued by a Certified Public Accountant with a license to practice in Puerto Rico.

Nevertheless, the Department has issued Information Bulletin 12-11 (IB 12-11) announcing that Administrative Determination 11-13 (AD 11-13) will remain in effect for taxable years commencing during 2012. This means that the requirement to submit consolidated financial statements has been postponed for another year. IB 12-11 also clarifies that the requirement to submit financial information for each member of the group is satisfied by filing Form AS 2652.1, Apportionment of the Deduction for the Additional Tax Calculation—Group of Related Corporations. Also, AD 11-13 provides that if an entity is required to file consolidated financial statements for having a combined volume of more than $3 million, and its separate volume of business exceeds $1 million, it must file an audited financial statement for its individual activity alone.


1 Note that the terms “controlled group of corporations” and “group of related entities” are used for different purposes within the Code. “Group of related entities” is used more often and affects such items as the corporate income tax calculation and when audited financial statements are required. For “controlled group of corporations,” an 80 percent ownership test applies. For the broader concept defined as a “group of related entities,” a 50 percent ownership test applies. Thus, an entity that is owned 60 percent is considered part of a “group of related entities” but is not a part of a “controlled group of corporations.

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