Puerto Rico will soon be replacing its existing state-level sales and use tax with a value added tax (VAT) system. Despite early indications that the transition would be delayed, the government has indicated that the implementation will take place in two major phases on April 1 and June 1, 2016. The VAT will be assessed at a rate of 10.5 percent, with an effective total tax rate of 11.5 percent on many transactions when combined with the municipal sales and use tax of 1 percent.
In early 2015, the Puerto Rican government drafted H.B. 2329, a bill for comprehensive tax reform in Puerto Rico, to address the territory's budget deficit. This legislation sought to reduce certain income tax rates and phase in a VAT, the Impuesto de Valor Añadido (IVA). Although the initial bill was voted down, a subsequent bill imposing the IVA, H.B. 2482, was signed into law as Act 72-2015 on May 29, 2015.
Act 72-2015 provided for the phased implementation of several tax reforms, including raising Puerto Rico's state-level sales and use tax, the Impuesto sobre Ventas y Uso (IVU), from 6 percent to 10.5 percent, effective July 1, 2015. The 10.5 percent state IVU is levied alongside the existing 1 percent municipal IVU, making the effective tax rate 11.5 percent under many circumstances. In addition to raising the state IVU rates, Act 72-2015 created a new statutory IVU, applicable to business-to-business (B2B) services, and transactions involving certain designated professional services. This statutory IVU is imposed at a rate of 4 percent from October 1, 2015 until March 31, 2016, or the last day before implementation of the IVA. Transactions subject to the 4 percent statutory IVU are not subject to the 1 percent municipal IVU.
The IVA proposal in Act 72-2015 was initially met with some skepticism. However, the Comisión de Alternativas para Transformar el Impuesto al Consumo (CATIC), a committee designed to review the proposal, concluded that the IVA is a favorable alternative to Puerto Rico's previously imposed excise tax. CATIC noted that the required excise tax rate to achieve comparable revenue projections to current regulations would be between 19 percent and 38 percent, compared to the VAT/IVA rate of 11.5 percent. Skepticism was further reduced in December 2015 when the Puerto Rico Treasury Department issued Administrative Determination AD-26, affirming the implementation of Puerto Rico's IVA.
Implementation of VAT in Puerto Rico
VAT – General Mechanics
Like a sales tax, a VAT is a transaction tax. While a sales tax is imposed only on retail purchases, a VAT is typically assessed at every step of the supply chain. For instance, when importers and manufacturers purchase goods and materials, they generally pay VAT on these expenditures. When those goods are later resold to retailers, the importers and manufacturers collect VAT from the purchasers on the sale price. The importers and manufacturers then take a credit against the VAT collected on the resale in the amount of the VAT paid on the initial purchase. This process repeats when retailers sell goods to consumers. Consumers pay VAT to the retailers on the final sales price, and the retailers receive a credit for the VAT that they paid on their initial costs. Consumers do not receive credits for VAT since they are the final recipients of the goods and services.
Implementation of IVA
On December 29, 2015, the Department issued Administrative Determination AD-26, which affirms the implementation of Puerto Rico's IVA and outlines the implementation process in two stages. The first stage of implementation begins on April 1, 2016 when the IVA goes into effect. Merchants will be required to register with the Department and file a monthly return. This monthly form will be due by the 20th day of the month following the collection of the VAT. The first due date is May 20, 2016. Failure to register with the Department prior to conducting business could result in penalties up to $10,000. The IVA rate will be 10.5 percent, applicable to both goods and services. Services formerly subject to the 4 percent statutory tax mentioned above will be subject to the new IVA at the 10.5 percent rate. For some transactions, however, such as the sale of goods or services for export and certain sales to qualifying manufacturers, the IVA rate will be 0 percent.
Merchants with gross sales under $125,000 will be able to obtain a certificate exempting them from the collection and filing requirements. This classification is only for VAT purposes; small merchants will continue to be subject to the 1 percent municipal IVU unless otherwise exempted.
The municipal IVU of 1 percent will continue to be applicable in addition to the 10.5 percent VAT for many transactions, meaning that the effective tax rate will often be 11.5 percent. B2B transactions and transactions involving designated service professionals previously subject to the 4 percent IVU will continue to be exempt from the 1 percent municipal IVU.
A new online tool, the Sistema Unificado de Rentas Internas (SURI), will be made partially available by April 1, 2016. Over time, this tool seeks to integrate all of Puerto Rico's existing tax systems into one application. Initially, SURI will complement the existing PICO system used for payment of sales and use taxes. SURI will be used for registrations with the Department and will also be the source for the monthly VAT return, or Planilla Mensual de IVA. Taxes from collections relating to designated professional services and B2B services performed before April 1 but collected between April and September 2016 will be reported using the PICO system.
The second stage of IVA implementation occurs on June 1, 2016. This is the last day that IVU eligible reseller certificates will be valid. Other IVU certificates will remain valid until IVA certificates are issued by the Department. This is also the time at which taxpayers will be able to begin applying for refunds of IVA overpayments.
Exempt and Excluded Transactions
While the IVA is levied on all non-exempt sales of goods and services, the definitions of the terms "goods" and "services" exclude several categories of transactions, such as transactions involving utilities like electricity and water, and those involving investments in currency, stocks and bonds, and intangible assets (except for computer software). Other examples of exclusions include blood and human organs, alcohol stored in bonded warehouses under certain conditions, and transactions involving property owned by the U.S. or Puerto Rican governments.
In addition to the exclusions above, a substantial number of exemptions are available for a wide range of industries. A partial list of the available exemptions includes transactions involving financial services, food and agriculture, certain consumer goods, and real property. Additionally, a number of healthcare-related exemptions are available for the sales of prescription medicines and articles for treatment of health conditions; sales and services qualifying for reimbursement under Medicare, Medicaid, or Puerto Rico's government insurance plan; sales of articles to assist the disabled; and certain sales to hospitals.
Exemptions also exist covering certain unprepared foods and ingredients, sales to bona fide farmers, printed books, certain education and childcare services, certain hotel-related transactions, and the sale of petroleum products. Likewise, transactions involving not-forprofit organizations, sales of solar equipment, and repairs and maintenance pertaining to aircraft also are eligible for exemption.
Taxpayers are generally unable to claim credits for VAT paid on purchases of goods or services that are related to subsequent exempt transactions. Taxpayers may, however, claim a credit for IVA paid on purchases of goods or services that are related to subsequent transactions subject to the 0 percent rate. Accordingly, it is important that taxpayers differentiate between exempt and excluded transactions and those subject to IVA at the 0 percent rate.
In order to claim a credit for VAT paid, purchasers of goods or services subject to IVU must collect from vendors a fiscal statement, or "comprobante fiscal." The fiscal statement will include, among other information, a description of the goods or services purchased, the price of the goods or services, and the IVA invoiced. This statement is provided to the buyer by the seller and is used in determining the credit for IVA paid. For retail sales, fiscal statements are not required, but a receipt or invoice showing IVA as a separate line item is required. Fiscal statements are also not required for 0 percent transactions, exempt transactions and transactions involving small merchants.
Additionally, to the extent that the price of a transaction increases or decreases after a fiscal statement is issued (because of a return of merchandise, discount applied, or price change, for instance), a taxpayer's IVA obligations may consequently increase or decrease. In instances where the value of the sale disclosed in the fiscal statement is reduced, the vendor must issue a credit note to the purchaser. Conversely, when the value in the fiscal statement is increased, the vendor must issue a debit note. The credit or debit note must include, among other information, the original and adjusted price, the change in the VAT obligation, and a description of the reasons for adjusting the value of the fiscal statement.
The Department has indicated that additional guidance will be released regarding the IVA. This guidance will likely include more information related to new forms for required certificates, additional information regarding the portal system used for filing reports, and clarification of the technical regulations. Taxpayers impacted by the IVA should monitor the Department's website for additional updates.
The comprehensive tax reform enacted by Act 72-2015 will impact nearly every business operating in Puerto Rico in a myriad of ways. Among the most important items that businesses should consider are:
- Classification of transactions and applicable tax rates;
- Integration of new invoice and disclosure requirements into an existing information technology infrastructure;
- Impact and applicability of VAT on new and existing contractual agreements; And
- Impact of VAT changes on human resources and staffing processes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.