Understanding the Proposed Changes To the Puerto Rico Consumption Tax System
On February 11, the Governor of Puerto Rico introduced PS 1304. The intent of this bill is to fundamentally change the Puerto Rico tax system. According to the Governor, dramatic change is necessary as the current tax system is considered to be rife with loopholes and distortions that prevent the raising of necessary revenue and trumps the growth of local businesses and the economy. In a nutshell, the proposed law would significantly reduce personal and corporate income tax, eliminate the existing state and local sales tax, and replace the lost revenue with a Value Added Tax (VAT). The new VAT would become effective April 1, 2015. In this blog entry, we will discuss some of the interesting points of the new proposed Puerto Rico VAT.
Tax Base: VAT would apply to the supply of all goods and services except those exempt under the law. Some important exemptions are detailed below.
Tax Rate: The standard VAT rate of 16% would apply to all local sales of taxable goods and services. A 0% rate would apply to exports. The proposal does not identify any zero-rated products.
Taxpayer Defined: The consumer/buyer of local taxable goods and services is considered responsible for the payment of VAT. However, the proposal imposes on the seller the obligation of withholding such tax from the buyer and remitting the same to the Treasury Department. While a seller may be also responsible for penalty and interests for VAT that is improperly collected or remitted, the proposal provides the Treasury Department with the authority to obtain VAT payments directly and/or concomitantly from the buyer. With respect to imports, the taxpayer is the importer of record.
Direct Pay Permits: Here, Puerto Rico is borrowing a feature from traditional sales tax systems. According to the proposal, the Secretary of the Treasury may grant direct pay authority to certain taxpayers/buyers. When a direct pay certificate is provided, the seller is relieved of the obligation to collect or remit VAT on an otherwise taxable supply. The concept of direct pay is not dissimilar to the reverse charge mechanism that applies in many VAT systems, except that reverse charge systems generally apply to certain types of transactions whereas direct pay permits are granted to certain qualifying entities. A buyer holding a direct pay permit would pay the VAT due on their purchases directly to the Treasury Department provided certain conditions established by law are satisfied.
Determination of the Tax Due: As is the case in other VAT systems, the proposal provides that the VAT paid on inputs (purchases), whether for machinery and equipment, raw materials or goods acquired for resale, may be deducted from the VAT collected on sales. However, the credits and debits necessary to calculate tax liability will vary based on the accounting method utilized for income tax reporting. For example, businesses using the cash method to report their income tax will be required to use the same method for calculating VAT liability. The same applies for accrual-based taxpayers.
Interestingly, there is a proposed provision which notes that in the case of credit sales when a buyer uses the cash method of accounting, the seller should not issue a buyer a fiscal invoice (needed for determining VAT inputs), regardless of the accounting method applied by the seller. In these instances, the fiscal invoice would only be issued when the buyer effectively pays for the item purchased along with the corresponding VAT due at the time of the supply.
Goods and services intended for consumption by the taxpayer would not be creditable against VAT collected on sales. That is, only the VAT paid on goods and services directly incorporated into the final product would be deductible. If a good or a service has a mixed use or purpose (e.g. self-consumption and/or resale), the VAT paid would be deducted in proportion to the percentage of total goods used for the deductible purpose.
Another interesting feature of the proposed VAT law would effectively eliminate the input VAT credit scheme and allow for qualifying manufacturers to purchase free of VAT any equipment, raw material and services needed in manufacturing goods or for sale.
Carry-Forward of Credits: In those periods where creditable VAT is greater than the VAT collected on sales, the excess credits may be carried forward by the taxpayer. If it is determined that excess tax was paid on inputs, the proposal allows for direct reimbursement to the taxpayer, assuming certain conditions are met.
Exemptions: The proposed VAT will maintain most of the exemptions that exist under the current sales tax rules. As such, the following goods and services would be exempt from VAT.
Expected Exempt Goods:
- Non processed food
- Real property
- Prescription medicines
- Drugs and medical equipment covered by Medicare or Medicaid
- Certain “certified” medical equipment
- Intangibles (as defined in the law)
- Gasoline and other petroleum based fuels or products except propane gas
- Motor vehicles, buses, trailers and trucks
Expected Exempt Services:
- Most financial services
- Leases of real property subject to the existing accommodations tax
- Student rental housing
- Health care
Expected Entity and Usage Based Exemptions:
- Occasional sales by churches and non-profit organizations
- Purchases of agricultural machinery and equipment made by bona fide farmers
- Purchases of goods and services by businesses certified by the Tourism Bureau
- Purchases and imports of medical equipment as well as surgical materials by hospitals
- Purchases of goods and services by the government and other public agencies
- Purchases made by certified exporters
- Sales made by businesses with gross revenues of less than $75,000 per year.
With respect to taxable sales to exempt entities, the proposal provides that an exemption will be contingent on the buyer presenting to the seller a valid Exemption Certificate as approved and provided by the Secretary of Treasury.
An interesting difference between the existing sales tax system and the proposed VAT is that most professional and educational services (except those provided by public institutions) will become taxable under the new VAT.
Invoice requirements: The proposal calls upon the Secretary of the Treasury to issueregulations specifying how the new VAT will be properly invoiced within the following requirements in mind.
- Business to Business (B2B) supply of goods or services for resale are required to be accompanied by a Fiscal Invoice that details the good or service being sold in addition to the amount of VAT applied. A fiscal invoice would generally be issued in all cases except when a sale is made on credit and the buyer uses a cash method of accounting.
- Businesses to Consumer (B2C) sales require the issuance of a bill with a VAT-inclusive price. Unlike other VAT scheme’s, the proposed law in Puerto Rico prohibits the VAT from being separately stated on a B2C invoice. Most other jurisdictions merely “allow” for VAT inclusive invoicing.
Filing the Tax Return: The VAT return would be due no later than the 20th of the month following the reportable month end for local sales of goods and services. In the case of imports (including items imported from the mainland US), VAT would be filed and paid before the imported goods could clear customs. With respect to electronic goods which, by definition do not pass through Customs, the importer would file and pay the VAT due on those Imports no later than the 10th of the next month in which the Import was made. The same deadline would apply for imports allowed to clear Customs without payment of the VAT provided the taxpayer is Bonded, as explained below.
In summary, there are expected to be (4) basic returns due under the new VAT system:
- VAT return for sales of goods/services, due no later than the 20th of the next month preceding the month end of reportable sales;
- VAT return for Imports cleared through Customs under a Bond, as well on goods that did not pass through Customs, due before the 10th of the next month preceding the reportable sales;
- VAT return for Imports due at the time the goods clear Customs.
- A yearly Informational Return to be filed by taxpayers qualified as small suppliers under the law. (Qualifying businesses with gross revenues of less than $75K per year).
Bonded taxpayers: The new VAT would leave in place the concept of a Bonded taxpayer. Under the current system, certain taxpayers who post a Bond equal to 125% of their monthly tax liability may defer VAT due until the 10th of the month following the month VAT was due to Customs on import.
VAT Refunds: VAT on purchases of goods by non-residents of Puerto Rico will be refunded if the following conditions apply:
- The amount of the purchase exceeds $1,000, and
- The non-resident spent less than 30 days in Puerto Rico.
The proposal offers a refund system that is designed to reduce the burden placed on certain individuals. That is, some taxpayers (e.g. elderly, ill, low income) would be able to apply for a refund of the VAT they paid on goods and services. The availability this refund would be contingent on Puerto Rico hitting certain VAT revenue benchmarks.
Local Tax: Under the current proposal, the application of local (city level) sales tax would disappear. Municipalities would be outright prohibited from applying a sales tax or any other similar tax on consumption. This is likely to be an extremely controversial point. Local authorities are already contending that the city level sales tax must stay in place unless the proposed 16% rate is increased to accommodate local funding.
Conclusion: This general overview of the proposed VAT in Puerto Rico is far from definitive as the provisions of this bill are being actively debated in the legislature. Please know that Taxware is actively tracking these developments and will provide our clients with more detail as it becomes available. In the interim, should you have any questions or concerns, please know that you may always log your Tax Inquiries with our Technical Support team.
For your reference, a copy of PS 1304 (in Spanish) can be found here.
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