The Act 20/22 Study
Tax incentives created by Acts 20 and 22 of 2012 to promote exports and attract investors should remain in place because they can boost Puerto Rico’s economic development, with several thousand new jobs created thus far and millions of dollars invested in local real estate, but the public and private sectors still need to capture their spillover effects, a study commissioned by the Economic Development & Commerce Department (DDEC by its Spanish acronym) has found.
By spillover effects, the study means economic events in one context that occur because of something else in a seemingly unrelated context. For instance, if an incentive helps create several information-system companies, it would yield a demand for trained people in that field that may not have been there previously. A spillover effect would be a local college or university deciding to create a program to train individuals in information systems to fill that void. Another example would be when an incentive creates the need for trained individuals in construction or engineering, and a university creates a training program to provide personnel for it. The study “recognizes the need for the government as well as the private sector and service providers to capture the spillover effects of the laws.”
The research, conducted by the firm Estudios Técnicos, measured the impact of the
law for the year 2014 and uses as a basis the annual reports submitted by the companies that use the laws and their application for decrees.
The study, whose preliminary results were obtained exclusively by Caribbean Business, encompasses 328 decrees approved under Act 20, and 574 decrees approved under Act 22 from 2012 to November 2015. However, to date, there are a total of 1,291 decrees that have been either signed or are pending approval.
To continue attracting investors, DDEC is promoting the 2016 Investment Summit that is slated to be held Feb.11 and 12 at the Puerto Rico Convention Center in San Juan. The summit is a forum in which guest speakers seek to promote Acts 20 and 22, as well as other incentives such as those provided by Act 73, the Industrial Incentives Law, and Acts 273 and 399, which provide incentives for financial and insurance centers.
Act 20 of 2012 promotes the export of services through incentives that include a 100% tax exemption on earnings and profit distributions on income generated from export services; a 4% flat income-tax rate on income generated from export services or a 3% tax when more than 90% of a service provider’s gross income is from export services; and a 100% property-tax ex-emption for the initial five years of operation for certain export services.
Along with Act 20, the government passed Act 22, the “Act to Promote the Relocation of Individual Investors,” which offers nonresident individuals 100% tax exemptions on all interest, dividends and long-term capital gains to entice them to move to Puerto Rico. An individual’s 183-day physical presence in Puerto Rico establishes a presumption of residency under the Puerto Rico Tax Code.
This new law has attracted much interest because U.S. citizens, even when they live abroad, have to file federal income-tax reports, with the sole exception of Puerto Rico, which is the only place in the world U.S. citizens don’t have to pay federal income taxes unless they report stateside income. Wealthy taxpayers who opt to re-establish overseas to a foreign country have to surrender their U.S. passports and pay an exit tax of 23.8% on unrealized capital gains, but not in Puerto Rico.
TOO EARLY TO STUDY LAWS’ BENEFITS
While the study acknowledges that any analysis on the laws’ impact is premature because it takes at least five years to observe their effects on the local economy, the study did conclude that Acts 20 and 22 have the capacity to yield investments, stimulate construction and help spur the service industry.
“The programs only have been around three years and we have to let them become ripe. I have noticed a [sense of] desperation in trying to move the process forward instead of letting it take its natural course,” DDEC Secretary Alberto Bacó said to Caribbean Business.
The secretary noted the need to attract new capital to Puerto Rico, which has lost about $150 billion in capital because of property devaluations and the downgrades in bank stocks and the island’s credit rating.
The study found that Act 20, or the Export Services Law, could represent an impact of 1% of Puerto Rico’s gross domestic product, which was around $103 billion in 2014. “This is high compared with similar programs such as the EB-5 (a program created in 1990 to stimulate the U.S. economy through job creation and capital investment by foreign investors), which had an impact of 0.7% in the U.S. economy in a period of 20 years,” the study says.
In 2014 alone, Act 20 created 3,713 direct, full-time jobs in Puerto Rico with an average salary of $45,000 a year and a total annual payroll of $78 million. The study didn’t say if these numbers met DDEC’s goals, but it does say that those numbers are expected to go up in the coming years. The average salary in Puerto Rico is $27,500 a year, so Act 20 is having a positive impact in terms of increasing average salaries for local employees. The total income of companies that have decrees under Act 20 is $1.2 billion, while the amount in individual taxes paid by the jobs created by the program is estimated at $13.7 million a year. “The projection is that some 45,000 new jobs will be created in the service sector over the next 20 years,” the study says. Bacó said the growth of Act 20 has been spurred by the high number of local businesses that are now taking advantage of the law to export their products. Overall, Act 20 has shown growth in three categories. These are local businesses that want to export their products; new residents who have moved to Puerto Rico because of Act 22 and now want to export services through Act 20 incentives; and businesses that weren’t originally from the island, but have moved their operations to Puerto Rico, he said.
The projection is that some 45,000 jobs will be created in the service sector over the next 20 years, the study says. Besides Condado, investors have moved to Dorado, Rincón and Humacao.
Exporting their services and products has become important for many local businesses as the island’s population continues to shrink. Puerto Rico’s nearly 10-year economic malaise has resulted in more than 200,000 people leaving the island for the U.S. mainland between 2010 and 2014, a 10% drop, according to the U.S. Census Bureau.
The numbers reflect a 61% increase in Act 20 decrees from 2012 to 2013, a 138% increase from 2013 to 2014 and a 151% increase from 2014 to 2015. In 2013, some 53 decrees were signed under Act 20 compared with 129 in 2014.
Act 22, or the Individual Investors’ Law, on the other hand, resulted in $260 million in real-estate investments in Puerto Rico during 2014, something particularly relevant due to the excess inventory of homes (both apartments and houses) that have to be sold. The act also yielded $50 million in property mortgages and $73 million in consumption expenditures for that year.
“The projection is that the law could have an impact of $1.7 billion over the next 10 years,” the study says. Act 22 shows a 617% increase in decrees from 2012 to 2013, a 104% increase in decrees from 2013 to 2014 and a 34% increase from 2014 to 2014.
FOCUS ON LONG-TERM EFFECTS AND WORKING IN TANDEM
Still, the study acknowledges that the true impact of Acts 20 and 22 can’t be measured only by the number of jobs created, but by their long-term effects over the “internationalization” of local services—designing products in such a way that they can meet the needs of users in many countries—as well as the development of technical knowledge that can stimulate local innovation.
“This requires the private sector to broaden its business horizons and seek a market beyond internal demand,” Bacó said.
Another important finding from the study is that Acts 20 and 22 must work in tandem to be successful. Bacó said that in the past, there was a law in Puerto Rico that promoted exports but it wasn’t successful.
“The programs have been successful, but they are just one of the 15 to 20 initiatives that we have. These alone aren’t going to take us out of [the commonwealth’s] economic problems,” he said.
In that regard, Bacó said Puerto Rico still needs an economic alternative similar to Section 936 that gave tax credits to U.S. subsidiaries operating in Puerto Rico and was gradually phased out by 2006. “The time is good to do it now. The matter has been on the table in the U.S. House & Ways Committee and we should all be together to get this because it is best for these businesses to stay in the U.S. than to move to a foreign jurisdiction like Ireland,” he said.
FAMOUS NAMES UNDER ACTS 20/22
Bacó as well as DDEC’s Assistant Secretary Juan Carlos Suárez disputed claims that the local government is benefiting U.S. investors in favor of the local residents who are carrying the brunt of paying taxes.
Bacó said Act 185, the Private Equity Funds Act, gives local investors “the same benefits that millionaire investors get under Act 22. “Anyone who has money to invest can benefit,” he said.
Still, he noted changes have been made to make Acts 20 and 22 more efficient and prevent abuse. Act 22 already requires millionaire participants to make investments and buy housing as it is focused upon enhancing foreign investment.
“More importantly, they have to open up local bank accounts. We have to continue the evaluation,” Suárez said.
While DDEC does background checks on millionaire investors to take out any “undesirable people,” the investors are required to open up bank accounts because banks also do background checks.
“We have denied decrees to about 2% or 3% of the applicants. We believe this is a right, not a privilege,” Bacó said, adding that individuals have been rejected for failing criminal background checks. Regarding Act 20, officials want to increase the number of jobs that each business creates. The law doesn’t specify a minimum number of jobs that each decree must establish. To date, though, the average number of fulltime jobs per decree is 11.
Bacó said he is also making eff orts for the decrees to be more transparent. For example, Act 20 applicants must agree to appear with the government in press conferences and provide information about their decrees because it helps promote the positive aspects of the law.
The government tries not to reveal information on Act 22 applicants because they are families that expect a certain degree of privacy, he noted.
While the study says more needs to be done for the island to benefit from the spillover effects of the incentives, Acts 20 and 22 have helped create a new industry that helps cater to the needs of beneficiaries of the laws. Besides new investments, the acts have spurred new types of services in the areas of human resources, law, banking, insurance and real estate. They have also brought more companies from the defense industry, which must operate in a U.S. jurisdiction.
Individuals who have benefited from the laws are spread all over the island in places such as Dorado, Humacao, Rincón and San Juan.
Among the well-known individuals and companies are Richard Melero, the principal of a commercial and real-estate firm; the St. Claire Group, which is taking control of Empress Hotel in the Isla Verde neighborhood of Carolina; and Elliott Group and Interlink, which have taken over Ambassador Hotel in the Condado neighborhood of San Juan.
The select list also includes the Morgan Reed group, which is buying properties in Santurce and other areas in San Juan, as well as Putnam Investments, which is headed by another Act 22 businessman, Nicholas Prouty.
Orlando Bustos, the head of OHorizons Networks, a management consulting firm, is also a beneficiary of the programs and recently purchased real estate around Meliá Hotel in Rio Grande.
Other people who have moved to Puerto Rico and have been featured by Caribbean Business include Frank L. Holder, chairman of the Latin American region of FTI Consulting, which includes offices in Buenos Aires, Bogotá, Madrid, Mexico City, Panama City, São Paulo and Rio de Janeiro. Holder, who was previously based in Miami, is a specialist in forensic and litigation consulting, with expertise in risk management, national security, operational risk and uncovering money-laundering operations.
The list also includes important hedge funds such as Randy Swan’s Swan Wealth Advisors, Mark Graham’s Blue Alternative Asset Management, John Helmers’ Long Focus Capital, Damon Vickers’ Nine Points Capital Management, Peter Schiff ’s Euro Pacifi c Management, Steven Stuart’s Garrison Investment Group and Thomas McOsker’s and Nick Paidas’ BloxTrade.
By Eva Llorens Vélez