(Credit: John Woodcock/iStockphoto.com)
Providing a dazzling array of federal and state tax exemptions and credits, a hugely untapped market serving all other states’ card holders, and relief from profitability’s greatest obstacle, IRC Section 280E, Puerto Rico is swiftly becoming the nation’s most attractive jurisdiction to grow and dispense marijuana.
Puerto Rico’s Medical Marijuana Industry
To bolster its manufacturing and tourism industries and facilitate new businesses’ creation, Puerto Rico established an aggressive economic and tax incentives program and, pursuant to an May 3, 2015, executive order, launched its ambitious medical marijuana program.
A U.S. territory since 1898, manufacturing comprises 44 percent of Puerto Rico’s gross domestic product, five million tourists visit annually, and $580 million is currently invested, and $2.8 billion is “under development,” for hotels, resorts, casinos and golf courses.
Because it is not a state, federal taxes do not apply to income generated by Puerto Rican individuals or entities. Instead, individual bona fide residents are not federally taxed on income derived from Puerto Rican sources and Puerto Rican corporations are treated as foreign corporations immune to U.S. corporate taxes.
Puerto Rico’s marijuana program is tailored to advance its manufacturing and tourism industries. Beyond providing economic incentives and tax exemptions/credits to hydroponic planting and cultivation, laboratory-based research and development, commercial scale manufacture and recycling, Puerto Rico’s program services an estimated 100,000 resident patients and five million of annual tourists eligible to purchase cannabis with out-of-state registration cards.
Shelter from Section 280e’s ‘Profit Killing’
Because it does not impose cannabis’ greatest obstacle to profitability, Section 280E of U.S. Internal Revenue Code of 1986, as amended (IRC), Puerto Rico is the nation’s most lucrative marijuana growing and dispensing location.
Pursuant to Section 280E, the Internal Revenue Service forbids legal cannabis businesses from deducting otherwise ordinary business expenses from gross income associated with “trafficking” Controlled Substance Act’s Schedule 1 substances like marijuana, 21 U.S.C. Sections 801, Et. Seq (1970), (prohibits marijuana’s “manufacture, distribution, and dispensation”); 26 U.S.C. Sections 280E (“No deduction … shall be allowed for any amount paid … in carrying on any trade or business if such business … consists of trafficking in controlled substances …”).
Thus, because it prohibits claiming any tax deduction other than costs of goods sold (i.e., direct expenses attributable to the production of products sold by a company), Section 280E denies marijuana business owners from claiming typical retail business deductions like rent, utilities and maintenance.
Stated another way, by locating its operations in Puerto Rico, a marijuana-related business may double the income it realizes.
Puerto Rico’s Domestic Tax Incentives
Although in a U.S. territory, pursuant to Section 933 of the IRC, bona fide Puerto Rico residents are not subject to U.S. federal income taxes on income derived from sources within Puerto Rico and, pursuant to Act 73, Act 22 and Act 20, Puerto Rico’s tax incentives enhance its attractiveness to marijuana growers, processors and dispensaries.
The “Economic Incentives for the Development of Puerto Rico Act,” Act No. 73 of 2008 (Act 73) provides tax exemptions and credits to businesses engaged in “eligible activities” including:
• hydroponic planting and cultivation;
• commercial manufacturing;
• laboratory based research and development;
• developing commercial licensed/patented software;
• owning “exempt business used real/personal property” (ex., real estate lessor); and
• recycling which transforms recyclable materials into commercial articles, raw material or manufacturing ingredients, or recycled raw material for sale, use or exportation.
Act 73′s tax exemptions include:
• 4 percent fixed tax rate on income and gains from sale of exempt business;
• 1 percent fixed income tax rate for “pioneering” activities/operations;
• 0.5 percent fixed income tax rate reduction for businesses located in industrial areas of “low” or “intermediate” development designation;
• 12 percent fixed income tax rate on royalties paid to foreign entities for intangible property used in exempt business;
• 100 percent exemption on taxes on dividend distributions, municipal construction, excise, sales/use on raw material and machinery/equipment used in the production process;
• tax exemptions of 90 percent personal (that can be up to 8.83 percent resulting in .883 percent effective rate) and real (that can be up to 10.83 percent resulting in 1.083 percent effective rate) property; and
• 100 percent accelerated depreciation in first-year with ability to carry over to subsequent tax years until exhausted.
Act 73 also provides tax credits including:
• 25 percent on purchases of Puerto Rico manufactured products and 35% on those manufactured from recycled materials;
• $1,000 to $2,500 per job created during first year of operations in industrial areas of “low” or “intermediate” development designation; and
• 50 percent on eligible research and development activity costs.
To attract new capital, the “Individual Investors Act,” Act No. 22 of 2012, as amended (Act 22), provides tax exemptions to bona fide Puerto Rico residents whom were not bona-fide Puerto Rico residents for six-year period preceding the act’s enactment.
Qualifying as a bona fide Puerto Rico resident requires: (being present for at least 183 days during taxable year; and having no tax home outside of Puerto Rico during taxable year, nor a closer connection to the United States or foreign country other than Puerto Rico.
Not subject to federal income taxes on income derived from sources within Puerto Rico pursuant to Section 933 of IRC, bona fide Puerto Rico residents must only pay federal income tax on income derived from sources outside of Puerto Rico. Act 22′s “qualified investments tax exemptions” to new Puerto Rican bona fide residents include 100 percent tax exemption on all dividends, interest, and short-term and long-term capital gains.
To promote export services, Puerto Rico enacted “Act to Promote the Export of Services,” Act No. 20 of 2012, as amended (Act 20), providing tax exemptions and credits to businesses engaged in “eligible activities”
• assembly, bottling and packaging of products for export;
• storage and distribution centers;
• research and development;
• advertising and public relations;
• consulting services including architectural and engineering, project management, economic, scientific, environmental, technological, managerial, marketing, human resources, computer and auditing;
• professional services such as legal, tax and accounting;
• licensable computer software development;
• hospital, laboratory, educational and training services; and
• financial services including investment banking, asset management and management of investment alternatives, private capital, and hedge funds.
For income derived from customers located outside of Puerto Rico in relation to services rendered from Puerto Rico, Act 20 provides:
• 4 percent fixed income tax rate;
• 100 percent tax exemption on earnings and profits distributions;
• tax exemptions of 90 percent personal (that can be up to 8.83 percent resulting in .883 percent effective rate) and real (that can be up to 10.83 percent resulting in 1.083 percent effective rate) property;
• 60 percent tax exemption on municipal taxes. •