Puerto Rico Income Tax Deductions for Corporations: A Step-by-Step Guide

Deductions on the Puerto Rico Corporate Income Tax Return
Aiming to heighten its scrutiny over business deductions, the Puerto Rico Government and Treasury have imposed more rigorous requirements to allow taxpayers to claim certain expenses in their returns. Before these changes, claiming a deduction was simpler and it generally required the taxpayer to document it on their books, and be prepared to justify it as a reasonable, necessary, and ordinary business expense. Now, the availability to claim certain expenses entails more than proper documentation.

As part of this discussion, it is important to mention that in Puerto Rico, corporations may be subject to both regular tax and alternative minimum tax (AMT). Furthermore, there are some key differences between the rules and deductions for regular and AMT to consider.

Under regular tax rules, corporations in Puerto Rico can typically deduct business expenses, such as salaries, rent, utilities, advertising, and professional services; subject to certain limitations, and guidelines, and that the applicable informative tax filings are timely made.

Nevertheless, in order to claim certain deductions for AMT purposes, the corporation must include with the income tax return Audited Financial Statements (AFS) or an Agreed Upon Procedures. Both should be prepared by a CPA with a valid license from Puerto Rico. Entitiesthat are not part of a controlled group of related entities are required to submit AFS with their tax returns if their annual volume of business totals or exceeds more than $10 million.

In the case of entities that belong to a controlled group of related entities, the rule is different. They may be required to submit AFS with their Puerto Rico income tax return if their combined annual volume of business is $10 million or more. The test to verify if the AFS is required is made by each individual entity. If the entity’s gross volume equals or exceeds $3 million, it must include AFS. Nonetheless, if the entity’s gross volume is less than $3 million, it must submit an AUP or has the option to submit AFS to claim the expenses for AMT purposes.  The decision to prepare one or the other is based on their cost and usefulness. AFS can also be used for bank purposes, may be required by suppliers, or to address other business needs. AUPs may be less costly but their use is more limited since they are specifically prepared for the income tax return.

There are three categories of income tax deductions in the return. They are as follows: (1) Deductions that must be reported on informative returns, (2) Deductions that are not required to be reported on informative returns, and (3) Other deductions that are required to be reported in AFS or AUPs.  The rationale for these classifications is to ease the tax return review process for the PR Treasury. Therefore, the reporting requirements are higher for those expenses that are more difficult to verify through a secondary source.

The first category of the aforementioned tax deductions includes certain expenses that in order to be claimed on the tax return, the taxpayer must validate them with the filing of informative returns (Forms 480). It was a challenge for PR Treasury to match the deduction and income on this type of expense and it is why they decided to implement this process. Although it could be done by the same taxpayer, since it is an automated process, it facilitates their review.

These forms are due annually by the end of February, but even if they are not filed on time, the corporation may claim the deduction and it will be subject to a late filing penalty of $500 per each informative.

Practice Point: If the company fails to meet the deadline, it is suggested to analyze the impact of the deduction versus the cost of the penalty to be incurred. In most cases, the tax savings would be higher than the penalties to be incurred.

The second category consists of several other deductions as indicated in the summary provided below.

Finally, the deductions subject to AFS or AUP indicated on the third category of expenses must be supported by these reports to validate the deductions for purposes of AMT.

Practice Point: There are further requirements on this category of expenses, such as the payment of sales and use tax and filing of the respective monthly tax returns, that will also be taken into consideration for the application of the deduction.

Below, we include a summary of the expenses included within these three types of categories reported on the Puerto Rico Corporation Income Tax Return (Form 480.20).