Puerto Rico: VAT effective date delayed; discussion of draft regulations

Puerto Rico: VAT effective date is delayed

The Treasury Department of the Commonwealth of Puerto Rico on February 19, 2016, published 300+ pages of draft regulations for implementing a value added tax (VAT) system.

Related content

Read text of the draft VAT regulations (Spanish) [PDF 5.6 MB]

New effective date, after May 31

Puerto Rico is scheduled to replace its sales and use tax (imposed at rates of 10.5% and 4%) with a new VAT to be imposed at a rate of 10.5%. The effective date for the VAT regime was set for April 1, 2016. 

Today, it was announced that the effective date for the VAT regime is being delayed until after May 31 2016. Read the release (Spanish)

Draft regulations—definitions

The draft VAT regulations aim to explain and provide examples, largely based on the already existing sales and use tax rules, with respect to definitions that apply for VAT purposes. The draft regulations clarify that:

  • Audio-books and downloaded music qualify as computer programs and are considered “goods” for VAT purposes.
  • Goods introduced in a foreign trade zone are not considered introduced into Puerto Rico and are not subject to VAT until they leave the foreign trade zone.
  • Goods and services that are excluded from VAT (e.g., intangibles, services between related persons in Puerto Rico, and shipping services) are considered to be exempt for VAT recovery purposes (i.e., any income related to excluded transactions will affect the VAT recovery apportionment computation).
  • Services provided for a customer’s operations in Puerto Rico will be subject to VAT, including services related to business activities that have been or will be performed in Puerto Rico.
  • Services provided from Puerto Rico that relate to the customer’s operations outside of Puerto Rico will be considered exported services and will be zero-rated.
  • Donated goods are considered subject to VAT, unless the donated goods have no commercial value (i.e., the free distribution of inventory products may result in a VAT liability).

Zero-rating vs. VAT exemptions

Under the draft regulations, the sale of goods or services constituting an “export” will be zero-rated for VAT purposes (i.e., taxable at a rate of zero percent (0%)) regardless of whether the sale would be considered VAT-exempt if performed in Puerto Rico. Therefore, merchants exporting VAT-exempt goods and services will be entitled to recover VAT incurred on expenditures in accordance with the VAT recovery rules. The draft regulations further include several examples of various VAT exemptions—e.g., the exemption for food products, sales to the government of Puerto Rico, sales to a merchant in the tourism business, and toll manufacturing and contract manufacturing services.

VAT vs. municipal sales and use tax

The draft regulations include a reminder that the provisions of the municipal sales and use tax have not changed. Details of the interaction between the new Commonwealth VAT and the municipal sales and use tax are provided, with the draft regulations differentiating between the following situations:

Situations in which neither VAT nor municipal sales and use tax is due:

  • Purchases or import of goods or services excluded from VAT and municipal sales and use tax (e.g., intangibles) 
  • Occasional sales

Situations in which the transaction would be exempt for both VAT and municipal sales and use tax purposes:

  • Purchase or import of exempt goods (e.g., food products)
  • Purchase or import of exempt services (e.g., commercial rent of office space)

Situations in which VAT and municipal sales and use tax will be charged individually or concurrently:

  • Sales that are zero rated for VAT purpose and exempt for municipal sales and use tax purposes (e.g., sale of chemical components to a manufacturing plant holding the required certificate)
  • Sales that are VAT exempt, but subject to municipal sales and use tax (e.g., certain food products)
  • Sales that are subject to VAT, but not to the municipal sales and use tax (e.g., import of taxable goods and services; provision of services that are not subject to municipal sales and use tax such as designated professional services and most business-to-business services)
  • Sales that are subject to both VAT and municipal sales and use tax (e.g., sale of prepared food)

Invoicing

The draft regulations do not provide further details on the VAT invoicing requirements outlined in the law. The draft regulations do provide that VAT invoices can be issued electronically and that merchant vendor performing multiple recurring sales have the option of agreeing with the merchant-buyer to issue an invoice on a monthly basis. 

Guidance—Administrative Determination 16-01—issued in late February 2016 clarified that during the transitional phase commercial invoices / receipts issued by merchants will serve as “tax receipts” for VAT recovery purposes. Read TaxNewsFlash-United States

VAT credits

The draft regulations include guidance about VAT credits, especially in situations when a merchant is engaged in both taxable and exempt transactions. According to the draft regulations, merchants will be required to segregate input VAT (i.e., VAT paid or self-assessed) that is:

  • Directly related to taxable sales (also referred to as direct input VAT)
  • Indirectly related to taxable sales (also referred to as indirect input VAT)
  • Incurred on the purchase of assets

With respect to direct input VAT, merchants will be required to separately identify input VAT incurred in relation to the sale of taxable goods (i.e., goods purchased for resale) and input VAT incurred in relation to the sale of taxable services (i.e., outsourced services). 

For goods purchased for resale, merchants will be required to separately identify those goods resold within the month that are taxable and those that are exempt because the person acquiring the goods holds an exemption certificate (e.g., the government of Puerto Rico). Input VAT incurred on these goods will only be recoverable based on the following formula: 

 

(VAT paid in a month on goods for resale) x (total sales of goods in a month minus sales to exempt persons) ÷ total sale of goods in a month

 

Merchants will be required to adjust the input VAT recovered in relation to taxable sale of goods every month using this formula.

 

The recovery of VAT on outsourced services will be based on the following formula: 

 

(VAT paid in a month on outsourced services) x (sales of taxable services in a month) ÷ total sales of services in a month

 

The draft regulations clarify that indirect input VAT is any input VAT incurred in a month that does not fall qualify as direct input VAT. Indirect input VAT can be recovered based on the following formula: 

 

(Input VAT indirectly related to taxable sales in a month) x (taxable sales in a month) ÷ total sales in a month

 

The draft regulations provide for an exception to the input VAT apportionment rules when a merchant has exempt sales that do not exceed the lesser of 5% of monthly sales or $1,000.

According to the draft regulations, any input VAT incurred in relation to the purchase of an asset is creditable in the month in which the asset was acquired. However, when the acquisition of the fixed asset results in an excess input VAT position (i.e., the input VAT would be refundable) merchants will be required to carry over the excess input VAT for a 12-month period and use it to offset any potential VAT payable in that period. 

Finally, the draft regulations address situations in which: (1) VAT was incurred but the merchant does not make sales in a particular month (including at the beginning of the activity); and (2) input VAT exists when a business is liquidated. The draft regulations also provide examples for merchants mainly engaged in the retail sale of food and the retail sale or wholesale of prescription drugs, fuels, and cars. 

Other items

Other provisions cover the VAT treatment of vouchers; the sourcing of telecommunications and broadcasting services; VAT adjustments in case of price fluctuations; VAT refunds; and the validity of prior guidance issued for sales and use tax purposes.

 

For more information contact a KPMG tax professional:

Leah Durner | + 1 (202) 533-5542 | ldurner@kpmg.com

Carlos Molina | +1 (787) 622-5311 | cmolina@kpmg.com

Jeremy Gray | +1 (267) 256-3497 | jpgray@kpmg.com

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