US House Ways & Means reconciliation bill proposes important credits and incentives that would encourage investment in Puerto Rico

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EY Global

14 Oct 2021
Subject Tax Alert
Categories Corporate Tax
Jurisdictions Puerto Rico United States

The United States (US) House Ways & Means Committee’s reconciliation bill includes provisions that would encourage investment in Puerto Rico, including an economic activity credit and additional allocations of the New Markets Tax Credit (NMTC).

Possessions economic activity credit

The proposal would establish a new 10-year general business credit for business activities conducted by qualified domestic corporations in American Samoa, Guam, the Commonwealth of Northern Marianas, the Commonwealth of Puerto Rico and the US Virgin Islands. The credit would equal 20% of the sum of qualified possession wages and fringe benefits paid or incurred by a qualified domestic corporation on behalf of an employee principally employed in a possession in a tax year.

In general, qualified possession wages (as defined in Internal Revenue Code1 Sections 3306(b) (determined without regard to that section’s dollar limitation) and 51(h)(2)) are capped at US$50,0002 per employee per year; fringe benefits taken into account when determining the credit could not exceed 15% of qualified possession wages, resulting in a maximum annual credit of $11,500 per employee. Fringe benefits include: (i) employer contributions under a stock bonus, pension, profit-sharing or annuity plan; (ii) employer-provided coverage under an accident or health plan for employees; and (iii) the cost of life or disability insurance provided to employees.

The maximum credit allowed with respect to an employee’s wages would be pro-rated for employees that do not work full-time or work outside of a possession for a part of the year. For qualified small domestic corporations, the credit percentage and qualified possession wages would increase to 50% and $139,500, respectively, resulting in a maximum credit of $80,212.50 per employee per year. A “qualified small domestic corporation” is one that: (i) has average annual gross receipts $50 million or less for the three years preceding the close of the year for which the credit is claimed; and (ii) no more than 30 employees group-wide (5 of whom must be full-time employees in a US possession). Section 52 would be taken into account in determining gross receipts and employee counts for purposes of determining whether a qualified domestic corporation is a qualified small domestic corporation.

The proposal would define a “qualified corporation” as a corporation that:

  • Is a US corporation or a US shareholder of a foreign qualified corporation that is wholly owned by the same US group
  • Satisfies the source-of-income test and the active-conduct-of-a-trade-or-business test

The source-of-income and trade-or-business tests are similar to the tests for the expired possession tax credit under former Sections 30A and 936. The source-of-income test would require the qualified corporation to receive 80% or more of its income from sources within a US possession for the three years preceding the close of the year for which the credit is claimed (determined without regard to Section 904(f)). The trade-or-business test would require the corporation to derive 75% of its gross income from the active conduct of a trade or business for the three years preceding the close of the year for which the credit is claimed.

If a foreign corporation, which is 100% owned by a US shareholder group, does not meet the qualified corporation requirements but has a separate and clearly identified eligible foreign business unit that would meet the requirements if it were treated as a corporation, the proposal would allow the US shareholder to elect to treat the business unit as a foreign corporation. For purposes of this special rule, the term “eligible foreign business unit” would mean a foreign business unit that maintains separate books and records and includes partnerships and disregarded entities.

The proposal would generally be effective for tax years beginning after the enactment date. For qualified corporations that are foreign corporations, the proposal would be effective for tax years beginning after the enactment date and to the tax year of US shareholders that includes the date on which the foreign corporation’s tax year ends.

Additional new markets tax credit allocations for territories

To encourage investment in low-income communities, the NMTC program under Section 45D(a) provides NMTCs to investors making qualified equity investments in qualified community development entities (CDE). Under current law, the annual general allocation limitation is $5 billion for calendar years 2020 through 2025. The US Treasury Department’s Community Development Financial Institutions Fund (CDFI Fund) allocates the NMTCs to qualified CDEs through a competitive application process; the CDEs, in turn, issue the NMTCs to investors.

In general, low-income communities include census tracts that have a poverty rate of at least 20% or median family income that does not exceed 80% of the greater of metropolitan area median family income or statewide median family income (possession-wide median family income for census tracts in US territories). Treasury may also designate specific areas as NMTC-eligible. The CDFI Fund is responsible for allocating the NMTCs to metropolitan and non-metropolitan counties in a proportional manner.

The proposal would increase NMTC funding in several ways. First, it would increase the general allocation limitation from $5 billion to $7 billion in 2022 and from $5 billion to $6 billion in 2023. Second, it would extend the NMTC permanently, with allocation amounts indexed for inflation after 2024. Third, it would create an additional allocation limitation of $80 million for NMTCs that may be allocated to low-income communities in Puerto Rico beginning in 2022. Another $20 million would be allocated to low-income communities in Guam, the Commonwealth of Northern Marianas, the US Virgin Islands or American Samoa. The $80 million and $20 million amounts would also be indexed for inflation after 2024. Low-income communities in those territories would still be eligible for the general allocation limitation. In addition, any unused additional allocation limitation may be rolled over to the following year for five years (becoming part of the general allocation limitation in year six).

The proposal would be effective for calendar years after 2021.


The proposed reconciliation bill demonstrates a renewed interest in encouraging new investment and the retention of existing business activity in Puerto Rico and other US territories.

With a maximum credit of $11,500 per employee per year for large employers, US taxpayers doing business in the US territories would be able to take a new general business credit on wages and fringe benefits paid or incurred on behalf of employees with a principal place of employment in a US possession. All US taxpayers with employees (or foreign corporations with employees) in US territories should review their business activity and sources of income over the last three years to determine if they may be eligible for the new possessions economic activity credit. Taxpayers that do not meet the qualified corporation requirements at the foreign corporation level should also examine their organizational structure to determine if they may meet the requirements for one or more separate and clearly identifiable business units of a foreign corporation.

The proposed possessions economic activity tax credit differs from expired Sections 936 and 30A credits in several ways. First, while the starting point for the expired credits was foreign-sourced taxable income from an active trade or business in a US territory and subsequently limited to a certain percentage of possession wages, fringe benefits and depreciation allowances, the new credit would solely be based on qualified wages and fringe benefits paid or incurred by the qualified corporation. Second, because the calculation of the new credit would only take into account qualified wages and fringe benefits, and not foreign-sourced income, unlike the expired provision, there are no elections to consider related to computing taxable income based on cost sharing, profit split, etc. In short, the new possessions economic activity tax credit would target employers that retain and hire new employees in US territories. Although the new credit would not carry as much value as the expired credits, taxpayers that took advantage of the expired credit(s) would have a head start due to their familiarity with the source-of-income and trade-or-business requirements that would be a part of the new credit and, in general, should benefit from a less complex credit calculation.

From time to time, Congress has directly set aside a portion of the annual NMTC allocation limitation to specific areas affected by natural disasters, but it has never before allocated a specific amount to the US territories. Dedicated funding for the territories would provide a more level playing field for investors with qualifying investments in the territories and help spur job creation and investment in distressed communities.

For information about proposed international tax changes potentially impacting US taxpayers doing business in Puerto Rico, see EY Tax Alert, House Ways and Means Committee Chair proposes comprehensive international tax changes for reconciliation bill, dated 17 September 2021.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Puerto Rico LLC, State and Local Taxation Group, San Juan
  • Pablo Hymovitz Cardona
  • Rosa Rodriguez-Ramos
Ernst & Young LLP (United States), Global Location Investment, Credits & Incentives
  • Brian Smith, Phoenix 
  • Tim Parrish, Washington, DC
Ernst & Young LLP (United States), Tax Credit Investment Advisory Services
  • Michael Bernier, Boston
  • Megan Knutson, Minneapolis
  • Michael Roney, Cleveland

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.