AD 23-01 discusses the applicable entity classification provisions and provides specific examples. Below, please find a summary of its most relevant aspects.
On February 2, 2023, the Puerto Rico Treasury Department (PRTD) issued Administrative Determination 23-01 (AD 23-01) whereby it established the rules applicable to certain entities that wish to elect or revert their classification for Puerto Rico income tax purposes.
The Puerto Rico Internal Revenue Code of 2011, as amended (the P.R. Code), establishes default entity treatments (the Default Treatment) for corporations, partnerships and limited liability companies (LLCs) as follows:
Corporations - Corporate Taxation
Partnership - Pass-Through Taxation
LLCs - Corporate Taxation
The P.R. Code establishes that, in certain instances, these entities may elect to be taxed as a Pass-Through Entity or as a Disregarded Entity and provides the rules to make such an election. Nevertheless, the PR. Code does not establish a procedure with respect to the ability of entities to file an election to reverse said optional classification and return to their Default Treatment.
The PR. Code provides an exception to the general rule that allows LLCs to choose their tax treatment. Foreign LLCs (i.e. LLCs organized outside Puerto Rico), are not able to be taxed as a corporation if they, either by election or by virtue of law, are treated as a Pass-Through Entity or Disregarded Entity under the United States Internal Revenue Code of 1986, as amended (the US Code), or an analogous law of a foreign country. In these cases, LLCs will be subject to Pass-Through taxation. However, as of the first taxable year beginning after December 31, 2022, these foreign LLCs can instead choose to be treated as a Disregarded Entity if they have only one member.
New Version of Entity Classification Form
AD 23-01 notified that a revised version of the form used to elect entity classification (Form SC 6045) has been issued by the PRTD, effective for taxable year 2022. The new version of Form SC 6045 will now be required to be filed electronically, together with the income tax return that corresponds to the selected tax classification for the tax year for which such election will be effective. Form 6045 (together with the corresponding income tax return) must be filed no later than the deadline established for the filing of the return, including extensions.
In the case of the election of Disregarded Entity status, the election will be filed with the Individual Income Tax Return of the sole owner for the tax year for which such election will be effective.
AD 23-01 clarifies that any corporation, partnership or LLC that does not submit Form SC 6045 within the prescribed deadlines, where it expressly chooses to alternatively be taxed as a Pass-through Entity or to be treated as a Disregarded Entity, will be considered to have elected the Default Treatment.
It also states that the selection of a particular type of account for SURI registration purposes (e.g. Pass-Through Entity Account or Corporate Entity Account) will not constitute a choice of tax treatment for purposes of the PR Code.
Change in Classification Rules
All entities are subject to taxation under the Default Treatment unless they choose the Pass-Through Entity treatment or Disregarded Entity treatment. AD 23-01 establishes that the treatment resulting for the first taxable year of an entity, will be considered its original classification (Original Classification).
Any entity may choose to change said Original Classification by filing Form SC 6045 with the corresponding return of the taxable year for which the change of election will be effective (Change in Classification). In these cases, the return form to be used is the one corresponding to the new type of classification that is being chosen.
The PRTD determined that once an entity has filed a first Change in Classification, it will not be eligible to request another Change in Classification during the following sixty (60) months. Any subsequent change in the classification of the entity that is completed once elapsed the referred sixty (60) months will also be subject to said limitation under the new chosen classification.
On the other hand, an entity may change its classification within sixty (60) months when more than fifty percent (50%) of the ownership interest of the entity is owned by persons who did not hold, directly or indirectly, an ownership interest in the entity to the moment of the last Change in Classification.
In addition, foreign LLCs that are required to change their classification in Puerto Rico (due to their tax treatment in the US or foreign jurisdiction as a Pass-Through or Disregarded Entity), may do so even when it has made a Change in Classification within the last sixty (60) months.
In the case of an LLC which has filed its income tax return for taxable year 2021 or prior years as a partnership, without having submitted Form SC 6045 choosing to be taxed as a partnership, will not be required to amend said return in order to include the corresponding Form SC 6045.
AD 23-01 emphasizes that for taxable years 2022 onwards, it is a requirement that the election to be taxed as a Pass-Through Entity or as a Disregarded Entity must be done through the timely filing of Form SC 6045.
Conversion Tax Consequences
AD 23-01 notes that taxpayers should be aware of the tax consequences of any Change in Classification, as any such change could affect the tax responsibilities for both the entity and its owners for tax and informational purposes. These potential consequences can include the possibility of the taxable nature of the transaction.
It should also be noted that a Change in Classification could result in a change in the tax period, in accordance with the provisions of the P.R. Code. In these cases, the PRTD determined that, as a general rule, taxpayers will not have to request a private letter ruling in order to change their taxable year.
AD 21-03 also establishes that any entity that pays taxes as a corporation and decides to make a Change in Classification to a Pass-Through Entity or as a Disregarded Entity, must prepare an affidavit in accordance with the P.R. Code, notifying the PRTD and the partners, shareholders or members of the related liquidating distributions as part of the conversion. This affidavit must be included in the final Corporation Income Tax Return filed by the entity.
The provisions of AD 23-01 are established by the PRTD because of the enactment of Act 52-2022 and the new tax entities concepts introduced therein, namely, the introduction of Pass-Through Entities and Disregarded Entities. Taxpayers should be aware of these requirements in order to make timely entity classification elections and avoid unintended tax pitfalls.
At RSM Puerto Rico, we can provide you with additional information and advice regarding these matters. Please contact our tax advisors at (787) 751-6164 | [email protected] for help or more information.