Puerto Rico's Tax Pitch

NEW YORK ( TheStreet) -- There've been so many recent examples of nations making fiscal choices at odds with long-term economic aims, it's easy to miss choices aimed at wooing corporations and job creators to their shores.

To name just a few: Ireland's vigorously defended its eurozone-low 12.5% corporate tax rate; Sweden and Denmark recently rolled out the red carpet with tax incentives; and Belgians, Londoners and even the Russians have welcomed French businesses and high-earners put off by French President Francois Hollande's 75% tax proposal on incomes over one million euros.

Now Puerto Rico's getting in the game, seeking more attention from business leaders and entrepreneurs through a 2012 tax law change.

The law capitalizes on Puerto Rico's unique tax system. Most U.S. territories are required by the U.S. Internal Revenue Code (IRC) to "mirror" U.S. taxes near verbatim. For example, the territory cannot compete on corporate tax rates to try to win business because these are legally required to be harmonized (in euro-speak) with the mainland's prevailing rates.

However, the IRC allows Puerto Rico to craft its own tax rules and rates for individuals. Therefore, in its mission to attract business, Puerto Rico is choosing to recruit the owners, entrepreneurs and leaders of said businesses using the territory's wiggle room on individual taxes.

A law passed last year stipulates those who immigrate to Puerto Rico and haven't lived in the territory in the past 15 years may be exempted from U.S. taxes on capital gains accrued after they move there. Income derived from Puerto Rico-domiciled businesses -- specifically, what is derived from activity in Puerto Rico -- also may be exempted from most taxes. (Dividend and interest income paid by U.S.-domiciled companies would still be subject to federal taxes.)

For entrepreneurially minded folks, this might make Puerto Rico an attractive option to start or expand a venture. For wealthy retirees (or soon to be retirees), add "low taxes" to "pleasant climate" in Puerto Rico's "pro" list.

In an effort to ensure Puerto Rico doesn't wind up like Cyprus and become populated with residents who don't actually reside there, the law stipulates you have to live in Puerto Rico for a minimum of 183 days a year and prove "substantial" social and personal connections to the territory. So, you'd better pack the kitchen sink, brush up on your conversational Spanish and find at least a few long-lost relatives to boost your chances. (Perhaps one reason few folks have taken advantage of the deal so far.)

Another consideration: Should Puerto Rico become a state, the exemption would likely end. Given the territory's late-2012 nonbinding referendum on statehood showed 61% of Puerto Ricans support the idea, that might not be as far-fetched as it seems. And tax policy frequently shifts -- so this policy may come to an end the moment a different administration takes the reins in San Juan or if this proves politically unpalatable for other reasons.

For example, while lowering its corporate tax rate a la Ireland isn't in the cards legally today, this wasn't always the case. To combat unemployment and poverty on the island in the 1960s, the federal government used various tax incentives to lure U.S. manufacturing operations there. In 1976, Congress added a tax credit that effectively exempted profits U.S. companies attributed to Puerto Rico.

The combination of a tax credit, incentives, the proximity to the U.S. and available industrial sites prompted many U.S. companies to flock to the island. However, a 1993 law cut the full exemption to 40%, and a 1996 law phased out the tax break over a 10-year period. By 2006, many multinationals in Puerto Rico shuttered their operations.

Whether San Juan gets a big return on this move is anyone's guess -- and we wonder why, if they want to truly compete, they don't just enact a flatter, simpler taxes across the board. But either way, attempting to recruit business to the island is clearly a sensible aim and taxes are powerful incentives. In that sense, the proposal seems headed for the right target.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.