Operating Employee Stock Purchase Plans in Puerto Rico

This article describes the process that U.S. and international publicly traded companies doing business in Puerto Rico need to follow for offering their ESPPs to their Puerto Rico employees.

Operating Employee Stock Purchase Plans in Puerto Rico

Prior to July 1, 2022, publicly traded companies doing business in Puerto Rico could not for all intents and purposes offer their employee stock purchase plans (“ESPPs”) to their Puerto Rico employees because local tax laws did not exempt from income the discount on the purchase of employer stock through an ESPP.  Had Puerto Rico employees been allowed to participate in an ESPP, the discount on the purchase of employer stock would have been part of their taxable wages, which essentially would have defeated the purpose of offering the ESPP to them.

Fortunately, effective as of July 1, 2022, Puerto Rico Act No. 52-2022 [https://bvirtualogp.pr.gov/ogp/Bvirtual/leyesreferencia/PDF/2020/0052-2022.pdf] amended the Puerto Rico Internal Revenue Code of 2011 (the “PRIRC”) [https://bvirtualogp.pr.gov/ogp/Bvirtual/leyesreferencia/PDF/Códigos/1-2011/1-2011.pdf] to, among other things, allow for the operation of ESPPs in Puerto Rico.  Specifically, PRIRC § 1040.08(b)(4) now provides that the discount on the purchase of employer stock through an ESPP established and operated in accordance with Section 423 of the United States Internal Revenue Code of 1986, as amended (the “Code”), is exempt from Puerto Rico income taxation at the time of purchase.  Therefore, through their U.S.-based ESPPs, publicly traded companies can now sell their stock to their Puerto Rico employees at a discount of up to 15% in accordance with Code 423(b)(6), without resulting in immediate income taxation to the Puerto Rico employees.  Upon the subsequent sale or disposition of the employer stock, however, the Puerto Rico employees will realize a short-term or long-term capital gain or loss, depending on the length of the holding period.

Since offering an already existing ESPP to an additional group of employees does not represent many costs or administrative complications to an employer, some of the publicly traded companies doing business in Puerto Rico are now allowing their Puerto Rico employees to participate in their ESPPs.  This article summarizes the process that these companies should follow for including their Puerto Rico employees as participants in their U.S.-based ESPPs.

Operational Requirements

Except for registering or “qualifying” their ESPPs with the Puerto Rico Treasury Department (commonly known by its Spanish name as “Hacienda”, https://hacienda.pr.gov/) and complying with certain local employment law restrictions on the use of employee payroll deductions for purchasing employer stock, which are described below, publicly traded companies can safely and validly operate their ESPPs in Puerto Rico in accordance with the operational requirements of Code § 423.  Other than amending the official plan document to allow the Puerto Rico employees to participate, no special or different Puerto Rico-related terms, conditions, or testing requirements need to be adopted or complied with.  The same plan documents, employee communication materials, and recordkeeping procedures that are used in the U.S. may be used in Puerto Rico.

Securities Registration Exemption

Pursuant to Article 402(a)(8) of the Puerto Rico Uniform Securities Act of 1963, as amended [https://bvirtualogp.pr.gov/ogp/Bvirtual/leyesreferencia/PDF/60-1963.pdf], insofar as the employer stock sold through an ESPP is already listed in an established U.S. stock exchange (e.g., NYSE or NASDAQ), neither the employer stock nor ESPP itself has to be registered with the local securities regulator, the Office of the Puerto Rico Commissioner of Financial Institutions (commonly known by its Spanish acronym as “OCIF”, https://www.ocif.pr.gov/).

Hacienda Filing Requirements

Pursuant to Article 1046-4(a) of Hacienda Regulation No. 6246 of December 22, 2000 [https://hacienda.pr.gov/sites/default/files/6246.pdf], ESPPs in operation in Puerto Rico need to be filed with Hacienda following the procedures for requesting administrative determination letters set forth in Hacienda Circular Letter of Tax Policy No. 16-09 [https://hacienda.pr.gov/publicaciones/circular-letter-tax-policy-no-16-09-cl-tp-16-09].  Currently, the procedure for filing ESPPs with Hacienda is different from, and admittedly more elaborate than, the procedure for having retirement plans qualified by Hacienda, which is included in Hacienda Circular Letter of Tax Policy No. 16-08 [https://hacienda.pr.gov/publicaciones/carta-circular-de-politica-contributiva-num-16-08].

Ideally, the ESPP should be filed with Hacienda by the first anniversary of the date on which the ESPP began covering Puerto Rico participants.  That is, it is not necessary for the Hacienda filing to be completed before Puerto Rico employees begin participating in the ESPP.

The filing requires payment of the administrative fees listed in Article 6(a)(17)(vii) of Hacienda Regulation No. 9115 of October 8, 2019 [https://hacienda.pr.gov/sites/default/files/publicaciones/2019/10/9115.pdf], and such payment needs to be completed electronically through Hacienda’s online portal, Colecturía Virtual [https://colecturiavirtual.hacienda.pr.gov/portal].  It usually takes about nine months to a year for Hacienda to review the filing and issue the corresponding administrative determination letter approving the local tax-qualification of the ESPP.  Provided that the ESPP is operated in accordance with Code § 423, the employer may safely operate its ESPP in Puerto Rico while Hacienda completes its administrative review and approval process.

Employment Law Requirements

Pursuant to Section 5(n) of Puerto Rico Act No. 17-1931, as amended [https://bvirtualogp.pr.gov/ogp/Bvirtual/leyesreferencia/PDF/Sueldos/17-1931.pdf], employers can use employee payroll deductions to finance the purchase of employer stock through an ESPP, provided that the deductions are completely voluntary (i.e., the Puerto Rico employees have affirmatively elected to participate in the ESPP) and the administrative forms used by the employer or its designee for obtaining the Puerto Rico employees’ written authorization include the following legend (in capital letters):

“You are not required to purchase any shares of employer stock.  Your decision in this regard is completely voluntary and if you decide not to purchase employer stock, your employer cannot take any adverse action against you.  If you consider that you are being forced to purchase shares of employer stock or that your employer has taken adverse action against you for not doing so, you may file a claim with the legal division of the Puerto Rico Department of Labor and Human Services.  If the Department finds that your employer violated these rules, it will require your employer to refund you the amount withheld from your payroll plus an amount equal to five times the amount withheld.”

Tax Reporting & Withholding Requirements

Thus far, Hacienda has allowed publicly traded companies to use, in regard to the Puerto Rico participants in their ESPPs, the same U.S. tax forms used with U.S. participants.  That is, the employer or its designee should report (1) the purchase of employer stock by Puerto Rico participants by filing IRS Form 3922 [https://www.irs.gov/pub/irs-pdf/f3922.pdf] with the IRS – not with Hacienda – and providing a copy thereof to the Puerto Rico participants, and (2) the subsequent sale of employer stock by the Puerto Rico participants by filing IRS Form 1099-B [https://www.irs.gov/pub/irs-pdf/f1099b.pdf] with the IRS – not with Hacienda – and providing a copy thereof to the Puerto Rico participants.

Puerto Rico taxes do not need to be withheld and deposited with Hacienda on the proceeds from the sale of employer stock.

Individual Taxation

Provided that the discount on the purchase of employer stock does not exceed the maximum allowed under Code § 423(b)(6), Puerto Rico participants in an ESPP do not recognize any taxable income at the time of purchase [PRIRC § 1040.08(a)(1)].  Upon the subsequent sale of employer stock, they will realize a capital gain on the excess of the sales proceeds over the purchase price initially paid for the stock, or a capital loss if the sales proceeds are lower than the purchase price [PRIRC § 1034.03(a)].  If the participant’s holding period in the stock (i.e., the period between the initial purchase date and the subsequent sales date) exceeds twelve months, the resulting gain or loss is considered a long-term capital gain or loss, subject to a maximum income tax rate of 15% [PRIRC §§ 1034.01(a)(4) and 1023.02(a)].  But if the holding period is less than twelve months, the resulting gain or loss is considered a short-term capital gain or loss, subject to the ordinary income tax rates (i.e., between 0% and 33%, depending on the participant’s taxable income for the year of sale) [PRIRC §§ 1034.01(a)(2) and 1021.01(a)(3)].  The PRIRC does not have a local equivalent to the ordinary income recapture rule of Code § 423(c).  Therefore, the initial discount upon the purchase of the employer stock is subject to the same long-term or short-term capital gain or loss rules described above.

The Puerto Rico participants are responsible for reporting their taxable income resulting from the sale of employer stock, and paying any resulting local income taxes, in their Puerto Rico individual income tax returns, Hacienda Form 482 [https://hacienda.pr.gov/sites/default/files/individuos_2024_rev._20_may_24_9-30-24_informativo.pdf].

Corporate Taxation

The employer cannot claim a compensation deduction or any other credit or deduction on its Puerto Rico income tax return on account of operating its ESPP in Puerto Rico [PRIRC § 1040.08(a)(2)].