Puerto Rico, a US territory with limited autonomy in setting its own tax policies, is poised to be the first part of the US significantly impacted by Pillar Two, the global tax agreement. This agreement aims to establish a 15 percent minimum tax rate on corporate income, posing a significant threat to Puerto Rico’s development model, which has traditionally relied on lower taxes.
Puerto Rico has long used low taxes to attract global companies, particularly in the pharmaceutical and manufacturing sectors. However, Pillar Two could effectively force an increase in Puerto Rican tax rates. If Pillar Two is implemented and Puerto Rico maintains its current tax laws, other countries will tax income sourced in Puerto Rico. This scenario presents only downsides for Puerto Rico. Global corporate investment on the island will be affected by higher taxes, and the value of Puerto Rican tax incentives will be reduced or even completely nullified. However, the Puerto Rican government will not gain the revenues from these higher taxes.
Puerto Rican lawmakers are already considering changes to the tax code but were unable to pass a finished bill in the most recent session ending on June 30, 2024. This reflects the substantial difficulties of conforming to Pillar Two, pursuing a development strategy, and working within internal and external constraints, all simultaneously.
The US federal government has an interest in promoting Puerto Rico’s fiscal health, and it has a responsibility to represent Puerto Rico in international matters. Observers from the continental United States should consider how to use federal policy to help protect Puerto Rican competitiveness. But the Puerto Rican experience may also help build perspective on Pillar Two in general: the minimum tax may not be achieving its intended goals, while at the same time generating more complexity and difficulty in compliance, especially in jurisdictions where tax legislation is constrained by other factors.
The history of Puerto Rico’s tax strategy provides relevant context for its present and near future. It is constrained by contracts, fiscal oversight, and the federal government, whose policies have a powerful impact on its trajectory. It therefore has a limited ability to quickly change its tax code on demand.
Pillar Two involves a series of three taxes that backstop and reinforce each other to impose a 15 percent minimum rate on large global companies. The first, a qualified domestic minimum top-up tax (QDMTT), is assessed by jurisdictions on domestic activity and would require businesses that pay below a 15 percent rate to “top up” their taxes to that 15 percent minimum. The second, an income inclusion rule (IIR), would