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NEW YORK (MarketWatch) –— John Paulson is expected to expand his investment in Puerto Rico to $1 billion by the end of next year, as the hedge fund titan leads a growing brigade of wealthy U.S. business owners who are taking advantage of the languishing island’s efforts to transform itself into a tax haven.
The Paulson & Co. founder, estimated to be worth $11 billion, is headlining an invitation-only summit in San Juan, Puerto Rico, on Thursday to discuss two new tax laws that provide generous dividend and capital gains tax breaks for individuals willing to relocate their businesses to the tropical island, according to Puerto Rico officials.
For their part, the commonwealth’s political leaders are hoping the tax-breaks will attract businesses that can help jump-start Puerto Rico’s ailing economy, which is suffering from high unemployment rates and a declining population.
The tiny island is grappling with a debt burden of roughly $70 billion, and many municipal credit analysts see a broader economic revival in Puerto Rico as key to making good on that debt.
Paulson has already invested $260 million this year to create two high-end luxury resorts in San Juan’s Condado district. That follows investments last year in the St. Regis Bahia Beach Resort and the Bahia Beach Resort & Gold Club.
The government expects Paulson to invest a total of $1 billion in Puerto Rico by 2015. Paulson’s firm had no comment.
“Get on a plane now, and business class is filled with representatives from Blackstone, Goldman, DE Shaw, and every private equity firm I know,” said Nicholas Prouty, president of Putnam Bridge on the new interest in Puerto Rico from Wall Street’s elite.
Putnam Bridge Investments is expected to invest $200 million in Puerto Rico this year, according to the government.
A LOW-COST BASE
“What we are trying to achieve here is a second transformation with the Puerto Rico economy,” said Alberto Baco, the Puerto Rican secretary of economic development and commerce.
More than 150 companies are already looking to move their offices to Puerto Rico to take advantage of the new tax laws, and the government is expecting more than 300 applicants this year. Officials are expecting the move to create 90,000 jobs by 2016 and to add up to $7 billion to the island’s GDP.
“The cost of doing business is low, the cost of hiring local labor is lower,” said Peter Schiff, owner of Euro Pacific Asset Management .“And if I need to move employees form the mainland it’s easier, I don’t have to worry about visa issues.”
Schiff recently relocated his firm from California to Puerto Rico and is establishing his main office in the capital, San Juan.
“It’s been pretty nice here, the Puerto Rican people are very, very friendly and we have enjoyed that,” said Jim Nelson, a member of Schiff’s team. “The weather is excellent, it’s 80-85 degrees constantly.”
So what kind of savings is Euro Pacific experiencing?
While the investment broker wouldn’t give specifics, the savings are substantial and they will become more significant over time, he said. Schiff plans to eventually move to Puerto Rico himself and has already bought property there.
WOOING THE RICH
The two laws the government is actively promoting are Act 20 and Act 22., both of which were created in 2008. The laws aim to promote the export of services from the Caribbean island and to encourage the ‘import’ of wealthy individuals.
Act 20 seeks to incentivize businesses to come to Puerto Rico by taxing companies at a flat 4% on earnings, as well as offering them 100% tax exemption on dividends or profit distributions from export services. To qualify, a company has to employ at least 3 people.
Act 22 is the real gold mine, said Alex Daley of Casey Research, who commissioned a report called “Puerto Rico’s New Tax Advantages”, after moving to the island to take advantage of the new incentives.
“This is mostly geared towards U.S. citizens,” said Prouty. “It lets them take advantage of a new tax system.”
A citizen or green card-holder living outside the U.S is still subject to U.S. tax laws. But Puerto Rico has a unique status as a U.S. commonwealth. Residents are considered U.S. citizens, but are subject to different tax laws, which offers Americans from the mainland a window.
The act also exempts businesses from taxes on dividends and capital gains, a huge incentive for hedge funds, asset managers and traders who earn a lot of their income that way , said Daley.
“Taxes on capital gains are based wherever the investor is based,” said Daley. “If you are a trader or a venture capitalist and invest and recognize your capital gains – you don’t pay taxes if you get those tax exemptions.”
Puerto Rico, which has about 3.5 million residents today, went through its first transformation back in the 1950s, when the island developed a huge manufacturing base.
That helped it develop needed infrastructure and boosted economic growth. Since then, however, its fortunes have faded. The island has been mired in recession for the past eight years.
The government recently sold $3.5 billion of new municipal bonds in an effort to replenish its coffers and service its outstanding municipal debt burden. Bond investors are divided on whether the island will eventually have to go through some kind of restructuring.
The country needs to take measures to increase tax revenues, and also create more incentives to bring people to the island and retain them, according to experts.
“Puerto Rico is suffering from a major migration from the island,” said Dan Heckman, senior fixed income strategist at the wealth management division of U.S. Bank. “They have more deaths and decreasing births, so they have been going through a (period of) depopulating.”
In 2013, Puerto Rico received 155 applications from companies seeking to move offices to the island. In 2014, the government is expecting about 360 applications.
For many companies, the tax incentive is too good to pass up.
“Strictly speaking that was a tax motivation, I was looking at Singapore or Ireland,” said Schiff, who has other businesses, alongside his brokerage. “The corporate tax rate is 4% which compares favorably to Singapore and Ireland.”
What’s more, Puerto Rico is a lot closer to the mainland U.S., and for half the year is on East Coast time, he said.
“It’s like moving to Florida, but there is no federal income tax,” said Schiff.
Nelson, who moved to Puerto Rico six weeks ago with his wife and young child, acknowledged there are challenges.
“Obviously there are some sacrifices involved, like moving away from your family and there are some things you have to get used to — so-called Island Time — where things move slower,” said Nelson.
“It’s hard to find some groceries, different types of spices, and there’s not a lot of organic foods,” said Nelson. “And there are fewer restaurants.”
There’s also the cost of transferring your business, which includes various exit taxes.
“It’s not a simple rule,” said Nelson. “It’s takes quite a bit of time to get through the process from a legal and compliance standpoint.”
However, his boss says he’d rather pay less tax so that he can reinvest the money he saved back into the business to help it grow.
“If I moved to Singapore or Ireland, I would pay U.S. dividend tax,” said Schiff. “No other country treats its citizens as horribly as the U.S. does. If you are a citizen anywhere else and work outside that country, you are not expected to pay taxes to your country.”