INTERNATIONAL FINANCIAL ENTITIES

What are International Financial Entities?

International Financial Entities (“IFE’s”) are essentially international banks organized and
licensed in Puerto Rico. They are licensed and regulated by the Puerto Rico Office of the
Commissioner of Financial Institutions (“OCIF”) pursuant to Act No. 273 of September 25, 2012,
as amended (the IFE Act) and Regulation No. 5653.

The IFE Act authorizes IFE’s to engage in specific banking and financial activity in Puerto Rico
(Authorized IFE Activities) with non-residents of Puerto Rico. There are some activities allowed
with Puerto Rico residents, but they are the exception.

They remain a so far under-exploited opportunity for U.S. Banks to reduce their effective tax
rate.

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What are the Tax Benefits of Establishing an IFE?

All IFE’s are completely exempt from municipal and property taxes in Puerto Rico. As to income
taxes, there are two main possibilities.

     - If the IFE is established by a Puerto Rico shareholder, then the IFE will get an effective
       4% income tax rate and pay no Federal Taxes.

     - If the IFE is established as the subsidiary of a U.S. parent company and is a “Controlled
       Foreign Entity” as defined by the 2017 Tax Cuts & Jobs Act, then the effective tax rate
       for the U.S. parent will end up being 7.3% from today until 2025 and 9.9% from 2025
       onwards.

Under the IFE Act, both the IFE and its shareholders receive preferential tax treatment. The
IFEs have the following tax benefits:

    1. A fixed 4 percent income tax rate on the net income derived by the IFE from Authorized
        IFE Activities;

    2. Full property and municipal license tax exemptions on such activities; and

    3. Full exclusion of interest, financing charges or participation in partnerships benefits,
        which will not be considered gross income from Puerto Rico sources and therefore will
        not be subject to taxation or withholding provisions for nonresidents of Puerto Rico.

As for the shareholders, the tax benefits include:

    1. A 6 percent income tax rate on distributions to Puerto Rico resident shareholders of
       earnings and profits derived from Authorized IFE Activities;

    2. Full Puerto Rico income tax exemption on such distributions to non-PR-resident
        shareholders.

Pursuant to the 2017 Tax Cuts & Jobs Act, IFE’s which are controlled subsidiaries of a parent
company, are treated as foreign entities. Thus, if a U.S. corporation owns an IFE subsidiary, the
US parent generally will have to pay an immediate US income tax (at a 10.5% rate, increasing
to 13.1% after 2025) on the profits of its IFE, in the year those profits are earned regardless of
whether or when the profits are paid out as a dividend. The US parent is entitled to a credit
against this US income tax, for 80% of the total amount of non-US income taxes that it and its
subsidiaries pay.

Accordingly, given that IFE’s pay 4% income tax in Puerto Rico, the U.S. parent will be entitled
to a 3.2% credit on the taxes paid on the IFE’s income. This results in an effective tax rate of
7.3% until 2025, and 9.9% from 2025 onwards. 1 These are significant savings compared to the
U.S. 21.5% corporate tax rate.

It should also be noted that the U.S. parent will be entitled to a full deduction of the dividends
paid by the IEF subsidiary. Thus, there is no double taxation on dividends.

The tax benefits last for 15 years and are renewable for an additional two terms of 15 years.

What are “Foreign Persons” and “Domestic Persons” Under the IFE Act?

Under the IFE Act, Domestic Persons are (a) natural persons who are residents of Puerto Rico,
(b)any sort of legal entity organized under Puerto Rico law, and/or (c) the government of the
Commonwealth of Puerto Rico and its agencies, instrumentalities, and public corporations.
Foreign Persons, in turn are defined as any and all persons who are not Domestic Persons.

What are the Authorized IFE Activities?

1. Accept deposits from foreign persons in checking accounts, as well as demand or fixed
term deposits, including interbank demand deposits and fund deposits, or otherwise
borrow money from international financial institutions and any foreign person pursuant to
the regulations of the Commissioner. Every international financial institution may borrow
money on loan, provided, that said transactions are not tantamount to the acceptance of
deposits.

2. Accept properly collateralized deposits or otherwise borrow duly secured money from
the Government Development Bank for Puerto Rico and the Economic Development
Bank for Puerto Rico.

3. Make or place deposits in, and otherwise give money on loan to, the Government
Development Bank for Puerto Rico, the Economic Development Bank for Puerto Rico,

1 80% of 4% is 3.2%; 10.5% - 3.2% = 7.3%.
13.1%-10.5% = 2.6% increase beginning in 2025
7.3% +2.6% = 9.9%.

Any international financial institution, or any bank, including banks organized under the
laws of Puerto Rico, and branches in Puerto Rico of banks that are foreign persons.

4. Make, procure, place, guarantee, or service loans; none of such loans may be granted to
a domestic person, with certain exceptions subject to the approval of the Commissioner.

5. Issue, confirm, give notice, negotiate, or refinance letters of credit; provided, that the
client and the beneficiary requesting the letter of credit is not a domestic person, or
issue, confirm, give notice, negotiate, or refinance letters of credit in transactions for the
financing of exports, even if the beneficiary is a domestic person.

6. Discount, rediscount, deal or otherwise trade in money orders, bills of exchange, and
similar instruments; provided, that the drawer and the original debtor is not a domestic
person.

7. Invest in securities, stocks, notes, and bonds of the Government of Puerto Rico exempt
from the payment of taxes in Puerto Rico.

8. Carry out any banking transactions allowed by the IFE Act in the currency of any
country, or in gold or silver, and participate in foreign currency trade.

9. Underwrite, distribute, and otherwise trade in securities, notes, debt instruments, drafts,
and bills of exchange issued by a foreign person for final purchase outside of Puerto
Rico.

10. Engage in trade financing of import, export, barter and exchange of raw materials and
finished products activities with domestic persons, when the Commissioner has
determined through regulations, administrative determination, or order that the
international aspects of the underlying transaction override any involvement of the local
financial and business community, and that such activities would be appropriate for the
international financial institution.

11. Engage in any activity of a financial nature outside of Puerto Rico which would be
allowed to be done, directly or indirectly, by a bank holding company or by a foreign
office or subsidiary of a United States bank under applicable United States law.

12. After obtaining a special permit from the Commissioner, act as fiduciary, executor,
administrator, registrar of stocks and bonds, property custodian, assignee, trustee,
attorney-in-fact, agent, or in any other fiduciary capacity; provided, that such fiduciary
services shall not be offered to, nor inure to the benefit of domestic persons.

13. Acquire and lease personal property at the request of a lessee who is a foreign person,
pursuant to a financial lease agreement that complies with the Regulations of the
Commissioner.

14. Buy and sell securities outside of Puerto Rico, on the order of, or at its discretion, for
foreign persons and provide investment advice in relation to such transactions or
separate therefrom, to such persons.

15. Act as a clearinghouse in relation to financial contracts or instruments of foreign
persons, as authorized by regulations adopted by the Commissioner.

16. Organize, manage, and provide management services to international financial
institutions, and other types of financial entities located outside of Puerto Rico, such as
investment companies and mutual funds, provided, that the stock or participation in the
capital of such companies is not distributed directly by the international financial
institution to domestic persons.

17. Engage in such other activities as are expressly authorized by the regulations or order of
the Commissioner, or are incidental to the execution of the services authorized by the
IFE Act and the Regulations of the Commissioner, except those expressly prohibited by
the IFE Act.

18. Participate in the granting and/or securing of loans that originate and/or are secured by
the Government Development Bank for Puerto Rico and the Economic Development
Bank for Puerto Rico.

19. Finance, through loans or financial securities, projects in areas of priority for the
Government of Puerto Rico in those cases designated as extraordinary by the Secretary
of the Treasury and the Commissioner; and in all cases, the prior authorization of such
loans by the Secretary of the Treasury and the Commissioner shall be required.

20. Establish, upon authorization of the Commissioner, branches outside of Puerto Rico, in
the continental United States and its possessions, or in other foreign countries; provided,
that said branches do not accept any kind of deposit. The Commissioner is hereby
empowered to prescribe, by regulations, the procedure to obtain said authorization, and
the amount payable for application investigation expenses and annual quota fees for
each one ofsaid branches.

21. Upon authorization of the Commissioner, provide to other international financial
institutions or to foreign persons outside of Puerto Rico, those services of a financial
nature, as these are defined and generally accepted in the banking industry of the
United States and Puerto Rico and which are not listed in this section.

22. Engage in rendering of the following services: (i) asset management; (ii) alternative
investment management; (iii) management of private capital investment activities; (iv)
management of hedging funds or high risk funds; (v) pools of capital management; (vi)
administration of trusts that serve to convert different groups of assets into securities;
and (vii) escrow accounts administration services; provided, that such services are
offered to foreign persons.

What entities can be IFE’s?

Any person other than an individual, incorporated or organized under the laws of Puerto Rico,
the United States or any other country, or any entity constituted as a unit of said person, may
apply for a license to do business as an IFE.

What are the requirements to obtain an IFE License?

- Be organized as a corporation, partnership, limited liability company or other legal entity.
- Articles of incorporation, partnership agreement, operating agreement or any other
applicable organizational documents establishing the IFE. Said organizational
documents must contain

     (i)    the name of the IFE, which must include the words “International,”
            “Foreign,” or “Overseas,” or other similar words connoting the
             international character of the IFE;
     (ii)    the address of the principal place of business in Puerto Rico of the IFE;
     (iii)   the authorized or proposed capital of the IFE;
     (iv)   the term of existence of the IFE; and
     (v)    the purposes for which it is organized, including a specific limitation of
             its operations to carry out only those services authorized by the IFE Act.

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What requirements must an IFE meet once approved?

An IFE organized pursuant to the provisions of the IFE Act must have

     (i)     At least four full-time employees at its business offices in Puerto Rico, unless a
             lesser amount is authorized by the Commissioner;
     (ii)    Office space in Puerto Rico;
     (iii)   Authorized capital stock of no less than US$5 million, with at least US$250,000 of
             paid-in-capital at the time the license is issued; and
     (iv)   In addition to the paid-in capital minimum described in (iii) above, the IFE must at all
             times maintain US$300,000 of unencumbered assets or acceptable financial
             securities, or a lesser amount as authorized by the Commissioner, at its sole
             discretion.

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What practical functions can an IFE provide for a U.S. Parent Bank?

These functions can be divided between the “value added” or “subsidiary” activities that serve
as profit centers for banks and traditional banking activities.

- Value-Add
 

• Asset Management

• Brokerage & Clearinghouse Services

• Trust Administration

NOTE: an amendment to the IFE Act was proposed in January 2019 to allow IFE’s to loan funds for
construction and commercial loans to PR residents. The income derived from those particular loans
would be taxed at the 35% Puerto Rico income tax rate. On the other hand, given the Foreign Tax Credit,
a U.S. parent will end up paying 10.5%.

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• Foreign Exchange Serviceso

• Letter of Credit and Bills of Exchange for clients who do cross-border business

• Mortgage Servicing

• Sale & Leaseback Transactions

- Traditional Banking

• Unlimited as to international entities and persons (a brand new market for a U.S.

       Bank with no international operations).

• As to the US., the key Authorized Activity is “Engage in any activity of a financial

       nature outside of Puerto Rico which would be allowed to be done, directly or
       indirectly, by a bank holding company or by a foreign office or subsidiary of a
       United States bank under applicable United States law.”
          ◘ The Commissioner of Financial Institutions is accessible and open to
              discussing any sort of transaction. However, it is necessary to consult
              mainland U.S. attorneys as to the implications under Federal tax law and
              FDIC regulations.