John Paulson And Others Flocking To Puerto Rico

John Paulson And Others Flocking To Puerto Rico
Image source: Wikipedia

Puerto Rico has always offered beautiful weather, cheap local labor, sun, sand and surf. Now, in a move to bolster the island’s suffering economy, the island is looking to woo wealthy U.S. business owners with tax breaks that provide generous dividend and capital gains tax breaks for those willing to relocate their businesses to the tropical paradise.

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Paulson and others

John Paulson, founder of Paulson & Co., is looking to expand his investment in Puerto Rico to $1 billion by the end of 2015. Paulson with an estimated worth of $11 billion already invested $260 million earlier this year to create two luxury resorts San Juan’s Condado district. This investment comes on the heels of his investment in the St. Regis Bahia Beach Resort and the Bahia Beach Resort & Gold Club last year.

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While the company has yet to comment, Paulson is headlining an invitation-only summit in San Juan, Puerto Rico later this week to explain the tax breaks available to companies willing to make the move.

Despite a declining population, unemployment is rising on the island whose $70 billion debt burden has found it in the news quite often but for the wrong reasons.

Act 20 and Act 22

The Puerto Rican government would rather see Act 20 and Act 22, both of which were created in 2008, in the headlines. Act 20 offers incentives 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.

“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.

And it’s not just Paulson. According to the government, Putnam Bridge Investments is expected to invest around $200 million this year.

“Get on a plane now, and business class is filled with representatives from The Blackstone Group L.P. (NYSE:BX), Goldman Sachs Group Inc (NYSE:GS), DE Shaw, and every private equity firm I know,” said Nicholas Prouty, president of Putnam Bridge.

The government is expecting 300 applications for relocation this year, and is already well on its way with 150 active applications filed. The hope of the government is that these moves will add 90,000 jobs and an additional $7 billion to the island’s present GDP of just over $105 billion by the end of 2016.

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While studying economics, Brendan found himself comfortably falling down the rabbit hole of restaurant work, ultimately opening a consulting business and working as a private wine buyer. On a whim, he moved to China, and in his first week following a triumphant pub quiz victory, he found himself bleeding on the floor based on his arrogance. The same man who put him there offered him a job lecturing for the University of Wales in various sister universities throughout the Middle Kingdom. While primarily lecturing in descriptive and comparative statistics, Brendan simultaneously earned an Msc in Banking and International Finance from the University of Wales-Bangor. He's presently doing something he hates, respecting French people. Well, two, his wife and her mother in the lovely town of Antigua, Guatemala. <i>To contact Brendan or give him an exclusive, please contact him at</i>
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  1. A wealthy US taxpayer (aka Golden Goose) such as John Paulson who feels they pay too much tax has three basic strategies that they can follow:

    Option 1) “Play the Game Better”: This means using all the LEGAL methods of avoiding tax under the law of their taxing jurisdiction. This option has the advantage that the individual does not need to overcome life inertia with major life or business disruptions. The disadvantages are that there is only limited tax reduction which can be accomplished with this option AND the US government constantly moves the goal posts. This results in decreased future tax savings as loopholes/ exemptions disappear and the on-going costs of adjusting your previous strategy and structure. ;

    Option 2) “Leave the Game”: For most Golden Geese, this involves becoming non-resident, by centralizing their lives elsewhere and not spending more than 6 months in their current tax home in the future. For Americans, who want to lose US tax status, this also requires giving up their US citizenship or resident alien status. For most jurisdictions, a Golden Goose who departs brings forward the payment of capital gains. It is often misstated that there is an additional “exit tax”. There is not a additional new tax, it is simply a deemed disposition triggering a capital gains event. This is not necessarily a bad thing for the following reasons a) interest rates are low to borrow money to pay any tax immediately owing on a deemed disposition; b) no longer have any tax liability to their current tax home from this point forward; and c) do not have to worry if future governments in their current tax home decide to increase income, capital gains tax OR bring in new taxes like gift, estate, mansion or wealth taxes. The major disadvantage of this option is that the individual has to go through a one-time effort to overcome their life inertia. There are MANY places in the world that Golden Geese could move their tax residence which allows them to minimize their future tax payments without compromising their personal or business lifestyle, the future benefits could easily outweigh the one time effort;

    Option 3) “Cheat the Game”: In years past, it was cheap and easy to engage in tax evasion. The morally challenged Golden Geese who were considering this option, did not seriously consider that they would ever have to pay the penalty of discovery. However with Whistleblowers, FATCA, John Doe Summons, Qualified Intermediary Regimes and exchange of information treaties the inevitability of the discovery of cheating is obvious. This makes the penalties (tax, interest, financial penalties, criminal prosecution and public embarrassment) of executing Option 3, real and unattractive.

    The obvious impact of the US Golden Geese no longer considering cheating the game, is that they will be focusing on the first two options. Initially, more Golden Geese will be taking advantage of legally available tax avoidance strategies. Obviously the government will respond by closing current legal tax avoidance opportunities such as the earned income exemption. With cheating off the table and playing the game better having a decreasing value, the attention of the Golden Geese will focus on leaving. As they discover that the cost and difficulty of leaving the game is not really that high (now that they have seriously examined it), you will see an ever increasing number of Golden Geese consider leaving their current tax system.

    It is important to recognize that for American Golden Geese, Puerto Rico’s program is not “leaving the game”. Rather it is a method of “playing the game better”, by taking advantage of a specific program which is allowed under PR’s current fiscal relationship with the US. However, the PR government could change the rules or the US government could change the arrangement and kill the program, at any time.

    In all countries with a progressive tax system, the natural result is that the top 1% account for just over 1/3rd of all personal taxes collected. Whether you think it is “fair or not” is irrelevant to the FACT that a progressive tax system is a very unstable revenue model. With such over dependence on a small number of people for such an enormous percentage of tax revenue, even a slight increase in the number of Golden Geese who leave the tax system will have a dramatic negative impact on future tax revenues. The real question will be how will various governments globally legislatively respond to all of this.

    There are naive efforts to try and lobby for a global “level tax playing field” by groups like the OECD . This effort is doomed from the outset, because of the Prisoner’s Dilemma. Even efforts to try to impose standards for government fiscal policies across the eurozone weren’t possible. Trying to make a broader effort over a vastly increased number of independent countries, all of whole are trying to keep and attract Golden Geese to their shores, is hopeless.

    Therefore the real action will take place domestically as governments examine their options. If the US government continues to increase the cost of leaving (eg. the Ex-Patriot Act), they will continue to see the same result. Specifically, RECORD numbers of American Golden Geese leaving, before the cost gets even higher. If the US government were smart, they would rather bring in policies that would retain current Golden Geese and attract more Golden Geese to their tax system. This means making it more attractive than the system that the foreign Golden Goose is considering leaving. Just as a small number of departing Golden Geese has an asymmetric negative impact on total tax revenues, the attraction of even a relatively small number of new Golden Geese will have a disproportionate positive impact.

    Previously the US government could implement policies that continue to add to the tax burden to Golden Geese. If a Golden Goose reacted by cheating the game, they could prosecute them. If a Golden Goose reacted by trying to play the game better they could change the rules. However, in a globalized world where Golden Geese can set up their personal and business lives in many jurisdictions other than that of their birth, all governments will now see a reaction to their increased burdens on the Golden Geese that will immediately and dramatically cause a drop in total tax revenues. Recognition of this paradigm shift is the first requirement. Properly reacting to the paradigm shift is ultimately the most important step.

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