Internal Revenue Service
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 Rev. Rul. 77-86

1977-1 C.B. 241

Section 861
Section 931
Section 933

IRS Headnote

Income source; Puerto Rico; dividends paid by domestic corporation. A dividend paid to a 5-year resident of Puerto Rico by a domestic corporation that for more than 3 years has derived 96 percent of its gross income from the active conduct of business within Puerto Rico is treated as income from sources within Puerto Rico and is exempt from tax under section 933 of the Code.

Full Text

Rev. Rul. 77-86

Advice has been requested whether a United States citizen, who is a bona fide resident of Puerto Rico, must, for Federal income tax purposes, report as income any dividends received from a domestic corporation doing business in Puerto Rico, under the circumstances described below.

A, a United States citizen, has been a bona fide resident of Puerto Rico at all times since 1970. A is a shareholder of M, a domestic corporation carrying on business operations in Puerto Rico. During 1974 and 1975, A served as the president of M and was responsible for its business operations in Puerto Rico.

M was organized in 1970. Since its inception, 96 percent of M's gross income for each year has been derived from the active conduct of business within Puerto Rico. M does not have any office or place of business outside of Puerto Rico.

In 1975 M declared and paid cash dividends to its shareholders. A received a 500x dollar dividend payment.

Section 861(a)(2)(A) of the Internal Revenue Code of 1954 provides, in part, that the amount received as dividends from a domestic corporation other than a corporation entitled to the benefits of section 931, and other than a corporation less than 20 percent of whose gross income is shown to the satisfaction of the Secretary of the Treasury or the Secretary's delegate to have been derived from sources within the United States, as determined under the provisions of this part, for the 3-year period ending with the close of the taxable year of such corporation preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) shall be treated as income from sources within the United States.

Section 931(a) of the Code provides, in part, that a domestic corporation qualifies for the benefits of this section if 80 percent or more of its gross income for the 3-year period immediately preceding the close of the taxable year was derived from sources within a possession of the United States and if 50 percent or more of its gross income for such period was derived from the active conduct of a trade or business within a possession of the United States.

Section 933(1) of the Code provides, in part, that in the case of an individual who is a bona fide resident of Puerto Rico during the entire taxable year, income derived from sources within Puerto Rico (except amounts received for services performed as an employee of the United States or any agency thereof) shall not be included in gross income and shall be exempt from taxation.

Section 1.931-1(a) of the Income Tax Regulations provides, in part, that as used in section 931 of the Code the term "possession of the United States" includes Puerto Rico when used with respect to domestic corporations. This term does not include Puerto Rico when used with respect to citizens of the United States.

Section 1.933-1 of the regulations provides in effect that section 933 of the Code applies to a resident individual of Puerto Rico whether a United States citizen or an alien.

In the instant case, A, a United States citizen and bona fide resident of Puerto Rico, received a dividend from M, a domestic corporation doing business in Puerto Rico. M met the conditions prescribed by section 931(a)(1) and section 931(a)(2) of the Code to qualify for the special tax treatment thereunder. Thus, pursuant to section 861(a)(2)(A), the dividend paid is not considered as income received by A from sources within the United States. The dividend received by A is income from sources within Puerto Rico for purposes of section 933.

Accordingly, the dividend paid by M to A is treated as income from sources within Puerto Rico. Further, the dividend is not to be included in the gross income of A and is exempt from Federal income tax pursuant to the provisions of section 933 of the Code.