U.S. Virgin Islands Tax Incentive Programs: Income Eligible for Benefits

This is the first blog post in a series of blog posts that I hope explains the various tax incentive programs available in the U.S. Virgin Islands. My hope is that this series of blog posts can help explain the fundamentals of the tax incentive programs to Virgin Islanders as well as those persons, companies and businesses that are considering moving to the U.S. Virgin Islands. I am often surprised about the amount of misinformation and confusion surrounding the tax incentive programs, both from the residents of the U.S. Virgin Islands and from the people intending to move their businesses and families to the Territory to take advantage of those benefits.

So why does the U.S. Virgin Islands provide tax credits for the beneficiaries of the Economic Development Commission Program (EDC) and University of the Virgin Islands Research and Technology Park Program (RT Park)? As noted in the enabling legislation of the EDC, the reasoning behind enacting the program is to promote the growth, development and diversification of the economy of the Virgin Islands; to benefit the people of the Virgin Islands by discovering and developing, to the fullest possible extent, the human and economic resources available therein; and to establish and preserve opportunities of gainful employment for residents of the Virgin Islands, among other things. These purposes are echoed in the enabling legislation of the RT Park.

This begs the question – how does the U.S. Virgin Islands grant these benefits? That answer lies within the laws of the United States, specifically the Internal Revenue Code (IRC). The IRC permits the U.S. Virgin Islands to reduce taxes on income from “sources within the Virgin Islands” or for “income effectively connected with a trade or business within the Virgin Islands.” Determining whether income is sourced in or effectively connected to the Virgin Islands depends on the type of income being generated. The IRC has general source rules which are applicable for determining where income is sourced. The application of these rules is easy to understand in the context of a service or consulting company. For example, if a person sitting in Miami, Florida provides money management services to a customer in New York, let’s say advised the client to invest $100.00 in XYZ stock, and receives a service fee for that work in the amount of $2.00, then that $2.00 is earned for services being provided within the United States, and that fee income is “sourced” in the United States. Therefore, tax is due to the United States on that income. In contrast, if that same money manager is sitting in Frederiksted, St. Croix when she provides that same service that results in her earning $2.00, then her $2.00 fee is sourced in the U.S. Virgin Islands, because that is where she performed the service that gave rise to the fee. Obviously, there are many types of income other than fee income for services, and some income, such as capital gains or certain dividends and interest, may be eligible for benefits under certain circumstances and not eligible for benefits under others, and some income can never be eligible for benefits. Therefore, as will be stated frequently in this series, it is of the upmost importance to engage a legal and tax professional with experience in these matters before determining whether your income is sourced or effectively connected to the U.S. Virgin Islands.

Nevertheless, an important point remains with regards to how the U.S. Virgin Islands is permitted to provide tax incentives: it requires the establishment of an office and the undertaking of work in the U.S. Virgin Islands. This is why the tax incentive programs are such a valuable tool for job creation. The more work done on U.S. Virgin Islands soil, the more income the businesses can source in or effectively connect to the U.S. Virgin Islands. By the very nature of the IRC rules that govern the ability of the U.S. Virgin Islands to provide tax benefits, businesses are highly incentivized to move as many of their jobs to the Territory, because any work that earns income for services performed in the United States will likely not be eligible for the tax incentives.

This concept also provides another important point. I often hear from Virgin Islanders that businesses come to our Territory and “don’t pay any taxes”. This is not accurate. The only tax breaks that the Virgin Islands government gives (indeed, is allowed to give!) is on income that is earned for efforts the IRC determines is sourced in or effectively connected to the Territory. It is important for persons interested in tax incentives to understand that not all of their income will be eligible for the tax incentive. Likewise, Virgin Islanders should understand that those businesses that are eligible for benefits do not receive those benefits on ALL of their income. In fact, many of the beneficiaries pay tremendous amounts of taxes on their personal income, other than from their business in the U.S. Virgin Islands.