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CPI INVESTIGATES: Puerto Rico Act 22 tax incentive fails

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The jobs and economic impact anticipated by the Puerto Rico government never materialized. From being an instrument to attract millionaires and foreign investment, Act 22 went on to become a haven for cryptocurrency fans, YouTube personalities and consultants.

By Luis J. Valentín Ortiz, Joel Cintrón Arbasetti and Dalila M. Olmo López
Center for Investigative Journalism

A company owned by Hamed R. Wardak was investigated by the U.S. Congress in 2010 for allegedly paying Taliban insurgents with money from a contract with the U.S. Department of Defense. The contractor denied the allegation made in an investigative report.

In 2015, Wardak moved to Dorado and took advantage of Act 22. The incentive exempts foreigners from paying capital gains taxes — the law calls them “resident investors” — who move their main residence to the island. That is, 0% taxes on these people’s wealth.

Last year, Wardak’s former fiancée accused him of rape in a lawsuit filed in New York. Wardak, now a music producer, denied the allegations.

Aaron Vick, a U.S. contractor, was referred to the island Department of Justice after his signature appeared on the failed sale of 1 million COVID-19 tests to the Puerto Rico government. Two months later, with the transaction still under investigation, Vick obtained an Act 22 decree.

In 2019, Lancelot Patrice Michel De Montsegur and Michael Williams, both Act 22 beneficiaries, were charged with fraud in separate cases. De Montsegur pleaded guilty to processing fraudulent credit card payments. The court appointed a trustee for Williams and his bank accounts were frozen after the U.S. Securities and Exchange Commission (SEC) accused him of illegally appropriating funds from his clients.

Rishi Shah and Shradha Agarwal got Act 22 decrees in 2019. That same year, the SEC charged them with fraud for lying to investors, clients, and auditors of their company. Shah and Agarwal, who does not reside on the island, have more than $10 million seized by the U.S. government, including money that is in Puerto Rico banks.

A collaborative multimedia investigation revealed in October 2020 that Euro Pacific Bank, a Puerto Rico registered entity, is under investigation for an alleged link to an international money laundering ring. The bank’s senior partners, Peter Schiff and Mark Anderson, are Act 22 grantees since 2017.

Christopher Johnston, who received an Act 22 decree in 2017, was accused last September by the New Jersey U.S. attorney general’s office of fraud and identity theft along with two of his partners. Johnston is free on bail and cannot travel to Puerto Rico.

Keith St. Clair, another Act 22 grantee, announced more than $200 million in investments for the Island. Six years later, the four hotel projects and a film district he promised are either uninitiated or unfinished. The investor also faces lawsuits for collection of money, a financial dispute with the contractor of one of the hotels and a complaint from the Puerto Rico Department of Consumer Affairs.

In May, criminal charges were filed against Salil Zaveri for shooting a dog to death on a golf course with a Glock gun. Zaveri, who received Act 22 benefits in 2016, said he will plead guilty.

In almost 10 years, the Department of Economic Development and Commerce (DDEC, in Spanish) did not audit the 3,311 people covered by Act 22, even though it was required to do so under the law since 2015.

The DDEC did not verify the annual reports that grantees filed each year, the agency’s only oversight tool. This week, the DDEC sent, for the first time, 1,086 notifications of noncompliance to Act 22 grantees who failed to file their reports, the agency told the Center for Investigative Journalism (CPI, in Spanish).

The DDEC has never revoked one of these decrees. The statute allows cancellations only when the tax exemption is requested through fraud or false information. The track record of some recipients also reflects failures in running background checks of those who request the tax incentive.

Many Act 22 beneficiaries have moved to the Palmas del Mar complex in Humacao, in eastern Puerto Rico. (Credit: Xavier García/CPI).

“Investors” who don’t invest
Act 22’s failure is not only over bad apples. A random sample of 304 grantees, or 10% of the 3,040 Act 22 decrees granted under the program through June 2020, reflects that the majority barely create jobs and represent a minimal impact on the local economy.

Among the businesses that they have created are small financial advisory, investment management or real estate companies, headquartered in residences and apartments, an investigation by the CPI revealed. Of the nearly 400 companies identified in the sample, 27% were canceled or dissolved shortly after they were created. There are 115 beneficiaries, or 37%, who do not have a business registered under their name in Puerto Rico.

Moreover, at least 91 “resident investors” in the sample have family members who also obtained Act 22 decrees in their individual capacity just because they were related to the main investor, without the government knowing what they invested in, if anything. There are retired people and employees of technology, real estate, financial companies, startups and law firms who move to the island to work remotely, without making major investments or establishing a business here.

Economist José Caraballo Cueto said that the findings demonstrate Act 22’s meager impact on the economy and the need to make changes to the incentive to take advantage of it.

“Are there sectors that have benefited? Yes, real estate, for example, has done very well. But in the macroeconomic aspect, the impact is extremely limited,” he noted.

For him, it’s not the same thing to draw an investor with a business that creates dozens of jobs — and that does not compete with Puerto Rican companies — than an individual who only spends time on the island. “They cannot both receive the same incentive,” said Caraballo Cueto. And under no circumstances should anyone receive a 100% exemption as provided by Act 22, he added.

The original idea, when the incentive was proposed, was to attract new capital from investors who had no prior relationship with Puerto Rico. The analyzed sample found nearly 20 cases of people who obtained the decree even though they already had businesses on the island. Establishing themselves in Puerto Rico did not depend on having received the incentive.

For example, Richard Shinto founded the Puerto Rico Medicare and Medicaid Products Association (MMAPA) in 2008 and has been MMM’s CEO for more than a decade. Jim O’Drobinak has served as MCS’s CEO since 2011. They both got Act 22 decrees in 2016.

At that time, the law required that the grantee had not resided in Puerto Rico during the previous 15 years; this requirement was reduced to 10 years in 2019.

Shinto did not answer questions.

O’Drobinak told the CPI that he moved to the island in 2016. His biography on the MCS web page says that he has lived in the Condado sector of San Juan since 2012 and that he chaired over MMAPA from 2012 to 2016. When confronted with this information, the executive said he had been working in Puerto Rico since 2011 but traveled to the island from his U.S. residence.

Would O’Drobinak have moved to the island without the Act 22 incentive?

“Definitely. I have been working for MCS since 2011, although I kept my house in Tampa. However, I fell in love with Puerto Rico, its people and the company I work for and decided to move and settle here with my whole family in 2016,” he replied. Liana O’Drobinak, his wife, also has an Act 22 decree.

No one’s watching: The allure of poor enforcement
There are many who have promoted Act 22 from a stage, but the audience is different this time. Anarchapulco is an annual convention aimed at people who think that the free market should rule everything, and the State should not interfere in anything, a political vision that has been called anarcho-capitalism.

Sam Wolanyk said Puerto Rico is a unique opportunity for these people.

“It’s not a third world country. It’s like America lite. The government is totally broke. But this works in your favor because [Puerto Rico] can’t pay people to keep an eye on you. I like it,” Wolanyk said in 2018, addressing investors in virtual currencies like Bitcoin, an unregulated type of digital money.

“So if you did three months in the U.S., four months in Puerto Rico and five months tripping around Europe, chasing croissants, you’re probably good. I’m not saying for certain and I wouldn’t advertise this, but I can tell you that nobody’s watching,” Wolanyk said in Anarchapulco. He is a surfer, lives in Rincón and rents properties on Airbnb, although there is no company registered under his name on the island. In 2014, he got his decree, a contract with the government that grants him the Act 22 benefits until 2035.

An email to Wolanyk with questions about his efforts as a “resident investor” on the island and requesting an interview was not answered.

Until last year, the former Industrial Tax Exemption Office (OECI, in Spanish) administered Act 22 and nine other economic incentives with just over a dozen employees. The OECI received the annual reports required by law and that were never audited.

This document must include, among other information, the individual’s net worth, if they rent or own any property, the municipality where they reside, a copy of their tax return, how many jobs they generate, an estimate of their annual expenses and how many days they spent on the island, since they are required to live in Puerto Rico at least six months out of the year.

In April, the CPI sued the DDEC to obtain part of the information in these reports, but the government argues that they are confidential and that their publication would scare off investors.

In an interview with El Nuevo Día, the DDEC accepted flaws in its oversight of Act 22 and announced an audit for this year. The agency told the CPI that it expects to have its first findings before the end of 2021. The DDEC audit includes corroborating whether recipients resided in Puerto Rico, if they donated $5,000 to a nonprofit organization and if they filed their tax returns and annual reports.

The DDEC also said it will create an oversight and compliance division that is exclusively dedicated to reviewing fulfillment of the decrees. But in May, DDEC Secretary Manuel Cidre said in a budget hearing that cuts of nearly $50 million to his agency for next year by the Fiscal Control Board put this kind of effort at risk.

The Act 20/22 Society, which groups incentive beneficiaries on the island, did not respond to a request for comment.

Gap between the DDEC’s and the Treasury’s numbers
The number of income tax forms filed by Act 22 beneficiaries does not match the number of decrees granted, the CPI confirmed upon receiving the data as a result of the lawsuit for access to public information.

Tax returns vs. decrees. Since Act 22 was passed, there are fewer tax returns filed at the Treasury Department from beneficiaries than decrees granted so far.

For taxable year 2019, the Puerto Rico Treasury Department received 1,044 returns from individuals who had the incentive. The DDEC had more than 2,400 decrees in place, then. In other words, there were more than 1,350 fewer forms than decrees issued.

The explanation given by both agencies for this gap is that some individuals file forms together with their partner and that decrees were granted to people who have not moved to the island or who abandoned the process, so they did not have to file returns. However, Treasury Secretary Francisco Parés admitted that “there may also be noncompliance.”

The Incentive Code, to which Act 22 was integrated in 2019, requires beneficiaries to file an annual return with the Treasury. Before this, Act 22 had the same requirement. So, the number of returns filed should be directly related to the number of active decrees at the end of each taxable year. The difference between forms and decrees has existed since the beginning of the program in 2012 and each year is more marked, according to the data evaluated.

In February, Treasury announced that, like the DDEC, it will audit the compliance of Act 22 grantees. Secretary Parés, who has held the position since 2019, said he did not previously audit Act 22 beneficiaries because he prioritized resources in digitalizing the agency.

Treasury is waiting for the DDEC to have “a clearer picture” on who has active decrees under this law. “Once they have that information, we will proceed to compare it with our records,” Parés said.

He said the agency processes Act 22 tax returns without any type of special scrutiny beyond the normal controls that it normally applies and only has an estimate of the returns that it should receive from those benefiting from the tax benefit. The CPI requested these estimates, but the agency did not provide them.

From left: DDEC Secretary Manuel Cidre and Treasury Secretary Francisco Parés.

In the crosshairs of the IRS
“The government doesn’t follow you nor supervise you to tax you wherever you go. The IRS hasn’t done anything. It’s a unique offer,” said Lobo Tiggre, an investor in the metal mining industry with a decree under Act 22. He arrived on the island in 2014 and describes his experience as living in a “paradise with trash bags blowing in the wind.”

The U.S. Internal Revenue Service (IRS) has already warned that it is closely monitoring the use of this incentive. In February, the agency included Act 22 beneficiaries on a list of priority tax exemptions to be audited. A lawyer who asked to remain anonymous told the CPI that he is aware of multiple orders from federal authorities, in which they require financial information on several of these people.

“The IRS complaint is that Puerto Rico is not monitoring as much as they would like,” said CPA Kenneth Rivera.

To avoid paying taxes in the U.S., Act 22 beneficiaries must become bona fide residents of the island and send a formal notification to the IRS. They must also demonstrate that they do not maintain a closer connection with any other place in the U.S. The analyzed sample showed at least a dozen cases of grantees with main businesses outside Puerto Rico or that do not identify the island as their place of residence.

“They cannot have a direct connection. For example, you should not vote in the United States; must not have a United States driver’s license; the family, the ideal is for them to be here in Puerto Rico; and a series of factors that, like a checklist, [the IRS] is looking to show if they have more connection with the United States or with Puerto Rico,“ said Rivera, referring to the methodology used by the federal agency to determine the residence of a person.

Tyler R. Hatcher, special agent of the IRS in Miami, the office with jurisdiction over Puerto Rico, told the CPI that the agency “has prioritized the schemes that misuse these incentives and is vigorously pursuing taxpayers and tax professionals who fraudulently enrich themselves by abusing government tax incentive programs.” Hatcher did not respond to more specific questions about Act 22.

From Prouty’s investments to the Paul brothers’ videos
Between 2013 and 2014, investor Nicholas Prouty was the poster child of Act 22. A native of New York, he got the tax exemption benefit in 2013 and moved to Puerto Rico. He announced millionaire investments and jobs. He bought the Ciudadela housing complex in Santurce, which was in bankruptcy, and the Puerto del Rey Marina in Fajardo.

Five years later, Prouty’s image was replaced by the “Crypto Guys” led by Brock Pierce, a cryptocurrency trader, and more recently, by Internet personalities and now boxers, brothers Logan and Jake Paul.

Brock Pierce at a Department of Economic Development and Commerce event.

In 2017, the Rosselló Nevares administration amended the law to make the incentive application process more flexible and eliminated the OECI audit requirement. It also established a $5,000 annual donation to nonprofit organizations.

“Our administration’s aspiration is that in the next four years we can jump from what have always been a few decrees, [almost] 1,000, to 10,000 decrees for people who come to contribute, to bring new capital, who weren’t in Puerto Rico and that who come to boost the economy,” said Rosselló Nevares in the summer of 2017.

Rosselló Nevares’ expectation did not come to fruition. The number of decrees granted as of June 2020 was 3,040, 30% of the target. But with the laxer law and the lack of oversight, the profile of the Act 22 beneficiary changed from an executive in a tie to that of a tourist in beach wear.

Instead of announcing jobs or investments, Jake Paul appears on social media on a bridge showing his rear end or racing a Jeep down the beach at high speed over the nesting area of leatherback sea turtles. Saveri kills a dog with multiple shots on a golf course.

Sociologist Miriam Muñiz Varela points out the existing contrast between Act 22 incentives to attract foreigners, on the one hand, and, on the other, mass migration due to lack of jobs and government services; regressive taxes on the people such as the 11.5% sales tax; public spending cuts, such as those through Act 7 of 2009; limitations on pensions and reduction of rights for the working class in the 2017 labor reform. For Muñiz, those policies implemented since the beginning of the government debt crisis are “violent forms of social destruction.”

“The violence that I’m referring to is that of an economic model that doesn’t allow life to be sustained and grow with dignity,” says the sociology and anthropology professor at the University of Puerto Rico, Río Piedras campus. She believes the behavior of some Act 22 beneficiaries reflects “condescension and contempt toward a place and a population that is considered inferior.”

“That’s very typical of the ways of the white supremacist power regarding those who have another skin color. Of course, also in the machismos that are manifested with patriarchy. Racial and sexual markings have been part of the ways of the colonial power that Europe established with the American conquest more than 500 years ago. We know that this continues to happen in Puerto Rico,” said Muñiz, author of the book Goodbye to the economy (Adiós a la economía).

Was this the type of “resident investor” that the government wanted to attract with Act 22? CPI asked the DDEC and former governors Luis Fortuño and Alejandro García Padilla.

Fortuño did not respond. The DDEC said the law is aimed at anyone who meets its requirements. García Padilla said his administration sought the investor who created “hundreds of jobs.”

“This law has a bad side and a good side. By allowing people to come to Puerto Rico without investing, without creating jobs, the good part of the law is eliminated,” he said. The incentive, even under his administration, has never had any employment or investment requirement, beyond buying a home property.

García Padilla said an example of Act 22’s good side is the law firm Sanders Phillips Grossman (SPG). “I think they have more than 100 employees in Puerto Rico. […] They’re people who effectively create wealth in Puerto Rico,” he said.

The former governor is a consultant for this firm. He got there through one of SPG’s partners, Marc D. Grossman, a beneficiary of Act 22 since 2015. García Padilla assured that he did not meet Grossman until after leaving La Fortaleza. Although he assumed he was under Act 22, he said he never asked Grossman if he had the incentive.

Act 22 beneficiaries like Grossman and millionaire developer Prouty became the exception. And this has been public knowledge since 2019, when the government itself acknowledged that more than 80% of the beneficiaries have less than $10 million in their bank account, according to a report generated that year by Estudios Técnicos, an economic analysis firm.

“A lot of normal people come here [under this law], who don’t have a lot of money and what they’re doing is sort of speculating. ‘Look, I’ll buy $100,000 in cryptocurrencies and if it’s a hit and it jumps to $10 million, then I didn’t pay taxes on that.’ But someone who comes here with $100,000 isn’t the type of person who’s going to move the needle,” said CPA Kenneth Rivera, who chaired the Puerto Rico CPA Association and the Puerto Rico Chamber of Commerce.

In 2019, after a meeting with former Gov. Wanda Vázquez, Prouty said Act 22 needed to be evaluated. “What I would like to see is more investment from that community in Puerto Rico,” he said at the time.

Nicholas Prouty

The CPI requested an interview with Prouty, but he did not respond.

It doesn’t move the needle
Wolanyk said in Anarchapulco that when he arrived in Puerto Rico in 2014, he asked where hippies and artists lived on the island. They told him in Rincón.

“In two weeks I bought a car and a house, put the house on Airbnb, and it’s just pretty much been, you know, roses and unicorns ever since,” he said in 2018.

Two years later, Wolanyk sued the island government. He wanted the court to strike down the government’s curfew established during the COVID-19 pandemic. The lawsuit said Wolanyk was unable to enjoy the beach as a surfer, and that the order affected his Airbnb businesses, including six construction jobs he had at an Aguada property.

Between 2015 and 2019, nearly 2,000 Act 22 grantees had created just over 4,400 direct jobs, according to Estudios Técnicos. That is, less than three jobs per decree. The same firm estimated that, between 2012 and 2015, nearly 500 Act 22 beneficiaries created 2,500 jobs.

Despite the fact that each beneficiary must specify the number of jobs created each year, the Government has not wanted to publish this data beyond the estimates by Estudios Técnicos. The Incentive Code requires the DDEC to disclose this information annually through a report on all tax incentives. The last and only report of this nature, corresponding to fiscal year 2019-20, leaves the line of created or committed jobs under Act 22 blank.

“The Estudios Técnicos report itself states that job creation is mostly tied to Act 20 and not Act 22,” economist Caraballo Cueto said.

Early on, the government spoke of Act 22 in conjunction with Act 20, which imposes a reduced tax rate of 4% on companies that export services from the island. The package of laws was “the spearhead of a program of social and economic justice for the U.S. American citizens living in Puerto Rico,” said former DDEC secretary AlbertoBacó Bagué in 2013. His predecessor and mastermind of both laws, José Pérez Riera, called them “yin and yang.”

“Act 22 will bring people who will buy properties, which will help construction. They will also buy cars and spend money in stores and restaurants, and Act 20 will bring economic development. It will create jobs and, slowly but surely, a new source of revenue for the government,” Bacó said at the time.

But in most cases, there is no yin and yang. In the sample of 304 Act 22 beneficiaries, the CPI identified just over 90 with businesses under Act 20, only 30% of the selection. The data from Estudios Técnicos published in 2019 anticipated this: between 2015 and 2019, only 27% had businesses covered by Act 20.

“What we have to move toward is not to overestimate the crumbs that an incentive leaves, but to look at how to get the most out of it,” said Caraballo Cueto.

One way to do it, the economist said, is to require a minimum of jobs created. The government must also impose the appropriate tax rate. “I don’t know where the government gets rates of 0% or 4%. Where do those numbers come from? It is something that is quite arbitrary. I think we have to look better for the optimal tax rate to take advantage of the incentive,” he said.

Kenneth Rivera recommended stricter oversight over who gets the benefit as well as demanding a minimum investment on the island in return. “Maybe it should have been a little more formal in the requirements of who we’re going to give this to, and say, ‘wait, you have to come here with at least $1 million [to invest]’,” the CPA and lawyer said.

In late April, the House of Representatives launched an investigation into the compliance and performance of Act 22, to determine whether the statute should be changed or repealed. The House commission must report its results on or before six months. In the Senate, María de Lourdes Santiago and José Vargas Vidot submitted a bill in January to repeal Acts 20 and 22, but it has not been addressed in the Senate Finance Commission chaired by former Treasury Secretary Juan Zaragoza.

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This story was written by our staff based on a press release.
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