Lawfully Reduce Your Business Federal Income Tax by up to 90% in the U.S. Virgin Islands

Several years ago a particularly sharp CPA/attorney friend of mine asked if I was aware of the tax benefits of operating just about any business out of the United States Virgin Islands.  As he began to explain the peculiar legal status of the USVI it struck me as either too good to be true or some kind of tax scam sure to get anyone involved into trouble with the IRS.  In short, he said, so long as you make a modest cash investment, hire a few USVI residents, and locate all or part of your business on St. Thomas, St. John or St. Croix, all of the profits derived from those activities would be subject to only 10% of the usual Federal income tax.

It all seemed too improbable, and the USVI too remote and exotic, for any of this to make sense.  I wondered why the Islands were not sinking from the weight of new companies clamoring to establish themselves on this oasis of tax relief.  There also seemed to be an extraordinarily limited amount of information about the program on the Internet.  Could it be possible?  When I mentioned it to a few business clients they were similarly skeptical, but intrigued, as I continued to be.

After exhausting the readily available resources I decided to make a direct trip to the Islands to get the straight story from local officials and to see for myself whether the USVI was a place where a serious investment could be made.  Although I had been there twice on vacation, I wanted to make a business visit to all three Islands, see what sort of industrial infrastructure was already in place, get a feeling for the education level and work ethic of the local population, and generally develop a sense of whether I could recommend to any business person the idea of investing (and potentially living) on a semitropical island some 1,100 miles Southeast of Miami.

I made my first business trip in February 2005, which was followed by nine more during the 16 months that have followed. This included the 2005 annual seminar on the program sponsored by the Territorial Government as well as meetings with dozens of local business people and professionals.  This Memorandum is a summary of what I learned on these visits and why, to my amazement, I believe that for the right business there may be no better place to set up shop.

Where in the World is (are) the USVI?

You will find the USVI 90 miles east of the US territory of Puerto Rico, which is due East from the island shared by Haiti and the Dominican Republic, which are in turn due East of Cuba.  Although consisting of three primary islands, St. Thomas, St. John and St. Croix, the USVI actually has smaller islands as well.  St. Thomas is the most populated and well known, particularly for its magnificent deep water port and shopping Mecca/capital, Charlotte Amalie.  Direct flights, including 767 wide body airplanes, arrive every day from the major cities of the East coast of the US.

Best known of the USVI, St. Thomas is 13 miles long and 3 miles wide, and home to a population of about 53,000 among its steep hills.  Just three miles to the east of St. Thomas is the exclusive island of St. John.  Much smaller than St. Thomas, St. John has 5,000 full time residents and is accessible only by ferries that run from Charlotte Amalie and from the eastern tip of St. Thomas.1  The beaches are uniformly magnificent but the terrain is extremely hilly and the infrastructure, particularly at high season, is woefully inadequate to support the number of tourists. Most of St. John is a Federal nature reserve.  I saw no industry or commercial establishments there that were not at least indirectly connected to tourism.  Roads on both St. Thomas and St. John are narrow, steep, and often poorly maintained.  Large trash bins are stationed across these islands and are a jarring sight along with far too many abandoned vehicles.

Finally, and most importantly for the reasons to be discussed, 40 miles to the south of St. Thomas is the “big” island of St. Croix.  Locals call it “The Rock.”  Nearly twice the area of St. Thomas, St. Croix, also has a population of about 53,000, is considerably flatter as well and has large stretches of three and four lane highways running due east and west through the middle of the island where huge sugar cane plantations once stood.  There are scores of old stone windmills and ruins of plantation factories around the Island which were used to press the cane to make white sugar and molasses in the 18th and 19th centuries.2  The Island runs generally East to West and rises as high as 1000 feet above sea level in the rain forest of the northwest quarter.  St. Croix has its own international airport with scheduled commercial flights from Charlotte, Atlanta and Miami.  A miserable connection is also possible, but to be avoided, through Puerto Rico.  Access from St. Thomas is by passenger ferry during the tourist season of November through May3, by seaplane4 and small commuter airplane year round.5

St. Croix also has a large oil refinery on the south coast that provides significantly lower priced fuel to the Island.  Gasoline runs at least 50 cents per gallon cheaper than the other Caribbean islands, including the other islands of the USVI.  Such discounted fuel also encourages aviation and marine traffic to stop at St. Croix’s airport and deep water port (also on the south coast) to fill up.

These islands are a hub of navigation with luxury yachts, cruise ships, and smaller craft constantly moving between the Islands and traveling to the nearby British Virgin Islands, of Tortola, Virgin Gorda, and others.  The area is renowned for constant and perfect sailing winds, superb scuba and snorkeling, and many of the most beautiful beaches in the world.6  I can attest to the generally beautiful weather based upon a week long private cruise among the USVI and BVI in January 2004, a commercial liner cruise which made a one day port call to Charlotte Amalie in November 2001, my week long visit of February 2005 and many trips since then.

While on the topic of weather, hurricanes and tropical storms are a factor throughout the Caribbean, Gulf of Mexico, and all of the countries of Central America, Mexico and states from Texas to Maryland.  Of course Florida had four devastating hurricanes in 2004 alone and 2005 set the record with 29 named storms including Katrina.  None made land fall in the USVI - a matter of extreme good fortune.

Hurricanes are an inevitable reality in the USVI, however.  In fact, it was his widely published report of a hurricane on St. Croix around 1770 that caused a gifted but impoverished clerk and visitor named Alexander Hamilton to be noticed by wealthier planters who financed his education in the colonies to the North.  Hurricanes, at least one tidal wave and even earthquakes have left their mark on the islands over the centuries.

It was after a relatively calm period of some 60 years that hurricane Hugo, a Category 4 or 5 storm, struck in 1989, wreaking havoc for 12 hours over St. Croix.  This hurricane took a devastating toll with 90% of the structures damaged.  The town of Fredriksted on the Western edge of the island was all but destroyed.  The reputation of the island also took a hit with media reports of looting in the aftermath of the storm.

Subsequent hurricanes have come through , the most serious in the mid-90s which took off many roofs on St. Thomas.  This means there have been two serious hurricanes in the past 20 years, compared to four in Florida in 2004 alone.  However, strict building codes adopted by the USVI following Hugo has assured that storm damage is now mostly confined to fallen trees and power outages.  During the most recent tropical storm to hit the USVI most resorts were fully operational within a week.

In short, the tradeoff for near perfect weather most of the time is the inevitable hurricane.  This is a similar risk to that assumed by a substantial percentage of the US mainland population living in the Gulf States, Eastern Seaboard, Hawaii, and the tornado prone areas of the mid-west United States.  It is also a risk similar to the earthquake hazards that threaten the West Coast and Alaska.

What does Territorial Status Mean?

Although the United States purchased the USVI from Denmark in 1919 for $25 million, locals bristle at the thought of their home being referred to as a “possession” of the United States.  They are quick to point out that they are U.S. citizens, serve in the armed forces of the United States7, proudly fly the American flag, and would like to have the right to vote for the American President.  The USVI elects and sends to the US House of Representatives a non-voting member who sits on several committees and generally represents the USVI before various federal agencies.

The Islands enjoy self-rule which means they elect their Governor and Lt. Governor, along with a 15 member legislative Senate.  They have their own laws and criminal and civil courts for the resolution of local disputes.  There is a high literacy rate and although the official language is English, many in the Islands speak Spanish and a few here and there also speak French and Danish.  During my recent visits I heard at least four languages being spoken by tourists.

The University of the Virgin Islands is accredited and maintains campuses on both St. Thomas and St. Croix.  There is an established nursing school and talk of a medical school as well.  The hospitals appear to be the equivalent of a competent rural facility in the North, which is to say adequate for day to day needs but probably not the place to have your complex surgery.  This is why an air medical transport business maintains a busy schedule to and from the mainland.  Local health care capabilities are improving however with heart stent and balloon angioplasty procedures now being performed on St. Croix by board certified cardiologists.  Newer cancer treatment and cardiac centers are also up or in development on St. Thomas and St. Croix respectively.

All laws of the United States apply to the USVI, and the Islands are considered part of the Third Circuit courts (which oddly also covers Pennsylvania, New Jersey and Delaware) with a US District Court and US Bankruptcy Court.  All of which means that the USVI are part of the United States and fully integrated into its economic and judicial system, if not its political structure.  US and USVI citizens currently travel back and forth without a passport and without any visa or immigration restrictions or limitations.8  Goods manufactured in the USVI may lawfully be labeled as “Made in the USA.”  The currency is U.S. dollars.  However, as a territory the USVI has a certain level of autonomy which it has used to its advantage to attract business.

While the pace is slow, sometimes maddeningly so by New York standards, there appear to be many individuals willing to work hard in the retail and resort businesses and more and more mainlanders are relocating to the USVI such that a more Northern work ethic is taking hold.  Unemployment runs near 10% and another group is underemployed.  In addition the government is deliberately overstaffed in an effort to maintain a higher level of employment.

General Business Rules in the USVI

In this section I discuss the special incentives the USVI offers to certain new businesses that create employment opportunities or other economic growth advantages for the people of the Islands.  A useful understanding of these advantages first requires a quick review regarding how businesses are ordinarily treated by the government of the USVI.

First, the USVI has no sales tax.  It also has no “local” or “state” income tax per se.  Rather, residents and ordinary commercial establishments doing business in the USVI file annual tax returns which “mirror” the US federal income tax system, rules, and forms.  More to the point, the money collected by the IRS from the USVI is returned to the Islands.  In short, an ordinary resident or business in the USVI pays the same federal income taxes as any citizen of any state - but no other local, state or sales tax.

There are a few other standard taxes though.  A real estate tax of 12.5 mills is applied based on 60% of the market value of real estate.  This is substantially below what we are used to.  So a $500,000 business property is ordinarily subjected to an annual real estate tax of $3,750.9  There is also an “excise” tax of 6% on any goods brought into the Islands from the US mainland.  Last, there is normally a 4% gross receipts tax on corporate revenues.

All of which means that even without any special program incentives a business operating in the USVI will potentially enjoy more after tax income than it would operating in many states on the Continent.

Economic Development Authority Incentives

In order to attract new jobs and economy expanding businesses to the USVI, the Territory and United States Congress have made the following offer:

The Strings Attached

However, the Commission is authorized to waive any requirement based upon the circumstances and whether the proposed project is generally deemed to be in the best interests of the USVI.  In other words, the USVI can and will bend any or all of these rules where a compelling case is presented in support of a business that will enhance the economic welfare of the USVI.

They are looking for businesses that will bring new dollars to the USVI.  Anything having to do with tourism qualifies excepting retail stores, although shopping centers have qualified in the past.  Resorts are a prime candidate.  Industrial parks and new warehouse type facilities have been established on St. Thomas and St. Croix with rents in the $4 to $5 per foot range.  Some have been unoccupied for ten years and thus could potentially be had for even less.  Two separate fiber optic cables provide broadband service to St. Croix although the last mile service is problematic and expensive.  Small manufacturers, health care providers, and financial service companies are all comfortably within the terms of the program.

Procedures, Costs, Timing, and Enforcement

From initial application to approval the Economic Development Commission process takes about six months and includes at least one public hearing.  There are filing fees that can run as high as $5,000 depending upon the business.  Although not required, engagement of a local attorney is recommended despite the added expense.  One attorney quoted $15,000 to $25,000 as the fee range to hand hold an applicant through the process.

Once approved, the applicant has up to five years to start the qualifying business.  When up and running there are quarterly and annual reporting requirements and standards that the EDA uses to confirm compliance with the terms of the grant.  Compliance with the program is report intensive and the local officials make no apology for that as they believe the benefits are substantial and thus they are required by law, and the IRS, to assure that beneficiaries are playing by the rules.

Enforcement of the rules became more evident when the IRS began to crack down on one abusive operation where a financial service firm was taking on new “partners” on the mainland who falsely claimed to be USVI residents.  These new players would pay a fee to buy a partnership interest in an established EDC approved USVI financial services firm, hire a single secretary, and then run their mainland consulting or professional business revenues through the USVI partnership.  Such individuals would then claim the 90% tax waiver on their share of the partnership profits and avoid substantial taxes.

In the most noteworthy enforcement action, the “partner” in question was not a USVI resident at all and the whole exercise was a fraud.  The IRS raided the company office in a very public way with computers and records seized.  Under such pressure from the IRS and Congress the USVI has tightened the rules to avoid a repeat of this experience.  Some half dozen EDC defined services businesses quickly closed their doors and their owners placed their little used million dollar villas on the market. 

In 2004, Congress passed a bill that suggested that qualifying residency in the USVI would require being in the Islands at least 183 days of the year.  This was followed by IRS regulation in 2005 which imposed an onerous obligation to report your personal, business and even social connections to the Island if one was unable to meet the 183 day requirement but nevertheless claimed sufficient contacts with the territory to establish a bona fide residency.

While the IRS raid and regulations have thrown a bucket of cold water on the USVI program, the essential advantages remain.  Mainland businesses can establish a subsidiary in the USVI to provide products or services to the mainland or the rest of the world and the Federal tax liability will be reduced by 90% on the profits made from the USVI located operation.  Dividends paid by such corporations to those outside the USVI will be subject to the usual 15% federal tax, but the profits reinvested in the qualifying business essentially grow in a sheltered environment until the profits eventually flow to the shareholders.

If, as a share owner, you are willing to change your residence to the USVI then you only will pay 10% of the usual 15% dividends tax, but be prepared to jump through the IRS hoops as necessary to claim your tax benefit.

The Bottom Line

A business that can operate remotely from its market, such as a small manufacturer, a financial service company, a data processing firm can all but eliminate the tax load on such operations by relocating all or a part of its operations to the USVI.  There is sufficient business infrastructure to provide the human resources, air transportation, utilities, and telecommunications required to support any business.  The deep-water port on St. Croix comfortably accommodates freighters although commuting by ferry between the islands is impracticably slow and seasonal.

Assuming a business is anticipated to generate $500,000 or more in taxable profit the tax savings would be in excess of $140,000.  A million dollar profit translates to approximately $300,000 in tax savings.

These are numbers worth thinking twice about, which is exactly what the USVI had in mind.