INTRODUCTION TO Puerto Rico Tax Incentives
Few places on earth offer a return on investment the way Puerto Rico does. With an ever-growing array of services and emerging industries, part of your success will be directly attributable to the incentives available. In order to bolster a diversified economy, the local government has created an aggressive economic and tax incentives program with the purpose of helping operations on the island become more profitable to those companies who establish themselves here.
These incentives were created to ensure Puerto Rico’s competitiveness in attracting investments and they are an opportunity for companies all over the world, particularly those dedicated to state-of-the-art technologies and added value.
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Introduction to Puerto Rico’s Tax Codes
Puerto Rico, officially the Commonwealth of Puerto Rico, is a self-governing, territory of the United States, located in the northeastern Caribbean, east of the Dominican Republic and west of both the US Virgin Islands and the British Virgin Islands.
The government of Puerto Rico is composed of three branches: the executive, legislative, and judicial branches. The executive branch is headed by the governor. The legislative branch consists of a Legislative Assembly, made up of a Senate as its upper chamber and a House of Representatives as its lower chamber. The Senate is headed by the President of the Senate, while the House of Representatives is headed by the Speaker of the House. The governor and legislators are elected by popular vote every four years.
Puerto Rico has authority over its internal affairs unless US law is involved. The major differences between Puerto Rico and the 50 states are exemptions from some aspects of the Internal Revenue Code, its lack of voting representation, and the ineligibility of Puerto Ricans to vote in presidential elections.
The island is divided into 78 municipalities (counties/cities) with various degrees of autonomy from the central government. San Juan is the capital and most populated municipality, combined with nine other municipalities which form the San Juan Metropolitan Area. Within the 78 municipalities, 4 are considered major cities.
The island has been part of the U.S. since 1898 and those born in Puerto Rico have been citizens of the U.S. since 1917. Yet, because Puerto Rico is not a state, federal taxes do not apply generally to income generated by individuals or corporations within the Commonwealth. Puerto Rico corporations are treated for federal tax purposes as foreign corporations and are not generally subject to U.S. corporate taxes. Individual bonafide residents of Puerto Rico are not subject to federal taxes on income derived from Puerto Rico sources. In addition, Puerto Rico has provided incentives for manufacturing operations for over four decades. Products manufactured in Puerto Rico will carry the Made in USA label.
In 2008, a new Economic Incentives Act for the Development of Puerto Rico (hereinafter, Act 73 or Economic Incentives Act) went into effect. Also during the year 2012, two additional laws were enacted: Act 20 and Act 22, promoting the export of services from Puerto Rico and the transfer of wealthy individuals to Puerto Rico. These new laws established a legal framework of incentives designed to stimulate the establishment and development of a wide array of ventures, among them manufacturing, social media, other internet-based operations, commercial businesses, and the export of services.
Take Advantage of Tax Incentives by Owning Real Estate and Residing in Puerto Rico
Extraordinary tax incentives make living and working in Puerto Rico more enticing than ever before for U.S. citizens. They create a sense of urgency for investors to move to Puerto Rico and bring their businesses here.
Act 60
On July 1, 2019, Puerto Rico enacted legislation providing tax incentives for U.S. citizens that become residents of Puerto Rico. Of particular interest are Chapter 2 of Act 60 for Resident Individual Investors and Chapter 3 for Export Services, which shield new residents who live in Puerto Rico for at least half the year from paying most federal income taxes. The U.S. Internal Revenue Code generously exempts Puerto Rico-sourced income from federal income tax and, under Chapter 2 of Act 60, Puerto Rico residents pay minimal or possibly no taxes on interest, dividends, and certain capital gains. Additionally, property taxes are significantly lower than property taxes in the mainland U.S. Thus, Puerto Rico has become a mecca for the exportation of international services worldwide.
Tax Exemption Decrees for Act 60
To benefit from Chapters 2 and 3 of Act 60, a service provider and/or an individual must submit an online application through the Single Business Portal (SBP) online application platform. The government will issue a tax exemption decree that will provide full detail of tax rates and conditions mandated by Act 60. This decree will be considered a contract between the Government of Puerto Rico and the applicant. Once granted benefits, these will be guaranteed during the term of the decree, regardless of subsequent changes to the applicable Puerto Rico tax laws. The Export Services decree will have a term of 15 years with a possible 15-year extension, and the Resident Individual Investor decree will be valid until December 31, 2035.
Act 60 - Export Services and Commerce
Chapter 3 of Act 60 for Export Services and Commerce is intended to promote the exportation of services and commerce by providing great resources and opportunities for U.S. companies to bring their business to Puerto Rico to establish a trade and service center for the World. Services must be provided in Puerto Rico for customers outside Puerto Rico. The eligible service provided must not have a nexus with Puerto Rico; it cannot be related to the conduct of the trade, business, or other activity of the customer in Puerto Rico.
To become exempt, the business needs to apply for a tax concession via a tax exemption decree considered a contract with the Office of Incentives for Businesses of the Government of Puerto Rico. The decree will be secured during a term of 15 years with a possible 15-year extension, regardless of subsequent changes to the law itself. To qualify, the business cannot have any previous connections, dealings, or nexus with Puerto Rico.
Incentives:
Fixed Income tax rate of 4%.
100% income tax exemption for distributions from earnings and profits.
75% property tax exemption for real property used in the Export Business (taxable portion subject to a regular tax rate of up 11.83%).
75% property tax exemption for personal property used in the Export Services business (taxable portion subject to a regular tax rate of up to 8.83%).
50% exemption from municipal taxes (a taxable portion of gross receipts subject to a regular tax rate of 0.5%, or 1.5% for financial businesses).
Eligibility:
The following are considered eligible Export Services and Commerce activities:
Contract research and development. Advertising, public relations. Call centers, telecommunications, service centers. Centers for electronic data processing. Centralized management services (corporate headquarters), such as strategic direction, planning, distribution, logistics, and budgetary services. Consulting services, such as economic, scientific, environmental, technological, managerial, marketing, human resources, computer, and auditing. Computer software development. Creative industries. Educational and training services. Hospital and laboratory services, including medical tourism and telemedicine. Investment Banking and other financial services. Marketing centers. Production of blueprints, architectural and engineering services, and project management. Professional services such as legal, tax, and accounting. Shared service centers: accounting, finance, tax auditing, marketing, engineering, quality control, human resources, communications, electronic data processing, and others. Voice and data telecommunications for individuals outside of Puerto Rico. Distribution / licensing of computer programs (physical, cloud, or blockchain). Assembly, bottling, and packaging operations of products for export. Distribution of commercial and mercantile products manufactured in or outside Puerto Rico for use or consumption outside Puerto Rico. Storage and distribution centers. Trading services. Any other service determined by the Secretary of the Department of Economic Development and Commerce of Puerto Rico.
Act 60 - Resident Individual Investor
Chapter 2 of Act 60 for Resident Individual Investors seeks to attract individual investors by relocating to the Island. How? With total exemption from local income taxes on certain passive income earned after they become “bona fide” residents of Puerto Rico. These new residents of Puerto Rico are entitled to 100% income tax exemption on dividends, interest and certain capital gains. Although Puerto Rico is a U.S. territory, pursuant to section 933 of the U.S. Internal Revenue Code, bona fide residents of Puerto Rico are not subject to federal income taxes on Puerto Rico source income, but they continue to be subject to federal income taxes on income that is not sourced in Puerto Rico.
Incentives:
100% exemption from Puerto Rico income taxes on interest and dividends.
100% exemption from Puerto Rico income taxes on all short-term and long-term capital gains generated after the individual becomes a bonafide resident of Puerto Rico (“Puerto Rico Gain”). Special rules apply to capital gains on the sale of securities held before moving to Puerto Rico and sold after the move.
Individual investors can establish revocable or irrevocable trusts treated as grantor trusts for Puerto Rico tax purposes.
Investors may transfer or bestow freely all or some of their assets to the above-mentioned trusts.
Foreign trusts duly created under foreign laws will be considered valid in Puerto Rico.
Additional Tax Advantages
Act 60 – International Financial Entities
Chapter 4 of Act 60 for International Financial Entities (“IFE”) provides certain benefits to businesses engaged in eligible financial activities in P.R.
Incentives:
Income derived by the IFE will be subject to a fixed income tax rate of 4%.
Interest, financing charges, dividends, or partnership benefits will not be considered gross income from Puerto Rico sources; thus, not subject to taxation or withholding provisions applicable to non-residents.
Fixed income tax rate of 6% on dividends and other distributions of profits received by Puerto Rico residents that are shareholders or partners.
75% property tax exemption for real and personal property of an IFE.
50% tax exemption from municipal taxes.
Eligibility:
An entity can be incorporated or organized under the laws of Puerto Rico, the United States, or a foreign country. Must employ at least four full-time employees at its Puerto Rico business office. It is required to apply for a permit and license with the Office of the Commissioner of Financial Institutions (“Commissioner”) and obtain a tax exemption decree from the Office of Incentives for Businesses. The Decree will be effective for 15 years, but one additional extension of 15 years may be available. Payment of an initial license fee of $5,000, renewable annually with payment of a $5,000 fee. The entity must comply with all requirements established in the Federal Anti-Money Laundering Laws and Regulations, and with OFAC sanctions programs. The amount of its authorized capital stock cannot be less than $5 million, or $500,000 if limited to certain financial activities, or a higher amount, as required by the Commissioner, of which at least $250,000 must be paid before the license is issued. To obtain the license, in addition to the minimum capital requirement, must own at least $300,000 in restricted assets (generally, a CD with a local bank or other IFE) free of liens or financial guarantees. Once the license is obtained, the IFE may engage in a list of permitted transactions, as established in its license.
Act 60 - Private Equity Funds
Chapter 4 of Act 60 for Private Equity Funds seeks to improve access to capital for entrepreneurs and businesses at different activity and development stages. Chapter 4 provides a structure for investors to deploy capital with limited personal liability and without double taxation while enjoying certain tax benefits such as exemptions, deductions, and fixed income tax rates. Funds can qualify as either “Private Equity Funds” or “Puerto Rico Private Equity Funds.” Fund investment requirements vary depending on the type of fund and the amount of the deduction allowed to investors for amounts invested in the funds. Qualifying investors in the funds are, in general, partners in a partnership or members in a limited liability company electing partnership treatment for Puerto Rico income tax purposes. Investors must be “Accredited Investors” as defined under Act 60.
Incentives:
Private Equity Funds are not subject to municipal taxes, and all property owned by the fund is 75% exempt from property taxes.
Resident investors (which include PR resident individuals, US citizens which are not PR residents, foreign entities if all of its shareholders are residents of Puerto Rico, and a PR entity) are entitled to deduct from taxable income up to a maximum of 30% (60% if the investment is in a Puerto Rico Private Equity Fund) of their initial investment within a maximum period of 10 years (15 years if investment in a Puerto Rico Private Equity Fund) provided the deduction does not exceed 15% (30% if the investment is in a Puerto Rico Private Equity Fund) of their net income prior to such deduction.
An accredited investor’s share of income derived by a Private Equity Fund from interest and dividends is subject to an income tax rate of 10%, while capital gains are exempt.
Capital gains from the sale of ownership interests by an Accredited Investor in a Private Equity Fund are generally taxed at a fixed rate of 5%.
General Managers and Investment Advisors are also subject to certain tax benefits on income attributable to their ownership interest in a private equity fund.
Eligibility:
The fund must be a partnership or limited liability company organized under laws of the United States, a foreign jurisdiction or the Commonwealth of Puerto Rico, engaged in the business of buying and selling securities that are not offered at public securities exchange markets in the U.S. or any foreign country. The fund must have an office located in Puerto Rico. 80% of its paid-in capital must be invested in securities issued by entities that at the time of the acquisition are not offered at public securities markets. Invest up to 20% in allowable short-term investments. Within 4 years of the organization.
A “Private Equity Fund” must maintain a minimum of 15% of paid-in capital invested in securities that (i) are not offered at public securities exchange markets, and (ii) which have been issued by entities engaged in an active trade or business, or entities that derive at least 80% of their gross income from Puerto Rico sources or income effectively connected with a Puerto Rico trade or business (securities that comply with (i) and (ii) are referred to as “PR Securities”). A “Puerto Rico Private Equity Fund” must maintain a minimum of 60% of the paid-in capital invested in PR Securities.
Fund investors must qualify as “Accredited Investors” as defined in Act 60. Must use an investment advisor with an office in Puerto Rico engaged in a trade or business in Puerto Rico and duly registered with the Puerto Rico governmental authorities or exempt from registration, as applicable. Must operate as a diversified investment fund. Must have a minimum committed capital of $10 million on or before 24 months from the date of the first issuance of its partnership or membership interests. Must appoint at least one of its investors or limited partners to an advisory board. If the fund is organized outside of Puerto Rico, its General Manager or Investment Advisor must be engaged in trade or business in Puerto Rico and must generate at least 80% of its gross income from Puerto Rico sources or must be treated as income effectively connected with a Puerto Rico trade or business.
Act 60 – Tourism Incentives
Chapter 5 of Act 60 provides incentives to the tourism industry to facilitate and promote world-class tourism initiatives. Benefits generally will remain valid for 15 years starting with the date an application was duly filed with the Department of Economic Development and Commerce (“DDEC”) with the possibility of requesting a 15-year extension under the Act.
Incentives:
Tourism Tax credits of either 30% or 40% of the Tourism Eligible Investment, which generally includes the amount of cash contributed to the exempt business in exchange for its ownership interest and loans guaranteed by the exempt business, its parent, or affiliates.
Municipal construction excise tax exemption of up to 75%.
Excise and sales and use tax exemption of up to 100%.
Municipal license and other municipal tax exemptions of up to 50%.
4% fixed income tax rate.
100% exemption on the dividends or distributions of tourism development income.
Real and personal property tax exemption of up to 75%.
100% exemption on petroleum-derived products and any other hydrocarbon mixture (including propane and natural gas) used as fuel by the exempt business to generate electricity or thermal energy for the tourism activity.
4% income tax rate on any gain from the sale of substantially all the assets or ownership interests of the exempt business.
12% special withholding income tax rate on royalties, rents, or rights paid to foreign entities for the use of the intangible property.
100% exemption from income tax and municipal taxes on interest, charges, and other revenue paid by the exempt business on account of bonds, notes, or other obligations if the proceeds are used for the development, construction, rehabilitation, or improvement of an exempt business.
90% exemption from the payment of internal revenue and notarial stamps, vouchers, and other fees paid for execution and filing of public instruments.
Eligibility:
The following are considered tourism activities eligible to benefit from Act 60:
Guesthouses, hotels, hostels, condo-hotels, timeshares, vacation clubs, country inns, bed, and breakfasts. Theme parks. Golf courses (if operated by or associated with a hotel or within a resort). Casinos (if located within a hotel). Tourism Marina, Nautical Tourism, or facilities in port areas for tourism purposes. Agrohospices and Agrotourism. Medical Tourism. Development and administration of sustainable tourism and ecotourism businesses and of natural resources as a source of active, passive, or recreational entertainment, such as caverns, forests, canyons, natural reserves, and lakes. Activities of eSports and Fantasy Leagues. The lease of real property and certain personal property to an exempt business. Other facilities or activities that due to their use as a source of active, passive, or recreational entertainment stimulate internal or external tourism. Any other tourism sector if the Secretary of the DDEC determines that the operation is necessary and convenient for the development of tourism in Puerto Rico.
Act 60 and Act 399
Act 399-2004 provides the legal basis for the creation of an International Insurance Center (“IIC”) in Puerto Rico, which provides a competitive environment for international insurers and reinsurers to ensure risks outside of Puerto Rico, and reinsure risks inside and outside of Puerto Rico, under a secure but flexible regulatory system. International insurers and reinsurers authorized under Act 399 enjoy attractive tax benefits under Act 60 for an initial period of 15 years, with possible renewals.
Benefits:
Alternative risk management strategies as captive or associated captive insurers.
Insurers or reinsurers’ vehicles to enter Latin America or U.S. markets.
Special purpose vehicles.
Vehicle for integrated insurance plans.
Corporate reorganization using international insurer holding companies.
Segregated assets plans.
Securitization programs.
Incentives:
100% exemption from premium taxes
100% exemption from income taxes on dividends and other profit distributions made by the International Insurer and International Insurer Holding Company.
75% property tax exemption for real and personal property.
50% municipal tax exemption.
100% exemption from income withholding taxes on payments of dividends and other profit distributions.
Isolation of proceeds and benefits paid by international insurers are not subject to income taxes.
Tax exemption of up to $1.2 million on net income applicable at the individual cell level for Protected Cell Company arrangements and at the company level.
Preferred 4% tax rate on net income.
Act 60 - Manufacturing
Chapter 6 of Act 60 provides incentives, tax exemptions, and credits to eligible businesses in the manufacturing sector. Act 60 promotes the continued development of local industries and attracts foreign investment from all around the globe, particularly those engaged in technology advancement. Additionally, Act 60 promotes investment in research, development, and initiatives from the academic and private sectors by granting credits and exemptions.
Incentives:
Fixed income tax of 4%.
The income tax rate for innovative activities of 1% to 4%.
4% income tax rate on any gain from the sale of substantially all the assets or ownership interests of the manufacturing business.
12% special withholding income tax rate on royalties or rights paid to foreign entities for the use of the intangible property.
100% tax exemption for distributions of earnings and profits.
75% property tax exemption for real and personal property used in the exempt manufacturing business.
50% tax exemption for municipal taxes (a taxable portion of gross receipts subject to a regular tax rate of 0.5%).
A tax credit of up to 25% for purchasing local and recycled local products.
A tax credit of up to 50% of eligible investment in research and development.
Rebates for investing in structures, machinery, and equipment.
Cash incentives for job creation.
Act 29 – Public-Private Partnership Act
Act 29, known as the “Public-Private Partnership Act”, was enacted on June 8, 2009, to provide a legal framework to promote the use of such partnerships (“PPPs”) for the development of infrastructure projects and the rendering of some services more efficiently and in a less costly manner by delegating the risks inherent to such development or service to the party capable of managing such risks. Partnership agreements cannot exceed 50 years, but such terms can be extended for successive terms that collectively cannot exceed 25 additional years, subject to the evaluation and approval of the Government Entity, the Governor, or the Public-Private Partnership Authority.
Incentives:
Small scale projects (with an estimated $55 million budget) enjoy an expedited process of evaluation.
100% exemption from real and personal property taxes on property used exclusively in the facility and owned by the Partnering Government Entity.
The contractors and the municipal governments may establish payment agreements or exemptions from municipal license fees, excise taxes, or municipal taxes.
Fixed income tax rate of 10% on net income derived from the operations under the partnership contract.
Shareholders of a special contracting partnership will be subject to a fixed income tax rate of 20% on net income derived from operations under the partnership contract.
For Sales and Use Tax purposes, contractors may qualify as Government agents, and therefore enjoy an exemption if they comply with certain requirements imposed under the Puerto Rico Internal Revenue Code and Administrative Determinations issued by the PR Treasury Department.
Eligibility:
Must meet the requirements provided in the request for a proposal designed for the Partnership. The proponent must be a person authorized to do business in Puerto Rico. The proponent must have available corporate or equity capital or securities or other financial resources necessary for the proper operation of the Partnership. The proponent must have a good reputation and the managerial, organizational, and technical capability, as well as the experience, to develop and administer the Partnership. Certification that neither the Proponent nor any of its members, directors, bondholders, or any person that is the alter ego or the passive economic agent thereof, have been convicted for acts of corruption.
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