Export Service Businesses in Puerto Rico Can Save on Taxes
- Posted: July 19, 2023
- Posted by: Travis Lynk
- Last Reviewed: July 20, 2023
Read on for our overview of how you and your business can receive significant tax benefits from Puerto Rico’s efforts to become a hub for exporting services.
- Who Counts as an Officer-Owner?
- What Is a “Reasonable Salary” and How Has This Changed?
- Reasonable Salary Income Taxes
Ownership of a Puerto Rico Export Services Company
If you’re the owner of a U.S. company that can export services, tremendous opportunities are waiting for you in Puerto Rico.
Boosting economic development is one of the top priorities of the government of Puerto Rico. The island has taken steps to move away from its previous focus on manufacturing and become a major export service provider.
Let’s dive right into the related tax benefits that Puerto Rico has created, how you can make them work for you, and what pitfalls to avoid if you’re thinking about moving your business from the mainland to the island.
How and Why Puerto Rico Incentivizes Export Services
Understandably, Puerto Rico offers significant tax incentives to attract valuable companies and talented entrepreneurs who do business with those beyond the territory’s shores.
Advertising, financial, marketing, securities trading, software development, and consulting services are some of the most popular industries that count under Act 60’s Export Services Tax Incentive.
In doing so, the territory aims to entice business entities to set up shop on the island. This creates more jobs for the local population and helps to further modernize and develop Puerto Rico.
If your export services company is conducting its activities inside Puerto Rico, it may be eligible for substantial benefits that apply to income received from customers outside of Puerto Rico.
One of these is a super low 4% corporate tax rate. This is much lower than the 21% corporate tax rate, plus state taxes, that your business would probably have to pay on the mainland.
Eligible Export Services
The full list of businesses that count under Act 60’s Export Services Tax Incentive is longer than you might think.
Eligible Businesses under Article 2031.01 of Act 60 can qualify for major tax incentives.
Keep some of these important requirements in mind:
- First, the business must have a bona fide office or establishment physically located inside the territory. The business’s work output must have been created on Puerto Rico’s soil.
- Second, each business owner and employee must be paid a reasonable salary for the work they perform. Furthermore, these individuals will be taxed at the regular income tax rate for Puerto Rico.
- Third, the business must conduct one or more eligible services that are considered Export Services or Promoter Services.
Such services include:
- Research and development
- Advertising and public relations
- Consulting services, including but not limited to economic, environmental, technological, scientific, management, marketing, human resources, IT, and auditing consulting services
- Advice on matters related to any industry or business
- Creative industries
- Production of construction plans, engineering and architecture services, and project management services
- Professional services, such as legal, tax, and accounting services
- Centralized management services, such as strategic direction, planning, and budgeting
- Electronic data processing centers
- Development of computer programs
- Distribution of computer programs in physical form, on the cyber network, by cloud computing, or as part of a blockchain network, and the income from licensing, program subscriptions, or service charges
- Voice, video, audio, and data telecommunication to people located outside of Puerto Rico
- Call centers
- Shared services centers
- Educational and training services
- Hospital and laboratory services, including medical tourism services and telemedicine facilities
- Investment banking and other financial services
- Marketing centers
If you’re unsure of whether your company falls into one of these eligible services categories under Act 60, feel free to contact us for a consultation.
Tax Breaks on Exported Services
A business based in Puerto Rico may be eligible for incredible tax savings. These benefits include:
- A 4% corporate tax rate
- A 50% municipal taxes exemption
- A 75% municipal and state property taxes exemption (small and medium businesses can receive 100% property taxes exemptions during their first five years of operation)
- A 100% tax exemption on distributions from earnings and profits
So if you have a qualifying business, how exactly do these tax incentives on exported services work?
Think Twice about Doing Business with Other Businesses in Puerto Rico
As the name of the incentive suggests, these tax breaks apply to those businesses that conduct eligible services related to export.
Exported services are aimed at individuals, entities, or estates that are not residents of Puerto Rico. Clients must be physically located outside of the territory; after all, the tax incentive isn’t supposed to take job opportunities away from Puerto Rican businesses. An Eligible Business owner cannot have clients both inside and outside of Puerto Rico and still qualify for the Export Services Tax Incentive.
Furthermore, these services must not have a connection, or “nexus,” with Puerto Rico. If your company provides services connected to commercial activities on the island or gives advice regarding the administrative duties, laws, and regulations of Puerto Rico, in most cases it is not providing export services, because there is a connection.
However, there’s an exception. “Promoter services” related to establishing a new business in Puerto Rico still count as “eligible services,” even though they have a nexus with Puerto Rico.
These are important points to remember; if your company does business with other entities based on the island or if your company’s services have a “nexus” with Puerto Rico, you’ll risk losing its status as a tax-exempt business in most cases.
Salary Caps for Export Services Company Officer-Owners
Meeting the requirements for an Eligible Business in Puerto Rico does not mean that 100% of your company’s revenue will be subject to this low 4% tax rate.
Higher tax rates will apply to the salary of the officer-owner of this Eligible Business.
Who Counts as an Officer-Owner?
On October 13, 2015, the Secretary of the Treasury in Puerto Rico released Administrative Determination (AD) 15-22, which provided updated salary rules for officer-owners of Act 60 Export Services businesses.
That ruling defines an officer-owner as a shareholder or partner who at the end of the taxable year:
- Meets the requirements to be considered a bona fide resident of Puerto Rico
- Holds a proprietary interest in an Act 60 Export Services company in which they dedicate at least 80% of their time to business matters
What Is a “Reasonable Salary” and How Has This Changed?
Keep in mind that as the owner of an export services company, you must pay yourself a “reasonable salary” commensurate with the services you provide to this Eligible Business. AD 15-22 increased the officer-owner “reasonable salary” cap by $100,000 annually.
This change allows Puerto Rico’s Secretary of the Treasury greater autonomy to evaluate the reasonableness of income received from services rendered to Export Services companies. The Secretary can allocate additional salaries of up to $350,000 to better reflect the income of the officer-owner, as deemed appropriate, based on how well the business is performing and the officer-owner’s duties.
Reasonable Salary Income Taxes
As the owner of an Eligible Business, you won’t be eligible for a complete Puerto Rico export salary tax exemption. The island retains tax authority over its residents, and you must still pay Puerto Rico income tax.
If your taxable income for the year exceeds $61,500, the regular Puerto Rican income tax rate of 33% will apply to your reasonable salary. However, this reasonable salary counts as Puerto Rico sourced income, so it will be exempt from U.S. federal income tax.
After you draw your reasonable salary and pay regular Puerto Rico income tax on this amount, your business will incur only a 4% corporate income tax rate.
After paying this 4% tax rate, the remaining revenue is considered a profit distribution with 0% taxes.
If you have a net income of $1 million annually in Puerto Rico, you could conceivably save more than $300,000 relative to what you’d keep on the mainland.
A word of caution: there’s a great deal of nuance with taxes. Be sure to consult a qualified tax advisor who is familiar with the particulars of your individual financial situation for appropriate tax advice.
How to Make the Application Process Easier
To be eligible for such tax breaks, you must file an application for a grant of tax exemption with a Puerto Rico entity called the Office of Industrial Tax Exemption (OITE). The OITE is subordinate to the Department of Economic Development and Commerce of Puerto Rico (DDEC).
Completing the application on your own would involve completing many unfamiliar steps, forms, and in-person visits to relevant offices in Puerto Rico. Approval from Puerto Rican authorities would take up to eight months, and perhaps longer if you make mistakes on your application.
Note that the OITE will subject each Act 60 business to an independent audit at least once every two years. Your business will have to adhere to annual filing requirements as well.
Move to Puerto Rico Today and Save Your Money
To recap, bona fide residents of Puerto Rico and their qualified export service businesses can largely escape federal income taxation, instead paying lower Puerto Rican income taxes. Your Eligible Business can benefit from huge tax savings on the island, but make sure you avoid a nexus between your business and Puerto Rico, pay yourself a reasonable salary, and adhere to other requirements so you don’t jeopardize these generous tax incentives.
The potential tax savings don’t stop with your export service business. If you relocate yourself under Act 60’s Individual Resident Investor Tax Incentive, you can reap additional benefits. This incentive lets individual investors keep more of their Puerto Rico source income. If you’re a bona fide resident of Puerto Rico receiving interest and dividends from investments that count as Puerto Rico source income, those profits won’t be subject to U.S. federal income tax.
Our friendly expert team is standing by to answer any and all questions about your move to this Caribbean paradise. We’ve helped more than 2,000 individuals and businesses relocate to Puerto Rico. You too can be the envy of others on the mainland by enjoying sizable Puerto Rico tax benefits and a luxurious Caribbean lifestyle.
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Disclaimer: Neither PRelocate, LLC, nor any of its affiliates (together “PRelocate”) are law firms, and this is not legal advice. You should use common sense and rely on your own legal counsel for a formal legal opinion on Puerto Rico’s tax incentives, maintaining bona fide residence in Puerto Rico, and any other issues related to taxes or residency in Puerto Rico. PRelocate does not assume any responsibility for the contents of, or the consequences of using, any version of any real estate or other document templates or any spreadsheets found on our website (together, the “Materials”). Before using any Materials, you should consult with legal counsel licensed to practice in the relevant jurisdiction.