Chapter 3 of Act 60—the Export Services Act—provides one of the most favorable corporate tax rates available in any U.S. jurisdiction: a 4% fixed income tax rate on net income from eligible export service activities. This compares to a standard Puerto Rico corporate rate that can reach 37.5% and a federal corporate rate of 21%.
The potential benefit is substantial. But the 4% rate is not automatic. It applies only to income that meets specific eligibility requirements, and the interaction between Act 60 and the federal income sourcing rules creates compliance requirements that must be managed carefully.
Eligibility Requirements
To qualify for Chapter 3 benefits, the business must meet all of the following conditions:
Services must be exported. The services must be rendered to clients located outside of Puerto Rico. This is the fundamental requirement. Services provided to Puerto Rico-based clients do not qualify for the 4% rate, regardless of the nature of the service.
Services must be performed from Puerto Rico. The services must be rendered from Puerto Rico. This means the individuals performing the work must be physically located in Puerto Rico when the services are delivered. Services performed on the mainland or in other jurisdictions do not generate eligible export service income.
Eligible service categories. The Export Services Act covers a broad range of professional and technical services, including consulting, management, technology development, marketing, financial services, research, creative services, and many others. The key criterion is that the service must be exportable—capable of being delivered to clients outside Puerto Rico.
A Chapter 3 decree must be in effect. The business must apply for and obtain a Chapter 3 decree from the DDEC. The 4% rate applies only during the decree period and only to income from eligible activities.
How the 4% Rate Works
The 4% rate applies to net income from eligible export service activities. This is a Puerto Rico tax—not a federal tax. The interaction with the federal system is as follows:
Income from services performed in Puerto Rico for clients outside Puerto Rico is Puerto Rico-source income under the federal sourcing rules. For a bona fide Puerto Rico resident, this income is excluded from U.S. gross income under IRC §933. It is then taxed by Puerto Rico at the 4% rate under the Chapter 3 decree.
Distributions from the export service entity to its Puerto Rico-resident shareholders are eligible for a 100% tax exemption under Act 60. This means the effective tax burden on qualifying export service income can be limited to the 4% entity-level tax, with no additional tax on shareholder distributions.
The Sourcing Problem: Mainland Work Days
The most significant compliance issue for Chapter 3 decree holders is the interaction between the export services framework and the federal sourcing rules for services income.
Services income is sourced where the services are performed. If employees or principals of the export service entity perform services while physically present on the mainland United States, the income attributable to those U.S. working days may be treated as U.S.-source effectively connected income. That income is subject to regular federal income tax at full rates, not the 4% Act 60 rate.
The implication is direct: every day that an employee or principal works on the mainland reduces the income eligible for the 4% rate and increases the income subject to regular federal tax. This is not a technicality—it is one of the most material compliance issues in the Chapter 3 context.
Structuring Considerations
Businesses seeking to maximize the benefit of the 4% rate should structure their operations with the sourcing rules in mind:
Perform substantially all services from Puerto Rico. The more service delivery occurs from Puerto Rico, the greater the proportion of income eligible for the 4% rate. Client meetings, project work, and consulting engagements should be conducted from Puerto Rico to the greatest extent possible.
Limit mainland business travel. When mainland travel is necessary, keep it as brief as possible and document the business purpose. Each mainland working day generates U.S.-source income outside the 4% rate.
Use videoconference and remote delivery. Services delivered remotely from Puerto Rico are Puerto Rico-source, regardless of where the client is located. Structuring engagements for remote delivery from Puerto Rico directly supports both the export requirement and the sourcing analysis.
Maintain detailed work-location records. For each employee and principal, maintain contemporaneous records of where work is performed on each day. These records are essential to defending the sourcing allocation in an examination.
Avoid maintaining a U.S. office. The office attribution rule under IRC §865(e)(2) can re-source gains to a U.S. office location. While this rule is most directly applicable to gains from the sale of personal property, maintaining a U.S. office also undermines the tax home test and raises sourcing questions for services income.
Additional Benefits
In addition to the 4% income tax rate, Chapter 3 decree holders may be eligible for:
- 75% exemption on municipal taxes
- Full or partial exemptions on property taxes for qualifying business property
- 100% tax exemption on distributions to Puerto Rico-resident shareholders
These additional benefits are decree-specific and subject to the conditions set forth in the decree.
Ongoing Compliance
Chapter 3 decree holders must comply with the annual reporting requirements of the DDEC, maintain bona fide residency (for individual decree holders and shareholder-level benefits), and ensure that the entity’s operations continue to meet the export services eligibility criteria. Changes in business operations—such as beginning to serve Puerto Rico-based clients, shifting service delivery to the mainland, or ceasing to perform qualifying export activities—can affect eligibility.
The decree itself sets forth the specific conditions and compliance obligations. Review of the decree terms should be part of the annual compliance process.
This article is for educational purposes only and does not constitute legal or tax advice. Individual circumstances vary. Consult a qualified tax attorney before making decisions based on this information.
Riefkohl Law advises businesses on Chapter 3 Export Services decree compliance, business structuring, and income sourcing analysis. Schedule a consultation to discuss your specific situation.