A substantial number of Act 60 applicants are technology entrepreneurs, software developers, and SaaS company founders. For these individuals and businesses, the classification of software-related income is not a secondary detail—it is the threshold question that determines which sourcing rules apply and, consequently, the scope of available Act 60 benefits.

The controlling authority is Treas. Reg. §1.861-18, which classifies transactions involving computer programs into four categories. Each category triggers a different sourcing rule. Misclassifying your revenue streams can lead to either overstating or understating your Puerto Rico-source income, with corresponding compliance and audit exposure.

The Four Categories of Software Transactions

1. Transfer of Copyright Rights

When a transferee acquires one or more of the substantial rights in the copyright—reproduction, modification, public distribution, public performance, or public display—the transaction is treated as a sale or license of intangible property. The resulting income is classified as royalties and sourced to the location where the intangible is used.

For an Act 60 resident, this means the income is Puerto Rico-source only if the intellectual property is used within Puerto Rico. If the end users or licensees are using the software on the mainland or internationally, the income may be sourced outside Puerto Rico regardless of where the licensor resides.

2. Transfer of a Copyrighted Article

When the transferee acquires only a copy of the program—a “copyrighted article”—without obtaining substantial copyright rights, the transaction is treated as either a sale of goods or a lease. This is the typical end-user software transaction: downloading an application, purchasing a software license for personal use, or accessing a standard software product.

If treated as a sale of personal property, the general rule under IRC §865 sources the gain to the seller’s tax residence. For a bona fide Puerto Rico resident, this is favorable: the income would generally be Puerto Rico-source. However, the office attribution rule under §865(e)(2) still applies—if gains are attributable to a U.S. office, they may be re-sourced to the United States.

3. Provision of Services

When the transaction is properly characterized as the provision of services—such as custom software development, programming services, or consulting engagements—the resulting income is services income sourced to the location where the services are physically performed.

This is the most common classification for many tech Act 60 clients, and it carries the most direct compliance requirement: the work must be performed from Puerto Rico to generate Puerto Rico-source income. Days spent coding, designing, or consulting on the mainland generate U.S.-source income subject to the working-days allocation.

4. Provision of Know-How

When the transferor provides trade secrets or proprietary information about computer programming techniques, the income is treated as a royalty. As with other royalty income, it is sourced to the location where the know-how is used.

Why Classification Matters for Act 60 Benefits

The classification determines everything. Consider a Puerto Rico-based tech company that earns $2 million in annual revenue:

For the same revenue, the Puerto Rico-source percentage—and therefore the Act 60 tax benefit—can vary dramatically depending on classification. A company whose revenue is properly classified as sales of copyrighted articles may have substantially all of its income treated as Puerto Rico-source. The same company, if its revenue is properly classified as services income, must demonstrate that the services were performed in Puerto Rico to claim the same result.

Blended Revenue Streams

Most technology businesses do not generate revenue from a single, cleanly classified source. A typical SaaS company may earn income from subscriptions (potentially copyrighted article sales or services), custom development engagements (services), licensing arrangements (royalties), and consulting (services). Each revenue stream must be analyzed independently under §1.861-18.

Failure to disaggregate and properly classify each revenue stream is a compliance risk. Treating all revenue as a single category when the underlying transactions are mixed can lead to material misstatement of Puerto Rico-source income.

Interaction with Chapter 3 (Export Services)

For Chapter 3 (Export Services) decree holders, the classification also determines eligibility for the 4% fixed rate. The Export Services Act applies to services exported from Puerto Rico. If a technology company’s income is properly classified as services income and the services are performed in Puerto Rico for clients outside Puerto Rico, the income qualifies for the 4% rate. If the income is classified as product sales or royalties, different analysis applies.

The classification must be correct under federal law, not merely convenient for Act 60 purposes. The IRS applies §1.861-18 based on the substance of the transaction, and a characterization that does not match the economic reality will not withstand examination.

Planning and Compliance

Technology entrepreneurs considering Act 60 should undertake a revenue stream analysis before relocating—or, for existing decree holders, as part of ongoing compliance review. This analysis should identify each revenue stream, classify it under §1.861-18, determine the applicable sourcing rule, and assess the resulting Puerto Rico-source percentage.

Where classification is uncertain, the analysis should be documented and supported by a reasoned legal position. In audit, the IRS will examine the substance of the transactions, not the labels assigned by the taxpayer.

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 technology companies and entrepreneurs on Act 60 income classification, sourcing analysis, and export services decree compliance. Schedule a consultation to discuss your specific situation.