Funds take note: Puerto Rico's new Incentives Code is now in effect

Puerto Rico's new Incentives Code, Act No. 60, is now in effect.

The Incentives Code effectively consolidates all tax incentives available for different economic activities in a single code. With its enactment on July 1, 2019, the Private Equity Funds Act, Act No. 185-2014, was repealed.

Act 185 granted special Puerto Rico tax treatment to qualifying funds meeting certain requirements, as well as to their investors. The core requirement was that qualifying funds invested in securities which were not offered at public securities exchange markets in the United States or any foreign country. For a detailed discussion of Act 185 and its benefits, please see our alert Private equity and hedge funds in Puerto Rico – a welcoming environment in the Caribbean.

Although the Incentives Code generally incorporates the provisions of Act 185, certain provisions have been clarified and certain benefits have changed. In addition, the process for qualifying a private equity fund (PEF) in order to obtain such benefits has changed, as discussed further below.

Under Act 185, qualifying PEFs were required to have an investment adviser with a business office in Puerto Rico. Under the Incentives Code, this requirement is still included, but it is clarified that said investment adviser can subcontract another investment adviser that is located outside Puerto Rico.

The Incentives Code also explicitly provides that series limited liability companies (LLCs) may elect to be treated as a single "private equity fund," regardless of the number of series. The Incentives Code also clarifies that securities issued by the Government of Puerto Rico are eligible investments for purposes of the minimum investment in Puerto Rico securities requirements. Finally, the diversification threshold was increased from 20 percent to 50 percent, effectively allowing a qualifying PEF to invest more capital in a single business.

Most of the tax benefits granted to PEFs and their investors under the Incentives Code are the same as under Act 185. However, a notable difference is that under the Incentives Code, all real and personal property owned by a qualifying PEF will only enjoy a 75 percent exemption on property taxes, instead of a full exemption. Despite this, however, property such as stock, bonds, notes, promissory notes and other securities or debt instruments in which a PEF invests is exempt property under the Municipal Property Tax Act of 1991, as amended, and is not otherwise subject to PR personal property taxes.

The incentives granted under the Incentives Code for PEFs became available as of July 1, 2019. A qualifying PEF wishing to obtain these tax benefits must file an application for a tax exemption grant online with the Department of Economic Development and Commerce (DDEC, for its Spanish acronym). The content and specifications of this application are not yet available. Upon approval of the application, the DDEC will issue a tax exemption grant, which is a binding contract with the Government of Puerto Rico. Thus, the constitutional prohibition against the impairment of contracts should protect the awarded tax benefits from any potential revocation or amendment by subsequent legislation.

It is uncertain what impact the Incentives Code will have on PEFs that are already qualified under Act 185, given the immediate repeal of Act 185. Sponsors of PEFs, or prospective PEFs, are encouraged to consult with their legal advisors as to available alternatives.