Historical Background:
Since the beginning of the 20th century, Puerto Rico's economy has relied on various types of tax incentives to attract capital and support its productive functioning. In the 1920s, the United States Congress approved Section 931 of the Federal Internal Revenue Code, aimed primarily at providing contributory benefits to U.S. investments in the Philippines compared to European investments in the former North American colony in the Pacific.
This incentive allowed North American companies to repatriate profits to the US tax-free. Section 931 was eventually extended to Puerto Rico and was the preamble to the creation of the industrial development program created by the local government.
In 1948, the Puerto Rican government introduced its first Economic Incentives Act that allowed the industrialization of the Island, through the attraction of industrial capital from the United States. Through the program known as “industrialization by invitation”, Puerto Rico managed to achieve a level of development higher than that of the region and other developing economies. So powerful and effective was that law, that other Asian economies such as Taiwan and Singapore replicated and improved it, and today they surpass us in competitiveness and economic growth.
However, the takeoff and success of Puerto Rico's industrialization program was not immediate. Attracting investment and industrial capital was a gradual process that took several years to gain traction. Between 1943 and 1948, the industrialization program managed to attract only 13 manufacturing plants, in 1948, 24 companies arrived, in 1949, the number doubled to 50, and by 1950, it increased to 80 establishments, and by 1955 there were 300 manufacturing companies all over the island. By the end of the 1950s, there were already 530 manufacturing companies in Puerto Rico, and the industrial development process had a life of its own, and the Island was beginning its economic takeoff. Between 1950 and 1977, the Island's GDP increased by 300%.
Faced with the acute crisis that our economy began to experience, the government devised several strategies to prevent further economic deterioration. The objective was to activate local private capital and at the same time attract companies and investors to support the government's recovery, without relying on public investment.
Ante la aguda crisis que comenzó a experimentar nuestra economía el gobierno ideó varias estrategias para evitar un deterioro económico mayor. El objetivo era activar el capital privado local y a la misma vez atraer empresas e inversionistas para fundamentar la recuperación del gobierno, sin depender de la inversión pública.
Approval of Laws 20/22
and the competitive repositioning of Puerto Rico
With the limitations of the manufacturing sector, the government's strategic efforts focused on positioning the island as an attractive place for private investment to turn Puerto Rico into a global center for exporting services and restoring economic sectors affected by the economic crisis. To achieve these ends, in the year 2011-12, the government created a combined offer of tax incentives that has succeeded in boosting the economic investment of private investors in the Island and the exponential growth of the export of services from Puerto Rico to other parts of the world.
In 2012, Laws 20 and 22 were jointly approved, today Law 60-2019. Law 20-2012 provides a tax rate of 4% for the export of services from Puerto Rico to other jurisdictions. Law 22-2012 allows individuals who establish their residence in Puerto Rico to pay 0% of contributions on their investment income such as interest and dividends, as well as a fixed rate between 0 and 10% on long-term capital gains, provided that they establish their residence in Puerto Rico and meet all requirements.
It is imperative to understand that both laws work together. They do not work or perform adequately separately, since the concept of exporting services has been in our legal system since the Industrial Tax Incentives Act of 1987. However, for the 2011-2012 fiscal year, the DDEC Incentive Office had a record of fewer than 50 service export decrees over a period of approximately 25 years. This is despite the fact that the maximum contribution rate was 3.9% of net export income when the 90% exemption provided by the Incentives Act of 1987 was taken into consideration.
For this reason, in order to encourage the export of services, passive income benefits (which eventually ended up being Law 22) were created to make it attractive for investors to move to Puerto Rico and export services from the Island to other parts of the world. In other words, using the 4% rate of Law 20 alone would not generate the interest of people to move to Puerto Rico. On the other hand, setting the 0% rate for passive income and maintaining 4% for the export of services has proven to give the expected results to increase the export of services from Puerto Rico.
Over a 10-year period (with hurricanes, earthquakes and pandemic), more than 1,400 service export decrees have been generated. An increase of over 2,800% since laws 20 and 22 were created. These data are clear evidence that both laws complement each other and must be marketed together to move the service export sector and attract investors to the island at a time when Puerto Rico is bankrupt and has no access to capital markets.
Therefore, the export of services cannot be separated from the attraction of resident investors. Separating them is a fundamental mistake. The incentives contained in Law 20-2012 were not what changed in 2012 and generated about 62,500 jobs on its own; what changed was the new creation of Law 22-2012 for investors to move to Puerto Rico and offer their services from the Island.
The approval of Laws 20/22 in 2012 was and is essential to encourage the attraction of new capital to the Island, attract new skilled human capital, and new companies focused on the export of services. Since then, a new ecosystem began to be created within the economy that has had significant macroeconomic effects, positively affecting other sectors and serving as a substitute for the extinct Section 936.
