Act 60 Substance Requirements Explained

Act 60 Substance Requirements: What You Must Actually Do to Qualify

Act 60 offers significant tax benefits to eligible businesses and individuals in Puerto Rico, but the law is not a paper exercise. The Puerto Rico Department of Treasury and the IRS both scrutinize applications and ongoing compliance to ensure that beneficiaries maintain real, measurable business activity on the island. Understanding and meeting Act 60 substance requirements is not optional. It determines whether your tax benefits remain valid or face revocation.

This article explains what substance means under Act 60, what the government actually looks for during audits, and how to structure your business to satisfy these requirements from day one.

What Substance Means Under Act 60

Substance is the legal and practical reality of your business operations in Puerto Rico. It is not a filing status or a tax election. Substance means your business must conduct genuine commercial activity, employ real people, maintain physical presence, and generate actual income from operations on the island.

The IRS and Puerto Rico tax authorities apply a multi-factor test to determine whether a business has sufficient substance. This test looks at where decisions are made, where employees work, where assets are located, where income is generated, and whether the business maintains a genuine economic purpose beyond tax reduction.

Many businesses fail substance audits because they treat Act 60 as a tax shelter rather than a legitimate business framework. The government will not accept a shell company with a Puerto Rico address and a mailbox service. Your business must operate with the same operational reality as any other commercial enterprise.

Physical Presence and Office Requirements

Act 60 beneficiaries must maintain a physical office or workplace in Puerto Rico. This is not a suggestion. The office must be real, functional, and used for actual business purposes.

Your office should include the following elements:

A dedicated physical address on the island, not a virtual mailbox or shared coworking space used only for mail receipt
Furniture, equipment, and technology appropriate to your business type
Regular occupancy and use by employees or principals conducting business
Utilities, internet, and other services active and in use
Documentation showing lease agreements, utility bills, and office expenses

The office does not need to be large or expensive. A small, functional workspace is sufficient if it reflects the actual size and nature of your business. However, the office must be genuinely used. Auditors will visit. They will speak with employees. They will review utility records and lease agreements. A pristine, unused office will raise immediate red flags.

If your business is seasonal or operates on a project basis, document the periods of activity and explain why the office is not continuously occupied. Provide evidence of work performed during active periods. Auditors understand that not all businesses operate at constant capacity year-round.

Employee and Payroll Requirements

Substance requires that your business employ people in Puerto Rico and pay them through the formal payroll system. The number of employees depends on your business size and type, but the requirement is absolute: you cannot operate a meaningful business with zero employees.

Your payroll must meet these standards:

Employees must be hired through proper employment contracts
Payroll must be processed through the Puerto Rico Department of Treasury and Social Security system
Withholding taxes and contributions must be paid on time
Employees must perform actual work for the business
Compensation must be reasonable for the work performed
Records must document job duties, hours worked, and performance

You cannot satisfy this requirement by hiring family members at inflated salaries or by creating fake positions. Auditors review employment records, interview employees, and verify that work was actually performed. If an employee cannot describe their job duties or the work they performed, the arrangement will be questioned.

The size of your payroll should be proportional to your business revenue and operations. A business generating millions in annual revenue with only one part-time employee will face scrutiny. Conversely, a small consulting business with two full-time employees and reasonable compensation is defensible.

Decision-Making Authority and Management

Act 60 substance requires that significant business decisions be made in Puerto Rico by people physically present on the island. You cannot run your business from Miami or New York and claim Act 60 benefits.

This means the following:

Your board of directors or management team must include individuals based in Puerto Rico
Major business decisions must be documented as made in Puerto Rico
Board meetings or management meetings must occur on the island
Minutes and records must reflect Puerto Rico-based decision-making
Day-to-day operations must be managed from the Puerto Rico office

If you are the owner and principal decision-maker, you must spend significant time in Puerto Rico conducting business. This does not mean you must live there full-time, but your presence must be regular and documented. Travel records, calendar entries, and employee testimony should support that you are actively managing the business from the island.

If your business is managed by a Puerto Rico-based general manager or executive, that person must have real authority to make decisions and must exercise that authority regularly. A figurehead manager hired only to satisfy Act 60 requirements will not pass scrutiny.

Income Generation and Business Activity

Your business must generate income from actual commercial activity. The income must be earned through services rendered, products sold, or legitimate business operations. Passive income, investment returns, or income derived primarily from sources outside Puerto Rico does not satisfy substance requirements.

Document your business activity through the following:

Client contracts and service agreements showing work performed in Puerto Rico
Invoices and payment records demonstrating income from customers
Bank statements showing deposits from business operations
Accounting records that track revenue by source and type
Customer communications and project documentation
Tax returns that report business income consistently

If your business serves clients outside Puerto Rico, that is acceptable. Many Act 60 businesses provide services to mainland clients or international customers. What matters is that the work is performed in Puerto Rico by Puerto Rico-based employees and that the income is properly documented and reported.

Avoid structures where income flows through Puerto Rico but the actual work is performed elsewhere. For example, if your business is a consulting firm, the consulting work must be performed by your Puerto Rico employees. You cannot simply invoice clients and pass the work to contractors in other jurisdictions.

Asset Location and Ownership

Business assets should be located in Puerto Rico and owned by your Act 60 entity. This includes equipment, inventory, intellectual property, and other resources used in operations.

Maintain records showing:

Where equipment and assets are physically located
Title and ownership documentation
Depreciation and maintenance records
Insurance policies covering Puerto Rico-based assets
Lease agreements for equipment or property

If your business relies on intellectual property, consider registering trademarks, patents, or copyrights in Puerto Rico or ensuring that your Act 60 entity owns the rights to materials used in Puerto Rico operations. This strengthens the argument that your business has real substance and is not merely a shell.

Banking and Financial Records

Maintain a Puerto Rico business bank account and conduct all business transactions through that account. Do not commingle personal and business funds. Do not use mainland accounts as your primary business account.

Your banking practices should reflect the following:

A dedicated business account with a Puerto Rico bank or a mainland bank with Puerto Rico operations
Regular deposits from business income
Payments for Puerto Rico-based expenses
Payroll processed through the account
Clear documentation of all transactions
Reconciliation with accounting records and tax returns

Auditors will review your bank statements to verify that business activity is occurring and that funds are flowing in and out in patterns consistent with your stated business operations. Unusual transactions, large transfers to personal accounts, or unexplained deposits will raise questions.

Documentation and Record-Keeping

Substance is proven through documentation. You must maintain organized, contemporaneous records that demonstrate your business operations and compliance with Act 60 requirements.

Essential documents include:

Corporate bylaws and board resolutions documenting Puerto Rico-based decisions
Employment contracts and payroll records
Lease agreements for office space and equipment
Client contracts and service agreements
Invoices and payment records
Bank statements and accounting records
Tax returns filed in Puerto Rico and the United States
Travel records and calendar entries showing time spent in Puerto Rico
Photographs or video of your office and operations
Communications with clients, employees, and vendors

Organize these records by category and year. Make them easily accessible for audit. If you cannot quickly produce documentation supporting your claimed business activity, auditors will assume the activity did not occur.

Common Substance Failures and How to Avoid Them

Certain patterns consistently trigger substance audits and denials. Understanding these failures helps you structure your business correctly from the start.

The first common failure is the shell company model. A business with no employees, no office, and no actual operations will not qualify. If your only presence in Puerto Rico is a registered agent address, you have no substance.

The second failure is passive income structures. Act 60 is designed for active business operations, not investment portfolios. If your business simply collects rental income, investment returns, or royalties without performing services or conducting operations, substance requirements are not met.

The third failure is absentee ownership. If you live and work outside Puerto Rico and make no effort to manage your business from the island, substance is lacking. You must demonstrate regular presence and active involvement in Puerto Rico-based decision-making.

The fourth failure is inadequate payroll. A business generating significant revenue with minimal or no employees is suspicious. Scale your payroll to match your business size and revenue.

The fifth failure is poor documentation. If you cannot produce records supporting your claimed business activity, auditors will not accept your claims. Document everything contemporaneously.

Substance Requirements for Different Business Types

Substance requirements apply to all Act 60 businesses, but the specific evidence varies by business type.

For service businesses such as consulting, accounting, or legal services, substance is demonstrated through client contracts, work product, employee time records, and client communications. Your employees must perform the services in Puerto Rico.

For technology or software businesses, substance includes a development team based in Puerto Rico, office space where development occurs, version control records showing code development, and client contracts for software services or licensing.

For trading or financial services businesses, substance includes Puerto Rico-based traders or analysts, trading records, client accounts, and documentation of decision-making regarding investments or trades.

For manufacturing or product businesses, substance includes a Puerto Rico facility, equipment, inventory, employees performing manufacturing or assembly, and documentation of product sales.

For import-export or distribution businesses, substance includes a Puerto Rico warehouse or distribution center, inventory records, shipping documentation, and employees managing logistics and sales.

Regardless of your business type, the core principle remains the same: your business must conduct real operations in Puerto Rico with real employees, real assets, and real income generation.

Ongoing Compliance and Substance Maintenance

Substance is not a one-time requirement. You must maintain substance throughout your Act 60 benefit period. Auditors will review your operations annually or during random audits to confirm that substance continues.

Maintain substance by doing the following:

Keep your office operational and in use
Maintain consistent payroll and employee count
Continue generating business income from Puerto Rico operations
Hold regular board or management meetings in Puerto Rico
Document all business activity and decisions
File accurate tax returns in Puerto Rico and the United States
Maintain Puerto Rico business licenses and registrations
Keep insurance and utilities active

If your business circumstances change, such as a significant reduction in employees or relocation of operations, notify your tax advisor immediately. Changes that affect substance may require adjustments to your Act 60 structure or may trigger compliance issues.

The Role of Professional Guidance

Act 60 substance requirements are complex and fact-specific. The difference between a compliant business and one that fails audit often comes down to how the business is structured and documented from the beginning.

An experienced Puerto Rico business attorney can help you structure your Act 60 business to satisfy substance requirements, establish proper documentation practices, and maintain compliance throughout your benefit period. This guidance is particularly important if your business involves complex structures, multiple entities, or significant tax planning.

For more information about Act 60 requirements and how to structure your business for compliance, visit our Act 60 page.

Next Steps

If you are considering Act 60 benefits or currently operating under Act 60, understanding and meeting substance requirements is essential to protecting your tax benefits. The cost of non-compliance is high: loss of tax benefits, back taxes, penalties, and interest.

Christian M. Frank Fas, Esq. provides a free initial evaluation to discuss your Act 60 business structure, substance compliance, and documentation practices. During this evaluation, we will review your current operations, identify any substance gaps, and recommend steps to ensure ongoing compliance.