March 2026 | Client Alert
On March 11, 2026, the Puerto Rico Department of Economic Development and Commerce issued Administrative Order No. DDEC 2026-002, in consultation with the Office of the Commissioner of Financial Institutions, in order to formalize certain norms that govern the operation of private equity funds operating under tax decrees granted pursuant to Act No. 60, known as the Puerto Rico Incentives Code. The Order primarily addresses recurring questions regarding the eligibility of investments made by private equity funds and the rules relating to the tax deduction provided by the Incentives Code to investors in such funds. The stated purpose of the rules established by the Order is to ensure that private equity funds focus on long-term investments that promote substantial economic activity in Puerto Rico.
Definition of Entity “Actively Engaged in a Trade or Business”
The Incentives Code requires that private equity funds invest a certain percentage of their paid-in capital in entities “actively engaged in a trade or business.” The Order provides that to be considered actively engaged in a trade or business, the entity must directly, continuously, and regularly participate in the conduct of a business or economic activity in Puerto Rico, generating income from active commercial operations. The entity must have personnel, facilities or assets in Puerto Rico, and demonstrate continuous participation in the conduct of its operation on the island. In addition, at least 80% of the entity’s gross income for the taxable year must be derived from the business or economic activity in which the entity is actively engaged. For this purpose, the activities of majority-owned subsidiaries may be considered under certain circumstances. The Order does not distinguish between entities organized under the laws of Puerto Rico and entities organized under the laws of other jurisdictions. Entities that do not meet this test are considered “passive entities.” The Order includes many examples of entities that would be considered “actively engaged in a trade or business” and of “passive entities,” which are helpful in assessing whether an investment will be considered eligible for purposes of meeting the fund’s investment requirement.
Eligibility of In-Kind Contributions
The Order also tightens the rules governing in-kind contributions of securities and other eligible assets, with the goal of ensuring that they contribute to the economic growth of Puerto Rico. The purpose of such contributions must be to promote industry or commerce in Puerto Rico, not solely to obtain the tax benefits provided by the Incentives Code. Therefore, the contributed securities, as well as any proceeds from their disposition (measured by the tax basis of the contributed assets and adjusted for gain or loss), must generally remain in the fund for at least 24 months, subject to limited exceptions. The Order further states that the tax deduction generated by an in-kind contribution is determined by reference to the contributed asset’s tax basis, not its fair market value at the time of contribution, and that contributions of real property are not eligible as in-kind investments to a private equity fund.
Capital Recycling Arrangements
The Order also targets “capital recycling” arrangements. As a general rule, a private equity fund may not invest in an entity related to an investor that owns 20% or more of the fund, unless the investment is directed to new business activities, operational expansion, or job creation. Any such related-party investment must be supported by a detailed economic-impact analysis available for review by the Office of Incentives for Businesses in Puerto Rico and the Office of the Commissioner of Financial Institutions, and the immediate use of those funds for distributions or payments back to the investor is disfavored unless the related entity retains the funds for at least 24 months.
Special Tax Deduction and Net Contribution Determination
For purposes of claiming the special tax deduction generated by an investment in a private equity fund, the Order clarifies when an investor’s contribution is considered reinvested by the fund and how the amount of the deduction is calculated. A contribution is treated as reinvested by the fund when the fund actually invests and assigns the contributed cash to eligible projects, businesses, activities, or assets and documents that assignment in its records, or when the fund receives non-cash property as a capital contribution. The Order also adopts a “net contribution” rule: if an investor contributes capital to a fund and receives a loan from the fund within 120 days, the basis for the determination of the deduction is reduced by the amount of the loan, unless the loan is made after 120 days or the fund maintains contemporaneous documentation evidencing an investment plan from the outset.
General Investment Requirements
The Order also reiterates that private equity funds must comply with the applicable investment requirements under the Incentives Code, operate as diversified investment vehicles, and refrain from using paid-in capital to invest in ineligible entities or to make loans or financing to natural persons.
The provisions of the Order take effect immediately, although the rules on in-kind contributions, capital recycling, and net contribution calculations apply to contributions made after the publication of the Order. Funds with existing decrees may elect to apply one or more of these provisions retroactively. Private equity funds, managers, and investors should promptly review entity classifications, subscription and contribution mechanics, related-party investment policies, and accounting documentation to ensure compliance with the Order.
O’Neill & Borges LLC is available to assist clients in evaluating the impact of this Order, including reviewing fund structures, assessing compliance with the new guidance, and advising on related tax and operational implications.
Because of the general nature and informative purpose of this newsletter, nothing herein should be considered as legal advice or a legal opinion. For further information about the contents of this newsletter, or should you need further assistance in connection with these matters, please contact us at info@oneillborges.com or your primary contact attorney at O’Neill & Borges LLC.