Starting a Business
Doing Business in Costa Rica & Specific Taxes
By Explore Costa Rica Staff
Nov 8, 2007, 05:09

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Doing Business in Costa Rica

Specific Taxes in Costa Rica

Reviewed by Alonso Arroyo and Sergio García KPMG Tax

General Overview
In terms of revenue, Costa Rican tax system is based on Consumption Taxes (Sales Tax, Excise Taxes, and Import Duties), Income Tax, and Real Estate Tax and other Municipal Taxes. Many other specific taxes apply on certain transactions or selected industries (e.g. transfer taxes or taxes on gambling activities).

The Tax System is currently under review, and a general reform of the system is expected.

A proposal was presented by the Government to Congress to change the current Sales Tax to a Value Added Tax, and to completely change the Income Tax, which currently is based on a territorial principle (the tax applies on earnings from goods located, services rendered or capital invested within the country) and on schedular or analytic taxes (different rates and tax treatments apply to income depending on the type of income: dividends, interest from bonds, ordinary income) to a global and worldwide system. This proposal was withdrawn by the government and a new project is expected.

Specifically, changes to the Income Tax System have generated a strong debate in Congress that would probably lead to a more moderate reform than the initial Proposal, especially on issues that relate to worldwide taxation.

Corporate Income Tax General Rules
Gross income includes earnings, benefits and rents, whether in cash or in kind. Companies may deduct from gross income all costs and expenses necessary to produce taxable income or to protect their investments. Partnerships are treated as corporations independent of their partners and are liable for corporate taxes on net profits.

As a general rule, capital gains and losses on non-depreciable assets or shares of other companies are excluded from gross income for income tax purposes (if they do not derive from the normal activity of the taxpayer). Branch income is taxed at the same rate applied to corporations and foreign source income is not taxed. Nevertheless, there is a trend in case law to try to tax foreign source income based on “enterprise’s activity” concept.

The tax treatment of capital gains generated by the sale of shares has evolved due to administrative case law. It is advisable to request tax advisory in these situations.

Corporate Income Tax Rates
With the exception of qualified and limited Free Zone Companies and other entities as provided by article 3 of the Income Tax Law, corporate net profits are taxed according to annual gross income as follows:

Gross income up to ¢27.811.000,00 10%

Gross income up to ¢55.943.000,00 20%

Gross income in excess of ¢55.943.000,00 30%

The tax is levied on net income before dividends or reserve distributions.

Taxes on dividends
According to Costa Rican law, upon accrual or payment of a dividend, whichever occurs first, the company must withhold 15% of the amount credited or paid. The 15% withholding tax rate does not apply if:

1. Payments are made in shares of the distributing entity;

2. Payment is made to another Costa Rican corporation subject to income tax; or

3. Foreign tax credits are not allowed by the recipient country (previous authorization from local Tax Authorities is required).

If the distributing company is registered in a local stock exchange and the shareholder acquired the shares through the stock exchange, the applicable withholding tax rate decreases to 5%.

The amounts withheld must be deposited with Tax Authorities within the first 15 calendar days of the month following the date of credit or payment of the dividend.

Deductions
Table 1 shows a summary of the deductions corporations can take against gross income.

Taxpayers may request an authorization to use a different depreciation method. This new method would only be acceptable if this authorization is granted.

Depreciation and Other Allowances
• Unless authorized by the Tax Authorities, depreciation rates cannot be higher than those prescribed by the Regulations to the Income Tax Law. A company can choose either the straight line or the sum-of-the-year-digits methods of depreciation. However, once chosen, that method must be used consistently. Accelerated depreciation is allowed in certain circumstances.

• Annual depletion allowance is granted to companies that use natural and depletable resources.

• Organizational and pre-operational expenses can be amortized in five years.

• Operational losses can only be carried forward up to three years by companies engaged in industrial operations and five years for agricultural operations. The amount to be carried forward or used as a deduction is up to the discretion of the taxpayer. Amounts not used during the allotted time periods are lost.

Foreign Remittances
Costa Rican source income accrued or paid to non-domiciled entities is subject to withholding taxes. Foreign remittances such as royalties, leasing, technical advisory services, salaries and other services (e.g. transportation, communications, and insurance related expenses) are subject to withholding taxes ranging from 5% to 50 percent.

Payments or accruals made by subsidiaries or branches to parent companies for royalties, franchises, trademarks and similar and advisory services, are limited to a maximum of 10% of gross sales of the subsidiary or branch.

Interest payments made to non-domiciled entities are subject to a 15% withholding tax rate. The withholding requirement is waived if the lender is a financial institution or bank duly recognized by the Tax Administration or in the case of financing made by suppliers of goods imported into the country.
Table 1 - Corporate Deductions Allowed Against Gross Income

• Expenses necessary to produce taxable income are deductible provided they are duly recorded, deemed necessary and the obligation to withhold (if applicable) has been met.

• Bad debts provided legal requirements and jurisprudence requirements are met.

• Payments to residents or nonresidents for rents, royalties, technical or financial advisory services, trademarks, franchises and similar items, provided the proper withholding is made (with the limitations established above). If such payments are made from a local entity to its parent Company, the amounts are limited to 10% of gross income of the local entity.

• Taxes paid, except income, sales and consumption taxes or related penalties.

• Interest payments on business loans, as well as the costs of obtaining said loans.

• Loss of assets and casualty losses not covered by insurance.

• Contributions to a recognized cultural or charitable institution.

• Local insurance premiums.

• Foreign exchange losses, except when related to the acquisition of fixed assets.

Sales Tax
The general sales tax is an imperfect value added tax which is levied on the sale and import of goods and the rendering of specified services (e.g. insurance, restaurants, repair shops and photocopiers). The tax is applied in such a way that, through a system of shifts and credits, the tax is charged only once on the various transactions in chargeable goods. This means that the tax is computed by the subtraction method, i.e. crediting taxes paid on purchases (regarding inputs physically incorporated in the production of taxable goods) against tax liabilities arising from sales.

The filing of the tax return and the corresponding payment must be made, at the latest, the fifteenth calendar day of the month that follows the date in which the sale took place. The normal sales tax rate is 13%. A 10% rate applies to the sale of wood and a 5% rate to the consumption electric energy for residential purposes.

Municipal, Permit and Stamp Taxes
Costa Rica has no state or city income taxes. There are, however, minor municipal taxes, operation permit fees and stamp taxes. These municipal taxes vary from one municipality to another. Stamp taxes are levied on most legal documents.

Education & Culture Stamp Tax & Tax on Equity
An education and culture statutory stamp tax is imposed annually, with fees ranging from ¢750 to ¢9,000, based on the capital stock of the company.

Real Estate Tax
This tax is applicable to real estate, land, buildings and permanent structures. The tax is managed, assessed and controlled by local governments (Municipalities) of the administrative district where the property is located. The taxable base is the value of the property registered with the Municipality. The tax rate is 0.25%.

Import Tariffs
At the time of Costa Rica’s entry into the General Agreement on Tariffs and Trade (GATT) in 1990, the country had a maximum duty of 55% on imported goods of Import Tariff (Derecho Arancelario a la Importación (DAI)).

Under GATT, this rate was lowered to (currently) a maximum of 15% for final goods and a minimum of 0% for raw materials and capital assets. Intermediate assets that are not produced in Central America have a DAI of 5%.

This rate is increased to 10% if similar assets are produced in the Central American region. As an exception, there are some goods that are subject to tariffs that exceed the normal 15% maximum, such as milk, certain faming products, and others. Furthermore, luxury items may be subject to combined tariffs and taxes (such as the selective consumption tax and specific taxes, among others) with rates of up to 100%. A detailed explanation of how imports are taxed is beyond the scope of this book. AmCham strongly recommends consulting qualified professionals if you are considering importing goods.

Investment & Tax Treaties
Costa Rica has bilateral investment treaties already in effect with different countries. Among those are treaties with Canada, Chile, Great Britain (not in force), France, Spain, Germany, Switzerland, China (Taiwan), Korea, Venezuela, Paraguay, Argentina, the Czech Republic and the Netherlands. There are bilateral investment treaties signed but not yet ratified with Bolivia, Ecuador, Finland, and Belgium-Luxemburg. The bilateral investment treaty with Poland is pending signature and the bilateral investment treaties with the following countries are under negotiation; Austria, Barbados, Brazil, Denmark, United States of America, Greece, Ireland, Jamaica, Italy, Norway, Peru, Portugal, Romania, Sweden and Uruguay.

Costa Rica and the United States signed a Tax Information Exchange Agreement, which was passed on February 1, 1991 and came into force on February 2, 1991. The agreement satisfies the conditions set forth in the US Caribbean Basin Initiative.

In addition, Costa Rica and Spain signed an Income Tax Treaty in March 2004; however, Congress has not yet ratified this treaty. Other Income Tax Treaties are under negotiation (e.g. Switzerland).

Trade Agreements
The Caricom Trade Agreement is a negotiation agreement between the Caribbean Island Communities and Costa Rica to improve the access and trade between their markets. Caricom Trade Agreement is in effect as of November 15, 2005.

CAFTA is a trade agreement signed on August 5th, 2004 between the United States of America and the Central American countries and Dominican Republic. The Costa Rican Congress is currently studying the agreement for its approval. All the countries that signed this trade agreement have already approved it in Congress, only Costa Rica is still pending.

Other agreements include those with Canada, Chile, Mexico, Panama, and Dominican Republic.

Export Subsidies
The most important export subsidy applicable in Costa Rica is the Free Zone Incentive System. This system is a combination of benefits and tax incentives granted by the State to companies dedicated to handling, manufacturing, processing, trading, producing, repairing or providing goods or services destined to be exported or re-exported to third markets. Also companies dedicated to scientific or technological development can be located and operate under this system.

Initially, those benefits were supposed to be abolished on December 31, 2002, nonetheless, the World Trade Organization agreed to an extension in order to allow affected countries to adapt their economic system to the new scheme. The application of export subsidies, such as income tax exemption granted to companies under the Free Trade Zone Regime, has been extended until December 31, 2007. Service companies are not included in this time limitation.

Source: AMCHAM Costa Rican -  American Chamber of Commerce

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