Costa Rica: Domestic Corporate Taxation

Costa Rica is not a financial center in the traditional sense and so does not distinguish between onshore and offshore activity. The main taxes affecting a business are business income tax, employers social insurance, withholding tax, import duty and sales tax at 13%. Tax exemptions applying to businesses under various foreign investment incentive schemes are described in Offshore Legal and Tax Regimes.

Since 2002, the government has been struggling to pass a Permanent Fiscal Reform Package in an attempt to reduce the country's deficit. The key components of the package are a switch from a territorial tax system to one which taxes worldwide income and the replacement of the 13% sales tax with a Value Added Tax system; taxes payable by Free Zone companies would also be increased over a period of time.

The bill itself was eventually killed off shortly before the 2006 presidential elections when the Sala IV constitutional court ruled that supporters acted illegally in the Legislative Assembly by creating new procedures to "fast track" priority legislation, including the tax bill.

In August, 2006, following Oscar Arias's election to the presidency, Costa Rica's legislators once again begun to discuss the vexed question of reforming the country's taxation system, although it would appear likely that the same problems that blocked the former fiscal reform bill for four years could hinder the progress of the new proposals.

The new tax plan is a mixture of the old one, which includes reforms to the income tax system and a new system of value-added tax, and new proposals championed by President Arias designed to redistribute wealth from rich to poor through such mechanisms as a real estate tax on luxury properties and a 0.5% financial transactions tax.

A new tax on corporations has also been proposed as part of the comprehensive tax reform plans. The $200 tax would apply to all personas juridicas, or legal persons, and will be payable within ten days of the start of a new tax year, which will run from January 1 to December 31.

In August 2009, the International Monetary Fund noted that the tax reform was needed to reduce the government's fiscal deficit. "Fostering an early consensus on the need to increase revenues would be desirable to ensure a swift debate and passage of tax reform," the Fund stated.

The need for tax reform was also flagged up in the IMF's 2008 Article IV consultation, when the IMF observed that:

"The authorities and the mission agreed that the approval of a substantial tax reform, including a revamp of the income tax and Value Added Tax (VAT), remains a priority."

Details below apply to the pre-existing tax regime, which remains in force.

Costa Rica Scope of Income Tax

In Costa Rica business tax legislation is currently based on the principle of territoriality meaning that all business income which has a foreign source is tax exempt. Only that proportion of business revenue earned within Costa Rica is subject to an assessment by the tax authorities.

All business entities whatever their form and whether they be sole proprietorships, partnerships, branches, stock corporations or limited liability companies pay income tax on the profits of their trade

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Costa Rica Rates of Income Tax

The income tax rates payable by a business are set out in Article 15 of the Income Tax Law.

There are 4 business income tax rates, the rate payable varying according to the level of gross income. The 4 rates (in 2008/2009) are:

• Full tax exemption for a predetermined period for all businesses operating under the free trade zone legislation;
• 10% tax for a business whose gross income is less than 38,891,000 colons;
• 20% tax for a business whose gross income is more than 38,891,000 colons but less than 78,231,000 colons;
• 30% tax for a business whose gross income is more than 78,231,000 colons.

Companies are subject to a further 10% tax on any brought-forward losses or investment allowances that are used to reduce chargeable income.

Local authorities levy an annual business license tax on all businesses engaged in profitable activities in their territory. This tax is paid quarterly, varies according to the nature of the business and is based on the previous year's net taxable income. The amount depends on the costs incurred by the local authorities in running basic services such as street lighting and rubbish collection.

Business income tax is assessed on the difference between gross income and allowable deductions.

Although there is no capital gains tax in Costa Rica profits made on the sale of a capital asset are taxed as business income, and losses made on the sale of an asset may be set off against trading profits. The sale of land, shares and patent rights are excepted from this rule unless the seller's business revolves around their habitual sale.

There are a number of allowances which can be deducted from gross income for the purposes of an assessment:

• Depreciation is permitted at prescribed rates, which are fairly normal; accelerated depreciation is available on certain types of asset;
• 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;
• 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.
• Inventories are usually valued by the weighted-average method; LIFO is also permitted;
• Interest payments are an allowable deduction. However under Article 10 of the Income Tax Law the allowable rate for tax deduction purposes is the interest rate prescribed by the Central Bank. Interest paid on shares because of special rights attaching thereto is treated as a dividend and is therefore not deductible;
• Dividends received by resident corporations from other resident corporations are not taxable; interest income on marketable securities is also tax-exempt.

Group and consortium relief is not available.

No credits are granted in Costa Rica for taxes paid in a foreign country.

Costa Rica Filing Requirements and Payment of Tax

Tax is assessed provisionally based on the previous year's results and is payable each quarter. The fiscal year runs from 1st October to the following 30th September and any balance of tax due is payable on the following 31st December.

Costa Rica Withholding Tax

(Note: the proposed tax reforms will, if eventually passed, eliminate the 15% withholding tax rule in its entirety.)

The general rule is that irrespective of whether the recipient is a resident or non-resident entity, 15% withholding tax is levied at source on all dividends remitted to shareholders, all commissions paid to third parties, all loan interest repayments, all interest credited on bank deposits, all interest paid by a private or public entity on any kind of security (e.g. bonds), all distributions by business entities (e.g. partnerships & sole proprietorships) of profits to its members and all distributions of trust funds to beneficiaries.

The general rule is subject to the following exceptions:

• Dividends paid by companies registered on a public stock exchange attract a withholding tax rate of 5%;
• Loan interest paid by an enterprise registered in Costa Rica to a foreign bank which is recognized by the Central Bank of Costa Rica as being a bank that finances international operations is not subject to any withholding tax;
• Interest repayments on loans which have been made to finance industrial or agricultural projects in Costa Rica do not attract any withholding taxes so long as they paid to an institution which is recognized as such by the Central Bank of Costa Rica;
• Payments made under a contract for the leasing of capital goods do not attract any withholding taxes so long as they are paid to an institution which is recognized as such by the Central Bank of Costa Rica;
• Interest paid on bills of exchange, promissory notes and mortgage bonds is exempt from withholding taxes;
• An 8% withholding tax is deducted on interest payments made in respect of registered debentures which are listed on a recognized stock exchange or which are issued by certain financial institutions registered with the Central Bank;
• Remittances relating to the use of intellectual property rights such as royalties on trademarks, patents, franchises etc attract withholding taxes of 25%;
• Remittances to non-resident foreign entities engaged in the provision of technical, financial or administrative services in Costa Rica attract a withholding tax of 25%;
• Transport and communications services are subject to withholding tax of 8.5%;
• Reinsurance contracts attract a rate of 5.5%.

With the exception of stock corporations, any undistributed profits in the balance sheet of an enterprise at the end of a financial period are subject to withholding tax as if they had been distributed. Capitalisation of such undistributed profits (ie they cannot be distributed in future) avoids the tax.

Under law 7092 of 1988, the branch of a foreign corporation pays 15% withholding tax on profits which can be distributed as 'dividends' irrespective of whether those profits have or have not been remitted. The branch does not of course have the option of 'capitalisation'.

Dividends paid by businesses registered under the free zone legislation are free of withholding taxes for the period specified in the license.

Costa Rican withholding taxes are not comparable to most countries' equivalent taxes, since they are levied on post-tax business profits, and don't have any element of tax credit about them for the paying company. In effect, they mean that the marginal rate of corporate taxation is 30% plus 15% of 70% = 40.5%. This underlines the importance of the concessions under investment incentive programmes.

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Costa Rica Stamp Duties

The law relating to Stamp Duty is contained in Law no 5923 of 1976 and Law no 6879 of 1983 (otherwise known as the Stamp Duty for Education and Culture Law).

Stamp duty is only payable by corporate entities and the branches of foreign corporate entities which are registered in the Costa Rican companies registry.

There are two types of stamp duty, namely a set duty for every entry recorded in the companies registry, and an annual stamp duty charge based on a company's issued share capital.

The tax is payable in February - March each year.