Contributed By Deloitte Tax Costa Rica
Businesses generally adopt a corporate form in Costa Rica. Commercial corporations pursue profits as their main goal, while it is uncommon to use civil corporations to conduct business in Costa Rica.
Corporations are taxed as separate legal entities from the individuals that incorporated them.
Taxpayers usually structure their business through corporations (Sociedad Anónima) or limited liability companies (Sociedad de Responsabilidad Limitada).
Costa Rica does not have pass-through tax rules included in its current legislation, except for investment funds that act as withholding agents of their investors.
As stated in 1.2 Transparent Entities, Costa Rica does not have pass-through tax legislation.
On 4 December 2018, Costa Rica enacted a tax reform bill, the Law on the Strengthening of Public Finances. The reform brought new rules on permanent establishments following the OECD model definition. This reform entered into force on 1 July 2019. In general, non-domiciled parties engaging in local activities for over 183 days may be deemed as having a permanent establishment.
Costa Rica has executed three double taxation treaties (Germany, Spain and Mexico) and tax residence rules may vary from one treaty to another.
Legal entities (local or non-local) developing businesses within Costa Rica generate Costa Rican-source income. Costa Rican-source income accrued by legal entities is subject to the following corporate income tax rates.
According to Article 1 of the Income Tax Law, income tax is levied on Costa Rican-source income derived from for-profit activities. Costa Rican tax systems follow a territoriality principle.
Therefore, income tax is applicable to Costa Rican-source income, regardless of the nationality, domicile or residence of the recipient.
Costa Rican-source income is any amount arising from services rendered, goods located or capital used in the territory of Costa Rica.
Income tax is assessed on an accrual basis.
Taxable profits are calculated by subtracting deductible expenses from the gross income.
According to Article 10 of the Income Tax Law, expenses are deductible provided that:
In Costa Rica there are no special incentives for technology investments, but many tech-oriented businesses are developed under a Free Trade Zone Regime (explained in 2.3 Other Special Incentives).
Companies operating under the Free Trade Zone Regime that are located in the Great Extended Metropolitan Area (GEMA) benefit from an income tax exemption of 100% for the first eight years and 50% for the next four years. Companies located outside the GEMA benefit from an income tax exemption of 100% for the first 12 years and 50% for the next six years.
The Ministry of National Planning and Economic Policy specifies which areas are considered part of the GEMA.
With no expiry lifespan, companies under the regimen (located inside or outside the GEMA) are also exempt from value added tax and remittances abroad tax. These companies are granted an exemption from any taxes or customs duties on the importation of items such as raw materials, products, parts, packing material, containers, machinery, equipment, spare parts and other goods necessary for their operation.
In order to comply with Costa Rica’s commitments as a member of the World Trade Organization, Law 8794 amended the Free Trade Zone Regime Law. A new category of companies that can apply for the Free Trade Zone Regime was included. This option is for companies producing goods, regardless of whether those are destined for exportation. Companies in this category are subject to income tax at reduced rates (0%, 5%, 6% or 15%) for a specified number of years depending on whether they are located inside or outside the GEMA or depending on the amount of the investment.
Prior to the tax reform, carry-forward of losses was only allowed for industrial and agricultural companies. Losses incurred by commercial enterprises were not able to be carried forward.
As of 1 July 2019, any type of company may carry forward net operating losses for three years. Agricultural companies may carry forward net operating losses for five years. Losses generated in prior fiscal years cannot be deducted.
Net operating losses may not be carried back.
Net operating losses cannot be offset against capital gains and vice versa.
Costa Rica has no thin capitalisation rules, with the exception of a restraining rule in the case of credits granted by non-financial institutions, as explained in 5.7 Constraints on Related-Party Borrowing.
Costa Rica does not allow tax consolidation.
A taxpayer’s losses should remain separate regardless of whether they are part of a group of companies.
Capital gains generated by corporations or legal entities engaged in for-profit activities are subject to the standard corporate income tax rate (30%) if the gain derives from the sale or transfer of assets and/or rights used in said activities. If not, the gain will be subject to a 15% tax.
Corporations or legal entities not engaged in for-profit activities are subject to capital income and capital gains rules. According to said rules, a capital gain will be subject to a 15% tax; however, if the assets and/or rights belonged to the taxpayer before 1 July 2019, the taxpayer may opt to pay the capital gains tax, calculated as 2.25% of the sale price (no deductions allowed).
Value added tax is accrued on the sale of goods, the rendering of services, the rent of property or the importation of goods or services. There are different rates and some goods and services are exempted, but the general rule is that a 13% VAT applies on the purchase of goods and services.
A special tax applies to imports or the manufacturing of alcoholic and carbonated beverages and all kinds of cigars; also, a selective consumption tax applies regarding the importation of luxury goods.
The Real Estate Tax Law is administered by the local governments, also called municipalities. The tax is collected on a quarterly basis and calculated on the registered value or appraised value of the real estate (including land and all permanent buildings and structures located within the territory of the municipality).
The tax rate is 0.25% of the base or appraised value of the property.
The appraised value is established by the municipal tax administration.
The value can also be revised at any time by the tax administration or automatically adjusted when an updated value surfaces from documents subject to registration before the Public Registry.
Real estate taxes are deductible for income tax purposes.
Employers’ social security contributions are imposed on all remuneration paid to employees, including benefits in kind. There is no maximum amount.
The employer rate of social security is 26.33%. The employee rate is 10.34%.
Most closely held local businesses operate in corporate form.
In the case of individuals operating businesses or rendering professional services directly, the rates are as follows:
There is no rule that forbids or limits individuals from rendering professional services through corporations or legal entities.
No rules prevent closely held corporations from accumulating earnings for investment purposes.
Individuals receiving dividends from a corporation or another legal entity are subject to a 15% withholding. The payer must act as withholding agent.
Individuals not engaged in for-profit activities are subject to capital income and capital gains rules. According to said rules, a capital gain will be subject to a 15% tax; however, if the assets and/or rights belonged to the taxpayer before 1 July 2019, the taxpayer may opt to pay the capital gains tax calculated as 2.25% of the sale price (no deductions allowed).
Because of the tax reform, distribution of dividends from publicly traded corporations to individuals is taxed at 15%. Gains derived from the sale of shares in publicly traded entities is taxed according to the capital gains rules. There are specific regulations regarding shares acquired prior to the reform entering into force.
In general, interest payments from Costa Rica to abroad are subject to a 15% withholding tax.
For interest payments, commissions and other financial expenses paid or credited by local financial entities subject to regulation by SUGEF (the Superintendence of Financial Institutions) to foreign financial entities (also subject to overseeing and inspection in similar terms by the equivalent authority in their jurisdiction) will be subject to a 5.5% withholding tax.
Dividends paid to an individual (local or non-local) or to a legal entity (local or non-local) are subject to a 15% withholding tax. Said withholding does not apply if the dividends are distributed to a local legal entity, as long as the recipient is engaged in a for-profit activity. Remittances abroad related to the use of patents, formulas, trade marks, privileges, franchises and royalties are subject to a 25% withholding tax.
Many international companies set up their holding entity in Panama (due its territorial tax system). Spain is also an option due to the existence of a double taxation treaty and the Spanish treatment for income deriving from investments outside that country.
The authors have no knowledge of cases in which the Tax Administration has questioned the application of double taxation treaties in this sense.
The main problem that Costa Rica has faced regarding transfer pricing application is the lack of uniformity during tax audits.
The majority of administrative and judicial cases related to transfer pricing concern the correct application of the method for calculating prices and open market comparable data that must be taken into account.
The resolution of these cases is still pending; once they are resolved, they will bring light into the discussion.
As a general principle, local tax authorities do not challenge the use of related-party limited risk distribution arrangements for the sale of goods or provision of services locally. In general, prices agreed between related parties should follow the arm’s-length principle.
The authors have no knowledge of judicial or administrative proceedings in which the authorities have questioned this type of agreement between companies.
In Costa Rica the rules applicable to transfer pricing do not have considerable differences from the OECD regulations on the matter. The discussions that have arisen are related to the correct application of the methodology or the utilisation of comparable data.
There is no experience in Costa Rica in this matter.
It is possible to compensate adjustments related to a transfer pricing claim, but the taxpayer should file a tax return in order to identify the specific amounts involved.
In Costa Rica there is no legal basis in order to propose a mutual agreement procedure (MAP) to the Tax Administration.
Taxation for local branches of non-local corporations and local subsidiaries of non-local corporations is the same. There is no difference in the treatment from the perspective of corporate income tax.
In general, capital gains are subject to taxation in Costa Rica. A non-resident party transferring stock in local corporations to a local taxpayer is subject to a 2.5% withholding tax that applies on the sale price. In principle, the non-resident party may self-assess the capital gains tax and use the withholding tax as a tax credit towards the capital gains tax.
As previously stated, taxpayers – including non-resident parties – may choose between two options in order to determine the capital gains tax: 2.25% on the sale price or 15% of the gain (as the difference between the cost or book value and the sale price).
Currently, Costa Rica has only three double taxation treaties in place. None of them has specific regulations on capital gains. Whether or not the sale of stock falls within the meaning of “business profits” is debatable; the authors are not aware of administrative or judicial precedents on this matter.
Changing control of local legal entities owning Costa Rican real estate triggers real estate transfer tax (change of control implies the transfer of at least 51% of the voting stock).
The concept of transfer includes direct transfer of real estate (typically, Costa Rican real estate is transferred by granting a public deed before a notary public) and indirect transfer by changing control of the legal entity.
This is not applicable in this jurisdiction.
Local affiliates are able to deduct payment for management and administrative services rendered by non-local affiliates. Similar to other expenses, these must be connected with the for-profit activity and the amount paid should follow the arm’s-length principle.
There are no specific rules constraining financing operations between related parties (local or domiciled abroad); however, the Income Tax Law includes an interest limitation rule, under which, interest expenses that exceed 20% of the taxpayer’s earnings before interest, taxes, depreciation and amortisation (EBITDA) will not be deductible for corporate income tax purposes.
In general, interest payments derived from debts with financial institutions (local or non-local) are excluded from this limitation. As a consequence, interest payments in favour of related companies (regardless of their tax residence) may fall under this limitation.
This provision is effective in the second tax year following the date of enactment of the tax reform. The deduction is limited to 30% for the first two tax years and will then be adjusted downward by two percentage points each year until it reaches 20%.
Costa Rica follows the territoriality principle, meaning that only Costa Rican-source income is subject to taxation.
As a consequence of the territoriality principle, local expenses attributed to foreign income should not be deductible.
Dividends received from non-local subsidiaries should not be subject to taxation.
The transfer of intangibles developed in Costa Rica should be done according to fair market value. It is the same in the case of licensing of intangibles developed in Costa Rica; the consideration should follow the arm’s-length principle.
Costa Rica has no controlled foreign corporation-type rules in its current tax legislation.
There is no applicable information in this jurisdiction.
Following the territoriality principle, gains deriving from the sale of shares in a foreign affiliate are not subject to taxation in Costa Rica.
In December 2018, Costa Rica enacted a tax reform bill, the Law on the Strengthening of Public Finances. Through this reform, a general anti-avoidance rule was included in the tax legislation. These rules seek to avoid aggressive tax strategies lacking economic and business purpose.
There are no regular audit cycles in Costa Rica.
However, the tax authority tends to audit more often large taxpayers annually. The Comptroller General of the Republic has advised and recommended the Tax Administration to audit large taxpayers on a regular basis in order to avoid the statute of limitation of tax periods.
For regular taxpayers, every tax period, the Tax Administration issues criteria in order to select activities or sectors that are relevant for said Administration.
As part of the tax reform, the taxation on financial returns was increased from 8% to 15%.
As discussed above, a rule on interest payments deduction is now part of the tax legislation in Costa Rica. The final version differs from the one proposed by the Tax Administration due to negotiation in Congress.
Prior to the tax reform, capital gains were not subject to taxation in Costa Rica. Now they are, regardless of whether they are habitual or not.
Costa Rica is in the process of being admitted as a member of the OECD. Implementing most of the BEPS recommendations is part of the government’s policy.
The Tax Administration has stressed a concern with tax havens and how they may affect local taxes in Costa Rica. In general, discussion about international tax surrounds that topic.
Costa Rica does not have a comprehensive competitive tax policy. The tax legislation lacks tax incentives aside from those related to the Free Trade Zone Regime.
During the discussion of the last tax reform, the Free Trade Zone Regime was a focus for political parties that were looking to modify such regime in order to eliminate or diminish its tax incentives. None of its features were modified.
As part of the tax reform, a specific rule on hybrid instruments was approved. Despite the fact that the rule is obscure, the intention is to reject expenses as being deductible if the related income is not subject to taxation.
The Costa Rican tax system is based on a territorial tax regime. Modifications to said regimen were not part of the discussions during the analysis of the tax reform. Not being able to deduct expenses related to investments located outside Costa Rica is a consequence of the regime due to the fact that the non-Costa Rican returns shall not be subject to taxation.
The authors do not foresee a change in the territorial tax system. A discussion of controlled foreign corporation (CFC) rules was not part of the most recent tax reform. From the authors' standpoint, the CFC rules and its variations should be part of a more comprehensive tax system shift.
Costa Rica has no rules similar to the Direct Taxes Code. As a consequence of the tax reform, an anti-avoidance rule was introduced to the country's tax legislation, as discussed in 7.1 Overarching Anti-avoidance Provisions.
Transfer pricing rules have been part of the tax system since 2003 (through Administrative Directive 20-2003). From that point, transfer pricing has evolved until it was included in Costa Rican income tax law as part of the most recent tax reform.
In particular, intellectual property does not bring additional difficulties to the regime.
Country-by-country reporting is part of the compliance obligations of certain taxpayers (in general, multinational companies having a predetermined amount of global earnings). However, the forms have not been published yet and, as a consequence, it has been delayed.
Under the framework of the most recent tax reform, the value added tax encompasses the taxation of digital businesses.
Now, cross-border digital services will be subject to VAT at a rate of 13%. The Costa Rican Tax Administration based its regulations on the OECD International Guidelines (2017), by proposing registration and compliance mechanisms to expedite tax collection in respect of transactions between non-domiciled parties and local consumers. Besides such mechanism, the Tax Administration also published a list of cross-border providers that will be subject to VAT.
Finally, if a digital service provider does not register as a VAT payer, law establishes the credit or debit card processors as responsible for the collection of tax in respect of online purchases.
See 9.12 Taxation of Digital Economy Businesses.
Costa Rica has no specific regulations on this matter.