Costa Rica tax: Free zone regime reform impending

Reform of Costa Rica's free zone law is expected to be approved by the Congress in the near future. The reform is designed to bring Costa Rica in line with World Trade Organization (WTO) rules, while maintaining a competitive and an attractive investment environment and continuing to promote investment in less developed areas.

The new law will phase out by 2015 all of the benefits that have been challenged as prohibited subsidies under WTO rules because, under the current system, the benefits are directly linked with the obligation to export. Under the reform, the requirement to export in order to enjoy tax benefits would be replaced by the concept of investment in a strategic sector.

One of the most controversial aspects of the reform is the introduction of a new income tax rate that would apply to companies in the Great Metropolitan Area that are engaged in operations considered strategic to the country or that invest in less developed areas. It was originally proposed that a 5% income tax rate would apply for eight years, but the government ultimately agreed on an eight-year 6% rate.

Companies operating in a free zone currently enjoy a 100% income tax holiday for the first eight years of operation and a 50% income tax holiday for the four following years (i.e. they are taxed at a rate of 15%, which is 50% of the standard 30% income tax rate). Thus, the only companies potentially affected by the reform are (manufacturing) companies that are still within the current 12-year income tax holiday time frame. Companies whose income tax benefit period has already expired as of the date the bill is formally approved will never have to pay the new 6% rate. It should be noted, however, that companies that make new investments of at least USD 10 million and that recruit more than 100 employees in an eight-year period will continue to be entitled to existing benefits, such as a 0% income tax and an exemption from withholding tax, customs duties, etc.

Another important feature of the bill is that it would allow "significant suppliers" of companies operating within a free zone to opt into the regime, provided they satisfy the conditions laid down in the bill. This option is intended to promote efficient supply chain management. Finally, to encourage reinvestment in the country's utilities, the training of Costa Rican personnel and the development of small business training suppliers, the bill provides for a 10% tax credit for reinvestment in utilities, expenditure on training and other related costs.