Costa Rica’s Free Zone Regime: an attractive market?
The Latin American country is encouraging investment with its free trade zone setup, offering tax and operational advantages for companies looking to do business in the jurisdiction, under the rules of the regime.
In Costa Rica, it is becoming increasingly attractive for companies to operate under a ‘Free Zone Regime’ (FZR). The FZR is a set of benefits and incentives granted by the Costa Rican government to companies making new investments in the country, as stated in the Free Zone Regime Act NN°7210 Act NN°8794 and in its bylaws.
The FZR accounts for approximately 50% of Costa Rica’s commercial shipments abroad, but firms that are under the free zone status and jurisdiction – and stand to benefit from the incentives – must comply with legally stipulated requirements.
Major benefits of the scheme include a number of tax incentives, among which is exemption from:
- Value Added Tax (VAT)
- Income tax
- Remittances abroad
An entity that operates under the FZR in Costa Rica benefits directly from general and administrative expenses of the income statement, due to the exemption of 13% of VAT granted by the regime on these areas. In some cases, this applies to the income tax rate, with the applicable corporate rate at 0% for operations within the regime.
Entities must comply with set obligations in order to operate within the regime. These include designing, implementing and maintaining the relevant internal controls relating to property, plant and equipment; internal controls at an administrative level; and closely following what the different local laws and regulations stipulate.
With this approach, entities can not only ensure their permanence within the regime, but also mitigate reputational risks to which they are exposed, that could derive from administrative processes with government authorities.
Here are some general recommendations that can guide you in compliance tasks, helping you ensure your entity maintains the current benefits offered by the Free Zone Regime:
- The local regulation comes first: it is quite usual for regimen companies to have their headquarters outside of Costa Rica, with financial reporting frameworks based on accounting regulations of other jurisdictions. However, tax and statutory rules of the special regime require entities to have and present financial statements in Costa Rican colóns, based on International Financial Reporting Standards (IFRS).
A hurdle to overcome is the conversion processes of financial information to a framework of accounting policies under IFRS. This means working with the ‘conversion adjustments’ on items where there are differences in recognition or measurement of economic events. Examples of these differences may be functional and presentation currency, share-based payments, capitalisation of right-of-use assets, or differences in useful lives.
- Being exempt from taxes does not mean being exempt from controls: in the instance of property, plant and equipment, although your company may have expressly authorised a different capitalisation policy than the one referred to in the Income Tax Law (LISR), this does not mean that low-value assets have been exempted from absolute control. When Promotora del Comercio Exterior de Costa Rica (PROCOMER) audit visits take place, it’s important to have an auxiliary register of such assets, which can become critical when samples are reviewed by that authority. Therefore, the control of assets and inventories within the regime merits particular attention, as they can be high risk.
- Not everything is for free: the regime offers a range of attractive exemptions (around 43% across VAT and income), but not everything that is purchased is exempt from taxes. It is important that, in the face of an audit, your company has sufficient internal controls that allow it to guarantee that only those expenses that meet the deductibility criteria of the LISR have been purchased VAT-free. Namely, those that are useful, necessary and relevant for the operation of your business. In a practical example, the VAT that private insurance companies usually pay as an incentive for their employees does not meet this criterion, so the corresponding VAT should be paid.
- Control of property, plant and equipment (PPE) is the entry ticket: it is vital to maintain control of assets based on local legislation, in accordance with the LISR regulations and its annexes. This should cover differential adjustments, sufficient details of identification (label, description, serial number) and its effects on deferred taxes. It is often incorrectly assumed that, because it is exempt from income tax, temporary differences should not be calculated for useful lives. If the fiscal effects prevail beyond the executive agreement it does have to be accounted for.
The completeness of the PPE must be periodically ensured through physical counts, using sampling techniques from accounting books. This is a fairly common audit procedure in inspections carried out by the regime authority. In our experience, if a PPE auxiliary register is not complete and accurate, management can be expected to receive subsequent visits, follow-up audits, and administrative proceedings for non-compliance.
Bear in mind that the value of PPE is the calculation base for the investment level, and this is the authority's incentive to renew the benefits in whole or in part, once the executive agreement has reached its limit.
- Other rules to consider: Within the regulatory framework of the FZR, there is the obligation of the beneficiary to comply with all the legal obligations that the country demands to maintain tax exemptions. Therefore, it is important for your company to periodically carry out a preventative review of compliance with the obligations related to the FZR. This includes, among others, the General Health Law, the Occupational Health Standard, the Smoking Regulation Law, administration of warehouses, security service, labelling of the authorised area, entry/exit registration, telework law and the correct calculation of labour benefits, maternity wards and discrimination rules.
At TMF Group we work with several companies that operate under the Free Zone Regime. Our team of experts has the knowledge and experience that can help you avoid or minimise compliance risks, which, if they materialise, can lead to sanctions that could impact the operation of your entity at regime level.
Contact us today to find out how we can help your business stay compliant.