Costa Rican Tax Reform (Project 20.580) – What Changes?

What motivates the tax reform?
Before starting with tax reform subject, we must understand that Costa Rica’s financial situation has become unsustainable due to the increase of its fiscal deficit. The Government’s expenses have gone up over time, much more than the income earn through taxes.

Main changes in tax reform
The tax reform does not mean only an income stream tax reform, it also includes a reform to public expenditures. The intention is to implement an integral tax reform, to at least mitigate the endemic deficit.

Regarding taxes, there are changes in Direct Taxes, which are taxed on the collection of passive and active income, and Indirect Taxes, which are taxed on the consumption of goods and services; in fact a directly proportional way to tax the result of wealth.

As for the public expenditures, the main change is to stop the leak in main components, which includes amendments to the Public Wages, mainly on issues like salary bonuses and incentives to public sector. The reform includes the Fiscal Rule, an element by which the increase in spending is limited in direct proportion to the result of the debt. Regarding a structural reform, the tax reform does not include structural changes in Costa Rica’s State composition, that are deeming to become part of a later step after this tax reform is enforceable.

Incorporation of the “General Anti-Avoidance rule”
One of the most important additions that occurred in the last modification of the bill, was the inclusion of the General Anti-Avoidance rule, which seeks to avoid aggressive tax strategies lacking economic reason other than the tax saving. Therefore, with this clause in place, every strategy must have a valid economic reason, different from that of the reduction to the payment of taxes, that must be documented and proven to the Tax Administration in case of an audit.

Value Added Tax
The incorporation of the Value Added Tax (VAT), overwrites the Sales Tax, effective since 1982. The final determination of the VAT payment at the end of the period will be the total of tax debits (the VAT charged by a taxpayer to its customers) minus the total tax credits (the right to refund the VAT paid). When the tax credit is greater than the tax debit in a fiscal year, the difference turns into a balance in favor of the taxpayer that may be offset against other tax obligations.

The VAT implementation imposes a 13% tariff on all goods and services used or traded in the country. It also includes differentiated rates at 4% for private healthcare sectors and plane tickets, 2% for medicines and personal insurance and 1% for a limited group of goods and services considered as basic for the local consumption.

It is important to indicate that the VAT will have full, partial or no right of deduction of the tax paid, depending on the type of sale that is performed. When the good or service purchase is to carry out a transaction subject to 13%, full accreditation will be granted. When the purchase is to carry out a transaction subject to a reduced rate, you will be entitled to partial accreditation. While, when it is a tax exempted purchase transaction, there will be no right to deductions, with some exceptions.

The VAT comes to broaden the tax base, which translates into a higher income for the Government. It generates controls over services provides which are not currently subject to Sale Taxes sus as private physicians, accountants and lawyers, amongst other services providers.

The tax should be liquidate before the fifteenth calendar day of the following month, calculating the sales and services corresponding to the previous month. On December, the taxpayer should calculate the final proportion of the tax credit according to the operations carried out in the corresponding calendar year.

Reforms in Income and Capital Gain Tax
The Income tax has several changes, among them the establishment of a dual income tax system, which consists of taxing income from lucrative activities, at a progressive rate, and capital income, at an uniform rate.

The reforms updates Costa Rica’s fiscal period which happens to be from January to December. Those taxpayers whose new tax period does not match with the one that had in operation, will have to present two tax statements. One for the period not covered in 2019, which goes from the first day following the fiscal year end of the previous period, until December 31st.

It established that gains and losses on exchange rate difference will be subject to income tax based on the general principle of accruals accounting. Regarding the deductibility of interest, it must be demonstrated to the Tax Administration the use for the loans whose interest intends to be deducted. These loans must be used to generate taxable income. In addition, non-bank interests have a maximum deductibility of 20% of the total profits before interest, taxes, depreciation and amortization (EBITDA) for each tax period.

The tax reform produces changes in tax rates on legal persons and dependent personnel (salary). Increasing personal taxation on wages from a maximum 15% to a new rate as high as 25%.

An Income and Capital Gain Tax is created and the rate applicable in this matter will be 15%.

For the income perceived from leasing properties, only 15% of the gross income can be deducted, with the tax base being 85% of the total income received.
The benefits received from savings on cooperatives, and employee’s solidarity associations, will have an exempt annual limit equivalent to 50% of a base salary; on the excess, the indicated rate of 8% will be retained and applied. The surplus or profits paid by Solidarity Associations, Cooperatives or others like their associates, will be subject to a 10% rate. For the first year of entry into force of this law, it will start with a rate of 7%, and increase one point each year, until it reaches 10%.

Tax Amnesty
The Tax Amnesty will provide a possibility to partial forgiveness of fines and complete waiving of any interest to taxpayers. It seeks to regularize the situation of taxpayers who did not comply adequately with their obligations to the 2017 fiscal period.
The reduction in sanctions and the terms go up to 80% if they make the payment of the amount owed during the first month after the law is approved, 70% if the payment is made during the second month, 60% if it is made during the third month and 40% in the event that, under the amnesty during the 3 months of appointment, a payment split is formalized. The cancellation deadline may not exceed 6 months and in which case the split debt must be supported with a bank guarantee.