Last December the Costa Rican government approved the Law on Strengthening Public Finances, an important tax reform with numerous changes that will affect companies that operate in the country. This reform will impact companies not only because of the fiscal impact, but also because of its effect in the areas of accounting, management, billing, sales and marketing.
The law proposes modifications to the VAT tax, with new rates and expanded categories of taxable products. It also includes adjustments to income tax and a reduction of wage benefits to public workers. Some of the measures have been implemented since their approval, becoming effective at the end of 2018 and into the beginning of 2019, but an additional block of measures is set to come into effect on July 1, 2019. The upcoming changes target tax management and consolidation, aiming to increase revenue and manage expenses for the country.
In this sense, the basic elements of government reform that will directly affect companies are:
- Substitution of the current sales tax by a generalized system of Value Added Tax (VAT)
- Capital gains tax reform
Another relevant aspect, which will affect all taxpayers, is the change of fiscal year, adjusted to coincide with the calendar year. The fiscal year that formerly ended on September 30th will transition to be governed by the calendar year, starting on January 1st and closing on December 31st.
Generalized VAT system
Due to its immediate impact on companies, the introduction of a system of indirect tax is particularly important. The tax is similar to VAT, which will replace the current General Sales Tax.
Currently, the latter applies a rate of 13%, but only taxes a limited number of products and in a single phase. With the introduction of the Value Added Tax on July 1st, the majority of products and services will be taxable throughout the various phases of production and distribution. Services provided by professionals such as lawyers, doctors, engineers, dentists, and accountants, among others, will also became subject to VAT.
The general tax rate will remain at 13%, but reduced rates will be introduced, including rates of 4%, 2% and 1% for certain products and services of primary necessity. For example, medical products, raw materials, and machinery used for production will be taxed at 2%, while basic foods included in a specific list will be taxed at 1%.
The Law of Strengthening of Public Finances contemplates some exemptions for certain products and services, among them:
- Export of goods and sale of goods and services for free trade zones
- Rental of houses when the amount of the rent is less than the equivalent of 1.5 times the minimum wage (CRC 646,000)
- Enrollment in public universities and private education
- Advertising space for radio and television programs
- Interest and costs for loans and credits
Income Tax
On the other hand, important Income Tax updates are introduced that affect companies. Among the changes, we highlight:
- A 15% tax rate for real estate and investment income. The capital contributions made by the shareholders, as well as the capital refunds when the company retains earnings, will also be taxed
- Interest tax on investment certificates will increase from 8% to 15%
- A withholding tax of 2.5%, which will affect non-domiciled individuals or legal entities that own real estate in Costa Rica and sell said assets
Companies that either operate or are considering operating in Costa Rica will have to adapt quickly to these fiscal changes (by July 1st), and adjust their accounting and tax management, billing, and support systems. They will also need to address their relationships with consumers and customers, who may see their prices rise due to the application of the new VAT rate. This increases the importance to involve the Marketing and Sales departments in the corporate adaption process in order to avoid losing competitive advantages.