Notably, the reform introduces a VAT Law that substitutes an antiquated sales tax system, and brings significant changes to income tax law adopted over 20 years ago in an attempt to harmonise it with international standards and the debatable recommendations of the OECD for a country such as Costa Rica (e.g. hybrid mismatch arrangements).
Having said that, the VAT Law and modified Income Tax Law include ambiguous or contradictory provisions, and certain concepts are inadequately defined.
There are even some errors, with private education services listed as VAT-exempt, even though it is still included in a list of goods and services subject to a reduced rate of 2%. The income tax changes are the result of a hurried compromise rather than a complete overhaul based on the recommendations of tax specialists.
Replacement of the sales tax with a VAT system
Under the new VAT system, services will generally be taxable, and only a certain amount of goods and services will be exempt. The standard rate will be 13%. There are 35 exemptions, and 12 situations in which VAT does not apply.
These include exports, the purchase of goods and services from free trade zone (FTZ) regime companies, interest and commissions on loans, the transfer of real property and registered movable property subject to a transfer tax. There are also three reduced rates:
- 4% for private health services provided by authorised health centres or health science professionals;
- 2% for pharmaceutical products or personal insurance premiums; and
- 1% for sales, imports or the clearance of agricultural items included in the list of basic foods.
To ensure the collection of VAT in cross-border digital transactions regarding services, Costa Rican banks will be required to act as VAT withholding agents. Importing intangibles will also be subject to VAT.
Furthermore, input tax (VAT charged on goods and services for business purposes) will be recoverable, with taxpayers entitled for reimbursement via tax credits.
However, exports will be eligible to receive a tax credit, even though they are exempt. Taxpayers with transactions subject to a reduced tax rate will only be entitled to a tax credit that is equal to the percentage of the reduced rate.
Lastly, VAT credits can be used for a total of four years. If the taxpayer is not able to use their VAT credit in the next three years, it can use it to offset other tax liabilities such as corporate income tax (CIT), or just request a refund. The latter is unlikely to occur in practice though.
New income tax law provisions
Income and capital gains made from a Costa Rican source will now constitute a new category of taxable income, with the capital gain to be subject to a new tax rate of 15%.
For the sale of goods or rights acquired before the tax reform was enacted, taxpayers will be able to choose whether to pay a reduced capital gains tax of 2.25% on the amount of the sale. On the other hand, gains derived from assets or rights connected with for-profit activities (or when they constitute an ordinary activity) will be subject to the ordinary income tax rate of 30% (on a net basis) and will not be eligible to the 2:25% rate.
Additionally, capital gains derived from the sale of shares that were not subject to taxation in situations where the seller was not engaged in a habitual trade will now be taxable.
In the realm of currencies, exchange differences in assets or liabilities that arise from the time the transaction is carried out, the date the income is recognised (or liability paid), or the close of the tax year, will be subject to income tax and will constitute a taxable gain or deductible loss.
Carrying forward losses will be possible for a three-year period and will continue being possible for five years in the agriculture sector.
Interest deductions will be subject to 30% of earnings before interest, tax, depreciation and amortisation (EBITDA), and will decrease to 20% in five years. However, interest derived from banking or any other type of local or foreign regulated financial entity should not be subject to this limitation.
There are also new anti-low tax jurisdiction provisions. Expenses paid to entities in non-cooperating jurisdictions (where the CIT is less than 40% of the applicable Costa Rican CIT rate of 30%, or jurisdictions that do not have a tax information exchange agreement or double taxation treaty) will not be deductible for CIT purposes. Expenses can nonetheless be recognised if the tax authorities determine that the taxpayer can prove that the expenses correspond to a transaction actually made.
Among all these changes, tax-free corporate reorganisation rules are also introduced.