San José, Costa Rica, since 1956

Tax Specialists Explain Controversial Reforms

WHILE legislators have been debating polemic taxreforms for more than three years, assembly sourcesnow say the plan could come to a vote for the first timeas soon as late September – heightening questionsamong both foreign residents and Costa Ricans aboutwhat the reforms, and the changes they have undergonesince first proposed in 2002, could mean to them.The much-discussed Permanent Fiscal ReformPackage would reform the income tax for individualsand corporations, create a value added tax to replace thecountry’s sales tax, and empower a new governmententity to enforce the laws, among other changes.The plan would also have an impact on the taxespaid by foreigners and foreign businesses. While theplan originally called for the implementation of whatis called a worldwide system, in which companies and individuals would be taxed on all foreign-earned income as well as income generated here – as opposed to the territorial system now in place, which taxes only income generated in the country – recent changes mean foreigners only pay taxes on income generated in, or brought into, Costa Rica. (For now, the plan still calls for Costa Ricans to pay taxes on all income in and outside of the country. However, this point is still under debate.)Legislators approved this change Monday, with Finance Minister Federico Carrillo’s approval.THE plan offers foreigners some important exemptions, according to tax attorney Diego Salto, a partner at the corporate law firm Asesores Fiscales Corporativos. For example, people who can prove their money has already been taxed in another jurisdiction, or that it has been invested in projects destined for activities related to Costa Rican national production, will be exempted from taxation. The money brought into Costa Rica by foreigners during their first year of residency will also be protected.Salto emphasized that it is the taxpayer’s responsibility to prove that the funds meet these or other exempted conditions.This most recent draft of the bill states that anyone who has his or her main economic activity in Costa Rica, and/or resides in the country for more than 183 days a year, is subject to taxes.SOME in the business community are not happy with the recent modifications to the proposed reforms.“It is a negative in terms of attracting foreign investors and foreign companies,” said Lynda Solar, Executive Director of the Costa Rican-American Chamber of Commerce. “We have been against universal taxation from the beginning. If the only way to get this tax bill passed is including universal taxation, but only when the money is repatriated (brought back into the country), that is probably something we’ll have to live with, but it’s not the ideal scenario.“Really, more than increasing taxes, what needs to be done is to have a more efficient tax collection system,” she added. “There is a lot of tax evasion. The system is very inefficient.”HOWEVER, according to Alonso Arroyo, a tax attorney with the firm KPMG, the worldwide system would reduce the tax evasion that has been taking place under the territorial system. Under current laws, people and businesses can claim that unexplained and untaxed sums of money, properties, or other assets came from abroad, he said.The change to a worldwide system would “provide the Tax Administration with a tool to tax people with a standard of living not congruent with their declared income,” Arroyo said.The tax reforms would also change the way income taxes, for foreigners and Costa Ricans alike, are calculated. Under the current system, different types of income have different tax rates. The new plan would add up all income and tax it as a total, based on what tax bracket the total falls under. In addition, it creates a special tax rate of 12% for income such as capital gains. Most capital gains are untaxed under the current system.According to Salto, the current draft of the tax plan would lower taxes for anyone making less than $3,000 a month, while those making more would see their taxes go up.Marietta Montero, a tax specialist at the Finance Ministry, told The Tico Times the new system would allow taxpayers a new series of reductions on their income taxes for factors such as having a family, medicine and medical treatments, and rent, among others.Another aspect of the tax plan will give further protection to the lower and middle classes, Montero said. The 13% sales tax under which the country currently operates would be changed to a value added tax (IVA); the significance is that the IVA would tax nearly all goods and services, still at 13%, rather than just the 15 services and limited number of goods that are currently covered, she added.However, certain services that the government deems vital would be protected, she said. For example, water usage up to 40 cubic meters would be untaxed, as well as electricity usage up to 280 kilowatts. Currently, electricity is taxed after 150 kilowatts. Professional services, such as doctor’s visits and private schooling, would also be excluded, she said.CORPORATIONS would see changes similar to those of individuals. For example, if a company has various economic activities, Montero explained, they now declare each activity separately and pay taxes on each separately. The new system would unite all the declarations into one, for more efficient and transparent taxation, she said. The tax plan proposes a general tax rate of 30% on corporations.However, according to Salto, under the current tax plan draft, if the taxes the government collects from both foreign and national individuals and corporations grow at a rate higher than that of the gross domestic product, then the 30% rate would be lowered by 1% each year after until it is at 25% in 2010, where it would stay.Because World Trade Organization (WTO) income-tax exemptions for companies in Costa Rica’s free zones are scheduled to expire in 2009, the corporate rates would apply to those enterprises after that date.“THIS tax project cannot go forward, however, without fortification (of tax authorities),” said Montero. To that end, the plan creates a new government entity called the National Tax Administration, which would unite existing tax enforcement agencies and give then more autonomy, as well as enforcement power. For example, fines for not paying taxes would double, Montero said.The tax reform plan was originally proposed by a group of former Finance Ministers in early 2002 as a means to update tax laws and provide the central government with more funds. For more than three years, the plan has struggled under assaults and challenges from opponents.The bill is moving forward thanks in part to the Legislative Assembly’s new “fast-track” procedure, a measure recently designed and approved with the tax plan in mind to allow a quicker legislative process for certain bills. Even after the approval of the procedure, controversy continued regarding whether or not the tax plan was eligible for the speedy process; changes to the text were made in committee so it would qualify (TT, May 27).LEGISLATORS are now working their way, in special sessions devoted to the tax plan, through more than 1,000 proposed reforms to the bill. Many of these motions were filed by Libertarian Movement Party legislators, who have long opposed the tax reform, as a successful tactic to stall the bill.Though the commission that studied the bill dismissed most of the motions, Libertarians have been able to reintroduce them, Franklin Carvajal, advisor to Assembly President Gerardo Gonzalez, told The Tico Times.Another tactic the Libertarians and other opponents have used to stall the bill is not attending sessions. If fewer than 38 legislators are present, then the assembly does not have quorum and cannot make progress on the hundreds of motions still encumbering the tax plan’s progress.THE tax plan quagmire has Carvajal, and others, concerned.“There are other important bills that need to be attended to as well,” Carvajal said. “Election reforms have to be ready for October, and there are many other things paralyzed.”President Abel Pacheco, for example, has conditioned sending the Central American Free-Trade Agreement with the United States (CAFTA) to the Legislative assembly on the approval of the tax reforms, much to the dismay of much of the business community.An “optimistic calculation” would put the bill on the floor for first debate at the end of September or beginning of October, Carvajal said. It would then await approval, analysis by the Constitutional Chamber of the Supreme Court (Sala IV), and a second round of voting.As Carvajal explained it, the bill is very complex, and its future “much more complicated than originally thought.”(Tico Times reporter Rebecca Kimitch contributed to this report.)

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