San José, Costa Rica, since 1956

Tax Reform Bill Close to Vote

The day is finally here – or near, at least. After years of debate, thousands of motions and changes, false starts, and being proclaimed “dead” on various occasions, the Permanent Fiscal Reform Package, which would overhaul the country’s tax system with significant changes for Costa Ricans and foreigners alike, is hours away from a vote in the Legislative Assembly. Legislators were discussing the reforms at press time, with some asserting a vote in first debate would take place last night.

An overall lack of clarity continues to characterize the plan’s passage through the assembly. Yesterday, doubt surrounded not only when a vote would take place and how many legislators would support the plan, but also how many votes are necessary for approval and how much the plan has changed from the original version proposed in 2002.

Legislators consulted by The Tico Times concurred the bulk of the plan has remained unchanged. Now, as then, the reforms would alter the way income tax is calculated, replace the sales tax with a broader valueadded tax, and give the government more power to enforce tax laws – generating additional revenue of approximately ¢190 billion ($380 million) per year, according to Social Christian Unity Party (PUSC) legislator Mario Redondo.

However, some of the modifications the assembly has made would have a significant impact on foreigners or Costa Ricans with assets outside the country. The assembly has backed off from the original plan’s proposal of a worldwide system, in which companies and individuals would be taxed on all foreign-earned income as well as income generated here. According to tax attorney Diego Salto, a partner at the corporate law firm Asesores Fiscales Corporativos, today’s tax plan creates an “imperfect worldwide system,” since only income generated here or brought into the country will be taxed, with certain exceptions.

“The worldwide income system (in the current draft) is totally different from the ones most (other) countries have,” Salto told The Tico Times yesterday, adding that the reforms proposed in 2002 drew heavily on European taxation models. “These exemptions have been put in by the assembly as a result of political negotiation with different civil sectors.”

Carlos Camacho, president of tax firm Grupo Camacho, said the tax plan “makes the magical concept of traditionally viewing Costa Rica as a fiscal paradise disappear,” though he emphasized the reforms would not have a negative effect on foreigners who have previously paid taxes in their countries of origin on their Costa Rican-generated income, assuming Costa Rica has tax treaties with those countries to prevent double taxation.

Legislators who support the reform have spent the past two weeks lobbying for lastminute support. At press time, few had speculated publicly about the likely outcome of a vote, though Redondo told The Tico Times yesterday afternoon he expected a vote to take place at approximately 8:30 p.m. with at least 30 votes in favor.

Federico Malavassi of the Libertarian Movement Party – arguably the staunchest opponent of the tax plan – told The Tico Times “you’re going to see a fight.” Libertarian legislators have successfully stalled the plan for years by filing thousands of motions and constitutional objections to slow its path through the assembly. (The party won one victory this week when its motion to reduce taxes on online gambling call centers, also called sporstbooks, was approved).

While the daily La República reported Thursday that disagreement continues over whether the tax plan requires a simple majority of 29 votes, or a two-thirds majority of 38 votes to pass – Redondo said the assembly has already resolved this question and 29 votes are all that’s needed.

Proponents of the plan often admit it may not be perfect, but say some form of tax reform is desperately needed.

“Costa Rica needs a tax plan…Maybe this isn’t the best, but overall I give it a good grade,” said Marta Zamora of the Citizen Action Party (PAC), who supports the plan.

Reforms, Then and Now

The controversial Permanent Fiscal Reform Package was first designed by a group of former finance ministers as a means to provide much-needed revenue to the tax-strapped central government. In presenting the plan to the assembly, then-Finance Minister Walter Bolaños told legislators Costa Rica was “paying for developed world benefits” in health care and education “with taxation levels of delayed countries” (TT, April 4, 2003).

Salto echoed those words this week, saying the tax plan represents an effort to “move to a system that most of the developed countries and developing countries of a certain level have,” he said.

The assembly’s failure to approve it has been ever-present in the public statements of President Abel Pacheco, who said Tuesday he will not submit any legislation that interferes with the tax plan to the assembly until the reforms are approved (see separate story).

With such a long legislative history, one might wonder how the current draft differs from the original. Apparently, legislators themselves wondered the same thing.When The Tico Times contacted Finance Ministry tax analyst Dario Amador Tuesday for comment on how the draft has changed, he said he was on his way to the assembly to answer that same question.

Salto explained that under the current plan, any tax resident – defined, for individuals, as anyone who spends more than 183 days per year in Costa Rica or whose primary economic activity takes place here – will pay taxes on any income generated in Costa Rica (as now); income generated elsewhere but brought into the country; or interest on income generated here but invested elsewhere.

“The residency status of a person has no relationship with his (tax) status,” Salto added. “A Colombian can be illegally in the country, but at the same time be a legal taxpayer.”

This differs from the tax system in the United States, for example, which is based on nationality, not residential criteria.

Because of this, tax specialist Camacho said the Finance Ministry’s agenda, if the tax plan is approved, will include signing tax treaties with the United States and other major economic partners of Costa Rica, to ensure those countries’ residents living here are not taxed twice.

The corporate tax rate would be 30% – a significant increase from the 18% rate proposed in the original plan (TT,April 16, 2004).

This rate would decrease in 1% increments until reaching 25% in 2010 if the government’s

tax revenue grows at a rate higher than that of the gross domestic product, which Salto said is likely based on current tax data.

A 13% value-added tax (VAT) on almost all goods and services would replace the current 13% sales tax on a limited number of these, according to Camacho. Capital gains, untaxed under the existing system, would be subject to a 10% tax, an important difference for foreign investors.

The plan would also create a new Tax Administration, combining the powers that today are divided among the Direct Tax Administration of the Finance Ministry, Customs and the Fiscal Police, Redondo said.

If approved in first debate, the bill would still require an evaluation by the Constitutional Chamber of the Supreme Court (Sala IV), which could take up to 30 days; a second vote; Pacheco’s signature; and publication in the official government daily La Gaceta to become law.

Even after that point, income-tax changes would not take effect until Jan. 1, 2007, according to Camacho. Now, the Costa Rican tax year runs Oct. 1-Sept. 31, and the assembly can’t modify yearly taxes during that period; also, the tax plan would change the tax year to Jan. 1-Dec. 31. Camacho said a short tax period, following the existing laws, would take place from Oct. 1-Dec. 31 if the tax plan is approved. The new system would then begin on Jan. 1 of the following year.

Camacho added that since the valueadded tax is monthly, not yearly, that part of the tax plan would take effect two months following its publication in La Gaceta.


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