In an end-of-the-year agreement, Costa Rican lawmakers approved a new free trade zone reform that offers tax incentives for businesses electing to set up operations in regions outside the Central Valley, among a host of other reforms.
Currently, most of the 247 companies in Costa Rica’s international free trade zones – known as zonas francas in Spanish – are in the San José area and in Heredia and Alajuela, north and northwest of the capital city, respectively.
In a free trade zone, businesses normally can import and export goods without barriers such as quotas or tariffs. Countries use them to attract foreign investment, which economists say is critical for developing countries like Costa Rica.
“The approved reform establishes a series of attractive fiscal benefits that keep Costa Rica competitive as an investment destination, versus countries that fight among themselves to attract foreign direct investment,” said Vanessa Gibson, director of the Costa Rican Investment Board (CINDE).
The reform was a topic of contention among lawmakers, particularly for members of the left-leaning Citizen Action Party (PAC) who had lobbied for alterations to the previous law for at least eight months.
At the top of a series of fiscal benefits, businesses that choose to operate in free zones in the Caribbean province of Limón, near the central Pacific port of Puntarenas and the northern Pacific province of Guanacaste will pay less in income taxes during their first six years of operations. The percentage of income taxes paid will be determined by the degree of investment made by the company or the number of people employed at the locations.
Companies with operations in San José and the greater metropolitan area will pay an income tax of 6 percent in the first six years and 15 percent the following four years. Businesses in the greater metropolitan area can also receive an income tax break if they meet minimum requirements for investment and employees.
“In the end, all sides were pleased with the outcome of the reform,” said Sergio Alfaro, a PAC legislator, “Companies will benefit from the improved tax measures, and foreign investment will be enticed to locate in areas other than San José.”
Much of the urgency to reform the law originated from pressure applied by foreign manufacturing companies operating in Costa Rica and the Foreign Trade Ministry (COMEX), as well as potential investors.
Their push to alter the law stemmed from the looming termination of a Word Trade Organization (WTO) provision that allowed developing countries to exempt manufacturing companies that exported 75 percent or more of their production from the payment of income tax.
The WTO has announced that at the end of 2015, this allowance will be pulled from Costa Rica. Given that understanding, all parties involved in free trade zones, including potential investors, were vying for a hurried reform that would allow free-trade operators to capitalize on the standing tax break before it is lifted in 2016.
“To adapt the free trade zone region to the requirements of the WTO was necessary, not only to maintain investment, but also to promote local investment and attract new capital,” said Jorge Brenes, president of the Costa Rican Association of Free Zone Businesses (AZOFRAS). “The reform of this law is a great boost to the development of Costa Rica.”
The reform, which will be presented to the WTO for approval in early 2010, includes some crafty attempts at maneuvering to salvage some of the existing tax breaks.
Members of COMEX and trade organizations will create a board that serves to assign free trade businesses to a particular sector. Because the lifting of the tax break will only apply to the manufacturing sector, the assembled board will determine whether a company is deemed be either a manufacturing or a service business.
Given the board will be looking out for the best interests of Costa Rica, it seems likely they may attempt to tag more companies as “service” industries in order to retain the tax break.
Though it will be the WTO that ultimately determines the exact terms of the reformed free trade zone law in early 2010, the parties that have pushed for the reforms can rest easy over the holidays with the knowledge that the Legislative Assembly’s approval has ended the long-running debate.
At its conclusion, the reform includes something for everyone: some tax breaks may be salvaged in years to come, the law has been refined to appeal to foreign investors and rewards have been put in place for companies that invest in underdeveloped zones.
As Alfaro said, “In the end, almost everyone was satisfied with the reforms.”
According to the Foreign Trade Ministry, businesses in the free trade zones employ more than 53,000 workers and 10,000 indirect workers.
The 247 companies operating in free trade zones accounted for $4.98 billion in exports in 2008, which is more than 54 percent of total exports earned in Costa Rica.
Tico Times reporter Daniel Shea contributed to this report.