Lawmakers debate tax on free-zone businesses

October 6, 2011

After last week’s legislative decision to put the latest tax reform proposal on a fast track, criticism has begun to surface about several aspects of the bill. To meet a December target date for a comprehensive agreement, lawmakers will face three months of tough negotiations. 

Although the tax reform bill is the result of a deal struck by the administration of Laura Chinchilla and opposition lawmakers from the Citizen Action Party (PAC), a proposal to levy taxes on businesses operating in Costa Rica’s free zones (zonas francas) could threaten that agreement. 

The most contentious issue is a plan by PAC lawmakers to levy a 15 percent tax on companies that set up in free zones beginning in 2015. Those companies could also be subject to an additional municipal property tax. 

Free zones were established so that businesses of a certain size pay no taxes. More than half of all Costa Rica’s exports are generated in free-zone businesses.

The fiscal reform bill would modify the most recent free-zone reform, passed in December 2009, which offered better tax incentives for businesses located outside the Central Valley. One of the many benefits of the reform was that more companies could pay significantly lower income taxes during their first six years of operation. 

Francisco Chacón, a legislator from the National Liberation Party (PLN), criticized the PAC proposal last week. Chacón, a former trade vice minister and husband of current Trade Minister Anabel González, warned that new taxes could hurt foreign investment. 

“We have to compete with a number of countries that in most cases offer better tax incentives than we do for foreign investment in free zones. We cannot afford to cause unilateral damage to the current situation,” Chacón said. “Free zones play a very important role as incentives for strategic companies and sectors to invest in the country.” 

PAC legislator Gustavo Arias disagrees with PLN’s vision for the tax-free zones: “This reform will not affect companies already in Costa Rica or coming here in the next three years. Most importantly, it’s a matter of fiscal responsibility, and we believe it will not affect the positive environment that encourages foreign investment.” 

According to Arias, revenue from new taxes on companies would be invested in education to help prepare Costa Rica’s labor force to meet the growing demand for better workers. “We need to be able to prepare our human capital to meet the needs of those companies, and in order to do that we need to tax them,” he said. 

The dispute over taxing companies in free zones could jeopardize important political advances made recently on fiscal reform, an important breakthrough for lawmakers who have been at odds all year. PLN legislators will now set out to convince their legislative colleagues from PAC to scrap the new corporate tax plans. 

Jorge Brenes, president of the Costa Rican Association of Free-Zone Businesses, also criticized the plan. “We are sending the wrong message to the world. How can it be possible to change a reform that was approved less than two years ago? We are not demonstrating that we have an environment of legal stability,” he said. 

If the tax bill makes it through the assembly, Brenes said two outcomes are possible: Costa Rica’s foreign investment would significantly drop, and companies would move to countries like Panama and the Dominican Republic, which offer better incentives. Another threat is that companies currently established in Costa Rica would leave. 

“I don’t understand why in 2009, 15 PAC lawmakers extended incentives to free-zone businesses, and today PAC is backtracking on those promises. We can’t change the rules every two years and tell companies that had been planning to relocate here that everything just changed,” Brenes said. 

Brenes credits investment in free zones with boosting Costa Rica’s economy in recent years. “We have increased our portfolio of exports from four or five traditional products to more than 100, particularly in the fields of technology and medical supplies,” he said. “Places like the provinces of Limón, Cartago and Alajuela have benefited recently from the previous reform. That boost could come to an end.”

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