A fixer upper in tax rules for business might not be the best solution yet

May 17, 2016
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Imagine that mom, looking for a clever way to improve the family’s finances, comes up with a new rule: anybody in the house who wants to eat ice cream has to pay a license to do so. Dad has to pay, your 17-year-old sister Annie (who gulps the stuff like there’s no tomorrow) also has to pay, and you, 6-year-old Timmy who eats it rather occasionally, have to pay as well. You think the cost of this license for Annie, who arguably gets a lot more enjoyment (and gallons) out of it, might be higher. You may also imagine that Dad, a grown up with a paycheck at the end of the month and who could afford a higher fee, would also pay more. But mom says no: everybody pays the same. You are Timmy. How do you feel?

A similar situation happened with Costa Rica’s tax on corporations. Before it was suspended by the Sala IV last year, there was only one flavor: a flat yearly fee of ₡212,000 or roughly $400. It didn’t matter if you were Walmart or the tiny coffee shop on the corner owned by doña Marta, you all had to pay the same. Kind of like Timmy’s situation. While for a big corporation paying $400 per year might be less than the annual budget for sugar packets and paper cups at the coffee station, for doña Marta, trust me, it was a big deal.

Now legislators are trying to bring the tax back in a more palatable form.

In what some believe is an improved version, the latest corporate tax bill includes differentiated fees according to a company’s revenue:

  • For companies with yearly revenue of less than ₡51 million ($96,000): the tax would be ₡106,000 ($200)
  • Between ₡51 million ($96,000) and ₡119 million ($225,000): ₡127,000 ($240)
  • More than ₡119 million ($225,000): ₡212,000 ($400) (the amount originally proposed)

Can you see what they did here, though? Walmart still pays the same $400. But now doña Marta pays half. We are not even going to discuss the difference between payment capacity because that’s evident even to 6-year-old Timmy, but it does make you wonder what the rationale behind this new proposal was. Because in order to give small business a break, the best solution they could come up with was giving doña Marta a discount, effectively reducing total tax revenue compared to the initial version of the law.

However there might be business people that view this new tax as a license, or a right to operate, and since everybody gets the same right, it shouldn’t matter how much money you make with it. Except it does. Taxing is one of the few mechanisms societies and governments have to fight wealth inequality and although it’s seldom used for those purposes, this was a great opportunity at least not to contribute to it. Because let’s be honest: if you are of the many companies whose annual revenue is north of $225,000 you can afford to pay four or five times what doña Marta pays. In perspective, a yearly expense of $800 is not going to make that much of a dent in your profits, will it?

The proposed change to the law does improve on giving new and small businesses a break, but the magnitude of the difference in the fees in regards to income is still disproportionate, and it effectively diminishes tax revenue by leaving big companies with the initial amount. A tier pricing model in which bigger companies could make up for the discount given to small and medium-sized businesses, or SMEs, would have seemed like a more sensible solution, and it’s hard to imagine nobody thought of that.

Now there is a workaround that would enable a small company to avoid paying altogether: If you register your startup or SME with the Ministry of Economy (MEIC). This encourages new companies to join the formal economy and gives them the break they critically need at the first stages. The process, however, is not as hassle-free as you would want it to be, and because it is not widely known, many small companies don’t take advantage of this.

In the end, there’s nothing wrong with mom trying to get a few extra bucks in exchange for ice cream privileges, but if not done correctly, Timmy might either give up eating ice cream altogether, or worse, might sneak to the fridge at night, when mom is not watching.

Read more “Doing Business columns” here

Randall Trejos works as a business developer, helping startups and medium-sized companies grow. He’s the co-director of the Founder Institute in Costa Rica and a strategy consultant at Grupo Impulso. You can follow his blog La Catapulta or contact him through LinkedIn. Stay tuned for the next edition of “Doing Business,” published twice-monthly.

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