New tax reform legislation in Costa Rica was passed 4 December 2018. The tax reform law includes significant income tax law changes such as the introduction of rules on the taxation of capital gains and interest expense deduction limitations, as well as rules addressing hybrid mismatch arrangements and anti-tax haven provisions. The tax reform legislation also modifies the prior sales tax system and the transformation into a new value added tax (VAT) regime—an indirect tax system with broader application.
Changes under the tax reform law generally have an effective date of 1 July 2019.
Overview of tax reform
Costa Rica’s territorial regime remains unchanged. Only Costa Rican-source income is subject to income tax. A new definition of “permanent establishment” is generally aligned with international standards:
A permanent establishment is defined as a “fixed place of business”; construction and services activities will be deemed to constitute a permanent establishment if the activities continue for 183 days in the aggregate over a period of 12 months. A dependent agent may also create a permanent establishment.
Passive income of movable and real estate capital
The new passive income regime imposes tax on capital gains at a rate of 15%. Taxpayers can deduct a fixed expense equal to 15% of the gross income from capital gains related to the sale of real estate. Taxpayers with one or more employees may elect to be taxed under the ordinary income tax rates (generally 30%).
The new law introduces the non-deduction of expenses paid to entities that are residents in a “tax haven” jurisdiction, unless the taxpayer can prove that the transaction “effectively took place” according to the following standards:
New limitation on interest deduction
Interest deductions are limited to 20% of EBITDA* and excess interest expense can be carried forward. The limitation will start to apply “progressively” beginning in 2020.
Payments with regard to hybrid instruments or made to a hybrid entity will be treated as not deductible in Costa Rica.
Compensation of operating losses
As a general rule, net operating losses (NOLs) can be carried forward for three years, and carried forward for five years with respect to agricultural activities.
In general, withholding tax on interest paid to Costa Rican residents is imposed at a rate of 15% (up from the previous 8% withholding tax rate). Withholding tax on payments for professional services to non-residents will be 25% (up from the previous rate of 15%).
Dividend distributions will be subject to a 15% withholding tax unless the beneficiary is: (1) a Costa Rican SA or SRL; (2) domiciled in Costa Rica; (3) one that engages in an economic activity; and (4) one that is subject to corporate tax. In practice, the tax reform measures render as inefficient those Costa Rican holding companies that do not engage on another activity.
Individual income tax
New income tax rates for individuals are as follows:
The new VAT regime replaces Costa Rica’s sales tax regime. The prior sales tax regime only applied to the sales of goods, with credit provided for taxes paid on the sale of goods or services used in the production, marketing or distribution of certain activities. The new VAT system is much broader.
The rates of VAT are:
The VAT measures also provide:
The tax reform law provides a tax amnesty period that expires 5 March 2019. During the amnesty period, taxpayers may pay certain taxes without paying interest and with certain reductions in fines and penalties. The percentage reduction of penalties is reduced for each passing month during the amnesty period.
For more information, contact a tax professional with KPMG’s Latin America Markets practice or with the KPMG member firm in Costa Rica:
Alfonso A-Pallete | +1 (305) 913 2789 | firstname.lastname@example.org
Sergio Garcia | +506 2201-4292 | email@example.com
Alvaro Castro | +506 2201-4189 | firstname.lastname@example.org