OPERATING UNDER FREE ZONE STATUS IN COSTA RICA

This report includes selected sections of the applicable law and its regulations, as well as practical issues addressed with top officials from the government and semi-government entities mainly involved in the treatment of this regime as well as input and real life conclusions from foreign companies currently doing business under the Free Zone structure in Costa Rica.

I. Free Trade Zones
The Free Trade Zone Regime (FTZR) is defined in Costa Rica as a set of incentives and benefits granted by the country to companies making new investments and complying with local requirements and obligations. This regime is governed by the Free Zone Regime Law, Number 7210, and its regulations.

This is not a permanent regime. Limitations have been established regarding the length of the benefits and incentives it grants, as they are intended to promote new investments and not to provide certain companies with unlimited commercial advantages over time.

Companies that benefit from this regime establish their operations on Industrial Parks, which are specific areas, strictly destined to this kind of industries and companies. These areas are called Free Trade Zones (FTZ).

An authorization may be obtained for a company to establish its operations outside a Free Trade Zone, but these are exceptional cases, requiring greater investments and a more extensive approval process.

FTZs are supervised by a government entity called Promotora del Comercio Exterior (PROCOMER), which is a part of the Ministry of Foreign Trade of Costa Rica.

II. Beneficiaries of the Free Trade Zone Regime

Companies that may benefit from this regime must be included in one out of several categories, namely handling, processing, manufacture, production, repair and maintenance of goods and the provision of services for exportation or re-exportation.

A minimum initial investment of US$150,000.00 in fixed assets is required. This investment must be completed within the first two years after the date the regime was granted.

Companies establishing operations on Free Trade Zones are required to comply with strict environmental policies, both local and international, and should be able to provide sufficient documentation proving their compliance with such.

III. Permitted activities

Corporate entities covered by this regime are permitted to carry out the activities normally performed by companies in their line of business as well as certain specific activities that are indicated in the law as permitted (this list of permitted activities does not have the purpose of limiting the scope of the activities allowed for the companies, which as said above, include, even if not listed, the activities normally performed in their line of business).

With specific reference to companies providing services, Section 18 b) of the Free Zone Regime Law allows for such companies to “Provide and retain services to and from the companies of the Free Zones and the individuals or legal entities domiciled abroad, such as: financing, insurance, shipment, forwarding, documentation, supply, lease of buildings, maintenance and any others that may be convenient for the development of the Free Zone or the regime in general”.

Other types of companies, such as manufacturers, processors and producers may “Introduce, store, exhibit, pack, unpack, manufacture, process, produce, mount, assemble, refine, distill, purify, mix, transform and handle all kinds of merchandises, products, raw materials, components, packing material, containers and other commercial items for exportation or re-exportation, except for those which importation, commercialization or manufacture is prohibited by the laws of the Republic, with the reservations made in Articles 22 and 24 of this Law.”.

Outsourcing of services is possible under the law, and is a practice already successfully performed by other companies currently under local FTZR. There is no limitation for such outsourcing as long as the services are given to foreign companies or entities locally established in free trade zones; if services will be given to companies operating locally out of a free zone, only a maximum of 50% of total sales can come from such clients. In a similar manner, local product sales for non-service companies may only represent 25% of the total sales by the company.

IV. Legal duties of FTZ companies

Very methodical and formal bookkeeping is of true relevance regarding FTZ companies. Based on the fact that these entities are granted special privileges and incentives, the law requires strict bookkeeping and maintenance of records, especially when registering goods and services that are obtained by them free of taxes.

Several reports are periodically required by authorities, regarding a variety of matters related to the operation of the company and the tax-free goods and services they acquire. Extensive verifications of these and similar matters must be allowed by the beneficiary of the regime in order to comply with its duties. Other reports that FTZ companies are legally bound to provide are the ones pertaining to number of employees, compliance with investment levels and national added value.

The signing of a contract with PROCOMER is also a legal duty. This contract reflects the commitments acquired by the company, and the specific regulations set forth for each particular case by the executive resolution granting the regime.

Specific duties are always included in the executive resolution that grants the regime. These vary from company to company, and are usually the product of the negotiations that are established between the company and PROCOMER prior to the granting of the regime.

V. Tax related Incentives

Special incentives are granted to companies operating under this regime. Most of the benefits are tax exemptions, but other types of incentives are also available to FTZ companies, as explained further in this document.

All incentives related to taxes are set forth in the FTZR law, and they are not subject to negotiation between the company and PROCOMER, as creation and/or elimination of taxes can only be made, in Costa Rica, by the means of a law.

The tax-related incentives, as established in article 20 of the FTZR Law are the following:

a) Exemption from payment of all taxes and consular duties on imports of raw materials, manufactured or semi-manufactured products, components and parts, packaging and container materials, as well as other merchandises and goods required for their operation.

The company must preferably acquire local products, if it is deemed that they provide the same conditions with regard to price, quality and timely delivery required for them.

b) Exemption from all taxes and consular duties affecting the imports of machinery and equipment, as well as those of their accessories and spare parts, and on imports of motor vehicles required for their operation, production, management and transportation.

Vehicles are required to have special characteristics, mainly, to be suitable for work purposes or transportation of 15 or more passengers. After five years, the vehicle may be sold locally without further tax payments. The tax exemption does not apply to personal use vehicles of owners, employees or managers of FTZ companies.

c) Exemption from all taxes and consular duties on imports of fuels, oils and lubricants required for the operation of these companies. Such exemption shall be granted only when these goods are not produced within the country with the quality, in the quantity and within the time necessary. The Ministry of Economy, Industry and Commerce shall grant prior authorization for such importation and issue a reasoned resolution on the matter within no more than fifteen business days.

ch) Exemption from all taxes associated with the exportation or re-exportation of products. This exemption shall be granted for re-exportation of production machinery and equipment from the Zones that have entered under this Law.

d) Exemption for a term of ten years counted from the start of the operations from payment of taxes on capital and net assets, from payment of property taxes and from payment of the tax on transfer of real estate.

There is some discussion regarding this matter. International Commerce negotiations have affected the interpretation of this particular benefit. Sections VIII and IX of this report will cover this issue with more detail.

e) Exemption from sales and excise taxes on purchases of goods and services.

f) Exemption from all taxes on remittances abroad.

g) Exemption from all taxes on profits, as well as any other which taxable base is determined on the basis of the gross or net profits, the dividends paid to shareholders or income or sales, in accordance with the following differences:

1. For companies located in zones of “higher relative development”, the exemption shall be one hundred percent (100%) for a term of up to eight years and fifty percent (50%) for the following four years.

2. For companies located in zones of “lower relative development”, the exemption shall be one hundred percent (100%) for a term of up to twelve years and fifty percent (50%) for the following six years.

For these purposes, there is a distinction between zones in the country based on statistics collected by the Ministry of National Planning and Economic Policy

h) Exemption from all municipal taxes and licenses for a term of ten years. The companies to which this article refers shall pay the municipal services they use. In this case, the respective Municipal Government can charge up to two times the rates established by law for those services. Notwithstanding the above, the companies established in Free Zones shall be authorized to retain those services from any individual or legal entity.

i) Exemption from all taxes on imports and exports of commercial or industrial samples, upon prior authorization of Corporación (PROCOMER).
j) The export processing companies, beneficiaries of the Free Zone Regime, which after four years of operating under such Regime do reinvest in the country can receive an additional exemption from payment of income taxes, in accordance with the following parameters:

1. If the re-investment exceeds twenty-five percent (25%) of the original investment, the exemption shall be for one additional year.

2. If the re-investment exceeds fifty percent (50%) of the original investment, the exemption shall be for two additional years.

3. If the re-investment exceeds seventy-five percent (75%) of the original investment, the exemption shall be for three additional years.

4. If the re-investment exceeds one hundred percent (100%) of the original investment, the exemption shall be for four additional years.

The additional exemptions shall be seventy-five percent (75%) of the income tax payable. Any additional exemptions herein granted shall apply after the eighth year of operations, without prejudice of the exemptions corresponding to the final term of four years originally granted, which shall apply once the additional exemption period hereby regulated expires. In the case of companies installed in zones of “lower relative development”, the additional exemption granted shall enter into force after their twelfth year of operations, without prejudice of the exemptions corresponding to the final period of six years originally granted, which shall enter into force after expiration of this period of the additional exemption. The reinvestment that results in the additional exemption shall be completed after the fourth year and before the start of the eighth year of operations under the Free Zone Regime.

The additional exemption can only be granted to companies which original initial investment in fixed assets has amounted to at least two million U.S. dollars (US$2,000,000.00).

VI Other incentives

The following additional incentives are also available:

a) Assistance for training, coordinated with Instituto Nacional de Aprendizaje (INA) (National Learning Institute), for the employees and persons wanting to become employees of the companies established in the Free Zones.

For this purpose, the Ministry of Labor and Social Security and the companies shall subscribe an agreement, in which the terms and conditions of the training should take place. A special subsidy may be paid to persons enrolled in these activities and that must be hired later on by the company.

b) Assistance in the selection of the personnel to be employed by the company. The selection activities are to be coordinated with different local authorities.

c) Assistance and advice on their requirements and needs before government and private institutions, which is a service provided by PROCOMER as well as Corporación Costarricense de Iniciativas para el Desarrollo (CINDE).

d) Assistance concerning housing and educational needs for their employees as well as their families, by means of coordination with the respective public institutions.

Notwithstanding what has been said in the second paragraph of this Section, in the cases of several companies that have selected Costa Rica as the jurisdiction to establish their projects, and mainly based on the size of the operation, special treatment by the government in fields such as telecommunications, energy and road access may be obtained and should be part of the negotiation.

VII. Future changes on the regime and the WTO

In view of current WTO policies and agreements, an issue of frequent concern by companies evaluating operations under FTZR is what will happen with tax exemptions from year 2007 on. On such year, tax exemptions on exports of goods, considered by WTO as subsidies, must be eliminated following Costa Rican commitments with that entity. As a matter of fact, the regime was supposed to end by 2003, but an exception was made and it will take place on the year 2007 instead.

Notwithstanding the above, there is no such obligation to eliminate incentives granted to companies providing services. It has been widely accepted that there are no commitments by the Costa Rican Government to reduce or eliminate incentives for service companies and the official standing on this matter is that the regime for services will continue with few or no changes at all.

This special regime is not bound to disappear as a direct effect of the Doha Qatar negotiations. The FTZ are based on local laws that establish many other incentives. The terms of the Agreement on Subsidies and Compensatory Measures signed at Doha, extended the deadline for the elimination of the income tax exemption from 2003 to 2007, plus a two-year period for progressive elimination. As a result, the regimes will maintain the same benefits as they have now until 2007, and on that year, only companies manufacturing and/or exporting goods (not companies providing services) will be affected by the elimination of the income tax exemption regime. All other incentives for FTZ companies will be maintained.

IX. Local tax reforms and FTZs

There are currently discussions at Congress on a national tax reform. Such discussions are at this point at a preliminary stage and as of now it does not seem that changes to be made (if any) would be incompatible with the free zone current legal treatment and tax incentives.

©2003 Henry Lang, Lang & Asociados. All rights reserved.