New Income Tax Law proposed in Costa Rica

On May 18, 2023 the Executive Branch submitted five bills to the Legislative Assembly related to fiscal and public finance matters. The aforementioned bills are:

  1. File 23759: Modification of the Tax Code regarding joint and several liability in tax matters.
  2. File 23760: New Income Tax Law.
  3. File 23761: New Vehicle Property Tax Law.
  4. File 23762: Strengthening of the Management of Public Finances.
  5. File 23763: Revision of some incentives and tax benefits in force (among others, related to VAT).

In this opportunity we share with you a description of file 27360 which intends to repeal the current Income Tax Law and replace it with a new one. In the words of the Government, the proposed amendment will promote the progressiveness, fairness and equity of income taxation, while complying with international standards that, among others, would allow the country to leave the list of non-cooperating countries of the European Union.

The proposed Law intends to divide our Income Tax into three taxes: (i) Personal Income Tax, (ii) Corporate Income Tax, and (iii) Non-Resident Income Tax.

At first sight, we would take as a parameter the Spanish model, whose tax is also divided into these three types of schedules, and with which, we would migrate to a new paradigm where it is presumed, for example, that all the income of a legal entity must be taxed under a single schedule at the rate of 30%, instead of the current regime, where certain income produced or generated by legal entities may enjoy a reduced rate (Chapter XI of the current Income Tax Law).

The following is a brief summary of each of the three tax schedules.

Personal Income Tax (IRPF)

The IRPF will be a personal and direct tax that taxes the income of individuals according to their nature, as opposed to what happens today, when the same person may be subject to different taxes on the income he/she obtains.

This tax would replace the income tax on salaries and pensions, and would globalize it with the tax on the profits of professionals and the capital income and capital gains provided for in the current Chapter XI.

In summary, this tax will be levied on income from Costa Rican sources derived from personal dependent work, retirements and the exercise of economic activities, both of a business or professional nature; as well as passive income generated in the national territory as well as outside of it (extended territoriality), including capital income and capital gains derived from goods or rights owned by the taxpayer.

Regarding labor income that will be considered of Costa Rican source, it would be those that come from work performed in the national territory or in favor of an employer that develops an economic activity in the country. Likewise, only pensions coming from any Costa Rican regime would be taxable, excluding pensions coming from other countries.

Only individuals who have their tax residence in Costa Rica will be taxpayers of this tax, which will generally be linked to the person being present in the national territory for a period of 183 days or more during the fiscal year, regardless of their nationality, or having their family nucleus or interest located in the country. Likewise, it is foreseen that Costa Ricans who become tax residents in non-cooperating countries or jurisdictions will not lose their tax residence in the country.

As for the tax period, it will correspond to a calendar year, that is, from January 1 to December 31 of each year, unless the taxpayer dies, in which case, the period will end at that time.

The great novelty of this schedule would be the way in which the tax is determined, since the intention is to reach a globality, which would imply an integration of all taxable income in a single taxable base, unlike what is currently the case. 

However, it is foreseen that given the effect this could have on passive income (e.g. interest), which, in general, can move from one place to another more easily (capital), as well as to avoid excessive taxation, it is proposed to separate the taxable base of individuals into two:

– General base, in which income from dependent personal work, retirements and pensions, income derived from the development of an economic activity and income from real estate capital will be integrated; and

– Special taxable income, which includes income from movable capital and capital gains.

In order to determine the general taxable income, taxpayers must compute their total income according to its nature and from this they may deduct those costs and expenses established by law. The net income resulting from these operations will be integrated and compensated to form the general taxable income.

Unfortunately, the Bill does not advance towards the recognition of certain normal expenses of individuals, such as mortgage interest, medical and educational expenses, etc., even though this proposal would be the appropriate means to include them, since in the end these incentives help the formality of the service providers, both for income tax and VAT purposes.

Subsequently, in order to guarantee the progressiveness of the system, this general taxable base will be adjusted by the vital minimum. This is set at the sum of ₡10,104,000.00 per year (approximately US$ 19,200), which would eliminate the distortion currently existing between salaried employees and independent professionals, whose exempt base is considerably lower than that of the former.

Once the general taxable base has been adjusted, a progressive rate ranging from 10% to 30% will be applied to this item, depending on the bracket in which the individual’s taxable income falls.

The calculation of the special taxable base will be made by integrating the income from movable capital, on which certain expenses can be deducted, and the capital gains and losses of the period.

A proportional tax rate of 15% will be applied to this special taxable base, from which the special tax liability will be obtained.

Finally, the total tax liability will be the result of adding the general tax liability and the special tax liability. This amount may be reduced by the amount corresponding to partial payments and withholdings, as well as by the deduction for international double taxation (income tax paid abroad, but only on capital income and capital gains), in order to arrive at the tax debt to be paid by taxpayers.

In terms of the management of this tax, the duty of taxpaying individuals to file an annual return with the Tax Administration and to make the payment of the tax debt in the same act is extended, being only exempted those taxpayers who receive exclusively earned income that does not exceed the annual exempt amount mentioned above.

In the same way, the Tax Administration is allowed to make previous tax assessments and to order the refund ex officio in those cases in which the payments on account exceed the full tax liability.

Finally, the simplified taxation regime is maintained as an alternative for those small taxpayers, both individuals and legal entities, who, complying with certain income requirements, may apply a series of simplified rules for the fulfillment of their tax obligations.  

Tax on Income of Legal Entities (IRPJ)

The IRPJ would replace the current Profits Tax and would be a tax levied on income obtained by legal entities and other entities, with or without legal personality, that are resident for tax purposes in Costa Rica. The concept of inactive company is changed to that of patrimonial company, prevailing the obligation to file an annual informative declaration of its patrimonial situation.

It is noteworthy that the concept of tax residency for corporations is to be broadened, since currently only those legal entities incorporated in Costa Rica are residents, but the bill also intends to broaden it to those legal entities incorporated abroad that have their effective place of management in Costa Rica or that have their registered office in the country.

The tax would be levied on Costa Rican source income received by legal entities, including those derived from the exercise of an economic activity, as well as capital income and capital gains. In the latter cases, since they are passive incomes, it is promoted that offshore income is also subject to taxation.

Income from exchange differences arising from foreign currency transactions is also considered as taxable. It is specified that all outstanding balances for unpaid debts or for income not received at the closing of the tax period, will be valued at the reference exchange rate for sale or for purchase, as the case may be, set by the Central Bank of Costa Rica at that date and will be computable for purposes of determining the tax.

The project specifies that it will be understood that Costa Rican source income are those generated in the national territory, coming from services rendered, goods located or capital used. Likewise, those coming from export operations of goods and services carried out from the national territory.

Regarding capital income and capital gains, those that come from assets whose ownership corresponds to the taxpayer, regardless of the place where they were produced and regardless of the residence of the payer, would be considered of Costa Rican source, that is, apparently, any income generated inside or outside Costa Rica, coming from assets or rights owned by the taxpayer.

This would imply in practice to change the current system where certain legal entities may become taxpayers of Chapter XI for certain passive income they obtain, in other words, under this project, all the net income of a legal entity would pay at 30%.

In fact, unlike the Personal Income Tax, for this tax a single taxable base is established, which is the result of integrating and compensating all the income obtained by the taxpayer entity during the tax period, reduced by the deductible costs and expenses, provided that these are useful, necessary and pertinent for the generation of taxable income with this tax.

In order to calculate the full tax liability, a single proportional rate of 30% will be applied to the taxable base, regardless of the gross income of the legal entity during the tax year, thus standardizing the treatment for this type of taxpayers and eliminating the reduced rates for certain legal entities.

As in the IRPF, for the determination of the net tax liability, the deduction of partial payments and withholdings made throughout the period will be allowed, as well as the tax paid abroad but only for capital income or capital gains in an amount not greater than the tax payable in Costa Rica, in order to mitigate the effect of international legal double taxation.

Regarding the tax period, it is maintained according to the calendar year.

Special tax assessment provisions are foreseen for certain economic activities, such as agriculture and construction. Likewise, the special regime for the case of business reorganizations is maintained, very similar to the current one.

In addition, the preferential tax treatment for micro and small companies registered before the Ministry of Economy, Industry and Commerce (MEIC) or before the Ministry of Agriculture and Livestock (MAG) is maintained, so that in their first year of operations they do not pay any tax and in the following two years it is 25% and 50% of the tax quota, respectively.

This tax also includes the provisions that regulate certain aspects of international taxation that have been incorporated into the national regulations, such as the provisions on transfer pricing, the non-deductibility of expenses incurred in operations with non-cooperating jurisdictions and those derived from hybrid asymmetries, as well as the limitation on the deductibility of interest (thin capitalization).

Non-Resident Income Tax (IRNR)

This bill would replace the current tax on remittances abroad and would generally tax Costa Rican source income obtained by taxpayers who qualify as tax non-residents in Costa Rica, also including the form of taxation of permanent establishments of non-domiciled persons.

Within the income considered as Costa Rican source income, it includes income derived from dependent personal work and pensions, in addition to income derived from the exercise of economic activities, with or without the intermediation of a permanent establishment, capital income and capital gains and losses.

As indicated, a differentiated treatment is included for non-residents who operate in the country through a permanent establishment, that is, through a fixed place of business in which they develop, totally or partially, their economic activity, who will be taxed under the rules of income tax for individuals or legal entities, as appropriate.

On the other hand, for those non-residents who operate in the country without a permanent establishment and obtain income from the development of an economic activity in the country, as well as any other income of Costa Rican source that is taxed with this tax, a single proportional rate of 15% is established, which will be applied on the gross amount corresponding to the respective income of national source, thus eliminating the diversity of rates that currently exists, simplifying the tax system.

As regards tax compliance, it is provided, as a general rule, that income received by non-resident taxpayers will be subject to withholding at source, except in those cases in which this is not possible, in which case it is established their duty to file a tax return and pay the respective tax, for example, for capital gains.