This past January 12th President Arias, the Minister of the Treasury, Jenny Philips, and the Minister of Foreign Trade, Marco Vinicio Ruiz signed the Law that reforms the Free Zone Regime.
This reform was essential for the sustainability of the Regime for manufacturing companies. As set forth in the Subvention and Compensatory Measures Agreement (SCMA) of the World Trade Organization (WTO), incentives and exemptions granted to manufacturing companies with the condition that their products are to be exported, are considered for all effects a subsidy to such products and therefore, discordant with the principles of free trade protected by the WTO. The Free Zone Law does effectively condition the incentives to the requirement that beneficiary companies export at least 75% of their production. This fact compels Costa Rica to modify the Regime specifically with respect to manufacturing companies. The term to eliminate such subsidies initially was to expire in 2003, but was extended to 2009. Subsequently, a new extension was granted with a 2015 deadline. The Costa Rican government considered it was fundamental to provide investors with a clear view of how Costa Rica would comply with WTO´s regulations, in order for them to factor in such scenario into their plans for establishing operations in the country, for their expansion plans, or for new investments.
The backbone of this reform consists of the creation of a new type of Free Zone Company for which the incentives are no longer linked to the requirement of exporting, but rather to belonging to a strategic sector, the definition of which will be assigned to a commission comprised of the Minister of Foreign Trade, the Minister of the Treasury and the Minister of Planning. To shed light on the work of such commission, the Law sets forth that a strategic sector should be consistent with the National Development Plan, as well as comply with certain characteristics such as generating high-quality employment, contributing to the modernization of the country’s productive system, the promotion of innovation and transfer of technology, among others. The commission will include two additional members from the private sector: a representative of the High-Technology Center and a representative of the productive sector elected among AZOFRAS, CINDE, CADEXCO and the Chamber of Industries.
An important clarification is that this reform does not affect Free Zone Service Companies -subsection c) of article 17-, since subsidies to services have not yet been regulated by the WTO. Neither does this reform affect Free Zone Manufacturing Companies –subsection a) of article 17- which are currently under the Free Trade Regime, since their incentives will continue until the expiration date of their operations agreement or until the term for Costa Rica to adjust to the WTO regulations expires; whichever comes first. These manufacturing companies also have the possibility of converting their regime to the new category, provided they fulfill the requirements to do so. If they do so, the will enjoy a new term of incentives as of such date.
Aside from the creation of this new category of Free Zone Company which incentives do not depend on the export condition, the main modifications to the Law are the following: With this reform, the concept of Zones of Lesser and Higher Relative Development used to grant different terms for the incentives, will give way to the concept of inside or outside the Enlarged Great Metropolitan Area (GAMA in Spanish) a territory which covers not only what is known as the Great Metropolitan Area, but also includes San Ramón, Palmares, Grecia, Naranjo and Valverde Vega. The reform contains a marked preference for companies which establish operations outside the GAMA. Free Zone companies under the new category that establish outside the GAMA will have a benefit of 0% income tax for a six-year period after which they will only pay 5% for another six years, and thereafter a final period of six years in which they will pay 15% income tax (current income tax for regular companies is 30%). On the other hand, the same type of company located inside the GAMA will need to pay 6% income tax during the first eight years and 15% during the remaining four years. Companies under this new category established outside the GAMA will require a minimum investment of only $100,000 if they choose to operate within an Industrial Park and only $500,000 if they settle outside a Park. In comparison, inside the GAMA, these companies must commit to an investment level of $500,000 inside a park and $2 million outside a park.
Moreover, if companies pertaining to this new category establish outside the GAMA, it will not be necessary for them to belong to a strategic sector in order to be eligible for the Free Zone Regime. Additionally, if such companies locate outside of the GAMA and also happen to pertain to a strategic sector, they will receive the benefit of 0% income tax benefit for the whole twelve-year period; provided only that they maintain a level of 100 or more employees, regardless of their investment level. For these same companies to obtain 0% income tax within the GAMA, they must invest a minimum of $10 million. Once the 0% exemption term has expired, companies established outside the GAMA may differ the corresponding income tax payment until a distribution of dividends is made or for a maximum period of 10 years. The differed tax payment will accrue interest in favor the tax authority calculated at a rate equal to the average of the six-month Basic Passive Rate (Tasa Básica Pasiva).
A very relevant aspect is that the reform eliminates the double taxation that used to exist on local sales. When a company made local sales, it was considered an import of product, which on one hand had to pay the applicable duties for the finished product including the value of raw material, but on the other hand, companies lost the proportional exemption for the raw material used to produce such article. In practice, with such system companies had to pay duties for those materials twice. The Law now allows local sales without losing exemptions on raw material, provided the final product pays the corresponding import duties.
With respect to production chains, the new law has important provisions. In the first place, non Free Zone companies may establish in an Industrial Park for supplying goods and services to Free Zone companies, without causing a reduction of benefits for the Industrial Park Developer. Secondly, if the proportion of the goods and services destined to Free Zone companies is 40% or more of their total sales, such companies are eligible to obtain the Free Zone Regime and enjoy all of its benefits.
In the next few days the Law will be published in the Official Gazette and it will consequently become effective. We applaud the fact that this law was supported by all political parties, with the sponsorship of the Executive Branch, therefore recognizing that Free Zones are a fundamental tool for the country’s development.
The law was supported by all political parties, with the sponsorship of the Executive Branch, therefore demonstrating Costa Rica´s commitment to Free Zones which have been a fundamental tool for the country’s development.
