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The free zone regime in Costa Rica with Laura  Pérez

by | Nov 11, 2023

Laura Pérez
Government Affairs & Free Trade Zone Manager
Arias Law Firm
laura.perez@ariaslaw.com

LATAM FDI: Today, we have Laura Perez with us. Laura is with a law firm that is very prominent in Latin America called Arias Law. I will let Laura tell us a little bit about herself and the company she represents before we begin our discussion of the free trade zone regime in Costa Rica. Laura, hi, how are you today?

Laura Pérez: Hi, Steve. I’m very well. Thank you very much for inviting me to talk about this topic. I work at the law firm Arias. As you said, I’ve been in charge of the special tax regimes and government affairs consulting area for more than eight years and have worked in the foreign direct investment world for over fifteen years. I’m more than happy to be here and answer any questions that you may have.

LATAM FDI: That means you have a very comprehensive knowledge of the free trade zone regime in Costa Rica. Would that be correct?

Laura Pérez: That is correct, Steve, yes.

LATAM FDI: Well, let’s start out with something very general. Why is Costa Rica a good place for foreign direct investors to set up shop? And what’s the value proposition that the country offers to these companies?

Laura Pérez: Sure. Steve. Yes. Costa Rica has been a magnet attracting foreign direct investment since the late eighties and early nineties. That’s because the country has a value proposition that has always circled around four main topics. Number one is definitely human talent. Companies find it easy to do business with Costa Ricans, and the professionals and technical teams that they have found in the country are very good. That’s the reason why they continue to stay and reinvest in Costa Rica. So, human talent is number one. The second thing will be the democratic stability that Costa Rica has. You know that we have many political issues throughout the Central American region and Latin America. Costa Rica has always been far away from that. The company is and has been a very stable democracy. That is something that is also very attractive. The third thing I would say is definitely the location. Eighty to ninety percent of foreign direct investment in Costa Rica comes from the United States and Canada. So, location and nearshoring are very important from business and logistics perspectives. Connectivity with the US from Costa Rica is really good, as well.

And the fourth thing definitely will be the free trade regime in Costa Rica. We will talk a little bit more about that. It is a special tax regime. That’s also something important. In most recent years, I will say that other sorts of external political and environmental matters also contribute to strengthening Costa Rica’s position as an attractor of foreign direct investment. Definitely, the tension between the United States and China and having more nearshoring and friendshoring is something important. Also, the pandemic triggered problems with the logistics and supply chain. This is also pushing more companies toward nearshoring friendshoring. Also, things like climate change, such as wildfires and floods, have an influence. Companies are looking for second and third locations to have redundancy. So that’s also important. I would say another thing that is external to Costa Rica but that has also strengthened Costa Rica’s position is the labor pool problem that the United States seems to have. Right? Companies sometimes want to grow but can’t find the right people because there’s not enough talent pool or it’s very expensive. I will say those initial four traditional human talent, democracy, location, and free trade regime in Costa Rica were the initial ones that still stand.

LATAM FDI: You mentioned the free trade zone regime in Costa Rica that’s been very successful over the last thirty or so years. Can you tell us what free trade zones in Costa Rica are? What are the benefits, and what kind of companies can apply to be in them?

Laura Pérez: Sure, Steve. The free trade zone regime in Costa Rica is a special tax regime that the Costa Rican government grants to companies willing to commit to certain levels of employment and investment and operate in certain specific strategic sectors if they want to operate inside the Greater Metro Area. I will go into that shortly. There are distinct categories that the companies can go into the free trade zone regime in Costa Rica. Still, manufacturing companies are the most popular ones, which add up to almost 90% of the cluster. They are more on electronics, medical devices, and services. Before, it was very popular to have Costa Rican services such as call centers, shared services, and back offices. That was like in the early 2000s, but now we have more sophisticated services like software development, and we are starting to see some AI and things like that. So, services and manufacturing are definitely the strongest ones. Also, in recent years, the government has made some changes and some amendments to the law to attract this type of project and others to less developed areas outside the Greater Metro Area. We have special incentives that are more flexible if you want to go outside the Greater Metro Area.

And we have included additional sectors, for example, like hospitals and specialized clinics and things like that. It’s been changing very recently because of that. Regarding benefits, the free trade zone regime in Costa Rica is a special tax regime that grants either a full tax, basically a full tax holiday for services companies in which you have a 0% income tax rate, or for manufacturing, we have lower rates. If you are operating inside the Greater Metro Area, which is basically a 6% income tax rate compared to the regular rate. That’s a significant break because the regular tax rate can go up to 30%; again, for services, it is 0%. If you go with manufacturing outside the Greater Metro Area, then you also get a 0% income tax rate. This depends on the investment you make and other things, but in general, you get that income tax benefit. In addition to that, you also get full exoneration of import and re-export taxes. You do not pay real estate transfer tax; you do not pay municipal tax. You’re exonerated from remittance payments, which is very important if your headquarters are elsewhere outside Costa Rica. Also, you do not pay local VAT tax.

And all the imports you do specifically for manufacturing raw materials are also exonerated from the payment of taxes. Those are the main benefits of the free trade zone regime in Costa Rica.

LATAM FDI: You mentioned several times the terms “inside the Greater Metropolitan Area ” and “Outside the Greater Metropolitan Area.” For those listeners who might not know what that refers to, can you explain those terms?

Laura Pérez: Sure. Absolutely. Costa Rica is divided into these two big areas. The Greater Metro Area is this place in the center of the country where we have the four biggest cities. It’s where almost 70% of the population live. Everything outside that north, south, east, and west is called outside the Greater Metro

Area. The government has divided free trade zones in these two big areas so they could provide better incentives for outside the Greater Metro Area so they can attract investments there. So that’s the reason why this is divided. That’s the difference between the Greater Metro Area and outside.

LATAM FDI: Okay, thank you for clearing that up. Is there a difference in the incentives and requirements available to manufacturers on the one hand and providers of services on the other?

Laura Pérez: Yes. So basically, what happens is that we need to go back to inside and outside the Greater Metro Area. That will be the first important thing. So, if you’re inside the Greater Metro Area for both services and manufacturing, the investment requirement is $150,000. Outside the Greater Metro

The area for both services and manufacturing the amount is $100,000. There’s also an option that is called outside of Free Trade Zone Park, which is not common. I’m not going to talk a lot about that, but if companies are interested in that, investments for that are a bit higher. But let’s stay with, let’s say, the regular projects. There’s also another category that is called megaproject. The investment requirement for a megaproject is $10 million. There’s a difference between, let’s say, these regular projects of $150,000 and the megaproject, and that is that for the regular projects, you need to invest that money in fixed assets. You need to invest that money and maintain those $10 million for megaprojects. Another difference is that for regular projects, you have three years to comply with that investment. And for megaprojects under the free trade zone regime in Costa Rica, you have up to eight years to comply with that investment.

And also, in addition to, let’s say, the investment, there are also various times of exoneration. So, for example, if you’re a services or manufacturing company inside the Greater Metro Area, you get a 0% income tax rate if you’re a service entity. If you’re manufacturing, you get a lower income tax rate, which is 6%. And if you’re a megaproject, then you get 0% inside and outside. The benefits’ length and period change depending on the size and location of your investment under the free trade zone regime in Costa Rica.

LATAM FDI: Okay. There’s one other phrase I’ve heard you mention before that I think is very important to bring up in the context of what you just said. Can you explain what reclocking is? I’ve heard you mention that a few times.

Laura Pérez: It is possible for companies to continue to reinvest, basically reclock how you’re saying the benefits. There’s a provision in the law, which is discretionary, that allows the government to basically renew and reclock your benefits from scratch. Suppose you are willing to make a significant additional investment before your initial term of exonerations comes up, which could be six years, eight years, or twelve years, depending on the category that you’re in. You can do that in that case, and your benefits start from scratch. That’s why we’ve had companies operating since the late eighties that have maintained their zero income tax rate since then and have been operating for almost 40 years under this free zone regime in Costa Rica. So, reclocking and continuing with your initial income tax rate is possible.

LATAM FDI: When a company applies for free trade zone regime treatment and is up and running, what kind of time frame is there to put everything in place so that companies can be ready to start producing?

Laura Pérez: We must differentiate between services and manufacturing because we have two processes to follow. The first is the regulatory process to get your free trade zone approval, which usually takes between four to six months. And then we have the construction aspect of it that also varies depending on if you are services or manufacturing and the complexity of your project. This can take from between six to 18 months. So usually, what we tell companies is that for services operations, it will take you up to six months. For manufacturing operations, actual construction is the one issue that guides your installation timeline. It could be up to 18 months or even more if it’s a very sophisticated construction that you have to do. Basically, how the process works is that in the first month, you need to incorporate your legal entity, prepare the environmental filings, and work on the free trade zone application. Then, it goes through an approval process within the Free Trade Zone authority that goes, and you need to get signatures from different legal departments, the Ministry of Foreign Trade, and even the President of the Republic. The process of getting those signatures is the one that takes two to three months.

In the end, you get your approval, which is basically an executive agreement from the government and a special resolution from Customs, which allows you to import and export tax-exempt. That happens for both services and manufacturing under the free trade zone regime in Costa Rica.

LATAM FDI: Once you’re up and running and in your free trade zone regime program, are there any things that happen on a continuing basis? For instance, are there any kind of audits that people should be aware of?

Laura Pérez: Yes. Under the free trade zone regime in Costa Rica, companies are subject to all, let’s say, regular obligations, just as any other company, but aside, let’s say, from those regular tax filings and et cetera. There are a couple of things. One is an annual operations report, which needs to be submitted, the latest in April, which is sort of a summary of what you did last year and a lot of financial information that is particular to free trade zones. Also, there are two types of audits. The first one is, let’s call it, the regular audits for free trade zones, which are very focused and asset-controlled. I will go into detail about that. And there’s a second type of audit called the expenses audit. The second audit process basically reviews that the expenses that are being exonerated are directly linked to the activities approved under the free trade zone regime in Costa Rica. I would say that asset management under the free trade zone regime is the number one thing companies need to be careful with because the government is basically granting you incentives. So, you buy goods that are exempted assets for you to perform specific activities. That’s why they track assets very closely.

So, assets need to be tagged and controlled. If you take them in and out of the facility, there are specific processes for that. If assets are outside the facility because they’re in an employee’s home, there are specific processes for that on a work-from-home system. So, I will say that taking care of asset control is very important from the beginning. Those will be the two additional things you need to have for tax-free treatment: the annual operations report and complying with these two audits.

LATAM FDI: Well, another thing I think is important to consider, given that multinational companies often make changes, is what kind of things happen in a merger and acquisition transaction scenario with respect to the foreign trade zone regime in Costa Rica?

Laura Pérez: Yes, that’s a very good question. The free trade zone regulation is very specific and strict regarding M & A transactions. First, you must know that companies operating in Costa Rica that already are subject to income tax and that already pay taxes cannot go into the free trade zone. There’s no viable way. The law doesn’t have anything around that. There’s a specific prohibition in the law to do that. So that’s one thing. If the merging companies are operating under the free trade zone in Costa Rica, then that’s different. You have two options. You can either notify Procomer in advance and comply with the 20 P, which is basically the reclocking we discussed. You can also inform Procomer, the free trade zone administrator, after completing the merger. The difference between doing that, let’s say in advance or later, is that if you do it in advance and you follow the 20-based rule of reinvestment. The benefits that prevail are the benefits of the company that has the longest exoneration period. If you don’t do that and you do the merger and tell the free trade administrator after you have done the merger, basically, they will merge both commitments of investment and employment. The prevailing benefits are the ones of the company with the shortest exoneration period ahead. So, there’s a significant difference regarding that and a very big prohibition of companies that cannot go into the free trade zone if they are already subject to income tax.

LATAM FDI: You mentioned Procomer, and they’re the administrator of the free trade regime in Costa Rica. Is there anything that’s important that you can say something about them for the listeners to understand who they are and what their role is as well?

Laura Pérez:  Procomer is the free trade zone administration. Authority over the free zone regime in Costa Rica is actually exercised by many institutions. Again, Procomer is the administrator of the Free trade zone. Then you have the Ministry of Foreign Trade, which is actually authority number one. And you also have the Ministry of Finance, which is authority number two of the free trade zone. Regarding the Ministry of Finance the Customs Authority is part of the Ministry of Finance. It also plays a key role. So those are the two free trade zone authorities, those two ministries, and Procomer is the administrator.

LATAM FDI: Well, that seems to be a lot of information we’ve covered in a very short time. What we find is the case with these podcasts is that they generate questions in our listener’s minds, and we like to put them in a position to be able to get follow through on their questions. How could somebody contact you if they have a question they’d like to ask or maybe even engage your services at the Arias Law Firm?

Laura Pérez: Absolutely, Steve. They can definitely reach out to me. My email is  laura.perez@ariaslaw.com. Also, listeners can visit our website, which is www.ariaslaw.com, and you can find my information there. We will be more than happy to answer any questions and have a courtesy meeting with anyone who is interested in the free trade zone regime in Costa Rica.

LATAM FDI: Okay, Laura, what we’ll do is we’ll have a link to your website, and we’ll put your email address on the webpage where the podcast sits. In addition to that, if you have a LinkedIn profile, would it be okay to include that as well?

Laura Pérez: Absolutely. I will send you that as well. Yes

LATAM FDI: Well, thank you very much for being with us. It was very informative. I wish you a wonderful day. We’re on the cusp of the weekend, the day that we’re recording this, so have a good weekend.

Laura Pérez: Thank you, Steve, for the invitation, and I really hope you have a really good weekend as well. Thank you.

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