Corporate Equity and Tax Evasion in Costa Rica

Publications that promote investments in Costa Rica are quick to point out advantages of offshore incorporation, but often fail to bring up the issue of double taxation. The same proverbial elephant is often hiding in the room when news reports in both English and Spanish discuss the problem of tax evasion in Costa Rica.

Indeed corporate taxation in Costa Rica is riddled with so many legal loop holes for avoiding taxes that it is a wonder the country is able to fund anything let alone the recent increases for public security, education and the public sector pay raises. For example, revenue coming into a Costa Rican corporate bank account from international sources is tax free. Capital gains generally get a free lunch as well, so there is reason to shout, “pura vida” after a shell corporation earns a tidy profit from a real estate deal.

Companies like Intel and Proctor and Gamble negotiated tax free deals when they setup in Costa Rica. The situation is particularly lucrative for these U.S. corporations because they also legally avoid or defer taxes in the United States for revenue attributed to foreign operations.

The double taxation issue is obvious for anyone who has operated a business in the United States, but comes more slowly to the uninitiated who incorporate in Costa Rica. Simply put it is not kosher to use the corporate checkbook to pay personal expenses or withdrawal money without doing some tax accounting.  Doing so in the United States will quickly attract the attention of the I.R.S., but in Costa Rica no one seems to care, including the tax authorities.

Tax law in Costa Rica requires a 15 percent withholding tax on corporate dividends, which means $15 needs to be sent to the tax office for every $85 withdrawn by the owners of the company. This tax is due immediately, and not at the end of the year.

Some avoid the dividend tax by taking the money as a payment made from the corporation in exchange for services. This also reduces net income for corporate income tax, but the recipient still has an obligation to pay personal income tax on the money received. Such payments are also expenses for the corporation, and Costa Rican tax law requires the total amounts to be summarized on an annual tax form. In the United States the I.R.S. would also hold these kinds of payments to requirements for self-employment tax, and in principle Costa Rica has the same rules. The methods legal and otherwise to dodge paying tax on distributions from corporate equity in Costa Rica are more numerous than can be described here.

Attempts by the Chinchilla administration to change the tax law would seek to close the loop holes. Much of what happens in the legislative debate is not publicly known until laws are passed and published. At least we know there is political will to end the free lunch for multinationals in the trade zone. A tax on worldwide income at a rate of 15 percent has also been proposed to eliminate the special deal Ticos and corporations registered here get on foreign sourced income.

The new $240 flat tax on corporations may have some long term implications for stepping up enforcement. While the government will collect some revenue from the measure there is some advantage for purging defunct entities may eliminate camouflage from the tax evasion landscape. Those who use corporations in Costa Rica for asset protection instead of income can certainly afford the extra fees.

Another theory is that once the courts approve the authority to collect this kind of tax obligation it will be easier to pass extra requirements. Requiring licensed accountants to certify annual financial statements for corporations, including those for corporate equity would be a good start. Few professionals are likely to help owners hide missing equity when their license to earn a living is on the line.

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