A frequent rumor in Costa Rica is that Americans living here have trees that produce a limitless supply of dollars. From the Costa Rica point of view the income in dollars is not fully transparent, given that Costa Rica does not tax or require reporting of income earned abroad.
However, if the government of Luis Guillermo Solís gets it way, then the law will be amended to tax the worldwide income of all “tax residents” in Costa Rica. The proposal was announced on Monday morning by the Ministry of Finance, Fernando Rodriguez before a legislative committee formed to investigate the Panama Papers.
Designated Tax Residents
The new designation of tax resident would extend to companies and individuals that have economic activity in Costa Rica. In the case of individuals the category would apply to any person who spends more than 183 days out of the calendar year, within the national territory of Costa Rica. In effect the designation as tax resident would apply even to tourists who leave every 90 days to renew their visa.
It’s unclear how such non-residents could register to report and pay taxes on their worldwide income. However, a recent presidential decree required the Banco de Costa Rica (BCR) to open bank accounts for foreigners who sought accounts. Taken together the decree and tax proposal imply that the government is perusing a consistent social policy to identify and tax all foreigners living in Costa Rica, irrespective of residency status. Foreigners who are legal residents are also required to pay social security taxes and enroll in the national healthcare system.
Exemptions and Foreign Earned Income
The proposal includes a provision that would exempt income when taxes are paid abroad on the foreign income. However, the government has not provided specifics on how the measure would be applied. For example, currently Costa Rica exempts individuals from income tax when they earn less than the equivalent of $6,546 per year. In 2015, the combined individual exemption and standard deduction was $10,300. The difference of $3,754 could be subject to taxes in Costa Rica. The proposal is also silent on details, such as qualified distributions from Roth IRAs, which are normally tax free in the United States.
In particular, the proposed tax law would snare expats who work virtually from Costa Rica for U.S. companies and may claim the Foreign Earned Income Credit, applied on up to $100,800 annually for 2015. Since this income is exempt from federal income tax in the United States, it would be taxed fully in Costa Rica.
There is also the administrative cost of hiring an accountant in Costa Rica to compile and translate into Spanish the records of worldwide income. Some expats may feel unconformable providing their detailed financial records to a foreign entity.
The proposal to tax worldwide income was added to debate in a legislative committee that is seeking to fight financial fraud in Costa Rica. The government has also proposed creating a registry of otherwise anonymous beneficial owners of corporations. The combined effect of the law would make it difficult for corporations to shift revenue to offshore shell corporations in Panama and avoid taxes, claiming income from abroad. Outrage over the revelations of the Panama Papers and massive tax evasion has spurred debate. Increasingly Costa Rica has come under international pressure to raise taxes and reduce government budget deficits.