INSIGHT: Costa Rica Introduces a New Value-Added Tax Regime

A significant tax reform has been enacted in Costa Rica. One of the key parts of the law is the replacement of the current sales tax system with a value-added tax (VAT) system.

Title I of the Law of the Strengthening of Public Finances, No. 9635 introduces the VAT, and was published on December 4, 2018. Subsequently, Article 1 of the General Sales Tax Law, No. 6826 (GSTL) has been completely modified.

The GSTL, published in 1982, taxed added value on the sale of goods and the provision of a few services, which is outdated in terms of a service-based national economy. According to data from the Central Bank, the relative importance of this segment went from representing 64% of total production in 2012, to 68% in 2017.

A 13% VAT generally applies to the sale or import of goods and to the provision of services, including intangibles. The VAT shall be declared within the first 15 days of the following month through form D-104.

Although the law introducing the VAT (VATL) constantly refers to the regulations for its due application, the regulations were only issued by the Executive Branch on June 7, 2019, which has hindered its implementation in some areas.

The VAT enters into force on July 1, 2019. There are a number of important issues to consider concerning its application, as discussed below.

Reduced Rates and Staggered Effective Dates

One particular feature of the new regulations, effective July 1, 2019, is the reduced rates and staggered effective dates. These special rules are analyzed in detail when examining the VAT implementation for a specific business sector, since, in some cases as discussed below, the principle of neutrality pursued by the VAT is infringed.

Although it may have been initially believed that the political negotiation carried out during the legislative process was aimed at gaining reduced rates and staggered effective dates for certain business sectors, given how the tax credit was implemented, in some cases the end result could still be negative. This is because the regulations restrict full credit application derived from taxpayer purchases, consequently implying that the latter will transfer that cost either to the profit margin or to the final price.

In summary, the reduced rates are:

• 1% on basic food basket, products, machinery, inputs related to the production of agricultural goods and veterinary products, agricultural and fishing inputs;
• 2% on medicines, raw materials, supplies, among others, private education services, personal insurance premiums, sales to government education-related institutions;
• 4% of the 10% on international transportation services and 4% regarding health services, unless paid using a debit or credit card.

The rates fall into two groups:

• rates granting a full credit right; and
• those allowing limited credit up to the amount of the rate applicable to a specific industry.

From the list of transactions subject to reduced rates, only the operations subject to the 1% reduced rate allow full credit.

In other words, even though the VAT is paid at the standard rate of 13% via the added value chain, the taxpayer can fully credit the total VAT paid. This protects the principle of neutrality and prevents price increases of products or services. However, the rest of the reduced rates grant restricted credit rights. The threshold would correspond exactly to the rate amount applicable to each operation. In this way, the taxpayer can deduct the excess VAT incurred, not creditable, as a cost or expense.

Similarly, although Article 8 of the VATL provides for a series of exempt operations, the VAT incurred by those taxpayers in the exempted activity does not grant a tax credit right. Hence, in these cases, the VAT incurred by the taxpayers will be transferred to the cost or price of their operations.

The previous situation is the same for the provision of services when VAT applies in a staggered manner:

• 0% in Year 1;
• 4% in Year 2;
• 8% in Year 3;
• 13% in Year 4.

Some of the services affected by the staggered effective dates are:

• construction and related services;
• management of recycling products; and
• tourism services duly registered with the Costa Rican Tourism Institute.

In the year when these services are exempt from VAT, in theory, the taxpayer will not be entitled to tax credit for the purchases of goods and services made for their provision. In turn, in the following years, the taxpayer may apply as credit up to the reduced rate amount.

Exemptions Scheme

Article 8 of the VATL provides an exhaustive list of tax exemptions, including the following:

• exports and related operations;
• sales to beneficiaries of the Free Trade Zone regime;
• credits, invoice discounting, financial leases and operational leases with a financial purpose;
• rentals of properties for housing with a value below 1.5 base salary. Likewise, the rentals of properties to micro-businesses and small businesses below the above-mentioned amount will be exempt;
• water and energy supply below the threshold described in the regulations; and
• condominium fees.

From the entry into force of the VATL, one of the major questions is whether the exemptions to the general sales tax (GST), approved through various special laws for companies, institutions, and government bodies, are still valid.

Article 63 of the Code of Tax Rules and Procedures provides that tax benefits do not extend to taxes established after their creation. In this sense, the official position issued by the Ministry of Treasury has been that with the application of the VATL, the GST was repealed and a new VAT came into effect, therefore tax benefits related to that first tax have expired.

However, we consider that such tax has not been repealed, but that with the introduction of VATL the legal system has only been updated.

Critical elements of GST and VAT, such as the standard rate of 13% and the tax creditor (central government) overlap, giving an extension to the taxpayer and the taxable event, in order to adjust tax to the national context.

The elimination of tax benefits to concession contracts could be very burdensome for the state. Based on that, the recently published regulations introduced in Section II of Law No. 9635 of the continuation of the exemption in those contracts which bid documentation acknowledges the GST benefit. In this way, although the Ministry of Treasury considers the tax benefit as eliminated, it is left unchanged for these contract types.

On the other hand, Section XIV of Law No. 9635 is based on the elimination of exemptions related to this tax, granted for “public institutions,” giving them a peremptory term. However, the VATL or its regulations omit a definition for public institutions, so the scope of applicability of this transitory is not clear.

Tax Immunity Principle

The regulations provide that, in accordance with the Principle of Budgetary Transparency, and in order to improve VAT’s traceability, the VATL removed tax immunity for the central government and branches of the Republic, keeping it only for the Costa Rican Social Security Fund (CRSF) and municipalities. Article 9 specifically considers such entities as not subject to the tax in terms of the goods and services they sell, lend or purchase.

However, we consider that this assessment of the regulation is technically incorrect, for two reasons.

First, there is no reference in the VATL to the elimination of tax immunity. Section XIV referred to in the previous paragraphs only mentions the elimination of exemptions for “public institutions,” which is technically different.

The only reference to tax immunity is made by Article 21 of the VATL, which states that “taxpayers who have carried out transactions with state institutions, by virtue of tax immunity, will be entitled to tax credit,” without the VATL pointing exclusively to the CRSF and municipalities as entities holding such tax immunity.

It is also based on an insurmountable inaccuracy. Legally, tax immunity refers to the elimination of tax liability as in the legal-tax relationship, the central government cannot assume the roles of tax creditor and taxpayer at the same time (Article 49 of the Code of Tax Rules and Procedures). In this way, the collection of VAT would not be technically appropriate for the various bodies that are part of the executive branch (tax creditor through to the Ministry of Treasury).

Therefore, affirming that tax immunity is upheld only for the CRSF and municipalities is incorrect since both are autonomous institutions that, strictly speaking, are not part of the executive branch, the principle of tax immunity does not apply to them.

As these institutions are covered by tax immunity, the only way to safeguard the tax credit right for taxpayers is to make transactions with those institutions.

Securing Cross-Border Services

The regulations confirm the reverted VAT figure, whereby when a taxpayer imports services or intangibles, the tax shall be auto-reimbursed. The taxpayer will issue an electronic invoice to support the tax debit, which, if applicable, may be acknowledged as a tax credit.

As indicated above, in the cases when the applicable VAT rate is lower than the general rate, full credit of the tax applicable to the import of services shall not proceed, which will result in an increase in costs. The regulations provide that the VAT payment does not apply to the import of services that are exempt in the national market. However, it does not refer to the fact that in the event the taxpayer is subject to a reduced rate, they could benefit from this rate when importing the service.

Electronic Invoicing

Since 2016, Costa Rica has been implementing an electronic invoicing model with the purpose of controlling tax evasion. To date, this regulation only applies to a few business sectors; thus, in addition to the VAT implementation, taxpayers must implement the changes introduced to the electronic invoicing model, known as version 4.3, for credit acknowledgment.

Tax on Services Provided through Platforms

Costa Rica is committed to implementing the Organization for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) plan, as well as the OECD’s recommendations for Addressing the Tax Challenges of the Digital Economy.

The consumption of digital platforms will be taxed. Payment processors will collect VAT from credit and debit cards. The regulatory norm has indicated that these provisions will not apply until the tax authority defines the codes of activities for which it will apply.

Planning Points

• New VAT taxpayers should register with the tax administration and adjust their business models to comply with formal obligations, including the new requirements for the electronic invoicing model.
• To register with the tax administration, the Ministry of Treasury has enabled a Virtual Tax Administration (ATV).
• The taxpayer should create a user account with his or her ID number or DIMEX (residency identification issued by the Migratory Authorities) . If the taxpayer operates the business through a company, the ATV will connect the company to the legal representative’s personal account.
• Once the user is created, the ATV provides an online form to register as a taxpayer. It is important to consider that if the company is represented by a foreign representative whose residence is abroad, the registration procedure should be filed before the tax administration in order to obtain a Tax Identification Number (NITE). This tax ID will allow the representative to access the ATV and file tax returns on behalf of the company.
• Business sectors subject to reduced rates should validate their business models in order to determine any possible consequences. Similarly, if both a reduced rate and a general rate are applicable, the tax credit on common purchases should be determined based on specific proportionality rules.
• Business with the state should be reviewed in order to determine the enforceability of the special regulations described in Section II of the Regulations.
• The Attorney General’s office still has to clarify the situation in relation to upholding the exemptions granted by special laws prior to the VAT approval.
• VAT implications are not identical for all sectors. Therefore, a case study of their application should be performed.

Anayansi Mora and Cristina Sansonetti are Tax Partners at Consortium Legal, Costa Rica.