Trade Zone Showdown Looms
A subtle battle over ideals will reach its tipping point in the Legislative Assembly in the next few weeks, each side armed with the same economic figures as their ammunition; the only difference being their interpretation of the numbers.
The battle almost will be an afterthought of the fight to pass the controversial Central American Free-Trade Agreement with the United States (CAFTA), with lower stakes and dampened – but still sore – emotions.
A reform of the free-trade zone law has been drafted and circulated throughout the halls of the legislature during the past couple of weeks. With a deadline from the World Trade Organization (WTO) looming, along with legal uncertainty for foreign manufacturers, interest groups and the Foreign Trade Ministry (COMEX) are trying urgently to push the bill through.
“The multinationals (corporations) that analyze destinations to install their operations … require clear regulations that define the panorama over a long period of time,” said Gabriela Llobet, general director of the Costa Rican Investment Board (CINDE). “In those moments, Costa Rica can’t clarify these conditions, so (the companies) can’t finalize their analysis and make decisions.”
But legislators opposed to the bill say they won’t be bullied into passing it in its current form because of some perceived urgency. There are holes in the draft legislation, left open for interpretation, which could turn into loopholes, according to some lawmakers.
The vagaries need clarification, Citizen Action Party (PAC) Legislator Sergio Alfaro said.
“This bill has a hidden program, from my point of view,” Alfaro said. “The hidden part is that the government is modifying all of the income taxes for the biggest companies.
“This proposal is presented to reform the law to sustain it…But when you look at the fine print, the big businesses can migrate from the old income taxes into the new.”
The draft’s supporters obviously deny such accusations, saying there is no such agenda – though some do admit to generalities in the wording, which they say could be clarified at a future time.
Backers of the bill seem to have the upper hand, as of now, and few foresee any legislative bouts in the epic style of CAFTA, which took years in the legislature and a national referendum to finally be ratified. But Alfaro said the bill will face the same scrutiny as CAFTA, at least from the ranks of the PAC, which holds 16 of the 57 seats in the Legislative Assembly.
A Long Time Coming
The reform of free-trade zones has been a long time coming.
While there has been a lot of gab, no action has been taken by the WTO to reform the damaging agricultural subsidies and export practices in the United States and Europe. However, the WTO did pass a resolution in 1995 that banned subsidizing manufacturing based on export levels – something which Costa Rica currently does to help boost and diversify its export base.
Under current Costa Rican law, companies exporting more than 75 percent of their product receive massive tax breaks for years.
According to the latest statistics at the Costa Rican Association of Free Zone Businesses (AZOFRAS), 52 percent of the country’s exports are generated in free-trade zones and exported to more than 100 countries. (A whopping 20 percent is made up of computer processors made by Intel.)
At the time of its ruling, the WTO ruling exempted developing countries –including Costa Rica– from its ban on subsidized manufacturing until 2003, later until 2009, and now to the end of 2015.
The reform is intended to only affect the manufacturing sector, leaving the recently booming service sector alone.
According to Timothy Scott, the director of AZOFRAS, while only a draft of the reforms should to be presented to the WTO by 2010, the extended deadline doesn’t solve the problem of trying to ease corporate uncertainty as to what the rules will be.
“For us, and for the companies, it’s not too soon,” Scott said, “because the companies need some kind of legal certainty, a long-term plan to be able to fall back on.” Countries like Malaysia, Singapore and Ireland have all made the necessary changes, he said.
After years of record-high foreign investment, many officials are predicting a steep slide for the upcoming year as a result of a combination of the global recession and an uncertain future. So, after 2008 raked in $2 billion, the Central Bank of Costa Rica is predicting a 33 percent drop, to $1.33 billion, through this year.
“We’re in a difficult position, because an investor could come and ask what will be the case after 2015, and we can’t tell them,” said Scott.
The proposed law would remove all references to benefits based on export numbers, establishing the benefits due to manufacturers on location and the size of the investment. Companies will be rewarded for establishing businesses in “less developed” areas, and for larger investments.
Based on how a company molds its operations, it could pay anywhere from zero to 15 percent corporate income tax for up to 18 years (see sidebar on Page 11 for specifics). But the law doesn’t specifically state what happens after the 18 years expire.
The Foreign Trade Ministry’s director of investment and cooperation, Marvin Rodríguez, said the companies would be incorporated into the regular tax scheme. But Alfaro, a lawyer, isn’t convinced.
“In this system, you can’t imagine,” he said. “It has to be written down.”
Alfaro is also worried that, with the way the draft is written, companies having already invested $2 million in the country – which he claims is about 75 percent of big taxpayers – could easily wiggle their way into paying less by using previous investments to “recycle” their tax credits.
Scott said that this was not a possibility and companies only would be able to use new investments. The draft’s current language simply says “initial investments,” and does not state clearly whether earlier investments could be applied toward receiving tax breaks.
The law also changes the formula companies use to deduct employee training, which would allow companies to save much more and hold on to the credit for years. Some feel the system is biased toward giant corporations, which can afford the big investments, and it leaves medium-to-small businesses with no similar benefit system.
“This country has always been like that, to help the bigger businesses,” said Anselmo Sánchez, president of the Small and Medium Businesses Association. “They almost never consult with small businesses.”
Rodríguez said the law could later be modified to lower the corporate income taxes across the board, which would help smaller Costa Rican businesses, too.
The End Game
The debate is likely to crystallize in the next few weeks, according to those interviewed for this article, with the end result in favor of the new draft, unless the PAC can gather more resistance outside of its own ranks.
Supporters seem to not only be holding the better cards but, with the support of companies like Procter & Gamble, Intel, Coca-Cola and Firestone, they have more chips on the table as well.
According to AZOFRAS, of the 247 companies now operating in the country’s freetrade zones, almost 98 percent of employees are Ticos. The 53,000 jobs provided are usually high-paying, technical positions.
In 2007, free-trade zones paid employees approximately $500 million (¢229,292 millones), and they paid over $100 million (¢59,081 millones) to Social Security, according to the Foreign Trade Ministry.
And for every dollar Costa Rica gives free-trade zones in tax incentives, it receives more than $6 in return, said Scott. But Alfaro sees the situation differently.
“We know and we agree that direct international investment is a tool of development, and we agree with that vision,” he said. “But the companies came to Costa Rica because of the environment they found here.”
He listed personal security, the historically stable democracy, the healthy and educated population as other incentives the country offers.
“They find, not just a business place, they find a lot of ambiance, but ambiance the country paid for…And it’s their responsibility to pay taxes to sustain that…Because if they want to keep operating here, they need an educated, healthy population.”
Free Trade Zones
A designated area where normal trade barriers, like tariffs and quotas, are eliminated in hopes of attracting foreign investment. Other incentives sometimes also are provided, such as tax breaks, government assistance in construction and relaxed labor requirements.
Current Export-Based Law:
A minimum investment – of $150,000.
– Must export a minimum of 75 percent of product.
– Pay zero corporate income taxes for the first eight years and 50 percent of the national tax for the following four years.
– Companies would be incorporated into the national corporate tax scheme after their incentives run out.
– A “Special Commission” made up of the foreign trade minister, the finance minister and the planning minister will have say over which companies fit into the “strategic sector for the development of the country,” which carries extra bonuses. Marvin Rodríguez, the Foreign Trade Ministry’s director of investment and cooperation, defined this as projects classified as offering a higher level of social development to the country.
– Minimum investment remains the same.
– Companies based in well-developed areas will pay a 5 percent tax on facilities and corporate income taxes for the first eight years and 15 percent for the following four years.
– Companies based in less-developed areas will pay a 5 percent tax on facilities and corporate income taxes for the first 12 years and 15 percent for the following six years.
– Companies that invest $10 million and employ 100 workers will maintain the same tax incentives that are given in the current law.
All changes must take place before Jan. 1, 2016, according to the World Trade Organization.
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