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Will investors leave Costa Rica?

October 13, 2011

A tax overhaul currently under discussion in the Legislative Assembly is becoming a thorn in the side of Costa Rican policymakers. 

Foreign investors say a legislative plan to tax free-zone companies would persuade businesses to take their investment abroad. Proponents of the plan, including lawmakers from the Citizen Action Party (PAC), President Laura Chinchilla and members of her Cabinet, say new taxes on free-zone companies are needed to fund government programs.

On Monday, the Costa Rican Investment Promotion Agency (CINDE) organized a conference with directors of companies operating in Costa Rica’s free zone, including Panduit and Intel. Company heads said they are concerned about the proposed legislation.

CINDE Executive Director Gabriela Llobet said that Costa Rica is sending a message of “legal instability” that may threaten foreign direct investment. 

“Pre-2010, Intel was considering Costa Rica for a large investment, and we chose to go abroad due to uncertain fiscal policies. It was a substantial economic loss for the country,” Intel Costa Rica General Manager Michael Forrest said. 

Under the current free-zone system, most companies pay no income taxes. The reform being considered by the lawmakers introduces two new taxes for companies entering free zones after 2015. The Finance Ministry would levy a 15 percent tax on companies that distribute their dividends outside Costa Rica. Multinationals that reinvest their profit in Costa Rica are exempted from the tax. 

The second change is a municipal property tax that would be levied on companies.

Lawmakers expect the reform to pass in the assembly by December.

William Ernest, general manager of Panduit, a U.S. fiber optics company based in Chicago, said adding more taxes to free-zone companies could be disastrous. “After a long selection process, Panduit was considering Costa Rica and Romania to locate a $2 million software development center. With the ongoing fiscal debate, we are putting that decision on hold,” Ernest said. Panduit operates a plant in the Central Valley coffee town of Grecia.

Allan White, Costa Rica vice president of operations for Aegis, a technology outsourcing services company in the Ultrapark Free Zone in Heredia, north of San José, said company plans were being put on hold. “In 2010, we started planning a new facility and considered establishing it in the Guanacaste area, to bring jobs to an area outside the metropolitan area. The pending legislation is making us reconsider our decision,” he said.

On Wednesday, former presidential candidate and PAC leader Ottón Solís called a meeting at his house in San Pedro, east of San José, with PAC legislative leader Manrique Oviedo, PAC President Elizabeth Fonseca and representatives from the Costa Rican Association of Free-Zone Businesses, CINDE, the Costa Rican-American Chamber of Commerce and the Costa Rican Chamber of Exporters. The meeting ended without an agreement. 

“We believe that a key factor to attract foreign investment and improve our business environment is to have a stable fiscal environment in which all economic sectors take on their fiscal responsibility,” Solís said. 

Solís said the need for tax reform is urgent to help stabilize the country’s finances. Costa Rica’s current deficit equals more than 5 percent of the gross domestic product, the highest in Latin America. 

According to Solís, new taxes on free-zone businesses could generate up to $133 million for the Costa Rican treasury. “We are facing an unsustainable fiscal situation that we have inherited from past presidents and legislators. I hope that these representatives that are coming to talk to me today have talked to the people who are responsible for the situation we are in,” he said.  

On Monday, the Foreign Trade Promotion Office presented a study showing that free zones  grew  167  percent  in  2010  compared to  2009.  For  every  tax-exempt  dollar earned by  256 companies in the free-zone system, $8 goes to the Costa Rican government. 

In 2010, those companies generated the equivalent of 8 percent of Costa Rica’s GDP. A total of 58,012 jobs were directly created by free-zone businesses in Costa Rica, the report said.

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