The CAFTA-DR Free Trade Treaty: A lawyer’s perspective

It´s important to remember that on January 1^st, 2009, the Free Trade Agreement between the Dominican Republic, Central America, and the United States, popularly known by its acronym, CAFTA-DR, came into effect. The CAFTA-DR Free Trade Treaty is one of Costa Rica’s main trade policy instruments. This is because it regulates trade with an important business partner like the United States.

1. The United States is the country’s leading commercial partner; what has been the impact of the U.S.-Costa Rica Free Trade Treaty?

Traditionally, Costa Rica’s leading trading partner has been the United States. However, the FTA with the Dominican Republic, Central America, and the United States has strengthened and energized this relationship. Unfortunately, in recent years, because of the COVID-19 health emergency, the regular flow of trade between the two countries has been adversely affected. Even so, indicators have pointed to a boost in the trade relationship and a revitalization of the national economy after the CAFTA-DR Free Trade Treaty was implemented.

In 2020, bilateral trade between the United States and Costa Rica reached a value of approximately US $10.5 billion. During this same year, exports reached US$ 5 billion, representing an increase of 4.9% compared to the previous year. On the other hand, imports decreased by 11.9%, totaling about US$ 5.4 billion. These indicators were affected in part by the global pandemic caused by COVID-19.

Before this situation, between 2005 and 2008, trade grew at an accelerated rate of 11.4%; however, in 2009, the first year the Treaty was enforced, due to the international crisis in the UU.S. economy, there was a break in this trend. Nonetheless, thanks to the Treaty’s boost and dynamism in commercial trade exchange, the recovery was faster than expected, generating renewed trade flows. As a result, between 2009 and 2017, an accumulated growth of 65.3% was recorded, for an average annual growth rate of 4.6%.

In 2020, 929 businesses exported their products to the United States, of which 235 were new companies. In the same year, the exportable supply was composed of 1,831 products. Among the most sold goods were: syringes, needles, catheters, cannulas; instruments and devices for veterinary medicine and surgery; pineapples; bananas; prosthetic devices; coffee; tires; electrodiagnostic appliances,; contact lenses, and sugar; among others.

2. Who has benefited the most from the implementation of CAFTA-DR?

Indeed, several groups have enjoyed the benefits generated by CAFTA-DR Free Trade Treaty.

First, the primary beneficiary has been the country. This has been primarily through foreign direct investment from the United States. The average FDI flow has been US$ 1.8 billion in recent years. As an example, in 2017, the largest share of investment was directed to the industrial sector (53.1%), followed by services (13.7%) and tourism (12.8%).

The second beneficiaries of the trade accord are local exporters. They have increased their export volumes and diversified the exportable supply. This has allowed the country to enter the leading global value chains and boosted the national economy.

Thirdly, and due to the progress of eliminating trade barriers, another group that we believe has benefited from the Agreement is undoubtedly the importers and traders of these goods and services. This benefit has been achieved by allowing the entry of duty-free goods with the consequent reduction of costs passed on to the consumer.   Because of this, it has become possible to increase sales and, thus, increase profits for businesses.

Finally, consumers of goods and services have felt the positive effects of the Agreement. These effects are reflected in the consumers’ final prices for goods and services from the U.S. and the increased supply. Finally,  consumers have seen a drop in the prices of certain products and their diversification, which was expected. Clear examples are the opening of the telecom and insurance markets as an early direct effect of the enactment of the Agreement. Those markets were subject to State monopoly and due to the entry of new operators. With the passage and implementation of the CAFTA-DR Free Trade Treaty, it has become possible to improve the quality of services at more competitive prices for consumers.

3. What are the current market access conditions under the Treaty?

As with all Free Trade Agreements, there is a process of tax relief aimed at facilitating trade and increasing commercial exchange. At present, due to the operation of tax relief, the use of the Treaty to take advantage of preferential treatments has decreased. For example, in 2022, only 17.34% of the total imports made in Costa Rica from CAFTA-DR member countries used the respective Treaty.

Under CAFTA-DR, Costa Rica’s tariff reduction schedule will end in 2025 for all parties to the trade accord. In 2015, Costa Rica eliminated most tariffs to comply with the tariff elimination schedule. This makes 95.3% of tariff lines for signatories of the Agreement tariff-free. In 2018, this percentage rose to 95.9%, provided the goods comply with the applicable rule of origin.

The goods that are still protected are all agricultural products. In 2016, the tariff reduction of “sensitive” agrarian goods began. This process will end in 2025. Agricultural products in this category include onions and potatoes, for example.

In the case of imports from the United States, quotas were negotiated for products with more extended tariff reduction periods, such as rice, pork, poultry meat (thighs, legs), fresh onions, fresh potatoes, and frozen potatoes for frying, as well as several dairy products (ice cream, powdered milk, butter, cheese, and others).

4. Under the application of this Treaty, are Free Trade Zone companies eligible for tariff preferences?

Yes, under the CAFTA-DR Free Trade Treaty, no distinction is made between the products manufactured by domestic companies operating under the traditional regime or companies with particular customs or fiscal regimes.

It is essential to understand that the regulations of this Agreement (CAFTA-DR) can be applied in the trade relationship between each of the countries party to the Agreement and the other six trading partners. CAFTA-DR generated a new tariff preference scheme for goods produced under special regimes, mainly due to the application among all the countries of the trading instrument.

CAFTA-DR establishes in its regulations a definition of “territory” that does not exclude particular customs or tax regimes such as free trade zones. Consequently, it would be understood that the goods processed and exported from these regimes come from the territory of the parties and therefore are subject to the tariff preferences established in the CAFTA-DR.

For any of these goods to benefit from the preferential tariff treatment provided for in the schedules of relief of each of the parties, it is sufficient that these goods comply with the specific rules of origin, regardless of whether the goods were processed under particular customs or tax regimes.

• What is a rule of origin?

Rules of origin are laws, regulations, or administrative decisions of general application by a country that determine the national origin of a product and whether it is entitled to receive preferential treatment under a Free Trade Agreement. These seek a substantial transformation, that is, sufficient industrial activity in a country party to the Treaty to meet the objective of productive development.

• What benefit has been generated between CAFTA-DR and the Free Trade Zone Regime for companies established in the country?

The indicators strengthen the importance of the Free Trade Zone Regime and its benefits to the different companies, mainly manufacturing companies. It enables them to import raw materials with tax benefits on imports and internal taxes, which allows the productive and industrial development of the country. Also, as previously mentioned, the importance of the Treaty has been in promoting trade in the Central American region, strengthening institutions and regulations to create better legal security and improve competitiveness. This triggers a more significant attraction of foreign investment in Costa Rica due to creating a suitable environment for companies. In addition, most of the exports to the United States have free access, which signifies a greater incentive.

• What are the particulars of the Costa Rican Free Zone Regine?

The Free Zone system is a special Tax Regime through which the Costa Rican Government grants certain types of companies a set of tax benefits and the advantage of being a Customs Auxiliary (entities that manage their own export/import processes).

The tax benefits range from preferential income tax rates or total exemptions, in the case of services and companies with investments of at least 10 million dollars, to exemptions for importing, exporting, dividends payments, remittances abroad, municipal taxes, and transfer of properties, among others.

These benefits are granted to companies willing to commit to certain levels of investment and employment that engage in specific activities authorized by the regulations.

The eligibility criteria to enter the FTZ have their complexity; since there are specific lists of activities that can operate under the FTZ, they are called strategic sectors. The list is very detailed for both services and manufacturing operations. Companies that decide to set up outside the Greater Metropolitan Area (GMA) outside of San Jose have more flexibility and even more benefits beginning last April 27th, when the Law for the Strengthening of Territorial Competitiveness was approved to promote the attraction of investments outside the Greater Metropolitan Area (GMA), which allows a greater number of activities and certain benefits in terms of employment. This new Law broadens the categories to include human health service centers, sustainable adventure parks, and companies that provide inputs for manufacturing companies.

The most common practice in this regime is for companies to choose to operate within the Greater Metropolitan Area (GMA) due to critical strategic matters such as proximity to the airport and availability of labor; thus, we find the highest concentration of both services and manufacturing parks.

The Free Trade Zone regulations are very stable, and we have registered companies operating under the Regime for more than 30 years. The country has historically understood its benefits and the spillover effect they generate. Most political parties generally support the system. We hope it continues to grow and benefit many people.