The Central American Group: Welcome to another installation of the Central American Group’s series of podcasts. In these recordings, we speak to experts in various fields of business in Central America, most specifically in Costa Rica and El Salvador. Today, we are very fortunate to have Carlos Camacho with us. Carlos is a partner in one of the leading law firms in Central America called Arias Law Firm. We’ll be discussing the Free Trade Zone Regime in Costa Rica.
Carlos, welcome to our podcast. Tell us a little bit about yourself.
Carlos Camacho: Thanks, Steven. It’s great to be here. As I said, we are a Central American law firm with over 80 years of experience working with foreign direct investment. We have offices in El Salvador, Guatemala, Honduras, Costa Rica, and Panama. Our main focus is working with companies in setting up their operations in any of these countries. I’m based in Costa Rica specifically. What I have been doing for most of my career is helping investors navigate the regulatory climate and successfully set up their shop in Costa Rica.
The Central American Group: Okay, that’s very interesting. Thank you for that summary. Today, the subject of the podcast is something that we as the Central American group always get questions about when we’re talking to prospective tenants of the Green Park Free Trade Zone. That, of course, is the Free Trade Zone Regime in Costa Rica. Costa Rica is very well known for foreign direct investment attraction over the last three decades. This success is because of the free trade zone regime program. Can you explain what it is and who can benefit from it?
Carlos Camacho: Of course, I agree. The free trade zone regime is the cornerstone of Costa Rica’s foreign direct investment strategy. The free zone regime is composed of a set of incentives that the Costa Rican government has created to attract companies that are willing to commit to a certain level of investment and the creation of employment in Costa Rica. These companies need to come from specific sectors.
Costa Rica has tailored what it has defined as strategic activities that are the ones that are eligible for these tax holidays. The most common and the most relevant are services and manufacturing. Within manufacturing and services, there are another set of subdivisions that are mainly focused to attract medical device companies and software development services, shared service centers, and anything else to do with research and development, specifically in the medical device industry. It’s very important to understand that Costa Rica has made significant efforts to create a hub of companies that have created an ecosystem where we have a large manufacturing medical device manufacturing companies to smaller and medium-sized companies that have become part of a supply chain environment. The free trade zone in Costa Rica, as such, basically provides incentives such as reduced income tax or zero income tax.
The regime provides for no importation taxes for raw materials, and no importation taxes for equipment. So, let’s say where you are a manufacturing company, anything that you bring into the country for the operation, once you have complied with the application, will be tax-exempt. Then anything that a company manufactures here in Costa Rica, we export on the exportation and the games that are produced for that activity in Costa Rica are taxes are very reduced income tax of only 6%. If you make a larger investment over $10 million, then that reduction goes to 0%. So, 0% income tax.
Very important to note is that there is an application for the free trade zone regime in Costa Rica that needs to be completed where the applicant must state what the investment commitment will be for the project. It has to be over a minimum of $150,000 in fixed assets, and then you have to make a commitment to employment. Basically, there is nothing set in the law, but you need to show that you’re going to have enough employment for the project to be attractive to the Costa Rican government.
And that’s what makes the mechanism very attractive for free trade zone companies. I would say the last advantage of the free zone regime in Costa Rica is that there is no withholding tax and there is no tax on remittances. So, the company that’s set up here in Costa Rica will be able to repatriate as dividends the funds that the holding company initially invested without having to pay any withholding taxes.
The Central American Group: You referred to an application that’s needed to gain Costa Rican free trade regime status. When companies are going through the process of doing that application, what are the things that they should look for?
Carlos Camacho: Yes, that’s a great question. The government has made the process fairly straightforward. It’s an electronic application that you submit through Procomer, which is the tax and fiscal authority. You will include information such as the location of the activity, the site where the company is going to be operating, the investment commitment, and a description of the services or manufacturing process that the company is going to be undertaking. Although the filing of the application is straightforward, you do need to be very careful in the preparation of the business plan and in the commitments that you strategically need to include in the application. The law provides three years to the companies to meet those commitments that they have made on investment and unemployment. So, it is very important that companies seek legal and expert advice on how to prepare applications. The Applications Usually the process usually takes between four to five months, and it’s divided into four distinct stages. The first stage is the technical review by Performer, then a legal review by the Ministry of Foreign Trade. Third is the signing process. The application needs to be authorized and signed by the Ministry of Foreign Trade and then by the President of Costa Rica.
Finally, the fourth step process works fairly smoothly, but there is the need to follow up and keep providing additional information whenever the authority requires it, especially when describing an elaborated manufacturing process or a service process that needs to be clarified.
The Central American Group: You mentioned the timeline and how long it takes to go through the entire process. From the time you submit to the time you receive the green light for your foreign trade zone regime application, are there ways that that application process might be delayed, and what are they?
Carlos Camacho: Yes. Usually, the whole time for setting up a free trade zone regime in Costa Rica is five to six months. The first month is more of incorporating a local entity and preparing the application. The delays can come from the final stages of the process. The signature process sometimes takes a while, depending on the availability of the Minister and the President, and the customs authority that is sometimes required to make an inspection of the site. Or there might be a heavy workload and might take longer than we usually expect, but I would say that normally we can expect the entire process to be completed within five to six months. Although the delays are expected, they’re typically not huge delays. The Costa Rican government is very aware that foreign direct investment is very important to the country. Accordingly, they tend to follow the timelines that they have set so that there are no major delays.
The Central American Group: During the time that the government is processing the application, what would you recommend that companies do? How should they use that time?
The Central American Group: Well, that’s a great question, Steve. Basically, what we recommend is updating in parallel order permits that are required, for example, registration before the Social Security Administration to involve the employees, registration before the tax authority, and the attention of the commercial license for the specific site. I would say that a very important task that needs to be front and center of any direct investment for Costa Rica is seeking the location.
The advantage of Costa Rica is that it has several options for industrial parks and office parks, and it’s key to finding the right partner when you’re looking for your site. There are several parks and there are some parks that have considerable experience and are very dedicated to working with companies. Also, if you make the right decision to find a good logistics partner where you set up your operation, the rest of the process may go smoother when you apply for this other purpose.
The Central American Group: Are there any activities that are restricted during the processing of the application?
Carlos Camacho: Yes, there are. You must make sure that you do not start any commercial activity before the free zone authorization is granted. So basically, you cannot engage in invoicing for those commercial activities. What is recommended during this three to five-month period is to start the hiring process, review human resource policies, and do all the housekeeping internally. The training of the human resources is key, and usually, companies do take those three to five months to train the staff in the process that they’re going to be undertaking. And then, of course, there’s time for construction of facilities, building improvements, installation of all the equipment and IT systems, all that is called preoperational work, and all of it is allowed for companies to perform while they’re waiting for the final authorization.
The Central American Group: One thing that is interesting about the free trade zone regime in Costa Rica is that it’s kind of dealt with in two diverse ways. One has to do with an area that’s called the Greater Metropolitan Area, and there is also what is known as the outside of the Greater Metropolitan Area. Can you tell us what that means?
Carlos Camacho: Sure. That’s very important because the law has a sense of trying to encourage companies to seek setting up their operation outside of Metropolitan areas to improve the quality of life of lesser developed areas of the country. However, both areas provide desirable benefits for companies. For example, inside the Metropolitan area, the investment commitment is $150,000 in fixed assets. If you set up inside a free trade zone park, well, if you go outside of the Metropolitan area, then only $100,000 of investment commitment is required to receive the tax benefits. The term of the free trade zone benefits is longer if you set up outside of the Metropolitan area. One of the things that keep companies inside of a GMA is the fact that most universities, most of the current medical device cluster, and the services cluster are in the Metropolitan area. Most of the human resources are still in the Metropolitan area. However, the outside Metropolitan area has become another option because of the increased availability of workers and because there is also new infrastructure outside of the Greater Metropolitan Area that is very attractive for companies.
The Central American Group: For the people that might not be familiar with the way Costa Rica is set up in geographical terms when you refer to the Greater Metropolitan Area, could you give an idea of what it includes, and what communities?
Carlos Camacho: Sure. The Metropolitan area is traditionally known as the San Jose downtown area, Alajuela, Heredia, and Cartago. Of course, there are parts of these four provinces that are out of the Metropolitan Area, but the confluence of these four provinces, which are the ones that hosted the main large, populated cities, is what is called the greater Metropolitan area.
The Central American Group: What happens when companies approach the end of their free trade zone regime program?
Carlos Camacho: Well, that is a great question and something that needs to be determined from the beginning of the term. As we said, the common term for the free trade regime in Costa Rica is eight or ten years, depending on the category and the location of the project. But when you are approaching the end of the term, each company has the possibility to renew the benefits by making a new project or a new significant investment. Usually, the government likes to see a new investment of between 20% and 30% of the total investment that was done during the first years of the free zone term. If you make that commitment, if you create a new project or make a new significant investment, the government will process your application and analyze it and will very likely grant you another eight years. They like the fact that you’re willing to make a new commitment on investment. Another very important thing is you do not need to wait for year seven or eight to start making that investment. If you finish your business plan during the first three years, you meet your initial investment commitment.
And as it happens, often companies realize that they like Costa Rica, that they like the human resources and they want to grow in Costa Rica. So, the law allows them to do what I like to call the “reclocking” of the investment. For instance, if you’re in year four and you want to make another significant investment that goes beyond that 20% of the total investment, you can apply for an extension of your free trade zone in Costa Rica. That means that you can apply for the renewal in year four and then you will get another eight years counted from that year four. So that will extend you up to twelve years if you’re willing to make additional investments while you’re still on your first term.
The Central American Group: So, in manufacturing, for instance, something like adding a production line might be an action that would enable you to continue to use your free zone regime status.
Carlos Camacho: Under the free trade zone regime in Costa Rica anything that will represent an investment in fixed assets will definitely be a good opportunity to reclock.
The Central American Group: I think we’ve covered a lot here. One thing that happens as a result of these podcasts is that when visitors to our website listen to them, they often have questions. What I like to do is ask our guests to give their contact information so that listeners can go directly to them and get access to experts. Can you tell us how somebody with questions about this topic might be able to get into contact with you and your law firm?
Carlos Camacho: Thanks, Steve. Yes, my office email is Carlos.Camacho@ariaslaw.com. Listeners can find more information about our firm and our free trade regime and foreign direct investment practice at www.ariaslaw.com. That’s www.ariaslaw.com.
The Central American Group: Well, Carlos, thanks for joining us today. What you had to present to us was extremely interesting and I know that it’s going to be useful to the listeners. Thank you and have a wonderful day.
Carlos Camacho: Thank you for having me. Bye.