Country of the month: Costa Rica

In a 2015 ad in a major Canadian newspaper, Costa Rica’s ambassador to Canada, Roberto Dormond-Cantú, played up the similarities between his country and Canada, citing common values and socialized healthcare. Whether or not those comments played a role, Canada was third in the number of visitors to Costa Rica last year, after the U.S. and neighbouring Nicaragua.

For snowbirds looking for a destination a little farther off the beaten path than Florida, Costa Rica might fit the bill. Here are things for clients to consider before retiring among the Ticos (what Costa Ricans call themselves).

Forget natural paradise—Costa Rica is a tax heaven

Costa Rica only taxes income earned in Costa Rica—a favourable system for those with outside income, who would also have no reporting requirements, says Francisco Villalobos, tax and legal partner with the Deloitte Costa Rica team.

For those with Costa Rican income, personal tax rates are progressive, up to 25%. Dividend income is subject to 5% withholding tax, and interest income is taxed at 8%.

Canadians itching to buy beachfront property can happily note Costa Rica has low property tax (0.25%) and generally no capital gains tax for individuals—for now. “We’re going through tax reform, but it’s very uncertain what’s going to happen,” says Villalobos, adding that a potential capital gains rate of 15% has been discussed.

Canada has no tax treaty with Costa Rica, so there’s no relief for Canadian residents from potential double taxation. For example, if clients buy property to run a resort or to rent out, income must be reported in both countries.

The little (economic) engine that could

While Canada’s recent GDP growth is impressive, Costa Rica’s is even more so: 4.3% in 2016, 3.8% in 2017, and the same expected in 2018, the IMF forecasts.

The country exports bananas, coffee, sugar and beef, and is a key ecotourism destination. In recent years, industrial and processed agricultural products have broadened exports, as well as value-added goods such as medical devices. In fact, value-added exports increased from 8.95% in 1999 to 46.4% in 2015 of total services exports, says the Costa Rican Investment Promotion Agency, citing figures from the central bank, Banco Central de Costa Rica.

Further, political stability and relatively high education levels attract foreign investors. The U.S.-Central American-Dominican Republic Free Trade Agreement (CAFTA-DR), effective for Costa Rica in 2009, helped increase foreign direct investment in key sectors of the economy, including insurance and telecommunication. But there’s more work to do. “Poor infrastructure, high energy costs, a complex bureaucracy, weak investor protection and uncertainty of contract enforcement impede greater investment,” says the CIA World Factbook.

Other economic challenges include rising fiscal debt, public debt, poverty and relatively low levels of domestic revenue. Moody’s downgraded Costa Rica’s credit rating from stable to negative in 2015 and again in 2017, putting upward pressure on lending rates, the budget deficit and the rate of return on investment.

Still, the country has 13 free trade agreements in place beyond the CAFTA-DR, comprising 49 trading partners—including Canada—and representing 83.4% of the country’s imports and 93.4% of its exports. More agreements are under negotiation, including the Pacific Alliance and an agreement between Central America and Korea.

No stocking up on stocks

Real estate or direct business investment might be a better bet than the Costa Rican stock exchange. Called the Bolsa Nacional de Valores, or Bolsa, the exchange has fewer than 60 listings (including Scotiabank). Still, that’s up from about a dozen two years ago.

Further, regulatory controls are relatively weak. In an April 2018 financial sector stability review, the IMF said Costa Rica has “serious vulnerabilities” in its secondary markets, pension sector and financial-crisis safety nets. “Supervision of the financial sector is becoming risk-based and intensive, but it lacks key legal powers, tools and responsibilities for the effective oversight of institutions and markets,” says the report. One IMF recommendation is for the Banco Central to implement an emergency liquidity support mechanism.

The basics

Official name: Republic of Costa Rica

Capital: San José

Government type: Presidential republic

Population: 4.93 million (July 2017)

Head of state: President Luis Guillermo Solís Rivera

Currency: Costa Rican colón

Citizenship: By birth or descent; dual citizenship recognized; residency requirement for naturalization is seven years

Source: CIA World Factbook

Economy

GDP (purchasing power parity): US$85.2 billion (2017)

GDP growth: 3.8% (2017)

Inflation rate: 1.7% (2017)

GDP per capita (PPP): US$17,200 (2017)

Unemployment rate: 8.1% (2017)

GDP by sector

Agriculture: 5.5%

Industry: 21%

Services: 73.5%

Source: CIA World Factbook, World Development Indicators database

Taxation

Corporate

Income: 30%, with rates of 10% and 20% applying to companies that earn income below certain thresholds

Branch tax rate: branches and permanent establishments of foreign companies are taxed in the same way as subsidiaries

Dividends: tax-exempt when issued and received by Costa Rican entities

Capital gains: in general, there’s no capital gains tax. In two instances, it’s 30%: when the activity generating the income is from the operation of a normal trade or business, or from the transfer of assets subject to depreciation/amortization.

Personal

Income: progressive up to 25%; those in the country for at least six months in a tax year are considered residents

Basis: territorial, on Costa Rica–sourced income; residents subject to income tax; non-residents subject to withholding tax

Capital gains: generally 0%

Dividends: 5% withholding tax

Interest: 8%

Real property tax: 0.25% annually on value of land plus buildings; luxury tax may also apply, depending on property value (real property tax also applies to corporations)

Inheritance or gift tax: None

Source: Deloitte’s Costa Rica Highlights 2018

Real estate advice

The Canadian government has a message for Canadians interested in purchasing property or making other investments in Costa Rica: “Seek legal advice from appropriate professionals in Canada and in Costa Rica before making commitments. Disputes arising from such activities could be prolonged and costly to resolve.”

“Prolonged” might be a good adjective to keep in mind for many situations in Costa Rica. Expat blogs continually remind potential newcomers to Costa Rica that routine chores, such as shopping and home repairs, will take much longer than in Canada. One blogger—an American expat—describes Costa Rica as built on process, not performance.

Becoming a non-resident

Costa Rica’s low cost of living and favourable tax rates might entice some clients to ditch Canadian residency. Those who decide to become non-residents must demonstrate they’ve severed Canadian ties and established new ones in Costa Rica (or any chosen country).

Costa Rican residents have no special tax status relative to non-residents, notes Deloitte’s Francisco Villalobos, but becoming a resident would mean being able to stay in the country longer than 90 days at a time and opening bank accounts more easily.

The primary tests to determine residency are the locations of a client’s house, spouse and dependents. If you sell your home, and your spouse and dependents move with you, “that’s a pretty strong test that you’ve left Canada and you’re no longer a resident,” says Harry Chana, international tax practice leader at BDO in Markham, Ont. Alternatively, a home in Canada could be leased instead of sold. In such a case, “make sure [the home is] rented out so it’s not available for [clients] to come back at any particular time,” he says.

Secondary considerations for residency include the locations of cars, recreational property and social ties, followed by citizenship and where a driver’s licence is issued (though a Canadian driver’s licence is valid in Costa Rica).

To avoid ambiguity, Chana suggests clients set up social, religious and economic ties in Costa Rica, including bank accounts and investments. “This is all critical because we don’t have a treaty with Costa Rica,” he says. “You want to make sure CRA can’t come back and say you’re a resident of Canada.”

If clients spend at least 183 days in Canada, they’re deemed resident and must pay Canadian tax (with no tax treaty, Canadian rules determine residency), he says.