Agreements to avoid double taxation and prevent tax evasion in terms of income and wealth taxes and prevent taxation are very important legal instruments to promote the development of economic activities between two or more jurisdictions.
These agreements materialize in International Treaties, which -in a simple way- establish the rules in fiscal matters. They are agreements that would be applicable between the residents of two jurisdictions when carrying out economic operations in the other territory.
In this context, states can:
- Cede the tax power by allowing a certain income to be taxed only in the jurisdiction of residence of the receiver, that is, the source state loses the right to collect.
- Share tax power, in this case, both states have the power to tax income. And with the particularity that the source State usually limits its tax power to a maximum percentage and the State of residence, maintains the responsibility to relieve double taxation.
Thus, a company resident in country X, when doing business with a resident in Costa Rica, will enjoy preferential treatment – from a tax perspective – compared to residents of other jurisdictions. And with which our country had not signed a treaty of this nature.
Responsible withholding agent
These treaties usually follow a similar structure and similar wording. However, each norm has its particularities and needs to be analyzed in great detail, since sometimes the jurisdictions agree on specific conditions that may not have been included in the other Treaties.
The review of the application of the Treaty must be done in a specific manner for each case. This aspect is relevant since, before a review by the Treasury, the risk of an eventual adjustment is assumed by the local company, tax resident in Costa Rica, which did not apply the withholding tax on remittances abroad or applied a lower withholding.
In all cases, there must be contractual documentation that explains very clearly the scope of the contract and the price. If an agreement is applicable, the non-resident provides the tax residence certificate. If this documentation is not available, the risks of questioning are much greater.
Knowledge of the operation that the non-resident would carry out
For a correct application of the treaties, it is required to have a detailed knowledge of the way in which the non-resident would carry out their operations in Costa Rica. This aspect becomes very relevant in situations where the non-resident must carry out their activities in Costa Rica, has a fixed place of business, is a construction site, or assembly, and owns the property, among other assumptions.
The relevance of knowing these details derives from the fact that the company/person residing abroad could eventually establish a permanent establishment in the country. In this case, the tax consequences are different.
The tax on remittances abroad is not applicable, but rather, local obligations are generated. Hence, the invoice or voucher that supports the expense must meet the requirements demanded by the legislation in Costa Rica.
Correct classification of the nature of the service
A third key aspect corresponds to the adequate classification within the articles of the Income Agreements that the foreign entity would generate. In this sense, as a general rule, all the articles of the Treaty must first be reviewed to determine if there is a specific regulation. If not residually, article 7 could be applied in the case of business profits or the article referring to other income.
To carry out the proper classification, it is necessary to review the comments to the Model Agreement of the Organization for Economic Cooperation and Development. This is because certain activities have generated discussions that merit a specific review. Within the review, special attention should be given to concepts such as effective beneficiary, definitions of dividends, canons, and services, among others.
Given the knowledge that our Tax Authorities have been acquiring, we have seen an increase in the questioning of the application of the Treaty based on the materiality of the operation.
Also of the structure that the service provider has in the country of residence. This situation occurs mainly when payments occur between companies that are part of the same economic group.
In light of recent changes in international taxation, it is advisable to carry out a review of these contracts, financing and holding structures. This in order to validate that they comply with the new parameters promoted by the OECD from the Beps Plan and avoid risks in fiscal matters.
