A Story About What Not To Do When Starting a Costa Rica Business

I, as a United States CPA and fellow business owner who has a accounting and financial services firm in Costa Rica have significant experience working with business owners and individuals. That being said, I wanted to share with you a story of a prospective client that I met with the other day. The story is to help remind those new business owners in Costa Rica and those who have been here for a while just to remember how you can get into trouble for relying on misinformation.

The story begins as a gringo, whom recently moved to Costa Rica full-time, who has a recently opened a new retail business in the Pacific Coast and wanted to meet me to see if he was in compliance with regulations and rules and talk about accounting and bookkeeping services that my firm offered.  The first thing I asked for was to see his licenses as I did not see them posted anywhere in the establishment. When I asked him why his licenses were not posted in the establishment, he told me that other people have told him you do not have to do so as long as you have them on-site for inspection. This was the first of many mistakes and misinformation this gentlemen has received.

Generally, you must have at least copies of your licenses including the health permits, noticeably posted in the business. Keeping the originals in a safe place is fine, but the copies must be posted. Inspectors, the police and others, including customers, have the right to see the licenses. Not having them posted inside the business will create a problem for you. It is also a good idea to have a copy of any receipts of payments of any municipal taxes for annual licenses or other fees.

To continue the story, he retrieved the information from a file of papers along with a certificacion personera juridica of the corporation . As I examined these documents, I noticed that the licenses did not have his name as the legal representative and the personera juridica had another name as the president and legal representative of the company – His name did not appear ANYWHERE. When I asked why this was, his response was quite astonishing. He said the name on the licenses was an attorney who applied for the various licenses. Afterwards, he changed this person as the legal representative and replaced it with a Costa Rican he has known for about a year.  He then told me he was applying for another kind of license and he was told that if a Costa Rican appears as the legal representative then that would make the process go faster with less questions.  He is also stated that he was not in possession of his books and records. That is being held by yet another attorney.

After telling me this, he then discloses that the same corporation operating the retail business, in which he rents the retail space, owns an unencumbered lot with a cabina on it in a different place in Costa Rica. I think I hurt my jaw from the impact of it hitting the floor after these comments were made. For those people who have been in Costa Rican a long time, you all know where this could lead. For those who have not been here to long, let me try to explain what the risks are.

First, the president and legal representative of a corporation has enormous power. The constitution of the company or by-laws describes the power and any limitations that a president has. But, most of the off the shelf companies that are formed or used in Costa Rica have very few limitations on the president’s power. The president can typically bind the corporation to any contracts, including loans. Although the owner(s) of the company, can replace the president, at anytime in a general assembly meeting, during the time the president is acting his capacity, any contracts, including debt, are binding and thus, obligate the company to perform under the agreed terms. Remember, that it is the general assembly meeting when you can make the changes to the officers, most notably the president and the secretary. Merely, telling someone they are no longer the president is generally not binding. If you do not have your books and records, the process of having a general assembly meeting can take time.

In this case, the owner of this company has entrusted another person with effective operating control over the company. This president can choose to mortgage the real estate property and take the cash proceeds for his own personal use.  Additionally, this president can bind the company to any kind of contract, even if has nothing to do with the company’s principal operations. And of course, this can be all done without the shareholder knowledge or consent. Once the president has bound the company, even if one were to claim that it was “not legal”, the ensuing legal dispute will take significant amounts of time to adjudicate. We all know the legal process in Costa Rica is at best slow and generally is slated against non-Costa Ricans. Meanwhile, the damage has occurred and if you are not in compliance with the agreement, then you are subject to the enforcement provisions contained therein. Additionally, the actions to be taken against bad president may be completely independent of the actions that can be taken by another party who has the binding contract against your organization. Only a lawyer will have a solution for this circumstance, but rest assured, it will cost significant amounts money and time.

The comment relating to “if a Costa Rican appears on a license or permit application then it less scrutinized or it will be processed faster then if a non-Tico appears” is untrue.  Licenses and permits are reviewed based upon the legal requirements that accompany each license or permit. If the license or permit is absent the proper documentation, the license or permit application will not be processed and or will be rejected. Having a competent attorney prepare the necessary documents is critical for an application for a license or permit to be processed timely. A good attorney who has a relationship with some of the government or administrative officials might be able to shepard the application through the system a little bit faster. Otherwise, the law provides the necessary time period to process a complete application.  Be warily of those people who tell you that they can get the permit or license quicker because they know somebody or if you pay them some money that it can be done quicker.  Many times these turn out to be either a shake down or complete scam.

The other risk that this person has inadvertently stumbled into under the current structure of the corporation is that he has combined an operating business that by its own nature is subject to incurring obligations with another other significant asset. For example, he is leasing his retail space for a period of three years. If his retail business is unsuccessful, the corporation is still legally bound to pay for the remainder of the lease term. Normally, if a corporation had no assets, then the landlord is limited in what they can legally pursue. However, in this case, the landlord can seize the land and cabina as it is an asset of the corporation. This arrangement has put all of his assets at risk!

The lessons here are obvious –

• The president and legal representative of the company should always be a shareholder of the company, not an employee, a lawyer or any other.
• Always keep control your books and records – never have a third party hold them, unless there is a legal requirement or you have a very competent attorney that is accessible.
• Always, to the extent that is practical, separate assets from one another. A piece of real estate should never be included in a company that has a retail operation. Your house, if held under a legal entity, should not be part of another piece of real estate that you earn rent from.

But yet the story is still not done with this gentleman. We then discussed sales taxes and employees. He was told by “several other entrepreneurs” that if he had a certain number of employees, he was exempt from paying sales taxes and if he has employees working less than a certain time period he was not required to enroll them in a workmans’ compensation policy or under the CCSS nor does he have to pay them for any vacation or Christmas bonus.

Once again, I had to educate him on these basic rules. In general, it does not matter on the number of employees you have to be required to file and pay sales taxes. If you run a retail establishment in a non-trade free zone, then you are required to charge and collect the 13% sales tax from your customers. Of course, what you are actually obligated to the Ministerio de Haceinda will depend in part on your purchases that you have paid IVA taxes on. These taxes for “ventas” are typically due in the middle of the month for the preceding month’s activities. If you use merchant services, remember, that a portion, about 5%, of the credit card payment is being transferred by the merchant to the Hacienda.

The second part relating to the employee comments are also incorrect. If you hire an employee, they are required before they start work to be registered under your workman’s compensation plan at INS. This can be done either electronically (if you are registered) or by a paper document submitted and signed by the employer. Equally, you must register the employee under the CCSS as they must have health insurance when they begin work. Now, practically, if you “try out” an employee for a few days to see if they are any good, you do not have to go through this process (although, I would recommend paying them in cash at the end of their shift). But, once you “hire” them, you need to follow the above in order to avoid significant problems with the MTSS, the CCSS and the INS.

It is equally important that the amount of pay and the hours worked are consistent with the minimum pay standards issued by the MTSS. Underpaying or not paying the proper shift time, if at night, will expose you to your employees when you terminate them and or when an inspector reviews the payroll records. The amounts and time periods can be found at the MTSS website.

Additionally, employees are entitled to receive both a Christmas bonus (usually paid around the middle of December) and vacation. Employees earn one month pay of Christmas bonus if they have worked for one complete year. The amount that they earn is based on the average amount of pay for the employee for the period of time.  Generally, the twelve time period of the computation ends November 30^th of the year. If the period of time worked is less than a year, the amount is pro-rated.

Employees also earn vacation time of two weeks per year and that is computed based on the date of hire and is prorated similarly as the Christmas bonus, if they have worked for less than one year.

Amounts with respect to the termination and severance pay, known as cesentia and proviso, begin accruing for an employee who has worked over ninety days for the employer. After which, a terminated employee is eligible to receive amounts equal to a schedule depending on the time period worked and the average salary earned over the previous twelve months.  There are limited exceptions to paying these cesentia and proviso amounts to terminated employees depending on the reason of the termination. These specifics are on a case by case basis and I would advise that you consult with an attorney for specifics. An employee who is terminated or resigns is always entitled to receive their Christmas bonus and vacation pay.

The lessons of story is that if you own or are planning to own and operate a business in Costa Rica, you need to get professional advice and help from both an competent attorney and an accountant. To the extent possible, have the lawyer write the recommendations so if there is a problem, you may have some recourse. Try to avoid listening and getting advice from “so called entrepreneurs” because many times they are not right. If it sounds illogical, then it probably is – so be skeptical, and go get the right answer from a professional. I hope this prospective client will heed the advice I gave him – if not, then I see only really bad outcomes occurring for him and his business with lots of unnecessary aggravation and stress. He could lose everything!!

Robert L. Pioso, CPA, with 20 years of experience as a CPA, CFO and owner of a Costa Rican business can help you navigate through the complexities of US taxation for US expats and those who own investments and assets in Costa Rica. You can contact him for a free consultation – CR 6050-3831 or US 312-235-2301 or visit him at www.richcoastaccounting.com  or by email at [email protected]. Rich Coast Accounting and Financial Services are focused at providing positive and tangible results that will bring real value to you or your business and offers a unique guaranty “You pay only for the value of the services received or the invoice, whichever is less.”