A great article by Rafavalverde at Outlier Legal Services on the costs of transfer taxes on the purchase of real estate in Costa Rica.
I am always baffled when dealing with real estate transactions, particularly because of the lack of knowledge of the parties involved in the transaction. I do not necessary hold the buyer or the seller responsible since they rely on professionals such as attorneys or real estate agents in order to do things right.
The issue at hand is the ignorance of the real estate agents and the attorneys. I have been getting used to being called ignorant, stupid, difficult, inexperienced and so many other things when I am involved in a real estate transaction. The most popular phrases I hear are: “I have never heard that before” and “This is the way we have always done it”.
I remember a real estate agent in Atenas who told me “I have been a real estate agent for over ten years and this is way we have always done it”. Fine! But it does not mean that you have been doing it right, I replied.
Let’s revise the law a little bit, and hopefully you, the reader, will be motivated to comply with the law and not engage in tax evasion.
In 1985, the CR Congress enacted a law imposing a tax on the transfer of real estate. The amount to be paid is 1.5% of the purchase price or the reported tax value, whichever is greater. In addition to the transfer tax which goes directly to the CR Treasury, there are other government fees to be paid along with the taxes. Namely, a Bar Association Fee, a National Registry Fee, a National Archives Fee, a County Fee, a Farm Institute Fee, and a Treasury Fee. In the following table, you be able to see the corresponding amounts to be paid.
Various laws and regulations have created the different fees and taxes to support the institutions under which the tax is named. The Bar Association fee was created by Decree Number 32493-J issued by the Department of Justice; the National Registry fee was created by the law regulating the registry; the Treasury fee was created by the Treasury Code; the Municipal Fee was created by the Municipal Code, which is Law 7794; the Archives fee was created by the law 7202 regulating the National Archive System; the Farming Tax was created by the Farm Development Law number 6735; and the transfer tax was created by Law number 6999. Lastly, the notary public fees are determined by the Bar Association and published by Decree of the Department of Justice. The last fee schedule was issued in 2015 by decree number 39708-JP.
When the tax for the transfer of real estate was created in 1985, attorneys looked for a way to avoid paying the tax. The method they devised to avoid the payment of the taxes and fees was to register the property in a corporation, thus, when a person wanted to buy and sell real estate, they would not directly transfer the real estate, instead, they would transfer the corporation.
This practice is not legal, but if you ask any attorney, they will tell you that it is.
The purpose of a corporation is to do business, not to avoid paying property taxes. Using corporations for the transfer of property is a travesty. In addition, the Criminal Code sets for a sentence of up to ten years for people who engage in false acts for the purposes of committing fraud. In this instance, the false act is pretending the sale of a corporation when in reality the purpose of the transfer is real estate.
A significant problem in Costa Rica, as we all know, is the inability of the government to enforce the laws. As of 2013, only 4.4% of reported crimes resulted in a criminal conviction. The low rate of convictions in the Costa Rican criminal system does not validate the other 95.5% of crimes, which means that the lack of law enforcement does not make theft legal.
Similarly, the lack of law enforcement does not make tax evasion legal. The government never had the means to enforce the compliance with the transfer tax and to determine who was doing tax evasion by transferring corporations instead of properties. As a result, they created a new law requiring to pay the transfer tax for properties transferred through corporations.
In 2012, Congress enacted a new law (Law 9069) with the purpose to improve the collection of taxes. The law redefined the meaning of “transfer of property” which includes the indirect transfer through a corporation. Thus, creating the obligation to pay taxes when transferring property through a corporation. I have not come across a real estate transaction where the other attorney or real estate agent knew about this requirement. In everybody’s mind, it is absolutely permissible to transfer property through a corporation and not pay taxes, which is false.
Once again, a significant problem in the Costa Rican legal system is the inability of the government to enforce the laws. Notwithstanding the legal requirements to pay taxes, thousands of transactions are completed without the appropriate payment of taxes. With very low chances of being audited or prosecuted, attorneys are not deterred from tax evasion, and therefore there is no incentive to comply with the mandatory tax.
On the contrary, attorneys use the tactic of offering lower fees to attract clients who are eager to hire the lowest common denominator when it comes to closing expenses. When a client, whether it is a real estate agent or a seller and buyer, are looking for attorneys to provide closing services, they will be confronted with two options: either to use the services of the more expensive attorney who is providing services according to the law with the correct closing costs, or to use an attorney who offers significant discount by evading taxes and telling the client that it is perfectly legal.
We encounter this problem on a constant basis in our business. We regularly see how prospective clients decide to use the services of other attorneys who are not complying with the law. What I usually tell people is to be weary of an attorney who is willing to break the law in order to get their business. What bothers me more about the tax evasion is not the loss of clients.
Fortunately, we have a healthy business and we are able to make ends meet. However, we are in fiscal crisis and this is a poor country, and attorneys have the option to be part of the solution and do the right thing and collect the taxes accordingly. On the other hand, it also bothers me the willingness of people to break the law.
According to Section 6 of Law 6999, both the parties to the transaction (buyer and seller) are equally liable for the payment of the taxes. Thus, the amount of the taxes must be divided in equal parts between the parties which generally would be 50% for the buyers and 50% for the sellers. The funds for the payment of the taxes should the transferred to the attorney recording the transfer who in turn is responsible to pay the taxes to the government.
In order to pay the taxes, the attorney must complete the form D-120 from the Revenue Service (Tributación Directa) which needs to be filed with Banco de Costa Rica who will collect the funds. As noted, both the seller and buyer share the liability to pay the taxes, as well as the criminal liability if the taxes are not paid.
Another practice that we encounter on a regular basis is under-reporting the value of the property in order to pay less taxes. This is very common practice, nevertheless it is illegal. Attorneys report a lower purchase price in order to pay less taxes. The funny part is that they charge their fees based in the actual purchase price. Thus, they are willing to help the client with “saving” taxes by reporting a lower purchase price, but they are not willing to help the client with saving money by basing the attorney fees in the lower amount.
My suggestion is fairly simple: report the correct amount for the purchase price and pay your taxes. Avoid dealing with any attorneys or real estate agents who suggest the contrary. While the penalty for tax fraud is between five and ten years in prison (and I am sure you will not want to spend any jail time in Costa Rica) the chances of going to jail over this type of fraud are very small. Nevertheless, you can do the right thing and be a part of the solution.
Original article was first published at Outlierlegal.com