The Truth About Free Trade Zones

The Truth About Free Trade Zones

Is it worth it for American companies to set up business operations in free trade zones? This blog offers lessons learned on the benefits and the hidden costs of the Free Trade Regime in Costa Rica.

We had a business problem. 70% of our call volume was generated in the Americas, but 70% of our call center personnel were located in Asia Pacific. We needed to balance out our global footprint, and Costa Rica was selected. The availability of talent at relatively lower labor costs, coupled with the free trade incentives, was the deciding factor. We are generally happy with the decision, but there were key lessons learned along the way. Here are some insights after successfully completing the Free Trade Regime application process and learning how to adjust our business operations to accommodate the ongoing requirements.

1. Getting free trade authorized is a long process

There are three steps, each managed by a different government entity, that culminate with your approval being signed into law by the President of the country. This whole process can take over three months, and your business will have little control over the timing/approvals of each step. This can put a serious monkey wrench in your business timelines to build out an office or start hiring people.

Lesson Learned: Fast tracking is not realistic. Build out a timeline that includes liberal estimates for deliverables such as entity creation, free trade designation, and establishing bank accounts, all of which take time and are pre-requisites for other critical path activities.

2. It’s a marriage with the host government

Although it may feel like the end of a long process when you finally achieve your free trade approval, it is the beginning of a long relationship with the government. PROCOMER, the government authority who manages free trade compliance, will regularly visit and check you’re on top of your obligations. You have to develop systems and process to maintain asset controls, down to the granularity of tracking every asset you purchased tax free.

Lesson learned: Understand up front the rules and expectations for ongoing administration so you can start properly from the beginning, because going back and fixing your documentation is very difficult.

3. Reduced strategic agility

This program is designed to keep you there. You will be faced with penalties including paying back the tax savings if you decide to exit the market, and there will be limitations to downsizing since you still need to meet minimum hiring and capital investment commitments. The Free Trade approval is conditional for a fixed amount of time. After this time expires, you must re-apply, and re-commit to more CAPEX and hiring in order to keep the free trade advantages. This could be a dilemma if it happens during a recession or if you are otherwise not inclined to grow there, especially in industries like high tech that are known for more volatility.

Lesson Learned: Joining a free trade regime must be part of a long term strategy, ideally to be leveraged interdepartmentally, with the understanding that you are trading flexibility in return for the benefits.

4. Get ready for lots of audits

Your first audit from PROCOMER will be three months after your free trade application is fully approved. PROCOMER should have your full respect and attention because they have authority to rescind your status if you fail your audits. The downstream repercussions from losing your status would be dire – Back taxes would have to be paid, and it could also affect your rights to continue to operate your office within your free trade regime affiliated business park. We did not pass our first audit. However, PROCOMER has been a fair partner to Citrix. They share the goal of us being successful in their country, so they gave us time to refine and improve our processes to reach ultimate success.

Lesson Learned: The audit process is intense, and the government demands perfection.

5. Don’t bypass the procurement process

Ordering things via the US and shipping them down causes many audit documentation problems. Also, your guaranteed minimum CAPEX investment is only realized when ordered against a local supplier with your local corporate entity listed as the buyer. Also, later on, it can be difficult to obtain support and maintenance on items purchased in the US. We used this approach because we were trying to fast track procurement while our entity, free trade status, and bank accounts were being established, but it ended up being a painful lesson as it’s very complicated to go back and fix the paperwork.

Lesson Learned: Find local partners, and procure everything via your local entity.

6. Go big or stay home

It only makes sense to go through all this effort and investment if you’re planning to have a large presence and if you’re sure that you plan to be there for the long term.

Lesson Learned: Make sure the business case shows solid size and scale to make all the complexities in maintaining free trade compliance worth the distraction.

7. Governance matters

Define up front the engagement model between Real Estate, treasury, tax, accounting, local teams, etc.

Clarify who is really in charge of the program. Make sure HR, Real Estate, Accounting, Tax, Treasury and functional leadership are at the table during strategic decision making to enter the free trade regime, because extra work will fall on these teams.

Lesson Learned: Departments are more likely to embrace the added responsibility if they have been included from the beginning.

8. Don’t expect the Costa Rican government to operate in English

PROCOMER proactively educates regarding free trade regime obligations, and they are willing to partner to help you succeed. However, they are not all English speaking, which highlights the need for full time local resources to manage the program. There are also periodic updates and changes to the rules that are communicated and managed locally. This is not something that can be effectively managed out of the US.

Lesson Learned: Build your village of local expertise to lead the way.

Costa Rica offers high quality human capital and leveraging their free trade incentives can be a great way to access highly trained people at relatively lower costs than the US, and all this is located only a three hour flight away from Miami. Operating your business there isn’t as straightforward as it seems, so make sure you know what you’re getting into.