Hidden dividends in Costa Rica: the primacy of economic reality over legal form

By Gabriela Páez

Tax Manager, EAS LATAM

In tax audits in Costa Rica, some adjustments do not stem from omitted income or technical errors in the calculation of income tax, but rather from the legal reclassification of expenditures recorded as deductible expenses, ees, loans, or other business transactions. . The tax administration's analysis is not merely documentary, but economic: determining whether the payment corresponds to a business transaction or a transfer of value to the shareholder.

Under the principle of economic reality, when the outflow of resources lacks real consideration or is not linked to the income-generating activity, it loses its character as a deductible expense and becomes a distribution of profits.

1. Principle of causality of expenditure

Articles 7 and 8 of the Income Tax Law (Law No. 7092) stipulate that only expenses necessary for generating taxable income and duly documented are deductible. The mere existence of an invoice or accounting record is insufficient; the economic relationship between the expense and the productive activity must be proven.

When the economic beneficiary of the payment is the partner and not the company, the disbursement ceases to be an expense and becomes distributed profit.

2. Principle of economic reality

Article 8 of the Tax Code (Law No. 4755) empowers the Administration to disregard the legal form when it does not reflect the material reality of the generating event.

The First Chamber has confirmed this criterion, validating the rejection of expenses even when contracts and documentation exist when their connection with the generation of taxable income is not demonstrated (Judgment No. 001256-2025).

3. Reclassification as a dividend

When the expenditure lacks business economic substance, the Administration not only rejects its deduction: it changes the legal nature of the operation.

The analysis shifts from business expenses to the shareholder's net worth. If there is a decrease in company equity with a corresponding enrichment of the shareholder without equivalent consideration, the transaction is considered an indirect distribution of profits, regardless of whether it is documented as a loan, fee, or advance.

These are not two separate transactions; it is a single transaction correctly classified according to its economic reality.

4. Typical cases detected in audits

The reclassification does not depend on a lack of documentation, but rather on the economic inconsistency of the transaction within the business. The Administration analyzes recurrence, the ultimate beneficiary, and its relationship to revenue generation.

Common cases in closed companies:

Loans with no real expectation of repayment

Permanent balances without a term, interest, or recovery management demonstrate a intent to distribute profits.

Payment of personal expenses

Personal expenses paid by the company constitutes a financial benefit for the partner.

Fees without economic independence

Billing for administrative functions is equivalent to indirect profit withdrawal.

Transfers at unreasonable values

The difference between market value and agreed value constitutes distributed profit.

In all cases, the determining factor is the final economic beneficiary.

5. Tax consequences of reclassification

Reclassification does not eliminate an expense; it reconstructs the transaction according to its true nature.

First, the amount is rejected as a deduction (Articles 7 and 8 of Law 7092) and increases taxable income. Then it is treated as a distribution of profits, generating the tax on dividends not withheld.

Both taxes coexist because they tax different things: business profits and their distribution to the shareholder. Interest and penalties are also levied from the date the withholding should have been applied.

The practical effect is a double tax burden on the same outflow of resources, usually higher than the cost of a formal distribution.

The contingency does not arise from transferring resources to the partner, but from doing so under an incorrect legal nature.

Legal references:

Income Tax Law No. 7092, arts. 7 and 8.

Regulations to the Income Tax Law, arts. 11 and 12.

Tax Code of Standards and Procedures, arts. 8, 140 and 147 inc. c.First Chamber of the Supreme Court of Justice, judgment No. 001256-2025.