The Inward Investment and International Taxation Review: Ecuador
Ecuador was a private investment-oriented country until 2006, when the government changed its direction and unilaterally amended the participation contracts for oil exploration and exploitation, introducing a clause establishing a legal requirement for government participation of up to 99 per cent of the difference between the international price of crude oil in force at the time such contracts were entered into (mostly in 1995) and the actual price. Shortly after this, during 2007 and 2008, the Constitutional Assembly heavily amended the taxation laws, imposing barriers to the judicial discussion of tax determination, increasing the taxation rates for private individuals and limiting tax incentives for corporate reinvestment of profits. Additionally, the scheme of taxation on corporate profits was also amended to double tax dividends, with both a corporate tax on profits and tax on personal income, and introducing a system where, even without taxable profits, companies and corporations were submitted to income tax on unearned profits, based on a rate of taxation of net worth. Public enterprises, on the contrary, were widely promoted, and privatisation was eliminated. This trend has smoothly changed since August 2018, when incentives were established for business located outside the main two cities of Ecuador: Quito and Guayaquil. In June 2019, amendments to the judicial procedural code reduced, but did not eliminate, the restrictions to access for taxpayers to judicial review of governmental rulings on taxation. Recent changes enacted on 31 December 2019 introduced provisions establishing different corporate taxation systems for certain areas of production businesses and for small enterprises, based, not on net income, but on gross revenues.
Bilateral investment treaties (BITs) were affected by Constitutional Court decisions holding some of them as contrary to the Constitution. Several BITs were denounced by Ecuador between 2007 and 2016, as was the ICSID Convention. The still-in-force BITs with Italy, Peru, Spain, the United States, Canada, Venezuela, France, the Netherlands, Sweden, Switzerland, China, Germany and the United Kingdom were denounced in May 2017, during the last days of the term of former president Rafael Correa. The Ministry of Foreign Commerce under new president Lenin Moreno has proposed new negotiations with the United States and other countries based on a draft prepared by his office. However, no new BIT has, in fact, been entered. A first phase of a free trade agreement with the United States has been signed in early December 2020 and is waiting for the approval of the National Assembly.
The free trade agreement originally signed between Peru and Colombia with the European Union, to which Ecuador adhered has been in force since 1 January 2017, with good results for free commerce.
The new government of Lenin Moreno, inaugurated on 24 May 2017, announced changes to encourage new investments, some of which became effective on 1 January 2018 others on 21 August 2018, 1 January 2019, 28 February 2020 and 22 June 2020. New amendments to the tax legislation have been announced by the Minister of Economy and Finances, as agreed with the International Monetary Fund.
The Constitutional Court has decided that the judges should not fulfil the provisional measures ordered by international investment arbitration panels, under the theory that they affect the sovereign state.2 Civil judges fulfilled the Constitutional Court order and compelled a foreign investor to enforce a judgment3 that the panel of arbitrators had ordered to temporarily stay,4 provisional measures that were extended in a first award that declared the liability of the Republic of Ecuador for denial of justice. The Council of Citizenship Participation and Social Control, empowered by the results of a referendum called by President Moreno, dismissed the nine judges of the Constitutional Court in September 2018, grounded on allegations of corruption. A new Constitutional Court was appointed, and changes have taken place in the National Court of Justice. During 2020, a trend for new policies on the energy industry encouraging participation contracts for oil exploitation has been developed.
On 16 March 2020, a status of exception as a consequence of the covid-19 pandemic was decreed, restricting free mobilisation and transportation and confining citizens to conduct activities at their homes. Special provisions concerning termination or suspension of labour contracts were established in the 'Organic Act of Humanitarian Support to Fight the Health Crisis Derived from Covid 19' enacted on 22 June 2020, that also ruled on social security provision, lease contracts and public utilities tariffs. The state of exception expired on 13 September 2020.
Common forms of business organisation and their tax treatment
For taxation purposes, there is no distinction between corporations (stock corporations), limited liability companies, partnerships, joint ventures, consortia or any other kind of business associations for profits, whether legally established or formed de facto.
The most commonly used forms of business structures are stock corporations (SA) and limited liability companies. The main differences between these two kinds of enterprises are that shares may be freely negotiated in stock corporations, while quotas of limited liability companies may only be transferred with the unanimous consent of all the partners or quota holders, and as a consequence, quotas of limited liability companies may not be seized or sold in public auction, although profits declared as dividends may be subject to seizure by debtors of the partners of limited liability companies. Simplified stock corporations (SAS) subject to the control of the Superintendence of Companies have been introduced in the corporate legislation to encourage new kind of entrepreneurial businesses
All of the above types of associations for business are considered under the general term of 'companies', and all of them are generally taxed under the same taxation principles. However, there is a trend to differentiate taxation treatment based on the kind of activities All companies are under a duty of registration before the Internal Revenue Service (SRI).
Branches of foreign companies authorised to conduct business in Ecuador are also taxed under the same general rules, as are permanent establishments of foreign companies.
Commercial trusts conducting entrepreneurial activities, independent or autonomous patrimonies (whether with or without juridical personality), and any other entity with economic unity not linked with its members are considered as companies for the purposes of taxation, and their benefits are treated in the same way that corporate profits are and are subject, in general, to the same formal tax obligations. Managers of trusts are liable for estate and donation taxes when trusts are devised to transfer assets. Civil companies incorporated with the approval of any notary are subject to the same taxation scheme. Benefits and profits derived from companies, financial funds and trusts devoted to investment or management of real property are tax exempted, provided the assets are not transferred to the beneficiaries and they have at least 50 beneficiaries, representing at least 49 per cent of the capital investment, not linked among them.
Limited liability unipersonal enterprises (i.e., established by only one person as managing owner) are treated for taxation purposes as stock corporations concerning profits and declared dividends.
In practice, 'civil and commercial companies', which are not recognised by any law, have also developed as businesses, and are subject to the same taxation treatment as all companies.
Direct taxation of businesses
i Tax on profits
Companies are subject to a flat-rate income tax of 25 per cent, which is calculated after the 15 per cent workers' and employees' profit share is deducted. The tax rate is increased to 28 per cent if 50 per cent of the corporate capital is owned by residents or beneficiaries located or resident in tax-haven jurisdictions. However, companies intending to use their profits to increase their capital for the purpose of investments in new industrial plants or other specially determined capital investments are taxed at a rate of 12 per cent.
However, companies devoted to activities related to the production and sale of banana products and others of the same species are subject to ta different taxation system based not in net income but in gross revenue to which a rate between 1.25 per cent and 2 per cent is applicable according to yearly executive decree by the President of the Republic, if the invoiced earnings are derived from local sales, and of 3 per cent on the 'free on board' total annual invoices of exported products, deducting as expenses only the minimum prices payable to the producers as established by the national authority in the field of agriculture or the actual prices paid, if higher to such minimum prices.
Companies conducting agricultural and cattle-related activities also have a different taxation treatment because they are subject to income tax based on gross revenues calculated on progressive tariffs from 1 per cent to 1.8 per cent if their products are destined for local consumption and of 1.3 per cent to 2 per cent if the products are exported, provided the goods are not subject to industrial transformation. Flower producers are not included in this special regimen. The market prices of the product are the bases to calculate the gross revenue.
All company revenues and earnings are subject to income tax in Ecuador, except income obtained abroad if it was taxed abroad unless such income is obtained in tax havens. Under specific tax treaties implemented to avoid double taxation, including the Andean Community of Nations regulations on double taxation, source-of-income principles on income taxation are applicable.
Under the general taxation structure, all expenses directly incurred to obtain, maintain and increase revenues by the company are deductible provided that they are shown in legally approved invoices, and if such expenses were incurred for payments abroad, a withholding income tax of 22 per cent is withheld.
Generally, 20 years' amortisation is applicable to buildings and constructions, while three to five years' amortisation is applicable to movable property, although under specific conditions, faster amortisation might be applied considering the obsolescence of the assets, while amortisation of investments, including pre-operational investments, is five years. Intangibles are amortised over 20 years. However, under international accounting standards rules, companies may establish their own amortisation and depreciation rates according to the effective life of each asset. Amortisation of 100 per cent is provided for the acquisition of equipment destined to improve clean production, the generation of renewable energy or reduction of environmental harm.
Losses may be amortised or carried over for a period of five years, with a maximum of 25 per cent of the losses per year.
Individuals, including those conducting commercial business without a company structure, are taxed at a progressive rate from 5 to 35 per cent. Dividends earned from companies are added to individuals' income, and taxed on the amount equivalent to 40 per cent of the received dividend.
Fiscal years correspond to calendar years. Income tax returns are filed during the first four months of the year by companies, and during the first three months by individuals, when the income tax or any balance thereof is also paid. Advanced income tax payment for the next year is equivalent to 50 per cent of the income tax of the preceding year, calculated after deduction of the amounts withheld at the source of the income. This is paid in two instalments during July and September. Such advanced income tax is calculated on the basis of the mathematical addition of 0.2 per cent of the net worth, 0.2 per cent of the expenses, 0.4 per cent of the total assets and 0.4 per cent of taxable income if such sum is higher than the advanced payment calculated on the basis of 50 per cent of income tax. Tax returns and tax payments are filed and made through private banking institutions.
The SRI is the only national administrative body regarding income tax, VAT, tax on special consumption and tax on remittances of money abroad, and other national taxes except customs duties, which are under the control of the National Customs Corporation. Municipalities administer and control municipal taxes such as, inter alia, real property tax, tax on transfers of real property, tax on capital gains derived from the sale of real property, tax on business capital assets and business year authorisation tax. The SRI has offices and agencies in all cities in Ecuador.
The SRI and other tax authorities have the power to regulate the application of taxes and answer matters raised by taxpayers, which become binding. The SRI has the power to audit national taxes and to decide on administrative claims filed by taxpayers concerning the results of tax decisions. Taxpayers may claim against original tax decisions or final administrative decisions before the courts. However, to suspend the enforcement of the decision of the taxing authorities, in the event a judicial claim is filed, a bond equivalent to 10 per cent of the tax debt should be rendered, otherwise the action brought will not be admitted.
Holding companies – that is, companies whose only corporate purpose is to own shares, quotas or rights in other companies with the purpose of having direct control over such other companies – may consolidate the financial results of all of the controlled companies, but for the purposes of taxation, each company forming the economic group is an independent taxpayer.
For the purposes of control by the SRI and other tax authorities, economic groups are those where one or more persons have at least a 40 per cent participation in other companies. The importance of economic groups relates to the rules on transfer pricing either internally or externally.
ii Other relevant taxes
VAT is applicable to the transfer of ownership or to the importation of movable goods of a corporeal nature in all phases of trading, as well as to the transfer of copyright and connected rights, and industrial property rights, and to services rendered as provided in the law. The ordinary rate is 12 per cent of the price or value of the good or service, except for some transactions that are subject to a zero per cent rate (which means that, in practice, there is tax).
Transfers for the purposes of the application of VAT are any act or contract intended to transfer ownership of the above-mentioned goods or rights, either by sale or gift, and the use or consumption of corporeal movable goods produced by the user or consumer.
Certain transactions are not subject to VAT, including:
- contributions to the capital of companies;
- sales of total assets and liabilities of all kinds of businesses;
- adjudications in the case of partitions of estates or liquidated companies, or dissolved marital property;
- company divisions;
- donations to public entities or to non-profit organisations; and
- transfers of shares, quotas or participations in companies.
VAT paid in the acquisition of goods or services are tax credits with respect to VAT generated in the transfer of goods or rendering of services by a taxpayer subject to VAT.
Tax on special consumption is applicable to the importation or transfer of specific movable goods of a corporeal nature or to specific services determined by law, such as cigarettes, alcoholic beverages, sodas, perfumes, video games, firearms, incandescent bulbs, vehicles, aeroplanes, ships, paid television services, casino services and social club affiliation services. The rates vary from 10 to 300 per cent of the price of the goods or services.
Other important taxes are:
- the 5 per cent tax on any transfer of money abroad, except importations and the payment of registered foreign loans;
- the annual contributions to the Superintendence of Companies by companies controlled by such entity, mainly stock corporations and limited liability companies, and to the Superintendence of Banks and Insurance by the companies controlled by such entity;
- the annual municipal taxes on total assets of commercial business (at a rate of 0.15 per cent); and
- customs duties.
All transfers of assets or rights to juridical persons or individuals domiciled in tax heaven jurisdictions are deemed as donations and subject to the applicable tax.
The municipalities also collect taxes on real property and on the transfer of real property, including taxes on capital gains derived from the sale of real property. There is also a tax on funds maintained abroad by financial companies and banks, and by companies managing funds and trusts.
Under the Environmental Development and State Resources Optimisation Act of 2012 (Act of 2012), banana production is subject to income tax calculated on the basis of a rate of 2 per cent on gross revenues. This way of determining income tax might be applicable, if requested by the producers' associations, to agriculture, fisheries and aquaculture activities. The Law on tax incentives for certain sectors, in force since 12 October 2016, imposes on other subsectors of agriculture activities, as well as on other subsectors of the fishery industry and of the aquaculture industries, a tax of 1 to 2 per cent on gross revenues.
Under the Act of 2012 and its amendments, rates for a special consumption tax on beer and cigarettes were increased through different models of calculations of taxation on units and ad valorem, or a mixture of both. Special consumption tax rates on other goods were also changed, especially in connection with vehicles, to encourage the production and importation of hybrid or electrical vehicles.
A special tax on environmental contamination is applicable to persons or companies that are owners of motor vehicles. The rates are established on the basis of the impact to the environment (based on the size and the age of the vehicle).
Tax residence and fiscal domicile
i Corporate residence
Companies incorporated in Ecuador should determine the city of their domicile. Foreign companies that have decided to conduct activities in Ecuador may obtain the approval of the Superintendence of Companies to establish a branch in Ecuador, while financial institutions, insurance companies and banks may obtain the same authorisation from the Superintendence of Banks and Insurance. With such authorisations, the entities involved establish the tax domicile of such branches as Ecuador at the same time. Like most taxpayers in Ecuador, they should register as taxpayers with the SRI.
Foreign companies receiving earnings from an Ecuadorian source may appoint an attorney-in-fact to represent them with respect to tax obligations in Ecuador. Taxpayer registration should also be obtained.
Financial institutions may have representatives in Ecuador, but they are not allowed to transact business.
ii Branch or permanent establishment
Branches of foreign companies authorised to conduct business in Ecuador are subject, in general, to the same tax regime as domestic companies.
Permanent establishments of foreign companies are qualified by the SRI if specific factors or elements of permanent presence in Ecuador exist, such as places to conduct economic activities in Ecuador, factories, warehouses, offices or a person with enough power to act as an agent of the foreign company. Such permanent establishments are taxed on the same basis as other companies doing business in Ecuador, whether incorporated in Ecuador or established as branches of foreign companies.
Tax incentives, special regimes and relief that may encourage inward investment
i Holding company regimes
Holding companies, namely, companies whose only corporate purpose is to acquire and maintain shares in other companies for the purposes of controlling them, may consolidate their balance sheets with the controlled companies, but each one of the controlled companies has an independent taxation regime. It is deemed that economic groups are formed by companies whose shares are owned in a proportion of 40 per cent or more by the same company or by the same group of companies, or belonging to the same physical persons. Holding companies are not subject to advanced payment of income tax that other companies and other taxpayers are.
ii IP regimes
Special tax regimes have been incorporated to the legislation. These regimes are based on taxation on gross revenues. Besides, special incentives consisting in exoneration of income tax during certain periods of time have been granted to new investment in several areas, including the industries of fresh food, forestry, metal and mechanical, petrochemical, pharmaceutical, tourism, renewable energy, cinematography, audiovisuals, biotechnology, applied software, logistic services, hospital infrastructure, educational services, and cultural and artistic services.
A special taxation regime on income tax, VAT and special consumption tax has been established for microenterprises, with the exception of those devoted to construction and land development and to professional services.
iii State aid
Investors conducting business as concessionaires of state-owned resources may enter into investment contracts with the government, whereby the state may guarantee that the economic equilibrium in the contract will be maintained if laws increasing the taxation affecting the concessionaire are implemented.
Reinvestments of company profits through capitalisation, if such capitalisation is destined for the acquisition of capital assets destined for production and scientific development (except real property), are subject to income tax at a rate of 12 per cent instead of 25 per cent.
Foreign investors not domiciled in tax havens are not subject to income tax on profits or dividends earned from local companies in which they own shares or have participation. However, as previously explained, the companies pay income tax on the companies' profits, which, with the exception of dividends received by physical persons, dividends received by companies as stockholders or partners of other companies, are not double taxed.
Special deductions are granted for five years for expenses incurred in training aimed at research, development and innovation conducted by medium-sized companies, as well for the expenses of such companies aimed at improving productivity or incurred during travel for commercial promotion and access to international markets.
Newly incorporated companies that have their activities in cities other than the urban areas of Quito and Guayaquil, and that are carrying out food production, forestry and products thereof, or are producing or involved in metal mechanisms, petrochemicals, pharmaceuticals, tourism, renewable energy, logistical services in foreign commerce, biotechnology, software and strategic sectors determined by the president, are income tax-exempted for five years after starting productive activities on revenues derived from new investments. This tax exemption to new companies has extended to companies devoted to services on hospitals structures, educational services and cultural and art services.
New productive investments, made after 21 August 2018, in agriculture, forestry, metallic mechanical industries, the petrochemical and oil chemical sector, pharmaceuticals, tourism, cinematography, audiovisuals, renewable energy, logistic services for foreign commerce, biotechnology and applied software, exported services, development and services of software, production and development of technological hardware, digital infrastructure, digital content, online services, energy efficiency, sustainable industries on materials and technology of construction, industrial, agro-industrial and agro-associative sectors, as well as sectors considered as strategic substitutes of import will be exempted for 12 years after the first year of generation of revenues, except if such investments are located in the urban areas of the cities of Quito and Guayaquil, which will enjoy such exemption for eight years after the first year of revenues earnings.
However, private financial companies, banks and issuers of credit cards do not enjoy the benefit of a 10 per cent deduction on income for reinvestment of profits, and have the duty to anticipate income tax on the basis of 3 per cent on gross revenues (with a possible reduction to 1 per cent). The monthly tax rate on funds and investments abroad of financial institutions and companies devoted to investment funds and trusts is established at 0.25 per cent, which increases to 0.35 per cent in the case of deposits or investment in tax havens.
Financial services are subject to 12 per cent VAT, instead of zero per cent.
Banks and financial institutions are under the duty to supply the SRI with any requested information of concern to taxpayers as the clients of such entities, without restriction.
The banana industry, including growing and production, either for local sale or export, is not subject to income tax provision but to taxation on gross revenues in rates from 1 per cent to 3 per cent, under detailed special regulations, including quality control. Agricultural and cattle productive activities and industries are taxed on the basis of gross sales at rates from zero per cent to 2 per cent. Microenterprises have a flat tax rate of 2 per cent on gross revenues and are subject to special treatment concerning withholding taxes, VAT and special consumption tax.
Withholding and taxation of non-local source income streams
i Withholding on outward-bound payments (domestic law)
All kinds of payments or credits abroad representing taxable income or reimbursement of taxable income are subject to 25 per cent withholding by domestic companies and business entities. Because companies' profits are taxable income for the companies, no withholding is applicable on taxes, unless the person or company receiving the dividend is a resident of a tax haven or of a country having a tax burden lower than the tax rate in force in Ecuador. Withholding is not applicable to reimbursement of expenses if certified by international firms of auditors doing business both in Ecuador and in the foreign country, unless reimbursement corresponds to fees, royalties or commissions.
ii Domestic law exclusions or exemptions from withholding on outward-bound payments
No withholding is applicable to:
- payments for imports;
- commissions paid for exports and tourism promotion if they do not exceed 2 per cent, except if the beneficiary is a party related to the exporter, a beneficiary of the tourism promotion or domiciled in a tax haven;
- 60 per cent of the interest in foreign loans registered with the Central Bank;
- payments abroad incurred by air or sea transportation companies connected with their operations in Ecuador, and similar expenses of high sea fishing companies related to such high sea activities;
- 96 per cent of reinsurance premiums paid to reinsurers not established or not having a representative in Ecuador;
- 90 per cent of payments made to international press agencies registered in Ecuador;
- 90 per cent of ship freight; and
- payments for international leasing of capital assets if the interest is no higher than the LIBOR rate, unless the lessee does not opt to acquire the leased assets, provided that the leasing is not made with persons linked with the lessee or payments made to tax havens, or the lease term is lower than the estimated life of the asset.
Indirect expenses charged from abroad to companies domiciled in Ecuador by their related parties are deductible expenses for the local company or the company doing business in Ecuador, provided such expenses do not exceed 5 per cent of the basis of the taxable income. In the case of companies conducting activities in the area of non-renewable natural resources, expenses connected with technical and administrative services are also considered among these indirect expenses.
iii Double tax treaties
Ecuador is a member of the Andean Community of Nations (CA) and is, therefore, ruled by Andean decisions on double taxation that establish, as a general principle, that income tax is only applicable in the country where the activity of the company is located, and that no withholding tax may be applied in connection with payments from one member country to another member country of the CA.
Treaties to avoid double taxation are in force with Argentina, Belgium, Brazil, Canada, Chile, France, Germany, Italy, Japan, Mexico, Romania, Spain and Switzerland. The treaty with Argentina is limited to air operations.
Ecuador is also a member of the 1979 Madrid Convention to avoid double taxation on copyright royalties and droit de suite.
Bilateral treaties are framed on the basis of the principle of origin or source of the income to establish the power to tax and the right of taxpayers to credit tax paid abroad. Some of them, such as the treaty with Italy, provide for a maximum rate of withholding tax.
If income has been imposed abroad to companies domiciled in Ecuador, there is no taxation in Ecuador, irrespective of any treaty provisions, unless income was taxed in tax haven jurisdictions.
iv Taxation on receipt
All companies should withhold 25 per cent of all dividends paid or advanced. In the case of dividends received by physical persons residing in Ecuador, such withholding constitutes a tax credit. If received by other companies established in Ecuador, it is a final income tax. If dividends are remitted abroad, the withholding is attributed as income tax for the person who has received the dividends so as to enable such foreign taxpayer to use it as a tax credit.
Taxation of funding structures
Together with original capital contributed by stockholders, quota holders or, in general, partners, companies are funded with credit, including credit from partners and issuance of debentures or bonds, which is only permitted for stock corporations.
i Thin capitalisation
Tax laws do not establish restrictions on debt or equity restrictions, but regulations on banks do provide such restrictions. Company losses should not exceed 50 per cent of net worth, otherwise companies should be dissolved unless such losses are offset either by direct contribution of the stockholders or partners, or through an increase of capital.
Investment funds should reach a net worth of at least US$52,578 within six months of starting operations provided they have at least 75 participants, otherwise they should be liquidated. Funds are under the control of the National Securities Council that works within the Superintendence of Corporations, which issues regulations for their operations.
Investment funds and complementary funds are tax-exempt, provided they withhold income tax, as applied to dividends, to participants.
ii Deduction of finance costs
In general, all finance costs are tax deductible except costs, including interest on foreign credit if the credit has not been registered with the Central Bank, or interest exceeding the tariffs established by the board of directors of the Central Bank, on the portion above the tariff. To deduct interest on foreign loans registered with the Central Bank, the amount of such loans should not exceed 300 per cent of a company's net worth or 60 per cent of the total assets of physical persons.
iii Restrictions on payments
The general principle is that net profits should be distributed unless intended for other uses, such as capital contributions or the offset of losses. Stock corporations and limited liability companies should distribute at least 50 per cent of net profits unless there is a decision otherwise unanimously approved by the general meeting of stockholders or quota holders. Therefore, the payment of dividends on such 50 per cent of net profits is compulsory, unless otherwise approved unanimously by such general meetings. To overcome the objection to direct profits towards other objectives, after declaring dividends on the proportion established in the law, the general meeting may approve a capital increase by the offset of credits on the amount declared as dividends.
iv Return of capital
Reduction of capital is allowed if the remaining capital permits the company to continue the business. Such reduction of capital does not generate income tax.
Acquisition structures, restructuring and exit charges
Unless foreign companies already have a corporate entity in Ecuador, they acquire companies in Ecuador through a company incorporated abroad. Normally the business is created through an acquisition of shares, after due diligence, because such transfer does not generate any tax.
Mergers do not generate any taxes. The surviving company is liable for all tax obligations of the merging companies. Only mergers between companies established in Ecuador are allowed.
Divisions of companies do not generate taxes. The agreement to split a company must determine how the companies will divide the profit and losses for the period the division is registered. Such agreement may provide that one of the companies will have the profits and losses of the original company. If the losses and profits are divided among the new companies, the profit and loss statement should establish an equitable allocation of the revenues with the costs.
A change of corporate domicile within Ecuador does not incur any tax penalties or effects. A change to a domicile abroad causes the dissolution of the company.
Anti-avoidance and other relevant legislation
i General anti-avoidance
Companies established in tax havens or low-tax jurisdictions, when transacting with local companies, are deemed related companies and, therefore, the costs incurred in such transactions are tax deductible only if their value corresponds to the commercial principles of arm's-length dealings.
Dividends received by companies established in tax haven jurisdictions or low-tax jurisdictions are not tax-exempt, and are therefore deemed taxable income.
An important decision was entered on 18 July 2013 by the Taxation Chamber of the National Court of Justice5 declaring as acceptable tax-deductible expenses the interest paid to related companies based on a contract between the Republic of Ecuador and a company operating an oil pipeline. However, through an action for extraordinary protection that under the Constitution is designed to guarantee due process of law, and to defend constitutional, human rights and civil liberties, the SRI obtained from the Constitutional Court vacation of the final decision6 and ordered the alternate judges of the Taxation Chamber of the National Court of Justice to enter a new decision, which was issued on 24 July 2014,7 by newly appointed associate judges, which considered that interest paid by the company operating the pipeline under a contract with the Republic was not a deductible expense, and established a new income tax with a surcharge of 20 per cent as a sanction for the taxpayer corporation. Previously, the Council of the Judiciary, without granting the judges that issued the 18 July 2013 decision the right to a hearing, had suspended and dismissed these judges.8 The Council of Citizenship Participation and Social Control dismissed all the Constitutional Court judges that rendered the decision.
ii Controlled foreign corporations
No special tax rules exist with respect to companies established in Ecuador that are controlled by foreign corporations.
All companies under the control of the Superintendence of Banks or the Superintendence of Companies having foreign companies as share or quota holders should remit to such entities the list of the partners of such foreign companies or a certificate providing evidence that they are public companies whose shares are registered on a stock exchange.
iii Transfer pricing
The transfer pricing regime is established with the purpose of ensuring that prices between related parties are established under the same parameters as prices between independent parties. Therefore, such prices should reflect principles of competition and comparability, and a methodology for establishing such prices is submitted for the approval of the SRI.
However, the transfer pricing regime is not applicable if the taxpayer pays income tax equivalent to at least 3 per cent of total gross revenues, does not conduct business with residents in tax havens or low-tax jurisdictions and does not have contracts with the state for the exploration and exploitation of non-renewable resources.
iv Tax clearances and rulings
It is possible to consult the SRI or other tax authorities on the interpretation and application of tax laws. The answers to such consultations are compulsory for both the tax authorities and the taxpayer, which constitutes a risk for the taxpayer. There are no cases of legal requirements to have such tax ruling in advance with respect to acquiring local business or in other cases linked to income tax.
Year in review
Since 2009, all physical persons having a patrimony higher than US$200,000 have been required to present each year a declaration concerning their assets and liabilities. Purportedly, this information will permit the establishment of a tax on the patrimony of physical persons in the future – a tax that has the support of the SRI's main officers as a means to reduce alleged inequalities. Regulations enacted during 2012 have established that physical persons not having the obligation to bear accounting books but with a certain level of gross revenues should report (in online form) all their expenses on a monthly basis to the SRI.
The Organic Law for Productive Development, published on 21 August 2018, re-established the rate of 25 per cent for corporate income tax, but this rate was increased to 28 per cent for companies having stockholders, partners, participants, incorporators, beneficiaries or similar physical persons regarding whom the companies have not informed to the regulator authority and to the SRI or if within the channel of ownership there are residents linked with a tax haven.
Such law also provided for a progressive capital gain tax of 2 per cent to 10 per cent on the sale of shares or other participation titles on companies.
As a consequence of the complete reorganisation of the judicial system during 2012, constantly on-going, the judges appointed for the majority of the tax courts are former officers of the SRI, which has led to suspicion regarding their impartiality.9
The surcharges on imports were eliminated as a consequence of a formal proceeding initiated by the Secretary General of the Andean Community.
The organic Law to avoid the evasion of taxation on inheritances is still in force. Thereunder, beneficiaries of trusts are subject to progressive taxation of between 5 per cent and 35 per cent.
A Public and Private Alliance Act establishing tax exemptions or benefits for energy and mining investment projects, supported by government planning, entered in force on 18 December 2015. Such law aims to encourage public projects in association with private investors by avoiding the rules for public contracting for specific projects.
VAT returned to 12 per cent from mid-2017. A special law on capital gains derived from sale of real property was enacted on 31 December 2016 establishing a rate of 75 per cent on the difference of the price at the time of acquisition after 1 January 2017 and the price of the first sale thereafter. Under the plebiscite called by President Moreno, such law was abrogated.
The Organic Law on Reactivation of the Economy, in force since 1 January 2018, exempted microenterprises from income tax for three years, eliminated the exemption of income tax on reinvestment of corporate profits, increased personal income tax for professionals, granted the SRI authority to establish presumptive profits, returned to the old income tax rate of 25 per cent for corporate income, except for microenterprises and exporting companies, established special tax reductions of value added tax if payment is made electronically, increased the term for the expiry of customs duties and other taxes based on statute of limitations, created a special gazette destined to inform taxpayers of audits and observations, and increased the powers of the Superintendence of Banks.
The Organic Law for Productive Development, in force since 21 August 2018, created special tax incentives exempting from income tax for 12 years new companies devoted to listed activities and businesses, granted a tax amnesty for payment of taxes owed condoning fines and interest, permitted the submission to international arbitration under specific rules controversies between the state and foreign investors investing tens of millions of dollars or more under investment contracts, and established additional tax incentives and benefits to private parties entering into alliances with public entities for conducting joint projects in specific areas. The Law also eliminated the subsidy to high-octane fuel, but maintained the subsidies for low-octane fuel and diesel.
Outlook and conclusions
A new trend to develop private investment, including foreign investment, has been implemented since 24 May 2017, when President Lenin Moreno was sworn in. Certain actions against corruption have been taken mainly through the Council of Citizenship Participation and Social Control, which dismissed all the members of the Council of the Judiciary to try to support the independence of the judicial system. The Council also dismissed, as said above, all the judges of the Constitutional Court because of allegations of corruption. The newly appointed Constitutional Court has taken decisions on debatable issues. An amendment to the Criminal Code was approved during the final days of December 2020 by the National Assembly, introducing new infringements described as corrupt practices, and including provisions to deprive infringers of their property.
The former government had appropriated and confiscated the revenues of private pension funds and had used funds destined to cover the social security benefits of retired persons in the public healthcare sector. The retirement pensions of members of the armed forces and of members of the national police were also reduced. The net worth and the cash flow of companies devoted to prepaid medical care has been affected by a law ordering that such companies should reimburse the amounts covered by the Social Security Institute.
A new Criminal Code, in force since 10 August 2014, considers as criminal offences subject to imprisonment several acts connected with accounting books and supporting documents triggering a reduction in taxes. Criminal liability is also established for juristic persons and corporations subject to the sanction of extinguishing their legal existence. Criminal cases under these new provisions may be brought even without sufficient evidence.
A new Organic Monetary and Financial Code, in force since 12 September 2014, contains provisions that may ease the elimination of the dollar as the country's legal currency and the introduction of a new local currency, but the Organic Law for Productive Development, in force since 1 January 2018, has strengthened the dollarisation in force in Ecuador since January 2000.
On 31 December 2019, a law designed to simplify and bring progress to the taxation system was promulgated, containing new ways of taxing specific industries and microenterprises. However, it also imposed special contributions destined to finance the high state expenses and eventual deficit, payable during 2020, 2021 and 2022 by corporations that had earnings above US$1 million dollars during 2018, with tariffs from 0.1 per cent to 0.2 per cent, with a cap equivalent to 25 per cent of the income tax paid during 2018. This way of collecting taxes in advance of the fiscal year, based on balances of the previous fiscal period seems contrary to the Constitution as it implies to establish retroactive effects to taxation laws, which contravenes constitutional provisions. Actions requesting to declare that such provisions are contrary to the Constitution have been filed, but no decision from the Constitutional Court has yet been rendered. During 2020, the tax courts delayed the prosecution of many cases because of the pandemic and the reorganisation decreed by the Council of the Judiciary destined to establish fixed three-member panels instead of a system of loop judges for each case. 'The Organic Act for Humanitarian Support to Combat the Health Crisis Derived from Covid 19' enacted on 22 June 2020, encouraged an advance payment of income tax offering the payment of normal interest on such advanced payments. The Ministry of Economy and Finance have announced new amendments to taxation laws as agreed in the letter of intention signed by Ecuador with the International Monetary Fund. A treaty to avoid double taxation signed on 15 January 2019 with the Kingdom of Japan was published in the Official Registry on 30 January 2020 and, therefore, is locally applicable since then by the internal revenue service and other tax authorities.
1 Alejandro Ponce Martínez is a senior partner at Quevedo & Ponce.
2 Prophar SA v. Judge Gabriela Lemos.
3 Prophar SA v. Merck & Co. Inc.
4 Merck & Co. Inc. v. the Republic of Ecuador.
5 Compañía Oleductos de Crudos Pesados v. Servicio de Rentas Internas.
6 Servicio de Rentas Internas v. Taxation Chamber of the National Court of Justice, 26 December 2013.
7 Oleducto de Crudos Pesados (OCP) Ecuador v. Servicio de Rentas Internas.
8 Disciplinary action Servicio de Rentas Internas v. Judges José Suing and Gustavo Durango, 20 December 2013.
9 In Juan Quevedo v. Servicio de Rentas Internas, the tax court of first instance ruled that even companies not having net worth and that only represent individuals are subject to anticipate income tax, which applied to double tax individuals. The National Tax Court refused to hear the case.