The Tax Disputes and Litigation Review: Ecuador

Introduction

In Ecuador, tax disputes can be dealt with through administrative and judicial channels.

An administrative challenge must be resolved by the Tax Administration within 120 business days of the claim being filed. Administrative decisions can also be challenged before the Tax Disputes Court, which typically takes one to two years. Either party may appeal a Tax Disputes Court decision to Ecuador's National Court. Appeals take approximately two years.

In judicial processes for other matters, there are two stages before the matter will reach the National Court, therefore the judicial tax process is considered to have fewer steps than those of other matters.

Broadly speaking, the Ecuadorian Tax Administration maintains a rigid position during tax disputes. We consider that the Tax Administration does not maintain openness while negotiating penalties due to lack of economic reality in taxpayer dealings and when the dispute involves the participation of shell companies or fake companies. Due to new legislation, in the future it will be necessary to verify the Treasury Department's position during negotiations.2

Until 2021, tax disputes could be heard before the Tax Disputes Court and in the headquarters of the Tax Administration. The Economic Development Law of 29 November 2021 introduced mediation as an alternative method of conflict resolution (see Section VII).

Tax dispute hearings may deal with the determination and collection of tax obligations, interest, surcharges and fines, as well as the terms and facilities for the payment of the debt, and the lifting of precautionary measures issued on the taxpayer.

Reaching a deal to resolve a tax dispute may involve the Tax Administration or taxpayer making concessions on factual aspects of disputed valuations while determining the tax base or during the dispute process. However, a deal will not compromise the general understanding or scope of legal concepts, but may adjust how such concepts apply in that specific case.

Commencing disputes

In order to initiate a challenge to a tax determination, a claim must be filed with the Tax Dispute Court (taxpayers maintain the status of plaintiff in judicial tax proceedings) or with the administrative headquarters of the Tax Administration.

The Tax Administration has the legal power to review tax returns made by taxpayers, which it uses to determine whether the tax settlement is correct or there are differences.

The Tax Administration can start the process of determining tax with a determination order. After the review process, it issues a Preliminary Determination which the taxpayer may present arguments against. Finally, the Administration will issue a Definitive Decision in which it establishes differences detected, if any exist.

There is a simplified process for smaller amounts, in which the Tax Administration issues a Communication of Differences which the taxpayer can challenge, followed by a Settlement of Differences where the Administration establishes penalties that will apply.

The Tax Administration's decisions can be challenged in administrative or judicial proceedings. Generally, the trigger for a legal dispute around taxes is the issuance of an administrative decision that is against the interests of the taxpayer. The grounds taxpayers may file an appeal against a tax determination include resolutions issued within administrative claims against determinations and resolutions issued within tax refund applications. There are cases in which requests for tax refunds have generated reviews of tax settlements by the Tax Administration. A dispute may also arise due to the Treasury denying a tax refund.

The Tax Administration can issue orders and resolutions following requests from taxpayers that will bind the taxpayer, but disputes can only be initiated by taxpayers.

A taxpayer must file a lawsuit challenging an administrative decision with the Tax Disputes Court within 60 working days from the day they were notified of the decision. Administrative challenges must be filed with the Tax Administration within 20 working days from the same date.

Tax disputes can be resolved through mediation (see Section VII). We believe challenges made through mediation could be resolved quicker than those made through ordinary judicial channels. Generally, mediation may be proposed during an initial hearing of a judicial proceeding.

The courts and tribunals

In Ecuador, challenges to the Tax Administration's decisions are heard in a Tax Dispute Courts before three judges. Which court holds jurisdiction depends on the matter, the territory and the class of action proposed. In the event that an appeal is filed with the National Court of Justice, it must be approved by a co-judge and sent to a specialised chamber made of three magistrates, which holds jurisdiction at the national level for certain subjects and types of cases.

Both the judges of the Tax Dispute Courts and the National Court are independent of Ecuador's tax authorities.

In general, a judicial tax dispute before a Tax Dispute Court begins with the presentation of a claim. The judges classify the claim and notify the Tax Administration so that it can present its response. In an ordinary dispute process, the judges convene a preliminary hearing where the points of the dispute are set out and the evidence that will be presented is declared. In the following hearing, which corresponds to a trial, the announced evidence is presented and both parties present their arguments. In the event of a summary process, the judges convene a single hearing where all of the ordinary process stage takes place. Summary processes are usually used during enforced collection processes.

The judicial system in Ecuador is oral, so although the actions of the parties must be based on a written complaint and provided evidence, oral presentation of the arguments by the parties is of vital importance, as is the presentation of evidence.

The stages of a Tax Dispute Court hearing do not vary due to the complexity of the dispute or the amount involved; however, the time in which cases are resolved does vary.

A judgment issued by the Tax Disputes Courts can be challenged through an appeal to the National Court. An appeal, which can take approximately two years to be resolved, may only refer to legal errors in the Tax Disputes Court's ruling and is the final stage of a tax dispute. However, an extraordinary protection action may be filed with the Constitutional Court regarding a National Court ruling, if there is a possible violation of constitutional rights. An appeal to the Constitutional Court can take approximately three years to be resolved. All parties to a dispute have the right to present a cassation appeal to the National Court or an extraordinary protection action, provided that legal requirements and formalities are met. In Ecuador, disputes with the tax authorities are frequently resolved by the Constitutional Court.

Generally, the rulings issued by the Tax Disputes Court's judges do not form binding precedents. However, if the National Court's judges issue three concordant rulings and declare this a mandatory jurisprudential precedent, the ruling becomes binding on taxpayers, the Tax Administration and the judges of the Tax Disputes Court.

Penalties and remedies

According to our Tax Code, civil sanctions (fines) can be imposed for two types of violations: contraventions, which are violations of formal tax compliance provisions imposed by law, and regulatory offences, which are transgressions of formal tax compliance provisions imposed at a lower level under the law. The penalties for contraventions and regulatory offences are fines of between US$30 and US$1,500 and US$30 and US$1,000 respectively.

There are other sanctions provided for in tax regulations, such as fines for financial entities failing to deliver information and fines for non-compliance by entities at the source of income tax (e.g., withholding agents). If a tax liability is determined after a tax review, the taxpayer is subject to a penalty charge of 20 per cent of the liability.

From the criminal perspective, the applicable penalties for tax fraud can range from one year to seven years in prison. The main causes of tax fraud are:

  1. failing to deliver monies received or withheld from taxes;
  2. the use of false identities, tax documents or accounting records;
  3. the use of deductions to which the taxpayer was not entitled;
  4. the use of non-existent invoices or invoices that do not match actual transactions;
  5. the use of closed premises;
  6. the illegal sale of alcohol without a licence;
  7. the omission of income or the transfer of tax benefits; and
  8. the use of non-existent companies to obtain deductions.

Although criminal tax offences are not common in Ecuador, there have been cases in which the Tax Administration has proposed prosecution and followed criminal proceedings to their conclusion. These cases are processed through the criminal courts following the standard procedure for a criminal trial, in which the accused's right to defence and access to all legal petitions relevant to the case are guaranteed.

With regard to administrative procedures, it is common for the tax authority to initiate sanction processes when reviews confirm regulatory faults, violations or other infractions. These procedures guarantee the right to defence, and any penalty can be challenged before the Tax Administration or the judicial authorities. Administrative sanctions include the confiscation of merchandise, the origin of which cannot be proved (this mainly occurs in cases regarding the transfer of goods) and the closure of commercial premises (this mainly occurs in cases involving the failure to deliver information and or to issue invoices).

Finally, national local legislation does not allow agreements or mediation in punitive administrative matters between taxpayers and the Tax Administration.

Tax claims

i Recovering overpaid tax

Overpayment of taxes, or payments made in error, can be recovered through administrative channels or through a hearing at a Tax Disputes Court (see Sections II and III). Administrative claims for refunds of undue payments or overpayments must be filed with the Tax Administration within three years from the date the payment was made. Such claims must be processed within 120 working days; if the Administration fails to issue a response before that deadline, the taxpayer's claim is assumed to succeed.

Foreign taxpayers also have the right to recover undue payments of tax, however they must grant a power of attorney or judicial proxy to a person in Ecuador to invoke this right.

The amount repaid to a taxpayer will include interest calculated from the moment the claim or request was made. The applicable rate is the reference active rate for 90 days established by the Central Bank of Ecuador.

Until 2021, there was an anti-avoidance rule that prevented the automatic application of the Agreements to Avoid Double Taxation, for which, without prejudice to the distribution of the tax power according to the Agreement, Ecuadorian tax residents had to apply a withholding tax at the source in Ecuador when making payments abroad. Despite the Tax Administration reimbursing withheld monies if verification of the transaction's economic status and the application of the Agreement showed Ecuador did not have the right to tax the payment, due to a series of errors and misinterpretations this policy hindered both the application of the Agreements to Avoid Double Taxation and the recovery of taxes. However, this regulatory provision was repealed in fiscal year 2022.

During the recovery of taxes, if the Tax Administration considers there is evidence of omissions or mistakes within a tax return, a complementary assessment process can be opened, which can cause the tax recovery process to be deferred until the authority verifies tax credits have been correctly applied.

In Ecuador, a taxpayer cannot assign a nominee to settle their tax liability on their behalf by means of a private contract, but certain joint and several liabilities or substitutions may affect who must pay the taxes due. However, the Tax Administration may use the civil right of repetition to recover taxes due from a taxpayer.

The fiscal consequences of professional negligence actions and the generation of excessive payments or indemnity guarantees must be collected through civil proceedings. In these cases, contract stipulations must be considered. However, initiating legal action regarding professional liability does not require a formal written contract.

ii Challenging administrative decisions

Ecuador's Constitution grants the principle of coordination, which means that all public entities must apply legal provisions equally to all parties in similar cases. The decisions of judicial authorities can be referred to during tax disputes before the Tax Administration or judicial authorities in which the rights of contributors are disputed. However, these judicial decisions do not form precedents that must be followed by the Administration or judicial authorities when deciding tax disputes.

When using its management and regulatory powers, the Tax Administration has the legal obligation to issue resolutions and updates (rules of lower hierarchy) that assist in the correct application of laws and regulations. General resolutions that contravene the law can be challenged before the courts, however taxpayers have the right to make queries to the Tax Administration in order to understand the scope of a rule. The Administration will be bound by its answer and is obliged to respect any information the taxpayer making the query provides as accurate. Although the Administration can review queries containing errors at any time, a revised decision cannot be applied retroactively – it only applies to future cases.

Within transfer pricing, a company may raise a prior valuation enquiry (an advance pricing agreement (APA)) to understand and validate if a proposed transaction conforms to the arm's-length principle.

Also, new and productive investment schemes may obtain investment protection contracts order to obtain tax stability with respect to certain benefits.

If the Tax Administration does not comply with guidance it issued in when responding to a query, a taxpayer may request compliance by means of administrative or judicial proceedings. In certain circumstances, taxpayers may also make use of the constitutional appeal process (see Section III).

Guidance or applications granted to a taxpayer do not form binding precedents for the Tax Administration. However, the National Court of has repeatedly ruled that the Tax Administration is required to follow and comply with guidance and applications it grants, therefore other taxpayers may use these as the basis of their defences and as evidence during administrative and judicial tax disputes.

iii Claimants and related parties

In general terms, a tax claim can be submitted by the taxpayer or a person with a direct interest in the tax. In the case of value added tax, the person accepting the tax credit originating in the payment of VAT will be challenged by the tax authorities, therefore they are the person authorised to file a claim with the authorities regarding this tax.

A claims for the repayment of an overpayment of tax can only be made by the taxpayer. The Tax Administration may credit overpayments towards the applicant's outstanding debts and obligations, but not towards those of any other parties. However, the Administration may only collect underpaid taxes directly from a taxpayer by means of an additional assessment process.

Costs

As the state cannot be ordered to pay costs, a judicial ruling that is favourable to the taxpayer does not obligate the state to compensate the litigant. Likewise, if an administrative proceeding finds for the taxpayer, the state will not pay the taxpayer's costs, as charges are not part of the procedure and or a matter of decision of the Tax Administration, as it is, in general terms, a claim issued by the taxpayer to the tax authority.

On the other hand, we have not found any judicial or administrative norm nor custom requiring a taxpayer to pay the authorities' costs, and there are no regulations that empower the tax authorities with the right to collect costs from a taxpayer. However, if coercive collection procedures are used, administrative authorities are authorised to charge the costs of enforcement to the taxpayer and to seize or embargo assets or goods to the value corresponding with the cost of execution.

Regarding the costs of execution or collection, the Tax Code indicates these include the fees of experts, auditors, depositaries and bailiffs, which are regulated by the executor (an administrative official) or the District Tax Court (a judge). Generally, taxpayers do not incur these types of charges (depositories, bailiffs, etc.) in their defence, except for fees for experts which can be onerous.

Alternative dispute resolution

In Ecuador, mediation is available as an alternative method to resolve tax disputes.

Taxpayers can request mediation directly on determination processes and challenge claims being submitted. The request must be submitted to a mediation centre, which will invite the Tax Administration to the process.

If a tax dispute is challenged in court, mediation may be requested during the preliminary hearing before the judge (see Section III). In both cases, the Tax Administration may accept or refuse mediation. If the authority accepts the results of the mediation process, it must issue a cost-benefit analysis and, if the matter involves amounts exceeding US$20,000, obtain authorisation from the State Attorney General's Office prior to signing an agreement.

In order to encourage mediation in tax disputes, the Economic Development Law dictates that a remittance of fines and interest may be applied to taxpayers' obligations, as follows:

  1. 100 per cent of the interest and surcharges for the difference in tax that the taxpayer agrees to pay, if they opted for mediation before 29 January 2022;
  2. 75 per cent of the interest and surcharges of the tax difference that the taxpayer agrees to pay, if they accepted mediation before 28 February 2022; and
  3. 50 per cent of the interest and surcharges of the tax difference that the taxpayer agrees to pay, if they opted for mediation between 1 March and 29 May 2022.

In all cases, when requesting mediation, a taxpayer must commit to immediately pay at least 25 per cent of the principal amount of the debt, even if a total or a partial agreement is not reached. The amount must be paid once the mediation process is concluded, before signing the mediation agreement.

As mediation in tax disputes is new in Ecuador, the Tax Administration's position regarding it is not yet known. However, it is expected that its position will vary on a case-by-case basis, depending on the legal and factual foundations established in the determination process and provided by the taxpayer.

Mediation must involve a qualified mediator who is independent from the Tax Administration.

Anti-avoidance

Ecuadorian tax legislation does contemplate a general anti-abuse rule (GAAR).3 This denotes a compound wording that introduces the concept of substance over form, extended in turn by the doctrine of the legal qualification of the facts that are subsumed in specific fiscal effects.

However, the Tax Administration has been applying this general clause in a non-technical and discordant way, without effectively recategorising transactions (i.e., without identifying the business being carried out). Also, it has ignored the acts or business carried out, only analysing the fiscal effect on one of the parties (usually the one that recorded the expense) without observing the transaction's effects on the other parties. The 2022 tax reforms4 have corrected this situation, and include the neutral effect of the operations. The 'neutral effect' of a transaction is understood to be the act of the first taxpayer deducting an expense from its income tax return and the counterparty, a second taxpayer, considering this income to be non-exempt for purposes of its income tax return. In such cases, the 'neutral' expense cannot be challenged. The Tax Dispute Courts (except in obvious cases of fraud) have generally ruled in favour of taxpayers and have analysed the aim of the transaction (a business purpose test). But the burden of proof falls on the taxpayer, who must show they did not engage in any abuse of tax laws or regulation, when it should be on the Tax Administration to prove that the taxpayer did.

Ecuador is not a member of the Organisation for Economic Co-operation and Development (OECD), so its recommendations are not mandatory – however, they do form soft law. Nevertheless, the OECD and its guidance on preventing domestic tax base erosion and profit shifting (the BEPS Action Plan) are a source of constant feedback and are a significant influence on Ecuador's fiscal performance. Although we do not foresee Ecuador modifying its tax system to align it with the BEPS Action Plan, progress has been made in some aspects, such as the deductibility of financial expenses (i.e., interest), transfer pricing, aspects of the digital economy and fiscal transparency.

Double taxation treaties

Ecuador's tax legislation provides that payments sent abroad that constitute taxable income are subject to the withholding of income tax at the general rate of 25 per cent. However, in principle, the double taxation treaties that Ecuador has signed tend to prevent double taxation.

Recently, jurisprudence has given support to the Tax Administration's position in respect of the application of double taxation agreements, and objections have been raised over the lack of withholding income tax on payments abroad, the main argument being this has led to 'treaty shopping'. A recent example of such an interpretation has occurred with certain payments for services made abroad related to the financial sector.

Until 2022, there were limitations on the application of double taxation treaties, whereby, despite what the treaties indicated, if payments made abroad to the same supplier and in the same period exceeded a certain amount, income tax could be withheld; the monies could be returned to the foreign taxpayer, after an application was received and the existence and type of accredited income were verified. These limitations were withdrawn from Ecuador's regulations with effect from 1 January 2022.

While the comments of the OECD and other doctrinal pronouncements do not effect Ecuador, it is feasible for tax disputes to be based on this type of soft law. The interpretation of these doctrines is subject to judicial assessment. However, by regulatory provision, the OECD's guidelines do apply to transfer pricing.

Areas of focus

In its latest cases, the Tax Administration have reviewed conceptual matters, such as related parties' interests on loans, economic substance, transfer pricing, and the use of double taxation treaties in payments made abroad.5 The general targets of the tax authorities are big taxpayers; the classification of which is carried out by administrative functionaries, and includes multinational companies and large Ecuadorian companies across all industries.

Since September 2020, 12 per cent VAT applies to digital services within Ecuador, which is assumed by the service's customers. We have not seen any resolved disputes regarding this policy that we can comment on.

We are looking forward to seeing if Ecuador will sign the OECD's global minimum corporate tax rate.

Outlook and conclusions

In Ecuador, a general process law was enacted in 20166 that imposed oral processes for judicial tax disputes. This change has resulted in such claims being more efficient and faster, and an improvement of understanding in judges hearing the cases.

At the end of 2021, mediation in tax disputes was allowed (see Section VII). This is a significant matter, and we look forward to seeing the results.

Footnotes

1 Carlos Coronel Endara and Pablo Arias Aizaga are partners, and Danny Espinosa Taipe is an associate at Lexvalor Abogados.

2 Article 56.1, Ecuadorian Tax Code. 29 November 2021.

3 Article 17. Ecuadorian Tax Code.

4 Tax Law Amendment (Economic Development and Fiscal Sustainability after the COVID 19 Pandemic), 29 November 2021.

5 Resolution number 07 – 2016, National Tax Court, 27 October 2016.

6 General Code of Processes, 22 May 2015.

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