Contributed By Almeida Guzmán & Asociados
Businesses commonly adopt a corporate form. The most common structures are corporations and limited liability companies (partnerships), which can adopt the following forms.
Corporate structures are taxed as independent entities. Stockholder and partner liability is limited to the amount of their equity in the company.
Consortiums and joint ventures are corporate entities that are not widely used in Ecuador. They are used primarily when undertaking public work contracts, as well as specific productive projects with a limited duration. For tax purposes, consortiums and joint ventures are regarded as independent entities and taxed accordingly. Nevertheless, their members’ liability is not limited to their equity.
All corporate entities are considered to be independent taxpayers. Dividends paid by corporate entities are subject to income tax withholding, except in the case that the beneficiary is a local corporation. Individual beneficiaries of the dividends may be subject to additional income tax if they fall within a tax bracket that is higher than the income tax applicable to corporations. Dividends paid to foreign investors are subject to a 10% income tax withholding. Exemptions may apply under double taxation treaties.
Stakeholders in sectors such as banks, insurance, the stock exchange and securities are obliged to use corporations to carry out their businesses.
The Ecuadorian stock exchange law provides for trusts, investment funds, commercial funds and hedge funds. Under Ecuadorian law, these legal entities are considered to be independent for both commercial and tax purposes. In some cases, trusts and funds are obliged to act as tax withholding agents.
Stakeholders in the construction sector (both for private and public projects) normally perform their activities using trusts, consortiums and joint ventures.
As a general principle, whenever an entity is domiciled and/or incorporated within Ecuadorian territory, it is regarded as a tax resident in the country.
Under Ecuadorian law, tax residency is determined as follows.
Ecuador has entered double taxation treaties with the following countries: Argentina (limited to air transportation), the Andean Community (Bolivia, Peru and Colombia), Belarus, Belgium, Brazil, Canada, Chile, China, Germany, France, Italy, Japan, Mexico, Qatar, Romania, Singapore, South Korea, Spain, Russia, Switzerland and Uruguay. Ecuadorian double taxation treaties generally follow the OECD model, except for the Andean Community Treaty, which follows certain premises suggested by the United Nations' Model Double Taxation Convention.
Under most of the double taxation treaties, Ecuadorian-source income is taxed locally except for corporate profits (for treaties that follow the OECD model). However, certain income sources – such as royalties and interests, and technical service fees – are subject to tax withholding at lower rates (10% and 15% compared to the general 25% rate).
Entities are subject to a 25% income tax levied on their net taxable profit. However, a 28% income tax rate applies whenever:
Ecuadorian law provides for 15% employee profit sharing, meaning that the entity is obliged to distribute 15% of its profits among its employees. This expense is tax deductible when determining the taxable base.
Income tax is paid in a single instalment during the first quarter of the fiscal year following the fiscal year that the profit corresponds to.
As of 2022, micro businesses are subject to up to a 2% income tax levied on their net income.
Regarding transparent entities, see 1.1 Corporate Structures and Tax Treatment and 1.2 Transparent Entities.
Individuals are taxed at progressive rates. The payable income tax bands and rates for 2022 are as follows:
Ecuadorian commercial entities are obliged to keep their accounting records according to International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS). However, accounting profit is subject to adjustment for tax purposes.
The main adjustments (accounting profit versus taxable profit) are as follows.
The adjustments are made in the applicable tax return, based on accounting records.
As of 2022 there are no special incentives specifically for technology investments. Nevertheless, new investments may apply for a general incentive; see 2.3 Other Special Incentives.
As of 2022, the Ecuadorian tax law provides for a reduction of three percentage points for new corporations and investments. The latter will be applicable for up to 15 years. The accumulated exemption may not exceed the amount invested.
Entities that concluded new investment contracts with the Ecuadorian government after November 2021 will benefit from a five percentage points reduction in the income tax rate. The accumulated exemption may not exceed the invested amount. The exemption will apply during the contract’s term, which may not exceed 15 years, unless the protected contract provides for a longer term. Nevertheless, the contract may be renewed for the same period of time or less. The entities may also benefit from an exemption on foreign trade taxes and the capital remittance tax (ISD), regarding the import of capital goods and raw materials related to the investment (whenever certain conditions are met).
Losses registered in a fiscal year can be amortised (carried forward) for up to five years. Taxpayers may offset only up to 25% of the taxable income. Ecuadorian law does not provide for loss carry-back, nor for offsetting income losses against capital gains or vice versa. Losses incurred in transactions with related parties are not tax deductible.
Interest is deductible whenever the related loan is needed for the debtor to undertake its commercial activity. For tax purposes, interest is deductible provided the rate does not exceed the maximum rate set by the Ecuadorian Monetary Authority.
This also applies to foreign loans, which, in certain cases, are subject to registration before the Ecuadorian Central Bank. For registration purposes, the capital of the loan must be deposited in an Ecuadorian bank. Interest paid exceeding the maximum rate applicable to this kind of transaction is subject to income tax withholding.
Interest paid to related parties that exceeds 20% of the entity’s EBITDA plus interests, depreciation and amortisation will not be deductible.
The consolidation of financial statements for tax purposes is not allowed under Ecuadorian law. As such, groups of companies are not allowed to record losses reported by entities other than those incurring the loss.
However, for reporting purposes before the Superintendence of Companies, IFRS rules on consolidating financial statements apply.
Overall, Ecuadorian law does not provide for particular tax treatment on capital gains, which are taxed as general income.
Despite the latter, there are exceptions to the general rule, which are listed below:
The taxable base applicable to the disposal of shares is determined as the difference between the sale price and:
Whenever the seller is a foreign entity, the Ecuadorian company whose shares are being transferred is obliged to act as a substitute taxpayer and pay the tax on behalf of the shareholder.
The sale of shares listed on an Ecuadorian stock exchange may benefit from the following exemptions and reductions:
The following taxes are commonly applicable.
The government is progressively reducing the rate and eliminating the tax for certain transactions, with an aim to fully eliminate it eventually.
Tax on Overseas Financial Assets
This tax applies at a rate of 0.1% to 0.35% and is levied on the monthly average of the funds held abroad. This tax applies to the funds held abroad by the following entities:
Special Temporary Equity Contribution
As of 2022, corporations are required to pay a contribution levied on their 2020 net equity, whenever the corporation’s net equity as of 31 December 2020 was equal to or greater than USD5 million. The tax rate is 0.80%. Corporations are required to pay the contribution both in 2022 and 2023. The contribution is not deductible for income tax purposes.
Corporations may file for a six-month payment convenience, and therefore pay the contribution in six equal instalments.
Special Temporary Contribution
As of 2020, businesses must pay a special contribution levied on the 2018 taxable base, provided that the business reported sales equal to or greater than USD1,000,000 in such fiscal period. The contribution must be paid in 2020, 2021 and 2022.
In any case, the contribution shall not exceed 25% of the income tax paid in 2018. The special contribution is not applicable to businesses that reported losses for 2018.
Tax on Profit Generated on the Sale of Real Estate
Profit generated on the sale of real estate is subject to this tax, at a rate of 10% and payable to the municipality in which the asset is located.
A deduction of 5% of the net profit for each year of ownership is permitted when determining the taxable base. Whenever the elapsed time is 20 years, the transfer is tax exempt.
Municipal Patent Tax
Businesses, whether individual or corporate structures, are also subject to a municipal tax called “Patente Municipal”, which is payable on an annual basis. The rate of the tax is determined by the municipality based on the entity's equity, and in no case whatsoever will the tax be lower than USD10 or higher than USD25,000.
1.5 per Thousand Taxed on Assets
Businesses are obliged to make an annual tax payment to the municipality of their domicile equivalent to 1.5 per thousand of their total accounting assets.
Most closely held local businesses operate using a corporate form. Commonly, the preferred corporate form is a corporation or a limited liability company. New businesses are expected to be incorporated as a simplified stock corporation, due to significant cost reductions on incorporating this type of entity.
Even though corporate rates are lower than individual rates, there are no rules to prevent individual professionals from earning income at corporate rates, because dividends paid by companies to individuals are taxed at individual rates and subject to a 10% income tax withholding rate. The income tax withheld by the entity distributing the dividends may be recorded as a tax credit by the individual, who then deducts such credit from their final tax.
There are no legal provisions that prevent closely held corporations from accumulating earnings for investment purposes. However, Ecuadorian law considers loans granted by business to their stockholders or partners as taxable dividends.
Dividends paid by Ecuadorian corporations to individuals are subject to a 10% income tax withholding. In any case, dividends received by individuals become part of their taxable income, and, as such, are subject to individual tax rates.
Regarding capital gains on the transfer of shares, please refer to 2.7 Capital Gains Taxation.
Dividends paid by publicly traded corporations are subject to the same treatment applicable to dividends in general.
As for capital gains on the sale of shares in publicly traded corporations, some exemptions may apply. Regarding the exemptions on the transfer of shares, please refer to 2.7 Capital Gains Taxation. Despite the latter, a 10% income tax withholding on the gains applies on transactions performed within a local stock exchange.
In the absence of double taxation treaties, the following tax withholding rates apply.
Despite the fact that Ecuador has entered into 20 bilateral double taxation treaties and a general treaty concluded within the Andean Community of Nations (which includes Colombia, Peru and Bolivia), the primary tax jurisdictions foreign investors use to invest in local corporate stock or debt are Spain, Uruguay, Germany, Brazil, Mexico and Canada.
Ecuador does not challenge the use of treaty country entities by non-treaty country residents.
However, the Ecuadorian Tax Administration may analyse whether the transactions that benefit from the treaties lack economic substance. In such case, the payments that benefited from the tax treaties will not be considered deductible for income tax purposes for the local corporation.
Benefits provided by the tax treaty concluded with Uruguay are conditioned. Namely, a corporation may benefit from the tax treaty whenever 50% of its beneficial owners are residents in Ecuador or Uruguay, or if the corporation’s stocks are listed in an Ecuadorian or a Uruguayan stock exchange.
Even though Ecuador is not a member of the OECD, the country applies transfer pricing parameters contained in the guidelines issued by the organisation. Indeed, its general provisions have become part of Ecuadorian tax law and its regulations.
The main concern is related to export prices as well as royalties, technical service fees and interest paid to related parties. Regarding these issues, local law allows Ecuadorian entities to file a consultation with the tax authority to determine the parameters under which the transfer pricing valuation will be performed.
Corporations that undergo frequent transactions with related parties (whenever certain requirements are met) must file before the Ecuadorian Tax Administration a yearly transfer pricing report. In such report, the corporation must demonstrate that the transactions concluded with its related parties comply with the arm’s-length principle.
Local tax authorities have not challenged the use of related-party limited risk distribution arrangements for the sale or provision of goods or services locally. Nonetheless, Ecuadorian tax law states that transactions between related parties should follow the arm’s-length principle.
Ecuador is not part of the OECD. Nevertheless, Ecuadorian transfer pricing principles and the applicable methodologies generally follow OECD guidelines. Accordingly, local transfer pricing rules and/or enforcement in theory do not vary from OECD standards.
Commonly, transfer pricing disputes are resolved before local tax authorities and courts. The authors are not aware of any international transfer pricing disputes being resolved through double taxation treaties. Local law does not allow mutual agreement procedures (MAPs) to resolve transfer pricing issues between tax authorities and private entities. The local tax authority has yet to publicly enter a MAP with foreign tax authorities.
Nevertheless, as of 2022, tax disputes may be solved through mediation, as per a tax reform enacted in November 2021. This represents a substantial modification in the Ecuadorian tax regime, since prior to the tax reform, all disputes had to be settled through administrative claims or judicial actions.
Until now, transfer pricing issues and claims have been resolved through administrative claims and judicial actions filed by private entities against the Ecuadorian tax authority. The authors are not aware of any specific MAP and/or PTC process that Ecuador has been a part of.
Local branches of non-local corporations and local subsidiaries of non-local corporations are taxed equally. The Ecuadorian Constitution and law expressly prohibit any discrimination in the treatment applicable to local and foreign individuals and entities. Nevertheless, payments made by local branches or subsidiaries to their parent corporation may be subject to lower taxation pursuant to tax treaties (see 4.1 Withholding Taxes).
Capital gains of non-residents on the sale of stock in local corporations are taxed in Ecuador. Indeed, the tax applies when the gain relates to shares of a non-local holding company that owns the stock of a local corporation, both directly and indirectly.
The main principle provided for under Ecuadorian tax law is to tax capital gains on the sale of shares issued by local corporations, whenever the indirect transfer of equity within the chain of ownership (including the one abroad) affects the ownership of an Ecuadorian entity and certain requirements are met.
There are no change of control provisions that could apply to trigger tax or duty charges, and, in particular, there are no such provisions that could apply to the disposal of an indirect holding much higher up in the overseas group. All issues related to the direct or indirect transfer of shares are included in previous sections of this chapter.
There are no formulas used to determine the income of foreign-owned local affiliates selling goods or providing services. However, transfer pricing guidelines and the arm’s-length principle apply to them.
Ecuador allows for the deduction of payments made to foreign companies, including foreign affiliates, whenever income tax is withheld and payments do not exceed some maximum limits. Ecuadorian entities may only deduct 5% of their taxable base on foreign allocated expenses and costs paid to a non-local affiliate. As of 2022, royalties and technical service fees paid by local affiliates to their head office and related entities can be fully deducted (before 2022, only up to an amount not exceeding 20% of the taxable income of the paying entity could be deducted).
The general provisions applicable to interest related to foreign loans are explained in 2.5 Imposed Limits on Deduction of Interest.
Additionally, the net amount of interest paid on loan transactions with related parties (for tax purposes) should be no greater than 20% of the EBITDA plus interest, depreciation and amortisation of the given fiscal year.
Ecuadorian corporations are taxed on their worldwide business income. As such, foreign income is taxed in Ecuador. However, Ecuadorian law states that the tax paid abroad on foreign income may be used as tax credit in the local corporation’s annual tax return. The tax credit may be applied only to the foreign-source income, and shall not exceed the relevant tax.
In general, expenses incurred to generate exempted income are non-deductible. This also applies to foreign exempt income.
Dividends paid by subsidiaries located abroad are regarded as foreign income (see 6.1 Foreign Income of Local Corporations) and taxed accordingly.
Intangible assets developed by local corporations can be used by non-local subsidiaries in their business. However, under transfer pricing principles, the local entity is obliged to charge for such use under the arm’s-length principle. All related income is taxable in Ecuador.
There are no specific provisions regarding controlled foreign corporation (CFC) rules in Ecuadorian legislation.
There are no rules related to the substance of non-local affiliates. Nevertheless, to record an expense as deductible, the latter must be related to taxable income, and the transaction must reflect economic substance. Therefore, under Ecuadorian law, transaction simulation is regarded as a felony and is therefore punishable by law. Likewise, practices regarded as tax avoidance are penalised under Ecuadorian criminal law.
Gains obtained by local corporations on the sale of shares held in non-local affiliates are taxed in Ecuador. No specific rule exists on the matter in local law. As such, these gains will be subject to a 25% income tax rate. If the income is taxed abroad, the local corporation could use tax credit in Ecuador, as outlined in 6.1 Foreign Income of Local Corporations.
Overall, the Ecuadorian tax regime considers any practice that may involve simulating a transaction for the sole purpose of evading taxes as a felony, and is punishable as such. It is important to note that assessments from the tax authorities in recent years tend to overlook tax-relevant transactions and operations that do not reflect economic substance and/or essence.
The Ecuadorian Internal Revenue Service (Servicio de Rentas Internas, or IRS) does not have a regular, routine audit cycle. Nevertheless, audits of a fiscal year are usually conducted within four years of the date of filing the corresponding tax return. Audits can be conducted within six years whenever the taxpayer fails to file the tax return on time.
Tax audits are normally performed by reviewing all accounting records and their supporting documentation.
The reports issued regarding tax audits can be challenged by the IRS. Any final administrative resolution issued by the IRS can be challenged before the Ecuadorian tax court.
The Ecuadorian government has already taken certain actions that are relatively aligned with Action 1 of the BEPS plan, and specifically the International VAT/GST Guidelines.
Even though Ecuador has not adopted BEPS within its tax regime, the following standards on the matter have been implemented.
As of 2020, the legal system expressly states that digital services are taxed with VAT whenever the consumer is a resident in Ecuador and the payment is made by such resident. Therefore, the Ecuadorian tax system provides for a registry of digital service suppliers (that are not domiciled in Ecuador). Such registry is administered by the Ecuadorian IRS.
Whenever the provider of a digital service is not registered before the Ecuadorian IRS, the consumer is obliged to act as tax collector. Nevertheless, if the payment is made through an intermediary (credit card issuer or bank), the former will be liable for collecting the VAT.
The Ecuadorian government is interested in complying with OECD standards and participating in the organisation’s committees. In this sense, the Ecuadorian government ratified the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (CAAM).
Nevertheless, there are no indications that the Ecuadorian government will sign the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.
The authors consider that, to date, international tax does not have a high public profile in Ecuador. However, it is evident that any new development on the matter, particularly regarding BEPS, will, in a relatively short period, be adopted by local authorities, as noted in relation to VAT applicable to digital services.
Regarding Pillar Two (substance), as stated in previous sections, the deductibility of expenses is allowed whenever the transaction reflects economic substance. The economic substance in transactions has been an important principle used by the Ecuadorian tax authority in its audits.
Regarding Pillar One (coherence), the Ecuadorian tax system lacks a strong technical background on international taxation. The Ecuadorian regime requires a transversal reform in order to comply with Pillar One of BEPS.
The Ecuadorian tax system is generally fair and balanced for competition between foreign and local entities.
Nevertheless, the existence of indiscriminate tax benefits creates a false sense of competitiveness. Over the past decade, Ecuador has implemented several tax benefits that have not incentivised new national and international investment. This has also been to the detriment of good tax practice by going against the principles of generality and equality that should be present in any tax regime.
As of 2022, several of the indiscriminate tax benefits have been eliminated by a recent reform.
Considering the particularities of the Ecuadorian tax regime regarding the characteristics of the country’s productive sector, the authors do not see any pressure for BEPS to be applicable in Ecuador. The country’s exposure to the international community is marginal. Therefore, the authors do not foresee pressure from the international or local community to implement tax amendments to fully comply with BEPS.
The main issue that the authors have identified in Ecuador’s tax system is enforceability, as well as generalised mistrust of taxpayers by the tax authority. It is imperative to implement serious initiatives to train the officials of the local tax authority.
The authors are not aware of prominent direct state aids in recent years, other than subsidies granted to the general public applied to the prices of hydrocarbons and fuels. However, the government has reduced the subsidy and did not fully eliminate it only due to potential civil unrest.
As previously stated, the Ecuadorian tax system lacks a strong technical background on international taxation. As such, the implementation of new mechanisms, such as actions to deal with hybrid instruments, is far from becoming a reality.
Likewise, the authors are not aware of any pieces of legislation or proposals for dealing with hybrid instruments.
Overall, the current tax regime applicable to interest does not provide for restrictions tailored to territorial tax regimes (special economic development zones). Ecuador is a country that requires strong inflows of capital, including capital related to foreign loans. In this sense, imposing additional restrictions to the deductibility of interest would be inconvenient.
Ecuador has not implemented CFC rules.
The authors do not foresee any impacts that double tax convention limitations might have for both inbound and outbound investors. It is important to note that Ecuador has complementary rules in place to avoid evasion and abuse of law.
The application of transfer pricing in Ecuador is still limited, and for now it mainly applies to export activities. In this sense, before the country implements any changes to transfer pricing, Ecuador needs to further develop its current system. The taxation of profits from intellectual property is not a particular source of controversy or difficulty under Ecuador’s tax regime. Profits related to intellectual property are generally taxed as royalties.
The authors agree with the proposal for transparency and country-by-country reporting. However, they do not anticipate it having relevance for Ecuadorian taxation purposes.
As of 2020, Ecuador has implemented certain legal provisions to tax transactions effected by digital businesses operating largely outside Ecuadorian territory. Specifically, the Ecuadorian tax system has implemented a registry for foreign digital service providers. Likewise, credit card issuers and banks are responsible for collecting the VAT charged on digital services provided by entities that are not registered before the Ecuadorian IRS.
Ecuador has taken few steps in relation to digital taxation (specifically, regarding Action 1 under the International VAT/GST Guidelines of BEPS, Ecuador has issued legal provisions to collect the VAT charged on digital services provided by foreign entities; see 9.1 Recommended Changes and 9.12 Taxation of Digital Economy Businesses).
Ecuador has not introduced any other provisions dealing with the taxation of offshore intellectual property deployed within the country. However, regarding the deductibility of royalties and technical service fees, please refer to 4.1 Withholding Taxes.