Corporate Tax 2020

Last Updated January 15, 2020

Ecuador

Law and Practice

Authors



Bustamante & Bustamante is a law firm of national as well as international standing, having advised national and multinational corporations, financial institutions and government organisations from countries such as the USA, China, England, Canada and Italy for over 60 years. It is one of the most reputable practices in Ecuador, known in particular for its tax division, with a team of six qualified lawyers headed by senior partner Juan Carlos Bustamante. Its experts strive to maximise return while reducing tax exposure, and provide a customised tax plan for each corporate strategy, thus achieving a competitive edge in M&A or restructuring. The team specialises in double-taxation treaties, capital gains, tax and beneficial owner issues. The firm also advises clients regarding numerous other matters, including IP, oil and gas, project finance, franchising, banking and financial services, corporate, mining, telecommunications, electrification, privatisation, insurance, real estate and labour law. Bustamante & Bustamante is an equal opportunity employer, with eight partners, over 50 attorneys and 70 support staff, many of whom have studied and worked in the USA, Europe and Asia, as well as Latin America.

The preferred corporate structure for businesses in Ecuador is generally that of a limited liability company. There are two types of companies with limited liability:

  • a stock company or SA (Sociedad Anónima) which can be incorporated in a single act or successive acts through the public subscription of shares, depending on the company’s articles of incorporation and by-laws; and
  • a limited liability company or Cía Ltda (Compañía de Responsabilidad Limitada), where the capital cannot be integrated by the public subscription of membership interests and where any change in membership requires the unanimous decision of all the members.

The common features of these two corporate forms are that they have legal status or corporate personhood, and that shareholders/members are liable only up to the amount of their contributions to capital, but not for the company’s debts and obligations, except in certain cases, as explained in the following paragraph.

Responsibility of Legal Representatives

Under Ecuadorian legislation, the legal representatives of a company are jointly responsible for the company’s labour and tax obligations and, therefore, could be held liable even with respect to their own personal assets in certain circumstances. The labour and tax obligations that administrators have to pay on behalf of the company to its workers or the treasury may be recovered from the shareholders/members if they approved the management’s report or the balance sheet at the general assembly. In such cases, the liability limited to contributed capital could go beyond the shareholders' stockholding or members' interest percentage. Although companies are not individuals, they could be held liable for certain criminal offences and, in tax-fraud cases involving criminal responsibility, such liability could also apply to shareholders/members who engaged in proven wilful misconduct.

Tax Compliance

For tax compliance purposes, foreign companies organised locally under one of these corporate structures must provide information concerning their registered shares to the tax authorities each year. The information must reveal the company’s chain of ownership down to the ultimate beneficiary owner. Failure to do so may result in the application of a higher income tax rate. Stock must consist of registered shares only, as Ecuadorian law does not allow shares to be issued to the bearer. 

Despite the long-standing local stock exchange market, there are not that many public corporations in Ecuador. Companies rely strongly on the banking system to finance their activities. Nonetheless, the use of securitisation trusts and investment funds has increased in the past two decades. 

In addition to the above-mentioned forms of companies, foreign corporations may also opt to enter into joint venture or consortium agreements, or to domicile a branch in the country.

For tax purposes, all these structures and joint ventures or consortium agreements are treated as a separate legal entity. As a rule, Ecuadorian tax law does not provide for tax treatment as transparent entities. Under the tax regime, any business structure, whether it has legal personhood or not, falls under the tax definition of sociedad and is taxed accordingly. Therefore, exclusively for tax purposes, the definition of sociedad is broad and includes corporations, consortiums, joint ventures, partnerships, trust and investment funds; and a company is defined as any entity carrying on a business as an economic unit or with private equity that is separate from that of its members. Partnerships are not treated as fiscally transparent or as passing-through entities; on the contrary, these entities are treated as a sociedad for tax purposes and are deemed to be a separate legal entity subject to the 25% corporate tax rate. However, despite this definition, some investment structures, such as trusts, are given income tax exemption that is tantamount to certain transparency, as explained in 1.2 Transparent Entities.

Certain structures, such as investment commercial trusts, investment funds and complementary funds fall within the scope of income tax-exempt entities, provided they do not carry out any economic activity and their beneficiaries are the ones liable for income tax purposes. Trustees and fund administrators must comply with withholding obligations when distributing earnings to their beneficiaries; otherwise, income tax will be levied on their benefits. In addition, the recently enacted Organic Law for Promoting Production amended Article 9.1 of the Internal Tax Regime Law to include tax incentives; eg, exempting proceeds or benefits derived from local securitisation trusts that only invest in real estate, where these are distributed to investors or account holders in collective funds. Investments in the construction sector are normally channelled through trusts structures. 

According to Ecuadorian tax law, the residence of an incorporated business is either the place specified in the incorporation deed or where the company’s statutory/registered main place of business is located; or in the absence of this, the place where any of the company’s economic activities are being carried out or the place where the taxable event occurred. 

The double-taxation treaties in effect between Ecuador and several European countries usually provide rules by which the actual place of management (tie-breaker rule) is decisive in the case of a corporation that has dual residence. However, other double-taxation treaties in effect, such as the treaties with Canada, Chile, Qatar and Uruguay, rely on nationality as the decisive criterion to solve dual residence, after having followed mutual agreement procedures. Only the treaties with China and Singapore, which have recently been executed, have followed the alternative case-by-case approach directly. In the absence of a mutual agreement between the competent authorities of the contracting states, the company will not be entitled to treaty benefits.

As a rule, companies are subject to an income tax rate of 25% on their net profit, after the 15% employee profit share has been deducted. The effective rate (income tax plus profit share) amounts to 36.25%. Tax on companies incorporated in Ecuador is levied on their worldwide income. Only the income of an Ecuadorian source of domiciled branches or permanent establishment (PE) of non-resident corporations is taxed. As of 2020, only dividends received by national companies are exempt. Therefore, dividends paid by resident companies to non-resident individuals or non-resident companies, as well as resident individuals, are not exempt and are subject to a 10% withholding tax upon their distribution, which can be used as tax credit in the annual income tax return. 

The standard corporate income tax (CIT) rate may increase by three percentage points, to a total of 28%, as the applicable CIT rate in the following cases, where:

  • the company breached its annual duty to report on the corporate composition (chain of ownership) of its shareholders, ownership members, stakeholders, constituents, beneficiaries etc, as required pursuant to Ecuadorian tax law; or
  • the chain of ownership includes an entitled resident, established in or protected by a tax haven, a lower taxation jurisdiction or a preferential tax regime, and the beneficial owner is a tax resident of Ecuador. 

The standard CIT rate may also be reduced by ten percentage points, thus lowering the CIT rate applicable to the amount of profits reinvested in the country to 15%, provided that:

  • the reinvestment is made by exporting companies or by companies engaged in the production and manufacture of goods, as long as at least 50% of their stock is owned by Ecuadorians, or by companies in the receptive tourism business;
  • profits are reinvested in productive assets, by purchasing new machinery or new equipment used for production; or profits are reinvested to purchase goods for research and technology to enhance production, diversify production and create jobs; and 
  • the company increases its capital and records the increase with the appropriate commercial registry by 31 December of following fiscal year.

Stock dividends distributed as a result of profit reinvestment, in the terms and conditions defined in Article 37 of the Internal Tax Regime Law, are exempt from income tax in the same proportion.

The income of individuals is taxed subject to the following chart:

Basic Excess Income Tax Income tax %

Fraction (BF) up to on BF on Excess BF

  • 011.3100 0%
  • 11.31014.4100 5%
  • 14.41018.010155 10%
  • 18.01021.630515 12%
  • 21.63043.250949 15%
  • 43.25064.8604.193 20%
  • 64.86086.4808.513 25%
  • 86.480115.29013.920 30%
  • 115.290 and above 22.563 35%

(The rates shown in this chart will be applied when calculating and paying the income tax of fiscal year 2019, due in the year 2020.) 

Please note 3.2 Individual Rates and Corporate Rates with respect to dividends' specific tax treatment and taxable base.

All companies, as well as individual taxpayers, whose annual business turnover equals or exceeds USD300,000, are required to keep books. Therefore, to determine the taxable base for CIT and IIT in these cases, corporations/companies as well as individual taxpayers must adjust their taxes based on the profits shown in their books. In addition, before the tax adjustments are made, businesses must calculate the 15% employee profit share, considering both exempt income as well as taxable income from profits. 

To establish the taxable base on which the income tax rate will be applied, companies and natural persons obligated to keep books must make the relevant adjustments as part of their income tax reconciliation. Basically, this consists of modifying profits or losses for the fiscal year as follows:

  • the employees’ share in the profits of the company is subtracted, in accordance with the provisions of the Labour Code;
  • the total value of exempt or non-taxed income is subtracted;
  • non-deductible expenses, whether incurred in or out of the country, are added in accordance with the Internal Tax Regime Law and Tax Regulation;
  • the adjustment is added to expenses incurred for the generation of exempt income, in the proportion established in the Tax Regulation;
  • the percentage of employees’ share in the company’s profits from exempt income is added;
  • losses amortised when reconciling taxes in previous years are subtracted, pursuant to the Internal Tax Regime Law and Tax Regulation;
  • any other legally established deduction to which the taxpayer is entitled is subtracted;
  • where applicable, the value of the adjustment made by applying the arm's length principle, following the transfer pricing methodology established in the Tax Regulation, is added; and
  • the net increase with respect to labour incentives is subtracted, premised on the Internal Tax Regime Law and Tax Regulation.

Taxpayers are required to keep books pursuant to the IFRS and profits are taxed on an accrual basis. There might, however, be certain digressions between tax accounts and financial accounts such as, inter alia, the restriction on applying the current value tax depreciation to permanent depreciation, and the provisions for employer-paid retirement pensions.

As a general rule, Article 9.1 of the Internal Tax Regime Law provides an income tax incentive to promote new investments in any of the country’s jurisdictions other than the main cities – Quito and Guayaquil – and targets specific economic sectors. The incentive consists of a five-year income tax exemption for all new companies doing business in specific economic sectors. These sectors include the industries of biotechnology and software, as well as biology and software development and related services, the production and development of technological hardware, digital infrastructure, computer security, products and digital content, and online services. Therefore, the general rule for this income tax incentive applies to technological investments as well. 

In addition to this general rule, the Organic Law for Promoting Production, enacted in August 2018, grants an income tax rate reduction of up to 10% for any sociedad that invests profits in sports, cultural, scientific research or technological development projects. 

Furthermore, the same law temporarily grants, as explained further in this point, extended income tax exemption to new investments in the types of technology mentioned above, as long as these activities meet the legal requirements established in the Organic Code of Production, Commerce and Investment (COPCI). The income tax exemption granted to all new companies or new investments, pursuant to this law, may be extended up to 12 or eight years, depending on their geographical location in the country. 

In accordance with the recently enacted Organic Law for Promoting Production, all the economy’s sectors listed as priority and those defined as basic industries in the COPCI, can benefit from temporary special tax incentives. 

The priority sectors are: 

  • petrochemical and oleochemical; 
  • tourism; 
  • cinematography, and audio-visuals, as well as international events; 
  • exportation of services; 
  • software development and services; 
  • production and development of technological hardware; 
  • digital infrastructure, IT security, digital products and content, as well as online services; 
  • energy efficiency, and industries involved in sustainable construction materials and technologies; 
  • the industrial, agro-industrial, and agro-association sector; and 
  • sectors for the strategic substitution of imports and encouragement of exports, as to be determined in an executive decree. 

The basic industries are: 

  • casting and refining of copper and/or aluminium; 
  • steel foundry for flat steel production; 
  • hydrocarbon refinement; 
  • the petrochemical industry; 
  • the cellulose industry; and 
  • naval vessel construction and repair.

The special tax incentives are summarised as follows.

  • Exoneration of income tax and income tax advance for 12 years. For new productive investments made outside the urban jurisdictions of Quito and Guayaquil. In priority sectors (Article 9.1, LRTI-Law of the Internal Tax Regime). This exoneration applies only to companies (new or existing) with a positive job turnover. 
  • Exoneration of income tax and income tax advance for eight years. For new productive investments made within the urban areas of Quito and Guayaquil. In priority sectors (Article 9.1, LRTI). This exoneration applies solely to companies (new or existing) with a positive job turnover.
  • Exoneration of income tax and income tax advance for 15 years. For investments in priority industrial, agro-industrial, and agro-association sectors in the country’s border areas. In priority sectors (Article 9.1.n, LRTI). This exoneration applies only to companies (new or existing) with a positive job turnover.
  • Exoneration of income tax and income tax advance for 15 years. For investment in basic industries as defined in the COPCI. Five-year extension of the exoneration period for investments in the country's border areas. This exoneration applies only to companies (new or existing) with a positive job turnover.

In all cases, the term will run from the first year in which gained revenue stemmed exclusively and directly from the new investment. 

These special tax incentives are available 24 months from the date of enactment of the Organic Law for Promoting Production, ie, up to 21 August 2020, for all new and existing companies receiving fresh investments, insofar as they meet the geographical location criterion, invest in the targeted economic sector and generate a positive job turnover. 

Corporate taxpayers and individuals required to keep books may carry forward tax losses for a period of five years. The carry-forward of a given year cannot exceed 25% of profits. In the case of liquidation of the company or termination of the company’s activities in the country, the balance of losses accrued in the five years prior is deductible in full in the tax year in which the company concludes its liquidation or terminates its activities.

Ecuadorian tax law imposes several limits and conditions on deducting interest payments as a financial expense, particularly when the payment is remitted abroad. Normally, interest remitted abroad is not subject to withholding tax, provided the loan is granted by a foreign financial entity duly incorporated abroad or a financial entity that is recognised by the relevant Ecuadorian authorities. For a company to benefit from this, the interest cannot exceed the maximum reference interest rates set by the Monetary and Financial Policy and Regulation Board on the date of registration of the loan or the date of novation thereof. It is mandatory to record foreign loans with the Central Bank of Ecuador. If these conditions are met, but the interest rate exceeds the maximum reference interest rate, the excess portion will be subject to the 25% withholding tax in order to be deductible. 

If a foreign loan is not recorded, the interest will not be deductible. Foreign loans with related parties are subject to the 25% withholding tax and the law stipulates certain conditions for the expense to be deductible, in particular, conditions preventing thin capitalisation. According to a thin capitalisation rule, the loan-to-equity ratio is set at 3:1 for foreign loans granted by related parties. For branches of foreign corporations, only capital will be taken into account. Back-to-back loans are expressly prohibited under Ecuadorian law.

Ecuadorian tax laws do not consider the possibility of consolidating the financial statements of companies belonging to the same economic group. A group of companies cannot, therefore, offset the losses of one member of the group with the profits obtained by another member. All company members of the group must comply with the obligation to file their own financial statements. Under the Companies’ Act, however, and exclusively for information purposes, parent companies are required to provide consolidated financial statements with respect to their subsidiaries. In such cases, the oversight regulator is the Superintendency of Companies. The company’s independent auditors must include an analysis of the consolidated financial statements in their report. 

All capital gains obtained from the direct or indirect transfer of shares, membership interests and other rights representing capital or other exploration, exploitation, concession or similar rights of a domiciled company or permanent establishment in Ecuador are subject to a single income tax at a progressive rate when the alienation takes place, in accordance with the following:

  • From zero to USD20,000: 0%
  • From USD20,001 to USD40,000: 2%
  • From USD40,001 to USD80,000: 4%
  • From USD80,001 to USD160,000: 6%
  • From USD160,001 to USD320,000: 8%
  • From USD320,001 and above: 10%

Capital gains up to USD20,000 are tax exempt. In addition, if the seller (shareholder/member of a domiciled company or PE) is a resident of any of the countries with which Ecuador has a tax treaty, the seller will be entitled to treaty benefits under Article 13 with respect to capital gains, provided the conditions in the treaty are met. In this case, the rules of the applicable treaty will be analysed to determine its correct application and to prevent potential double taxation.

The procedure established under tax law for determining how the capital gain arising from the transfer of shares or other rights representing capital will be calculated, is as follows:

  • taxable income is the real value of the alienation;
  • the deductible cost is the nominal value, the acquisition value or the proportional equity value of the shares or other rights representing capital, as applicable, in accordance with the applicable financial valuation method; and
  • expenses directly related to the transfer are also deductible.

In the event that immovable property is transferred, the real estate transfer tax (plusvalía) levied on the gain obtained from such transfer, must be paid to the relevant municipality. Under the Organic Code of Territorial Organisation, the general applicable rate is 10%, which can be reduced by way of a municipal ordinance. A deduction of 5% of the net profits is allowed for every year elapsing between the date of acquisition and the date of sale. If between such dates a period of twenty years has elapsed, no such tax will be levied. However, gains generated from the occasional sale of real estate, where the sale of assets is not part of the taxpayer’s regular business or activity, are exempt from income tax.

Value-added tax, at a rate of 12%, is levied on every transaction involving the sale of taxable goods, services and imports.

Special excise tax (ICE) is levied on luxury items, such as alcoholic and non-alcoholic beverages, cigarettes, vehicles, aircraft for private use, social club memberships, cable television services, guns for use in sports, and other items subject to sumptuary tax. 

Capital outflow tax (ISD) is levied on each offshore transfer or payment at a rate of 5%.

To carry out their economic, industrial or commercial activities within a defined territorial area, incorporated businesses must obtain a municipal patent from the relevant municipality. To obtain the patent, a municipal tax must be paid, defining the activity in which the incorporated business will engage. The patent must be obtained within 30 days from the start of the business and the tax must be paid each year.

In addition to the patent tax, incorporated businesses must pay a 0.15% asset tax each year that is calculated based on the financial statement of the previous fiscal year. 

Another important tax concerns the assets that the following entities have outside Ecuadorian territory: 

  • banks, savings and loans companies, and other private entities engaged in financial activities, in accordance with the provisions of the Monetary and Financial Organic Code; 
  • fund and trust management companies; 
  • brokerage houses; 
  • insurance companies and reinsurance companies under the oversight of the Superintendency of Companies, Securities and Insurance; and
  • companies for the administration, intermediation, management and/or purchase of a portfolio.

This tax applies only when the above-mentioned entities own or possess monetary assets outside Ecuadorian territory, in the form of sight accounts, checking accounts, time deposits, investment funds, investment portfolios, investment trusts, management or monetary trusts, fiduciary commissions or any other type of de facto or de jure financial instruments; as well as securitisations, bonds, shares or any mechanism for collecting direct or indirect resources. The rate is 0.25% over the asset and increases up to 0.35% when the asset is held in a tax haven or low-tax jurisdiction. The tax is levied on a monthly basis.

In Ecuador, closely held local businesses are mostly structured as limited liability companies (Cía Ltda). However, there are also a great number of closely held businesses incorporated as Sociedad Anónima.

Legislation in Ecuador does not include any provision that prevents individual professionals from incorporating a company and providing services through it at the corporate tax rate (general rate for companies is 25%).

Individual residents and recipients of dividends are required to declare the dividends on their income tax returns. As of FY2020, all dividends, except those received by national companies, will be taxed and subject to a 25% income withholding tax. The tax base for this purpose will be 40% of the total amount of the dividend effectively distributed, which amounts to 10% withholding on the total dividend’s amount, as mentioned above. If the company distributing the dividends fails to comply with its obligation to inform the corporate chain of ownership, those dividends will be subject to 35% withholding tax. 

Dividends remitted abroad to non-resident beneficiaries, whether companies or individuals, will also be subject to a 25% withholding tax levied on 40% of the total amount of the dividend.

There are no rules to prevent closely held corporations from accumulating earnings for investment purposes.

Individual taxpayers who are residents of Ecuador are subject to a withholding income tax of 10% upon receiving their dividends. Non-residents and national or foreign companies are exempt from such withholding, provided that the company that distributes the dividends fulfils its duty to report on its corporate composition.

In the case of the sale of shares, this is subject to payment of a single income tax on profits, or profits obtained in the transfer of shares. Depending on the amount of earnings, the tax is applied based on a progressive rate ranging from 2% to 10% (see 2.7 Capital Gains Taxation).

There is no difference with respect to individual taxation on dividends and on gain on the sale of shares in the case of closely held corporations or publicly traded corporations.

Interest and royalties remitted abroad are subject to the 25% withholding rate. Dividend payments are only exempt if the recipient is a national company. 

Ecuador has executed 21 bilateral tax treaties in order to prevent double taxation and tax evasion. Foreign investors benefit from treaties with Spain, Mexico, Chile and CAN (Community of Andean Nations). 

Ecuador has inserted very few provisions in its domestic law and in tax treaties in order to prevent the use of treaty country entities by non-treaty country residents. 

The tax authorities have questioned the use of structures located in countries with which Ecuador maintains a tax treaty, by residents of countries with which Ecuador has no tax treaty, who have tried to triangulate investments. 

For this purpose, the tax administration has contested the transaction on the grounds of absence of a solid commercial or economic essence, or effective benefits.

It appears that the tax authorities have not so far challenged the use of related party limited risks distribution arrangements for the sale of goods or provision of services locally.

Although Ecuador is not a member of the OECD, it does follow OECD standards with respect to its domestic transfer pricing rules.

Despite not being part of the OECD, Ecuador follows the OECD Model Tax Convention on Income and on Capital. The second paragraph of Article 9, pertaining to associated enterprises, is therefore followed for the majority of Ecuador’s treaties with other countries, except in the case of Mexico. In practice, although compensating adjustments are allowed under Article 9.2 of the treaties, the tax administration has not implemented a specific procedure in this regard.

The tax authority in Ecuador does not differentiate between branches and subsidiaries of non-local corporations for tax purposes.

Capital gains of non-residents on the sale of stock in local corporations are subject to single income tax at a progressive rate, as previously indicated in 2.7 Capital Gains Taxation. The tax is levied irrespective of whether the gain is on the sale of shares of a non-local holding company that owns the stock of a local corporation. The law deals with both the direct and indirect disposal of shares, membership interests and other rights representing capital or other exploration, exploitation, concession or similar rights of a domiciled company or permanent establishment in Ecuador.   

When rights representing capital are transferred from a non-resident company that directly or indirectly owns a resident company or permanent establishment in Ecuador, it is regarded as an indirect alienation, provided the following concurrently occur:

  • at any time during the fiscal year in which the sale takes place, the real value of the rights representing capital of the resident company or permanent establishment in Ecuador directly or indirectly represent 20% or more of the real value of all the representative rights of the non-resident company in Ecuador; and
  • within the same tax year, or during the 12 months prior to the transaction, the alienation or disposal of rights representing capital of the non-resident company, whose transferor is the same natural person or company or its related parties, directly or indirectly corresponds to an accumulated amount exceeding 300 times the basic fraction of the exempt income tax base for individuals. This amount will be increased to 1,000 times the basic fraction of the exempt income tax base for individuals, when said transaction does not exceed 10% of the total share capital.

Neither of the above will apply if the beneficial owner is a tax resident of Ecuador, or if the shares being disposed of are in a company that is resident in, or established in, a tax haven or lower tax jurisdiction, in accordance with the provisions established under tax regulation. No direct or indirect alienation will be deemed to have occurred, when the transfer of shares, membership interests or other rights representing capital occurs as a result of corporate restructuring or merger or spin-off processes, provided that the beneficial owners of said shares, membership interests or rights representing capital, are the same before and after such processes.

Pursuant to Article 39 of the Tax Law, an Ecuadorian company whose shares are directly or indirectly disposed of, must act as a substitute for the foreign company and will be held jointly liable for paying capital gains tax.

With respect to tax treaties, only in the case mentioned in Article 13.5 of the Tax Law is the tax usually eliminated when the transfer does not fall within paragraph 4 and does not meet the conditions stipulated therein.

Under local tax law, there are no specific change-of-control provisions that will trigger tax or duty charges. Nonetheless, any change of control in connection with a direct or indirect change of ownership will trigger capital gains tax, as described in 5.3 Capital Gains of Non-residents.

There are no specific formulas to determine the income of foreign-owned local affiliates selling goods or providing services, aside from the general principle stating that transactions must be kept within arm’s length.

The Tax Law stipulates that only up to 5% of total expenses and costs can fall under indirect management and administrative expenses incurred by a non-local affiliate.

See 2.5 Imposed Limits on Deduction of Interest

Local corporations treat foreign income as exempt provided the country from which the income originates has withheld the applicable income tax. If the income was not subject to withholding tax, it will be treated as taxable income under certain circumstances. 

Local expenses for generating exempt foreign income are non-deductible expenses. The general rule for attributing expenses to taxable income is that they will be deductible provided they served to obtain and/or maintain income. Expenses incurred for obtaining and/or maintaining exempt foreign income, however, are excluded and are therefore not deductible. 

Corporations are required to state the dividends received from their foreign subsidiaries on their income tax returns. Such dividends are deemed to be income of a foreign source and are therefore taxed accordingly. If the dividends were taxed in the source country, however, they will be treated as exempt income, provided certain conditions are met.

Local corporations may transfer intangible assets or the use thereof by way of a license agreement (royalties) under arm’s length conditions, thus generating income that is taxable at the regular rates.

It is compulsory for all taxpayers to issue invoices for the sale of their intangibles or for licensing their use. If the use of developed intangibles is transferred without cost, the costs and expenses incurred for developing them will be non-deductible expenses. Conversely, any compensation that the local corporation receives for the use of the intangibles it developed will be deemed to be taxable income. 

There are no CFC provisions in Ecuador.

There are no domestic rules related to the substance of non-local affiliates. However, said provisions have been included in the Tax Treaty executed between Ecuador and Uruguay, providing grounds for the tax authority to challenge the relevant non-local affiliates lacking substance.

Per domestic law, corporations are required to state the amount of gain on the sale of shares in non-local affiliates on their income tax returns as income from a foreign source. If the gain was subject to capital gains tax in the country of residence of such non-local affiliate, it will be treated as exempt income. Otherwise, or if the tax levied on such gain was lower than the tax in Ecuador, the corporation must declare it as taxable income and the foreign tax paid will be taken into account when applying the domestic tax.

Ecuador has implemented a few domestic anti-treaty-shopping rules that primarily deal with deterring triangle transactions. One of these rules sets forth the following:

“If established that the taxpayer used an intermediary located in a country with which a double-taxation treaty was signed in order to triangulate and unduly apply the benefits of the agreement, the tax administration may assess the tax to be paid, notwithstanding any criminal liability that may arise.”

In 2014, Ecuadorian law also included a definition for "beneficial owner" in the use of different types of income in order to address the wrongful application of treaty benefits, as well as other potential treaty-abuse scenarios. 

No audit cycle has been established by law, but the IRS generally conducts an audit within two years after a tax return is filed. 

The IRS regularly initiates an assessment considering the company’s tax reporting obligations, income tax advance payments, VAT returns and annexes, ICE (if applicable), income tax withholdings and annexes thereto, transfer pricing annexes, reports (if applicable), financial statements, tax-compliance audit reports and shareholder annexes, as well as tax information requests made to third parties. 

Once the review process ends, the IRS performs its own income tax reconciliation reflected in a preliminary draft of its tax assessment act, which is then discussed with the taxpayer. The tax reconciliation report contains an itemised description of all non-deductible expenses and any additional tax deductions granted by special laws and tax incentives, such as those stipulated in the COPCI. Furthermore, the IRS will verify compliance with specific labour regulations for promoting a net increase in the number of employees and the hiring of handicapped individuals. In conclusion, the IRS checks the losses carried forward (if there are any) and withholdings, as well as foreign credits and the distribution of dividends made in and outside the country. 

The review usually covers the information of only one fiscal year. However, the tax administration may include one or more fiscal years in their reviews.

On 21 May 2019, Ecuador was accepted as a member of the Development Centre of the Organisation for Economic Co-operation and Development (OECD), which points the country in the right direction to achieve sustainable and inclusive growth.

With its inclusion in the Development Centre, Ecuador also becomes part of the OECD Regional Programme for Latin America and the Caribbean based on pillars of productivity, inclusion and good governance.

The country is very interested in being part of the OECD committees on investment, tourism and the anti-bribery working group, in addition to the specialised networks of Latin America and the Caribbean in the fields of public companies, budget, regulatory institutions in economic matters, anti-corruption law, public integrity, competition and investment.

To meet these objectives, the Ecuadorian government has been adapting its local legislation in line with the OECD's commentaries, analysis and guidelines in tax matters. Ecuador has ratified the Multilateral Convention on Mutual Administrative Assistance in Fiscal Matters (CAAM), but it is not yet certain when Ecuador will become part of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. 

As indicated in the previous point, the government is in the process of implementing several regulations and mechanisms to adapt, primarily, its acquired obligations under the Global Transparency Forum, pursuant to its ratification of the CAAM.   

In spite of not being a member of the OECD, Ecuador has, in recent years, also implemented domestic rules and mechanisms to prevent base erosion and to tackle profit shifting, such as: implementing specific tax treatment for entities located in tax havens, low-tax jurisdictions or preferential regimes, as well as implementing rules for dealing with beneficial ownership, thin capitalisation, transfer pricing adjustments, interest deductibility limits and limits to indirect expenses, among others.

Ecuador is open to globalisation and foreign investments and has quite a number of double-tax treaties in place. The implementation of additional measures to help promote a common understanding in the application of tax treaties, as well as a clear set of rules which contribute to preventing tax avoidance while giving taxpayers certainty on the tax treatment of their inbound or outbound investments, is therefore regarded as essential for the country. The Ecuadorian tax administration is aware that BEPS provides anti-avoidance mechanisms to tackle base erosion and give control to efficiently managed tax resources. However, as mentioned in the above paragraphs, it has not yet officially taken any of the actions recommended by BEPS.

Ecuador has a healthy fiscal competition policy through tax incentives aimed to provide specific benefits to productive sectors and public-private partnerships.

Tax incentives favour new investment in productive sectors. Tax law grants such incentives to investments directed towards already incorporated companies as well as those being created. No company therefore has an advantage over another because incentives are applied in proportion to the amount invested.

Proposals for dealing with hybrid instruments and changes recommended by the BEPS process, may take some time to be analysed and implemented in Ecuador due to the lack of domestic anti-avoidance rules dealing specifically with hybrid arrangements or instruments. 

Ecuador's domestic legislation establishes interest deductibility restrictions on foreign credits. Interest payments are deductible and tax exempt only if foreign credit meets specific tax requirements and complies with thin capitalisation rules.

The creditor shall be a financial entity or a qualified non-financial entity. The interest rates shall not exceed the maximum rates fixed by the Central Bank of Ecuador, and all external credit agreements shall be registered before said entity. There are special rules for external credits destined for productive activities.

Ecuador has not implemented the CFC rules.

In its internal regulations, Ecuador has implemented certain limits that restrict the automatic application of the benefits granted under double-tax treaties, by fixing a threshold over which any amount paid to a resident of a contracting state will be subject to withholding tax which will later be reimbursed through the non-resident tax refund mechanism. 

Ecuador's domestic tax law includes other anti-evasion measures to avoid triangular transactions and abuses of the law.

There has been good regulatory development in transfer pricing in Ecuador, which has followed OECD standards and guidelines. 

Transparency and reporting obligations are not only very useful for tax administration because they provide valuable comparative information, but also because they provide greater tax certainty to MNEs. Tax administrations should preferably not add unnecessary cost or excessive red tape that outweighs benefits.

As of FY2020, some digital services will be subject to 12% VAT in Ecuador. This was approved by the recently enacted tax bill. Among the digital services affected are those provided by downloading on a monthly payment basis, such as Netflix. 

Digital taxation has become an important target for tax administrations, and Ecuador is no exception. As mentioned in 9.12 Taxation of Digital Economy Businesses, internet and digital services are included among the transactions subject to 12% VAT in the recently enacted tax bill. The results of this will need to be assessed over time, since the main impact of this type of taxation is on users and consumers. It may be a long while before digital businesses are effectively assessed and taxed on their income.

Domestic tax legislation in Ecuador does not provide for the taxation of offshore IP.

There are no other general comments in this jurisdiction.

Bustamante & Bustamante

Ave. Patria E4-69 y Av. Amazonas
Edificio COFIEC, 10th floor
Quito
Ecuador

+593 22 564 064

+593 22 559 092

bustamanteybustamante@bustamante.com.ec www.bustamanteybustamante.com.ec
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Trends and Developments


Ecuador Moves Towards Transparency of Tax Information

In the last few years, Ecuador has taken action regarding the transparency and exchange of tax information, a situation that becomes relevant in order to mitigate risks of tax avoidance and evasion, and also because it allows the optimisation of the resources of the Tax Administration in the exercise of its power of control. Thus, Ecuador joined the Global Forum on Transparency and Exchange of Information for Tax Purposes, signed the Convention on Mutual Administrative Assistance in Tax Matters (MAAC) and started the implementation of the Common Reporting Standard of the Organisation for Economic Co-operation and Development (OECD). By being part of all these mechanisms, the Ecuadorian authorities aspire to substantially increase collections, as they may have confirmed information regarding tax residents of Ecuador.

Global Forum on Transparency and Exchange of Information for Tax Purposes

The Global Forum on Transparency and Exchange of Information for Tax Purposes is a multilateral framework that leads activities on transparency and exchange of information for tax purposes, integrated by member and non-member countries of the OECD. The Global Forum was founded in 2000 and has 158 members at the time of writing.

Since its restructuring in 2009, the Global Forum has become the main framework worldwide for the implementation of international standards for transparency of tax information.

In order to achieve a global participation, it performs activities of monitoring and exchange of information; besides, it facilitates that the increased tax transparency and international co-operation allow developing countries to benefit from a clear tax environment through technical assistance programmes.

Within this framework, on 26 April 2017, Ecuador joined the Global Forum and is implementing the standards of (i) exchange of information on request and (ii) automatic exchange of information regarding financial accounts.

According to the announcement by the authorities, the implementation of these standards by Ecuador will be performed with the technical assistance of the members of the Forum, and, after that, there will be a peer review of the said implementation.

The review has the objective of determining if the international standards of transparency and exchange of information are being effectively applied in the country; for this purpose, the Forum has created the Peer Review Group that will perform this task.

The review of the standard of Exchange of Information on Request will involve the implementation of essential elements related to availability of information (ownership, accounting and banking information), access to information by Ecuador, and how the exchange of information abroad is being performed (agreements, confidentiality and taxpayers’ rights).

As for the standard of automatic exchange of information regarding financial accounts, the application by Ecuador of the model of automatic exchange of information prepared by the OECD, called the Common Reporting Standard, will be reviewed.

Convention on Mutual Administrative Assistance in Tax Matters

On 29 October 2018, Ecuador signed the Convention on Mutual Administrative Assistance in Tax Matters, which became effective for the country as of 1 December 2019, with Ecuador being the 126th country to join this shared effort. On 7 March 2019, the Constitutional Court issued the constitutional ruling for the agreement, then, on 7 August 2019, the National Assembly of Ecuador approved the adherence and on 26 August 2019, Ecuador deposited the instrument of ratification to the Convention.

This multilateral agreement was developed by the OECD, and facilitates international promotion and co-operation for a better operation of tax law in each state. Among its advantages, it establishes access to tax information that other countries have and administrative co-operation in the collection of taxes, in order to fight tax avoidance and evasion.

Thus, the Convention provides assistance between tax administrations mainly focused on income taxes, capital gains, equity, inheritance, consumption and obligations concerning social security, among others. On this matter, the treaty establishes two forms of assistance: (i) exchange of information and (ii) collection assistance.

Exchange of information

The Convention establishes that the parties may exchange any type of information that is relevant to the application and administration of national legislation, through three different procedures: exchange of information on request, automatic exchange of information and spontaneous exchange of information.

Exchange of information on request must be made regarding specific persons or transactions through the tax authority of the requesting state.

Automatic exchange of information applies to categories of cases and assumptions that must be developed in a mutual agreement between two or more States Parties.

Spontaneous exchange of information occurs when information is exchanged between States Parties without the request of any of them, provided that any of the circumstances stipulated in the treaty are fulfilled; these are: loss of tax collection of the other party, when a person obtains a reduction in or an exemption from tax in the other state, existence of business dealing between persons of States Parties that may involve a saving in tax in any other state or a saving of tax that may result from artificial transfers of profits within groups of enterprises of the States Parties.

Additionally, the Convention establishes the possibility of performing simultaneous tax examinations; that is to say that each one examines, at the same time, the tax affairs of one or more persons who have some kind of relationship, with the purpose of exchanging information. The possibility is also foreseen that officials of the tax authority of one State Party assist a tax audit of other state.

Collection assistance

Likewise, the Convention establishes that among States Parties, necessary measures may be taken for the effective collection of tax credits in other countries, provided that they are enforceable and taxpayers are residents of that state.

Additionally, it is foreseen that one of the parties may request from the other the issuance of precautionary measures in order to ensure and achieve the collection of an enforceable tax.

This agreement includes obligations of confidentiality regarding the personal data of taxpayers and the information handled by tax administrations; similarly, it offers benefits for the control entities such as flexible processes since there is only one co-ordination body, flexibility regarding the scope each state establishes to the assistance that provides and the detection of financial crimes.

Common Reporting Standard (CRS)

The OECD, in order to standardise the exchange of information between tax administrations and to ensure the integrity of tax systems, approved the Common Reporting Standard for automatic exchange of tax information.

The CRS establishes the common standard to fulfil due diligence and reporting obligations related to the exchange of information regarding financial accounts, determining the minimum information that must be exchanged between tax administrations regarding financial accounts, under MAAC and the OECD Model Agreement.

Since 2019, Ecuador has been implementing the Common Reporting Standard in order to comply with its international obligations concerning transparency of tax information that have arisen from its adherence to the Global Forum on Transparency and Exchange of Information for Tax Purposes and the ratification of the Convention on Mutual Administrative Assistance in Tax Matters.

For this reason, the Ecuadorian Tax Administration, so that the institutions of the financial sector as well as the actors of the stock market and insurance sector may be able to report the different types of accounts and subject them to due diligence standards, issued rules and procedures for the effective implementation of the Common Reporting Standard and due diligence related to automatic exchange of information, through the presentation of the non-tax resident accounts form (CRS Annex).

Subjects obliged to present this annex are custody and deposit institutions, investment entities and insurance companies, who must report information related to interests, dividends, account balances, income from certain insurance products, account income from the sale of financial assets and other income generated by assets held in account, belonging to non-tax resident individuals or companies.

To report these accounts, the cut-off date established was 30 September 2019, to consider whether it is a pre-existing account or a new account, indicating besides that if they exceed the value of USD1 million, they will be considered as high-value accounts, and those that do not exceed that amount, low-value accounts.

In the CRS Annex, the required entity must present the information for each account or financial product, which includes the name, address, tax residence jurisdiction, tax identification number, date and place of birth of each reportable natural person, and in the case of account-holders of companies, if it is identified that there is one or more persons that exercise control and that are subject to report, the business name, address, tax residence jurisdiction and tax identification number of the said society should be included. In addition, the total account balance, up to the close of the calendar year, or the value of the last total balance must be included, and, if applicable, depending on the type of account in question, the amount of interest paid, or earnings or yields generated.

The CRS Annex must be submitted annually, until May of the following year to the one the information corresponds to, in accordance with the form and technical specifications issued by the Tax Administration, and will be related to the period January 1st to December 31st of each year.

Additionally, regulations issued by the Tax Administration establish specific procedures for due diligence in order to identify reportable accounts, with respect to pre-existing and new accounts of natural persons, and pre-existing and new accounts of companies; it also mentions the minimum standards for due diligence, by which it is foreseen that any company requested to submit information may freely apply to the pre-existing accounts the due diligence procedures provided for new accounts, or apply the procedures provided for high-value accounts to the less valuable accounts.

A very important aspect to highlight is the establishment of confidentiality, which ensures that any person who is working in the Tax Administration will treat the information received confidentially and will only reveal it when necessary, by virtue of compliance with international agreements and the law; observing as well that the information provided by the requested company may be used by the Internal Revenue Service for its own purposes and for the exchange of information with competent authorities of other states.

Finally, the Tax Administration establishes the sanction of 250 minimum wages (one minimum wage in 2019 = USD394) for those companies requested to submit the CRS Annex that present inconsistencies and do not correct or justify them within the granted period, for those companies that omit the presentation of the CRS Annex, as well as for those who omit to report information on any reportable account, as a result of non-compliance with due diligence duties.

Nowadays, the phenomena of tax evasion and avoidance cannot be conceived as internal situations of a country limited to its borders, but they arise from international technical and sophisticated studies, tending to erode tax bases in one or several countries, so their control cannot be done in an isolated way; in this sense, the entry of Ecuador to the Global Forum, the adherence to the MAAC and the implementation of international standards are solid steps tending to stop harmful tax practices, both nationally and internationally.

At the discretion of the Ecuadorian Tax Administration (Internal Revenue Service), these actions of the state will provide Ecuador with better tax collection strategies and tools that allow it to efficiently fight tax evasion.

Estudio Jurídico Prado

Av. Orellana E4-430 y Amazonas
Edificio Orellana 500, 5to piso
Quito - Ecuador

+593 (2) 2232 068 Ext. 243

+593 (2) 2228 100

consultas@ejprado.com www.ejprado.com
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Law and Practice

Authors



Bustamante & Bustamante is a law firm of national as well as international standing, having advised national and multinational corporations, financial institutions and government organisations from countries such as the USA, China, England, Canada and Italy for over 60 years. It is one of the most reputable practices in Ecuador, known in particular for its tax division, with a team of six qualified lawyers headed by senior partner Juan Carlos Bustamante. Its experts strive to maximise return while reducing tax exposure, and provide a customised tax plan for each corporate strategy, thus achieving a competitive edge in M&A or restructuring. The team specialises in double-taxation treaties, capital gains, tax and beneficial owner issues. The firm also advises clients regarding numerous other matters, including IP, oil and gas, project finance, franchising, banking and financial services, corporate, mining, telecommunications, electrification, privatisation, insurance, real estate and labour law. Bustamante & Bustamante is an equal opportunity employer, with eight partners, over 50 attorneys and 70 support staff, many of whom have studied and worked in the USA, Europe and Asia, as well as Latin America.

Trends and Development

Authors



Estudio Jurídico Prado was founded in Quito in 1984 and has grown into one of Ecuador's leading law firms. It is a full-service law firm that has been recognised as a leading firm in tax and finance. Among the firm's core values are its commitment to excellence, teamwork and work ethics, all in the service of and dedication to clients. The firm has been recognised with important national and international awards. For years it has provided legal services based on excellence, teamwork and innovation for the purpose of ensuring client satisfaction and serving society, clients and entrepreneurs. The firm's tax team, led by Dr Mario Prado, has 11 specialised professionals focused in managing clients' tax planning and offers them the best advice in accounting as well as in legal points of view, and provides them with tools to reach the best decision-making. The firm's key practice areas are tax accounting and legal planning, representation in administrative claims, and preventing based in advice and follow-up.

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