Businesses commonly adopt a corporate form. The most common structures are corporations and limited liability companies (partnerships). In 2020, the Ecuadorian legislation was amended to include a new type of entity referred to as a “simplified stock corporation”.
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 as 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.
In general, under Ecuadorian law, corporate forms are not considered transparent entities. In fact, local legislation provides limited liability for all stockholders and partners.
All corporate entities are considered to be independent taxpayers. Dividends paid by corporate entities are tax exempt unless the beneficiary is an Ecuadorian individual. However, the individual beneficiaries of the dividends may be subject to paying 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 rate. Exemptions 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 into 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 aforementioned double taxation treaties, Ecuadorian-source income is taxed locally. However, particular income – such as royalties, 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 2020, micro businesses are subject to a 2% income tax levied on their revenues.
With regard to 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 2021 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 aforementioned adjustments are made in the applicable tax return based on accounting records.
The Ecuadorian Income Tax Law provides for a five-year tax exemption on income arising from new investments in productive projects performed. Particular reference is made to technology projects, including biotechnology and software, as well as biological and software development, and related services. Also, the exemption applies to projects related to hardware production and development, digital infrastructure, computer security, products and digital content, and online services. This special tax treatment is subject to fulfilling specific requirements.
The Ecuadorian tax law provides for a five-year income tax exemption on profits generated by new projects in the following sectors:
This special tax treatment is subject to the investment being made in jurisdictions outside Quito and Guayaquil, as well as fulfilling specific requirements.
New productive investments in sectors regarded as basic industries benefit from a ten-year income tax exemption. The aforementioned benefit may be extended for an additional two to five years, whenever the investments are made in cities located on Ecuadorian borders. For the purposes of this special tax treatment, basic industries include the following:
Entities in the manufacturing sector, receptive tourism industry or qualified as habitual exporters may apply for a 10% reduction of the corporate income tax rate if the entity acquired fixed assets for the purpose of increasing its productivity and certain conditions are met.
New micro enterprises may benefit from a three-year income tax exemption, subject to meeting specific requirements.
Entities that manage or otherwise operate an Economic Special Development Zone will benefit from a ten-year income tax exemption.
Losses of up to 25% of the taxable income recorded in a fiscal year can be amortised (carried forward) for up to five years. 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 all cases, are subject to registration with 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 these kinds of transactions is subject to income tax withholding.
The consolidation of financial statements for tax purposes is not permitted under Ecuadorian law. As such, groups of companies are not allowed to record separate losses.
However, for reporting purposes before the Superintendence of Companies, IFRS rules on consolidating financial statements apply.
In general, Ecuadorian law does not provide for particular tax treatment on capital gains, which are taxed as general income.
Despite the aforementioned, there are exceptions, 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 withholding agent for the applicable income tax levied on the profit generated by the transaction.
The sale of shares listed on an Ecuadorian stock exchange is subject to a special tax treatment.
The applicable progressive rates for capital gains on the sale of shares and other equity rights are as follows:
The following taxes are commonly applicable.
The payment of dividends and interests, whenever certain requirements are met, may be exempt from ISD.
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:
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 on the 2020, 2021 and 2022 fiscal years.
In any case, the contribution does not exceed 25% of the income tax paid in 2018. The special contribution is not applicable to businesses that reported losses on the aforementioned fiscal year.
Tax on Profit Generated on the Sale of Real Estate
Profit generated on the sale of real estate is subject to this tax, which is 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 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.
Despite the fact that 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. Income tax paid by the entity distributing the dividends is recorded as 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. Both the corporate tax paid by the distributing companies and the aforementioned withholding tax are tax credit, which is then deducted from the final individual tax levied on the individual’s income.
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, the following treatment applies:
In the absence of double taxation treaties, the following tax withholding rates apply.
Despite the fact that Ecuador has entered into double taxation treaties with 21 countries, the primary tax treaty countries foreign investors use to make investments 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, local law provides for some particular rules on applying double taxation treaties. In fact, the exemption of tax withholdings on payments made to residents of countries holding a double taxation treaty applies only up to USD560,600 within a fiscal year. Payments exceeding such amount are subject to a 25% income tax withholding. However, the beneficiary can apply to the Ecuadorian tax authority for reimbursement of the amount withheld, which is granted after an analysis is made of the effective applicability of the double taxation treaty.
Despite the fact that 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 and 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 in order to determine the parameters under which the transfer pricing valuation will be performed.
To the best of the authors' knowledge, 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 generally 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 does 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 into a MAP with foreign tax authorities.
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.
Capital gains of non-residents on the sale of stock in local corporations are taxed in Ecuador. Indeed, the tax applies when the gain is on the 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.
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 total expenses and costs paid to a non-local affiliate. Likewise, royalties and technical service fees paid by local affiliates to their head office and related entities are allowed only up to an amount not exceeding 20% of the taxable income of the paying entity.
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 net profit plus interest, depreciation and amortisation of the given fiscal year.
Ecuadorian corporations are taxed on their worldwide business income. As such, foreign income is, in principle, taxed in Ecuador. However, Ecuadorian tax law states that foreign income that has been taxed abroad is considered exempt in Ecuador.
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.
Intangibles 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 particular provisions regarding controlled foreign corporation (CFC) rules in Ecuadorian legislation.
There are no rules related to the substance of non-local affiliates. Nevertheless, in order 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.
Gains obtained by local corporations on the sale of shares held in non-local affiliates are taxed in Ecuador. No particular rule exists on the matter in local law. As such, these gains will be subject to a 25% income tax rate.
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 will punish it 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 three years of the date when the corresponding tax return was filed.
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 appealed 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 Guidelines on VAT.
Despite the fact that 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 (who are not domiciled in Ecuador). Such registry is administered by the Ecuadorian IRS.
Whenever the provider of a digital service is not registered with 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.
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.
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 in order to comply with BEPS.
The main issue that the authors 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.
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.
In general, the current tax regime applicable to interest does not provide for restrictions tailored to territorial tax regimes (Special Economic Development Zones). Ecuador is considered to be 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 currently do not foresee any plans to include CFC rules in local legislation.
At this time, the authors do not foresee any impacts that DTC limitations might have for both inbound and outbound investors. It is important to note that Ecuador does have 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 Ecuadorian property is not a particular source of controversy or difficulty under Ecuador’s tax regime.
The authors agree with the proposal for transparency and country-by-country reporting. However, they do not anticipate it having particular 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 with the Ecuadorian IRS.
Ecuador has taken few steps in relation to the BEPS proposals for digital taxation (specifically, regarding Action 1 under the International VAT Guidelines, Ecuador has issued legal provisions in order 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.
Taxation of Digital Services in Ecuador
Digitalisation of the economy worldwide has generated several challenges for taxation, among them, to impose an effective tax system on digitalised transactions of goods and services.
In this regard, in 2013, the OECD adopted the base erosion and profit shifting (BEPS) initiative. Action 1 of the plan was formulated to analyse and design measures to address the tax challenges of the digital economy. In the framework of Action 1, the OECD identified risks related to the application of existing international taxation principles, base erosion and profit shifting for a digital business and the application of direct and indirect taxation.
In response to these initiatives, several countries have already implemented taxation on digital services, either directly or indirectly. However, there are still a variety of issues to be addressed, such as which jurisdiction should be the one that collects taxes, is the tax residence of the business determined by the place where it is located or by the location of the users who generate income or consumption, and, more importantly, how to tax subjects who are not residents of a country.
In Ecuador, in accordance with this need that has arisen from the globalisation of digital services, the enactment of the Tax Simplicity and Progressivity Law in December 2019 meant that digital services would be charged with value added tax (VAT), and the tax became effective on 16 September 2020. The current VAT rate in Ecuador is 12% as a general rule and 0% for specific goods and services determined by the Law.
How Are Digital Services Defined?
Ecuadorian regulations establish as a general definition that digital services are those services provided and/or contracted via the internet, which, by their nature, are automated and require minimal human intervention, regardless of the device used to download, view or make use of them.
Despite having a general definition, Ecuadorian regulations have exemplified certain services that are subsumed in this presupposition, such as the supply and hosting of web pages and sites; the supply of digitised products in general, including computer programs, as well as the access and/or download of digital books, designs, components, patterns and similar; reports; financial, data or market analysis; web services, software services; access and/or download of images, text, information, video, games of luck; online clubs or dating website services; services provided by online blogs, magazines or newspapers; and internet services provision.
Digital services in general will be taxed at a VAT rate of 12%, except for those services for which the Ecuadorian regulations have determined a 0% VAT rate, such as the supply of website domains, hosting servers and cloud computing, as well as free digital services.
When Does the Taxable Event Occur?
The taxable event for the purposes of digital services VAT has been established in Ecuadorian legislation as follows.
How Should the Tax Be Declared and Paid?
To implement the tax return and collection, it has been determined who will be considered as the VAT collection agent or withholding agent for the above-mentioned operations.
Thus, the collection agents are non-resident persons who provide digital services, as long as they are registered with the Ecuadorian tax administration, and submit the VAT return monthly.
Credit and debit card-issuing companies have been appointed as withholding agents, for those payments made in the acquisition of digital services, when the service provider is not registered with the Ecuadorian tax administration. In accordance with the previous section, regarding the moment at which the taxable event for digital services VAT occurs, the procedure will be the following.
The said withholding agents must take into account the following considerations that they need to comply with for such designation:
For a better understanding of how the regulations in this regard are applied, let us suppose that an Ecuadorian resident acquires a computer through a foreign digital platform and pays with a credit card; since it is a purchase of goods, it will not generate VAT for digital services, since it is not an import of this type.
On the other hand, if this Ecuadorian uses a foreign digital food delivery platform, he or she will pay the value of the food plus the commission fee for the use of the platform, and VAT will be generated on this commission fee (this last amount is the one the credit card-issuing company will withhold).
Finally, in the event that the Ecuadorian enrolls in a streaming subscription that will allow him or her to watch series and movies, in addition to the monthly membership fee, he or she will pay VAT on the amount.
What Are the Supporting Documents for the Tax Credit for VAT?
In order to have a supporting document for the tax credit, the taxpayer must issue a purchase voucher for goods or services, and if there is no intermediary in the payment process, the taxpayer will directly withhold 100% of the VAT generated.
If there is an intermediary in the payment – that is, if the service is paid with a credit or debit card – the account statement generated by the credit or debit card-issuing company will become proof of withholding and the supporting document of the tax credit.
Is There a Connection with Income Tax?
When taxpayers are compelled to keep accounting records, to support costs and expenses for the annual income tax return, they must issue a purchase voucher for goods and services. Although the regulations have conceived it as a way to support tax credit for VAT and to perform withholding, when there is no payment intermediary, the taxpayer would also be forced to make an income tax withholding to the digital services provided.
In this sense, even though Ecuadorian legislation does not formally charge income tax on the benefits generated through this type of business, indirectly the current regulations have made taxpayers subject to income tax on digital services in specific situations, such as the one described previously.
In spite of that, Ecuadorian tax legislation has not provided effective and clear mechanisms for this type of direct taxation on this kind of service.
After almost six months since the regulations came into force, the authors can indicate that the implementation of VAT on digital services has had good results overall for the tax administration.
A very important part of the chain for the effective collection of this tax is the appointment of credit and debit card-issuing companies as withholding agents for this tax. As has been seen, they have generated a collection of a type of service that, by its original nature, should be subject to VAT, but due to the special features of the digital economy, it was difficult to implement taxation and collection processes for non-residents of Ecuador. This has led the Ecuadorian tax administration to create a new source of tax revenue.
However, one of the problems generated is the excess withholding of the tax, since the registry established by the tax administration includes subjects that provide digital services but also that sell goods and the intermediary (credit card issuer) cannot know the concept of the invoice and only registers consumption in the registered establishment. Therefore, if a person buys goods from a supplier that is also registered as a digital service provider, VAT is generated on 100% of the amount of consumption and not on 10% of the said amount, generating an excessive withholding.
The effect of these issues on taxation is the indirect tax burden that taxpayers have, as well as the workload of the tax administration, since the only way to request the return of the said amounts is through a claim for overpaid tax, which must be resolved within 120 labour days.
Although taxation of the digital economy has been a risk that has been identified at the international level for some years now, in 2020, Ecuador began to apply measures to mitigate the risk and equally tax digital and non-digital services, in terms of VAT. Notwithstanding, there are still many points for improvement and the taxation of the digital economy is to be implemented in accordance with international standards, regarding indirect taxation as well as the design of an effective tax system related to income tax.