Ecuador: President-Elect Announces Tax Reforms

The date April 11, 2021 will unquestionably go down in Ecuadorian history as one of the country’s most memorable days. After a long year of pandemic-related restrictions and effects, not to mention years of governments dazzled by the promises of 21st century socialism, Guillermo Lasso, a center-right former banker, was elected as the next Ecuadorian president. President-elect Lasso will take the presidential oath on May 24, 2021.

With an approximate margin of five percentage points, the Ecuadorian people have chosen a new direction for their nation’s politics. The results of the election show a country eager for change, but also strongly divided between the coastal region, where the leftist candidate Andrés Arauz won, and the Highland and Amazon regions, where support for Lasso prevailed.

The President-elect has begun working on the transition and has already announced several reforms to stimulate the economy while complying with the general terms set out by the International Monetary Fund (IMF). In the past year, as a result of the pandemic and the sharp decline of the economy, President Lenin Moreno approached the IMF and obtained approval for a 27-month extended arrangement under the Extended Fund Facility for Ecuador.

Under the new deal, Ecuador has already received disbursements of $4 billion to ease the economic effects of the pandemic and cover part of the fiscal deficit. As explained in IMF Country Report 20/286, the country will receive a total of $6.5 billion in order to stabilize the economy, expand the coverage of social welfare programs, ensure fiscal and debt sustainability, and strengthen domestic institutions to lay the foundations for strong, job-rich, and long-lasting growth that benefits all Ecuadorians.

Relationship with Multilateral Agencies

Future measures are aimed at restoring fiscal sustainability while protecting the common interest of all Ecuadorians. Under the new agreement, national authorities are expected to implement a progressive tax reform by the end of September 2021.

The new president is expected to comply with the demands of the IMF, but his proposals differ from those initially expected, especially in terms of taxation. The appointed future Finance Minister, Simón Cueva, has already begun working with multilateral agencies in Washington D.C., such as the IMF and the Inter-American Development Bank. Cueva has considerable experience within the finance sector, having previously worked at the IMF as well as the Central Bank of Ecuador.

Lasso and his team will face the challenge of redirecting the economy, with strong support from the Ecuadorian private sector and the IMF. On Monday April 12, a day after the elections, the IMF’s First Deputy Managing Director, Geoffrey Okamoto, stated that the Fund is confident in the commitment of the new government of Ecuador to defeat the Covid-19 virus and stimulate growth in the coming years.

Taxation

Although the President-elect has not released the official text of the proposed tax reform, he has announced some of the new measures to be included in it. The primary changes announced by the future president include those discussed below.

Tax on Small and Medium Enterprises

• Elimination of a 2% income tax levied on small and medium-sized enterprises (SMEs)

This measure will provide relief for these entities, and this is critically important because in 2019 a special taxation system was created for SMEs to pay an income tax of 2% on gross income, meaning that this tax does not consider costs and expenses incurred by taxed businesses (Organic Tax Simplification and Progression Law, Section 38).

In the 2020 fiscal year, many SMEs recorded no profits because they did not work under normal conditions, given the Covid-19 restrictions that severely affected the internal and global economy. However, they still had to pay income tax of 2% on their gross income, which exacerbated the precarious financial situation of this important group of taxpayers.

Capital Overflow Tax (ISD)

• Progressive elimination of the 5% ISD over four years

This tax was initially created with an extra-fiscal nature, as its purpose was to keep money circulating inside Ecuador and prevent capital from being sent abroad. In recent years, the nature of the tax changed as taxpayers preferred to pay the tax and take their money out of the country. This has led to the state coffers now registering significant income from this tax, which means that the 5% ISD now has a fiscal nature.

Interestingly enough, as the tax lost its original purpose, it disincentivized foreign investment, which is why Guillermo Lasso has shown considerable interest in eliminating this tax. Nevertheless, there are several challenges in making this possible, especially as the state needs to fill the gap that eliminating the capital remittance tax will leave.

Value-added Tax

• Creation of four value-added tax (VAT) tax holidays

In the line of Lasso’s government plan, creating VAT holidays will encourage the public to consume more, and will consequently benefit local businesses by increasing their sales and revenue.

The Future

International investors were enormously relieved by the result of the elections. The effect was reflected in the transactional value of Ecuadorian bonds in international markets, and the decline of Ecuador´s country risk. The President-elect offers an economic program that promotes a free-market economy, open to foreign investment, fiscally responsible, seeking to achieve sustainable growth and generate employment.

Lasso’s economic proposal is based on growth, with private investment as the engine of the economy.

The interest of the foreign policy of the President-elect is based on the country’s adherence to agreements with robust markets, such as the Pacific Alliance (consisting of Chile, Colombia, Mexico and Peru), and the U.S. (its main client), among others.

Internally, passing the tax reform should not represent much of an issue for the new administration as the reforms are beneficial to the general public. SMEs will benefit from the tax reforms as they will no longer have to pay the additional 2% income tax that was applicable in 2020, meaning that they will be able to use their resources to expand their operations.

Regarding compliance with the IMF guidelines and the proposed tax reforms, the Ecuadorian government will have to reach a staff level agreement and then obtain approval from the board of directors of the IMF.

Local businesses are already benefiting from lower interest rates and higher confidence levels. The handling of the economy during the last year is also giving the international community greater confidence, as international reserves have increased from $1.9 billion (March 2020) to $5.7 billion (March 2021) and the international balance of trade is also positive by $558 million.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Diego Andrés Almeida is a Senior Consultant and Dayana Naranjo is an Associate with Almeida Guzmán & Asociados.

The authors may be contacted at: daa@almeidaguzman.com; dnaranjo@almeidaguzman.com