Ecuador Tackles Share Transactions to Cut Down on Tax Evasion

The transfer of shares or equity rights is a taxable event. Whether the transaction generates a profit for the transferor or it qualifies as a donation—free of charge transfer—income tax will be levied on it.

However, many Ecuadorian business groups commonly transfer shares at par value without complying with formal obligations and the payment of taxes that are triggered by such transactions.

They limit themselves to informing the Superintendence of Companies, Securities and Insurance, or SCVS, about the transaction through share transfer notes—a private instrument detailing the transferors and transferees, the par value of the shares, and the number of shares transferred.

This process doesn’t imply compliance with tax obligations.

The Ecuadorian Internal Revenue Service, or SRI, will now use its powers to audit these transactions to ensure that taxpayers comply with their formal obligations, identify their hidden capital gains, and pay the triggered taxes. The SRI also will closely monitor those taxpayers or companies for which non-compliance has already been identified.

It’s important for taxpayers involved in these transactions to comply with their formal obligations and pay the triggered taxes.

To avoid free interpretations by the SRI regarding the actual value of the transaction, and to properly formalize the share transfer, taxpayers should execute agreements and similar instruments with economic substance in line with market value, and, if applicable, with the arm’s-length principle. This reduces the risk of an arbitrary assessment of the actual value of the transaction.

The SRI already has served several taxpayers regarding undeclared share transfers. It has detected non-compliance through information provided by the SCVS, which maintains records of all share transfers relating to companies under its supervision.

The SRI has likely reconciled the tax returns filed with the share transfers reported by the SCVS. In this way, it has identified those taxpayers who have failed to comply with their obligation to file the return and potentially to pay the tax.

Taxable Event

The Ecuadorian tax system levies a 10% tax, the IRU, on the gain generated from the transfer of shares. The capital gain is calculated by deducting the acquisition cost, the proportional equity value, or the par value (whichever is higher) from the effective sale price of the shares.

The proportional equity value is the result of dividing the company’s equity by the number of shares. The equity used for this calculation is that recorded as of Dec. 31 in the year immediately preceding the transfer, excluding all undistributed profits.

The transfer of shares of companies that directly or indirectly hold shares in Ecuadorian tax resident entities is also subject to the tax, provided certain conditions are met. The SRI also seeks to audit this type of transaction (indirect transfer).

Formal Obligations

Those who transfer shares and equity rights must file the relevant tax return within the month following the transaction, even if no capital gain was generated. If the transferor isn’t an Ecuadorian tax resident, the company whose shares were transferred, directly or indirectly, will act as a substitute liable taxpayer. The company must file the return and pay the IRU on behalf of the transferor.

Additionally, the purchaser must withhold, as IRU, 1% of the price paid. This withholding may be used by the transferor as a tax credit when filing the IRU return.

The withholding is required even if the purchaser isn’t a withholding tax agent. The SRI designates taxpayers who must withhold taxes on all payments made. For certain transactions, taxpayers must withhold even if they aren’t qualified withholding agents.

Penalties and Fines

Failure to file the IRU return will result in a fine equal to 5% of the actual value of the transaction, plus the tax due and the interest accrued. Late return filing is fined with 3% of the tax for each month of delay—the fine may not exceed 100% of the tax—in addition to the tax due and interest.

In a case of late filing of a return that doesn’t register any tax due, the fine will be 0.1% of the actual value for each month of delay (not exceeding 5% of the total actual value).

Failure to pay the IRU subject to withholding is sanctioned with a fine of 100% of the total not withheld. In addition, the taxpayer must pay the un-withheld tax and the interest accrued.

Actual Value

Many transactions have been agreed at par value or below market price. The actual value of the transaction is therefore needed to determine the fine and to assess what the SRI has defined as hidden capital gains and, consequently, the tax triggered.

The value at which the share transfer was agreed may not coincide with the actual value of the transaction. This is because the transferred shares may confer rights over profitable entities that even record significant undistributed profits.

In such cases, taxpayers operating under financial and market logic would accept to transfer shares at a price substantially higher than their par value, even higher than the proportional equity value and probably higher than the acquisition cost, if applicable.

If that is the case, the hypothetical seller would realize a capital gain that, in practice, the transferor who transferred shares at lower values didn’t record or recognize, and on which no tax was paid. This is an assessment similar to those performed to determine the compliance of the transaction under the arm’s-length principle.

Based on these considerations, the SRI may determine a gain in the transaction and require payment of the tax generated, accrued interest, and fines in accordance with the guidelines described above. The SRI may assess the transaction’s actual value based on the financial situation of the company whose shares were transferred and in accordance with the market price.

The Ecuadorian tax authority is tackling a long-standing practice of non-compliance with formal and economic obligations on the transfer of shares. It’s important for taxpayers to review past transactions to determine full conformity with the applicable tax regime.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Diego Andrés Almeida is a partner with Almeida Guzmán Asociados.

César Molina is a tax associate with Almeida Guzmán Asociados.

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