INSIGHT: Ecuador—New Taxes and International Agreements

October 2020 will mark the first anniversary of the social unrest caused by the protest of indigenous groups throughout Ecuadorian territory. Well before the Covid-19 pandemic reached Ecuador, the economy suffered a significant deterioration, obliging the government to reduce public spending and introduce several fiscal reforms.

The Ecuadorian authorities have implemented economic and fiscal reforms in response to the economic crisis and the effects of the Covid-19 pandemic. The international community, in turn, has recognized these efforts. As a result, Ecuador has reached a staff-level agreement with the International Monetary Fund (IMF) for close to $6.5 billion.

The new arrangement has complemented a successful and market-friendly debt exchange of $17.4 billion in global bonds between Ecuador and its bondholders. According to the IMF’s respective procedure, the agreement still needs to be ratified by its Board of Directors.

According to the IMF, Ecuador’s gross domestic product will suffer a contraction of nearly 11% in 2020. The corresponding Ecuadorian authorities have committed to improving public finances during the recovery period. Governmental actions include enacting a new law for the ordering of public finances. Ecuador will also have to implement a fiscal reform that includes the moderation of current and capital expenditure, as well as a comprehensive tax reform. The scope of this comprehensive tax reform remains unknown.

To increase tax collection, authorities have issued new tax laws. In order to incentivize foreign trade, Ecuador has also entered into new trade agreements with large trading partners, including the U.K., the European Free Trade Association (EFTA) (Iceland, Liechtenstein, Norway and Switzerland), and Chile.

Taxation

After an initial setback at the Constitutional Court, the Internal Revenue Service (IRS) has called for an early income tax payment. According to IRS Resolution NAC-DGERCGC20-00000054, both individuals and companies, including branches of foreign entities residing in the country and permanent establishments of nonresident foreign companies, are obliged to make an income tax payment in advance when:

• they have reported taxable income, except income earned under a direct labor relationship;
• their total income recorded in the 2019 income tax return is equal to or greater than $5 million; and
• between January and July 2020, they show a profit in their accounting records.

Exemptions apply to small and medium enterprises, taxpayers domiciled in the Galapagos Islands, and taxpayers in the tourism and agricultural industries, as well as exporters, among others.

Value-added Tax

Starting in September 2020, a 12% value-added tax (VAT) is charged on digital services. Digital service providers domiciled in Ecuador will have to collect the VAT from their customers. In cases where the provider is not duly registered in Ecuadorian territory, the payment intermediary will be required to withhold the tax.

It is important to note that according to the IRS, VAT collection hit its lowest in May 2020, totaling only 53% of the amount collected in May 2019. On a positive note, the month of July showed a significant increase, as collection was only 32% lower than the amount collected in July 2019.

Trade Agreements

As a result of the U.K.’s exit from the EU, Ecuador ratified a trade agreement with Great Britain and Northern Ireland. As set out in the agreement, many of Ecuador’s products will benefit from 0% tax if exported to the U.K., thereby providing new opportunities to Ecuadorian exporters in the fifth largest economy in the world. The agreement covers the trade of goods and services, including provisions on rules of origin, preferential tariffs and quotas, intellectual property, geographical indications, and government procurement. Overall, the agreement is similar to the EU–Ecuador, Peru and Colombian Multiparty Trade Agreement.

Ecuador has also signed a Comprehensive Economic Partnership with the European Free Trade Association. The agreement is expected to take effect in October 2020. The terms set out in the agreement will facilitate trade and investment between Ecuador and the EFTA member states, including provisions related to market access for goods, rules of origin, sanitary measures, trade facilitation, intellectual property, public procurement, sustainable development, and cooperation, among others.

In August 2020, Ecuadorian and Chilean authorities signed a new Trade Integration Agreement. The event marks an important step towards Ecuador’s eventual integration into the Pacific Alliance. As part of the new deal, 160 Ecuadorian products will benefit from special tariffs when exported to Chile, while Chilean products imported to Ecuador will also benefit. Such products include oil and vegetable fats, wheat, wheat flour, pasta, sweeteners, bovine meat, and seeds, among others.

Economic Overview

The 2020 national budget was structured around an oil price of $51.30 per barrel with an estimated income of over $2 billion. The international collapse of oil prices has generated an even larger deficit than originally expected. As such, Ecuador had to reach out to multilaterals for additional resources. The country also had to appeal to bondholders in order to exchange $17.4 billion in global bonds.

As a result of the economic measures taken by the government and the agreements reached with bondholders, Fitch Ratings upgraded Ecuador’s Long-Term Foreign Currency Issuer Default Rating (IDR) to “B-“ from “RD”. S&P Global Ratings also upgraded the Ecuadorian ratings to “B- “.

Ecuador’s Country Risk closed the month of August 2020 at around 2,170 basic points. It is important to note that this indicator reached over 6,000 points in March 2020. While the figure remains high, it represents a significant improvement.

President Lenin Moreno has also announced a potential debt agreement with China. If an accord is reached, Ecuador could receive up to $2 billion in fresh funds.

In the first half of 2020, Ecuador’s trade balance has remained positive at around $1.3 billion.

Closing Considerations

The agreements reached with the IMF represent a radical change in the country´s position. After more than a decade, Ecuador has returned to the IMF, leaving behind a marked reluctance for engaging with it. The injection of new resources will close the fiscal gap with remarkably favorable conditions for the country.

Apart from radical socialist sectors identified with the previous government, the agreements reached with multilateral agencies have been viewed favorably by the Ecuadorian population. It is evident that the support from the IMF and, consequently, of other multilateral agencies and bondholders, is essential for the future recovery of the Ecuadorian economy.

The tax regime currently in effect in Ecuador requires a different approach. The current system is simply not responding to the new reality that the country is facing as a result of the pandemic and the deterioration of its economy. The ideology under which the previous government conceived public policies has proven to be detrimental to the economy. The current government has made significant efforts to overcome the effects of historical misconceptions regarding how the economic system was handled.

Presidential elections are less than a year away. Candidates are faced with the pressing need to continue down the path that the current government has taken to overturn past economic, fiscal, and legal approaches that have proven to be inadequate for the economy.

Diego Almeida Guzmán is the Senior and Technical Partner, and Diego Andrés Almeida is Senior Consultant, with Almeida Guzmán & Asociados.

The authors may be contacted at: dalmeida@almeidaguzman.com and daa@almeidaguzman.com

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