An amendment to the Ecuador Internal Tax Regime Law (ITRL) introduced on December 31, 2019, established that digital services will be subject to 12% value-added tax (VAT) starting September 16, 2020. The President issued the relevant regulations for applying this reform on July 28, 2020. We will discuss the legal reform and the effects for nonresident digital service providers below.
Definition of “Digital Services”
Article 140.1 of the ITRL Regulations describes digital services as those: “provided and/or contracted through the internet, or any adaptation or application of protocols, platforms or technology used through the internet, or other network through which similar services are provided that, because of their nature, are automated and require minimal human intervention, regardless of the devices used for download, display or use.”
The definition included in the ITRL Regulations is too broad. It classifies as “digital services” services that do not have such a nature, only because they are provided through the internet. According to this definition, personal or professional services would be regarded as digital services when provided through the internet.
To avoid this confusion, other legislation, such as the common VAT system of the EU, restricts the definition of digital services to those impossible to ensure in the absence of information technology. Directive 2006/112/EC of the EU and its regulations describe digital services as those “delivered over the internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention, and impossible to ensure in the absence of information technology.”
Additionally, the ITRL establishes that web domain services, hosting and cloud computing services are subject to 0% VAT. Article 184.1 of the ITRL Regulations defines these services as follows:
- web domain services: the provision of internet domain names (domain name system);
- hosting servers: the provision of hosting information, images or video, or any content, accessible to the public through the internet;
- cloud computing: the provision of private storage of all types of data through an internet or telematic network.
The definition of “cloud computing services” is too narrow. According to the United States National Institute of Standards and Technology: “cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.”
Cloud computing is not limited to storage services, it is a model for providing computing services. These services allow users to access multiple data processing functionalities and emerging technologies like artificial intelligence, machine learning, the internet of things, blockchain, among others.
If the legislators decided to tax the provision of cloud computing services with a 0% rate instead of 12%, their intention was to make these services more affordable to Ecuadorian users. Including a narrower definition of cloud computing services in the regulations makes the services excluded from the definition subject to 12% VAT and less affordable to Ecuadorian developers, businesses, and end-users.
Collection and Remittance of VAT: Complying with Obligations
Guideline 3.1. of the Organization for Economic Co-operation and Development (OECD) International VAT/GST Guidelines establishes that “for consumption tax purposes, internationally traded services and intangibles should be taxed according to the rules of the jurisdiction of consumption.” The application of this guideline ensures that cross-border transactions are levied only in the jurisdiction where the final consumption occurs, thereby achieving VAT neutrality in international trade.
In general, the local provision and the import of services are subject to VAT. Therefore, the provision and import of digital services is already levied with VAT. In practice, no VAT was collected on cross-border business-to-consumer (B2C) services transactions, such as monthly payments for subscriptions to Netflix or Spotify. The amendment aims to apply to these transactions.
Collection and remittance of VAT are traditionally obligations of the supplier: however, when the supplier is not located in the jurisdiction of taxation, complying with these obligations is more complex. For cross-border business-to-business (B2B) services transactions, the ITRL provides a reverse charge mechanism where the liability to pay the tax shifts from the supplier to the customer.
This reverse charge mechanism is not an appropriate solution for collecting VAT on B2C services. The OECD and other international organizations consider that the most effective approach to ensure the collection of VAT on cross-border B2C service transactions is to require the nonresident supplier to register and collect the VAT in the jurisdiction of taxation.
This is the approach included in the amendment to the ITRL. According to the ITRL provisions:
- if the entity registers in Ecuador as a nonresident digital service provider, the entity will be required to collect the VAT from the consumer and pay the VAT to the tax authority;
- if the entity does not register in Ecuador as a nonresident digital service provider, and
- the payment is made through an intermediary, for example through a credit or debit card, the credit card issuer will be required to withhold the VAT from the consumer and pay the VAT to the tax authority;
- the payment is not made through an intermediary, the consumer will be required to liquidate and pay the VAT to the tax authority.
In general, the VAT taxable base is equal to the price of the service. In the case of sharing economy business models, the VAT taxable base is equal to the commission charged by the platform and not the price of the goods or services traded through such platform.
If the nonresident service provider is registered in Ecuador, identifying the taxable base would not be a challenge: however, if the provider is not registered, the intermediary (credit/debit card issuer) will be required to identify the taxable base. In the case of platforms, if the intermediary is not able to identify the amount of the commission, the VAT taxable base will be equal to 10% of the amount paid.
The OECD International VAT/GST Guidelines recommend tax authorities to implement a simplified registration and compliance regime for nonresident suppliers, taking into consideration the burden that may be involved for nonresident—filing returns, paying the tax, keeping records, and issuing invoices.
These guidelines recognize that invoicing requirements are among the most burdensome responsibilities; therefore, it recommends considering eliminating invoice requirements for B2C suppliers, considering that the customers involved generally will not be entitled to deduct the VAT paid on these services.
Regulations issued on July 28, 2020 establish that the digital service provider must file monthly VAT returns. The process for registering as a nonresident digital service provider and to file the VAT returns must be regulated by the tax authority. Therefore, one of the challenges of the authority when issuing the regulations will be to establish a simplified process that enables the nonresident provider to comply with its obligations, whether directly or through third-party service providers.
Looking forward, nonresident digital service providers should be aware of the following:
- Starting September 16, 2020 digital services will be charged with 12% VAT. Therefore, from such date B2C services will be 12% more expensive for final consumers located in Ecuador.
- Nonresident service providers should identify whether their services may be regarded as web domain services, hosting and cloud computing services which are subject to 0% VAT.
- Nonresident service providers should decide whether to register as a digital service provider in Ecuador. To make such decision it is important to identify the benefits and obligations of registering in Ecuador.
- Registering as a nonresident digital service provider can be useful since:
- the provider will be able to identify and communicate to the client the final price of its service; and
- the provider will be able to identify the taxable base and collect the correct amount of VAT from the consumer. This is especially important for platforms such as Uber, Booking or Glovo since, as explained above, if the provider is not registered and the payment is made through an intermediary, the VAT may be charged over 10% of the amount paid.
- Currently, it is not possible to identity the burden that will be involved by registering in Ecuador as a nonresident service provider, since the tax authority has not issued the applicable regulations.
- Registering as a nonresident digital service provider does not generate a permanent establishment in Ecuador for the foreign entity.
Andrea Moya Hidalgo is a Partner with CorralRosales.
The author may be contacted at: firstname.lastname@example.org
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.