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Daily Tax Report: International

INSIGHT: Ecuador—Tax, Labor and Economic Measures to Respond to the Pandemic

May 11, 2020, 7:01 AM

The coronavirus pandemic hit Ecuador at a difficult time for its economy. Before the pandemic reached the country, the economy was already in a recession, after two quarters of economic contraction. By the time the pandemic has run its course in Ecuador, it is estimated that GDP will decrease by at least another 7-8 percentage points.

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 as a result of the pandemic has generated an even larger deficit than originally expected. This is compounded by the fact that oil is Ecuador’s largest export commodity.

In the 2020 budget, the sale and/or granting of concessions for state assets was budgeted in an amount of $2 billion. Negotiations and due diligence processes continue, but finalization of any agreements will surely be delayed by the current health crisis.

Worsening the problem, the legal system of Ecuador lacks sufficient tools to adequately respond to the issues arising from the pandemic. The Ecuadorian regulations on employment are rigid. Some historic rules and principles of labor law make it very difficult to issue new laws to enact amendments to respond to the crisis. A practical way to solve specific issues in the short-term is one-off negotiations between employers and employees. However, such processes must always consider that employees’ rights are inalienable, which represents an important obstacle in settling labor disputes.

Ecuador experienced a period of profound social unrest in October 2019, including heavy protests in the capital city of Quito. This was due to the blanket elimination of fuel subsidies that had been in place for nearly 40 years, estimated to have cost the Treasury a total of approximately $80 billion.

The turmoil in a broader sense was also related to President Lenin Moreno’s decision to engage with the International Monetary Fund (IMF), seeking a capital injection of $4.2 billion, needed to shore up the economy. Hundreds of thousands of people from distant provinces came to Quito to protest these hotly debated governmental actions. The conflict elevated to such a point that the country was effectively shut down for about a week, paralyzing the economy before the pandemic was even a consideration.

Tax Measures

At the time of writing this article, the country’s response in tax matters has been limited to granting longer terms for fulfillment of tax obligations and reducing some import duties. New decrees issued as a response to the crisis include new tax withholding rates.

Examples of benefits for companies include the extension of the time frame for the payment of value-added tax (VAT), in up to six monthly installments throughout the remainder of 2020. An extension has also been offered related to the deadlines for paying the “corporate annual contribution” to the Superintendence of Companies, Values and Securities. During the state of emergency, customs duties will be reduced to 0% for imports of certain devices and products related to the prevention and treatment of Covid-19, such as devices for respiratory-related illnesses, surgical scrubs and masks, antibacterial gel and hospital gowns.

The government has submitted a new bill to the Ecuadorian National Assembly in which extraordinary contributions (tax) are proposed, which will allow the entry of unbudgeted resources into the national treasury. If the law is approved (expected by the end of May 2020) these contributions must be paid by companies and individuals. Companies that reported profits of more than $1 million during the 2019 fiscal year would have to contribute such extraordinary tax. Regarding individuals, contributions will be payable on income above the basic family basket, estimated at around $700 per month, at progressive tax rates.

Labor Measures

Ecuadorian law provides for fixed-term labor contracts; temporary contracts are allowed only under very limited circumstances. Overall, termination of labor contracts is subject to a large severance payout (1.25 times salary per year of employment). Employees who have committed grave and demonstrable transgressions could be fired without any severance payment. However, under the legal principle known as in dubio pro operario it is not easy to demonstrate the offense.

Due to the complications of the existing structure, during March 2020 the Ministry of Labor enacted several decrees allowing for the reduction, modification, and/or suspension of working hours, with the consequent effect of reducing expenses in employers’ cash flows. However, these savings are temporary, as the regulations stipulate that the lost wages must be paid back to workers in the future.

Force majeure as a reason for termination of employment contracts has already been used by some companies during the current crisis as an argument for firing workers. Although this modality is technically legal within the Ecuadorian framework, its practical application during the pandemic is problematic, and cases have already arisen which will have to be resolved at the judicial level. In fact, it is estimated that the indiscriminate use of this type of termination of labor relations will generate further social conflict in the country, with unpredictable consequences.

Any possible amendment to the Ecuadorian labor regime has an important limiting element, which is the constitutional principle of inalienable labor rights.

Economic Measures

Vicente Albornoz, Dean of the School of Business and Economics of the Universidad de las Americas, estimates the economic repercussions of the health crisis will cause a contraction in the Ecuadorian economy of 2% per month of confinement.

In order to avoid a default on the payment of 2020 bonds, the Ecuadorian government made a payment of $326 million on March 23, 2020 towards the outstanding capital and also renegotiated the interest due, with a favorable result as the bondholders accepted the proposal made by the government.

On April 16, 2020, Ecuador announced that the EU would help with both humanitarian assistance and economic aid. On April 28, 2020, the Interamerican Development Bank announced that Ecuador will receive $700 million to address the health, social, and economic emergency resulting from the pandemic. On May 1, 2020, the IMF announced that it would grant a loan of $643 million, payable in five years with a three-year grace period and an interest rate of 1.05%, and May 7, 2020, the World Bank approved an additional credit for $506 million to stimulate the Ecuadorian economy.

The Future

Alongside Citibank and Lazard Freres, the Ecuadorian Ministry of Finance and Economy, led by Minister Richard Martinez, Vice Minister Fabian Carrillo and Vice Minister Esteban Ferro, is working to renegotiate the national debt.

On May 4, 2020, Ecuador started a period of “social distancing.” New labor norms will be put in place in order to mitigate the risk of contagion in workplaces. As one of the three officially dollarized economies in the hemisphere, Ecuador will face a tough challenge as the economy will rely heavily on the export market to keep dollars flowing into the local economy. The Latin American Development Bank has committed to disburse an extra $300 million within the first two weeks of May 2020.

With the extra funds and the passing of new stimulus packages, it is expected that Ecuadorian exporters will be the driving force to rebuild the economy under a “new normal” that will include a change in the composition of GDP. Remittances sent by Ecuadorians working abroad will also continue to be an important force for the economy; however, predictions regarding the amounts are hard to make as the main countries of origin, the U.S., Spain, and Italy, are still suffering the effects of the pandemic.

With almost one year until the next presidential election, Ecuadorian politicians are scrambling to make new alliances.

Planning Points

Companies doing business in Ecuador will have to work on consensual agreements with their workers to mitigate future risks, at least until a new set of laws is passed, but they should be careful not to impinge upon the constitutional rights of workers, as doing so could only deepen social conflict.

Due to the cash shortage and the impossibility of printing currency because of dollarization, government, banks and companies will have to perform careful planning in order to mitigate risks.

International investors could take advantage of tax benefits: exemptions from income tax, reductions of import duties, application of extraordinary deductions to determine taxable base, among others.

Finally, it will be important to monitor the social unrest that might arise as a result of the passing of new laws and the potential eliminations of the last fuel subsidies in place.

Diego Andrés Almeida is Senior Consultant with Almeida Guzmán & Asociados.

The author may be contacted at: daa@almeidaguzman.com

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

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