INSIGHT: Ecuador—Taxation and Other Considerations for Investors

Ecuador has been officially dollarized since 2000, and the monetary stability and certainty created by the U.S. dollar has increased interest on the part of foreign investors during the past two decades. Although the Ecuadorian economy has suffered a significant hit because of the Covid-19 pandemic, there are many other considerations that make Ecuador a viable and attractive market for international investors.

The 2020 national budget included the projection of income of $2 billion arising from the sale and/or granting of concessions for state assets. In the private sector, many family-owned enterprises are also considering opening their capital to new investors due to the need for fresh resources and/or due to the desire to diversify risks.

Economy

Oil is Ecuador’s main export. In addition to oil, Ecuadorian exports include bananas, shrimp, tuna/fish, flowers, cacao, and other agricultural products. In the first quarter of 2020, oil exports were valued at approximately $1.5 billion, which in comparison to the same period in 2019 reflect a decrease of roughly 44%. Exports of other goods and services in the first quarter of 2020 were approximately $4.8 billion, representing an increase of 10% in comparison to the previous year. As of May 2020, the national balance of trade is positive by $887 million, (Central Bank of Ecuador) mainly due to the decrease in imports.

In July 2020, the International Monetary Fund (IMF) presented its revised projection of the effect of the pandemic on Ecuador’s gross domestic product (GDP). According to the IMF, the economy will suffer a contraction of 10.9% by the end of the year.

On a positive note, Ecuador has been involved in the process of renegotiating its international debt. Negotiation efforts have been eased by the recent enactment of the “Organic Law for the Ordering of Public Finances.” Currently, the total national debt represents approximately 60% of GDP. External debt amounts to approximately 43% of GDP; the balance represents internal public debt. On August 3, 2020, the Ecuadorian President announced that the government has reached an agreement with the lenders. Ecuador will benefit from cash flow relief, reduction of principal, reduction of interest rates, longer payment terms, and a grace period.

It is also worth noting that, according to the Institute of National Statistics, inflation during the pandemic is only 0.3%. According to Vicente Albornoz, Dean of the School of Business and Economics at the Universidad de las Americas, it is estimated that inflation for 2020 will be close to 0%.

Taxation

Ecuador has entered into double taxation treaties with the following countries: Argentina (applies only to air transport), Andean Community (Bolivia, Peru and Colombia), Belarus, Belgium, Brazil, Canada, Chile, China, Germany, France, Italy, Japan, Mexico, Qatar, Romania, Singapore, South Korea, Spain, Russia, Switzerland, and Uruguay Internal Revenue Service. Ecuadorian double taxation treaties generally follow the Organization for Economic Co-operation and Development (OECD) model, except for the Andean Community Treaty, which does not follow the model suggested by the OECD.

Regarding information exchange, it is important to note that Ecuador signed the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information and ratified the Convention on Mutual Administrative Assistance in Tax Matters. Overall, the Ecuadorian tax regime has strong controls on transactions executed with tax havens and levies additional rates on such transactions.

Ecuadorian source income remitted abroad is subject to income tax withholding. The following rates apply:

• 25% on transactions without a specific rate, interests, royalties, technical assistance, and services;
• up to 10% on capital gains; and
• 25% on 40% of dividends remitted abroad.

Certain exceptions apply to which there can be a 0% income tax withholding rate. There could also be an additional 10% withholding tax when the payment beneficiary is domiciled in a tax haven or a lower taxation territory.

A 5% capital overflow tax applies, overall, on payments made abroad. Important exemptions apply and include dividends remitted abroad (when the beneficiary is not an Ecuadorian citizen), and interest paid on foreign credits duly registered with the Ecuadorian Central Bank.

The Ecuadorian transfer pricing regime is mainly based on the OECD principles and technical guidelines. Taxpayers must file transfer pricing reports under certain conditions. Transfer pricing controls may also apply on domestic transactions, which are supposed to be performed under arm’s-length principles.

Ecuador´s corporate income tax rate is 25%, levied over the taxable base, which according to national law is determined as the difference between income/revenue minus costs and deductible expenses. Local law also provides for a 15% employees profit sharing (EPS), which is calculated over the accounting profit. The EPS is a deductible item for tax purposes.

Labor

New labor legislation has been enacted to cope with the results of the pandemic in the economy. A new “special emergency contract” has been introduced in the Ecuadorian labor legal regime as a mechanism to incentivize the economy after the pandemic. This new modality allows employers to hire workers for a one-year period, renewable for an extra year. Investors should be aware that, overall, termination of labor contracts is subject to a severance payout (1.25 times salary per year of employment).

Liability of Shareholders and Legal Representatives

Shareholders are liable only up to the equity held in the company. Legal representatives have unlimited liability for tax and labor obligations of the company that they represent.

Shareholders are obliged to disclose their chain of ownership up to the beneficial owner. Exceptions apply in the case of companies that are duly registered on national or international stock exchanges.

Opportunities for International Investors

International investors and lenders can take advantage of the 0% income tax withholding on interest paid to private international financial institutions, specialized non-financial institutions duly registered with the Superintendence of Banks, and multilateral financial institutions, as long as the interest rate does not exceed the maximum authorized by the Central Bank of Ecuador. As of July 2020, the maximum interest rate for foreign credits was set at 9.37% (Central Bank of Ecuador). Interest paid abroad, over such rate, is subject to income tax withholding.

Local legislation provides for several tax incentives for investments in new strategic industries and the development of the latter in regions outside the two main cities of Ecuador (Quito D.M. and Guayaquil). These general incentives include exemption from income tax for periods of up to five years, and additional 100% cost deduction associated with depreciation of new assets. Furthermore, the law provides for specific incentives such as exemption of import duties applicable to machinery and equipment, duplication of deductions of salaries paid, additional deductions for the calculation of income tax, as mechanisms to incentivize productivity, innovation and eco-efficient production. The tax incentives will be provided for in the investment contracts entered into between the Ecuadorian government and the enterprises applying for such benefits.

Investors in the pharmaceutical, food and beverage, and other industries, have already signed investment contracts with the government. These provide juridical certainty and legal stability in case of eventual tax reforms. In order to access such benefits, the private party must comply with the milestones set out in the contracts.

According to the OECD, Ecuador´s total tax collection to GDP ratio (20.6% in 2018) has historically been lower than the average for Latin America, and it is approximately 10% lower than the average of OECD members.

A recently enacted law provides for a new type of corporate structure referred to as a “Simplified Stock Company” (Sociedad por Acciones Simplificada, S.A.S.). The incorporation of an S.A.S. does not require a public deed. All corporate acts, such as capital increases/reductions, amendments to its incorporation contracts and bylaws, can be executed through private instruments. This being the case, the cost of incorporation and future maintenance will be significantly reduced in comparison to the previous corporate structures.

Diego Andrés Almeida is a Senior Consultant at 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.