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Ecuadorian Tax Reforms and Issues Impacting the Economy

Nov. 30, 2022, 8:00 AM

Ecuador’s Constitutional Court issued Ruling 110-21-IN/22 on Oct. 28, whereby it declared the partial unconstitutionality of the Law for Economic Development and Fiscal Sustainability after the Covid-19 pandemic, originally published on Nov. 29, 2021.

The enactment of the law was critical to continue with the International Monetary Fund financing program, which is important considering the devastating effects of the pandemic on the Ecuadorian economy.

This article will analyze the main effects of the court’s decision. Regarding taxation, a main topic of the ruling is the loss of exemption on inheritance tax. The law provided that those within the first degree of kinship, as well as the surviving spouse, were exempt from estate tax in the event of a person’s passing.

Regarding the repatriation and regularization of capital, the court provides that the relevant authorities can now investigate the origin of funds and consequently prosecute eventual tax fraud, which previously was not the case.

The amendments to the Law on the Special System of the Province of Galapagos have been declared unconstitutional. The amendments to the Hydrocarbons Law were declared unconstitutional as well, except for the exemption of foreign trade tax on the importation of fuels, hydrocarbon derivatives, biofuels and natural gas made by individuals or local and foreign entities.

Inheritance Tax

Ecuador levies tax on gifts, inheritances and legacies at progressive rates ranging from 5% to 35%. The law provides for a general exemption threshold of up to $71,434 for 2021 and up to $72,750 for 2022.

Beneficiaries within the first degree of kinship of a deceased individual were exempt from this tax according to the law. The exemption also applied to the surviving spouse of the deceased individual, provided there are no children to inherit the estate. Based on the court ruling, the inheritance tax exemption for these beneficiaries is no longer applicable.

At the time of writing, the Ecuadorian Internal Revenue Service has not issued specific regulations regarding future taxation on inheritance. However, it is expected that the IRS will enact regulations relating to this matter soon.

Capital Repatriation and Regularization

The law enacted a special regime to promote capital repatriation and regularization. Companies and individuals domiciled in Ecuador that, as of Dec. 31, 2020, owned funds, stock, or assets acquired with profits earned in Ecuador, are able to regularize their status with the IRS. The system also applied to Ecuadorian residents who did not pay the capital remittance tax (ISD). The law provided a liability waiver, for tax-related criminal offenses and felonies, in favor of those who qualified and applied the special regime.

As a result of the ruling, the IRS may inform the financial and economic analysis unit or attorney general’s office of any suspicious activity. Individuals who intended to regularize assets before the end of 2022 will now have concerns about doing so, as they could face legal action.

Electronic Invoicing

On May 27, the IRS published a resolution to establish the parameters for electronic billing, as established in the Law for Economic Development and Fiscal Sustainability. The main purpose of electronic billing is to reduce tax evasion and paper waste when issuing sales receipts, withholding vouchers, and other supporting documents.

As of Nov. 30, authorization for issuing printed invoices will only be given to taxpayers who previously obtained authorization for issuing electronic invoices, and their use will only be permitted in cases of force majeure. Paper invoices must fulfill the requirements established in the regulation on sales vouchers, withholding slips, and other supporting documents. The number of paper invoices issued per year cannot surpass 1% of the total sales invoices issued in the previous fiscal year.

Taxpayers also will be able to access a free tool offered by the IRS to create electronic documents. Companies and individuals may also use their own software, as long as it meets the specifications established in the current law.

The electronic invoicing system will not apply to taxpayers considered “micro businesses”—those with annual sales totaling less than $20,000—unless they previously had been required to issue electronic invoices, withholding slips, and other supporting documents.

Other Significant Tax Developments

According to Executive Decree 586, issued by the president of Ecuador on Oct. 31, the deductibility of royalties, technical, administrative, and consulting service fees paid to related parties—whether domiciled in Ecuador or not—is limited to 5% of the entity’s taxable income. However, the limit will be 10% of the total assets for those taxpayers who are in the pre-operative cycle of their business.

Such deductibility limit will not apply for those taxpayers whose only economic activity is the provision of technical services to independent parties, provided certain requirements are met.

In accordance with Executive Decree No. 298 issued by the president of the republic, whereby the progressive reduction of capital remittance for 2022 was established, operations in the last quarter of 2022 will be subject to an ISD rate of 4%, down from the previous ISD rate of 4.25%.

The Economy and Other Issues

According to the official IRS records, between January and September, IRS collections were over budget. Income tax collection accounted for $4.1 billion, while internal value-added tax operations reached $4.2 billion. Import taxes—VAT and excise tax—totaled $2 billion in comparison to a budgeted amount of $1.6 billion.

As of October, the country risk of Ecuador was around 1600 basic points. It is important to note that this indicator was at around 800 points in October 2021. According to Ecuador´s National Institute of Statistics, annual inflation in August climbed to 4.12%. While the figure is significantly higher than the 1.07% recorded in the same period in 2021, it is one of the lowest on the continent, which is associated with the country’s dollarized economy.

During the first quarter of 2022, Ecuador’s debt ratio reached 55.24% of its GDP, compared to 58.50% in the previous fiscal year. This reduction is in line with the agreements reached with the IMF, and subsequent fulfillment of the terms established by the Ecuadorian government. As of September, Ecuador’s international reserves had reached $8.3 billion, a significant improvement over the same period in 2021, when they were $6.2 billion.

The ongoing crisis in prisons in Ecuador has caused security concerns throughout the nation. On Nov. 1, Ecuador suffered a series of attacks linked to criminal groups operating in Ecuadorian territories and their allies abroad. Several car bombs were detonated in the provinces of Guayas, Santo Domingo, and Esmeraldas, and police officers were injured.

In response to the recent wave of violence, President Guillermo Lasso announced a state of emergency for these provinces, as well as a mandatory curfew. The national police and the nation’s armed forces will be intensifying their initiatives to prevent new attacks. It is estimated that businesses operating in those provinces will suffer losses as a result of the curfew and public fear.

The Lasso administration has been in a constant battle to combat the increase in crime, but limited resources have prevented the government from fully and efficiently tackling the problem and engaging the criminal groups.

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

Author Information

Diego Andrés Almeida is the Administrative Partner and Ignacio Jijón is a Tax Associate at Almeida Guzmán & Asociados.

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