By Diego Andrés Almeida and Cesar Molina
Diego Andrés Almeida and Cesar Molina of Almeida Guzmán & Asociados outline the fundamental measures included in Ecuador’s recently enacted tax reform program and their key role in ensuring the country’s continued economic recovery.
After two failed attempts to pass the Law for Economic Development and Fiscal Sustainability after the Covid-19 Pandemic, Ecuadorian President Guillermo Lasso has now signed it and ordered its publication in the official registry. The bill was published on Nov. 29, 2021.
The enactment of the law is absolutely critical to continuing with the International Monetary Fund finance program, which is crucial, considering the devastating effects of the Covid-19 pandemic on the Ecuadorian economy.
The fundamental reforms presented in the law are summarized below.
Companies that negotiate investment contracts with the government under the new legal regime will benefit from a reduction of up to five percentage points in the corporate income tax rate. The accumulated amount of the benefit cannot exceed the total amount of the investment duly provided in the related contract. The benefit will not last any longer than the period for which the contract is subscribed.
Companies that enter into investment contracts may also benefit from an exemption of foreign trade taxes and capital outflow tax (ISD) on the import of capital goods and raw materials.
Every investment contract must provide several conditions, such as: terms and conditions; tax-related benefits; and other applicable regulations (including sector-specific regulations that are deemed to be essential). The latter will be determined by Ecuador’s Committee for Promoting and Attracting Investment.
The term of the investment contract may not exceed 15 years, but may be renewed for the same number of years or less. It is important to note that contractual renewal is not automatic.
A special tax is payable by individuals who, as of Jan. 1, 2021, have a net equity greater than $1 million. A similar amount is due from married couples with a net equity equal to or greater than $2 million.
Ecuadorian nationals who do not reside within Ecuadorian territory, and foreigners with assets located in Ecuador, are also obliged to pay this tax. In those situations, the taxable equity is equivalent to the assets situated in Ecuador.
This tax is due by March 31, 2022. The applicable rate is 1% on equity up to $1,199,999.99, and 1.5% for equity equal to or greater than $1.2 million.
Ecuadorian companies will act as the surrogate of the shareholder in the payment of the tax. Nevertheless, the company has the right of recourse to the nonresident.
The special tax is also payable by companies that are domiciled in Ecuador if their net equity, as of Dec. 31, 2020, is equal to or greater than $5 million. The tax rate is 0.8%. Companies are required to pay the tax in both 2022 and 2023.
Public entities, diplomatic missions, international agencies and organizations, and nonprofit entities are not required to pay this special tax.
Any delay in payment will incur interest and may result in fines. Nevertheless, both companies and individuals may file for a six-month payment schedule, which, if granted, will allow taxpayers to pay the special tax in six equal installments.
As of December 2021, the benefits provided in double taxation treaties will apply automatically. Prior to the enactment of the law, Ecuadorian entities had to withhold payments made to residents in countries with which Ecuador had signed a double taxation treaty whenever the amount paid (in a year) exceeded a certain set amount ($565,000 in 2021).
The law also enacted a special regime to promote capital repatriation and regularization. Companies and individuals domiciled in Ecuador that, as of Dec. 31, 2020, owned funds, shares or assets acquired with profits earned in Ecuador, may regularize their status with the Ecuadorian Inland Revenue Service (IRS). The regime also applies to Ecuadorian residents who did not pay ISD.
In order to benefit from this special regime, an Ecuadorian resident must file a statement of equity for all assets located abroad. The resident is also required to pay a special tax up to Dec. 31, 2022. The taxable basis includes the assets encompassed in the statement of equity, and the tax rate ranges from 3.5% to 5.5%, depending on the payment date.
The new law also provides that those with first degree of kinship as well as the surviving spouse are exempted from the estate tax in the event of a person’s passing.
In addition, capital gains on the sale of shares through Ecuadorian stock exchanges are exempt from income tax on the first $565,500. This exemption applies as long as the amount sold does not exceed 25% of a company’s equity. A 5% income tax applies on the amount not exempted.
Under special conditions, entities incorporated after the enactment of the law benefit from a reduction of 3 percentage points in the corporate income tax rate (currently 25%).
The following income tax exemptions are eliminated:
The following are exempt from VAT:
The following transactions are exempt from ISD:
Tax disputes, including tax assessments performed by the Ecuadorian IRS, may now be settled through mediation. Prior to the reform, every tax-related dispute was subject to an administrative procedure filed with the tax authority or a judicial procedure before the Ecuadorian tax courts.
Mediation may be requested by the taxpayer in both an administrative procedure or a judicial dispute. Subsequently, the dispute will be referred to a mediation center. For a limited amount of time from the enactment of the law (and the fulfillment of certain conditions), tax-related matters that are resolved through mediation will benefit from a reduction on interests and fines.
As of November 2021, the country risk of Ecuador is around 850 basis points. It is important to note that this indicator soared to over 6,000 points in March 2020. While the current figure remains high, it represents a significant improvement.
The agreements reached with the International Monetary Fund (IMF), and subsequent fulfillment of the terms established therein by the Ecuadorian government, represent a radical change in the country’s position. After more than a decade, Ecuador has returned to the IMF, leaving behind its marked reluctance to engage with it.
The injection of new resources will close the fiscal gap and create remarkably favorable conditions for the country. In order to comply with IMF guidelines, Ecuadorian authorities have amended the Organic Code of Public Finance Planning (COPLAFIP). Long-term fiscal sustainability will be anchored to the debt ceiling of 57% of GDP by the end of 2025. During the first half of 2021, Ecuador’s debt ratio reached 61.52% of GDP. As of November 2021, its international reserves had reached $8.3 billion, a significant improvement over the same period in 2020, when they were only $5 billion.
According to Energy Minister Juan Carlos Bermeo, Ecuador expects to increase crude oil production by 8% by December 2021, which could help it tackle any liquidity problems. In the long term, the government of President Lasso will seek to double production, for which it foresees an investment requirement of nearly $14 billion.
Finally, it is important to consider that it is the government’s mandate to reinforce economic reactivation while establishing a legal framework that aims to attract foreign investment. During the “Ecuador is Open For Business” event celebrated in Quito in November 2021, the government presented an investment portfolio with a goal of securing more than $30 billion in investments in hydrocarbons, minerals, telecommunications, infrastructure and other sectors.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Diego Andrés Almeida is the Administrative Partner and Cesar Molina is a Tax Associate at Almeida Guzmán & Asociados.
The authors may be contacted at: email@example.com and firstname.lastname@example.org
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By Diego Andrés Almeida and Cesar Molina