Despite international financial and economic upheaval in the last four years, Latin American economies proved their resilience and have become more attractive to foreign investors. Ecuador has also benefitted from this trend. In this piece, we have included a summary of some considerations that foreign investors may consider before doing business in Ecuador.
Although Ecuador’s economy is undergoing a rapid transformation, foreign ownership, in general, is not restricted. There is no legal discrimination against foreign investors; however, some areas such as oil exploration and drilling, mining, utilities, and defense are highly regulated. All foreign investments must be registered with the Central Bank of Ecuador (CBE). Normally, a corporation (subsidiary), branch, or partnership can be used. Treatment for profits remitted abroad is the same for all companies, whether local or foreign.
A company’s formation is relatively simple; two or more individuals or legal entities must execute a public deed, which constitutes the company’s escritura, or charter. The value of the capital and stock presented in the charter should be in US dollars. This charter, along with the bylaws, must be notarized and submitted to the Superintendence of Companies for approval. After approval, these documents, together with the certificate of approval issued by the Superintendence of Companies, must be registered in the Mercantile Registry and an extract of the charter should be published, at least once, in a local newspaper. The legal existence of the corporation is effective upon registration in the Mercantile Registry. Finally, the company must obtain its Tax Identification Number (RUC) from the Internal Revenue Service (Servicio de Rentas Internas, or SRI).
Profit taxes comprise the total income received for professional, labor, commercial, industrial, agricultural, mining, service, and other economic activities (whether ordinary or extraordinary in nature), less discounts, costs, expenses, and deductions arising from activities necessary for the obtaining of such income.
According to the Ecuadorean Labor Code, companies must distribute 15% of their pre-tax earnings among their employees. This profit sharing is a deductible expense for corporate income tax purposes.
COMPANY TAXES ON DIFFERENT ENTITIES
The tax system in Ecuador is mainly unitary, with most categories of income being taxed at a single rate. A system of local withholdings is in operation whereby a certain percentage of a payment is withheld by the payer and deposited with the fiscal authorities. This amount is considered a tax credit toward taxes due at year end.
Income taxes in Ecuador are levied on individuals’ and corporate entities’ Ecuadorean-sourced income. Consequently, all individuals, partnerships, and corporations, whether national or foreign, are subject to tax on the part of their income that is earned in Ecuador. Individuals or corporations resident in Ecuador, national or foreign, are also taxed on their foreign-sourced income. An exemption method is granted for the latter type of income.
However, depending on their business activity, companies could be subject to tax incentives designed to promote foreign investment such as the strategic substitution of imports
and the promotion of exports with corporate income tax exemptions for a period of five years.
AUDITING REQUIREMENTS FOR COMPANIES
Generally, companies are required to contract the services of statutory auditors, normally referred to as comisarios (surveillance agents). Statutory auditors carry out a function that differs from that assigned to external auditors.
Business concerns, regulated by the Superintendence of Companies and Superintendence of Banks, are required to file financial statements examined by external auditors in the following cases:
•Corporations with assets greater than $1,000,000
•Companies or partnerships with assets of at least $100,000.
•Branches of foreign companies, or their associations, with assets greater than $100,000.
As of 2012, companies must apply IFRS.
LAND & PROPERTY TAXES
The municipal asset tax is levied on all individuals and companies required to keep accounting records in accordance with Ecuadorean tax legislation. This tax is levied annually at a rate of 1.5 per 1,000 (or 0.15%) of total assets less current and contingent liabilities, as shown on the balance sheet.
The city governments assess an annual municipal property tax, which ranges between 0.025% and 0.5% of the commercial value of a property, as determined by a valuation carried out every five years by the city government for both urban and rural properties. Rural property is taxed at a maximum of 0.3%.
The real estate transfer tax applies to the transfer of real estate at 10% of the profit.
Most consumer goods imports pay 20%, while intermediate goods are usually imported at a 10% or 15% rate. Raw materials and capital goods are generally subject to 0% to 5% tax. Ecuador has negotiated exceptions under the Andean common tariff that allow lower duties on certain capital goods and industrial inputs. There is duty-free import of agricultural goods and equipment.
In addition to import duties, all imports are subject to 12% value-added tax (VAT), 0.5% tax for the Children’s Development Fund, and 5% on remittance tax, which can be considered as a tax credit for income tax computation purposes in the case of raw materials to be incorporated in finished products.
Finally, a Special Consumption Tax (Impuesto a los Consumos Especiales, or ICE) is imposed on domestic and imported goods, which are explicitly listed in the law, including automobiles, airplanes, cigarettes, alcoholic beverages, and soft drinks. The ICE tax base for imported goods is the ad valorem value.
SUBMISSION OF TAX RETURNS
Income tax returns should be submitted in April after the fiscal year end, based on the ninth digit of the RUC. The tax year is the calendar year.
If activities are finalized before year end, the taxpayer should present an anticipated income tax return up to 30 days after the termination date.
VAT and withholding tax declarations should be submitted on a monthly basis, based on the ninth digit of the RUC.
In 2011, taxes on corporate income were levied at a rate of 24%, while reinvested profits were levied at a rate of 14%. Note that these rates are reduced annually by 1% until they reach 22% and 12%, respectively, in 2013.
Profits distributed to national individuals are taxed, while those paid to foreign investors are not subject to an additional income tax, except if they are located in tax haven countries where a penalty tax of 10% must be paid.
Investments made by new companies located outside the cities of Guayaquil and Quito, in specific sectors determined by the law, will have five years worth of income tax exemptions.
PERSONAL INCOME TAXES
Personal income tax rates vary from 0% to 35%, according to a specific table stated in the law; $9,210 being the minimum annual income not subject to taxes and over $93,890 the income subject to the maximum marginal rate of 35%.
Personal expenses for living, food, tuition, and healthcare can be deducted from income earned. The deduction limit for these expense categories—with the exception of healthcare, which is unlimited—varies every year.
Non-resident income obtained by the provision of ad-hoc services in Ecuador will be taxed at a 24% rate of the total income obtained.
MINING & MINERAL RESOURCE TAXES
Ecuadorean law does not grant special treatment for mining companies. Therefore, the income tax for these types of companies is 24% for fiscal year 2011. However, they are obliged to pay royalties.
VAT is levied at the rates of either 12% or 0% on the ownership transfer of goods, import of goods and services, and services rendered within the country or imported. Royalties and intangible property imported or locally paid are also levied at a 12% VAT rate.
In general, in-kind contributions to companies’ capital, transfer of the whole business, merging, spin-offs, and transfer of shares and securities are transactions not subject to 12% VAT.
Goods and services that are subject to a 0% rate are explicitly listed in the law, including primary products, medicines, agricultural and machinery equipment, exported goods, milk, salt, sugar, transportation of persons and cargo, housing rental, utilities, and financial services, among others.
A 12% VAT paid on imports and local purchases can be deducted only from the 12% VAT charged on sales or services rendered (not when taxed at the 0% VAT rate). The VAT paid on raw materials, fixed assets, or components required for the production of goods or rendering of services is also creditable when the final product is considered taxable at 12% VAT. Similarly, VAT paid on raw materials, services, components, or fixed assets necessary for the production of export goods is also recoverable.
DOUBLE TAXATION TREATIES
As a member of the Andean Community, Ecuador has adopted Decision 578, which provides relief from double taxation for individuals or company members. Furthermore, Ecuador has similar tax treaties with Belgium, Brazil, Uruguay, Canada, Chile, France, Germany, Italy, Mexico, Romania, Spain, and Switzerland.
The base for the assessment of corporate income tax is taxable income, generally defined as the difference between gross revenue and expenses allowed under the tax law. In general, all expenses required to obtain income are deductible, regardless of where they were incurred (within Ecuador or abroad). There are no territorial prohibitions (with some limits) on payments to foreign affiliates or others; however, all payments abroad (with certain minor exceptions) are subject to withholding tax at a 24% rate. There are no distinctions among or limitations on capital expenditures.
Straight-line depreciation applies at rates specified by law (real estate 5%, machinery 10%, vehicles 20%, and computers 33%). Depreciation rates apply to the cost of assets. Intangible assets are amortized either within the terms specified in the contract or over a 20-year period.
Interest on debts incurred for business purposes are deductible as long as the lender is not located in a tax haven or lower tax jurisdiction, up to the limits fixed by the CBE.
Organization, experimentation, and pre-operational expenses are to be amortized over five years at the rate of 20% per year.
Taxes, rates, levies, and contributions to the social security system related to the generation of taxable income are deductible.
Interest and fines paid as penalties imposed on late payments of tax obligations and on income tax payments are not deductible for income tax calculation purposes.
The carry forward of losses is allowed to a maximum of five years, with an amortization limit of 25% per year over the taxable base. There is no loss carry back.
Transfer pricing rules must be applied in transactions carried out with related parties. Local legislation follows the guidelines established by the Organization for Economic Cooperation and Development (OECD). Formal documentation requirements exist.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
TBY would like to thank PwC Ecuador for compiling this analysis.