Ecuador’s Internal Revenue Service (SRI) has in recent years initiated a strong tax program to regulate commercial activities and increase tax-collection. Sanctions for tax evasion have been considerably increased. Romero Arteta Ponce counsels our clients on the new tax code and oversees the auditing and accounting process.
1. REPORT ECUADORIAN TAX REGIME
This report covers the general tax regime applicable to all companies or branches of foreign companies established in Ecuador.
1. ACCOUNT AND TAXES
Branch operations in Ecuador are generally subject to the same legal regulations and obligations as any other Ecuadorian company. For legal purposes, the holder of the parent company’s power of attorney generally manages the branch of a foreign corporation.
Ecuadorian branches of non-resident companies must keep accounts separate from those of their main offices, as in the eyes of the law they are seen as separate entities.
1.1. Accounting Period
The tax accounting period for a company may not be longer than 12 months, normally following the calendar year, beginning on January 1, and ending on December 31.
2. INCOME TAX RATE FOR COMPANIES
Companies incorporated in Ecuador, as well as the branches of foreign companies domiciled in the country and the permanent establishments of foreign not domiciled companies, who obtain taxable income, will be subject to the tax rate of twenty-two percent (22%) on their tax base.
The taxable income means the net income, after subtracting 15% (profit sharing) from this net income, which by law is to be distributed to the company’s employees. Local and foreign shareholders and corporations are taxed at the same rate.
3. WITHHOLDING
Companies must withhold taxes when they pay for any concept that constitutes taxable income.
Companies act as withholding agents for income taxes on the payments they make to individuals and organizations who provide goods and/or services. Withholding practices are as follows:
3.1. Withholding from local payments
Every local payment and which constitute taxable income of the beneficiary is subject to withholding in percentages which range from 1% to 10%,
3.2. Withholding from payments abroad
Companies should withhold 22% on total payments, remittances or transfers abroad. This same rate is applied in the following special cases involving calculations of the taxable base.
Ecuadorian tax law provides exemptions for certain foreign payments, like the following:
- Payments for imports are exempt from withholding of income tax
• Payments of interest on foreign loans and credit lines obtained from foreign financial institutions dully register in Central Bank
3.3. Dividends to be paid to shareholders
Generally, dividend payments must be made in relation to the benefits earned and received within the same fiscal year and once the corresponding income tax has been paid. Therefore, the company will only distribute pending dividends from previous years, formerly closed, with the payment of the corresponding income tax.
Dividends paid from one resident company to another resident company do not generate additional taxes. In the case of dividends remitted, paid, or credited to stockholders or foreign corporations who have not established residency in Ecuador, there is no additional income tax since it was already paid in Ecuador. Nevertheless, the Ecuadorian Tax Law establishes a withholding tax for profits or dividends paid for foreign companies located in Tax Heavens, as we analyze in the following point.
3.3.1. Dividends to be paid to Shareholders resident in tax heaven
Dividends and profits paid by national and foreign companies resident in Ecuador in favour of National and foreign companies resident in tax havens or jurisdictions of lesser imposition.
In this case, the company paying dividends to shareholder resident in tax heaven must make the corresponding income tax withholding at source. The percentage of this withholding shall be equal to the difference between the maximum rate of income tax for individuals and the general rate of income tax provided for companies. Consequently, considering that the maximum rate of income tax for individuals is USD$ 35% and the general rate for companies will be 22% so the rate for dividend payments to tax havens will be 13%.
4. TAXATION OF FOREIGN OPERATIONS
In general, the income which a company domiciled in Ecuador derives from its foreign operations is treated the same as income derived from Ecuadorian sources.
5. CONSORTIUMS AND JOINT VENTURES
Companies who associate or combine to undertake joint ventures will pay income tax on every consolidated transaction they conduct.
6. VALUE-ADDED TAX (VAT)
Value-added tax is assessed on the value of all goods of which title is transferred, imported goods, and the value of services rendered. Value-added tax (IVA) is to be assessed at all points of exchange (distribution, retail, and wholesale).
6.1. Transactions Liable to Value-Added Tax
* All transactions that involve the transference of title of material goods between individuals or companies even when transfer of title does not involve monetary transactions.
* The sale of material goods that have been received on consignment, goods leased with an option to buy, goods exchanged, goods presented as payment in kind, loans or services, the sale of commercial merchandise, and commercial leases.
* The personal consumption of the goods or merchandise that constitute the merchant’s usual source of income.
6.2. Calculation of Value-Added Tax
Value-added tax is assessed at a flat rate of 0% or 12%. VAT is to be assessed of the total value of goods transferred or services rendered, including other costs that may be legally added to the base price.
6.3. Payment and Recording of VAT
All natural and corporate individuals required to keep accounting books and public companies usually making transactions subject to 12% VAT, must present monthly declarations.
7. TAX ON FOREIGN EXCHANGE OUTFLOW
The tax on foreign exchange outflow (ISD) taxes the value of all monetary operations and transactions made abroad, with or without the intervention of the institutions of the financial system.
7.1. Tax Rate. –The Tax rate on foreign exchange outflow is 5%, including withholding for imports, unless these relate to goods to be again exported abroad.
7.2. Tax on Foreign Exchange Outflow (ISD) in Imports. – In the case of imports, it would correspond to the importer to pay the tax on foreign exchange outflow, which rate as we have indicated is 5%. In the event that the import payment is made through transfers or currency shipments, banks will charge the tax at the time of the transfer or shipment. Financial entities constitute withholding agents for transfers made by their customers´ disposal. Also, in the case of sending a check via Courier, the active laws establish the obligation to declare and pay the respective tax.
It is important to take into account that the ISD will be paid even if the payments are made by an Ecuadorian company or a branch domiciled in Ecuador, from the outside, under a registered account locally in the company’s accounts.
CODE FOR PRODUCTION, COMMERCE AND INVESTMENTS:
Via Official Register Supplement No. 351 dated December 29th, 2010, the Organic Code for Production, Commerce and Investments was published in which 10 laws are repealed, 7 are reformed, and which contains 9 general dispositions and 19 transitory dispositions.
The Regulations to the Organic Code for Production must be issued within 90 days after publication of the Code.
Scope of the Code:
The Code is fundamentally divided into 4 areas:
• Development, promotion and regulation of investments
• Development of MSMC companies and handcrafters
• Foreign commerce and instruments of commercial policy
• Ease of foreign commerce and customs control
The objectives of this Code are: an increase in business productivity, incentives for investments and productive competitiveness, in spite of the fact that there a number of conditions for incentives.
The Code puts emphasis on the absence of discriminative deals between private investors and foreigners and that the incentives shall not apply to foreign individuals or legal entities domiciled in tax havens.
Below we will expand on several issues of importance:
1.-INCENTIVES: Throughout the Code, reference is made to several incentives: fiscal, tax, labour, customs, SZED, MSMC, foreign commerce and ecosystem policies.
1.1.- Fiscal Incentives: include three (3) types: General, Sectional and for Depressed Areas – with a lower grade of industrialization.
1.2.- TAXES (TAX INCENTIVES): These have been incorporated as reforms to the Internal Tax Regime Law and the Reform for Tax Equity in Ecuador:
1.2.1.- Income Tax Exemptions:
- This includes that earnings obtained from mercantile trusts and earnings obtained from investment funds and complementary funds are exempt from income tax, provided that at the time that benefits are distributed, the fund administrator or trust company has withheld the income tax at source from the beneficiary.
- Other items are established that may be exonerated from income tax such as: yields for deposits, obtained by investments in titles in fixed income or by mercantile trusts, investment funds, provided that these are issued within the term of a year more; interest paid to workers for loans and economic compensation for a fair salary[1].
Five years without income tax: - The exoneration of income tax is established for the development of new companies and not for new investments from companies already set up. This benefit runs from the first year that the new company generates taxable income, thereby guaranteeing exoneration for five years. In the case of this incentive, the new company must operate outside of Quito and Guayaquil.
- Recently formed companies, new investments, individuals and undivided successions obliged to record accounts, which initiate activities, are subject to the payment of this item after the fifth year of effective operation.