Streamlined For Success

According to the economic policies of the government of President Correa, Ecuador has been improving its business environment in order to achieve more foreign and national investments. Indeed, over the past four years Ecuador has changed several key laws, with which the government is improving the production process and decreasing paperwork to start economic activities through a company.

The General Code for Production and Investment was issued to regulate production processes, in the stages of production, distribution, exchange, trade, consumption, management of externalities, and productive investments oriented toward living well. This recent regulation sets several tax benefits for new investments especially in those economic activities considered strategic sectors, such as food production, biotechnology, and petrochemicals among others.

DOING BUSINESS IN ECUADOR

In Ecuador, it is usual to constitute two kinds of commercial company, corporations and limited-liability companies, since they limit their partners’ liability to the amounts they have put into them.

The corporate norms are set forth in Ecuador by the Civil Code, the Commercial Code, and the Law on Companies, the last having recently been reformed in May, 2014.

When the capital of any of these companies comes from foreign investors, they are called subsidiaries, and must register with the Central Bank of Ecuador, according to the type of investment they make (local, direct foreign, sub-regional, or neutral).

In the event that an Ecuadorean company has shareholders or partners that are foreign companies, it must inform the Superintendence of Companies who the shareholders or partners of those foreign companies are.

It must also disclose to the Ecuadorean Internal Revenue Service the names of those who appear as shareholders down to the level at which actual individuals are identified. Both regulations are trying to clarify people who are behind the companies in order to prevent tax evasion, crime of money laundering and the trafficing of influence in negotiations with the State.

For a company constituted abroad to be able to habitually engage in its activities in Ecuador, it must have a permanent representative in Ecuador with full powers to carry out all actions and legal matters that must be done and have effect in the Nation’s territory, and especially to be able to reply to lawsuits and meet contractual obligations.

However, if the activities of a foreign company in Ecuador entail the implementation of public works, public service provision, or extraction of Ecuador’s natural resources, it must establish domicile in Ecuador before signing the corresponding contract.

It is important to mention that Ecuadorean Law is friendly to new investments; this explains why just two months ago it was issued a new regulation that eliminates several inefficient procedures in incorporating companies.

TAX SYSTEM

The Ecuadorean tax structure comprises taxes, fees, and contributions. Taxes can be national, provincial and municipal. The main taxes are outlined below:

National Income tax (IR)

This tax is levied over the total income obtained by Ecuadorean or foreign corporate bodies, individuals and undivided estates.

Ecuadorean and foreign companies are treated the same. Overall income is understood as all income the taxpayer has received.

The taxable base income for this tax is the total taxable income minus the costs and expenses that, according to Ecuadorean norms, are deductible. Some activities are exempt from income tax in order to promote investment (as it was mentioned before concerning the Production Code), for social reasons, and for other reasons exonerating taxpayers from paying taxes.

According to prevailing legal norms, there is income considered exempt from income tax, such as dividends distributed to shareholders and partners who are individuals or corporate bodies domiciled abroad (but not in a “fiscal paradise”), or Ecuadorean corporate bodies, and income obtained under international agreements, among others.

Income tax for Individuals

Individuals and single-owner businesses pay income tax proportionally to their income, at a rate varying according to the income received, from 5% to up to a maximum of 35%.

Expenses that individuals may deduct for income tax purposes include “personal expenses”, which cover: health, education, clothing, and food, and which are deductible up to an overall maximum of 50% of total taxable income, as long as this does not exceed the equivalent of 1.3 times the basic un-taxed base amount for income tax for individuals ($10,410.00 as of 2014).

• Corporate Income tax. There is a single tax rate for companies of 22% on a taxable amount calculated through the process called “tax reconciliation.” The Tax Administration grants a discount of ten percentage points in the 12% tax rate for companies that decide to reinvest their Available Profits, providing that this reinvested amount is used to purchase new machinery or equipment, as well as to purchase goods related to research and technology to improve productivity, diversify production, and increase employment, among other cases. As a requirement to take advantage of this tax benefit, the company must formalize the reinvestment (by Capital Increase) in the Mercantile Register by the following year.

National Value-added tax (VAT)

VAT is an indirect tax levied on consumption whenever a taxpayer takes an action or signs a contract for the purpose of transferring or importing physical chattel goods, transferring copyright or horizontal property, at all stages of the selling; and provision of services (local and imported). Rates for VAT are 12% or 0%.

This tax can be transferred by one taxpayer to another, because the intention is for the tax burden to be paid by the end consumer, if producing goods and services subject to the 12% tax rate. Otherwise, a proportional part of this tax credit can be used.

National Tax on Foreign Currency Payments (ISD)

The tax on outgoing foreign currency is levied on all monetary transactions that are done abroad, with or without the intervention of the institutions comprising the financial system. The taxable action for this tax is the transfer or movement of foreign currency abroad as cash, or by drawing checks, transfers, sending, withdrawing or paying in any way. The tax rate on Outgoing Foreign Exchange is 5%.

Additionally to the above taxable actions, it will be legally presumed that there has been outgoing foreign currency in the following cases:

• In all payments made abroad by Ecuadorean or foreign individuals, or corporate entities domiciled or resident in Ecuador.

• In the case of exports of goods or services generated in Ecuador, and realized by individuals or corporate entities domiciled in Ecuador, who engage in economic activities of exportation, when the foreign exchange to pay for those exports does not enter Ecuador within 180 days time.

Tax on Extra Income

This tax is levied on extra income obtained by companies that have signed contracts with the national government for exploration and extraction of non-renewable resources.

The taxable base amount is the total extra income, that ‘is, the difference between the selling price and the base price established in the contract, multiplied by the number of units sold at that price. This tax rate is 70%.

Tax on special consumption

This tax is levied on cigarettes, alcoholic beverages, soft drinks, perfumes and toilette waters, video games, firearms, sports weapons and ammunition, motor vehicles and hybrid, or electric vehicles, paid television services, dues, shares or subscriptions to social clubs, whether from Ecuador or imported.

The taxable base amount is the sales price to the public suggested by the manufacturer or importer, minus the VAT and the ICE (as long as this amount is not lower than the result of adding 25% to the presumptive minimum marketing margin to the ex-factory or ex-customs price, as the case may be) or on the basis of the reference prices established by a Resolution annually by the Director-General of the Ecuadorean Internal Revenue Service.

Tax on holding assets abroad

The monthly tax on funds available and investments held abroad by private entities regulated by the Superintendence of Banks and Insurance and the Intendancies of the Securities Market in the Superintendence of Companies is based on holding any certificate for funds available in entities domiciled outside Ecuadorean territory, whether directly or through affiliated subsidiaries or offices of the taxpayer abroad; and investments abroad by entities regulated by the National Securities Council.

Taxpayers must pay the equivalent of 0.25% monthly of the average monthly balance of funds available in foreign entities and investments issued by entities domiciled outside national territory.

When the funds are received or the investments held or made through subsidiaries located in fiscal paradises or preferential fiscal systems or through affiliates or offices abroad of the taxpayer, the applicable rate will be 0.35% monthly of the taxable base income.

REGULATION OF TRANSFER PRICES AND FULL COMPETITION

In 2005, Ecuador incorporated OECD guidelines in its legislation on regulating transfer prices, to regulate those transactions completed by related companies when the sales are at or below cost. This regulates prices so they will not be lower than those current on foreign markets at the time of the sale; whereas for imports it will make sure they are not higher than international prices.

The norms state that related parties are when an individual or company, with domicile in Ecuador or abroad, participates directly or indirectly in the management, administration, control, or stock of the other company; or when a third party (an individual or company, with domicile in Ecuador or abroad) participates directly or indirectly in the management, administration, control, or stock of these companies.

The norms oblige certain taxpayers to present studies and information on their transactions with related parties to the Tax Administration, along with their income tax declaration.

AUDITING AND ACCOUNTING

Accounting must be kept using the double-entry system, in the Spanish language and in US dollars, taking into consideration generally accepted accounting principles.

For corporate bodies subject to control and oversight by the Superintendencies of Companies or of Banks and Insurance, their accounting must be kept according to International Financial Reporting Standards (IFRS) adopted for preparing financial statements as of January 1 2009.

INTERNATIONAL RELATIONSHIPS FOR INVESTMENTS

Ecuador has signed bilateral treaties on investment with the following countries: Germany, Argentina, Bolivia, Bulgaria, Canada, Chile, China, Costa Rica, Denmark, El Salvador, Spain, the US, Finland, France, Honduras, Nicaragua, Paraguay, Peru, the Netherlands, the UK, Sweden, Switzerland, Dominican Republic, and Venezuela.

Those international treaties try to provide legal security for foreign investors and guarantee economic conditions in the future.

Furthermore, Ecuador has treaties to avoid dual taxation for income tax in international transactions. Ecuador has signed those international agreements with: Belgium, Canada, Chile, France, Italy, Rumania, Switzerland, Spain, Germany, Brazil, Mexico, South Korea, and Uruguay; China’s agreement is in the final stage of approval.

Additionally Ecuador has signed Decision 578: a system with which to avoid dual taxation and prevent tax evasion among the countries of the Andean Community. This Treaty uses the overriding principle of taxation in the source country instead of the residence principle. A treaty with Argentina (applicable only for air transport) has also been signed.

To verify payments abroad for agreements on dual taxation for transactions done in a given fiscal year, totaling more than one basic tax-free amount for income tax for individuals ($10,410.00 for 2014) requires certification by Independent auditors. A certificate of fiscal residence, issued by the relevant authority of the other country, with a translation into Spanish, if necessary, and authenticated by the respective Ecuadorean Consul, is also required.

In recent years, Ecuadorian government has been negotiating several international agreements to avoid double taxation, which demonstrates the intention to stimulate foreign investment.

Indeed, the government is looking to achieve other international agreements, especially with countries in which direct providers of the state are residents, and therefore, it would be possible to secure better conditions and decrease the tax burden for companies with international operations in the future.