Tax Simplicity and Progressivity Law

On 30 December 2019, Ecuador’s National Assembly approved a bill submitted by the president and enacted it as the “ Simplicity and Progressivity Law,” which contains numerous direct and indirect measures that generally aim to simplify the tax system and raise . The law was published in Ecuador’s official gazette on 31 December 2019 and generally is effective as from 1 January 2020.

The law includes tax measures that affect the withholding tax rules for dividends paid by resident companies and the deductibility of interest expense, impose a temporary additional tax on companies with high taxable revenue, eliminate the requirement for companies to make advance payments of (prepaid income tax) and impose value added tax (VAT) on digital services, among other things.

The National Assembly rejected a previous version of the bill in November 2019, which included non-tax measures that aimed to stimulate employment and strengthen the monetary and financial systems and the responsible management of public finances. The enacted law is focused mainly on tax issues, but there are some differences between the tax proposals in the previous version of the bill and the enacted law.

The principal tax reforms in the enacted law are as follows:

Income tax

Income and withholding tax treatment of dividends

The from dividends distributed by resident companies is now equal to 40% of the dividends distributed, and the withholding varies depending on the beneficial owner:

 A 25% income tax (resulting in an effective tax rate of 10% on the gross payment) must be withheld on the taxable portion where dividends are distributed by resident companies to nonresident companies that do not have Ecuadorian resident individual beneficial owners.  In the case of dividends distributed directly to Ecuadorian resident individuals or to nonresident companies that have Ecuadorian resident individual beneficial owners, the withholding income tax rate is up to 25% (effective rate of 10%) on the taxable portion (the specific rate will be based on tax regulations to be issued by the government).  A 35% withholding income tax (resulting in an effective tax rate of 14% on the gross payment) applies if the payer corporation has not duly disclosed the complete chain of its shareholders up to the ultimate beneficial owner to the tax authorities.

Previously, dividends paid to a nonresident out of profits that were subject to corporate income tax generally were not subject to withholding tax, but dividends paid to a nonresident company recipient with an Ecuadorian resident individual beneficial owner were subject to a 7% or 10% withholding tax, as were dividends paid in cases where the payer corporation had not duly disclosed the complete chain of its shareholders up to the ultimate beneficial owner to the tax authorities. Dividends paid to a resident individual were subject to withholding tax at a rate equal to the difference between the maximum progressive personal income tax rate and the applicable corporate income tax rate for the year to which the dividends related (22%, 25% or 28%, depending on the year).

Another change in the enacted law is that reinvestments of profits will not be considered as a dividend distribution (previously, certain reinvestments of profits could be considered as dividend distributions). Therefore, any reinvestment of profits is exempt from income tax.

Deductibility of interest

The restriction on the deduction of interest on related party foreign loans granted for banks, insurance companies and financial sector entities within the “popular” and “community- based” economy (a micro sector within the financial sector) remains at 300% of equity. For other companies and self-employed individuals or entrepreneurs, the restriction is changed to 20% of the business’s profit before employee profit-sharing, plus interest, corporate income tax, depreciation and amortization.

Regarding domestic loans, the restriction under which interest expense is not deductible to the extent that the interest rate on the loan exceeds a maximum rate set by the central bank for domestic loans is now applicable only to banks, insurance companies and financial sector entities within the popular and community-based economy.

Advance income tax

Payment of advance income tax by companies, which formerly was mandatory, has become voluntary. Where a company opts to pay advance income tax, the calculation of the tax is changed from the previous formula (which was based on specified factors relating to assets, equity, revenues and total costs/expenses) to 50% of the tax liability from the previous fiscal year, less any income tax withheld.

Other income tax changes

 The limit on the deduction of publicity and advertising costs and expenses remains at 20% of taxable revenue. However, if the advertising or sponsorship expenses are incurred in relation to athletes, sports programs or projects previously approved by Ecuador’s states, the limit will not apply and the expenses incurred are 100% deductible.  Expenses related to the organization and sponsorship of artistic and cultural events are deductible up to 150% of the actual cost, meaning that the taxpayer benefits from an additional deduction equal to 50% of the total expenses incurred.  Accruals made for retirement or severance benefits that have been considered as a deductible expense by the employer but that have not been effectively paid to the employees must be considered as Ecuadorian-source income (additional clarification from the tax authorities is expected on this provision).  As from 1 January 2021, accruals made relating to employees’ severance will be considered a deductible expense if such accruals are supported by reports submitted by registered actuaries. The same tax treatment will apply in the case of retirement/pension accruals for: o Employees with more than 10 years of seniority; and o Specialized fund management companies duly registered on the Ecuadorian stock market.  Hospital infrastructure, educational and cultural and artistic services are included as part of the priority sectors that are eligible for an income tax holiday of a minimum of five years.

 The special income tax rate regime for banana sector activities is modified with respect to activities relating to the production, local sale and of bananas grown in Ecuador.  A special income tax rate regime is introduced for agricultural and livestock activities relating to local production and/or marketing, or to .  Individuals with annual net income exceeding USD 100,000 are allowed to deduct only personal expenses related to “catastrophic,” “rare” or “orphan” diseases duly certified by Ministry of Health. The deduction may not exceed 50% of individuals’ annual taxable income and also may not exceed 1.3 times the first bracket of the progressive income tax chart for individuals (for 2020, the limit will be USD 14,709 (USD 11,315 x 1.3)).  The provision establishing the right to claim the underlying tax paid by a company as a on an individual’s global income in relation to dividends received from the company is eliminated.  The number of taxpayers required to act as withholding agents for income tax purposes will be limited. The tax authorities will identify taxpayers required to act as withholding agents based on conditions that will be provided in tax regulations issued subsequently.

Temporary additional tax on certain companies

Companies with taxable revenues exceeding USD 1 million in fiscal year 2018 will be required to pay an additional tax/contribution calculated based on the following table in fiscal years 2020, 2021 and 2022:

Taxable revenue (USD) Tax 1 million up to 5 million 0.10% 5,000,001 up to 10 million 0.15% Over 10 million 0.20%

The additional tax may not exceed 25% of the company’s income tax liability declared or determined for fiscal year 2018.

The declaration and payment of the tax must be made by 31 March of each fiscal year from 2020 to 2022.

The tax paid cannot be claimed as a tax credit or as a deductible expense for purposes of the determination and settlement of other .

Special tax regime for microenterprises

A new tax regime for microenterprises (entities with no more than nine employees and gross sales below USD 300,000 annually) is introduced that applies for income tax, VAT and purposes. Taxpayers providing professional, construction, urbanization, land division and independent occupational services; those under an employment contract; and those whose only income is received from capital are not eligible for the regime.

Under the regime, income tax is calculated by applying a 2% rate on the gross income for the fiscal year originating solely from the entity’s business activity.

VAT and excise duty returns must be filed biannually under the regime; otherwise, those returns are filed monthly.

Entities eligible for the regime will not be required to act as withholding agents for income tax or VAT purposes, except in limited cases (e.g. to withhold income tax on employee payroll, payments abroad and dividends, and to withhold VAT where the reverse charge applies).

VAT

Digital services supplied by nonresidents to residents will be subject to VAT at the standard 12% rate, with the taxable event being the time of payment for the services. There will be exemptions from VAT for the provision of web page domain names, hosting services and cloud computing services.

Delivery and dispatch services provided or contracted for through the internet for tangible movable property also are treated as digital services, and commissions on such services are considered taxable for VAT purposes.

The importers of digital services (including both business and private consumers) will be liable for payment of the VAT. If nonresident digital services providers are not registered with Ecuador’s tax authorities, the importer of services will be responsible for paying the VAT; however, if the payment for the services is made through an intermediary that is a credit card issuer, the issuer will act as the withholding agent on the payment.

To support the relevant costs and expenses upon the importation of digital services, taxpayers must issue “settlement of purchase of goods and provision of services” invoices, or they will be unable to deduct the costs.

Additional details relating to the VAT on digital services will be provided in tax regulations relating to its application. The VAT on digital services will enter into force 180 days after the publication of the law in the official gazette (as from 1 July 2020), to allow the tax authorities time to publish the regulations.

Other changes relating to VAT include the following:

 The goods subject to a 0% VAT rate are expanded to include flowers, newsprint paper, insulin pumps, pacemakers, glucose test strips, boats, machinery, navigation equipment and materials focused on artisanal fisheries, as well as tractor tires for tractors with up to 300 horsepower (HP) (previously 200 HP).  The number of taxpayers required to act as withholding agents for VAT purposes will be limited. The tax authorities will identify taxpayers required to act as withholding agents based on conditions that will be provided in tax regulations issued subsequently.

Excise duties (ICE)

 Amendments are made to the tax base to include a 30% presumptive minimum marketing margin.  Additional goods and services are subject to tax, namely, plastic bags and mobile telephone services provided to individuals.

Overseas remittance tax (ISD)

All remittances abroad are subject to the ISD, a 5% special tax charged by the bank transferring the funds, which is then declared to the tax authorities. The tax is deductible for the company transferring the funds abroad. Payments made from overseas, whether for goods or services, also are subject to the ISD. The changes to the ISD include the following:

 Exemptions apply for loans with a term of 180 days or more destined for investments in assets or rights representing capital.  Dividends paid abroad generally are exempt from the ISD unless they are distributed to foreign entities that have individuals or companies resident or domiciled in Ecuador in their shareholder chain that also are shareholders of the company distributing the dividends.

Other reforms

 The tax authorities will identify taxpayers required to apply control mechanisms to identify, mark, authenticate, track and trace assets.  Exporters will be able to benefit from a simplified procedure for tax reimbursements on foreign .  The government will promote telecommunications projects through the relevant regulatory entity, to reduce the digital gap.