November 23, 2022
Ecuador enacts new regulations on Income Tax, including lower income tax rates for new investments
Through Presidential Decree enacted on 10 November 2022, a reform to Law regulations determines how to apply the lower income tax rates as a benefit for new investments and companies signing an Investment Agreement with the Ecuadorian Government.
In addition, there are new conditions for asset depreciation and the deductibility limit for income tax purposes on royalties, technical services, as well as administrative and advisory services with related parties.
Lower Corporate Income Tax (CIT) rate for new investments and Investment Agreements
Currently, the general CIT rate is 25%. Companies triggering new investments or entering into an Investment Agreement can benefit from a reduction of this tax rate.
New companies or existing companies that develop new investments can benefit with a three-percentage point reduction of the Income Tax rate (22% CIT). This reduction must be applied as follows:
- To calculate the percentage attributable to the new investment over the total non-current assets
- To calculate the taxable basis attributable to the new investment
- To determine the applicable income tax attributable to the new investment
- To determine the income tax not attributable to the new investment
Also, for Companies with an Investment Agreement, the benefit is a reduction of five percentage points on CIT (20%). For the application of this benefit, the following must be considered:
- The Investment Agreement will determine the reduced percentage points with respect to the CIT and the possibility of having a cost center.
- If it is evidenced before the Authority that it is not possible for the Company to keep a cost center, the taxpayer can apply the reduced CIT rate over the total taxable basis.
- If it is possible to apply a cost center, then the CIT reduction will be applied on the taxable income triggered by the investment for which the Agreement is signed.
Tax benefits accumulated during the investment period shall in no case exceed the amount of the investment or the term of the benefit stipulated in the investment contract and/or its addendums.
Depreciation of Assets
The request for accelerated depreciation on assets is no longer applicable since such effects will have to be treated through deferred taxes.
Depreciation of assets imported into Ecuador shall be deductible if the value-added tax (VAT) has been paid.
Deduction of royalties, technical, administrative, and consulting services with related parties
It is established by Law that payments between related parties related to royalties, technical services, administrative services and/or advisory are deductible for income tax purposes up to a limit that is established by the Regulations to such Law.
The last reform precisely set forth the regulations for considering the limit on deductibility, as follows:
- The referred payments must be directly linked to the main economic activity of the company which triggers taxable income.
- The total sum of such expenses paid by entities domiciled (or not) in Ecuador to any related parties will be deductible up to an amount equivalent to 5% of the taxable income in the respective fiscal year, unless the following cases apply:
- For taxpayers that are in the pre-operating cycle of the business, the limit applicable to the sum of this type of expenses will correspond to 10% of the total assets.
- For taxpayers whose only activity is to provide technical services to third independent parties and their operating margin is equal or higher than 7.5%, there is no deductibility limit; otherwise: (i) operating sales are multiplied by 7.5%. Operating profit is subtracted on this result; and (ii) the deductibility limit will be equivalent to the accumulated amount of services in an annual basis plus royalties with related parties less the result of the formula in the paragraph immediate above.
There is no deductibility limit in the following cases:
- Operations with related parties that are Ecuadorian residents every time the taxpayer incurring the expense or cost is under a CIT rate equal or lower than its related party.
- The total operations (royalties, technical services, etc.) with related parties reported within a fiscal year, do not exceed US$226,200.
If an asset for which a royalty has been paid belonged to the Ecuadorian taxpayer for over 20 years, the expense is not deductible at all.
The taxpayer may request a higher limit of deductibility, under an Advance Pricing Agreement authorized by the Ecuadorian Tax Authority.
For additional information with respect to this Alert, please contact the following:
EY Addvalue Asesores Cia. Ltda., Quito
EY Addvalue Asesores Cia. Ltda., Guayaquil
Ernst & Young LLP (United States), Latin America Business Center, New York
Ernst & Young LLP (United Kingdom), Latin American Business Center, London
Ernst & Young Tax Co., Latin American Business Center, Japan & Asia Pacific