TICKING ALL THE BOXES

The Tax Simplicity and Progressivity Law contains numerous direct and indirect tax reform measures that aim to simplify the tax system and raise tax revenue.

ECUADOR BEGAN 2020 with new tax rules defined by the Organic Law on Tax Simplification and Progressivity, which was published in the official gazette on December 31, 2019. The law is part of Ecuador’s commitments set in the new monetary plan that was designed with the help of the International Monetary Fund. With this fiscal reform, Ecuador seeks to simplify certain aspects of its tax regime and collect USD600 million in taxes in 2020. One of the highlights of this law is the elimination of advance payment of income tax, a payment that should be made even if companies do not generate income in a fiscal year. This elimination was one of the historical demands of the productive sector. The tax reform expands the exceptions of the 5% remittance tax to include the contracting of loans with related parties located in tax havens, as well as the distribution of dividends to shareholders who are residents in tax havens. The law also creates a simplified regime for companies with annual revenues of up to USD300,000, and eliminates the 12% VAT on some medical supplies, flowers, and hosting services, among other aspects. Under the new law, which will be applicable as of September 2020, VAT will also be applied to digital services. Until then, the Ecuadorian Tax Administration will issue the procedures and regulations necessary for the application of this tax, which has a general rate of 12%. Furthermore, the interest on loans granted by related parties, both national and foreign, as of fiscal year 2020, will be deductible from income tax up to an amount of 20% of EBITDA for each fiscal year. This limit is not a “safe harbor," so in addition to complying with the limit mentioned above, the financing operations must comply with the conditions of substance and materiality required by the national tax law. The previous thin-capitalization rule that allowed one to deduct interest from external loans granted by related parties, which did not exceed 300% of the borrower's equity, will be applied only when the borrower is a bank, a credit union, or an insurance company. Another aspect covered by this reform is the elimination of the income tax exemption on dividends that are distributed by Ecuadorian companies to shareholders with no tax residence in Ecuador. These dividends are now taxed on a base of 40% of the distributed value, to which a general rate of 25% is applied. This rate increases to 35% when the company that distributes the dividend does not inform the Internal Revenue Service of its beneficial owner. It is important to clarify that this law also applies to shareholders with tax residence in Ecuador; nevertheless, it does not have significant impact, although in some cases the amount of the tax increases marginally. The new regulations are in force for all those dividends that are distributed as of December 31, 2019, regardless of the fiscal year in which they were generated. The Simplification Law also creates a temporary contribution to be paid during 2020, 2021, and 2022 by companies that have obtained revenues taxed with income tax in 2018 fiscal year, over which they will apply a 0.10% rate when said revenues are between USD1 million and USD5 million, 0.15% when revenues are been between USD5 million and USD10 million, and 0.20% when revenues exceed USD10 million. The amount to be paid in each of the three years, in which this contribution will be in force, cannot exceed 25% of the income tax generated by the company in 2018 fiscal year. This contribution is not deductible from income tax nor is it considered a tax credit. Finally, it is important to consider that the application of this law depends largely on the regulations that are issued by the President of the Republic and the Internal Revenue Service in 1Q2020.