The Ultimate Guide To Operating And Starting A Business In Ecuador.
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Introduction
Ecuador‘s economy is the ninth largest in Latin America and the Caribbean (out of 33 countries), and it has enormous economic potential in mining, energy, tourism, and agriculture. Large natural mineral reserves (gold, copper, and iron), ideal conditions for the development of energy projects, particularly photovoltaic and hydroelectric energy, and tourist destinations such as the Galapagos Islands, Amazon, Sierra, Coast, and East for what is considered one of the world’s most biodiverse countries Ecuador is also a significant exporter of bananas, shrimp, flowers, and cocoa.
Because of these and other factors, such as the fact that it is a dollarized economy, current government policy has centred on promoting favourable conditions for foreign investors and working to improve the benefits already granted in the Organic Production Code, Commerce and Investment (COPCI), which was published in December 2010.
The Law of Productive Development, Attraction of Investments, Employment Generation, and Fiscal Stability (Investment Law), which was promulgated in August 2018, provides investors with attractive benefits such as tax exemptions (income tax and income tax), reduced fees, legal stability, and the signing of arbitration agreements and investment contracts with the State.
System Of Justice
Ecuador’s common law legal system governs the country’s regions and territory. Ecuador’s legal system is founded on a Constitution that complies with international treaties and conventions. The remaining legal orders are made up of provincial laws, regulations, and municipal ordinances. Contracts with the government
Ecuador has a civil law system for private law, which is based on the Ecuadorian Civil Code. While the Constituent Assembly has the jurisdiction to enact certain laws, others fall under the purview of provincial government and public powers.
Regulations On Taxes
When it comes to tax regulations, the IRS is the national authority with the jurisdiction to issue them.
The following are the primary taxes in Ecuador; a more detailed analysis can be found here:
Income tax (corporate, effective distribution of profits, and natural people with Ecuadorian tax residency): 25%
Employees’ share of firm profits is 15%.
VAT (Value Added Tax): 12 percent rate.
Withholdings at the source of income tax and VAT: 1 percent, 10%, and 25%
Rate of foreign currency outflow tax (ISD): 5% (some exceptions apply).
Municipal taxes are based on the value of the property or business.
Contribution to the Corporations Superintendence: Only for corporations governed by the Corporations Superintendence.
Other taxes are effective beginning in fiscal year 2021.
Similarly, there are a number of tax benefits associated with new productive investments, including exemption from income tax and foreign currency outflow tax, as well as other tax benefits.
Fiscal Authorities
The following authorities are in charge of Ecuador’s tax system:
Internal Revenue Service (IRS): The IRS is in charge of administering income taxes for a variety of organisations.
Ecuador’s National Customs Service (SENAE): SENAE is responsible for the collection of taxes arising from the importation of commodities.
Each province’s autonomous decentralised government administers municipal taxes such as the property tax.
Vehicles For Business
There are several types of businesses in Ecuador, including civil societies and commercial enterprises. The former are governed only by the Civil Code’s requirements, as there is no regulatory agency in place to oversee them. Under the Companies Law, the Superintendence of Companies, Insurance, and Securities regulates and controls the latter. Here’s a quick rundown of each of them, along with their classification:
Civil Societies: In Ecuador, the establishment of Public Limited Companies is approved by a notary public, hence they are not regulated by the Securities and Insurance Companies Superintendence.
Commercial Firms: According to Ecuador’s Companies Law, there are five categories of commercial companies that can be used to develop economic activities:
The partners have personal, joint, and unlimited culpability for all of the company’s acts, and the company’s name must include their names. These businesses are seldom utilised and are not generally recommended.
The limited company can be simple or divided by shares, and it is a partnership made up of two types of partners: limited partners and limited partners who are fund providers with responsibility limited to the amount of their contributions.
Restricted Liability Business (Ca. Ltd.): In this company, the partners’ liability is limited to their individual contributions, and they are solely liable for obligations to the extent of their individual contributions.
Anonymous Company (S.A.): This sort of business is made up of two or more stockholders with freely transferable shares.
Mixed Economy Company: This type of company must be formed by legal or natural persons of public or semi-public law, as well as legal or natural persons of private law.
Simplified Stock Company (S.A.S.): Because the autonomy of its shareholders prevails, this type of company has flexibility in terms of its statute and internal organisation, as well as the option of self-regulation.
The Anonymous Company (S.A.), the Limited Liability Company (Ca. Ltd.), and the Simplified Public Limited Company are the most frequent commercial businesses employed as a vehicle for the establishment of a business (S.A.S).
Corporate Subsidiary Financing
Equity Investment
Paid-Up Capital Distributions
Except for dividends issued to an Ecuadorian firm, dividends distributed to all types of taxpayers, regardless of their tax residence, are subject to withholding at the source of income tax. The following is how the withholding tax will be calculated:
The taxable basis on which the withholding rate will be applied is 40% of the dividend effectively disbursed, often known as “taxable income.”
The withholding rate is calculated at the source, taking into account the following factors:
The “taxable income” of non-residents will be taxed at a rate of 25%. (Because the dividend effectively given comprises 25% of the 40%, the Company can essentially apply the 10% withholding immediately to it.)
If the firm that distributes the dividends fails to notify its corporate composition to its beneficial owner, the “taxable income” must be taxed at a rate of 35%. (The Company can practically directly apply the 14 percent withholding on the effectively distributed dividend, since this represents 35 percent of the 40 percent ).
If it is distributed to natural persons residing in Ecuador, or if it is distributed to a non-resident whose effective beneficiary is a natural person residing in Ecuador, it will be taxed at a progressive rate of 0% to 35% “on the basis of “taxable income.”
Tax Occurrence
The decision of the shareholders’ meeting, which resolves the need to pay dividends, will be deemed effective in the distribution of dividends. If the company is a “permanent establishment of non-resident companies,” the generating event will be when the operation’s surplus is remitted to the parent company based on the income, costs, and expenses attributable to the operation in Ecuador, after subtracting labour participation and income tax.
Agents Of Withholding
The company that distributes the dividends becomes the withholding agent, and the tax must be withheld at the source (within the 30-day period following the shareholders’ meeting decision), and in the case of dividends, the tax must be withheld at the source “establishment non-resident companies,” the date of withholding will be the date of the distributing entity’s income tax enforceability.
Debt Capital
General
If the following conditions are met, interest on loans incurred as a result of the business is deductible for income tax purposes:
The interest rate is set by the Monetary and Financial Policy and Regulation Board and does not exceed it.
The credit must be registered with the Ecuadorian Central Bank in the case of external credit.
The entire amount of interest paid or accrued by banks, insurance companies, and financial sector firms in the Popular and Solidarity Economy for external credits issued directly or indirectly by connected parties may not exceed 300 percent of equity.
The entire amount of net interest in operations carried out with linked parties cannot exceed 20% (20%) of EBITDA in the case of other companies or persons.
Implications Of Withholding Taxes
Payments made in connection with external financing to legally established foreign financial institutions or specialised non-financial entities qualified by the corresponding control entities in Ecuador, as well as interest on external credit granted by governments or multilateral organisations, are all deductible. These will not be subject to income tax or withholding at source in Ecuador. The interest cannot exceed the maximum reference interest rates set by the Monetary and Financial Policy and Regulation Board on the date of credit registration or novation in certain situations. If they exceed them, a withholding at source equal to the general corporate income tax rate on that percentage must be made in order for it to be deductible.
A withholding tax equal to the 25% tax rate must be imposed to interest paid overseas that is not covered by the previous paragraph, regardless of the financier’s residence.
Income Tax On Corporations
Rate of income tax
The national average is 25%. Under some circumstances, this rate can be increased or decreased. There are also unique perks for exporters.
When one or both of the following requirements are met, the general tax rate is raised to 28 percent:
Until the last effective beneficiary, the corporation does not publish its shareholding composition in a timely manner.
The beneficial owner is an Ecuadorian tax resident who is shielded in a tax haven, a reduced tax country, or a favourable tax regime, and his or her involvement surpasses 50%. If the participation rate is less than 50%, the 28 percent rate will be applied to the fraction of said participation.
Tax havens include:
The IRS in Ecuador considers domains, jurisdictions, territories, connected states, or preferential tax regimes to be tax havens if the income tax rate or a similar or analogous nature is less than 60% of the rate in Ecuador on income of the same nature (15 percent ). This is especially true when it comes to payments for services provided by such jurisdictions.
Gains In Capital
Profits from the direct or indirect alienation of shares, participations, other rights representing capital, or other rights that prove the exploration, exploitation, concession, or similar of natural resources; of companies domiciled or permanent establishments in Ecuador are defined as capital gains. When profits exceed US$20,000, they are subject to a progressive tax rate ranging from 0% to 10% if the transaction is not completed through the Ecuadorian stock exchange.
Profits from the direct or indirect sale of shares via Ecuadorian stock exchanges will be taxed from a base of US$42,424 in 2021. This database is updated once a year.
When a transaction occurs between related parties, losses from the direct or indirect disposition of fixed or current assets, shares, participations, other rights representing capital, or other rights that allow exploration, exploitation, concession, or similar will not be deductible.
Branch Taxation
Profits a branch has made
An IRS tax equal to 25% of a non-resident corporation’s after-tax profits is imposed by the IRS. The branch tax is essentially equivalent to a 25 percent dividend withholding tax. An applicable double-tax treaty may lower or eliminate the branch tax.
Taxable Income Calculation
Base Taxable
The tax base generated, which is the taxable profit for a period set by the taxpayer, is the subject of income tax.
The accounting profit must be used to determine the tax base (income minus expenditures and expenses, the result of which must be applied and removed 15% of employees’ participation).
This taxable base is subject to a 25 percent income tax rate, which is enhanced to 28 percent under certain circumstances as indicated in the tax rate section.
Deductions
All expenses that are required to create taxable revenue are generally deductible.
Expenses are not tax deductible in some circumstances, such as when:
These are used to produce tax-free revenue.
They lack supporting documentation.
These are not economically important.
These expenses exceed the specified deductibility limits for each kind of expense (depreciation, royalties, loans, other expenses).
Reporting of Taxes
All natural people, undivided successions, and corporations, national or foreign, domiciled or not in the country, must file an income tax return based on the results of their economic activity, even if all of their income is exempt, with the exception of:
Payers who are based abroad, do not have a local agent, and only have revenue subject to withholding at source.
Individuals whose gross income does not exceed the untaxed basic fraction within the fiscal year.
Each year in April, the income tax declaration is done based on the ninth digit of the Single Taxpayer Registry (RUC), which is declared between April 10 and April 28.
Payments Between Countries
Pricing For Transfers
Ecuador is not a member of the Organisation for Economic Cooperation and Development (OECD), but it has adopted the OECD’s pillars on the arm’s length principle, which allows the IRS to determine transfer pricing adjustments in a review process for transactions that are not carried out under full terms and conditions. Ecuadorian taxpayers are expected to keep records of transactions that are subject to transfer pricing restrictions. As a general rule, transactions between related parties involving more than US$3 million must file a Transfer Pricing Annex with the IRS each year, and if the amount exceeds US$15 million, the IRS must file a report of transfer pricing prices to demonstrate that its transactions are aligned with the arm’s length principle.
Income Tax Withholding
Payments made outside of Ecuador by an Ecuadorian resident for services, interests, rents, royalties, management or administrative expenses, and other ideas are taxed at a rate of 25%. However, due to a double tax treaty with each country with which Ecuador has an agreement, the rate may be reduced.
Ecuador needs a certificate of tax residence for each fiscal year to exploit the benefits established in the double taxation agreements, in order to avoid abusive tax practises.
Instrument Multilateral
Ecuador is not a signatory to the Multilateral Convention on the Application of Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, which was established to prevent base erosion and profit shifting (MLI). To apply the Base Erosion and Profit Shifting criteria, Ecuador instead relies on the limitation on benefits provisions in its current income tax treaties and domestic law, particularly in parts connected to the arm’s length concept.
Taxes On Wages
In Ecuador, a person is regarded an employee of a corporation when they enter into an agreement with another or others to give their lawful and personal services, under their reliance, for a recompense determined by the agreement.
As of 2021, a unified basic monthly wage of US$400 has been established for 8 hours of labour per day (Monday to Friday) and 40 hours per week, with annual fluctuations.
Contributions to the Ecuadorian Social Security Institute
There are two types of contributions:
Employer contribution: The employer makes a contribution. (12.15%) of the population.
Employee contribution: Employee contribution (9.45 percent )
It takes place every month till the 15th of the month.
Method of calculation: The percentage to be paid is 21.6 percent of the worker’s monthly wage, which must be paid as follows: The employee’s salary is deducted 9.45 percent for personal contribution, while the company pays the remaining 12.15 percent.
Profit Distribution
Method of Calculation: Each fiscal year, the company must distribute 15% of its net profit to its employees.
Term: Until April 15th, this amount must be paid annually.
Distribution method:
10% of these benefits are awarded to all current and previous employees based on the length of time they have worked.
The remaining 5% is dispersed in proportion to each worker’s and former worker’s family responsibilities.
Former employees will be compensated in accordance to the time they spent working for the permanent institution during the year.
Individuals With A Tax Residence In Ecuador Are Subject To Income Tax
A natural person with a tax residence in Ecuador will be subject to income tax based on a progressive rate that is proportional to their annual net income.
Returns, discounts, charges, expenses, and deductions attributable to such income must be removed from the total taxable income in order to compute the income tax that a taxpayer must pay. This is referred to as the “tax base.”
The Tax Basis
Taxable income from labour in a dependence relationship is calculated by subtracting taxed income from the value of personal contributions to the Ecuadorian Social Security Institute (IESS) (equal to 9.45 percent of salary), unless the employer pays these contributions.
Seniors’ tax base: Seniors will be deducted a baseline fraction taxable at zero percent (US$11,212 in 2021).
Taxable base for substitutes or people with disabilities: According to the table below, people with disabilities or substitutes will be deducted two basic fractions taxed at zero percent (US$22,424 in 2021):
Allowable Deductions
Personal costs are deductible up to 0.325 times the basic taxable fraction of IR 0 percent of natural persons (in 2021, it is 11,212 x 0.325) or up to 1.3 times the basic fraction of IR 0 percent (in 2021, it is US$14,575.60 = 1.3 x11,212), or up to 50% of total income:
Unless the taxpayer, their parents, their spouse or partner, or their economically dependent children suffer from catastrophic, unusual, or orphan issues, natural persons with net income over US$100,000 will no longer be able to deduct personal costs after 2020.
Rate Of Income Tax
The appropriate income tax rate is graduated according to the natural person’s annual net income. Net income above US$11,212 per year is subject to a progressive income tax ranging from 0% to 35%.
Taxes Levied Indirectly
Added-Value Tax
The VAT applies to all domain transfers and services provided in Ecuador, at all phases of commercialization, whether for a fee or without. The current VAT rate is set at 12%. The VAT rate is 0% in some circumstances, such as exports of goods and services.
Discounts and bonuses, items and packaging returned by the buyer, interest, and insurance payments could all be subtracted in instalment purchases.
You are entitled to a tax credit for VAT paid on goods and services subject to this tax if the goods and services are utilised in the manufacture and sale of other VAT-exempt products and services.
Special Consumptions Are Taxed (TSC)
The Tax on Special Consumptions (TSC) levies a tax on product distributors, manufacturers, importers, and all other products that are taxable under the law.
The consumption of domestically produced commodities and items imported when the customs process begins is the triggering event for this tax.
The tax rates vary depending on the type of commodities and products. The IRS publishes the applicable rates every year.
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