Ecuador published Executive Decree No. 586 of 31 October 2022 in the Official Gazette on 10 November 2022, including various reform measures in relation to trade, investment, and tax policy for economic development. One of the key reform measures is new rules for the deduction of expenses incurred in relation to royalty and technical, administrative, and consulting services payments to related parties. The new rules provide that the deduction of such expenses is limited to 5% of taxable income per year, with certain exceptions:
- For taxpayers who are in the pre-operational phase of the business, the limit for the deduction of such expenses is 10% of total assets; and
- For taxpayers whose only activity is to provide separate independent technical services, no deductibility limit applies if the operating margin indicator, resulting from the operating profit on the company's operating sales, is equal to or greater than 7.5%, otherwise, the deductibility limit resulting from the following calculation will be applied:
- operating sales is multiplied by 7.5% and operating profit is subtracted from the result; and
- the deductibility limit is equal to the accumulated annual value of service and royalty expenses incurred with related parties less the value resulting from the previous step.
In the above cases, taxpayers may request a higher deductibility limit, under the legal, regulatory, and procedural provisions established for the consultation of the prior valuation of operations between related parties (i.e., APAs).
It is further provided that there will be no deductibility limits in the following cases:
- Operations with related parties resident in Ecuador or permanent establishments in Ecuador, as long as the taxpayer incurring the cost or expense is subject to an effective tax rate equal to or less than that of the related party performing the operation; or
- The total royalties and technical, administrative, and consulting services with related parties reported within a fiscal year does not exceed 20 times the 0% individual income tax bracket (current 0% bracket for 2022 is up to USD 11,310.00).
It is also provided that no royalty expenses are deductible if the underlying asset for which the royalties are being paid to related parties has belonged to a resident company or permanent establishment in Ecuador in the previous 20 years.
Some of the other main measures are summarized as follows:
- New rules are introduced for the classification of non-existent companies, "phantom" companies, or taxpayers with non-existent transactions by the tax authority, including that companies/taxpayers classified as such have 30 business days to present documentation proving otherwise;
- New related rules are introduced providing that taxpayers may not deduct expenses incurred with companies classified as non-existent or a phantom company or taxpayers with non-existent transactions, and may not request a refund or use as a tax credit the taxes that have been generated in operations carried out with such companies/taxpayers, unless the taxpayer adequately supports the material and economic purpose of the expenses;
- The rules on the depreciation of fixed assets are revised, including maximum depreciation rates as follows:
- real estate (except land), ships, aircraft, barges, and the like - 5% per year.
- facilities, machinery, equipment, and furniture - 10% per year.
- vehicles, transport equipment, and mobile road equipment - 20% per year.
- computer equipment and software - 33% per year.
- It is provided that losses or discounts generated in the sale of financial assets corresponding to commercial credits or portfolios that are negotiated outside the stock market or with related parties are not deductible for natural persons or non-financial entities;
- New deferred tax rules are introduced for the impairment of financial assets corresponding to bad debts and differences between financial depreciation and tax depreciation:
- in the case of non-financial entities, it is provided that the impairment value of financial assets corresponding to bad debts, which exceed the deduction limits provided for under the tax regulation, will be non-deductible in the period they are recorded for accounting purposes, although a deferred tax will be recognized for this surplus, which must be used in the fiscal year in which the terms and conditions established for the elimination of uncollectible accounts (bad debts) are met or when the sale of the financial asset occurs; and
- it is provided that the difference between the financial depreciation of property, plant, and equipment and the deductibility limits of said depreciation in accordance with the provisions of the tax regulation, must be considered as non-deductible, although a deferred tax will be recognized, which must be used from the fiscal period following the end of the financially established useful life and must be distributed evenly during the remaining years of useful life of the asset;
- It is provided that the required period for maintaining supporting documentation in relation to amortization and depreciation will be counted from the period in which the deduction of the amortization/depreciation expenses ended;
- New provisions are introduced to provide legal certainty and stability of tax incentives included in an investment contract, which will apply until their expiration, unless more favorable incentives are subsequently introduced; and
- An exemption is introduced from remittance tax on foreign currency outflows (ISD) on the import of capital goods and raw materials for an investment contract;
The measures of Executive Decree No. 586 generally entered into force the date it was published, 10 November 2022, although it is provided that the new deferred tax rules apply where impairment is generated as of the fiscal year 2023 and in respect of depreciable assets acquired from the fiscal year 2023. Although not clearly specified in the Decree, the new rules limiting the deduction of royalties and service payments to related parties are to also apply from 2023. Further details on the implementation of the measures will be published once available.