The income tax treaty between Ecuador and Japan entered into force on 28 December 2019. The treaty, signed 15 January 2019, is the first of its kind between the two countries.

Taxes Covered

The treaty covers Ecuadorian income tax and covers Japanese income tax, corporation tax, special income tax for reconstruction, local corporation tax, and local inhabitant taxes.

Residence

If a company is considered resident in both Contracting States, the competent authorities of both States will determine its residence for the purpose of the treaty through mutual agreement based on its place of head or main office, its place of effective management, the place where it is incorporated or otherwise constituted, and any other relevant factors. If no agreement is reached, the company will not be entitled to any relief or exemption from tax provided by the treaty.

Service PE

The treaty includes the provision that a permanent establishment will be deemed constituted when an enterprise furnishes services in a Contracting State through employees or other engaged personnel when the activities continue for a period or periods aggregating more than 183 days within any 12-month period.

Withholding Tax Rates

• Dividends – 5% in general, although the rate is 10% if the dividends are deductible in computing the taxable income of the paying company in its Contracting State of residence
• Interest – 10%, with an exemption where:
  • the beneficial owner is either Contracting State;
  • the beneficial owner is a resident of a Contracting State and the debt-claims are guaranteed, insured, or indirectly financed by that State; or
  • the beneficial owner is a bank, provided that it is established and regulated as such under the laws of a Contracting State
• Royalties – 10%

Capital Gains

The following capital gains derived by a resident of one Contracting State may be taxed by the other State:

• Gains from the alienation of immovable property situated in the other State;
• Gains from the alienation of any property, other than immovable property, forming part of the business property of a permanent establishment in the other State; and
• Gains from the alienation of shares or comparable interests if, at any time during the 365 days preceding the alienation, the shares or comparable interests derived at least 50% of their value directly or indirectly from immovable property situated in the other State, with an exemption if the shares or comparable interests are traded on a recognized stock exchange and the alienator and related parties own 5% or less of the class of such shares or comparable interests.

Gains from the alienation of other property by a resident of a Contracting State may only be taxed by that State.

Double Taxation Relief

Ecuador generally applies the exemption method for the elimination of double taxation, while Japan applies the credit method. However, for income covered by Articles 10 (Dividends), 11 (Interest), and 12 (Royalties), Ecuador applies the credit method.

Entitlement to Benefits

Article 28 (Entitlement to Benefits) includes a general anti-abuse provision, which provides that a benefit under the treaty will not be granted in respect of an item of income if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit would be in accordance with the object and purpose of the relevant provisions of the treaty.

Provisions are also included in the final protocol to the treaty to restrict treaty benefits where income of a resident of a Contracting State is attributed to a permanent establishment in a third state, and:

• the income is exempt from tax in that Contracting State; and
• the rate of tax in the third state is less than 60% of the tax that would be imposed in that Contracting State had the income not been attributed to the permanent establishment.

This restriction will not apply, however, if the income emanates from or is incidental to the active conduct of a business carried on through the permanent establishment, other than the business of making, managing or simply holding investments for the enterprise's own account, unless these activities are banking, insurance or securities activities carried on by a bank, insurance enterprise or registered securities dealer, respectively. Further, even where benefits would be denied for income attributed to a PE in a third state as above, the competent authority of a Contracting State may still grant benefits in respect of the income if it is determined that granting the benefits would be justified.

Silent Partnership

The final protocol to the treaty provides that any income derived by a silent partner that is a resident of a Contracting State in respect of a silent partnership (Tokumei Kumiai) contract or another similar contract concluded under the laws of Japan or any contract similar to those contracts concluded under the laws of Ecuador that are introduced after the date of signature of the treaty may be taxed in the other Contracting State according to the laws of that other State, provided that such income arises in that other State and is deductible in computing the taxable income of the payer in that other State.

Effective Date

The treaty generally applies from 1 January 2020, although Article 25 (Exchange of Information) applies from 28 December 2019 and Article 26 (Assistance in the Collection of Taxes) will apply from the date to be agreed between the Governments of the Contracting States through an exchange of diplomatic notes.