Ecuador: Bill for Fiscal Transparency

On October 18, 2019, the President of Ecuador presented the “Bill for Fiscal Transparency, to Optimize Tax Spending, Encourage Job Creation, Secure the Monetary and Financial Systems, and for Responsible Management of Public Finances” to the National Assembly, as an urgent economic matter. It covers three core areas:

• Tax reform.
• Financial and monetary system reform.
• Amendments to other laws, including to the Law for the Special Regime of Galapagos Province, the Telecommunications Law, Organic Administrative Code and Civil Aviation Law.
  
  

The main reforms proposed by the Bill are:
FIRST AREA:
Tax Reform

1. A single and temporary tax on corporate income
   This would apply to companies engaged in economic activities (except state-owned companies) who have generated gross income of more than USD 1,000,000 in fiscal year 2018. The new tax will be applicable for fiscal years 2020, 2021 and 2022. The tax rate will be in accordance with a table of progressive rates from 0.10% to 0.20%.
   
   
2. A voluntary regularization tax (an offshore voluntary disclosure program)
   For Ecuadorian residents who, as at December 31, 2018, have foreign income that was subject to undeclared income tax in Ecuador or who have performed money transactions subject to tax on the remittance of currency (ISD) without declaring this or without paying the corresponding tax, a voluntary regularization tax would apply with the following rates:
   
   

• 1% (or two percent) if the declaration and payment of tax is made by March 31, 2020;
• 2% (or three percent) if this is done between April 1, 2020 and June 30, 2020;
• 4% if this is done between July 1, 2020 and December 31, 2020; and
• 8% when the taxpayer only declares foreign income, assets or investments, without returning these to, or investing these in, Ecuador. The declaration and payment of this tax shall occur up to December 31 2020.Important note: There is a discrepancy on tax rates included in the proposed bill between the amounts written and the same amounts in numbers.
  
  

3. Amendment to the tax system for dividends

• Dividends distributed to non-resident companies or individuals would be subject to income tax in Ecuador. The taxed income will only correspond to 40% of the distributed dividend.
• The tax rate applicable to the taxed income will be 25%, but if the obligation to report the shareholding structure has not been fulfilled, a 35% withholding must be applied to the dividends.
  
  

4. Amendments for entrepreneurs and micro-entrepreneurs

• A simplified tax system is proposed for entrepreneurs and micro-entrepreneurs who have from one to nine employees and a maximum of USD 300,000 in net sales, with a fixed rate of 2% on gross income from the respective fiscal year.
  
  

5. Several amendments to the Tax Code

• The IRS would have the authority to disregard the forms, actions or procedures and instead address the essence of transactions, to prevent evasion and to tax the “savings” generated  by such forms, actions or procedures.
• The possibility of issuing administrative decisions digitally, with notifications of assessments published in the tax gazette.
  
  

6. Various amendments to income tax

• Eliminate the mandatory income tax advance payment and all references thereto. The advance payment would be voluntary.
• Expand the concept of income to include income from indemnification, fees and benefits.
• Include hospital infrastructure, education, cultural and artistic services in the category of priority sectors, , subject to exemptions and benefits.
• Limit the deductibility of interest paid by individuals and companies (except IFI’s and insurers) to 20% of the operating profit.
• Eliminate the deductibility of indirect expenses allocated by related parties.
• An additional deduction for expenses for taking out export credit insurance.
• Reduce the additional deduction benefit to 50% for: i) depreciation and amortization of machinery for clean energy; ii) net increase in employment; and iii) expenses for private medical insurance and/or prepaid medical insurance for employees.
• Eliminate the deduction of personal expenses for individuals with net income of USD 100,000 or more.
• Make gifts made to projects or scholarships in the sport, education, research and business venture sectors deductible.
• Withholding agents should only be those who meet the conditions to be defined in the Regulations.
• For the reimbursement of expenses, the withholding should be applied when, in the absence of intermediaries, it would have been applicable.
• Income from lottery prizes will not be exempt.
• Only income from the occasional sale of real property for housing will be exempt, based on one sale in a five-year period.
• Include an exemption on the profits from the sale of shares via the stock exchange that do not exceed 25% of capital stock.
• Include exemptions on income received for the development of new sports, cultural, scientific research, technological development, education and professional training projects; and funds and gifts received by business ventures approved by the authority.
  
  

7. Amendments to the Tax on Remittance of Currency (ISD)
   

• Regarding the ISD exemption on foreign loan payments, eliminate the requirement for the loan to be granted for 360 days or more, and permit the funds to be invested in rights representing capital.
• Exempt foreign dividend payments from ISD, including those to companies domiciled in tax havens, provided that the beneficial owner is not an Ecuadorian resident.
• Decrease the rate of ISD from 5% to 2.5% for payments made for the import of raw materials, inputs and capital assets included on the list issued by the Tax Policy Committee. Eliminate the possibility of using this ISD as a tax credit, which must be recorded as an expense.
  
  

8. Various amendments to VAT

• Apply the 0% rate to flowers, tractors up to 300 hp, test strips for measuring glucose levels and newsprint.
• The tax credit may be used within up to five years from the date of the sales invoice.
• Apply VAT to imports of digital services used or consumed by Ecuadorian residents. Credit card issuers who make payments to a digital services supplier not registered in Ecuador will act as withholding agents of the 12% VAT.
  
  

9. Amend the Excise Tax (ICE)

• Introduce an Excise Tax on plastic bags – USD 0.10 per unit – given to the consumer to carry products sold by the commercial establishment. Does not include bags for industrial, agricultural, agroindustry or export uses, for frozen goods, used as primary packaging or biodegradable bags.
• Apply a 50% tax to tobacco, vaping devices, and liquids that contain nicotine.
• Amend the calculation formula for motorized vehicles.
• Apply a 10% Excise Tax on mobile phone services provided to individuals, excluding the prepayment.
• Reduce the Excise Tax on artisanal beer and increase the tax on industrial beer in its different market sectors.
• Amend the Excise Tax on non-alcoholic beverages and carbonated drinks with a sugar content of more than 25g.
  
  

10. Amendments to sectoral taxes

• Replace “vehicle tax” with “annual tax on vehicle circulation”.
• For purposes of the patent tax and 1.5 per 1,000 tax on total assets, clarify that “establishments” are those listed in the RUC – Taxpayer Register.
  
  

Amend the single tax on the banana sector, and introduce a single tax on agricultural activities excluding the banana sector

 
SECOND AREA:
FINANCIAL AND MONETARY SYSTEM
Proposed amendment to the Organic Monetary and Financial Code
The proposed amendments to the Monetary and Financial Code are mainly aimed at restoring the autonomy of the Central Bank of Ecuador. Changes would include:

• Create a Board of Directors at the Central Bank of Ecuador.
• Restore the Central Bank’s capacity to regulate monetary activity.
• Change the name of the Monetary and Financial Policy and Regulation Board to the Policy, Regulation and Stability Board, and remove its capacity to regulate monetary activity.
• Reinforce the prohibition against the Central Bank financing the public sector.
• The Central Bank cannot hold shares in public or private sector entities.
• Reinforce accounting systems.
  
  

Additionally, change the composition of the Monetary and Financial Policy and Regulation Board, and its members need not be public servants from the public sector.
Other significant changes include the elimination of the requirement to have a local liquidity reserve, to enable the distribution of risk in private banking in the event of a systemic crisis in Ecuador.


Amendment to the Organic Code for Planning and Public Finances
The proposed changes would include fiscal sustainability as a governing parameter for public finances. For example, for purposes of scheduling public investment, it will no longer be enough to consider the entities’ actual delivery capacity and the capacity to cover the investment expenditure; it must also guarantee fiscal sustainability.

Preventive measures are introduced for planning and public finances. For example, these include the concept of pre-investment programs and capital preservation programs. These are studies that evaluate and determine the technical, economic, financial and institutional viability of the investment projects.

They also establish that the governing entity for public finances must issue a mitigation and fiscal risk management policy, to be annexed to the pro forma of the General State Budget. They expressly include the ability to contract for services or create mechanisms to achieve a minimum level of income from oil sales, as well as the need to create a stabilization fund with surplus income.

Strengthen the role of the Ministry of Economy and Finance as the governing entity of public finances. It should issue a methodology and establish a budget ceiling for various entities which is consistent with the principle of fiscal sustainability. It would also have the power to establish policies on procedures and maximum deadlines for delivering advance payments for public procurement, agreements and other arrangements that involve disbursements.

However, the Ministry can only increase and decrease the income and expenses that change the levels set in the General State Budget up to a total of 5% in respect of the figures approved by the National Assembly.
Strengthen the financial guidelines for state-owned companies and social security entities. The fiscal rules for these entities must use as a mandatory framework the long-term and annual fiscal scheduling of the Non-Financial Public Sector and include restrictions on its ability to take on debt.

Regarding indebtedness, rules are expanded regarding obtaining debt and its destination, and it clarifies that public debt is the set the obligations acquired by public sector entities or otherwise. The definition of debt excludes contractual rights arising from or connected to ordinary transactions that do not require a sovereign guarantee, although some of these transactions are taken into account for the indices to be produced.

The role of Treasury Certificates is restricted. Now, Treasury Notes can only be used to manage temporary cash shortfalls, up to 8% of the total expenses of the General State Budget. The Central Bank cannot under any circumstances invest in these Treasury Notes or in any securities issued by the State or state institutions.

Lastly, emphasis is made on transparency of information, stating that more detailed information will be given on the financial terms and conditions of all public debt transactions, novation of existing debt and repurchases of public debt to comply with article 289 of the Constitution.


THIRD AREA:
Amendments to other laws
The bill proposes amendments to several laws:

• Law for the Special Regime of Galapagos Province: changes to the permit system for tour operations.
• Telecommunications Law: Include public providers of telecom services and subscription services as parties subject to the market concentration payment; increase the term of the licenses.
• Mining Law: Allocate 50% of the mining royalty to social investment projects to cover basic needs that have not been met or for territorial or productive development; a 10% increase in the budget of the Decentralized Autonomous Governments.
• Civil Aviation Law: The Ministry of Finance should set the fees for airport services at airports managed by the Civil Aviation Authority.
• Higher Education Law: Automatic recognition of degrees from foreign universities of excellence (under an agreement) and subsequent oversight of virtual or online programs by CACES instead of the previous control.