These conditions are:
Paid taxes should be more than 3% of taxable income
Taxpayers cannot be involved in transactions with residents of tax haven
The company should not any contract with the State for the exploration and exploitation of non-renewable resources
The exemption is one of the most daring elements of the tax reform as it implies a mix between traditional transfer pricing regimes with safe harbour regimes.
The law seems to be directed at rewarding companies not just because they are not in sensitive industries, such as oil or mining, or do not engage in transactions with tax havens, but because they are part of high value functions. If the profit sharing with workers that is due by law in Ecuador is added to the 3% of paid taxes, this implies that the earnings before taxes must be 14.12%. That is an unusually high profit for activities different than manufacturing or rendering of strategic services.
The same regulation seems to be punishing activities that are leveraged with borrowed funds, irrespective of whether the source of the money is a related or unrelated party, because the exemption does not consider the operation itself, but the final profit to be taxed.
The scope of the exemption is not clearly defined in the law, though it is thought that the government will issue the regulations for the law, probably by the middle of the year. However, as the transfer pricing regime in Ecuador is composed of the arm’s-length principle, comparability guides and an advance pricing agreement (APA)-like procedure, it seems possible that the exemption could not just include the formalities of contemporaneous documentation filing, but the possibility of allowing tax planning procedures that were voided in Ecuador since the transfer pricing regime was implemented on 2005.
A sample of taxpayers shows that about 20% of companies subject to the cross-border transfer pricing regime will be able to take advantage of this regulation, and that the average shows that each one of these companies could be able to reduce its paid taxes by up to half of what they pay now.
It represents an opportunity to restructure international operations with Ecuador and to take advantage of the differences between the Ecuadorian regime - where the combined effect between the profit sharing and income taxes equals 36.25% - and taxes to be paid in other countries where the corporate tax rate is lower.
Alexis Carrera (alexis.carrera@ec.ey.com) is a senior manager in the international tax services – transfer pricing practice of Ernst & Young in Ecuador
