ECUADOR Trends and Developments Contributed by: Diego Almeida-Guzmán, Andrés Álvarez-Toapanta, Cesar Molina-Delgado and Ignacio Jijón-Chiriboga, Almeida Guzmán & Asociados
Triggering event and withholding obligation It is important to note that the obligation to with - hold income tax on the transaction is triggered at the moment the resolution to distribute dividends is adopted, regardless of when payment is actually made. That is, the triggering event occurs when the company, through its authorised governing body, resolves to deliver dividends to its shareholders or partners and, consequently, records the correspond - ing accounts payable. Capital reductions as dividend distributions The reform introduces a significant new taxable event: capital reductions derived from undistributed profits shall be treated as dividend distributions. Until the effective date of the reform, this constituted common practice in Ecuador, whereby companies increased capital through undistributed profits and subsequently transferred such amounts to shareholders and ben - eficial owners through capital reductions, without the law expressly characterising such transactions as dividends. It was a mechanism to not pay – alto - gether – the tax on dividends. Previously, the tax authority audited significant capital reductions as the aforementioned and treated them as taxable dividend distributions, notwithstanding the absence of explicit statutory regulation for such characterisation. Nota - bly, however, the reform does regard capital increases charged to profits as a taxable event. Branch profit determination The reform further established the methodology for determining the benefits of branches of foreign companies domiciled in Ecuador attributable to their head offices. Any excess in favour of the head office shall be deemed a dividend from the branch. Such excess must be determined in accordance with the arm’s length principle and considering income, costs and expenses attributable to local operations, after deducting employee profit sharing (in Ecuador, 15% of the taxpayer’s accounting profit) and income tax accrued during the period. Provisions unchanged by the reform Notwithstanding the reform, several aspects of the dividend distribution regime remain unchanged. Par - ticularly, dividend distributions between companies
are not subject to tax provided that both the distrib - uting and receiving entities are domiciled in Ecuador. Advance dividend distributions Another noteworthy aspect unchanged by the reform concerns advance dividend distributions, which remain subject to an additional income tax withholding beyond the otherwise applicable rate. The withholding in such cases is 25% of the distributed amount. Criti - cally, however, this amount is borne by the Ecuadorian company distributing the advance dividends and is not deducted from the amount to be received by the beneficiaries. The Ecuadorian company may, in any event, utilise the 25% withheld (and borne by it) as an income tax credit. Strictly speaking, advance dividend distributions occur when distribution is made against the pro - spective results of a fiscal year. No advance dividend distribution occurs when distribution is made against profits from a closed fiscal year with known results, regardless of when such distribution takes place. In any event, tax regulations treat, as advance dividend distributions, cases in which a company domiciled in Ecuador grants cash loans to its shareholders or hold - ers of equity rights. This treatment applies equally to loans made to related parties where such loans lack a demonstrable commercial purpose. In such cases, the transfer of funds to shareholders, beneficial owners or related parties shall be taxed as an advance divi - dend distribution. The only exception to the advance dividend distribution regime applies to entities whose sole economic activity is the holding of shares (hold - ing companies). Creation of a Taxable Event Imposing Income Tax on Undistributed Profits Legislative intent and scope The Organic Law on Social Transparency established a new income tax taxable event. Under this new pro - vision, taxation applies when a company resident in Ecuador or a permanent establishment (branch) of a foreign company has failed to distribute its accumu - lated profits from the prior fiscal year or to capitalise such profits by July 31st of each fiscal year, provided that undistributed profits exceed USD1 million.
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