Taxing authority and tax law
Tax authority: Internal Revenue Service (Servicio de Rentas Internas or SRI)
Tax law: Internal Tax Regime Organic Law (Ley Orgánica de Régimen Tributario Interno or LORTI) and its Regulation
Relevant regulations and rulings
In the First Title, Chapter I, First Section, the first unnumbered Article after the Article 4 of the Internal Tax Regime Organic Law defined related parties.
The First Title, Chapter IV, Second Section, in the first unnumbered Article after the Article 15 of the Internal Tax Regime Organic Law, established the transfer pricing regime.
In the same section mentioned above, the fifth unnumbered Article after the Article 15, established and exception of the transfer pricing regime application when a taxpayer comply with this conditions: tax payable greater than the 3% of their taxable income, do not perform transactions with tax heavens, do not have contracts with the Government for the exploration and exploitation of none renewable resources.
Article 90 of the Internal Tax Regime Organic Law, established the utilization of secret comparables for the review of the application of the Arm’s Length principle.
Article 87 of the Tax Regulation (Reglamento para la Aplicación del Régimen Tributarios Interno) established the median calculation and arm’s length standard.
In addition the Tax Regulation established the concept of sub-capitalization, which requires the amount of the external debt not be greater than 300% of the equity in order to consider interest payments abroad as deductible expenses.
The SRI Resolution NAC-DGER2008-0464 established the transfer pricing exhibit and transfer pricing integral report content requirements.
OECD guidelines treatment
The SRI considers the 1995 edition of the OECD guidelines as a technical reference for analyzing intercompany transactions. However the Internal Tax Regime Organic Law has supremacy over the OECD guidelines.
Ecuador follows a hierarchy of transfer pricing methods. Local regulations establish that only the six methods established in the OECD Guidelines are applicable. The CPM and full profit split method are considered the last resort methods by the SRI.
Priorities/pricing methods
The SRI accepts the CUP, Resale, Cost Plus, Profit Split, Residual Profit Split, and Transactional Net Margin Method. There is a hierarchy of methods. Indeed, the SRI has made the application of the CUP method mandatory. If the CUP method cannot be applied, the Resale or the Cost Plus methods must be implemented. If none of these methods can be executed due to the complexity of the transactions under analysis, the SRI accepts the other analyses frameworks mentioned above as valid ones, leaving the Transactional Net Margin Method as the method of last resort. The direct implication is that all method rejections must be thoughtfully documented.
There are specific CUP method applications. More specifically, for exports and imports of tangible goods between related and independent parties where there is an international price in transparent markets, the market price is used, unless there is evidence to the contrary. In addition, there is another application for companies that operate through international intermediaries, who are not the final consignees or producers of the goods. Such goods include all products with well-known prices in transparent markets. In these cases, the price to be applied is the price in those markets on the day the goods are loaded for shipment or the agreed-upon price if higher. This method may not apply if the local exporter or importer is able to prove the substance of the operations of the consignee abroad and that this intermediary party has not more than 20% of its operations with related parties.
Transfer pricing penalties
Ecuador has a specific transfer pricing penalty regime. There are processes in place to ensure the consistent application of transfer pricing penalties in the jurisdiction.
Penalties up to US$ 15,000 could be applied if deadlines are not met or where inaccuracies are detected. Interest could be applicable on unpaid adjustments as part of the income tax.
Penalty relief
No penalty relief regime has been provided.
Documentation requirements
The SRI requires a Transfer Pricing Annex report to be filed, detailing:
- All transactions with foreign related-parties
- The methods applied in analyzing each transaction
- Calculated adjustments for each transaction using software provided by the tax administration
This declaration must be filed by companies with accumulated transactions with related parties exceeding US$ 3m in the reported fiscal year or companies with accumulated transactions with related parties between US$ 1m and US$ 3m in the reported fiscal year, which amount represents up to 50% of the total revenues.
Additionally, the Transfer Pricing Integral Report must be presented to the SRI by companies with accumulated transactions with related parties exceeding US$ 5m in the reported fiscal year. This Report must substantiate the analyses made of all transactions reported in the Annex. Both documents must be filed up to two months after the income tax return deadline.
Nevertheless, the SRI may require, at any time, the Transfer Pricing Annex and/or the Integral Report even though the company does not reach the threshold, or in the case of intercompany transactions between domestic related companies.
Transfer Pricing Integral Report Requirements:
- Full functional analysis of the multinational group and the local party
- Risk analysis of the local company and assets detail
- Intercompany transactions detail and functional description
- Market analysis including global and local descriptions and a demand analysis for both levels
- Economic analysis including:
- Detailed and quantified information for each type of operation held with foreign related parties
- Detailed reasoning for acceptance or rejection of a method
- Profit level indicator selection process
- Comparable companies detail
- Applied adjustments explanation
- Reason for rejection of searched comparable companies
- Accepted comparable companies activities description and financial statements
- Analysis description and conclusion
Documentation deadlines
Adjustments and intercompany transaction figures must be included on an Income Tax Return form (due in April).
The Transfer Pricing Annex and Integral Report must be filed two months after filing the tax return. That is, from 10 June to 28 June depending on the ninth digit of the company Tax ID Number.
Statute of limitations on transfer pricing assessments
The statute of limitations is three years from the date of the income tax return filing and six years if overall tax compliance was not accomplished.
The obligation to prepare and present the Transfer Pricing Annex starts when related parties’ transactions exceed US$ 3m or when related-parties’ transactions between US$ 1m and US$ 3m represents up to 50% of the total revenues.
The Integral Report must be delivered in addition to the Annex only when those transactions exceed US$ 5m.
Return disclosures/related-party disclosures
No specific related-party information, aside from the documentation required by transfer pricing regulations, is required. However, these regulations also require the following additional parties to be treated as related:
- Tax-haven located companies
- Parties buying or selling more than 50% of the products sold or bought by the local company
- Parties on which the local company has at least a threshold of 25% ownership
Resolution NAC-DGER2008-0182 established a list of tax havens or low tax rate jurisdictions as well as the contents and the mandatory filing of a transfer pricing study.
The Article 1 of the Resolution NAC-DGERCGC09-00704, exclude Uruguay from the list of counties considered as a tax haven by the SRI.
Audit risk/transfer pricing scrutiny
Ecuador Transfer pricing risks of audit could be assessed as high. Recent audit activity included a specific focus on transfer pricing. For the first semester of 2010, the SRI has performed 44 intensive reviewing processes.
In recent years, the number of ongoing litigation and undergoing domestic appeals cases (preceding court action) has increased. Tax havens are frequently involved in disputes.
The sale of tangible goods (representing 80% of the current case load) and intra-group services (approximately 20% of the current case load) are currently the focus of the Directorate of Taxes for transfer pricing review.
A transfer pricing audit is instigated by a central decision-making body. Various considerations are taken into account in determining which taxpayers to audit, including (ranked in order of importance):
- The outcome of a risk assessment by the SRI
- The nature of related-party transactions undertaken by the taxpayer
- The outcome of customs
- Previous tax audits of the taxpayer
- The profitability of the local taxpayer
A high risk of audits could be assessed for oil, agriculture, pharmaceutical, construction and fishing industries and the activities related with them. Several auditor teams are acting simultaneously on about 40 relevant companies at a time.
APA opportunity
Ecuador has no formal APA program. The local law outlines the possibility of APA procedures and prescribes that regulations will be issued by the tax administration on the application process of APA. However, the relevant regulations have not been issued. Therefore, no taxpayers have started consultation for an APA.
Generally, the procedures require taxpayers to satisfy inquiries relating to the previous two taxable years from the tax administration, after which taxpayers may propose, through consultation with the tax administration, applicable prices for the APA Term. The APA Term includes the year preceding the APA application, the year of the APA application and the two tax years following the application and the SRI has two years to resolve the proposal.
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