Global transfer pricing guide

Transfer pricing - Ecuador

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Introduction to transfer pricing in Ecuador
Transfer pricing rules

The Transfer Pricing (TP) legislation in Ecuador is established in the articles following art. 15 of the Internal Tax Regime Law (LRTI), and in arts. 84 to 91 of the respective Regulation. In addition, the Internal Revenue Service (SRI) continuously updates the Technical Sheet for the Standardization of Transfer Pricing Analysis (FTSAPT), in which parameters are defined in terms of the form of presentation, content, calculation, economic analysis, and other supporting documentation of the operations with related parties.

With this document and the Transfer Pricing Guidelines (TPG), the IRS has reinforced the elaboration of robust functional analysis that describe the risks incurred, the assets used, and the functions performed in each of the intercompany transactions analyzed, stating, exposing that a deficient functional analysis could lead to erroneous conclusions

OECD guidance
  • The 'Guidelines on Transfer Pricing for Multinational Companies and Tax Administrations' (TPG), approved by the Council of the Organization for Economic Cooperation and Development (OECD) in force as of January 1 of the fiscal period, are used as a technical reference, and will be applicable for as long as they are consistent with the provisions of the LRTI and its regulations, with the treaties entered by Ecuador, and the applicable resolutions of the Internal Revenue Service (SRI).
Transfer pricing methods
  • To determine compliance with the arm's length principle in the prices agreed upon between related parties; the taxpayer may use any of the following methods, in accordance with the provisions of the LRTI:
    1. Uncontrolled Comparable Price Method;
    2. Resale Price Method;
    3. Cost Plus Method;
    4. Profit Sharing Method; and,
    5. Transactional Net Margin Method.
  • Once chosen, the selection of the method must be justified by indicating the reasons for which it was considered the method that best reflected the arm's length principle. If the taxpayer modifies the method from one fiscal period to the other, he must also justify the reason for the change.
Documentation available to the tax administration and measures to avoid abuse
  • The Tax Administration in exercise of its legal authority may request information to taxpayers who carry out operations with related parties within the country or abroad, for any amount and for any type of operation or transaction. The presentation of the information which determines whether the arm's length principle was applied, will be filed on a period of no less than 2 months.
  • For the application of the arm's length principle, the Tax Administration may use all the information, both its own and those of third parties, in accordance with the provisions of the Tax Code and the LRTI.
    The Tax Administration may establish technical and methodological measures to avoid the abuse of transfer pricing, considering among others: the method to apply the arm's length principle; the existence of reference prices for tax purposes; the identification of sources of information on prices or margins; the availability of information on the contribution period; and the use of intermediaries.
Transfer pricing documentation
Preparation of transfer pricing documentation
  • The Regulation to the LRTI in its article 84 and Resolution No. NAC-DGERCGC15-00000455 indicates that taxpayers who are not exempt from the Transfer Pricing regime, if in a fiscal period they have carried out operations with related parties in an accumulated amount above USD 3,000,000, must submit the Annex of Operations with Related Parties (AOPR). If such amount is greater than USD 15,000,000, the mentioned taxpayers must submit, in addition to the AOPR, the Comprehensive Transfer Pricing Report.
  • The taxpayer must submit said information within a period of no more than two months from the date of enforceability of the Income Tax return.
  • The report must contain the details of the operations with related parties and their characteristics, functional analysis of the multinational group and the local company, assets used and risks assumed, contractual terms, market analysis, and economic analysis: acceptance and discard matrix of the comparables, selection of the method, segments, indicators, comparable companies, financial information, capital adjustments and other comparability adjustments, interquartile range, conclusions, and supplementary information required in the report.
  • Additionally, in the annual income tax return, a summary of the operations with related parties must be submitted.
Master and local file
  • At present, Ecuador has not incorporated into the TP legislation the documentation scheme proposed by the OECD in the framework of BEPS. And although the 'Master and Local file' structure is best and standardized practice, there are local elements of the transfer pricing regulation that would be left out and could end in non-compliance with the TP rules.
    Unlike other jurisdictions, the definition of 'related party' for tax purposes in Ecuador is broader, including domestic operations and operations carried out with subjects located in tax havens and preferential regimes, suppliers/clients that represent more than 50% of purchases/sales, and those determined by presumption by the Tax Administration.
Some risk factors for challenge
  • These are not prohibited operations, but extra care should be taken to document them, in case questions arise. Examples include:
    • Recurring tax 'losses'
    • Reduction of the income tax rate of any of the Group companies
    • Increase in accrued interest with related parties
    • Significant increase in transactions with tax havens
    • Relevant increase in trade accounts receivable and payable between related parties
    • Progressive reduction of the tax base
    • Payments related to intangible assets, such as license fees and royalties
    • Business or organizational restructuring
    • Change of TP evaluation methodology.
Penalties
  • The penalties related to the presentation outside the legal term (until June 30) of the Transfer Pricing Report or Annex, constitute a regulatory offense and will be up to USD 333.00.
  • Non-delivery of the IPT, as well as incomplete, inaccurate, or false information, will be sanctioned with fines of up to USD 15,000.
Economic analysis and how to demonstrate an arm’s length result
  • The reasons and basis for which a certain method was considered the most appropriate to reflect the arm's length principle must be informed.
    If the taxpayer modifies the method in a fiscal period, it is necessary to justify the reason for the change.
  • The profitability indicator will be calculated only with the financial information of the year under analysis; data from the previous year will be used if the relevant conditions in both periods did not change.
    The information available on public domain portals as of April 10 of the year following the one analyzed will be used, as long as the accounting closure is dated after August 10 of the analyzed year.
  • The comparables used should not present losses unless those are justified as a characteristic of the business or market circumstance.
  • Comparable companies located in tax havens will be rejected.
  • When using segmented financial information, consistency in the allocation criteria should be considered.
  • The quality in a comparable company does not depend only on the database but on a well-performed functional analysis.
  • The Tax Administration could use secret comparables and all its own- or third-party information available.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
  • Taxpayers may request the Tax Administration to determine the valuation of the operations carried out between related parties prior to carrying them out, and will be accompanied by a submission based on the assessment according to the arm's length principle.
  • The query submitted by the taxpayer and cleared by the Tax Administration will take effect on operations carried out after the date it is approved and will be valid for the three following fiscal periods, the current fiscal year, and the previous period, if the deadline for filing its income tax return has not ended.
  • Information must be provided on the operations carried out in the tax period in which the methodology, prices or profit margins are applied, a description of the circumstances that occurred, the justification for compliance of the assumptions established in the methodology, and a description of the application of the methodology to the results of the fiscal year.
Exemptions
  • Taxpayers will be exempt from the transfer pricing regime when:
    • taxable base greater than 3% of their taxable income
    • they do not carry out operations with residents in tax havens or preferential tax regimes
    • they do not have a contract with the State for the exploration and exploitation of non-renewable resources.
  • Additionally, operations with local related parties are not considered within the global computation if they meet certain conditions.
Related developments
Digital services tax
  • There are new VAT rules for companies dedicated to the digital economy. Therefore, those do not have TP effects.
Tax authorities and taxpayer behaviour
  • Since August 2019, the Local Tax Authority in collaboration with the Inter-American Center of Tax Administrations (CIAT) developed a Transfer Pricing Risk Model for Ecuador, mainly focused on identifying risk variables and indicators, using artificial intelligence techniques. The population studied were companies that carried out operations with related parties during the years 2012 to 2017.
Common mistakes in Transfer Pricing analysis
  • Omission of internal comparables (operations of the same company with third parties)
  • Relevant information that contradicts conclusions of the analysis (industry analysis, functional analysis).
  • Lack of segmentation by type of activity
  • Incorrect application of transfer pricing methods and profitability indicators in the analysis.
  • Inadequate consideration of business cycles.
  • Transfer Pricing foreign advisors are not familiar with local regulations.
COVID-19
  • The economic effects of the COVID-19 pandemic will require many companies to re-evaluate their transfer pricing policies and even modify them to adapt to changes in current demand behaviors.
  • The general rule does not change, transfer prices should behave in a similar way to prices between third parties. Unfortunately, it is not always possible to have real-time information, but it is recommended that companies analyze their industry on an ongoing basis and collect the information that supports their tax positions. Both gains and losses are expected to be consistent with the arm's length principle.
  • The companies must review in detail the comparable companies, the comparability adjustments, the functional analysis, the industrial analysis, as well as review the new contractual clauses.

For further information on transfer pricing in Ecuador please contact:

Rafael Moncayo.png

Rafael Moncayo
T +593 999960558
E rafael.moncayo@tax.ec.gt.com

Kevin Moscol.png

Kevin Moscol
T +593 994335808
E kevin.moscol@tax.ec.gt.com