Since August 2018, various criteria have been generated regarding whether or not the income received by employees from employment participation in profit sharing is taxable income subject to the payment of income tax.

According to the provisions of the second paragraph of article 108 of the Labor Code: “The participation in the profit sharing to which employees are entitled will not be considered as private income and is not subject to taxation of any kind” (emphasis added)

Until August 20, 2018, the last paragraph of article 9 of the Internal Tax Regime Law (hereinafter referred to as “LRTI”), established that:

“In the determination and settlement of income tax, no exemptions other than those provided for in this article will be recognized, even if other laws, whether general or special, establish exclusions or exemptions in favor of any taxpayer, with the exception of what is provided for in the Law of Tax Benefits for new Productive Investments, Employment Generation and Service Provision.” (emphasis added)

On August 21, 2018, the “Organic Law for Productive Development, Investment Attraction, Employment Generation, and Fiscal Stability and Balance” was published in the Official Registry Supplement, which eliminated said provision and thus began the discussion on the possibility of considering the income received by employees from employment participation in profit sharing as exempt from paying income tax.

Considering that article 9 of the LRTI does not establish employment participation in the profit sharing received by employees as tax-exempt income, it is necessary to analyze whether the labor standard – Labor Code – can establish a tax exemption.

In this situation, several criteria have been generated. Some, based on the provisions of article 425 of the Constitution of the Republic, establish that the standard hierarchy must be applied, the Labor Code is an organic norm, while the LRTI is an ordinary norm. On the other hand, there are those who point out that the specialty of the norm should prevail, in which case, the tax norm is in charge of regulating the relationship between taxpayers and taxes.

In this regard, the Internal Revenue Service (hereinafter referred to as “SRI”), in response to a query, through Official Letter No. 917012022OCON003142 dated March 10, 2023, made it clear that at its discretion: “the payment of profits in favor of the employee in Ecuador constitutes income of Ecuadorian origin from work, therefore, it is income taxed with income tax.”

In the context of the analysis carried out by the SRI to determine the applicability of article 108 of the Labor Code, the clear contradiction that exists between the provisions of article 2 of the Tax Code and the labor standard, which in law is known as a legal antinomy, was taken as a starting point.

Article 2 of the Tax Code determines that: “The provisions of this Code and THE OTHER TAX LAWS will prevail over all other general laws. Consequently, laws and decrees that in any way contravene this precept will not be applicable by the administration or by the jurisdictional bodies.” (emphasis added)

According to article 3 of the Organic Law of Jurisdictional Guarantees and Constitutional Control, if there are contradictions between legal norms to determine which norm prevails, “the competent one, the hierarchically superior one, the special one, or the later one will be applied.”

The Tax Code and the Labor Code are organic norms, therefore, to establish which norm prevails, the SRI established that it is not possible to apply the principle of standard hierarchy.

To resolve this contradiction, the SRI considered the specialty of the norm as a determining factor. The Tax Code in its article 1 determines that: “The precepts of this Code regulate the legal relationships arising from taxes (…)”. While article 1 of the Labor Code establishes that: “the precepts of this Code regulate the relationships between employers and employees (…)”.

In conclusion, although the position adopted by the Tax Authority does not establish specific reasons why the labor standard could not establish a tax exemption, I consider that the exemption contemplated in article 108 of the Labor Code is inapplicable, by virtue of the constitutional principle, which guarantees that the tax regime will be governed by the principles of generality and equity, accompanied by the constitutional guarantee that provides that people will enjoy the same duties, therefore, there are no elements that justify discriminatory tax treatment with respect to income that people under a contracted relationship receive from employment participation in profit sharing.

© TobarZVS 

This publication contains information of general interest and does not constitute legal opinion on specific issues. Any analysis will require legal advice from the Firm.

Alfredo Salazar Senior Tax Consultant asalazar@tzvs.ec https://www.tzvs.ec/inAlfredoSalazar +593 2 2986456

On January 12^th, 2024, through Resolution No. NAC-DGERCGC24-00000003, the Internal Revenue Service (SRI), issued regulations applicable to the self-retention of Income Tax by corporations qualified as “Large Taxpayers.” A summary of the most relevant points is detailed below:

1. CHARGEABLE BASE
   
   

The chargeable base for self-retention encompasses all monthly received taxable income, except items related to:

• Service contracts for the exploration and exploitation of hydrocarbons.
  
  
• Income derived from contracts with state entities and public companies (central government, decentralized autonomous governments, public companies, decentralized entities, social security entities).
  
  

For “Large Taxpayers” receiving income as commission agents, self-retention will be calculated considering only the margin of their commission.

2. PERCENTAGES OF SEL-RETENTION BASED ON ECONOMIC ACTIVITY TYPE:
   
   

SRI has established self-retention percentages based on the usual economic activity of the called “Large Taxpayers”, according to the following ranges:

Self-retentions will be applied to the monthly taxable income, as a result of which, the corresponding withholding receipt will be issued. In the event that the large taxpayer cis not able to differentiate between taxable and exempt income, this self-retention will be calculated on the total of the monthly received income received.

As well, “Large Taxpayers”, under the regime of the banana, agricultural, or any other specific sector, are exempt from self-retaining Income Tax on their earnings. Consequently, Withholding agents are required to implement the relevant withholding in adherence to the established general regulations.

3. DECLARATION AND SELF-RETENTION PAYMENT:
   
   

The declaration and payment of the self-retentions mentioned in this resolution will be done in the same way as the procedure implemented for the settlement and payment of withholding taxes on Income Tax and must be submitted on the dates stipulated in articles 102 and 254 of the “Regulations for the Implementation of the Internal Tax Regime” Statute.

The self-retention percentages for companies categorized as “Large Taxpayers” will be effective starting in January of the 2024 tax year.

4. REDUCTION OF SELF-RETENTION PERCENTAGE
   
   

SRI has the discretion to modify the self-retention percentages at any time, according to the economic circumstances of each sector or when it is anticipated that taxable income may decrease significantly in the current fiscal year, compared to the immediate previous one.

5. SANCTIONS:
   
   

If a taxpayer fails to withhold or does so partially, they must pay the corresponding amounts with the applicable interest and a penalty of 100% of the withholding, as stipulated in article 21 of the “Tax Code” and in correspondence to article 50 of the “Internal Tax Regime” statute.

© TobarZVS 

This publication contains information of general interest and does not constitute legal opinion on specific issues. Any analysis will require legal advice from the Firm.