Transfer Pricing: Concept and Regulation in Ecuador

As economic globalization advances, intercompany transactions have become increasingly frequent and with it transfer pricing issues have taken on greater relevance.

But, what are transfer prices?, since this is the name given to the price or consideration agreed upon between related parties for the transactions carried out between them.

The importance of these is recognized by different countries, which have been regulating them in their legislation on tax matters.

Ecuador is no stranger to this phenomenon of international taxation, so it has regulated the transfer pricing regime in the Organic Law of the Internal Tax Regime (LORTI), in the Regulations for the Application of the Internal Tax Regime Law (RLRTI) and in various Resolutions issued by the Internal Revenue Service (SRI).

Principle of Full Competition: Definition

This principle, also known as the “Arm’s Length Principle”, is based on the fact that the prices agreed between related parties are consistent with those that would have been agreed by independent companies.

LORTI has adopted the principle of full competition, in its Second Section, stating as a tax effect for those transactions that are not in accordance with this principle, but that if they had been, a profit would have been generated, the imposition of the latter.

Definition of Related Parties in Ecuador

According to the provisions of LORTI, it is understood as parties related to individuals or companies, whether domiciled or not in Ecuador, in which :

• One of the parties exercises control in a direct or indirect manner through the management, administration or capital of the other.
• Or in which a third party participates directly or indirectly in the management, administration or capital of the same.

Likewise, it is worth mentioning that Article 4 of the LRTI Regulations establishes the criteria of connection between related parties when these are by capital or volume of transactions.

Thus, the aforementioned article lists a series of situations, not exhaustive, in which the aforementioned types of relationship are established, such as the following:

• When a natural person or company is the direct or indirect owner of 25% or more of the capital stock or equity in another company.
• Companies in which there are partners or shareholders in common and these participate directly or indirectly in the proportion indicated above, even when this corresponds to their spouses or relatives up to the fourth degree of consanguinity or second of affinity.
• The link will also be formed when these maintain commercial transactions, provide services or are in a relationship of dependence.
• When a natural person or company is the direct or indirect owner of 25% or more of the capital stock or equity in two or more companies.
• When a natural person or company, makes 50% or more of its sales or purchases of goods or services, with a natural person or company. In this case, the Tax Administration must inform the taxpayer.

Additionally, LORTI also considers as related parties the companies domiciled, constituted or located in Tax Havens or in a tax jurisdiction of lesser taxation.

Transfer Pricing Methods in Ecuador

According to Article 85 of the RLRTI, in order to determine the prices of transactions between related parties, reflecting the principle of full competition, any of the following methods may be used:

• Comparable Non-Controlled Price Method (MPCNC).
• Resale Price Method (MPR).
• Added Cost Method (ACM).
• Residual Income Distribution Method (REM).
• Transactional Margin Operating Method (MMTUO).

Comparability Criteria in Ecuador

According to Section Two of the LORTI, the following criteria should be taken into consideration to determine whether an operation is comparable:

• The characteristics of the operations.
• The analysis based on functions, assets and risks.
• The contractual terms.
• The economic or market circumstances.
• The business strategies, including those related to market penetration, permanence and expansion

Formal Transfer Pricing Obligations in Ecuador

Ecuadorian transfer pricing legislation provides for two types of formal obligations, so that prices agreed between related parties are shown to be in accordance with the principle of full competition.

According to Article 84 of the RLRTI and Article 2 of Resolution NAC-DGERCGC15-00000455, published in May 2015, taxpayers who have made transactions with related parties that exceed the thresholds established therein, shall be obliged to submit the Annex of Operations with Related Parties, as well as the Comprehensive Transfer Pricing Report, if applicable.

Transfer Pricing Information Affidavit

According to the aforementioned rules, taxpayers who have, during a fiscal year, transactions with related parties for an amount greater than three million US dollars, will be obliged to submit the Annex of Operations with Related Parties.

Said Annex must be filled out taking into account the considerations indicated in the Technical Form published by the IRS, which describes aspects of its content, such as information related to the taxpayer, its related parties and the detail of the operations performed.

Transfer Pricing Technical Study

Those taxpayers whose amounts for transactions with related parties exceed US$ 15 million during the same fiscal year will be obliged to submit, in addition to the Annex, the Comprehensive Transfer Pricing Report (Study).

The referred Report must be presented following the specifications contained in the Technical Sheet for the Standardization of Transfer Pricing Analysis.

Date of presentation

Both the Annex of Operations with Related Parties and the Integral Report must be submitted within a period not exceeding two (2) months after the filing of the annual income tax return, according to the last digit of the RUC.

Subjects Excluded from the Transfer Pricing Regime in Ecuador

LORTI points out that taxpayers conducting transactions with related parties are outside the scope of the transfer pricing regime when:

• They have a tax due in excess of 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.

OECD Guidelines

Although Ecuador is not a member of the OECD, it follows as a technical reference for the provisions of transfer pricing legislation, the “Guidelines on Transfer Pricing for Multinational Enterprises and Tax Administrations” approved by this organization, in force as of January 1 of the corresponding fiscal period.

Sanctions for non-compliance

The Ecuadorian legislation on transfer pricing provides for a penalty in case of failure to submit the Transfer Pricing Report or the Annex of Operations with Related Parties, as well as if they are declared inaccurately.

According to the unnumbered article following Article 22 of the LORTI, and Article 84 of the RLRTI, the infraction mentioned will be sanctioned with a fine of up to 15 thousand US dollars.

However, the IRS issued an Instruction for the Establishment of Pecuniary Sanctions in order to establish the amount of the fine according to the seriousness of the failure or misdemeanor, which in case of late delivery or incomplete information could result in a fine of up to $333 U.S. dollars.