VZCZCXYZ0023
RR RUEHWEB

DE RUEHQT #0930/01 2671739
ZNR UUUUU ZZH
R 241739Z SEP 09
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC 0114
INFO RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEAIIA/CIA WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHBO/AMEMBASSY BOGOTA
RUEHCV/AMEMBASSY CARACAS 0027
RUEHGL/AMCONSUL GUAYAQUIL
RUEHLP/AMEMBASSY LA PAZ SEP LIMA 0032

UNCLAS QUITO 000930 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD PGOV EC
SUBJECT: GoE TAX REFORMS SEEK TO BOOST REVENUE, LIMIT DOLLAR OUTFLOWS 
 
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Summary 
 
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¶1. (U) On August 26th the GOE proposed to Congress a tax reform 
bill, aimed at achieving a more equitable distribution of income, 
combating tax evasion, and reducing the trade deficit.  Private 
sector representatives say they will have difficulty absorbing the 
additional costs resulting from the new bill and argue that taxes 
should not be increased while the country is in the middle of a 
recession.  This reform is expected to pass easily in the current 
Correa-allied Congress.  End Summary. 
 
 
 
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Measures to combat tax evasion 
 
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¶2. (U) In order to reduce tax evasion, the proposal requires 
greater consistency and transparency in financial reporting by 
companies.  In particular, the proposal requires that companies 
report the same debt information to financial institutions as 
reported to the SRI, Ecuador's Internal Revenue Service.  Also, in 
order to deduct certain costs as business expenses, the proposal 
would require that companies confirm that the payments were made to 
legitimate businesses, i.e., those businesses included on the GoE's 
list of entities authorized to issue invoices.  The reform would 
also limit income tax deductions by professionals to 50% of claimed 
expenses.  According to the SRI, these proposals were prompted by 
concerns that a significant number of companies that have not been 
paying taxes have reported losses to the SRI while simultaneously 
reporting healthier income statements to lenders. 
 
 
 
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Balance of Payments Measures 
 
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¶3. (U) The GoE is proposing a number of measures to improve the 
country's balance of payments.  With oil revenues accounting for 
about one-third of the GOE's income, the dramatic fall in crude 
prices from their 2008 highs has negatively affected Ecuador's 
trade balance.  The GOE expects to record a current account deficit 
of US$1.5 billion for 2009, compared to a US$1.19 billion current 
account surplus in 2008. 
 
 
 
¶4. (U) In an attempt to directly improve the trade balance, the GOE 
proposes increasing the Luxury Consumptions Tax for alcoholic 
beverages, cigarettes and soft drinks.  The tax on alcoholic 
beverages, which are mostly imported, would consist of a US$5 per 
liter specific tax coupled with a 40% ad-valorem tax on those 
bottles for which the producer has identified a suggested sales 
price of over US$8.00. When interviewed by the press, local 
businessmen argued that the GoE's tax on alcoholic beverages is 
intended to protect the national beer and rum industry.  However, 
some analysts predict the provision will in practice promote 
greater consumption of smuggled products or artisanal liquors. 
 
 
 
¶5. (U) The reform bill also includes a tax of US$0.08 per liter on 
carbonated drinks.  Several analysts warn that this tax will have 
an inflationary effect due to widespread consumption of soft 
drinks.  In another provision, the tax applied to cigarettes would 
change from an ad-valorem tax to a specific tax of US$0.07 per 
 
cigarette.  The effective increase in the cigarette tax per pack 
ranges from around 18% for some expensive brands to as much as 200% 
for the least expensive brands.  Coordinating Minister of Economic 
Policy, Diego Borja, identified two objectives for the luxury 
taxes: 1) to simplify the tax; and 2) to reduce consumption of 
products that have negative consequences for public health. 
 
 
 
¶6. (U) Another provision would raise the capital outflow tax to 2% 
from 1%, with the ostensible purpose of stemming capital flight. 
On August 27, President Correa stated that capital outflow so far 
in 2009 totaled US$ 5.2 billion, compared to US$4.9 billion for all 
of 2008.  However, the President of Ecuador's Federation of 
Chambers of Commerce argued that the tax increase will not reduce 
capital outflows because resources are leaving the country due to 
the insecure investment climate.  Sebasti????n Borja, head of the 
Pichincha Industrials Chamber, said that the capital outflow tax 
effectively annuls an import tariff reduction applied in 2007 to 
several raw materials and capital goods.  The result, added Borja, 
would be an increase in production costs and a decline in 
Ecuadorian companies' competitiveness. 
 
 
 
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Measures to promote production 
 
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¶7. (U) The GoE's bill would grant a 10% income tax exemption to 
companies reinvesting in productive fixed assets related to 
research and technology.  Another provision under the same heading 
would eliminate the ability of companies to use as a tax credit the 
mandatory payment of an "advance income tax" should they end up 
operating at a loss over the tax period.  Any payments made as an 
advance income tax would be forfeit and used "to compensate for use 
of public infrastructure," unless an audit by the SRI confirmed the 
company's loss.  Companies will only be able to request an SRI 
audit once every three years.  Coordinating Minister for Production 
Nathalie Cely has justified this de facto "minimum tax" saying that 
"All businesses should contribute to the development of the 
country's infrastructure in order to make it more competitive." 
 
 
 
¶8. (SBU) According to economic analyst Walter Spurrier, a minimum 
income tax, irrespective of reported losses, in a sense assumes 
that companies reporting losses should be treated as if they are 
evading taxes.  He adds that it is unwise to increase taxes on weak 
firms, whose closures would affect not only shareholders but also 
employees and creditors.  To reduce a potential negative impact, 
the SRI is analyzing how to apply exemptions for different sectors, 
such as for tuna producers or tourism operators. 
 
 
 
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Other Measures 
 
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¶9. (SBU) In another reform, shareholders' dividends will be 
considered personal income subject to income tax.  Since these 
dividends are also subject to income tax for the company, under the 
reform, dividends will be charged both the company and personal 
income tax.  This change could undermine Central Bank efforts to 
promote Ecuador's equity markets through the issuance of a new 
"stock market" law.  Monica Villagomez, President of Quito's Stock 
Exchange, has commented that stocks and market capitalization are 
falling because the GoE has contributed to a negative operating 
environment. 
 
¶10. (SBU) A controversial reform included in the bill is a 12% 
Value Added Tax (VAT) applied to newspaper print.  The print media 
is interpreting the provision as a direct retaliation against them 
for critical reporting about GOE actions, and for their demands 
that the GoE respect the freedom of expression. According to the 
SRI, collections from this tax will be minimal as most magazines do 
not use this type of paper and therefore will not be affected. 
Several prominent economists told visiting USG officials August 27 
that the GoE has previously been successful in using its control 
over spectrum licenses to encourage television and radio media 
outlets to self-censor their broadcasts.  However, print media were 
heretofore immune to this kind of pressure.  This new VAT, 
according to these analysts, is the GoE's way of sending a message 
to newspapers that the GoE can find ways to get to them as well. 
 
 
 
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OVERALL FISCAL IMPACT 
 
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¶11. (U) Overall, the GoE expects to collect an additional US$668 
million in revenues as a result of the tax reform over the next 
three years: almost US$49 million in 2009; US$195 million in 2010; 
and US$425 million in 2011 (when all provisions will have fully 
entered into force). 
 
 
 
Expected Collections (US$ Million) 
 
Tax                               2009         2010        2011 
 
--------------------------------------------- ------------------- 
 
Income tax 
 
--Dividends Income tax---------------------------------------50 
 
--Minimum income tax----------------------------------------20 0 
 
--Professional expenses deduction----------------------------30 
 
--Profits reinvestment--------------------------------- -----(50) 
 
Value Added Tax--------------------3.75----------15------ ----15 
 
Luxury Consumptions Tax------------17.5----------70----------70 
 
Capital Outflow Tax----------------27.5---------110---------1 10 
 
 
 
TOTAL-----------------------------48.75------ ---195---------425 
 
 
 
¶12. (SBU) Ecuador's central government posted a fiscal deficit of 
$466 million the first semester of 2009 versus a surplus of $325 
million in the same period in 2008. Jaime Carrera, head of renowned 
local think tank, the Fiscal Policy Observatory, said to the press 
that the GOE is desperately seeking to raise money because it is 
already in arrears of around $500 million with several public 
entities.  However, according to Minister Cely, the goal of this 
reform is not just to boost fiscal revenues, but also to ensure 
that private companies pay the amount of taxes they owe. 
 
 
 
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Comment 
 
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¶13. (SBU) With constrained fiscal resources and a contracting 
economy, the GOE's planned tax reform primarily aims to generate 
additional tax revenues and reduce dollar outflows.  Several 
economic analysts argue the GOE is not using tax policy to promote 
investment or to modulate economic crisis as it should during the 
current recession.  The reform also signals the GOE's interest in 
promoting the economic model in which the State takes an 
increasingly larger role in controlling economic activity.  End 
Comment 
 
 
 
CHRITTON 
CHRITTON