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Cablegate: Ecuador's New Tax Reform Law

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OO RUEHWEB

DE RUEHQT #0055/01 0171325
ZNR UUUUU ZZH
O 171325Z JAN 08
FM AMEMBASSY QUITO
TO RUEHC/SECSTATE WASHDC IMMEDIATE 8298
INFO RUEHBO/AMEMBASSY BOGOTA PRIORITY 7248
RUEHCV/AMEMBASSY CARACAS PRIORITY 2823
RUEHLP/AMEMBASSY LA PAZ JAN 0856
RUEHPE/AMEMBASSY LIMA PRIORITY 2285
RUEHGL/AMCONSUL GUAYAQUIL PRIORITY 3201
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY

UNCLAS QUITO 000055

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR MEWENS

E.O. 12958: N/A
TAGS: EFIN PGOV EINV EC
SUBJECT: ECUADOR'S NEW TAX REFORM LAW

REF A: 2007 Quito 2659; B: 2007 Guayaquil 512

1. (SBU) Summary: Ecuador's Constituent Assembly passed its first
law, the Administration's tax reform package, December 28. The
Assembly walked back some of the Administration's controversial
proposals, eliminating a proposed tax on luxury private schools, and
reducing the proposed inheritance tax from 70% to 35%. It
maintained proposed taxes on capital outflows, unproductive lands
and extraordinary income, and higher excise taxes on a number of
products. It also upheld the Administration proposal for increased
powers for the IRS. End Summary.

2. (SBU) Ecuador's Constituent Assembly approved the
Administration's proposed tax law with some modifications on
December 28, following a short 11-day review period over the
Christmas break. This was the first law to be passed by the
Assembly, preceding any discussion of text for the new constitution
which is supposed to be the Assembly's primary focus. Implementing
regulations for the law have yet to be drafted, but the law will be
implemented in early 2008, giving tax payers and collectors little
time to adjust to the new requirements.

3. (SBU) Several of the controversial items in the Administration's
proposal (Ref a) were changed due to public outcry. These include a
proposed tax on expensive private school tuition, which was
completely eliminated. A progressive inheritance tax (rather than
the previous flat 5% rate) was kept, but the maximum rate was
reduced from the Administration's initial proposal of 70% to 35%
(plus a fixed fee). The tax will be applied to the amount each
inheritor receives rather than to the total inheritance, and only to
amounts over $50,000.

4. (SBU) However, many of the key elements of the Administration's
proposal remain. The proposed tax on capital outflows generated
little reaction from the general public and remained in the law at
0.5% per transaction. Banking and other business interests remain
concerned about the tax, and bankers complain they would be
responsible for retaining the tax even if a transaction were
processed through a courier office, making tracking and collection
extremely difficult. The tighter corporate income tax provisions
(more onerous advance payment provisions, fewer allowable
deductibles) remain in place. The proposed elimination of the 15%
excise tax on telecommunications remained in the law, along with
increased excise taxes on alcoholic beverages, firearms lightbulbs,
luxury vehicles, club memberships, casino services, etc (although
some of the increases are lower than originally proposed due to
business sector opposition).

5. (SBU) A tax on "unproductive land" remains in the law. The tax
approved by the Assembly of $7.85 per hectare is actually higher
than the initial Administration proposal of $5 per hectare.
However, the numerous exceptions established in the draft remain.
The interpretation of "unproductive" will be defined in the
implementing legislation.

6. (SBU) The tax on "extraordinary income" remains in the law at
70%, applicable to contracts that are signed after the law enters
into force between companies and the State for the development of
non-renewable resources. (Comment: this might be beneficial for
petroleum companies that are currently in the process of
renegotiating contracts with the GOE and are subject to a decree
requiring them to pay 99% of extraordinary income to the State.)

7. (SBU) One of the most controversial aspects of the new law is
the vastly increased powers of Ecuador's Internal Revenue Service
(SRI). The SRI now has more discretion in interpreting laws,
investigating possible tax violations, and assessing fines.
(Comment: If used correctly, the enhanced powers could reduce tax
evasion in a country where rates of tax evasion are very high.
However, many people assert that the enhanced powers could easily be
abused by the GOE.)

8. (SBU) Another aspect of the law that generated opposition is the
elimination of donations to municipalities. Previously, taxpayers
could direct 25% of federal income tax that they paid to their
municipality, rather than paying it to the central government. This
provision has been removed, although President Correa promised
mayors in a December 26 meeting that the municipalities would be
compensated for the loss during 2008. Mayors initially strongly
opposed the elimination of the donation, notably Guayaquil mayor
Jaime Nebot, who was blocked by police when he tried to organize a
protest against the tax bill in Montecristi where the Assembly meets
(Ref B). However, many mayors now seem at least publicly satisfied
by the promised compensation. (Comment: In changing the provision,
the power to direct income will transfer from the taxpayers to the
federal government, increasing federal power over the
municipalities.)

9. (SBU) Comment: It is noteworthy that the Constituent Assembly
responded to some of the public outcry by changing a few provisions
that principally affect individuals, thereby countering critics who
saw the Assembly as a rubber stamp for measures submitted by the
President. However, complaints by the business community about the
capital outflow tax, increased SRI enforcement provisions, or
changes to the way corporate income tax is calculated were ignored.
The business sector has questioned the constitutionality of the law,
arguing that the Constituent Assembly's enabling statute stipulates
that measures approved by the Assembly must be approved by
referendum (President Correa and his Proud and Sovereign Fatherland
movement, or PAIS, do not share this interpretation). Now that the
new law has been published and the Constitutional Tribunal has
refused to consider the business sector complaint, the business
community appears to be focusing its efforts on working with the
government in forming implementing legislation.

10. (SBU) Comment, continued: We continue to believe the tax
reform package is a mix of decent and undesirable ideas. Regardless
of how one sees the balance of those two strands, one thing is
clear. By moving the package quickly and with no private sector
input, the new tax law exacerbates the tense relationship between
the Correa administration and business, and further compounds the
uncertainty that has discouraged private investment. End Comment.

JEWELL

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