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Cablegate: Goe Tax Reforms Seek to Boost Revenue, Limit Dollar Outflows

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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

----------------------------

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

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