Expenses for royalties, technical, administrative and consulting services received from related parties

In Executive Decree 617 published on December 20, 2018, section 16 of article 28 of the RALORTI was modified, which indicates the deductibility limits for royalties, technical, administrative and consulting services expenses received from related parties.

In addition to complying with the causality criteria of the taxable income, the limit of these expenses is found in numeral 16 of article 28 of the RALORTI. This limit, with the reform, is divided into the following groups:

  1. The general limit already existing, whose limit of this type of expenses is 20% of the tax base plus the value of said expenses.
  2. The new, in the case of companies whose sole activity is to provide services to independent engineering parties, or similar technical services for the construction of civil works or infrastructure, this limit will not apply if the operating margin indicator (Operating profit / sales) is equal to or greater than 7.5%. In case your utility is lower, the limit is as follows:

L = G – [(RevenueOP * 7.5%) – UOP]

Where:

L = Deductibility limit established

G = Expenses for royalties, technical, administrative and consulting services received from related parties accumulated during the year.

RevenueOP = Operating income

UOP = Operating profit

The established formula is the same as that followed in an adjustment of transfer prices under the net margin method. To give an example of the effect of this formula is the following exercise:

DataUSD thousand
Income (a) 100,000.00
Operating profit (b)3,000.00
Expenses subject to limit (c)500.00

Limit Calculation:

DataUSD thousand
Income (a) Setting [d = (a * 7.5%) – b]4,500.00
OLimit [c – d]–   4,000.00

In the example, none of the expense under this limit is deductible, therefore, all values ​​below the adjustment determined in the formula would be non-deductible. Depending on the value of the expenses subject to limits, this new limit for companies in the engineering sector would be more restrictive than the existing one, given that, with the general limitation that no longer applies, in our example, all expenses would be deductible.

It is important to note that, in the event that they are non-deductible, these expenses are within the transfer pricing regime and, as the case may be, should be considered to determine the formal obligations of the scheme, which could have a double tax impact.       

3. For Taxpayers in the preoperative business cycle, the limit applicable to the sum of this type of expenses corresponds to 10% of the total assets.

The taxpayer may request a higher deductibility limit through the Prior Valuation Consultation procedure. In this sense TP Consulting Ecuador has extensive experience and puts them at your disposal.

This limit does not apply in the following cases:

  1. Transactions with local residents as long as these parties correspond to the transactions between them, the same effective tax rate applicable:
  2. Transactions with related natural persons resident in Ecuador, as long as said persons have a tax rate equal to or greater than the rate applicable to the company or permanent establishment.

Regarding the above, the following sentence was deleted: “In case no income tax base is determined, said expenses will not be deductible.

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