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Since August 2018, various criteria have been generated regarding whether or not the income received by employees from employment participation in profit sharing is taxable income subject to the payment of income tax.

According to the provisions of the second paragraph of article 108 of the Labor Code: “The participation in the profit sharing to which employees are entitled will not be considered as private income and is not subject to taxation of any kind” (emphasis added)

Until August 20, 2018, the last paragraph of article 9 of the Internal Tax Regime Law (hereinafter referred to as “LRTI”), established that:

In the determination and settlement of income tax, no exemptions other than those provided for in this article will be recognized, even if other laws, whether general or special, establish exclusions or exemptions in favor of any taxpayer, with the exception of what is provided for in the Law of Tax Benefits for new Productive Investments, Employment Generation and Service Provision.” (emphasis added)

On August 21, 2018, the “Organic Law for Productive Development, Investment Attraction, Employment Generation, and Fiscal Stability and Balance” was published in the Official Registry Supplement, which eliminated said provision and thus began the discussion on the possibility of considering the income received by employees from employment participation in profit sharing as exempt from paying income tax.

Considering that article 9 of the LRTI does not establish employment participation in the profit sharing received by employees as tax-exempt income, it is necessary to analyze whether the labor standard – Labor Code – can establish a tax exemption.

In this situation, several criteria have been generated. Some, based on the provisions of article 425 of the Constitution of the Republic, establish that the standard hierarchy must be applied, the Labor Code is an organic norm, while the LRTI is an ordinary norm. On the other hand, there are those who point out that the specialty of the norm should prevail, in which case, the tax norm is in charge of regulating the relationship between taxpayers and taxes.

In this regard, the Internal Revenue Service (hereinafter referred to as “SRI”), in response to a query, through Official Letter No. 917012022OCON003142 dated March 10, 2023, made it clear that at its discretion: “the payment of profits in favor of the employee in Ecuador constitutes income of Ecuadorian origin from work, therefore, it is income taxed with income tax.”

In the context of the analysis carried out by the SRI to determine the applicability of article 108 of the Labor Code, the clear contradiction that exists between the provisions of article 2 of the Tax Code and the labor standard, which in law is known as a legal antinomy, was taken as a starting point.

Article 2 of the Tax Code determines that: “The provisions of this Code and THE OTHER TAX LAWS will prevail over all other general laws. Consequently, laws and decrees that in any way contravene this precept will not be applicable by the administration or by the jurisdictional bodies.” (emphasis added)

According to article 3 of the Organic Law of Jurisdictional Guarantees and Constitutional Control, if there are contradictions between legal norms to determine which norm prevails, “the competent one, the hierarchically superior one, the special one, or the later one will be applied.”

The Tax Code and the Labor Code are organic norms, therefore, to establish which norm prevails, the SRI established that it is not possible to apply the principle of standard hierarchy.

To resolve this contradiction, the SRI considered the specialty of the norm as a determining factor. The Tax Code in its article 1 determines that: “The precepts of this Code regulate the legal relationships arising from taxes (…)”. While article 1 of the Labor Code establishes that: “the precepts of this Code regulate the relationships between employers and employees (…)”.

In conclusion, although the position adopted by the Tax Authority does not establish specific reasons why the labor standard could not establish a tax exemption, I consider that the exemption contemplated in article 108 of the Labor Code is inapplicable, by virtue of the constitutional principle, which guarantees that the tax regime will be governed by the principles of generality and equity, accompanied by the constitutional guarantee that provides that people will enjoy the same duties, therefore, there are no elements that justify discriminatory tax treatment with respect to income that people under a contracted relationship receive from employment participation in profit sharing.

© TobarZVS 

This publication contains information of general interest and does not constitute legal opinion on specific issues. Any analysis will require legal advice from the Firm.

Alfredo Salazar

Senior Tax Consultant



+593 2 2986456