Why do employees pay personal income tax on the employer’s profit sharing?

Categorias: - July 10, 2018

The 2nd subsection of Art.108 of the Labor Code states: “The participation in the profits to which the workers are entitled shall not be considered as personal income and it’s not subject to taxation of any kind”. However, this exemption is not included in the restricted list of exempted income from personal income tax provided in Art.9 of the Internal Tax Regime Law, which in its final provision states: “In the determination and liquidation of income tax, it shall not be recognized other exemptions than those provided herein, although other laws, general or special, stipulate exclusions or waivers in favor of any taxpayer, (…)”.

In the face of this evident conflict between two Laws it becomes necessary to determine which one prevails. In this regard, the Constitution of the Republic of Ecuador prescribes (Art.133) that organic laws prevail over ordinary laws, matter ratified thereof (Art.425) when establishing the hierarchical order of the legislation in Ecuador.

Now, organic laws are not such because their name so indicates. Neither are those that happen to be named or considered as organic by provision of another Law, as occurred when the Reform Law for Tax Equity in Ecuador (Art.153) declared organic the Internal Tax Regime Law.

The Constitutional Court, in its ruling of May 16th, 2018, clarifies that this categorization of “organic” contravenes the constitutional rule (Art.133), which determines that organic laws must comply with one of the following characteristics: 1) Regulate the organization and functioning of the institutions created by the Constitution; 2) Regulate the exercise of constitutional rights; 3) Regulates the organization, powers, faculties and functioning of the decentralized autonomous governments; and, 4) Those related to the regime of political parties and the electoral system. Consequently, the laws that do not comply with these characteristics, such as the Internal Tax Regime Law, are ordinary, which has a lower normative hierarchy than organic laws.

In lieu of the above, we could conclude that the Labor Code, which regulates the exercise of a constitutional right (Art.33), is an organic law, even when its name does not expressly include this word. Therefore, if organic laws prevail over ordinary laws, why should workers pay income tax on their employer’s profit sharing? Those who have paid personal income tax on this income would be entitled to their refund.