The Guide to Infrastructure and Energy Investment

Ecuadorian Public-Private Partnerships in a Nutshell: What We Can Tell So Far

In December 2015, the Ecuadorian legislative body enacted the Organic Law on Incentives for Public-Private Partnerships and Foreign Investment (PPP Law), which provides for private initiatives to propose and execute common interest projects, in alliance with the central or local governments. Since then, four public-private partnership (PPP) contracts have already being signed in the country, establishing different methods of investment and compensation.

By way of introduction, it is useful to know that the implementation of this concept comes at a time in which the country is facing a serious recession and is in need of private investment. In fact, the very name of law indicates that it establishes a series of tax benefits and assurances for the local or foreign investor that executes an assignment.

This structure is inspired by the implementation of such partnerships in countries such as Chile, Peru, Uruguay and Colombia, which have attracted billions of dollars in foreign investment.

It is not new, of course, that private players can intervene in the provision of public services throughout concessions. However, the legislation that regulates such assignments is far less permissive, and does not allow for the same tax incentives and protections provided for in the PPP Law. Moreover, only a few years ago, concessions originated by private initiative were exclusively for the construction and maintenance of roads.

Background

PPPs were not impossible before the PPP Law. It has an antecedent in the Code of Production, Commerce and Investment (COIP), enacted in 2010, as an exceptional delegation, which may take place when it is necessary to satisfy public interest, when the government lacks technical or financial capability, or when the demand for a service cannot be met by the government or public or mixed economy companies. Under this exceptional regime, private players can participate in the development of ‘strategic sectors’ of the economy, and in the provision of public services such as electricity, road construction and maintenance, port or airport infrastructure, railway and others.

The first step towards consolidating the PPP model was Presidential Decree 582, signed on 18 February 2015. This Decree established the basic rules for the public-private cooperation that would path the way for the PPP Law.

The ground rule that remains unchanged is that the proposed project, despite being presented by an individual private player on its own initiative and cost, must be open to offers from the public. This represented the biggest concern for the private sector representatives, since the idea for the project is not itself subject to registration or recognition.

A whole set of issues had to be resolved, and a complex incentives regimen established, through the PPP Law, before the first PPP contract could be signed in June 2016.

Process

The private proponent is the real risk-bearer in this partnership. Starting with the proposal, which may or may not be qualified or even raise interest in the competent public entity, it is up to the private party to present the studies and designs to back up its proposal.

The proposal is presented to the public entity, on a local or central government level, according to the legal competencies, and must be evaluated in light of the principles and guidelines established by the PPP Law and by the PPP Committee. If the public entity decides to back the project, the proposal is submitted to the Committee for its analysis and approval.

The PPP Committee is formed by authorities from the executive branch. A representative of the ‘sponsoring’ public entity, which will later be the delegating entity, and a delegate from the Internal Revenue Service may be heard by the Committee during the debate of the project.

The Committee will be in charge of assessing the necessity and importance of the project, its viability and the tax incentives that will benefit the private party that executes the project. In a more general sense, the Committee is in charge of defining which areas of the economy and services should be prioritised and incentivised through the PPP model.

Even though this partnership is supposed to be an exceptional delegation, it is accompanied by a fair amount of red tape. If the project raises enough interest not only from the competent public entity but also from the central government, the President can, by decree, simplify the procedures needed to obtain permits and approvals for the project, in order to expedite its execution. The local government has the same authority, with respect to the administrative procedures established by their level of government. The only permit that cannot be obtained through this ‘shortcut’ is an environmental licence.

Once the Committee has approved the project, the public entity will elaborate and publish the basis of the public contest and set the terms for the submission of proposals. The initial proponent of the project will be allowed to amend its offer, to match or improve the conditions offered by third parties. If a different private entity gets awarded with the contract, the initial proponent is entitled to a reimbursement for the project’s general design – no less than the cost of the studies performed to design the project that was submitted at the initial stage.

The delegating public entity will negotiate the contractual terms and supervise the execution of the project, according to the Committee’s guidelines. Up until now, the ministry in charge of public works and transportation has adjudicated most PPP contracts. However, it is likely that other public entities will also use the PPP model to determine whether projects are being conducted in a competent manner.

We say some municipalities, because the decentralised administrative regime in Ecuador allows for delegation of some responsibilities to municipalities, according to their technical, infrastructural and financial capability. Cities like Guayaquil and Quito have relative independence in the administration of public works and services, while smaller and less developed jurisdictions depend on the provincial level of government.

Risks and rewards

According to the principles established by the PPP Law, the risks of the project must be adequately balanced; nonetheless, at least some risk of financing and the planning and design corresponds to the private party exclusively. The private party must get partial or total financing, even though the cost of capital for a state will always be lower, but it will benefit from tax exemptions and in some cases can be guaranteed by the government before its creditors.

Among the general principles and guidelines that must be observed in PPP negotiations is the adequate distribution of risks and benefits. Such factors must be properly identified and ‘assumed, transferred or shared’ between the public entity and the private party. This will usually involve investment from the proponent, or financing secured by the proponent.

For the purpose of the PPP, a new entity is created with the sole objective of carrying out the project. This will be the entity benefiting from the incentives conferred by the Committee. The most important incentives for encouraging the PPP model, which are established by the PPP Law, are income tax exemption for 10 years, remittance tax exemption and other exemptions on foreign trade. Most of these exemptions extend to the private entity’s interest holders, with regard to the dividends and benefits accrued from such entity. This is the main reason why the entity must have a tax ID number exclusively for the execution of the public project.

Some of the tax incentives conceived in the PPP Law and in other laws amended by the PPP Law include the following:

  • Income tax exemption for 10 years, counting from the first fiscal year in which the entity generates operational profits from the execution of the public work or service. As mentioned, this exemption benefits the interest holders, under the same terms and regardless of their fiscal domicile, with regard to their dividends. For private entities under the normal regime, income tax is 22 per cent or 25 per cent – depending on their interest holders’ tax regime.[1] Moreover, some interest holders, depending on their country of residence, are also subject to income tax for their dividends.[2]
  • Remittance tax exemption for payments abroad, which are related to the development and execution of the public project, regardless of the payment’s destination. Remittance tax is 5 per cent under the normal tax regime. The following transactions may be exempt from this tax:
  • import of goods;
  • hiring of services;
  • payments to the financing agents;
  • payment of dividends to interest holders, regardless of their domicile; and
  • payments for the purchase of shares, rights or interests of the private Ecuadorian entity.
  • Beneficial treatment, whether for the purpose of foreign trade tax exemptions or other benefits, for the import of goods to be directly destined to the public project, in the same terms as the public delegating entity would enjoy.

Other incentives include legal stability, with regard to the local and specific regulations that are enounced in the PPP contract as essential for the association, and the possibility of obtaining subventions, other tax exemptions and public guarantees to ensure financing.

Legal stability is, of course, a key factor for the purpose of investing. However, the stability does not apply to regulations that are declared unconstitutional or illegal.

The law allows for different methods of compensation for the private investor, and for a combination of them. Such methods may include differing payments, which can depend on availability, use or investment, to be accredited either by the user of the service or by the delegating public entity. The law does not establish a time limit for the concession of the service, which encourages longer-term investment projects and willingness from the private party to take on risk, since it can make an agreement for a method of compensation directly from the user.

Depending on the negotiation and on the criteria of the PPP Committee, the government can commit to make pecuniary contributions, differing payments or to ensure a minimum income for the private entity. In order to secure financing, the private party can execute pledges and other securities on such credits.

Dispute resolution

The Ecuadorian government has serious reservations about submitting investment disputes for international arbitration. Even though the International Centre for Settlement of Investment Disputes (ICSID) is no longer available as a forum to resolve investment-related disputes with Ecuador, the PPP Law expressly provides for the possibility of international arbitration, but on national or Latin American ground. However, as is required for all investment contracts, the arbitration clause will not be valid without the Attorney General’s approval.

The PPP contract must establish the rules for international arbitration, necessarily choosing national or regional jurisdiction. This method of dispute resolution has to be opted for a last instance resource, and after the administrative remedies have been exhausted. Once notified of the resolution that puts an end to the administrative remedies, the private entity has 30 days to file a claim before the arbitral authority.

If no arbitration clause is introduced in the contract, the disputes will be subject to the Ecuadorian administrative jurisdiction. Tax-related disputes are not subject to arbitration.

Two of the recent PPPs have established Santiago de Chile, Chile, as their jurisdiction for arbitration.

The experience – four PPPs in eight months

It is remarkable that, in a country where concessions were recently reserved to only a few areas of the public domain, and which has had a large amount of investment disputes over the past years, four partnerships have already been signed with the government. The market has shown real interest in stepping in to take the opportunities provided by the administration, and the government has benefited from securing public works at the risk of the private sector.

Posorja Port –direct engament with DP World

The first PPP was signed on 6 June 2016, between the Guayaquil Port Authority, by delegation of the Ministry of Transportation and Public Works (MTOP), and Dubai Port World Investments (DP World), for the construction and operation of a new deep-water port in Posorja, a city in the Province of Guayas that lies along the delta of the Guayas River. This concession was signed by way of direct engagement. Such direct engagement is unusual (as the projects for which PPPs are used are commonly subject to public offers), but was possible because the Dubai estate owns about 80 per cent of DP World. In cases where the delegated entity is owned by a state that is part of the international community, the COIP allows for the delegation to be executed as a direct engagement, without the obligation to open the project up to offers from the public.

This concession was seen as a significant accomplishment on behalf of the Ecuadorian government, due to the fact that most of the operators that would be hired for the execution of the project would be local. The concessionary predicts that around 90 per cent of its suppliers would be hired from local businesses. The concession will represent a total investment of US$1.2 million by DP World, during the 50 years that the PPP will last, and is estimated to generate about 2,000 jobs. The new port will allow the arrival of ‘Post Panamax’ ships and is expected to enhance the country’s commerce.

The method of compensation chosen for this project involves no contribution by the government. During the period of the concession, DP World will be entitled to the fee or toll charged to the final consumer, for the use of three services: the road leading to the port, the deep-water canal dredged by DP World and the mandatory and optional port charges.

Río Siete Road concession

On 22 July 2016, the second PPP was signed, between the MTOP and CONSUR, a Colombian construction company, for the construction and maintenance of the first stretch of a five-highway road system designed by the MTOP: the Río Siete-Huaquillas road. The road will be 95km in length, and will allegedly reduce the time of transportation by 50 per cent. It connects the provinces of Guayas and El Oro, and ends in the border with Peru. This was the first road concession under the PPP structure.

In this case, the project was designed by the government in such a way that the private sector will be completely in charge of the investment. After the public offering period ended, CONSUR was assigned the project, for a period of 30 years. CONSUR’s investment will be US$1.837 million, and will generate around 1,000 direct jobs in its initial phase. In addition, the concessionaire’s profit will come directly from the tolls paid by users.

According to the MTOP’s plans, four more concessions will be executed to complete the highway road system. The government has already announced its intention to sign the second stretch, Río Siete-Naranjal, over the next few months.

Puerto Bolívar concession

Even though the Posorja Port was the first concession signed under the PPP model, the Puerto Bolívar project was the first to be officially approved. On 8 August 2016, the Port Authority of Puerto Bolívar assigned Yilport Holding, a Turkish multinational, the contract for the expansion and modernisation of the maritime terminal of Puerto Bolívar, El Oro.

The concession will last 50 years, during which Yilport will invest US$750 million. The expansion and dredging will allow for bigger ships to arrive in Puerto Bolívar, in an effort to compete with the new Panama Canal. President Correa emphasised that the Panama Canal expansion and the global growth of the navy industry caused such intervention to be considered urgent for the interests of the country.

The government is currently planning the concession for the modernisation of the port of Manta, Manabí. Such investment in this province is expected to have an important impact on its strategic geographical location, and to boost Manabí’s economy after the losses left by the earthquake that struck the province earlier this year.

Social housing project in Pichincha

Finally, the most recent PPP was signed on 31 August 2016, between the public entity Empresa Pública de Vivienda (EPV) and four private developers, Nobahorm Constructora Noboa Cía Ltda, Alberto Andino y Asociados Cía Ltda, Héctor Homero Sánchez Pérez and Consorcio Bellavista-BCC, for the development of four social housing projects in the provinces of Pichincha and Santo Domingo de los Tsáchilas.

This project is the first PPP for social housing, which, according to the PPP law, must be considered a priority among the strategic projects that may be assigned by delegation to the private sector. It was promoted by the EPV through a public contest, and involves an important contribution from the public entity, which is the land where the housing project will be executed.

Notes

  1. The 25 per cent tarif is applied to companies with shareholders residing in tax heavens or lower taxation regimes.
  2. Ecuadorians, permanent residents and residents of tax havens.

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