Panama: A Tax Update and Business Opportunities
As everyone in the Offshore Industry knows, Panama has a Tax System that is based on the Territorial Principle of Taxation. This principle that Panama has embraced means that only Panama-sourced income is taxed.
An entity or an individual which has its activities outside or from Panama will escape the obligation to file tax returns and further pay Income Tax on its foreign source income.
Recent Amendments to several taxes in Panama
With the enactment of Law 49 of September 17 of 2009 and Law 8 of March 15 of 2010 the new Government of President Ricardo Martinelli, has introduced amendments to several taxes and imposed taxes on sectors that before were not paying any and thus not contributing to the system.
As indicated above, a person or entity with foreign sourced income will immediately escape the obligation to pay income tax in Panama.
According to Paragraph 2 of Article 694 of our Fiscal Code, The income derived from the following activities is not considered from Panamanian source:
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Aided by stable, pro-business governments using the invaluable canal as a catalyst, Panama's friendly tax and regulation system has helped to establish the country as one of the most modern and respectable business and financial centres outside the established 'onshore' countries, and ranks as probably the most important trading and business hub in the region.
Panama Background: A Booming Economy
Under President Martin Torrijos (in power from September 2004 to July 2009), Panama enjoyed something of a boom; growth was 8.1% in 2006, exceeded 10% in 2007 and was 8.3% in 2008. The rate of growth fell to 2.3% in 2009; but under the stewardship of conservative President and Democratic Change party leader Ricardo Martinelli, Panama's economy rebounded quickly following the 2008–09 global crisis. Supported by strong fundamentals, political stability, and prudent fiscal management, real GDP growth rates have been among the highest in the region. Macroeconomic stability and policies to foster greater social inclusion have reduced unemployment to historic lows.
Following the 2009 slowdown, output grew by 7.5% in 2010, by 10.6% in 2011 and by 10.8% in 2012. Construction, commerce and transportation have been the most dynamic sectors, while canal traffic has been buoyed by strong demand from emerging Asia and South America. Crucially, the strength of the financial system also helped to buffer Panama against the worst effects of the financial crisis in 2008/9. Robust economic growth and steady fiscal consolidation have also contributed to lowering the public debt ratio, which fell from 43.3% of GDP in 2010 to 37% in 2012.
The IMF suggests that Panama's macroeconomic outlook is "favourable", with future growth likely to be underpinned by the vast Panama Canal expansion project, and other large public investment projects; economic growth forecasts for 2013 range from 7.5% to 8.5%.
The IMF also commended Panama's success in establishing a strong banking center, which has become an important regional hub (see below).
Panama Tax Residence and Liability to Tax
General taxation in Panama is imposed on a territorial basis, meaning that taxes only apply to income or earnings derived from business undertaken within the country's borders. The existence of a sales or administration office in Panama, or the re-invoicing of external transactions at a profit, does not of itself give rise to taxation if the underlying transactions take place outside Panama.
An individual is considered resident if he is present in Panama for more than 180 days in any one tax year. Individuals are taxed on wages, income derived from the carrying on of a commercial or agricultural business, and investment income.
Panama Tax Rates
The rate of corporate income tax in Panama has been reduced in stages from 30% as a result of a fiscal bill passed in the first months of 2010. A 27.5% rate applied from January 1, 2010 until January 1, 2011 when it fell to 25%. However, companies in the energy, telecoms, financial, insurance, banking and mining industries continued to pay corporate tax at 30% until 2012, when the rate dropped to 27.5% The rate for these companies will fall to 25% in 2014. Companies with turnover of less than PAB200,000 per year pay income tax at individual rates.
There is a withholding tax of 10% on dividends paid out of taxed income. If less than 40% of taxed income is distributed, then Undistributed Profits Tax of 10% becomes payable on the undistributed balance; this therefore amounts to a maximum of 4% tax. In effect this is an advance withholding tax, and it is creditable against the 10% tax on later distributions of the taxed profit.
From 2010, a minimum estimated tax was established for legal entities with annual revenue over PAB1.5m, imposed at 4.67% of total taxable income, although this excludes foreign income.
For businesses, capital gains made in the ordinary course of business are subject to the regular corporate tax. Capital gains tax from real estate transactions is generally paid at a flat rate of 10% in Panama by both companies and individuals. However, some changes to the tax treatment of real estate were introduced in January 2011, including a 3% advance capital gains tax on certain real estate sales levied on the higher of the sales price or the value of the property. Sales of listed shares are usually capital gains tax exempt, but unlisted shares attract a 5% withholding tax which is creditable against future capital gains tax liability.
In 2007 Panama inaugurated a headquarters company regime (sedes de empresas multinacionales, or SEM) which offers tax breaks to encourage multinational companies to set up various types of service companies. SEM companies are exempt from VAT on services rendered to non-Panamanian taxpayers, and are exempt from income tax on profits from such services. Expatriate employees of SEM companies also receive tax privileges. In order to achieve SEM status, group assets must be worth at least USD200 million. A minimum initial capital of USD2 million is required if the group's main office is to be in Panama.
On July 1, 2010, the other following tax changes became effective:
In 2013, individual income is taxed at the following rates: the first PAB11,000 of income is exempt from income tax; a 15% rate applies on income above PAB11,000 and below PAB50,000; and a 25% rate applies on income above PAB50,000.
There is a 12.5% withholding tax on the gross income of non-residents providing services to Panamanian residents for periods of less than 183 days in a calendar year.
Panama Tax Agreements
Since Panama does not levy taxes on foreign source income, it has until recently refrained from negotiating double tax treaties. However, renewed pressure from the OECD and the G20 on the issue of tax transparency has forced the country into a rethink.
In the aftermath of the G20 Summit in London in April 2009, when Panama was listed as a country which had committed to, but not substantially implemented, the international tax transparency standard, the Panamanian Government entered into negotiations with several countries with a view to signing bilateral double tax avoidance agreements (DTAAs) and tax information exchange agreements (TIEAs). Key among them is the TIEA with the United States, which was signed on November 30, 2010 and which entered into force on April 18, 2011. The agreement permits the US and Panama to seek information from each other on various types of national taxes, in both civil and criminal matters, for the tax years beginning on or after November 30, 2007.
In total, Panama has signed 24 agreements, being 15 DTAAs and nine TIEAs.
Panama Company Formation
Although Panama is often considered an 'offshore' territory for tax purposes, the term is not used in Panama legislation; since taxation is on a 'territorial' basis, i.e. only Panama-sourced income is taxed, an entity which has its activities or assets outside Panama will automatically escape taxation. There are more than 120,000 corporate entities in Panama, of which the majority are 'offshore'.
The Corporation (Sociedad Anonima) is the most frequently used corporate form in Panama, and is the usual choice for an offshore operation.
Corporations are formed under the Law No. 32 of 1927 and the Commercial Code (Decree-Law No. 5 of 1997, Article 5).
A corporation is formed by two subscribers (or nominees in the case of absent foreign subscribers) who execute the Articles of Incorporation (Statutes) before a notary and then record them at the Public Registry Office. All commercial and industrial businesses must have a Notice of Operations in order to engage in business unless they are specifically exempt. Following incorporation, only one shareholder is necessary. Shares can be of various classes, can have par value or not, may be registered or bearer. There is no minimum capital, and no paying-up rules, except that no-par-value and bearer shares must be fully-paid when issued.
Strict regulations now apply to bearer shares: the registered agent must keep the bearer share certificate in safe custody and must notify the Registrar about such shares. There must be at least three directors, and their names must be in the Articles as filed; changes to directors must also be filed. Each corporation must have a resident Panamanian agent (a lawyer), named in the Articles; there are no other filing requirements unless the Articles are changed or the corporation is merged or dissolved.
Law No.2 of 2011 introduced new 'know your customer' requirements, whereby all registered agents operating in Panama must keep and maintain information on their clients in order that they can be properly identified upon request by the authorities. These new rules also cover the identity and location of holders of bearer shares.
Panamanian law also allows the following types of company to be formed:
Licenses are required only for financial institutions. Corporations do not have to disclose beneficial ownership, and Trusts and Foundations (see below) need not disclose the names of their beneficiaries. Limited Partnerships do however need to disclose the names of their members.
Panama Free Zones
Recent governments have sought to take full advantage of the country's financial stability by offering significant tax breaks for firms setting up in a growing number of 'free trade zones' occupying sites formerly used as bases by the US military. The largest of these is the Colon Free Trade Zone, situated at the northern end of the canal in close proximity to the major ports on the Caribbean coast, which offers firms exemption from tax on all import and export movements.
Companies in the Colon Free Zone, or in other Export Processing Zones, are treated in the same way as companies with external operations, i.e. they are exempt from income tax on external (i.e. re-export) operations. They are also exempt from paying sales taxes, import taxes and municipal taxes. However, a fiscal package introduced in 2005 aimed at reducing Panama's indebtedness included a 1% turnover tax to apply to all operations in the Free Zones, and a 1.4% turnover tax which may apply to some other types of companies. Furthermore, under a 2009 law, an exemption from dividends tax was removed for free zone companies.
In addition, Free Zone companies benefit from an absence of certain bureaucratic requirements such as licensing and guarantees. Overall, this generous incentive regime has attracted around 2,500 merchants generating exports and re-exports estimated to be worth in excess of USD16bn per year.
A draft law establishing a simplified and comprehensive scheme for establishment and operation in the free zone was approved by the Executive in December, 2010. Minister for Trade and Industry, Roberto Henriquez, explained that the initiative seeks to adapt national legislation to meet WTO standards. The bill encourages new investment in high-tech companies, logistics and environmental services as well as higher education establishments and research centres.
Seeking to capitalise on the success of the Colon Free Trade Zone, the Panamanian government in 2003 announced plans in partnership with the World Bank's International Finance Corporation (IFC) to transform the American military's Howard airforce base into a special economic zone equipped with high-tech logistical and telecommunications facilities with similar tax advantages for firms locating there. It is hoped that the project, now called Panama Pacifico, will attract some USD600 million in investment and create 20,000 jobs over two decades.
Fiscal benefits for companies located in Panama Pacifico are established by Tax Law 41 of 2004 and include exemption from all indirect taxes and income tax and dividend tax. Panama Pacifico companies also benefit from relaxed labour and immigration laws, including for overtime pay, compulsory rest days, employment contracts and visa rules, with three- to five-year work visas allowed instead of the usual one-year visa. The scheme also offers a five-year investment visa for those investing more than USD250,000 in the zone.
Significantly, in March 2013 the Panama Pacifico Special Economic Area was selected as one of the top-ten public-private partnership projects in the whole of Latin America by the IFC. The IFC ranked Panama Pacifico as the number one project in Panama and number seven in the region.
"Panama Pacifico is the only public-private partnership in Panama to be recognized in this Latin American ranking," said LRP Chief Financial Officer Christian Rinkel, upon learning of the award. "Panama Pacifico is honored to be thus recognized, and included in the IFC-IJ publication Emerging Partnerships. This type of recognition puts the spotlight on the efforts of hundreds, both in the private and public sector, who have worked so hard and made Panama Pacifico what it is today…a powerful engine in Panama's growth."
A 'Technopark' has also been established at the former US Army base at Fort Clayton on the Pacific coast which has attracted the likes of Microsoft, Oracle and Cisco. Now known as the City of Knowledge, this business park also offers companies tax and immigration benefits and direct access to the land portion of five international fibre optic cables that go across Panama. The City of Knowledge hosts research centres, educational institutions, and companies in the software development, telecommunications, multimedia, logistic applications, outsourcing and IT security industries.
Panama has placed a great deal of emphasis on building up a modern, hi-tech telecommunications infrastructure, with firms having ready access to high-bandwidth fibre-optic networks, marking the country out as Central America's e-commerce hub. Its promoters are also keen to point out that unlike other countries in the region, Panama is less prone to natural disasters such as hurricanes and earthquakes, minimising the risks of frequent and prolonged down time.
Wealth Management and Asset Protection
The Panamanian banking industry grew during the last quarter of the 20th century into a regional banking centre for Latin American and the Caribbean, due to a variety of factors including the absence of exchange controls, the rapidly increasing volume of trade being conducted through the country (and through the Colon Free Zone in particular), liberal banking legislation and tight secrecy provisions. At the end of 1997 more than 100 banks were licensed in Panama, from more than 20 countries and with assets of about USD23bn; however the country responded to international pressure by tightening up on banking regulation, and a number of banks closed their offices in 2000 and 2001. By mid-2005, 80 licensed banks remained, of which 30 had international licences.
Thanks to new financial regulation, Panama is once again developing itself into an important centre for banking. The legislation introduced a new licensing system for the industry and stricter compliance procedures, whilst subsequent laws and decrees have established modern anti-money laundering, fraud and terrorist financing rules. These initiatives helped to secure Panama's omission from the FATF (Financial Action Task Force on anti-money laundering) 'blacklist' of non-cooperative jurisdictions in 2001, and have transformed the nation into one of the world's most reputable international banking centres.
Banking assets grew steadily through 2011: in January 2012, the total assets of Panama's banking centre stood at USD81.4bn, almost USD9bn higher than in January 2011. Domestic deposits were USD30.5bn in January 2011 and USD33.65bn in January 2012. Foreign private banking represents the largest proportion of Panama's banking assets, followed by domestic private banking. Total banking assets in 2013 are an estimated USD82bn, of which USD26bn is domestic banking assets and the remainder foreign banking assets.
Panama is also a suitable jurisdiction in which to establish asset protection and succession planning structures with legislation allowing for the formation of both foundation and trust entities.
The Private Foundation Law 1995 governs private foundations in Panama. Unlike the common law trust, the foundation is an autonomous legal entity with no members or shareholders. It is generally used for the protection of assets and no business activities are permitted. Panamanian law specifically excludes the operation of foreign 'forced heirship' rules or judgements against foundation assets. Panama itself has abandoned these typical civil law provisions in its own legislation.
Panamanian trust law was updated with Law No 1 of 1984. Panamanian trusts (Fideicomiso) must be expressed in writing, so cannot be constructive. Trusts can be stated to be revocable but otherwise are irrevocable. The settlor, trustees and beneficiaries need not be Panamanian nationals or resident in Panama. A Panamanian lawyer must act as an agent for the trust. Trusts may be settled in respect of existing or future property; additional property may be included after the settlement either by the settlor or a third party. Unlike foundations, trusts are not protected by specific provisions against foreign inheritance laws, judgements or creditors. However, purpose trusts are allowed for.
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