PANAMA TAX TREATY DEVELOPMENTS AND NEW POLICIES: THE IMPLICATIONS By Leopoldo J. Martinez.[i]
Panama is rapidly changing its tax policies without loosing its attractiveness.
For several years Panamá has been characterized as a “tax heaven”, thus, blacklisted by many jurisdictions for tax purposes, including the OECD countries. Being a blacklisted jurisdiction pays a price that sometimes out weights the benefits provided by low or none income taxes in such jurisdiction. Many Latin American countries increase income tax withholding rates on payments to blacklisted jurisdictions and impose stringent reporting requirements that include treatment of the entity as a local taxpayer. Outbound tax regulations in the US and other OECD countries do have some negative implications for “blacklisted jurisdictions” in different ways. Finally; the OECD list is used as a reference for many other compliance matters in the financial regulations terrain; and as such, an obstacle to long lasting development policies fostering foreign investment and free trade. In fact, interesting opportunities with the European Union, Chile and the United States have pushed Panama to move out of the “darkness” of being listed as a “tax haven” to enter into free trade and investments agreements. Panamá, a country with a growing population and economic potential, has the ambition of embracing international transparency, promoting policies that will make economic growth sustainable and diverse, yet not giving up its attractiveness for foreign investors, both in the real economy or the financial sector. Consequently, Panama’s new policy has moved to negotiate and execute international tax treaties, while preserving a tax system that raises domestic revenue without loosing international competitiveness, therefore, offering incentives to new projects attracted by its strategic geographical location to serve as a platform to reach into the emerging developing Latin America economy, without becoming a typical “tax haven”.
The government of Panama has introduced a number of changes in tax policy and legislation. One very important development relates to the signing of Tax Treaties with OECD countries. Tax Treaties to prevent double taxation also bring transparency to the table as tax information, transfer pricing requirements come together with measures to relief international taxpayers from the tax implications of doing cross-border business or engaging in international, multijurisdictional operations or investments. In the intergovernmental relation, tax treaties offer enhanced exchange of information to fight against tax evasion, as well as rules to resolve sourcing of income or transfer pricing issues through competent authority procedures if necessary. Treaties have been signed by Panama with Mexico and Spain; concluded negotiations with Barbados, Italy, France, Belgium, The Netherlands, and advancing negotiations with Luxembourg, Singapore, Ireland, Check Republic and Korea. The government expects to have 12 treaties in force by September and October this year. With such target, Panamá could be removed from the OECD low tax jurisdictions list, gaining status and recognition for international transparency and commitment to prevent tax evasion, but at the same time, granting investors and businesses relief from double taxation. The model OECD treaty has been the central piece or point of departure for all negotiations.
However, Panama domestic income tax system remains highly competitive and offers interesting incentives. The maximum nominal income tax rate applicable is 30%. However, capital gains are taxed at lower flat rates of 10 % for real property and 5% for personal property and securities. Distributions made by the SA and SRL to its shareholders are also taxable. A 10% withholding tax would be imposed upon the distribution of dividends by the SRL to the stockholders. Under Panamá Law dividends must be paid out of earnings and profits received and liquidated. Return capital and other non-divided distributions could result from redemptions and liquidation. However, all distributions will be subject to the 10% withholding tax. Retained earning will be subject to a “retained earnings tax” or minimum dividend tax of 10% of 40% of the after tax income. There is an Alternative Minimum Tax of 1.401% of the gross taxable income creditable towards income taxes (thus, the company pays the higher of 30% of net income or 1.4% of gross). Nonetheless, the Panamá income tax system only taxes territorial income, therefore, all income not sourced to Panama under the sourcing rules will escape taxation in Panamá. Re-invoicing is considered non-territorial income, which includes sales done from Panama of goods that did not enter Panama territory. Accordingly, outbound or extraterritorial income could pass-through a panama entity without major implications in Panama, including for dividend distributions.
On the other hand, Panamá had introduced the “Colon Free Trade Zone” and “Export Processing Zones”, among other tax incentives to trade and investment.. Tax laws provide under this two regimes a set of incentives to export and re-export operations under the Colon Free Trade Zone and the Special Regime applicable to Export Processing Zones.
Located near the northern entrance of the Panama Canal, the Colon Free Zone (CFZ) offers free movement of goods and full exemption from taxation on imports and exports. The CFZ is a major factor in facilitating the supply of goods from large industrialized countries to the consumer markets in Latin America. Firms located in the CFZ are exempt from import duties as well as from guarantees, licensing and other requirements and limitations on imports. There are no taxes on the export of capital or the payment of dividends. Companies operating in the Free Zone must separate their accounting systems for their external operations from their internal operations. External operations are defined as the re-export of merchandise from CFZ warehouses and are exempt from income tax. Internal operations are those in which sales are made from CFZ warehouses to customers located within the customs territory of Panama, including those made to ships and airplanes using canal facilities, and to passengers in transit. Profits arising from internal operations are not subject to any special treatment. In general, commercial or industrial enterprises are required to obtain a license to carry on their activities in Panamá. An annual business and industrial license tax is levied at the rate of 1% on the net worth of the company concerned, which is increased by amounts owed to any parent company or head office located abroad. This license tax may not exceed US$20,000. Companies engaged exclusively in off shore or CFZ are not required to have a license. Companies established in the Colon Free Trade Zone are exempt from the obligation of filing any type of tax return for income derived from “external operations”, which is the re-export of merchandise from Colon Free Trade Zone warehouses.
The Special Incentives for Export Processing Zones (EPZ) are provided pursuant to Law Nº25 of 1992, these are basically private free zones, that allow for import and re-export operations with total exemption from duties. Among the Enterprises that can participate in the EPZ are manufacturing enterprises; assembly enterprises (“maquilas”); finished or semi-elaborated products processing enterprises; services export enterprises; general services enterprises. The main tax incentives for an EPZ are:
• The enterprises, as well as its activities, are exempt from all local direct or indirect taxes, contributions, assessments, rights, and charges. Nevertheless, there is some discussion on whether income tax exemption will be granted to those foreign enterprises whose countries permit the deduction or crediting of taxes paid in Panamá.
• Duty free importation of machinery, equipment, raw materials, tools, accessories, lubricants, and all goods and services required for operation.
• Exemption from license tax.
Recently, the Panamanian government introduced some changes applicable to the Colon Free Trade Zone. Accordingly, a 5% withholding tax applies to dividends paid by enterprises in the Colon free trade Zone, but the companies continue to be free of taxation from extraterritorial operations (i.e. re-exportation operations), export or other categories of exempted income.
One interesting issue emerging from Panama’s crusade to become a treaty partner to OECD countries will be transfer pricing. Panama income tax law has no transfer pricing requirements or regulations. However, most of the model treaties upon which negotiations are based do require in their Article 9 that “Associated Enterprises” do comply with transfer pricing.
Finally, some of the Panama withholding taxes imposed on remittances, services or dividends could be reduced or eliminated by the tax treaties signed, particularly when there is no Permanent Establishment in Panama (i.e. Business, profits, Royalties) or dividends are paid to a fully owned subsidiary or one where the parent company controls more than 75% or 80%.
 There is a 5% withholding tax on the gross income of the transaction, which is a final tax unless the gain tax results in a lower tax liability, recoverable through a credit or a refund process in the yearly tax filings of the entity.
 This withholding tax will increase to 20% if stock is issued to bearer.
[i] Leopoldo J Martinez is the Managing Partner of LMN CONSULTING LLC, an international strategic and tax planning specializing in the Latin American market place, with affiliates in Dallas, Miami, Mexico, Panama and Caracas.