Interview: Panama's Legal Tax System

In our country focus we have already covered Panama's tax rates and how they can benefit foreign investors and entrepreneurs, however, it is always better to receive a direct feed from the experts.

Fortunately, at Mundo we rely on professionals dedicated to carefully help clients find the right jurisdiction based on their profile and needs, thus maximizing their benefits.

This time, Jorge Garcia, our panama's tax system expert partner, gave us a detailed interview to clarify the most common doubts on this topic.

Not sure about the taxes that apply to your company? Read on and find the answer.

1. We would like to welcome you and thank you for attending this interview. In terms of taxation many of our readers are often confused about how double taxation treaties work and why they are important. Could you give us some general examples of how they work and can be used in tax structuring and optimization?

It is my pleasure. Well, this is actually a very simple matter. Panama is a multicultural country that has been able to adapt to its ethnic diversity, without affecting the tax status that tourists or foreign investors want to keep in their countries.

Speaking from a more academic perspective, we could say that Panama has a territorial income applicable to commercial activities within the country, such as imports and retail, services, and the sale of goods or products, always at a domestic level.

Clearly, this situation involves many aspects that require special guidance regarding the wide range of tax incentives and exemptions available. In other words, despite the fact that the income for local companies is 25%, this country has a broad range of options for obtaining tax exemptions.

However, the situation becomes much more pleasant regarding cross-border transactions, as income is now reduced from 25% to 0%, since transactions generated abroad are not taxed.

Nevertheless, you should always consider many variants, especially when it comes to international operations. For example:

i) If a company produces in the country and sells abroad, the most appropriate approach is to seek a tax regime that does not generate a tax payment (similar to VAT) at the local level.

ii) If your company makes purchases abroad and sells abroad, it has no tax impact, but it will certainly have a lot of information to provide to the country where it sells its products. Therefore, you must have everything perfectly calculated and, above all, allow yourself to be guided.

iii) If it is a holding company of other companies that operate abroad, chances are that it will want to invoice some service or will have to provide a report to the country for the tax authorities of its subsidiaries. Here is where, if you do not have the right tax advice, your 0% tax savings may undergo in the country of your markets.

2. How do the tax incentives and exemptions you mention for local businesses work?

It would take a long time to explain all the tax benefits; however, I can give you an example of the range of opportunities:

i) There are some incentives for tourism businesses within the Panama City area and tourism incentives for specific areas of interest. There are only variations in the percentage of exemptions and the years of terms applied. Yet, the following apply: hotels, restaurants, night clubs, bars, hostels, rental cabins, car, motorcycle and boat rental businesses, among others, as well as tour operators.

ii) As for the financial issue, we have incentives for interest derived from Time Deposit Certificates, financial derivative and compound products with 100 % exemption, such as forward sales and swaps.

iii) Exemptions are also found for industries. For example, the Free Trade Zones with exemptions for industries of first and second transformation, also the Free Trade Zones for Technological Industries around Internet, and the Free Trade Zones of Colon and Panama Pacifico for businesses providing services abroad or commercializing goods.

iv) Finally, I mention the exemptions for all the companies that are created and follow the regime of Small and Medium Enterprises known as AMPYMES, which are exempted from the Income Tax in the first 2 years of their creation, of course with some limitations especially in the billing limit.

3. Also, for foreign companies, how does international income exemptions work?

It is actually very simple: when you register your company at the General Revenue Office, all you need to do is to enable the foreign revenue box. But if this is not done at that time you can do it later.

As soon as this is enabled, all income must be declared as extraterritorial, and therefore not as income.

For Panamanian individuals, the issue has been resolved. However, the lack of taxation in this country can lead to certain issues elsewhere, particularly regarding the following topics:

- Lack of treaties to avoid double taxation. If there is no treaty to avoid double taxation in the country where companies have commercial or corporate relationships within an international structure, they will treat Panama under International Fiscal Transparency (CFC) rules, where normally capital income or capital gains and losses are higher.

There is even a risk of being able to apply Permanent Establishment criteria. Therefore, whenever you want to establish a company in this country for offshore business, you should consider comprehensive advice and even advice on the international structuring you are looking for.

- Regulation on Transfer Pricing. Transfer pricing is no longer just for OECD members, it is also mandatory in a global economy. However, companies must comply with this level of collaboration even if they are not taxed, especially because they have a duty of fiscal transparency and a duty to share information. Even if there is a tax exemption, there will always be a level of reporting or exchange of information to assume, especially if companies operate or integrate into a global economy.

Note that this does not apply to small businesses, because, although it does, it would not really be financially viable for these reporting levels and neither would the time and resources of the tax institutions.

- International Fiscal Transparency. Given the constant changes experienced by Panama in recent years, where one summer it is on the grey list and the next it is off it, CFC rules have become imperative for international corporations. This is especially true for those countries that impose high taxes on transactions between countries within such lists. However, this does not mean that the issue of Panama is unfeasible, but that the work that must be done by tax advisors will be more detailed in order to structure international businesses.

Anyone can sell a company in this country, it is not the issue, but very few warn customers of the correct international management that should be done, perhaps due to ignorance, negligence or lack of tools to provide customers with added value guiding them through a correct path and tax optimization.

4. Does Panama have many treaties to avoid double taxation?

Still, no one has yet removed Spain's title as the largest (Spanish-speaking) country with treaties to avoid double taxation. Nevertheless, 17 is not a modest number. In addition, it has 10 Tax Information Exchange Agreements. Spain, France, Italy and Mexico occupy the top spot in the first group, while Canada, the United States and Japan are in the second group.

5. What does this large number of tax treaties and agreements mean in terms of investment?

There are many benefits involved. For example, the income generated in this country does not have to be taxed in the foreigners' countries of residence, since it has already been declared and in some cases even paid in Panama. Another mechanism is through the tax credit that can be granted in the investor's country of origin for income paid in Panama.

From another standpoint, one could say that Panama can share the information of many companies or high net worth individuals with these countries. In fact, what it means is that Panama has room for people who pay taxes in this country so that they are not harmed by the taxes on their domiciles, since they have already been declared and paid here.

6. Now, regarding tax residence, how does it work?

This is a very interesting issue, especially when it comes to treaties to avoid double taxation. Each treaty can have its own reservations, according to the signatory country. Nevertheless, whenever it is allowed, it is necessary to look for a connection with any of the causes that may enable the connections to set up a tax residence, such as having a main business center in the country, a residence for owning a house in the country, being there for certain days, residence of the family nucleus, among others.

For each case, we must understand that it can be a different process according to the purposes sought: a tax residence for companies is not the same as for individuals.

7. In terms of transfer pricing, is Panama aggressive?

Not at all. Panama has Transfer Pricing regulations that make it easier for holding companies to keep a whole transnational group in order and to be able to face the tax requirements, which nowadays are being developed in the international sphere, for example: "Tax Inspectors Without Borders" or TIWB.

In fact, it has the classic valuation and transaction methods, which are almost uniform in most countries that follow the OECD Transfer Pricing Guidelines.

Additionally, the fact that the currency is US dollarized and the IASB's IFRS accounting standards are the ones authorized by the country for tax purposes, makes transfer pricing studies much easier, especially when it comes to cost accounting, which is where there is a lack of understanding between tax administrations and companies on transfer pricing issues.

Likewise, this accounting standard and the OECD guidelines entail the opportunity to incorporate or transpose extraterritorial criteria on transfer pricing matters, thus benefiting companies in managing a uniform accounting between their subsidiaries and parent company in Panama or vice versa.

8. To conclude, how do you perceive Panama in terms of international taxation?

Well, of all the Central American region, Panama is the country with the largest progress in this area, followed closely - but never equally - by Costa Rica.

Thank you very much for your time, Mr. Garcia, our readers will be delighted to have such valuable information regarding taxation in Panama.

No doubt this is the ideal country to establish a company. For more information, please contact our team immediately.

Like Mr. Garcia, the rest of our team is integrated by professionals and experts with more than two decades in the financial field.

Find out for yourself during your consultation.

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