Tax and Tax Residency

Income tax is only levied on income derived from operations within Panama. This is true of both individuals and corporations.

This means that there are considerable advantages for a Panamanian individual or corporation to establish second residency and tax residency in Panama. In terms of a corporation:

A Panama business entity can direct its offshore activities from Panama without becoming liable for tax. The Fiscal Code (Article 694) excludes the following types of income from taxation:

1. The profits of reinvoicing external goods or services;
2. The profits of operations that are directed from Panama but carried out externally.
3. The distribution of dividends derived from external income, including the above types of income.

Interest on deposits with Panamanian banks is exempt from taxation whatever the source of the cash.

An entity with both external and Panamanian business activities is taxed only on the Panama-derived income and is subject to withholding tax only on that income.

Panama business entities with only external operations are exempt from dividends (withholding) tax, undistributed profits tax, business tax and from stamp duty on contracts executed in Panama to be performed elsewhere.

How to obtain a second residency? An individual wishing to obtain tax residency in Panama must first obtain residency. After this he must establish significant economic and social ties to the country sufficient to be granted a tax residency certificate. The granting of such a certificate depends on the assessment by the authorities as this his tax residency status at a particular time and is renewed each year. Of course, it is better to give up an existing tax residency before applying for Panamanian tax residency.

In order to maintain tax residency, the individual or company must file tax statements every year prepared by a locally certified accountant. Although tax needs to be paid on local income (apartment rental receipts, wages or consultancy earned within Panama, sale to local Panamanian entities -the good part is that your worldwide income is absolutely tax free and can be lawfully declared with zero tax.

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Tax incentives and territorial system

Panama offers the best second residency in the world. This country 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:

-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.

-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.

-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.

 

Tax incentives for local businesses

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

-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.

-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.

-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.

-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.

 

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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, no problem! It can be done later.

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

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

1. 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.
2. 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.

3. 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. For this reason, we recommend consulting with highly skilled and experienced professionals such as the experts of Mundo.

Double taxation treaties

Nowadays, Panama is the country in the Central American region that has more fiscal treaties. Some of these treaties are the following:

Treaties to avoid double taxation (CDI)

Panama has 17 treaties to avoid double taxation, signed and certified by the National Assembly. These treaties have been implemented since 2010 till today.

There are three new signed treaties that are waiting for the Assembly’s approval. 

Treaties for the Exchange of tax information (AIIT)

However, many of those countries that haven´t yet signed a CDI with Panama but have signed an AIIT. These are some examples of countries that signed treaties to exchange tax information:

1. Most of the CDI and AIIT that Panama signed are under the OECD standards. This helped Panama to be excluded from the blacklists and to stop being considered as a tax haven.
2. The chapter of the treaties do not vary much, they both allow for tax reduction in the original countries of the company or individuals, for the income generated in the other country. This is especially useful for those countries that tax for the worldwide generated income.

For Panama, this doesn´t change the picture much, as all foreign income is not taxed in Panama. However, if a person is exempted of taxes in Panama, he or she may still be subject in their original country or in the country where they conduct the activities.

These double taxation treaties only apply to income tax, but not to indirect tax like VAT, importation taxes or special taxes.

Every investor in Panama needs to know these treaties very well in order to choose the right way to structure their international businesses. These treaties not only allow for the tax reduction in the place of residence, but also allows for the establishment in other countries where the person operates.

For example:

If you are a citizen of a European country, like Spain, where you have a wine business, and if you also have a Sociedad in Florida, which distributes your products in the US, the products may be invoiced in Panama through a Sociedad Anonima. It is probable that in the short term you´ll encounter issues with the IRS because of transfer pricing since you are operating in a tax friendly country.

For this reason, it is vital to get the right assistance of a tax specialist when it comes to international taxation, so that you can minimize the risks and be in compliance with the legislation of each country involved.

Benefits of double taxation treaties

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.

Next, we illustrate again with an example:

If a Mexican person has an income in Panama and declares it, the payment of those taxes or their exoneration could be deductible in his/her country. However, if the person has already transferred his tax residence from his country to Panama and the treaty guarantees such tax residence, it will not be necessary to declare income in Mexico.

The Information Exchange Agreement may finally allow all income declared in Panama to enjoy a legitimate reputation in the countries where the agreement is in force.

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Tax residence requirements and double taxation

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 amount of 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.

Transfer pricing in Panama

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.