By Lowtax Editorial
12 August, 2014
The Republic of Panama lies in Central America between the Caribbean Sea and the North Pacific Ocean and is probably best known for its eponymous canal, which remains a vital artery for trade in goods between East and West.
Thanks in large part to the Canal, shipping is one of Panama's strongest economic pillars, alongside banking, financial services and tourism. A thriving re-export industry has grown up in recent decades centred on the Colon Free Zone, and the country is home to tens of thousands of international companies chiefly as a result of its benign tax regime and strong confidentiality laws. Panama's low taxes and sub-tropical climate have also attracted a large community of expat pensioners, particularly from the United States. There are also a range of incentives for domestic and foreign investors alike.
In July 2014, the population of Panama was estimated at just over 3.6 million with half the population residing in urban areas, and the majority of those (over 1m) in Panama City itself. Spanish is the official language, but English is widely spoken and understood in major cities.
Panama is an independent sovereign state with a democratically-elected government and president. Until late 1999 a coalition of the Democratic Revolutionary Party, the Popular Nationalist Party and the National Liberal Party was in power. After losing the presidential battle in 1999, Martin Torrijos (son of Omar Torrijos, who ruled Panama between 1968 and 1981) assumed leadership of his father's party, sought to reform it, and created a platform based on combating corruption, boosting employment, and reforming Panama's fiscal system. Pro-business Ricardo Martinelli Berrocal, leader of the Democratic Change party, was President for five years until being replaced on July 1, 2014 by Juan Carlon Varela of the centrist Panamenista Party.
Under President Torrijos, 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 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. The economy grew by 10.8% in 2011, 10.7% in 2012 and 7.5% in 2013. GDP per head was USD16,500 (2013 est.) at Purchasing Power Parity. Macroeconomic stability and policies to foster greater social inclusion have reduced unemployment to historic lows.
Panama is focussed on banking, mining, commerce and tourism, with the canal and the shipping business generally playing an important role. The Government has introduced many investment incentives (see below).
The unit of currency used in Panama is the Balboa (PAB), which is pegged at parity to the dollar. There is no Panamanian paper currency and the US dollar is the de facto official currency for all but minor transactions. As a result, the Government cannot print money.
In terms of business and communications infrastructure, the long-term US influence on Panama has been very beneficial, Panama City in particular having the highest international standards. The well-established banking sector, however doubtful some of its antecedents, has also demanded high standards.
The IMF also commended Panama's success in establishing a strong banking center, which has become an important regional hub. However, to compete globally and in a broader range of investment and wealth management services, the Fund believes that the country will need to upgrade its financial sector supervision and infrastructure.
Panama is of course recognised globally for its eponymous canal, and the importance of this vital waterway to the local economy cannot be overstated. Around 12% of the United States' seaborne trade in tonnage terms passes through the canal every year, which in total sees 13,000 ship movements annually, carrying 192m tons of cargo. And by navigating the 40-mile waterway, a cargo vessel bound from Japan to the eastern seaboard of the United States can reduce its journey by some 3,000 miles. By the end of 2010, more than 1 million vessels had transited through the canal since its opening in 1914.
The canal was built between 1904 and 1914 by the US. It spans 81.3 km between the Pacific Ocean and the Caribbean Sea. However, with the development and construction of ever-larger cargo vessels, and year-on-year increases in global trade in physical goods the vast majority of which is carried by sea the canal has suffered from under-capacity in recent years. In August 2002, after five years of construction, expansion of the Galliard Cut was completed, allowing two Panamax'-sized vessels to pass through simultaneously. But it soon became clear that the waterway was badly in need of investment, and in October, 2006, 79% of Panamanian voters approved a USD5.25bn plan to expand the Panama Canal even further. President Martin Torrijos said that the vote on expansion of the Canal was the most important national vote since Panama gained its independence.
Under the expansion plans, two 3-chamber locks are being constructed at both ends of the canal. This will create a third lane of traffic wide enough to handle the largest of modern container ships and tankers. New approach channels will also be prepared, whilst existing channels will be dredged to ensure large craft can enter the system. The project was due to take about seven years and employ up to 8,000 people. Inevitably perhaps with such a large infrastructure project, the completion date has been pushed back to 2015.
Shipping has grown to be one of the most important industries in Panama, which has the world's largest registered merchant fleet whether measured in terms of total tonnage or in terms of number of vessels.
The registry was founded in 1925 and has no restrictions either on the nationality or domicile of owners or on the age, size or type of vessel. In fact, it accepts many types of vessel that are not counted as such by other registries, such as drilling rigs.
In 2013, there were 8,580 vessels registered in Panama, totalling over 220m million gross tons, making it the world's top ranking open registry flag.
The registry forms part of the Panama Maritime Authority, and has offices in London, New York, Houston and New Orleans. Provisional registration is effected through lawyers in Panama, but the provisional registration documents can be issued by Panamanian consuls. They are valid for six months, renewable. A considerable amount of information must be supplied, comparable with other registries. On provisional registration, a renewable 6-month Provisional Patente of Navigation is issued, along with a renewable 3-month Radio Permit. Permanent registration with a renewable 4-year navigation patent will follow issue of the provisional documents and completion of documentation.
There are both initial fees and annual fees and taxes payable when a vessel is registered in Panama. The initial registration fee depends on the vessels tonnage and ranges from a minimum of USD500 to a maximum of USD6,500. The annual tonnage tax (Impuesto Annual) is USD0.10 per NRT. There is also an annual fee (TasaUnica Annual) ranging from USD1,200 to USD3,000 depending on vessel tonnage. An annual inspection fee of between USD400 and USD1,800, depending on vessel type and tonnage, also applies.
There is a separate scale of duties for barges, pontoons and vessels operated other than for profit.
There is also a separate regime for pleasure vessels under which registration is on a renewable 2-year basis, but pleasure vessels are exempt from duties and other Tasa charges.
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 see below), 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. Assets amounted to USD7bn. By the end of 2013, there were around 90 institutions in Panama with assets of just under USD99bn. The majority of assets are domestic as opposed to offshore as demand by wealthy expats, particularly from the US, for loans on second homes increases seemingly unabated.
Panama introduced a new and comprehensive banking law (which covers local trust companies as well) in February, 1999, replacing one that had been in place since the 1960s. The National Banking Commission that previously issued licenses has been replaced by a Superintendency which comprises a Board of Directors composed of distinguished professionals and entrepreneurs with no links with the banking sector and a Superintendent. In addition to increased investigative powers, the new law has tightened general controls and regulations and brought the country's supervision more in line with the regulatory standards found in European and American banking centres.
There are three types of banking license:
- General Licences permit trading both in and outside Panama, and can be issued to Panamanian or foreign banks; minimum capital is USD10m.
- International ('Restricted') licences allow offshore banking to be conducted from an office in Panama; minimum capital is USD3m.
- Representation Licences are issued to foreign banks and permit a local office but no local trading. Activities must be limited to contacting third parties interested in carrying out operations with the Head Office. Representative Offices are not authorized to carry out any kind of operations from or within Panama.
- Combined General and International licences are available. Licence fees are, approximately, USD5,000 and up to USD50,000 depending upon the jurisdiction and the type of licence required.
Branches of major international banks are particularly welcome as they will be able to offer not only traditional retail banking, but also services such as investment management, back-to-back loans and documentary credit facilities, credit card services and trust management.
Although confidentiality is enshrined in the new law, a prima facie case proving funds are illicit will open criminals to exposure. Banks must conform with stringent monitoring and vetting procedures; each bank has a compliance officer who is responsible for ensuring that controls are applied.
Three additional laws passed in 2003 have increased Panama's defences against financial crimes, money laundering and terrorism.
Only banks with General Licenses will have any tax liability (see taxation, below), and then only in respect of Panamanian income.
A first-time Financial Sector Assessment Program (FSAP) conducted by the International Monetary Fund (IMF) in September 2011 confirmed that the financial system is sound, and that it would remain adequately capitalized even under challenging external conditions.
In its annual review of the Panamanian economy, the IMF commended Panama for establishing a strong banking centre, which has become an important regional hub. However, to compete globally and in a broader range of investment and wealth management services, the IMF said that Panama will need to upgrade its financial sector supervision and infrastructure. Furthermore, risk-based and consolidated banking supervision and oversight of non-bank segments will need to be enhanced, the report stated.
Says the report: "For the most part, banks follow a fairly traditional business model, while insurance, equity, and capital markets are relatively small and/or underdeveloped. However, to be competitive in a broader range of investment and wealth management services, Panama would have to make improvements in several areas. According to the FSAP these include: bringing financial system oversight more closely in line with international best practices; and upgrading all non-bank segments of the financial system."
Offshore Business Regimes
The term 'offshore' 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'.
In June 2000, Panama was identified by the FATF as a non-cooperative tax haven in the global fight against money-laundering. The result of this was that Panama was one of fifteen tax jurisdictions placed on an FATF blacklist. Each offending tax haven had a year in which to correct its regulations and legislation.
The FATF released an annual report in June 2001, in which the organisation revised its list of countries and territories deemed non-cooperative. Only four were removed from the list, including Panama.
In April 2009, following that month's landmark G20 summit in London, Panama was placed on the OECD's 'grey list' of territories which had committed to, but not yet substantially implemented, the internationally agreed standard in tax transparency and information exchange. Later that month, the government of Panama announced the conclusion of the first round of negotiations towards a double tax agreement with the Netherlands, including tax information exchange provisions in line with the OECD standard.
The OECD announced in July 2011 that Panama had moved to the list of jurisdictions considered to have substantially implemented the standard for exchange of information when it signed a tax information exchange agreement (TIEA) with France. In 2014, Panama has exchange of information relationships with 25 jurisdictions, including 16 double tax conventions and nine TIEAs.
Licenses are required only for financial institutions. Corporations do not have to disclose beneficial ownership, and Trusts and Foundations need not disclose the names of their beneficiaries. Limited Partnerships do however need to disclose the names of their members.
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 USD200m. A minimum initial capital of USD2m is required if the group's main office is to be in Panama.
The corporation limited by shares (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.
Other company forms available in Panama include the Foreign Corporation, the General Partnership, the Limited Partnership, the Civil Partnership, The Commandite Company (a hybrid partnership and corporation), the Foundation, and the Trust.
For firms carrying on business outside of the special zones (see below), general taxation 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, so dividends paid out of such earnings are free of taxation.
The rate of 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, gaming and gambling, 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.
The 2005 reform package introduced a 'minimum income tax' provision, under which the net taxable income of a legal entity will be the higher of the amount resulting from application of the ordinary Income Tax rules (gross income minus deductible expenses minus deductible allowances equals net taxable income), or 4.67% of gross income. Whenever the effective income tax rate exceeds 30% of the net taxable income earned by a taxpayer, a waiver may be obtained from the Tax Administration and no presumptive taxation will apply. The same will apply in the event of losses for taxable purposes. The waiver may be granted for a maximum period of 4 fiscal years (the year for which the waiver is granted and the 3 subsequent fiscal years). The minimum alternative tax was replaced in 2010 by a new minimum estimated tax for companies with revenues exceeding PAB1.5m.
As regards personal taxation, there is no distinction between foreign and Panamanian individuals. The territorial basis of taxation applies to individuals as it does to business entities, so that individuals pay income tax on Panama-source income. 'Panamanian-source' means that the services rendered are deemed to be provided within Panama if a Panamanian entity pays an employee for services rendered abroad, tax will not be due.
There are no statutory residence rules as such, but an individual is considered resident if she is present in Panama for more than 183 days in any one tax year. Whether the centre of economic and family interests remains within Panama is also a factor in determining tax residence.
Income is defined as the aggregate of income from Panamanian sources after deduction of allowable expenses and losses and ignoring exempt income. Income includes income from employment and from rendering independent personal services, income from business activities, and investment income.
Employment income in respect of work done in Panama is taxable regardless of where the payment is made or received. Capital gains are included in taxable income.
In 2014, the rates of tax on personal income are as follows: 0% up to USD11,000; 15% from USD11,001 to USD50,000; and 25% above USD50,000.
Employers and employees make social security contributions in Panama: in 2014 the employer pays 13.5% while the employee pays 10.25%. The employer deducts the social security contribution along with income tax. The self-employed also make contributions at 13.5%.
For expats, Panama's Pensionado Visa Program offers a variety of tax breaks and discounts on such things as car imports, furniture, mortgages, utility and medical bills.
The Colon Free Zone
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. They must also pay an annual franchise tax of PAB300.
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.
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 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 USD600m 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, 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.
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