Use of Panama Entities Increases Despite Changes to Tax Rules

Contributed by Lombardi Aguilar Group

April 15 2005


Introduction

Despite increases in maintenance costs, incorporations in Panama have increased by 30%. According to official statistics, in the first 11 months of 2004 23,138 corporations were formed, compared with 17,755 in 2003. This represents an increase of 30.3% even without the whole of 2004 being considered.

Panamanian corporations provide the following advantages:

• Fast incorporation procedures are available (subject to legal formalities);
• No paid-in capital is required;
• Shares may be issued in bearer form, or the charter may be drafted to allow only registered shares;
• Shares may be issued in US dollars or any other currency;
• The shareholders, directors and officers may be of any nationality and may be residents of any country;
• Directors, officers and/or shareholders may be either corporate entities or individuals; and
• Shareholders and/or directors may hold their meetings in any country and may attend such meetings by proxy, telephone or other means of communication.

With regard to private interest foundations, 2,734 foundations were formed up to November 2004, as opposed to 1,902 in 2003 - an increase of 40%. Panamanian private foundations are separate entities that hold assets for later distributions to beneficiaries in a similar way to trustees holding assets in trust.

All Panamanian entities which have no income from operations in Panama are exempt from Panamanian income and withholding taxes.

New Measures for Annual Corporate Tax

The Panamanian legislature has approved Law 6/2005, which enacts changes to the Tax Code. After much opposition from the Panama Bar Association and other legal profession groups to a proposed 40% increase, the annual tax for Panama private foundations and corporations was set at the current rate of $250 for the first year. After the first year the flat tax will increase to $300 per year, which is equal to the rate currently in force in the British Virgin Islands, the Turks & Caicos Islands and Vanuatu.

The first annual tax of $250 is now payable in advance upon incorporation instead of the normal due date. Corporations and foundations formed in the first half of the year have until July 15 to pay their tax; those formed in the second half have until January 15 of the following year. Late payments are penalized with a surcharge of $50.

Entities existing at the time of enactment of Law 6/2005 will pay the $300 tax when it falls due after January 1 2006.

Penalties for Non-payment

Lack of payment will result in the non-registration of any minutes or documents related to the corporation or foundation. After two years without payment, a fine of $300 is levied and the entity is registered in the Public Register as owing taxes. Once the outstanding taxes and fines are paid, the entity will be returned to its good standing.

Lack of payment for 10 consecutive years will result in the corporation or foundation being permanently deleted from the Public Registry. As a consequence, the entity will be held as dissolved for all legal purposes.

Annual tax payments must be made through the resident agent of the corporation or foundation. If a resident agent delays forwarding annual taxes to the government, it will be fined between five and 10 times the unpaid amount.

Relief from Government Errors

As a relief from administrative delays resulting from errors in the receipt of annual taxes by the government, payments appearing in official receipts dated before December 31 2004 are considered to have been paid even if the funds did not enter the Treasury due to causes unrelated to the taxpayer, its legal representative or resident agent. Surcharges for late payment are not applicable when official receipts kept by the taxpayer show that payment was made but the government entered the data incorrectly.

Income Tax Rules Applicable to Panama-Source Income

Article 684 of the Tax Code is the cornerstone of the Panamanian taxation system. It provides that income earned by Panamanian corporations or individuals from activities taking place outside Panama is not subject to Panamanian taxation. This provision is intended to attract foreign investment by multinationals, which would then generate jobs in handling of merchandise outside Panama.

However, Law 6/2005 introduces exceptions in order to prevent abuse of these facilities by Panamanian individuals or expatriates based outside Panama. Under a new paragraph, income from professions both in and outside Panama will be considered to be earned from Panamanian sources if the taxpayer is in Panama for at least 70% of the working days in the calendar year.

If the services provided are not economically related to the taxable activities of the individual, the income will be considered as foreign-source income. Therefore, it is not taxable. As a concession to individuals acting on behalf of overseas subsidiaries of Panama-based insurance and banking companies, individuals who occasionally serve as consultants or deliver presentations or conferences abroad are exempt from the 70% rule, even when they stay outside Panama for less than 30% of the working year.

Income received by individuals or entities domiciled outside Panama will be considered as Panama-source income and taxable if it is earned from activities that benefit taxpayers in Panama. These activities include royalties from copyright, patents, software, know-how and other commercial secrets, as well as any commissions from the sale of services in Panama. By the term 'benefit' the provision specifically refers to taxpayers in Panama who deduct the licence as an expense for the production of Panama-source income. Fifty percent of the gross payments made to beneficiaries abroad will be subject to withholding by the payor in Panama at the regular tax rates.

An additional provision further clarifies that taxpayers who, by reason of their international business activities, carry out operations outside of the national territory which are required for the generation of income reported as taxable in Panama will not be subject to the withholding on payments for goods and services financed, agreed or performed entirely outside of Panama, which will not be considered as taxable income.

Deductible Expenses

Expenses incurred for the production of local-source income are deductible. The 2005 tax reform modified several deductions as follows:

• Deductibility of donations to government-approved charities is limited to a maximum of 1% of the taxable income of donor entities, or up to $50,000 of donor individuals;
• Company earnings distributed among employees are deductible by the company, with a limit of one month's salary for employees who own more than 15% of the company shares and their relatives; and
  
• Thirty percent of the amount invested in agricultural and ranching activities is no longer deductible.

Alternative Minimum Tax

In order to levy tax from taxpayers experiencing recurrent losses, the 2005 tax reform requires these taxpayers to pay whichever is the greater of the tax under the normal rates and an alternative minimum tax (AMT) rate. Initial fears of a global taxation system vanished when the tax reform was enacted with an AMT solely on 4.67% of Panama-source income.

Entities will be taxed at 30% of the greater of the net taxable income under normal tax rules (Panama-source income minus deductible expenses) and the net taxable income minus 95.33% of said income.

Companies selling goods subject to the gas tax and the selective consumption tax (similar to a luxury tax) may also deduct those taxes from the income subject to AMT. Small enterprises with less than $150,000 in annual sales are exempt from AMT.

If, after payment of the income tax, the company makes a loss or has an effective tax rate above 30%, it may request in writing an exemption from the AMT. However, the tax authority is not compelled to grant this exemption and may audit the taxpayer making the request.

In order to validate the tax returns, the taxpayer must submit certified financial statements under the International Financial Reporting Standards. Taxpayers may also request an exemption from this requirement - this exemption is meant for small enterprises.

Professional partnerships are also given a third option of having the partners pay a 6% tax on the taxable earnings of the partnership under a flow-through taxation method.

Income tax rates for individuals are subject to a lower number of tax brackets and individuals with a gross annual income above $60,000 will have to pay the greater of the normal tax rate or a 6% AMT on Panama-source gross income. However, individuals holding business licences because of their mercantile activity are subject to AMT under the corporate tax rates.

Rules for Special Industries

Foreign distributors of movies for radio and television broadcast through any means have their 10% tax rate automatically reduced to 6%.

Commissions and fees received from warehousing, renting of warehouses, repackaging, invoicing and other activities carried out in the free trade zones are considered as taxable, unless they are carried out for merchandise which is re-exported outside Panama.

Gains from the sale of shares from an initial public offering of a publicly held corporation are no longer exempt from taxation. Only gains from the sale of shares, bonds and other securities of publicly held corporations conducted through a Panama stock exchange, or from a merger or reorganization, continue to be exempt from taxation. This incentive makes the use of Panamanian special purpose vehicles an attractive way of raising funds for Latin American operating companies.

Payments of interest, commissions and other charges from loans or financing, the funds from which are used outside Panama, continue to be exempt from Panamanian taxation. However, when such funds are used in Panama, payments to foreign creditors are subject to withholding of the normal tax rate (30% for corporate creditors) on half of the gross payments made.

The benefit of exempting charterers from tax on leasing of international services ships has been extended to leasing of aircraft.

Several incentives are reduced in reforestation, tourism and construction, as well as credits for improvements in industries and infrastructure. Taxpayers hoping to use tax credits must report them before August 3 2005.

Property Tax

Properties with a value below $30,000 are exempt from property tax. Additional benefits were enacted for:

• parcels with assessed value below $150,000 used for agriculture, which are tax exempt;
• private schools and hospitals, which can credit to their property tax liability the amounts spent in teaching or caring for indigent users; and
• landowners submitting updated assessments of their property values, who may be granted a 40% to 50% discount in their tax liability for five years (at the discretion of the tax authority).

The 20-year property tax exemption is maintained for improvements with building permits granted before September 1 2005. Other improvements will remain with five to 15-year property tax holidays.

Taxes Abolished

Several taxes, the collection of which became an administrative burden, were abolished. These are:

• 12% tax on long-distance calls, intended to promote the establishment of call centres in Panama;
• $1.50 per hectare tax on unused lands above 500 hectares;
• tax on sugar production;
• tax on theatre tickets; and
• tax of up to $25,000 on assets of insurers with local risks.

For further information on this topic please contact Alvaro Aguilar at Lombardi Aguilar Group by telephone (+507 340 6447) or by fax (+507 340 6446) or by email (aaguilar @nysbar.com). further information on this topic.