Overview of changes to special tax regimes and introduction of new regime
Panama revised two of its special tax regimes in 2018 to bring them in line with international initiatives, such as the OECD/G20 BEPS project. Specifically, the multinational headquarters regime (SEM) and the Panama Pacific economic regime were amended. Additionally, a new multinational headquarters regime for the establishment and operation of manufacturing-related services (EMMA) was introduced in 2020.
Highlights of corporate income tax system
Panama’s tax system is based on the territoriality principle rather than the worldwide taxation system used in many countries. Under the territorial regime, all income derived from local operations is subject to income tax, but income derived from foreign sources is exempt.
Corporate income tax is imposed only on income generated or produced in Panama, regardless of where the relevant contracts are signed, where the income is paid or received, or the nationality, domicile or residence of the beneficiary. Income is considered to be from a Panamanian source where it is generated in Panama and where services are rendered in Panama.
Entities that generate Panamanian-source income generally are subject to a 25% corporate income tax. Taxable income or revenue for these purposes includes all income derived from business activities in Panama less expenses incurred wholly and exclusively in the production of taxable income or the preservation of the source of income. Net taxable income is the amount that results from deducting exempt income, foreign-source income, and deductible costs and expenses from gross income or general earnings.
Revenue in Panama must be recognized in the year in which it is earned. The tax base for taxpayers whose annual taxable income exceeds USD 1.5 million is calculated using two methods: the ordinary income tax calculation method and the alternate income tax or “CAIR” calculation method. The 25% tax rate applies under the former method and a 4.67% rate applies under the latter. The taxpayer pays the higher of the amounts calculated under these methods but must include the calculation in the annual income tax return.
Panama actively encourages foreign investment and operates several special regimes that provide various types of tax incentives, such as tax exemptions or rate reductions. Currently, there are 10 such regimes: free zone regime, SEM, Panama Pacific special economic regime, EMMA, Colon Free Zone, Baru Free Zone, Ciudad del Saber (“knowledge city”), Casco Antiguo, public-private partnerships and Agro parks.
The SEM regime is designed to attract and promote investment in Panama, create new job opportunities and develop technology to help the country become more competitive globally. The SEM regime provides tax, immigration and labour incentives to multinational enterprises willing to set up and operate a regional headquarters office in Panama that will only provide services to related group subsidiaries and affiliates (click here for prior coverage of the SEM regime).
A SEM license will be granted to a company that operates as a foreign company registered in Panama or as a Panamanian subsidiary owned by a multinational. Companies holding a SEM license may carry out the following activities:
- Management of regional operations;
- Logistics and storage;
- Technical assistance to group companies or customers that purchase a product or service from the company;
- Accounting and design construction plans for the headquarters or any subsidiaries;
- Consulting, marketing and advertising services for the group;
- Electronic processing and operations support;
- Research and development; and
- Financial assistance, including financial management, risk and credit analysis, due diligence, document custody, data processing and treasury services.
Companies operating under the SEM regime previously were exempt from income tax, but based on the 2018 changes, a 5% tax rate now applies to taxable net income derived from the above activities provided certain substance requirements are met. To meet the substance requirements, the company must:
- Carry out its principal activity(ies) within Panama;
- Maintain an adequate number of employees;
- Incur sufficient operating expenses to carry out the principal activity(ies); and
- File annual reports with the SEM Commission of the Ministry of Industry and Commerce that include the company’s financial audited statements, affidavits by the company’s legal representative and CPA who signs the corporate income tax return and detailed information on the company’s activities and income.
If the company fails to comply with the substance requirements, it will be subject to the normal corporate income tax rate of 25%, as well as interest, penalties and surcharges.
SEM companies must file an annual income tax return. Such companies may claim a tax credit for any income tax paid abroad on Panama-source income provided the foreign tax paid is at least 2% of the net Panama-source income; however, the credit may not be carried forward or back, nor can it be refunded.
Panama Pacific economic regime
Panama Pacific is an economic area located in the Arrajan district that offers special rules for legal, tax, customs, labour, immigration purposes and special businesses, for the establishment and operation of a Special Economic Area. Companies established under this regime must be located in the Arrajan district area.
In principle, companies established in the Panama Pacific area may carry out all types of activities that are not expressly prohibited by Panama’s health, safety and public order rules. However, showrooms for products that are sold wholesale internationally may not be established in other free zones or in areas that grant special tax treatment.
As was the case with the SEM regime, companies located in the Panama Pacific area previously were exempt from corporate income tax, but this was changed in 2018 when a 5% tax and substance requirements were introduced (see above under the SEM regime). However, it should be noted that the 5% corporate income tax rate applies only to certain activities, such as office management services, multimodal and logistics services, and call centres.
Companies operating under the Panama Pacific regime must file an annual income tax return. Such companies may claim a tax credit for any income tax paid abroad on Panama-source income provided the foreign tax paid is at least 2% of the net Panama-source income; however, the credit may not be carried forward or back, nor can it be refunded.
The EMMA regime is similar to the SEM regime, but it focuses on manufacturing activities provided for the benefit of affiliated or group companies rather than the provision of services (click here for prior coverage of the EMMA regime). Qualifying companies are granted beneficial tax, customs, labour and immigration treatment.
The EMMA regime is available only to foreign multinational companies that are registered in Panama or that have a Panamanian subsidiary and provide manufacturing-related services to members of the same group of companies. Activities that may be carried out under the regime are as follows:
- Services related to the manufacturing of products, machinery and equipment for group companies;
- Assembly services for products, machinery and equipment for group companies;
- Maintenance and repair services for products, machinery and equipment for group companies;
- Services related to the re-manufacturing of products, machinery and equipment provided to group companies;
- Services related to the conditioning of products provided to group companies;
- Product development services, research or innovation of existing products or processes for group companies;
- Analysis, laboratory testing or other services related to the provision of manufacturing services for group companies; and
- Logistics services, such as the storage, deployment and distribution of components or parts required for the provision of manufacturing services.
Companies with an EMMA license may set up in existing special economic areas in Panama or free zones.
Companies qualifying for the EMMA regime are granted several tax incentives, including a preferential 5% corporate income tax rate on net taxable income derived from the relevant activities. The same substance and compliance requirement apply under the EMMA regime as under the SEM and Panama Pacific regimes.