Panama enacts further tax reform

Panama Law No. 8 of 15 March 2010 (2010 tax reform) contains comprehensive amendments to Panama's Fiscal Code, including a reduction in the corporate and individual income tax rates and an increase in the current VAT rate. This is the second in a set of tax reforms in the past six months as the government seeks to collect revenue to fulfill its education, health and social projects. Law No. 49 of 2009 that became effective in September 2009 introduced, as a preliminary step in reform, major changes to the tax system, such as extending the dividend tax to apply to dividends paid out of foreign-source profits and those paid by companies located in one of Panama's free zones.

The 2010 tax reform generally takes effect on 1 July 2010, although the reductions in the corporate and individual income tax rates are already in effect and retroactively apply as from 1 January 2010.


Corporate income tax rate

The 2010 tax reform reduces the corporate income tax rate for many entities from 30% to 27.5%, retroactive as from 1 January 2010. The rate will be further reduced to 25% as from 1 January 2011. The corporate income tax applies to corporations, limited liability companies, partnerships, branches of foreign corporations and any other entity considered a juridical person by law. Such entities also are required to make an alternative calculation of taxable income for purposes of the Panamanian alternative minimum tax (CAIR), which is calculated on a percentage of gross taxable revenue. The higher of the two calculations is generally considered the income tax liability for the year, although taxpayers can request nonapplication of the minimum tax if they have net operating losses or their effective tax rate is higher than the nominal income tax rate. The 2010 tax reform eliminates the CAIR calculation for companies with taxable revenue of less than USD 1,500,000.

The 30% income tax rate will remain in effect for two years for certain entities, i.e. those engaged in the insurance and reinsurance business, banking services, certain financial services, the generation and distribution of electricity, telecommunications services, gaming and casinos, mining and the fabrication of cement. The rate will reduce by 2.5 percentage points on 1 January 2012 (i.e. to 27.5%) and will be further reduced to 25% on 1 January 2014. The same rates will apply to a subsidiary and/or affiliated company the main activity of which is to provide services to one of the above entities.

Companies in which the government has a participation of more than 40% will remain subject to the 30% income tax rate.


Dividends

The 2010 tax reform clarifies when a distribution of dividends is subject to tax and specifically indicates the situations that trigger the tax. As part of the 2009 tax reform, all companies that have a "Notice of Operations" are required to withhold a 10% tax on dividends paid out of domestic profits and a 5% tax on dividends paid out of foreign-source profits. Companies located in a Panamanian free zone must pay a 5% dividend tax on the distribution of profits, regardless of the source of the profits (and also must have a Notice of Operations permit).

Under the 2010 amendments, dividend tax withholding will apply not only when an entity holds a Notice of Operations permit (which was the only condition to apply this tax) but also if it generates taxable income in Panama or carries on operations in the Colon Free Trade Area or a Petroleum Free Zone, regardless of whether it holds a Notice of Operations permit. The following companies are exempt from the dividend tax: licensed multinational headquarters, certain companies operating in the Panama-Pacific Special Economic Area and Panamanian companies whose operations are completed, used or take place abroad with no links to the Panama market. The new rules also provide that, when a tax treaty applies, the treaty provisions will prevail over domestic legislation.


Individual income tax rates

Retroactive as from 1 January 2010, the top progressive individual income tax rate is reduced from 27% to 25% and the taxable income brackets are broadened to bring more taxpayers within the tax-exempt bracket. The new rate scale is as follows:

Taxable income (USD) / Tax amount / % on excess
0-11,000                             0                   0%
11,000-50,000                     0                 15%
Over 50,000                     5,850              25%


Value added tax

The value added tax (VAT), which is assessed on the provision of goods and services, will increase from 5% to 7% on 1 July 2010.


Miscellaneous

Tax Deductions – The reform introduces limits on the deductibility of business expenses. Currently, expenses incurred wholly and exclusively for the production of taxable income or for the conservation of its source are deductible for income tax purposes. The allocation of expenses among various sources of income is carried out primarily by tracing the cost and/or expense directly to the source of income it aims to produce and/or maintain. Expenses incurred to obtain different sources of income (e.g. taxable, exempt and/or foreign-source income) may be deducted in proportion to the taxpayer's total income. Under the new rules, an apportionment formula (the proportion of the taxpayer's domestic gross income to its total gross income) will be required to calculate allowable deductions, even if – in most cases – the expenses can be traced directly to the relevant source of income. However, expenses such as bad debts, donations to charitable organizations or the government, the Notice of Operations tax, technical costs related to insurable risks assumed by an insurance company and any other expense the tax authorities consider as able to be directly traced will be excluded in the apportionment formula and instead will be traced and deducted directly from their source of income (taxable, exempt or foreign). The authorities are expected to issue supplementary regulations addressing this issue.

Advance payment of tax – The reform makes changes to the advance payment of corporate income tax. Companies in Panama currently are required to estimate the next year's income tax liability based on the actual taxable income of the previous year and make three advance payments of tax in equal installments (June, September and December). Any excess tax paid may be used as a credit against the following year's estimated income tax. Under the 2010 tax reform, companies will be subject to a monthly advance payment of 1% calculated on gross taxable income, with any adjustment between the actual income tax assessment and the monthly advance payments made in the annual income tax return. Excess tax paid will be available as a credit against future monthly advance payments, used to pay another type of tax or be refunded.

Tax on banks and exchanges houses – The annual progressive tax on banking institutions holding a general license, which is based on total assets, will be between USD 75,000 and USD 1 million. International license banks will pay a fixed tax of USD 75,000. The tax currently is capped at USD 35,000.

Tax on international transportation companies – Income of international transportation companies derived from freight, passage, cargo and similar services whose origin or final destination is Panama is deemed to arise in Panama and, therefore, is subject to tax in Panama, regardless of where the company is incorporated, domiciled or resident. Currently, no credit or deduction is granted for foreign tax paid on such income; as from 1 July 2010, tax paid in a foreign jurisdiction and related to income subject to tax in Panama will be deductible for Panamanian income tax purposes against other income related to international transportation.