Economic Substance Rules for Foreign-Source Passive Income

Law 526, enacted on May 28, 2026, introduced a new chapter to the Tax Code establishing economic substance requirements applicable to certain foreign-source passive income. Its provisions will apply starting from the fiscal period 2027.

In the Republic of Panama, under the territoriality principle, foreign-source passive income is not subject to any form of taxation. The new law preserves this principle, but now conditions it for entities that are part of a multinational group. In order for their foreign-source passive income to remain exempt, they must have real economic substance in Panama and demonstrate it to the authorities.

Key point: determining whether your structure qualifies as a “multinational group”

These rules apply exclusively to entities (corporations, limited liability companies, private interest foundations, etc.) that are part of a multinational group, defined by the law as “a group of two or more entities, linked by ownership or control, that are tax residents in different jurisdictions, including the parent company, subsidiaries, and permanent establishments.” In general terms, an entity is considered a tax resident in a country when, under that country’s rules, it is subject to taxation there.

Therefore, the rule applies when two elements are present: i) that the structure includes entities with tax residence in different jurisdictions; ii) and it generates foreign-source passive income.

Foreign-source passive income

This refers to income derived from the holding of assets or capital, rather than from active business operations. It includes six categories: dividends, interest, royalties, capital gains, real estate capital income, and other income from movable capital.

Implications: Qualified vs. Non-Qualified Entity

Only entities that are part of a multinational group and earn foreign-source passive income will be required to comply with economic substance requirements and to annually report such income to the authorities.

Entities subject to this regulation that meet the economic substance conditions and comply with the annual reporting obligation will be considered qualified entities.

Entities that fail to meet the economic substance requirements or the annual reporting obligation will be treated as non-qualified entities, and their foreign-source passive income will be subject to a 15% tax rate on taxable net income for the relevant fiscal period.

Pending regulation

The law will be regulated by the Executive Branch within ninety (90) days following its enactment. This regulation will define key aspects, meaning that any case analysis should also take into account the forthcoming provisions.

The specific scope of these rules will vary depending on the characteristics of each structure. Our team remains available to advise you on this regulation and its application. We invite you to contact us to timely assess how this new framework may impact your particular case.