A Look at Panama’s Tax Reform

Panama’s current administration began its tax reforms with Law 49 of September 17, 2009 (Law 49/2009). That was followed by Law 69 of November 6, 2009 (Law 69/2009), Law 8 of March 15, 2010 (Law 8/2010), Law 33 of June 30, 2010 (Law 33/2010), and finally Law 31 of April 5, 2011 (Law 31 / 2011). All were implemented through formal laws and complemented with subsequent reforms in related executive decrees.

The new norms generally include changes to tax rates, tax collection means, efforts to improve the administration of justice in tax matters (a responsibility of the tax authority, the Dirección Nacional de Ingresos (DGI)), as well as the adaptation and inclusion of regulations in our fiscal code regarding the interpretation and application of income tax treaties. The latter have been promoted by the current administration in order to exclude the country from blacklists.

In some cases, these reforms pose interesting questions for practical and theoretical analyses and, at times, even a dose of social controversy. Such is the case with the increase of the percentage applicable to the ITBMS (impuesto a las transferencias de bienes corporales muebles y la prestación de servicios), Panama’s version of a VAT, which increased the rate from 5 percent to 7 percent and included specific goods and services exempt by law before the Law 8/2010 reform. Similarly, the taxable base of the property tax (impuesto sobre bienes inmuebles (IBI)) was increased, mainly to those subject to the horizontal property regime.

The reforms also extend the dividend tax with a 5 percent rate on taxable income from a foreign source or export revenues and exempt revenues (that is, bank deposits), to those legal entities having a notice of operation (commercial or industrial license to operate in Panama), or that at the same time also generate local revenues (such as a company operating within a special regime).

The companies located and operating within special regimes such as the Colon Free Zone, export processing zones, City of Knowledge (Ciudad del Saber), or the Panama-Pacific Special Economic Area are also affected with the equity tax (notice of operation tax — with a 1 percent rate and a minimum limit of US $100 and a maximum of US $50,000).

Regarding income tax, legal entities with operations generating taxable income within Panama were affected by the creation of a system for payments in advance. These payments in advance are applied monthly on the taxable income generated by those taxpayers at a 1 percent rate. The regulation indicates some exceptions and circumstances applicable to specific commercial and industrial cases.

Note, however, that the tax reforms did not only increase tax rates; income tax rates applicable both for individuals and legal entities were considerably decreased.

These reforms have also changed the fiscal administrative procedure. For instance, an administrative tax court, responsible for ruling on appeals against resolutions issued by the DGI, was created; the assumptions of facts and types were hardened by the classification of new activities as tax evasion, as well as stronger penalties applicable on this matter; and a base was laid for a more reliable administrative tax procedure.

Finally, Law 33/2010 introduced changes to the fiscal code regarding the interpretation and application of regulations for income tax treaties. One of these changes concerns the rules related to transfer pricing.

LAW 31 OF APRIL 5, 2011
The most important changes in Law 31 of April 5, 2011, are those regarding the dividend tax and the TBMS.

Dividend Tax
A new method is developed to apply the dividend tax to every loan or credit that the corporation grants to its shareholders. The applicable tax rate will be 10 percent, including those cases in which the tax rate is 5 percent (that is, corporations under the Colon Free Zone regime). The percentage will vary in the case of bearer shares, in which the corporation must withhold 20 percent as a dividend when a loan is granted to the bearer shareholder.

In cases not related to bearer shares, it is understood that the dividend tax with applicable 10 percent rate can be liquidated and paid to the DGI when the loan is granted to the shareholder or when the period’s net income is distributed to the shareholders.

The regulation indicates that the sums of money reimbursed by shareholders to the corporation in cases of loans or credits, to which the dividend tax had been applied, may be distributed among the shareholders without having to withhold the dividend tax again.
The regulation was implemented to put an end to tax evasion that existed when companies granted loans to their shareholders that were later never repaid. This was done to avoid the dividend tax on the period’s net profits and ‘‘conceal’’ the real distribution of net profits through loans without any commercial justification or repayment guarantee.

Beginning January 1, 2012, dividend tax paid or credited on cumulative preferred shares issued by legal entities will not be applied as long as they comply with caveats in the regulation, such as:
• that the subscription of the preferred shares is paid in cash and that the shares increase the capital of the legal entity;
• that the issuance of the preferred shares does not exceed 40 percent of the capital of the legal entities;
• that the interest rate (dividend) on the preferred shares does not exceed the reference rate set forth in article 1072-A of the Fiscal Code; and
• that the capital of the legal entity has not suffered a reduction during the two years immediately before the date of issue and as long as the shares are outstanding, except if it is to pay dividends.

Law 31/2011 states that the transfer of cement, additives, and their derivatives made by subcontractors to the contractors of the Panama Canal Authority (ACP) in the expansion works of the waterway are exempt from the ITBMS. The same applies to the future construction of the third bridge over the Panama Canal in the Atlantic sector (province of Colon). Likewise, imports of raw materials to produce cement for these projects by the subcontractors of the ACP contractors are exempt. Services related to the preparation and delivery on-site of cement, additives, and their derivatives performed by the subcontractors of ACP contractors, regarding the projects noted above and commented in Law 28/2006 (law about the expansion of the Panama Canal) will be free from paying ITBMS. This regulation also indicates that the goods noted above and included in this reform will also be free from ITBMS when imported.

The rationale of this new exemption lies in the exemption the ACP has at the constitutional level. The ACP cannot be taxed at all, and this includes the ITBMS. Since the contractors of the canal expansion works were not able to charge the ACP for the ITBMS they paid for their subcontractors, the contractors had to assume it and include the ITBMS within the costs of the interoceanic works.