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Article Courtesy from
Business Panama
Panama - An Overview of the 2005 fiscal reform
By Rafael Rivera Castillo
General Comments
Recently, the Government enacted Law No.6 of 2005 whereby the Fiscal Reform, as
styled by the Government, was passed. This law was published in Official Gazette
No.25, 232 dated 3rd February 2005. The final version of this Fiscal Reform is
in line with the fundamental criteria of territorial taxation applicable in
Panama. In other words, income derived from offshore activities will remain
untaxed. No tax returns will need to be filed nor will reports to Tax
Authorities be required from companies or legal entities carrying out their
activities exclusively outside Panamanian territory.
Nevertheless, when it comes to foreign investment within Panamanian territory,
the new provisions may create several Income Tax issues for individuals or
companies engaged in activities both within and outside the Republic of Panama.
It should also be stressed that the new Fiscal Reform – apart from minor
modifications – follows the line of expanding the taxable base concerning
indirect taxation advocated in the 2002 Tax Reform. In other words, the
inclusion of the “services sector” as part of the taxable supplies subject to
Value Added Tax – known in Panama as ITBMS - has remained in the text of Law
No.6 of 2005.
Annual Franchise Tax
New Incorporations
Under the new rules, every new company or private foundation will be required to
pay a US$250.00 franchise tax at the time its articles of incorporation are
filed with the Panamanian Public Registry. Starting from their second year,
companies and private foundations will be required to pay a US$300.00 annual
franchise tax.
Existing Companies
For existing companies and private foundations, the annual franchise tax will be
increased to US$300.00 per year (from US$250.00 per year). Such an increase will
become effective as of 1st January 2006. – This means that for the year 2005,
all companies and private foundations will pay the current annual franchise of
US$250.00.
Payment Periods
The first payment of the annual franchise tax of companies and private
foundations will be made at the time of their incorporation. Subsequent payments
will be made: (a) on 15th July of every year (for entities incorporated between
1st January and 30th June ) or (b) on 15th January of every year (for entities
incorporated between 1st July and 31st December ). Formerly, payments were due
on 30th June and 31st December, respectively.
Fines and Penalties
Companies and private foundations that have not paid the respective annual
franchise tax for two (2) or more consecutive or alternate one-year periods will
be subject to a US$300.00 fine (increased from US$250.00). The penalty for late
payment remains at US$50.00 per one-year period.
According to the new provisions, every company or private foundation having ten
(10) consecutive delinquent periods will be subject to a statutory dissolution
procedure (i.e. the company or private foundation may not continue to carry on
with its existence and has to liquidate its assets and liabilities). Such legal
entities will be subject to a definitive de-registration at the Public Registry.
Moreover, it is important to note that fines ranging from five (5) to ten (10)
times the amount of the franchise tax owed to the Panamanian Treasury will apply
for persons (individuals or legal entities) who have received funds for paying
the annual franchise tax but have not in fact, settled such sums in accordance
with the provisions set forth in the Law.
Income Tax
Income derived from Personal Services (Presumptive Source Rule)
According to the newly introduced Paragraph 1-A of article 694 of the Fiscal
Code, income derived from personal services will be considered originated from a
source located within Panamanian territory –even though such personal services
may be physically and actually rendered both within and outside Panamanian
territory - if the individual taxpayer resides in the Republic of Panama for at
least 70% of the calendar days of any given year.
The aforementioned rule only applies to income from personal services, such as
wages, salaries and other personal remunerations. Therefore, only individuals –
and not legal entities of any type- will be obliged to apply this provision.
Other income (dividends, pension payments and interest, for example) is not
covered by the new rule.
Any individuals rendering services outside Panamanian territory on a temporary
basis (for example, consultancy services, professional presentations,
conferences and the like) may benefit from exclusion from this presumptive
Panamanian source rule. This could be the case even where these individuals do
not reach a percentage exceeding 30%, which the general rules requires for
reporting foreign source income.
Employment Income (Expense Allowances and Fringe Benefits)
As of February 2005, employees who are paid what is known as Gastos de
Representación (or expense-allowance) will be subject to the Income Tax
withholding applicable in general terms to salaries and wages. The main
difference is that the Income Tax to be withheld from this kind of remuneration
will be a fixed rate of 10%. This rule will apply to employees from both the
public and private sectors.
Individuals will continue to file an Income Tax return including this specific
type of remuneration and assessing the tax due at the progressive Income Tax
rates provided for in article 700 of the Fiscal Code.
Moreover, fringe benefits such as housing for company executives or the use of
cars, recreation or vacation packages, educational costs and others are now
included in the text of article 696 (a) of the Fiscal Code, as specific types of
gross income for Income Tax purposes. The only exclusion provided in the Law
refers to medical insurance provided by employers to their employees.
The main difficulties relating to the application of this new rule concern the
assignment of a specific monetary value to certain fringe benefits and the lack
of any schedule or reference in the Law in this regard. So far, Panama’s Tax
Administration has specified that fringe benefits will not be subject to the
withholding procedures but will be included in the individual tax returns of
beneficiaries.
Income earned by Non-residents (The Withholding Mechanism)
According to the newly introduced Paragraph 1-B of article 694 of the Fiscal
Code, all payments remitted abroad to beneficiaries not resident in the Republic
of Panama shall be subject to Income Tax withholdings if (1) payments are
related to the generation of income within Panamanian territory or the
conservation of a source of income located within Panamanian territory and (2)
the payments are considered to be deductible expenses by the payer operating
from Panama.
This provision is not restricted to a specific kind of income. Instead the law
specifies that it shall cover all sorts of payments arising from any services or
acts, whether documented or not, that benefit individuals or legal entities
established within Panamanian territory. As examples, a non-exhaustive list of
payments subject to the new rule has been inserted: fees and income relating to
intellectual property rights, royalties, know-how, technological or scientific
knowledge and the like.
Nevertheless, the taxable base for application of the Income Tax rates (article
699 for legal entities established abroad and article 700 for individuals
domiciled abroad) is not the total amount of the payment remitted, but only 50%
of such payment.
Last but not least, it is important to stress that Paragraph 1-B of article 694
of the Fiscal Code specifies certain cases where the withholding does not apply.
This is the case of individuals or legal entities engaged in “international
business activities” and carrying out operations outside Panamanian territory –
even if such operations is required to report income originating in the Republic
of Panama.
As the provision specifies, this category of taxpayers shall not consider any
payments – for goods or services totally financed, contracted or executed
outside Panamanian territory – to be Panamanian source income. In other words,
such payments will not be subject to any withholding tax.
Several questions remain as to the application of the aforementioned exclusion.
What activities may be considered to be “international business activities”?
What about services rendered within Panamanian territory but for the consumption
and benefit of clients located abroad –no tax deduction attached to such
payments-?
We should bear in mind that the provision itself refers to (1) a taxpayer
domiciled within Panamanian territory and obliged to report income to the Tax
Administration, and not to “pure” offshore activities which are not subject to
reporting, and (2) it only requires that certain operations of the taxpayer are
carried out outside Panamanian territory – in other words, the provision does
not imply that 100% of the taxpayer’s operations are carried out abroad.
As interpreted by certain analysts, this exclusion rule is aimed only at
so-called “pure” offshore transactions. I do not agree with this interpretation
of the provision since, as mentioned before, the wording of the text refers
specifically to taxpayers obliged to report income to the Tax Authorities and
that would not be the case of such offshore businesses.
This is yet another issue that the Tax Administration will clarify in the
Regulations soon to be issued and published, a situation that is clearly against
the principle of certainty and legality that should be the cornerstone of every
tax system.
Minimum Income Tax (Presumptive Taxation)
The concept of presumptive taxation is linked to a deviation from material
reality and the use of indirect means to determine tax liability, disregarding
the actual and concrete situation of a taxpayer. Examples of presumptive
taxation can range from the reconstruction of income earned by the taxpayer to
true minimum taxes with the tax base specified by the law. The latter (statutory
minimum taxable base) was the legislative decision adopted in the new text of
articles 699 and 700 of the Fiscal Code.
According to the new rules, the net taxable income of a legal entity will be the
higher of (1) the amount resulting from application of the ordinary Income Tax
rules (gross income minus deductible expenses minus deductible allowances equals
net taxable income), or (2) the amount equivalent to 4.67 % of the gross income
earned by the taxpayer. Consequently, in any given case, it may be that the
actual net income earned by the taxpayers is far less than the fixed 4.67 %
presumptive taxable base set forth in the tax law.
Whenever the effective Income Tax rate exceeds 30% of the net taxable income
earned by a taxpayer, a waiver may be obtained from the Tax Administration and
no presumptive taxation will apply. The same will apply in the event of losses
for taxable purposes. The waiver may be granted for a maximum period of 4 fiscal
years (the year for which the waiver is granted and the 3 subsequent fiscal
years).
A somewhat similar rule was introduced for individuals earning more than
US$60,000.00 per year. Nevertheless, in such cases the statutory presumption
does not refer to the taxable base, but the Income Tax itself. The presumptive
Income Tax in these cases is set as a fixed percentage of the gross income
earned by the taxpayer. As a consequence, it is assumed that the Income Tax
liability of individuals will be the higher of (1) their Income Tax liability
taxed in accordance with the ordinary rules, or (2) an amount equal to 6% of
their gross income earned in a given taxable year.
In the case of individuals, a waiver may be obtained from the Tax Administration
only in cases of losses -as determined for tax purposes- but not in cases where
the effective Income Tax rate could exceed the tax liability that could have
arise in accordance with the ordinary rules.
If a presumptive tax method is adopted, it shall need to take into consideration
legal constraints, including constitutional constraints, such as equity before
the law and confiscation of property. From the actual application of these new
rules, there may be several cases where taxpayers will be taxed on a
disproportionate basis owing to the fact that legislative presumptions do not
take into account the economic reality of an activity or transaction.
ITBMS Taxation
As mentioned before, the new Fiscal Reform is in line with the expansion of the
taxable base in respect of indirect taxation advocated in the 2002 Tax Reform.
Despite several unconstitutionality claims filed with the Supreme Court of
Justice in early 2003 –which are still pending a final decision - against the
imposition of indirect taxation on fees charged for services rendered by
professionals within the Republic of Panama, the inclusion of the “services
sector” – including “professional services” among the taxable categories subject
to Value Added Tax – domestically known as ITBMS - has remained unchanged in Law
No. 6 of 2005.
Minor changes concerning ITBMS taxation are: (1) the inclusion of other tobacco
derivatives – besides cigarettes – subject to a higher tax rate of 15%; (2) the
exemption of consumption in restaurants that do not serve alcoholic beverages –
mainly fast food chains; and (3) a clarification concerning the exemption of
export services, specifying that not only “legal” services, but also any other
kind of professional services will not be considered taxable items for ITBMS
purposes if the beneficiary is a person not resident in the Republic of Panama
and not earning any income from any source located within Panamanian territory.
Another aspect related to the application of ITBMS taxation – which has not yet
been widely discussed in any forum - relates to the new source rules introduced
for Income Tax purposes in Paragraphs 1-A and 1-B of article 694 of the Fiscal
Code. Even though it now appears evident that under the aforementioned
regulations the range of the concept of “Panamanian source income” has been
expanded to cover activities that may be conducted outside Panamanian territory,
the consequences thereof are not exactly the same in ITBMS taxation.
Moreover, these are two very different taxes. Each tax is drafted in line with
its very own nature and main features. In fact, law provisions applicable to
either one are inserted in separate sections of the Fiscal Code. Consequently,
each independent set of provisions is not applicable to issues related to the
other tax.
Therefore, it may be the case that tax is withheld for Income Tax purposes on
the basis of Paragraph 1-B of article 694 of the Fiscal Code, due to the
“expanded Panamanian source income” concept. Nevertheless, no ITBMS taxation
would be levied since the service could be completely provided from a foreign
jurisdiction. As provided for in Paragraph 3 of article 1057-V of the Fiscal
Code, taxable supplies are subject to ITBMS taxation only insofar as the
supplies are rendered within Panamanian territory. In other words, if the
rendering of services is carried out abroad, no ITBMS taxation shall be
assessable, even though Income Tax may be assessed on the basis of Paragraphs
1-A and 1-B of article 694 of the Fiscal Code.
Real Property Tax
A new schedule of progressive tax rates applicable to Real Estate property has
been inserted as article 766-A of the Fiscal Code. The new tax rates will only
be applied to immovable property that has been subject to a new assessment of
its cadastral value. The tax rates are as follows:
Regular Tax Rates
1.75% on any value exceeding
US$20,000.00 up to US$50,000.00
1.95% on any value exceeding
US$50,000.00 up to US$75,000.00
2.10% on any value in excess of US$75,000.00
New Tax Rates
0.70% on any value exceeding
US$30,000.00 up to US$50,000.00
0.90% on any value exceeding
US$50,000.00 up to US$75,000.00
1.00 % on any value in excess of US$75,000.00
The main purpose of this measure is to expedite the process of updating the
cadastral value of real property in the Republic of Panama. The Ministry of
Economy and Finance will review and approve the new value assessed for the
property. The period granted for updating cadastral values will end on 2nd
February 2006.
Up to 30th June 2005, owners of real estate property may pay any past due Real
Estate Tax without any interest or penalty if the requirements as to the new
assessment of the cadastral value are fulfilled.
Tax on the Transfer of Immovable Property
All the different kinds of transfers of real estate property will be subject to
a 2% tax, including donations or non-onerous transfers. Only transfers between
spouses or between parents and children will be considered to be tax free
transfers.
The new wording of article 1 of Law No.106 of 1974 poses questions as to the
taxability of transfers made under a trust arrangement or under a private
foundation charter (when assets are transferred both to or from these separate
estates). Even though most of these transfers are made without any intent to
obtain profits, the concept of taxing transfers of real property – even without
any profitability expectations - does create the need to analyze the tax
treatment of these arrangements.
On the other hand, the option of paying a 5% fixed Income Tax rate on any gain
arising from the transfer of real property has been removed. Instead, article
701 (a) of the Fiscal Code now provides for a new regime assessing a tax
liability at a 10% fixed Income Tax rate, only if one of the following
conditions is met: (1) if the immovable property has been one of the owner’s
assets for a period of more than 24 months, or (2) if the transaction does not
form part of the ordinary course of the owner’s business.
In any other case, the owner of the immovable property will be obliged to pay
the Income Tax levied on any gains derived from the disposal of real estate
property on the basis of the general rules set forth in the Fiscal Code.
Private Placements of Securities
The Fiscal Reform also modified an exemption relating to a subsidy surcharge (FECI)
on credit facilities granted by local banks through private placements of
securities issued by their clients. As provided for in the new text, such
structured financial arrangements shall only be considered as exempt from the
subsidy surcharge (FECI) if the securities issued are registered with the
National Securities Commission (Comisión Nacional de Valores).
Recently, the Banking Superintendent issued an administrative circular
concerning the Ministry of Economy and Finance’s position as to the obligation
of levying the subsidy surcharge (FECI) for private placements subscribed before
3rd February 2005 (the date on which the Fiscal Reform entered into force). As
provided for in Circular No. 003-2005 (FECI), the Banking Superintendent
submitted that the subsidy surcharge (FECI) is to be assessed only on issuances
subscribed on or after 3rd February 2005.
Conclusions
As may be ascertained, the newly enacted Fiscal Reform focuses mainly on changes
to the Panamanian Tax System. Therefore, stress has been placed on the analysis
of the tax related measures adopted through Law No.6 of 2005.
Many of the issues discussed in this document and several others (such as the
elimination of certain incentives for companies protected by the Investment
Stability Law – Law No.54 of 1998 - or the application of certain provisions of
the law in practical cases) were left unanswered by lawmakers and advisers of
the Ministry of Economy and Finance during the process of passing the original
bill into law.
As a consequence, many situations will be defined through the Regulations to be
issued by the Ministry of Economy and Finance. Needless to say, the limits and
criteria set forth in Law No.6 of 2005 shall be observed when drafting the
Regulations. Any excess in the regulatory provisions will generate reactions
from all sectors of the economy involved. Perhaps the Government will use this
interval to receive more feedback from the business community as to the best
options for ensuring the application of the law to day-to-day economic
activities.
Rafael Rivera Castillo is a lawyer who holds a Master’s degree (LL.M.) in
International Taxation and is experienced both in Tax Administration and private
tax consultancy. He is currently on the legal staff of MOSSACK FONSECA & CO.
You may contact Mr. Rivera at ( rarivera@mossfon.com ) or
by visiting his firm’s website: (
http://www.mossfon.com ).
Article Courtesy of Business Panama
The American
Chamber of Commerce (AMCHAM)
and Deal Inc.
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