NOTE: This article applies to corporations that are operating a business in Panama: those with offices, employees, and/or a physical presence. It does not apply to corporations or foundations that are used for asset protection, holding companies for bank accounts, etc.
Panama has adopted a set of transfer pricing regulations similar to the United States, and made them applicable to all related party transactions. The law change, contained in Law No. 52 of 2012, is effective for the tax year 2012, and taxpayers must file Form 930 by June 2013 to report related party transactions.
The legislative amendment also alters permanent establishment rules (tax residence) in Panama, for transfer pricing purposes. To ensure that the rules cannot be avoided by structuring transactions through individuals rather than companies, the amendment provides that an individual can also be deemed to constitute a permanent establishment in Panama. These rules thus apply both to natural and legal persons that reside abroad, and that are conducting operations in Panama, directly or by proxy, through an employee or agent that has a place of management, branch office, factory, workshop, installation, warehouse, shop, or other establishment in Panama.
So, what does this mean? It means that, if you are operating a business based in Panama, that business will be taxed on its worldwide income.
NOTE: The corporate tax rate in Panama varies by sector. If turnover is more than $200,000, corporate tax rates range from 25% to 30%.
Here is an example: You are operating a law firm on Calle 50, Panama City, Panama. You specialize is corporate formations and immigration law. Most of your corporate formation business comes from Americans and Europeans living outside of Panama.
In the past, you could form a subsidiary corporation in a country, such as the British Virgin Islands, that did not have a tax treaty with Panama. You could bill your American and European formation clients through your “offshore” company, and only pay tax on the income in Panama when you brought it in to Panama. The immigration component of your business is a “personal service,” thus was always taxable in Panama.
This loophole is gone. You are now required to disclose the offshore company and pay tax in Panama on any income earned in that entity which is the result of work done in Panama. In the example above, the BVI company has no employees, is just a holding company, and no value is being added by work done outside of Panama (in BVI). This means that 100% of the income in the offshore company is taxable in Panama.
Here is a second example: Let’s say you are operating an online publishing business with offices in Panama and Belize. Let’s assume that 30% of the work is done in Belize and 70% is done in Panama. Finally, let’s assume that Belize does not tax your business income because it comes from outside of Belize…mostly from subscribers in the United States and Canada.
In the past, you would bill your subscribers from your Belize company, transferring only what was needed to operate to your Panama company, thus effectively eliminating tax in Panama. Now, your best case scenario is that 70% of the income is taxable in Panama because 70% of the work is done is Panama.
How can this be the best case scenario? Because the Panama law says you must determine the value of the work done in Panama and the value of the work done in Belize, not just the quantity (man or woman hours), but the quality and worth.
If all of the company’s executives and decision makers are in Panama, and only a handful of lower paid call center workers are in Belize, then very little value may be attributed to Belize. It is possible that Panama would claim that 90% or more of the income is taxable.
Of course, whenever you have a significant tax law change, you have increased disclosures and compliance procedures. That is especially true in international tax, where your home country (Panama) does not have access to your offshore bank records.
To support the transfer pricing law change, Form 930 must be filed with the corporate tax return. In addition, the company must (1) maintain a transfer pricing report that supports the information presented on Form 930; (2) provide the transfer pricing report to the tax authorities within 45 days of a request being made; and (3) submit information about any multinational group to which the taxpayer belongs.
Item three means, if asked, you must prove who owns and who controls, any foreign corporation you do business with. If you are a member of a foreign corporation, you must disclose and prove who the other shareholders are. If you do significant business with a foreign entity, which you do not own, then you must be able to prove who does own and control that company.
As Panama steps up and taxes worldwide business income, one can only assume that they will begin to focus on compliance, fines, and punishment, as a means to enforcement. In the world of international taxation, extremely severe castigations are often exacted as a way to force compliance because traditional audits may not uncover ownership or control, and records may not be available to the Panamanian tax authorities.
by Chris Rusch, M.B.A., J.D.