4. Taxation

A. Introduction And Developments

Panama's taxation system is mainly territorial inasmuch as, generally speaking, only income earned from Panama sources or in respect to assets located in Panama is taxed. Income that is not derived from activities carried out in Panama is not subject to taxation. This territorial principle partially accounts for the successful development of Panama as a base for international operations.

Corporations, branches of foreign corporations, limited liability companies, private interest foundations and any other entity considered as a juridical person by law, are subject to a 25 per cent income tax. In the case of trusts, the trustee is deemed the taxpayer and the income tax rate applicable to the trust is generally that applicable to juridical persons since virtually all trustees are juridical persons. Income derived from offshore activities is not subject to income tax for trusts, private interest foundations and corporations. No tax returns are required to be filed by trusts, private interest foundations or corporations carrying out activities exclusively outside Panamanian territory.

B. Tax System: General Concepts Of Tax Regime

I. International Tax Matters

Since 2009, Panama has negotiated treaties for the avoidance of double taxation with Mexico, Italy, Belgium, Barbados, The Netherlands, Qatar, Spain, France, Luxembourg, Portugal, South Korea, Singapore, Ireland and Czech Republic. Panama has ratified the tax treaties with Mexico, Barbados, Portugal, Qatar, Luxembourg, Spain, The Netherlands, Singapore, South Korea and Italy. Nonetheless, only the tax treaty with Mexico is in force as of 2011. The rest of the treaties ratified would be in effect as of 1 January 2012.

Double taxation treaties generally include rules concerning, among other things, the determination of the tax residency of persons, the allocation of the taxing authority of various taxable events among the treaty parties and the treatment afforded to taxes paid in the other treaty party. The tax treaties also provide for reduced income tax withholding rates on payments from Panama to the treaty countries.

Furthermore, in June 2010 Panama amended the Tax Code to include provisions regarding the formation of international treaties for the avoidance of double taxation.

Finally, Panama has negotiated, signed and ratified a tax information exchange agreement with the US, which took effect from 18 April 2011.

Panama does not impose foreign exchange controls.

Ii. Taxation Of Trusts

Tax treatment for trusts whose assets are located outside of Panama differs from that of trusts with local assets. If trust assets are located abroad, or consist of monies deposited in trust by settlors whose income is not taxable in Panama, or if the trust assets comprise shares or securities of any kind issued by companies whose income does not derive from Panamanian sources, capital gains and income of any kind derived from such assets are exempted from all taxes, assessments, fees or charges, even if such monies, shares or securities have been deposited in the Republic of Panama. In such cases, no capital gains tax is levied on the settlor when assets are transferred to a trustee to be held in trust. In general, the same rule applies to private interest foundations.

In turn, taxation of trusts constituted over assets located within Panama must be analysed from at least three different perspectives: the constitution and the transfer of the assets to the trustee, the administration of the trust assets by the trustee and the distribution of the trust assets to the beneficiaries. From the first perspective, the transfer of the assets by the settlor to the trustee is subject to the transfer taxes that would normally apply to transfer of the relevant assets between ordinary parties. Notwithstanding, no transfer tax would be levied on transfers made by the settlor to the trust, provided that the trust is created as collateral of indebtedness or other obligations.

Second, once the trust has been constituted, any income generated by trust assets located or invested in Panama during the life of the trust is subject to the same income tax rates applicable to the relevant trustee.

Finally, any transfer made by the trust to the beneficiaries of assets located within Panama would be subject to the ordinary transfer taxes. Notwithstanding, no transfer tax applies to the transfer of assets made by a trustee of a collateral trust to the settlor once the secured obligations have been paid and discharged in full by the relevant borrower.

The distribution of assets located in Panama by a private interest foundation to its beneficiaries is not subject to transfer taxes if the transfer is made by the foundation to the parents, children or spouses of the founder of the foundation.

Beneficiaries, wherever located, are not taxable when not in receipt of income.

Iii. Taxation Of Estates

There is no estate tax in Panama.

Iv. Other Taxes

Other taxes that could potentially apply to a trust depending on its activities or the assets held by the trust are the value added tax applicable on the sale or transfer of any tangible chattel properties and rendering of services, import duty, immovable property tax, immovable property transfer tax, commercial and industrial licences tax, stamp duty and others.

V. Estate-planning Issues

Estate-planning structures (trusts and private foundations), combined with Panama corporate entities and/or foreign instruments or offshore entities, are commonly used within and outside Panama for wealth management, estate-planning and asset protection.