Panama maintains 100% of its Territorial Tax Principle

Panama’s tax system is characterized by its territorial principle, a distinctive feature that has made the country an attractive global financial and business hub. This principle means that only income generated within Panamanian territory is subject to income tax, leaving exempt any income earned outside its borders, regardless of whether the taxpayer is an individual or a legal entity, national or foreign, domiciled in the country or not.

This principle is established in Article 694 of Panama’s Fiscal Code, which clearly states: “Individuals and legal entities earning income from Panamanian sources, wherever it is received, are subject to income tax.” In practical terms, this means that income derived from commercial activities or services performed exclusively within the national territory will be taxable, while profits obtained from operations conducted abroad will be exempt.

Impact of the Principle of Territoriality

The principle of territoriality not only defines Panama’s tax system structure but also plays a key role in its economy and in attracting foreign investors. Multinational companies, entrepreneurs, and independent professionals see Panama as a favorable jurisdiction to establish their operations, thanks to the absence of taxes on income generated outside the country. This benefit is particularly appealing to businesses managing global operations, as they can reduce their tax liabilities without compromising legality.

From a local perspective, this system allows residents and companies operating in Panama to focus their efforts on developing economic activities within the country, promoting the growth of the domestic market and fostering job creation. Additionally, the principle of territoriality has been a decisive factor in Panama’s rise as a logistical and financial hub, establishing it as a key destination for foreign direct investment.

Complementary Regulations

Despite the simplicity of the principle, it is important to clarify what constitutes “income from Panamanian sources.” According to current legislation, any income derived from economic activities performed within the national territory, including trade, service provision, or rentals, will be considered Panamanian-source income and, therefore, subject to income tax. For example:

• If a company provides services in Panama to clients within the country, that income will be taxable.
• If an individual rents properties located in Panama, the rental income will also be subject to tax.
  On the other hand, if a Panamanian company provides services abroad or conducts operations outside Panama, the profits derived from those activities will be exempt.

Clarifications on Territoriality in Panama

In recent years, Panama has reiterated its commitment to the principle of fiscal territoriality, seeking to ensure transparency and compliance with international standards in tax matters. For instance, through tax information exchange agreements with other countries, Panama has managed to balance its territorial system with the demands of international organizations such as the OECD. This demonstrates that although income earned abroad is not taxed, Panama remains committed to preventing its tax system from being used for illegal practices such as tax evasion.

Benefits for Investors and Businesses

Panama’s tax system offers several advantages to investors and businesses looking to optimize their tax burden legally. Some key benefits include:

1. Exemption of foreign income: Companies and individuals do not pay taxes on profits earned outside Panama, making it ideal for international businesses.
2. Ease of business operations: The clear distinction between local and foreign income simplifies financial and accounting planning.
3. Attractiveness for foreign investment: This system, combined with tax incentives for special economic zones and strategic sectors like technology and logistics, positions Panama as a prime destination for global investors.

A System in Evolution

Over the years, Panama has implemented reforms to strengthen fiscal transparency without compromising its principle of territoriality. These reforms include repealing laws deemed inconsistent with international standards and adopting measures to prevent money laundering and other financial crimes.

In conclusion, Panama’s principle of fiscal territoriality remains one of the fundamental pillars of its tax system and a competitive advantage that attracts businesses and investments. However, it is essential for both companies and individuals to clearly understand the implications of this system and comply with their local tax obligations. By doing so, they can benefit from tax advantages while contributing to the country’s economic development.