Panama has introduced economic substance requirements that may expose some Panamanian entities to a new 15% tax on foreign passive income from tax year 2027. The new regime is narrow: it applies only to specific entities that are part of a multinational enterprise group, earn passive income, receive that passive income from foreign sources, and fail to meet Panama’s economic substance requirements.
The first question is whether the Panamanian entity is part of a multinational enterprise group, or MNE group.
Under the new law, an MNE group exists where:
- There are multiple entities linked by ownership or control, such as a parent company and subsidiary.
- Those entities are tax resident in at least two different jurisdictions.
- The group is structured so that the parent entity is required to prepare consolidated financial statements, or would be required to do so if publicly traded on a stock exchange.
If a Panamanian entity is not part of an MNE group, the analysis stops. It is not subject to the new economic substance law, does not need to show economic substance in Panama, and is not subject to the new 15% tax.
If the entity is part of an MNE group, the next question is whether the Panamanian entity earns passive income.
Passive income is described as income attributable to capital, including:
- Dividends
- Royalties
- Capital gains
- Rents
- Similar income
If an entity is part of an MNE group but earns only active business income, it is not subject to the new economic substance requirements and is not subject to the 15% tax.
If the entity is part of an MNE group and earns passive income, the next question is whether that passive income is foreign-source.
If the passive income is not foreign-source, the entity is not subject to the new economic substance regime and will not face the new 15% tax.
The entity falls within the scope of the new law only if all three conditions are met:
- It is part of an MNE group.
- It earns passive income.
- That passive income is foreign-source.
Qualified vs Non-Qualified Entities
Once an entity is within the scope of the new law, the next issue is whether it is a qualified entity or a non-qualified entity.
A qualified entity is one that meets the economic substance requirements in Panama.
This may include showing:
- Adequate personnel in Panama
- Proper compensation for personnel
- Offices in Panama
- Mind and management in Panama
- Decision-making activities taking place in Panama
If the entity meets these requirements, it is treated as qualified. In that case, even if it is part of an MNE group and earns foreign passive income, that foreign passive income remains tax-free in Panama.
A non-qualified entity is one that falls within the scope of the law but does not meet the economic substance requirements. Only in that situation does the new 15% tax on foreign passive income apply.
The 15% tax therefore applies only where:
- The entity is part of an MNE group.
- The entity earns passive income.
- The passive income is foreign-source.
- The entity fails to meet Panama’s economic substance requirements.
The tax applies from tax year 2027.
Panamanian Entity vs Panama Tax Resident
A Panamanian legal entity is not automatically a tax resident of Panama.
An entity may be formed under Panamanian law, such as:
- A private interest foundation
- A corporation
- A sociedad anónima
But it may still not be tax resident in Panama.
This matters because tax residence in multiple jurisdictions is one of the key elements in determining whether a structure is part of an MNE group. The ability to have a Panamanian entity that is not tax resident in Panama may therefore be relevant when analyzing or planning around the MNE definition.
Regulations Still Pending
The situation remains developing. The National Assembly approved the law and gave the president 90 days to issue further clarification.
The president cannot modify the law, but can determine how it will be enforced. Future regulations and guidance may affect practical compliance and planning.
Exceptions
The law includes narrow exceptions.
Entities are not subject to the economic substance law if they are:
- Involved in the financial services industry and directly supervised by Panama’s Superintendency of Banks or Superintendency of the Securities Market.
- Involved in the Merchant Navy, specifically owning and operating merchant vessels.
These exceptions are described as narrow and unlikely to apply to many entities.
Outsourcing Economic Substance
Economic substance requirements may be outsourced in Panama.
An entity does not necessarily need to establish its own office or hire its own personnel directly. It may be possible to hire local providers in Panama to meet the relevant substance requirements.
This approach is compared to the way economic substance can be handled in jurisdictions such as the BVI or Cayman Islands.
Tax Applies on a Net Basis
Where the new 15% tax applies, it applies on a net basis, not a gross basis.
This matters for businesses with actual expenses, because the tax is not imposed on gross foreign passive income before expenses.
Panama Compared With BVI and Cayman
The transcript emphasizes that Panama’s regime is narrower than economic substance regimes in some Caribbean jurisdictions.
In jurisdictions such as the BVI and Cayman Islands, every entity formed there is described as subject to economic substance requirements.
In Panama, the requirements apply only after a multi-step analysis. An entity must be part of an MNE group, earn passive income, receive foreign-source passive income, and then fail to meet substance requirements before the 15% tax becomes relevant.
The main caveat is that Panama’s new rules are complex and require entity-specific analysis. Headlines describing a general new 15% tax on foreign income in Panama are described as oversimplified. The regime does not eliminate Panama’s territorial tax system for all entities, but it does create a new risk for specific Panamanian structures connected to multinational groups and foreign passive income.
