Historically, one of the major factors responsible for the 35,000 holding company and tax sanctuary operations established in Panama by foreign business-men has been the relative tax freedom. Panama does not assess any income tax income produced from sources outside the country, including the proceeds of sales made outside of Panama. This territorial method of taxation was only one of the many advantages of incorporating in Panama. Income earned within Panama, including the proceeds of sales made within the country, is subject to Panamanian tax.

The normal corporate tax starts at 30% on income up to 100,000 balboas ($100,000) and graduates to 42% on income over 500,000 balboas ($500,000). Corporate dividends and earnings of branches of foreign corporations are subject to a 10% withholding tax. Interest paid or credited to the account of a foreign lender is subject to a 6% withholding tax. Interest on bonds, notes and other registered securities is taxed a flat 5% withholding tax unless traded on a registered exchange in Panama. Royalties paid to a foreign movie or television production company or distributor also are subject to a 6% withholding tax. Companies also must withhold a 10.75% social security tax on employees' salaries.

Tax rates begin at 3,000 balboas ($3,000), and individual income is taxable at 52% between 3,000 balboas ($3,000) and 3,250 balboas ($3,250) or a tax of 130 balboas ($130), then falls to 4% between 3,250 balboas and 4,000 balboas ($4,000), rising to 33% between 50,000 balboas ($50.000) and 200,000 balboas ($200.000), and then dropping back to 30% over 200,000 balboas ($200,000), at which the tax amount payable is 59,905 balboas ($59,905). The first 3,000 balboas of income are not taxable. Employees also must pay a 7,25% social security tax on wages and salaries withheld by the employer.

Foreign companies, which do not buy or sell goods in Panama or the Colon Free Zone, are exempted from the 10% dividend withholding tax. Headquarters companies rendering services to companies and offices outside of Panama are exempt from income tax but pay the 1% business tax levied on declared capital, with the maximum 20,000 balboas ($20,000). Income derived from transfer of shares in companies established under Panama law engaged exclusively in activities abroad is tax-free as it is considered to be foreign-source income.

Small Business Concessions

Under Law 31 of 1991, special rules were adopted for small enterprises or micro-businesses earning less than $200,000 in gross income annually. The first $100,000 of income is taxed at personal tax rates and the next $100,000 of income earned by the micro-business is taxed at corporate tax rates. The micro-business is exempt from the retained earnings tax and withholding tax on dividend distributions.

In addition to the favorable tax situation, some of the other reasons for which Panama's corporate law is considered to be desirable are that there are no minimum capital requirements nor is there a time limit for issuing shares. Moreover, there is no requirement to file either tax returns or financial statements annually and it is not necessary to maintain a share register. Capital can be in United States dollars or any other currency and foreigners can serve as directors and/or shareholders.

Reduction on Exterior Operations

In order to qualify for tax reduction, the law states that the taxpayer must declare the income and pay the tax in a foreign country, which does not permit a credit of the total or part of the tax paid to Panama. However, companies operating the Colon Free Zone have an option to pay their taxes to Panama or to the country of the parent corporation of the Panama entity. Thus, the exterior operation profits earned on export shipments from the Colon Free Zone are not subject to tax. Reduced rates on income derived in the Colon Free Zone from manufacturing operations by taxpayers whose financial year began on or after May 1, 1975, are imposed at 2,5% up to 15,000 balboas ($15,000), 4% between balboas ($30,000) and 100,000 balboas ($100,000), and 8,5% over 100,000 balboas ($100,000). Colon Free Zone companies are exempt from withholding tax on distributions of export profits. Reinvested earnings may be taxed. Individuals are permitted to discount from their tax on income payable to exterior operations in the Colon Free Zone 0.5% of the net taxable income if there are from 30-100 national workers permanently employed, 1% of net taxable income if from 101 to 200 national workers are permanently employed, and 1.5% of the net taxable income if 200 or more national workers are permanently employed. Beginning as of January 1, 1976, individuals deriving 80% of their income from exterior operations during the first five years of operations may qualify for a 95% rebate on taxes payable provided that a minimum of 30 national workers are permanently employed.

The rebate is reduced by 5% during the three years following the 20% deduction permitted in the first four years. Wage payments may not exceed 15% of the salaries in collective contracts and the increase in number of workers employed may not produce an expansion of more than 10% in fixed assets.

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