The General Tax System of Panama is deeply attractive to foreign investment and competitive at a regional level.

The General Tax System of Panama is deeply attractive to foreign investment and competitive at regional level. Our taxable income tax rate is lower than the regional average, our VAT is the lowest, we have no provincial taxation and the municipal taxation is minimal. There is no heterodox taxes in Panama, such as a financial transaction tax that exists in other countries, and interests on bank deposits are exempted. However, that same attractiveness as viewed from outside, suffers internally from severe distortions that promote unfair inequalities.

One of the causes of the imbalance has much to do with the recent debates. It is a fact that the existing legal framework of the income tax (ISR) of territorial source allows also the Tax Administration of Panama to be evaded by sophisticated taxpayers who use opaque corporate tax shelters conduits, to avoid providing their fair portion of tax. On this subject, we have already advanced some ideas in our article on November 12 last year, which can be read at the following link: The DGI needs agreements of tax information exchange

The essence of the issue can be summarized as follows: Certain taxpayers of high economic level benefit from the opacity of tax havens such as BVI, Bahamas, Belize, Cayman Islands, and others, in order to create mechanisms to reduce their tax payments in Panama.

The formulas are varied. From those jurisdictions, it is possible to create fictitious expenses for Panamanian taxpayers, through companies controlled by the same taxpayers in Panama, which invoice against the taxpayer in Panama in order to reduce their taxable base, by deducting those expenses.

The current situation allows the use of triangulation mechanisms to interpose ‘traders’ controlled by some Panamanian taxpayers. To provide a simple example, if they import 20 from Asia, they resell to Panama at 90; they leave 70 in the tax shelter without paying any tax. Then in Panama, the Panamanian taxpayer sells the products to the final consumer at 100 and reports to the Tax Administration a benefit of 10, while he had actually a profit of 80.

It is even possible to organize fake loans from abroad through companies linked to a taxpayer of Panama, with very high interest rates out of the market, payable from Panama, to generate high deductions of financial expenses. They reduce the tax in Panama, despite the withholding, and move part of the income to tax shelters with no or very low taxation. This scheme is much more effective for tax evasion when they combine it with the use of tax incentives that allow paying interests abroad without any withholding.

The most useful tool to combat these practices is the conventions for the exchange of tax information with tax shelters. Through them, the Panamanian Tax Department (DGI) could try to find who the final beneficiaries of the societies of those jurisdictions that have transactions with taxpayers of Panama are. It could determine if they have economic substance and are not just conduits for evasion. With that information, the DGI could better implement its other tools of control such as the tax evasion normative and the transfer pricing rules.

These measures of international tax transparency would help Panama to improve its tax collection to meet public needs, closing these areas of evasion that are used, above all, by large taxpayers.

Today Panama does not have these conventions referred to above. Therefore, the DGI has limited tools to combat these practices, which are not only illegal but also ethically questionable. They are a typical illustration of the inequality of the system, since they place at a clear disadvantage a large number of taxpayers, in particular individuals, who have to pay taxes on their wages and cannot use these tax cut options.

The inequality of the system is also reflected in the fact that, even if the overall system is competitive, there are in Panama many special regimes allowing a number of taxpayers to pay even less. The top example is the income tax exemption for the ports and the suppliers of ships crossing the canal. It is the exploitation of our geographical position. The wealth of the transit area should contribute to help the provinces; therefore, these exemptions on successful businesses go against Justice.

The Nobel Prize winner Joseph Stiglitz has written, “To make markets work as they are supposed to, a proper governmental policy is needed. But for this to happen, we need to have a democracy that reflects the general interest, not special interests or simply the interest of those above” (The price of inequality, Madrid, Taurus, 2012). I agree with that approach. Therefore, I think it is time that the Panamanian legal framework allows Panama to sign agreements for the exchange of tax information with the tax shelters, and at the same time to reduce the special regimes. This is an excellent way to progress towards a less unequal society, putting people first.

Publio Ricardo Cortés

DIRECTOR GENERAL DE LA DGI (Commissioner of the Tax Administration)

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The Article was originally published in La Estrella de Panamá on May 3, 2016. Reproduced here with authorization from the autor.

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