Luis Laguerre, Partner, KPMG in Panama, on tax treaties and Panama’s international financial services cluster

Luis Laguerre, Partner, KPMG in Panama

Since its emergence from the ocean to unite North and South America, Panama has been the preferred crossroad of the Western Hemisphere. During the Spanish colonial period the fairs of Portobelo, located on the country’s Atlantic Coast, were very popular. Merchants from all over both continents visited them to sell and showcase their products. At that time, Panama was also the transit route for Peruvian gold being shipped to Spain. Similarly, during California’s gold rush the old Camino de Cruces, or “crossroad”, was the location for the construction of the first interoceanic railroad, which facilitated commerce through the isthmus.

Panama’s destiny as a centre of global commerce has been built upon two significant milestones: the construction of the Panama Canal and the consolidation of the banking sector. These two key factors added to others, such as the use of the US dollar as the country’s legal tender, the corporations’ law and a vibrant community of business and professional leaders, which combined have resulted in the appropriate conditions for the creation of an international financial services cluster. One of the key elements of the financial services cluster is the local taxation system. The basis of Panama’s taxation system is the principle of territoriality, which stipulates that only income produced within Panamanian territory is subject to tax.

The nature of our tax system permitted it to develop almost independent of the principles that now guide international taxation. However, the phenomenon of globalisation, which has shortened distances and made countries more interconnected, made it impractical to continue this sort of isolation. It became necessary to cooperate with foreign tax administrations. Therefore, the global economic environment at the end of the 20th century and the 2008 fiscal and financial crisis in the developed world created the conditions that enabled Panama’s integration with international standards to become a reality.

It is under these circumstances that Panama has embarked upon efforts to negotiate treaties that will mitigate against double taxation for residents. This is the primary method of implementing cooperation with foreign tax authorities. However, given the stability of the tax system, based on the territoriality principle, questions have been raised as to whether it is necessary to harmonise the taxing rights with foreign countries. Treaties to avoid double taxation are not an end in and of themselves. They serve the purpose of granting juridical certainty that attracts foreign investment. Investors can properly establish the taxation costs of their operations and when such activities may be taxed by two or more authorities in different jurisdictions. The financial services sector is, therefore, fostered by these developments, since the number of companies selecting Panama to establish operations is increasing significantly. Panama’s treaty network becomes another aspect that adds to the wide range of attributes the country offers to foreign investors.

Tax treaties also grant assurances to investors regarding the discriminatory measures another country may implement against Panama, since all treaties agreed upon by Panama include a non-discrimination clause. Cooperation among tax administrations is performed through the exchange of information, which grants transparency to the international financial system with regard to taxes. With the development and negotiation of tax treaties Panama had to introduce legislation that facilitates the application of these treaties. Transfer pricing legislation, for example, was drafted utilising the Organisation for Economic Cooperation and Development’s guidelines. These rules permit multinational firms to establish cross-border, intra-group operations using globally accepted principles.

Although Panama stagnated in its past efforts to update the local tax system to the requirements of a globalised economy, the swift implementation of updates now will permit the financial services cluster to consolidate. Additionally, it will enhance Panama’s ability to serve the international business community with the efficiency that has made it a global centre.

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