New Panama Economic Substance Rules for Foreign Passive Income

Panama Adopts New Economic Substance Rules for Certain Foreign-Source Passive Income: What Does This Imply for International Structures?

The National Assembly of Panama has approved new legislation introducing economic substance requirements applicable to certain categories of foreign-source passive income earned by multinational group entities incorporated or domiciled in Panama.

The new law will become effective for fiscal year January 1^st, 2027, and will be supplemented by regulations to be issued by the Executive Branch in the coming months.

The new law responds to the updating on international compliance and tax standards that have already been adopted in jurisdictions such as Malta, Isle of Man, BVI, Grand Cayman , Belize, Nevis and others.

Panama Continues to Apply the Territorial Tax System

The most important aspect of this reform is what remains unchanged.

Panama continues to apply the territorial principle as the cornerstone of its tax system. As a general rule, foreign-source income remains outside the scope of Panamanian taxation.

The new legislation does not replace this model, nor does it transform Panama into a worldwide taxation jurisdiction. Instead, it introduces economic substance requirements applicable to certain activities generated by Panama entities earning specific categories of foreign-source passive income.

In other words, this is not a fundamental shift in Panama’s tax framework, but rather an evolution of the regulatory environment consistent with international standards already adopted in many financial and corporate services jurisdictions worldwide.

Who May Be Affected?

A key point is that the legislation is not directed at all Panamanian companies.

Its scope focuses on multinational group entities that derive certain categories of foreign-source passive income, including:

• Dividends and profit distributions.
• Interest income.
• Royalties.
• Capital gains.
• Foreign-source real estate income.
• Other passive investment income.

Accordingly, not all corporate or wealth-holding structures will be affected in the same way. Each structure should be analyzed individually, considering the nature of the activities conducted, the group's operational framework, and the type of income generated.

What Does Economic Substance Mean?

Generally speaking, economic substance refers to demonstrating that there is genuine activity associated with the generation, management, administration, or control of assets producing the relevant income.

The law considers factors such as:

• Adequate human resources.
• Appropriate facilities and infrastructure.
• Strategic decision-making conducted from Panama.
• Risk management and control.
• Operational expenditures consistent with the activity performed.

Importantly, the law expressly provides that these factors must be assessed in light of the nature, scale, complexity, and specific characteristics of each business activity.

Therefore, there is no one-size-fits-all approach, nor a uniform set of requirements applicable to every entity.

The Upcoming Regulations Will Be Critical

While the legislation establishes the general framework, many practical aspects will depend on the regulations that are yet to be issued.

Among other matters, further guidance is expected regarding:

• Reporting obligations.
• Documentation requirements.
• Evaluation criteria to be applied by the authorities.
• Rules applicable to holding and investment structures.
• Procedures for demonstrating economic substance.

For this reason, it would be premature to draw definitive conclusions or implement significant structural changes before the regulatory framework is finalized.

What Should Businesses Do Now?

Potentially affected entities should consider:

• Determining whether they form part of a multinational group.
• Identifying the nature of their income streams.
• Conducting a preliminary review of their operational structure.
• Organizing relevant corporate and financial documentation.
• Monitoring the forthcoming regulations.

At this stage, there is no reason to assume that every international structure established in Panama will automatically be impacted by the new rules. These provisions will begin to apply as from fiscal year 2027, subject to the terms and conditions established by the law and its forthcoming regulations. Therefore, potentially affected entities should use this time to assess their position, organize their documentation, and prepare accordingly.

Conclusion

The new Economic Substance Law represents another step in Panama’s ongoing process of regulatory modernization and alignment with international standards.

However, the legislation does not eliminate the territorial tax system, nor does it alter the fundamental principles that have historically made Panama an attractive jurisdiction for international business and investment structures.

As with any significant regulatory development, the key will be understanding the final regulations and evaluating each structure on a case-by-case basis.

At this stage, preparation is the appropriate course of action. Understanding the scope of the legislation, asking the right questions, and conducting a timely assessment will allow businesses and international groups to adapt efficiently once the new rules become effective.

Our team will continue to monitor the development of this legislation and remains available to assist clients in assessing how these new provisions may affect their specific structures and operations.