The Panama trust in international tax planning

Trusts & Trustees Advance Access published March 26, 2011
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Trusts & Trustees, 2011
The Panama trust in international tax
planning
Eduardo Gonza¤lez Garay*
Abstract
It may not be common knowledge that Panama enacted the very first law of trusts in Latin America as
far back as 1925. In the early 1920s, the accomplished
jurist, Dr Ricardo J Alfaro, campaigned strenuously
through publications and personal presentations
before the legal community and at all levels of government, to finally obtain the promulgation of Law 9
of 1925 on trusts, a concept of limited property
unknown by then in our civil law-based system.
The law of trusts of Panama has suffered only two
changes since 1925, and today we regulate trusts
under law 1 of 5 January 1984, which is currently
under review and should be amended significantly
during the course of 2011.
The work of Dr Alfaro is a testimony of Panama’s
enduring legacy of being a country at the forefront of
*Eduardo González Garay is a partner at Morgan & Morgan, Panama City, MMG Tower, 16th Floor, 53rd E Street, Marbella, Panama, PO Box 0832-00232 WTC
PA. Tel: (507) 265-7777; Fax: (507) 265-7643; E-mail: [email protected].
ß The Author (2011). Published by Oxford University Press. All rights reserved.
doi:10.1093/tandt/ttr028
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This article outlines the various commercial and
private uses of trusts in Panama, as well as the
position on taxation. The rules governing establishment, administration, and taxation of trusts
have recently been modernized, and Panama has
had a number of legislative tax initiatives establishing the regulatory framework for the adoption
and enforcement of Double Taxation Treaties,
10 of which have been signed so far.
innovation in the legal field, which over time has
brought about, among other notable achievements,
a contemporary and almost unchanged law of
Corporations in 1932, the establishment of what
would become in time the largest open ships register
in the world in 1925.
Panama trusts are employed in a variety of purposes, whether they be commercial, as in the case of
guarantee, development, or securitization trusts, or
for private purposes such as asset protection or succession trusts, and can be used indistinctively for
either domestic or international transactions, because
the law makes no difference between local or offshore
trusts as it occurs in other countries.
With Guarantee Trusts, the debtor surrenders one
or several assets to the trust company, for the benefit
of one or more creditors, in order to ensure compliance with his or her obligations. Guarantees on accounts receivable, rights, cash flows, and tolls, among
others, can be structured through this mechanism,
providing a more efficient, timely, and cost-effective
alternative to other types of guarantees whose execution require judicial enforcement, such as, for
example, pledges and mortgages.
The Real Estate Development Trust is a special
type of Management Trust, in which a property
owner, a developer, and/or promoter, together with
a bank and/or investor, pool assets together in the
hands of a professional trust company, which is
responsible for the supervision of the administration
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Article
My own opinion is that there is a well-recognized rule,
which has been enforced for at least 200 years or
thereabouts, under which these courts will not collect
the taxes of foreign States for the benefit of the sovereigns of those foreign States; and this is one of those
actions which these courts will not entertain.
Panama has therefore slowly but methodically been
adapting to the ever-changing landscape of international tax relations, and in doing so has fairly recently
adopted new domestic legislation, departing in some
ways from concepts that had withstood the test of
time until little over a year ago, which has both introduced fairly aggressive concepts regarding income
generated abroad by Panama nationals (albeit always
strictly related with the generation of local income)
and has opened the door to tax planning at levels not
thought possible before.
This is so mainly due to the fact that Panama is one
of the very few countries in the world where the tax
system is purely territorial, that is, only income generated in Panama or from a Panama-based source is
taxable in the country.
As such, until recently, there never had been a positive attitude towards any kind of tax agreements with
other countries, with the fatal consequence that
income earned in Panama by foreign individuals
and companies alike, including subsidiaries, would
be taxed both in the source country and in the
home country of the taxpayer without any form of
relief.
Nevertheless, it is necessary to mention that the existing domestic legislation, or the General Directorate
of Revenue (DGI for its initials in Spanish, Panama’s
tax collection authority) where the law is unclear or
silent, already do provide tax relief for trusts that is
not otherwise available to Panama corporations or
individuals. For instance, in the case of commercial
trusts such as guarantee or real estate development
trusts, the position of the DGI is that all transfers of
real estate property to these are exempt from capital
gains tax, which has a rate of 10 per cent, as well
as from real estate transfer tax, which has a rate of
2 per cent.
A feature that made it attractive to channel income
through trusts, being that these were taxed at the rate
applicable to natural persons which is still lower than
that for corporations for income over US$ 50,000,
was terminated by Law 8 of 2010, since as of this
year 2011, the income tax for both has been levelled
at 25 per cent.
Apart from the specific tax provisions found in the
Law 1 of 1984, any references to trusts are few and
scattered throughout the various tax laws of Panama,
which adds to the urgent need to legislate specifically
in this respect. The project of reform to the trust
law currently being drafted should address this
matter and, together with the already enacted statute
for the creation of an independent tax court, the
certainty regarding the application and interpretation
of the tax law will be greatly enhanced in our country,
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of the cash flows and construction timelines of a
building project, transfer the built units to the
buyers and the profits to the beneficiaries.
The Traded Securitization Trust allows a company
to issue bonds that may be freely traded in the stock
market through a trust that also holds the repayment
guarantee for the investors, thereby providing additional assurance as to the strength of the issue.
The main purpose of Investment Trusts is the investment or placement of money or other assets in
accordance with the instructions of the settlor.
Management Trusts allow any type of asset that normally requires professional management to be held by
a qualified Trustee, for the benefit of the settlor himself or of third parties, whether a spouse or minor
children, creditors, venture partners, or business
associates.
In the field of international taxation, Panama has
been more reactive than proactive in responding to the
trends that in the past 15 years, under the relentless
work of the Organization for Economic Cooperation
and Development (OECD), have paved the way for the
so-called ‘G’ countries to do well away with Viscount
Simonds’ well-known dictum that:
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Law 1 of 1984 contains only two articles on taxation
of trusts, Articles 15 and 35:
Art. 15: The assets of the trust shall constitute a separate patrimony from that of the personal assets for
the trustee . . . Consequently the trustee shall pay separately the taxes, duties and other levies caused by the
trust.
Art. 35: The acts by which a trust is constituted, modified, or extinguished, as well as the acts of transferring, transmitting, or encumbering the assets settled
into the trust, and the revenue generated by such
assets and any other acts regarding the assets is exempted from all taxes, duties, levies and contributions,
provided that the trust concerns:
1. Assets situated abroad
2. Money deposited by natural persons or legal entities whose income is not of Panamanian source
or taxable in Panama; or
3. Shares or stocks of any kind issued by corporations which revenue does not originate from a
Panamanian source, regardless of the fact that
such moneys, shares or stocks may be deposited
in the Republic of Panama.
The above concepts have been assimilated in the
domestic tax legislation, namely, in Executive
Decree 170 of 27 October 1993 which regulates
Income Tax in Panama. Article 81 of the Decree
includes ‘all trusts established under the law’ (sic) as
taxpayers, pointing out that in these cases the
trustee is to regarded as the taxpayer, and all
income is subject to the tax rate established in
the Tax Code for natural persons, which is lower
than that for corporations. Article 10(h) as amended
by Executive Decree 98 of 27 September 2010
copies Article 35 of the Law 1 on trusts with
respect to the non-Panamanian source of the assets
listed at numerals 1–3 of Article 35 mentioned
previously.
In considering the Panama Trust for tax planning
purposes, it is of essence to take into account Article
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to provide settlors and beneficiaries alike with wellregulated and administered legal and tax regimes.
The spate of legislative tax initiatives of the past
year peaks, under an international point of view,
with law 33 of 30 June 2010, which, for the first
time in Panamanian history, establishes the regulatory
framework for the adoption and enforcement of
Double Tax Treaties.
At the time of writing, Panama has signed 10 such
treaties with Mexico, Spain, Singapore, France, Qatar,
South Korea, Luxembourg, Barbados, Portugal, and
The Netherlands, although at present only the one
with Mexico has been ratified by both Congresses.
All treaties follow the OECD model but with
enough additions and modifications to allow us to
speak of a Panama model; in doing so with the purpose of being taken off the OECD’s ‘grey’ list of ‘uncooperative tax regimes’, Panama is also paving
the way towards a better structured tax regime that
will undoubtedly boost foreign investment in our
country.
In this scenario, the Panama trust acquires some
obvious advantages when considering it as a tool in
one’s asset planning structure, and it is to be hoped
that the treaty network will grow so as to allow as
much of the international community to claim
treaty benefits where their panama trust generates
income in their country, as we will see further on.
One of the basic features of taxation of trusts
in Panama is that, unlike in many other Latin
American countries, where in the case of trusts with
settlors as beneficiaries the taxpayer is the settlorbeneficiary himself, in Panama trusts, the taxpayer
is always deemed to be the trustee in his capacity as
such, but his obligation is limited to any taxable
income generated by the trust fund in Panama, and
only to the extent of the trust fund itself, in accordance with the principle that the trust is a separate
patrimony from that of the trustee.
Panama’s strictly territorial tax system immediately
assures the settlor that no income other than that
generated within Panama, and only from non-exempt
sources, will be taxed.
Article
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Article
12(r) of Executive Decree 170, where it is clearly
stated that:
all income from assets received as inheritance,
bequest, or donation is exempt from Income tax.
to be read together with Article 10 of law 1 of 1984
which states that:
. . . the trust intended to take effect after the death of
the settlor of the trust must be constituted by means
of a will. Moreover, it may be constituted by a private
instrument without the formalities of the will, when
lifetime, no one can claim any rights over that property by way of right of inheritance unless they are
named beneficiaries of the trust.
Coming to the impact of double taxation treaties
on trusts, the first thing we must bear in mind is that
Panama trusts, as in Common Law and elsewhere in
Latin America, are not legal entities, and therefore
lack the capacity to legally obligate themselves, as
this must be done through the trustee.
The OECD model convention regards as subjects of
a treaty only ‘persons’ and ‘companies’, the definition
of neither of which satisfies the essence of a trust. The
Panama–Mexico DTT states:
Article 1: Included Persons
This Treaty is applicable to persons resident of one
As a result, Panama law expressly provides that,
once a beneficiary has received trust property from
a trust intended to have effect after the death of the
settlor, all income deriving from such transfer is
income tax exempt in Panama, making an excellent
case for looking into suitable residence arrangements
either in Panama itself, or in a country where foreign
source income is only taxed on remittances.
This is particularly relevant when considering
asset protection alternatives for property in countries
with aggressive, worldwide tax regimes such as the
United States. For example, a non-US resident with
US property could effectively transfer such assets to a
Panama company whose shares would be held by a
Panama trust, structured in a proper manner so as to
not be considered a US trust. The shares would then
come to represent the effective assets held by the
Trust, which are now represented by a foreign
(not US) company shares, and therefore, being considered non-US assets, their transfer (and consequently that of the underlying assets) to the
beneficiaries of the trust would not cause estate tax
in the United States.
It must be pointed out that there is no Estate tax,
Succession tax, nor any kind of forced heirship legislation in Panama or recognition of foreign forced
heirship rulings. Once an individual has transferred
property into a Panama trust structure during his
or both contracting countries.
Article 3: General Definitions
.............
d) the term ‘person’ includes all natural persons,
companies, and any other society of persons;
e) the term ‘company’ means any body corporate or
any other entity that is considered such form tax
purposes;
.............
Nevertheless, a Panama trust being a special purpose patrimony administered by a trustee, who is separately liable for the taxes that such patrimony’s
income generates, certain provisions of Panama’s
DTTs (under the assumption that they will all
follow the same general pattern as the Mexico DTT)
regarding the taxes listed therein would apply to
them, specifically with respect to income from real
estate (Article 6), dividends (Article 10), interests
(Article 11), royalties (Article 12), and capital gains
(Article 13).
In the case of dividends, for instance, the adoption
by Panama of the DTT with Mexico, not only should
result in the former being struck off the latter’s
own list of tax havens, but despite it, immediately
eases dramatically the tax burden on dividends
paid by a Mexican company to a Panama beneficiary.
Formerly, under the black list regime, all dividend
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the trustee is a person or company duly licensed to
carry out trust services.
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payments to a Panama beneficiary from Mexico suffered a 30 per cent withholding; now, as Panama does
not tax foreign income, the tax rate on dividends
from a Mexican concern with a 25 per cent or
higher ownership by a Panama beneficiary, is taxed
at the source at the rate of 5 per cent, which is even
lower than that levied by Panama on domestic dividend distribution.
The Panama model convention also adopts an
interesting position on Interests. Article 11(6) establishes that:
interest shall be deemed to arise in a Contracting State
is a resident of a Contracting State or not, has in a
Contracting State a permanent establishment in connection with which the indebtedness on which the
interest is paid was incurred, and such interest is
borne by such permanent establishment, then such
interest shall be deemed to arise in the Contracting
State in which the permanent establishment is
situated.
The opportunity afforded by this article when structuring a transnational commercial structure cannot
escape the reader.
Furthermore, any income generated by the trust
would benefit from the provision for the avoidance
of double taxation established at Article 22 of the
treaty, which allows the application of the exemption
and credit methods, for the recognition of taxes paid
by the trust in the other state.
By way of example, in a scenario where the tax rate
for certain dividends in the source country is nil and
the treaty provisions allows that state to tax such
dividends, once these are distributed to the Panama
trust they become tax free for the trust, as Panama
will consider that under the treaty that the tax on
dividends has been paid at source.
Conclusion
The law of trusts was, since its inception, meant to
apply to both family relationships as well as to business needs. The rules governing establishment, administration, and taxation of trusts have been
modernized and continue to be the object of legislative attention as we write, to ensure that they are appropriate for contemporary commercial and private
purposes alike.
The adoption by Panama of certain international
taxation standards through the entering into Double
Taxation treaties clearly opens a plethora of opportunities for the tax planner and his clients, whether they
will be looking for simple estate planning advice or a
more sophisticated commercial structure.
Panama’s trust law and the current tax regime, provide a sound and attractive choice for any persons
wishing to establish a suitable asset protection or
business vehicle which will withstand the rigorous
scrutiny of cross-border regulation.
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when the payer is a resident of that State. Where,
however, the person paying the interest, whether he
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