Month: February 2026

Economic substance has become one of the most relevant concepts in international tax and corporate planning. What was once perceived as a technical or jurisdiction-specific requirement is now a central element in assessing whether corporate structures are defensible, sustainable and aligned with global transparency standards.

Panama is currently at a turning point. While the country has traditionally relied on the territorial tax system, international pressure—particularly from the European Union and OECD-driven standards—has accelerated a shift toward requiring demonstrable economic substance in certain scenarios. Understanding where Panama stands today and how the proposed Economic Substance Bill may change the landscape is essential for companies operating internationally.

The current framework: substance requirements limited to special regimes

At present, Panama does not impose a general economic substance regime applicable to all companies. This is a key distinction when compared to other jurisdictions that have adopted broad substance rules across the board. However, the absence of a general regime does not mean that substance is irrelevant under Panamanian law.

Specific special regimes already incorporate explicit substance requirements. The Multinational Headquarters regime (SEM) requires that authorized activities be genuinely performed from Panama, supported by qualified personnel, physical offices, operational expenses and effective decision-making at the local level. Economic substance is a fundamental condition for maintaining the tax and immigration benefits associated with this regime.

Similarly, companies operating under the Panama Pacifico regime must demonstrate real presence, investment, personnel and business operations within the special economic area. In both cases, substance is not a theoretical concept but a practical requirement subject to verification.

Outside these regimes, many Panamanian entities—particularly holding companies and investment vehicles—have historically benefited from the territorial system, exempting foreign-source income without explicit substance conditions.

Why the international focus on foreign-source income exemption regimes

The European Union has increasingly scrutinized Foreign Source Income Exemption (FSIE) regimes that allow passive income earned abroad to remain untaxed without requiring economic substance. From the EU’s perspective, such regimes may facilitate artificial profit shifting and the use of entities with little or no real activity.

In Panama’s case, the EU has identified the unconditional exemption of certain passive foreign-source income as a risk under its “fair taxation” criteria. Importantly, the objective is not to eliminate territorial taxation, but to ensure that tax benefits are supported by real economic activity.

Several jurisdictions with territorial systems—such as Costa Rica, Uruguay, Hong Kong and Seychelles—have already reformed their legislation to introduce substance requirements for specific categories of income and entities, successfully addressing EU concerns.

The proposed Economic Substance Bill: what would actually change

The Economic Substance Bill presented in December 2025 represents a significant development in Panama’s tax policy. The proposal maintains the territorial principle but introduces economic substance requirements for a defined group of taxpayers: entities that are part of a multinational group and receive passive foreign-source income.

Under the proposed rules, affected entities would need to demonstrate, in relation to each income-generating asset, that they have adequate qualified personnel in Panama, that strategic decisions and risk management are carried out locally, and that sufficient operating expenses are incurred in connection with those assets.

If the substance requirements are not met, the bill provides for the exceptional taxation of such passive foreign-source income, breaking with the traditional exemption approach. The proposal also introduces formal compliance obligations, including an annual economic substance affidavit, documentation retention requirements and a review process by the Panamanian tax authority.

In addition, the bill incorporates a general anti-abuse rule and updates the definition of permanent establishment in the Tax Code to align it with current OECD standards, reinforcing the focus on real economic presence.

Legal, tax and operational risks of inaction

One of the most significant risks for companies is not the approval of the bill itself, but failing to anticipate its impact. Structures that currently lack sufficient economic substance may face increased tax exposure, challenges in banking relationships, enhanced scrutiny by foreign tax authorities and reputational concerns.

Multinational groups with holding companies, IP-holding entities or investment vehicles receiving dividends, interest, royalties or capital gains from abroad should assess whether their Panamanian presence would withstand a substance analysis under the proposed framework.

Experience shows that restructuring after a challenge has arisen is often more complex, costly and disruptive than proactive alignment.

Panama’s competitive position: substance as a strategic design element

Panama’s approach, consistent with international practice, is not intended to impose rigid or disproportionate requirements. Economic substance is inherently linked to the nature of the activity, the scale of operations and the role of each entity within a corporate group.

When properly designed, substance enhances—not undermines—Panama’s position as a regional and international business hub. The key lies in proportionality, documentation and strategic alignment between legal form and operational reality.

Conclusion

Economic substance in Panama is no longer a purely theoretical issue or a future concern. Substance requirements already exist under special regimes, and the proposed Economic Substance Bill signals a broader shift affecting certain multinational structures.

Understanding the current framework, anticipating regulatory changes and evaluating exposure allows companies to strengthen their legal and tax position, reduce uncertainty and preserve long-term structural integrity in an increasingly transparent global environment.