New Requirements of Economic Substance for the Regime of Multinational Headquarters
As of 2007, a special regime was created in Panama with the purpose of attracting multinational business groups to establish their regional and global operations center in Panama. This special regime was called Multinational Headquarters, or as it is commonly known in Panama, SEM.
Since then, it has been modified and new regulations have been issued in accordance with the international reality in commercial matters and best practices and transparency in the tax field.
Recently, the National Government issued Executive Decree No. 241 of September 16, 2020, which amends the Regulations to Law 41 of 2007. In said Executive Decree, the requirements related to substance which must be complied with by companies with a SEM license in Panama are regulated.
It is important to highlight that the concept of “substance or economic substance” has been promoted by the Organisation for Economic Co-operation and Development (OECD), through the BEPS initiative (Base erosion and profit shifting) and is mainly linked to the activities that generate the income by the taxpayer benefiting from the tax incentive, are made within the jurisdiction and/or country offering such benefits and that these taxpayers to whom the incentive is granted must have an adequate number of qualified workers and operating expenses in order to perform that main activity.
This new regulation issued by the National Government establishes the new review and follow-up procedures that the Secretariat of the License Commission of Multinational Headquarter shall follow for companies with a SEM License in Panama.
These new measures that must be complied with in order to comply with the requirements of substance that allow maintaining the tax incentive of the reduced rate of five percent (5%) of the Income Tax, are classified as follows:
1. The main activity in Panama must be carried out in Panama.
2. To maintain in Panama an adequate number of qualified full-time workers, dedicated to performing the main activities.
3. To maintain an adequate amount of operating expenses directly related to the main activity;
4. To comply with the presentation of the corresponding declarations and reports to the Secretariat of the License Commission of Multinational Headquarter, which are the following:
a. sworn statement of income within the three months following the fiscal closing;
b. annual report within six months after the fiscal closing.
5. To keep records, books and relevant documentation supporting the level of substance.
These new requirements shall apply to companies with a SEM License in Panama, as described below:
1. Companies that obtained the SEM License before October 17, 2017, must comply with the new sworn statement requirements as of July 1, 2021;
2. Companies that obtained the SEM License after October 17, 2017, must comply with the sworn statement requirements as of the fiscal year 2019;
3. All SEM companies shall have until December 31, 2020 to submit the report for fiscal year 2019.
It is important to highlight that the companies registered before October 17, 2017 and that after obtaining their SEM License have added to their registration activities subject to substance requirement, shall be subject to comply with such requirements, as of fiscal period 2019.
On the other hand, companies with a SEM License must submit within a period of six (6) months after the closing of their fiscal period the report with the information described below:
1. Sworn statement signed by the legal representative;
2. Copy of the company’s Audited Financial Statements;
3. Any other information that may be required by the Technical Secretariat of the SEM Licensing Commission to verify that the company complies with the substance requirements of SEM.
Once the annual report is submitted, the Technical Secretariat shall issue, within six months from the expiration date, the administrative resolution declaring the compliance or noncompliance of the substance.
For each case, the Technical Secretariat shall perform a basic review procedure or an extended review procedure, depending on the type of company.
The Executive Decree establishes that they shall be:
1. Basic: When the company executes the main activity using its own resources and personnel;
2. Extended: When the main activity and/or operating expenses are outsourced; number of employees and expenses that are not in accordance with; or secondary activities are outsourced outside the jurisdiction.
Once the review has been completed, the Technical Secretariat shall issue a resolution indicating that the substance is being complied with, which shall be shared with the General Revenue Office (DGI) and the 5% tax shall be maintained.
In case of non-compliance, the resolution shall be notified to the DGI which shall initiate the procedure to request the liquidation of the 25% Income Tax, plus the application of interest and corresponding fines.
The company with a SEM license shall have a term of five (5) working days following its notification to file a Reconsideration Appeal before the Technical Secretariat of the License Commission of Multinational Companies’ Head Offices, which shall have thirty (30) working days to respond to such appeal.
In case the Technical Secretariat maintains its decision, the company with a SEM license may file an Appeal before the Multinational Companies License Commission, thus exhausting the governmental channel.
Finally, some relevant definitions are established that must be considered when interpreting the new provisions of economic substance.
1. Main Activity: is the one that is directly associated with the creation of value, whose execution becomes necessary for the rendering of the service or operation generating the income, and that must be executed by the company in Panama. The main activity may be rendered by the company with SEM license or it may be outsourced. According to Executive Decree No. 241, it may be outsourced provided that the outsourced activity is executed entirely within Panama and that the company with a SEM license has the tools to control and supervise the outsourced activity;
2. Ancillary Activity: is the one that is not essential for the generation of the income susceptible to the application of the benefit of the reduced Income Tax. According to the standard, this type of activity could be outsourced to companies located both inside and outside the Republic of Panama
3. Adequate: what is appropriate and sufficient for the execution of the main activities;
4. Provider: the one whose resources are used for the execution of all or part of the main or ancillary activity.