Economic Substance Law Panama: Requirements and Scope

The Economic Substance Law introduced by Law 526 of May 28, 2026, represents one of the most significant changes in Panama’s tax regime in recent years. This regulation introduces economic substance requirements applicable to certain foreign-source passive income and seeks to align Panamanian legislation with international tax standards.

1. Scope of the Law

Article 707-A establishes that these provisions apply to entities incorporated or domiciled in Panama (corporations or foundations) that:

• Form part of a multinational group, and

• Earn foreign-source passive income.

Accordingly, the Law does not have general application but is limited to structures with international presence and the generation of passive income abroad.

2. Concept of Economic Substance

The Law defines economic substance as the actual existence and effective use, in Panama, of:

• Human resources

• Assets

• Facilities

• Management and direction

• Risk control

• Adequate operating expenses

All of this must be proportionate to the nature and complexity of the foreign passive income-generating activity.

In practical terms, the mere formal existence of an entity in Panama is not sufficient; real operational presence is required.

3. Who Does the Economic Substance Law Apply To?

The regulation applies only to entities that form part of a multinational group, defined as:
Two or more related entities through ownership or control and tax residents in different jurisdictions.

Practical implications:

• There must be at least one Panamanian entity and one foreign related entity.

• The following do not qualify:

– Purely local structures

– Panamanian entities with no relationship to foreign entities

This element acts as an initial filter to determine applicability.

4. Foreign-Source Passive Income

The Law classifies the following as passive income:

• Dividends

• Interest

• Royalties

• Capital gains

• Real estate income

• Other income derived from capital

These types of income are traditionally considered low operational in nature, which is why they are subject to economic substance analysis.

5. Qualified Entities and Compliance

So-called qualified entities may retain income tax exemptions, provided they comply with economic substance requirements.

Key requirements:

• Annual filing of a declaration

• Evidence of:

– Adequate personnel in Panama

– Local infrastructure

– Strategic decision-making in the country

– Assumption of risk within the jurisdiction

– Operating costs incurred in Panama

Outsourcing of functions is permitted, provided that such functions are carried out within Panamanian territory.

Partial exemptions:
Some entities are subject to more flexible requirements, such as:

• Holding companies

• Certain passive real estate structures

6. Non-Compliance: Non-Qualified Entities

An entity is considered non-qualified if:

• It fails to demonstrate economic substance, or

• It fails to comply with reporting obligations (including omissions or inconsistent information)

Consequences of Non-Compliance

Once the administrative determination becomes final, a single 15% tax will be applied to the net taxable income of the relevant period.

This tax is final and does not generate additional tax obligations.

7. Relevant Exclusions

Maritime Sector

Entities linked to Panamanian merchant shipping may demonstrate economic substance through compliance with the maritime regime, provided their income is related to such activities.

Regulated Entities

Subject to certain conditions, the following are excluded:

• Banks

• Securities market entities

• Insurance and reinsurance companies

• Pension funds

• Investment managers

These entities must demonstrate:

• Effective supervision

• Real economic activity

• A link between income and their business model

• Substantial presence in Panama

8. Effective Date

Law 526:

• Will enter into force starting from fiscal year 2027

• Will be regulated by the Executive Branch within 90 days of its enactment (May 28, 2026)

9. Final Considerations

The introduction of these rules represents an important step in the evolution of Panama’s tax system, reinforcing the principle that tax benefits must be supported by real economic activity.

However, its impact will largely depend on:

• The corresponding regulations

• The tax authority’s enforcement approach

• The adaptability of existing corporate structures

In this context, entities should carefully assess their level of compliance and, where necessary, adjust their operations to align with the new requirements. Contact us