Panama's economic substance framework arrived as part of a broader international push by the OECD and FATF to prevent jurisdictions from serving as conduits for tax avoidance structures with no real economic activity. Law 70 of 2019, supplemented by Executive Decree 168 of 2020, introduced substance requirements for legal entities operating in Panama that derive income from certain "relevant activities." For CSPs administering Panamanian corporations and foundations, understanding these requirements is now a core operational necessity.
Which Entities Are In Scope?
Panama's economic substance rules apply to legal entities — primarily corporations (sociedades anónimas) and private interest foundations — that are resident in Panama for tax purposes and carry out one or more "relevant activities." The relevant activity categories mirror those adopted across other OECD-participating jurisdictions:
- Banking
- Insurance
- Fund management
- Finance and leasing
- Headquarters operations
- Shipping
- Holding company activities
- Intellectual property (IP) holding
- Distribution and service centre activities
Entities that are not tax resident in Panama, or that do not conduct any relevant activity, are generally outside scope — though they may still have reporting obligations to confirm their out-of-scope status.
Important distinction: Holding companies face a lighter substance test than operating companies — they must demonstrate adequate human resources and premises, but are not required to show the same level of directed and managed activity as entities conducting active business.
The Three-Part Substance Test
To satisfy Panama's economic substance requirements, an in-scope entity must demonstrate:
- Direction and management in Panama — board meetings held in Panama with directors physically present (or a majority), strategic decisions made locally, and meeting minutes maintained.
- Core income-generating activities conducted in Panama — the specific activities vary by relevant activity category. For a headquarters company, this means performing group coordination, purchasing decisions, or treasury functions locally.
- Adequate people, premises, and expenditure — the entity must have qualified employees, physical office space, and operating expenditure proportionate to its activity level.
For pure equity holding companies, the test is simplified: entities must have adequate human resources to hold equity and manage equity participations, and must comply with all corporate and tax filing requirements in Panama.
Reporting Obligations for CSPs
Panama's substance reporting is administered through the Dirección General de Ingresos (DGI), Panama's tax authority. In-scope entities must file an economic substance report annually, within six months of their fiscal year end.
The report requires entities to disclose:
- Whether they conduct a relevant activity
- The level of income derived from the relevant activity
- Number of qualified full-time employees engaged in the activity
- Operating expenditure incurred in Panama
- Details of premises used in Panama
- Location where board meetings are held and minutes kept
CSPs acting as resident agents have an indirect interest in ensuring their client entities meet these obligations, as the resident agent may face scrutiny if associated entities consistently fail to file.
Penalties for Non-Compliance
Entities that fail to meet the substance test or fail to file the required report face escalating consequences:
- First failure: financial penalty of up to $50,000 USD and a notice to remedy within 12 months
- Second failure: penalty of up to $100,000 USD and referral to the relevant tax authority in the jurisdiction of the beneficial owner for information exchange purposes
- Continued non-compliance: the DGI may strike off the entity or refer for criminal investigation
Panama participates in the OECD's Common Reporting Standard (CRS) and has signed exchange of information agreements with numerous countries. This means non-compliant entities may trigger automatic reporting to the tax authorities of beneficial owners' home jurisdictions — significantly raising the stakes of substance failures.
Panama's FATF Grey-Listing and Its Impact on CSPs
Panama was placed on the FATF grey list (Jurisdictions Under Increased Monitoring) in June 2019 and was removed in October 2023 following implementation of the required reforms. However, the period on the grey list significantly affected the reputation of Panamanian entities, with banks and correspondent institutions applying enhanced due diligence to Panamanian structures.
For CSPs, the grey-listing period created substantial additional workload: more intensive KYC for client onboarding involving Panamanian entities, more frequent AML reviews, and increased requests for substance evidence from banking counterparties. Even following removal from the grey list, many institutions maintain elevated scrutiny for Panama, and CSPs should anticipate ongoing due diligence requests.
CSP operational tip: Maintain a substance evidence file for each Panamanian entity in scope — including board meeting minutes, lease agreements for office space, payroll records, and activity summaries. This evidence package should be available on request and updated annually.
Practical Steps for CSPs Managing Panamanian Portfolios
CSPs with Panamanian entities in their portfolios should take the following steps as a baseline:
- Classify each Panamanian entity by relevant activity category and document the classification rationale.
- Set annual DGI substance report deadlines in your compliance calendar, six months from each entity's fiscal year end.
- Collect substance evidence from clients annually — payroll records, board minutes, lease agreements, activity statements — and store these linked to the entity record.
- Review holding company arrangements to ensure directors (or a majority) are resident in Panama or can document local meetings.
- Coordinate with clients in advance of fiscal year-end to ensure substance arrangements are in place before the reporting period closes.
- Apply enhanced due diligence to newly incorporated Panamanian entities to understand their planned activities and substance arrangements from the outset.
Panama's economic substance framework, while less mature than those in the BVI or Cayman Islands, is developing rapidly. CSPs that establish robust internal processes now will be well positioned as reporting requirements continue to evolve — and as international scrutiny of Panama's offshore sector remains elevated.