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Ask most people around the world their thoughts on Panama and you would probably be met with the same one word reply: canal. However, after a small amount of further investigation you would find that this country at the gateway of Central and South America certainly isn't as one dimensional as that. Aided by more stable, pro-business governments using the invaluable canal as a catalyst, Panama's friendly tax and regulation system has helped to established the country as one of the most modern and respectable business and financial centres outside the established 'onshore' countries, and ranks as probably the most important trading and business hub in the region.

Around 400 miles long and between 30 and 115 miles wide, Panama appears on the map as a narrow isthmus running from east to west, forming an important land bridge between continental South America and North America, dividing the North Atlantic and Pacific Oceans. Its strategic advantages in terms of trade were recognised as far back as the first Spanish colonisers, prompting them to establish their first permanent settlement in the New World at Panama City in 1513.

Panama remained a Spanish colony for approximately three hundred years to 1821 before it was annexed by Colombia. This state of affairs endured until 1903 when the US helped win the modern day country its independence in return for a slice of land that would eventually see the Americans building and operating the famous canal, completed by the Army Corp in 1914.

However, over the last two decades, the United States has gradually scaled back both its military presence and political influence in Panama, and a second treaty signed by the former President Torrijos (father of the more recent President) and US President Carter in 1977 set in train a 25-year transition period that saw the administration and running of the canal pass back to the Panamanians.

The Canal

Obviously, it is hard to understate the importance of the canal in terms of its advantages both for world trade and as an asset for Panama (even though the canal itself is technically neutral territory). Around 12% of the United State's seaborne trade in tonnage terms passes through the canal every year, which in total sees 13,000 ship movements annually carrying 192 million tons of cargo. And by navigating the 40-mile waterway, a cargo vessel bound from Japan to the eastern seaboard of the United States can reduce its journey by some 3,000 miles.

Shipping then, has grown to be one of the most important industries in Panama, which has the world's largest registered merchant fleet, and a recent investment programme has seen billions of dollars used in the building of four more container ports and the widening of the canal to accommodate more 'Panamax' ships.

Then, in October, 2006, 79% of Panamanian voters approved a $5.25bn plan to expand the Panama Canal even further. Panama's President Martin Torrijos said that the vote on expansion of the Canal was the most important national vote since Panama gained its independence.

Under the expansion plans, two 3-chamber locks will be constructed at both ends of the canal. This will create a third lane of traffic wide enough to handle the largest of modern container ships and tankers. New approach channels will also be prepared, whilst existing channels will be dredged to ensure large craft can enter the system.

The project will take about seven years and employ up to 8,000 people. In December, 2008, Panamanian President Martin Torrijos and Panama Canal Authority (ACP) Administrator/CEO, Alberto Aleman Zubieta, signed a USD2.3bn agreement with leaders from five multilateral and development agencies to finance the waterway's expansion project.

On December 31, 2009, Panama celebrated the tenth anniversary of nationalized operations at the Canal. A statement from the Canal noted that “the canal has long stood as one of the world's most recognized and respected engineering marvels and a crucial link in the global supply chain. Building on this, the decade of Panamanian stewardship and leadership has been evidenced by change, achievement and growth. By nearly every measure, the Canal's role in world trade and value to global commerce has increased significantly in the past 10 years.”

"Through trade booms and economic recession, the ACP has steadfastly provided excellent service to our customers and world trade," said Panama Canal Authority (ACP) Board Chairman and Minister for Canal Affairs Romulo Roux. "After the handover in 1999 and shifting our business model from a profit-neutral utility to a market-oriented business model, we never lost sight of our vision and responsibility to global trade. I believe that has been a key tenet of the Canal's success."

After a decade of Panamanian management, ACP Administrator/CEO Alberto Alemán Zubieta spoke of his vision for Panama's hopeful future: "Reflecting over the past decade, I am proud of what we have achieved," he said. "Proud of the employees of the ACP, proud of our accomplishments and proud of Panama. We have achieved goals that some thought were daunting and overcome obstacles that, at times, seemed insurmountable."

Panama's Economy

Alongside the Canal, another legacy from the country's interdependence with the United States that has played an equally vital part in Panama's recent economic successes has been its peg to the dollar at par. Since there is no government-controlled central bank printing notes, Panama has had very little problem with inflation, unprecedented in the region, and with the dollar the effective currency in all but name (the balboa is the 'official' currency), investor confidence has not been the issue that perhaps it has in other nascent business centres.

In the 1990s, growth had been running at 4% with low inflation, however it fell from 2.5% in 2000 to only 0.3% in 2001 and about 0.8% in 2002. Growth picked up again in 2003 to 4.1% and jumped to 6% in 2004, due partly to a one-off tax break aimed at investors in housing construction. Under President Torrijos, Panama enjoyed something of a boom; growth was 8.1% in 2006, exceeded 10% in 2007 and was 8.3% in 2008. The rate of growth fell to 2.3% in 2009, however.

GDP per head is $11,900 (2009 est) at Purchasing Power Parity and unemployment levels are at 7.1% (2009 est). As of 2009, Panama's GDP was valued at $40bn.

In the fall of 2005, Panama took advantage of an improved credit rating to file a shelf issue of $2 billion worth of debt with the US Securities and Exchange Commission (SEC). Panama said it planned to issue the securities to raise money for general refinancing and other spending needs. The ‘shelf registration’ allowed Panama to sell securities in one or more offerings, determining details such as size and price at the time of sale.

In March, 2010, Panama received an upgrade to the credit rating on its debt to investment-grade after ‘sustained improvements in public finances, underpinned by recent tax reforms’. Fitch Ratings on March 23 announced that it had upgraded Panama's long-term foreign currency and local currency Issuer Default Ratings (IDRs) to 'BBB-' from 'BB+'. Both Rating Outlooks remain Positive. Fitch has also upgraded the short-term foreign currency IDR to 'F3' from 'B' and the country ceiling to 'A-' from 'BBB+'.

“The upgrades reflect a sustained improvement in public finances, underpinned by recent tax reforms, and the economy's resilience to the global financial crisis and associated recession. Although economic growth decelerated to 2.4% in 2009 from 10.7% in 2008, it was one of the strongest rates of growth in Latin America and among 'BBB' rated peers. Similarly, fiscal deterioration was moderate, especially by international standards while Panama's general government debt/GDP ratio stabilized around 45%. The Positive Outlook reflects the expectation that government debt/GDP ratio will further decline as the growth accelerates and fiscal discipline is maintained despite an ambitious public investment program,” Fitch Ratings’ statement said.

Theresa Paiz Fredel, Senior Director in Fitch's Sovereign Ratings team, further commented: “Panama's key credit metrics have been on an improving trend since the middle of the last decade and held up well to the worst global downturn since World War II. Recent tax and fiscal reforms signaled a continuing commitment to fiscal discipline and enhancing the flexibility and quality of public finances. Further upgrades will depend on additional measures to strengthen the management of public finances, successful implementation of the government's ambitious public investment program and sustainable economic recovery. “The passage of two tax reforms in the first nine months of the Martinelli Administration, which are expected to yield around 1.6% of GDP in additional revenue this year, underpin the government's commitment to sustainable fiscal policies.”

Fitch Ratings’ statement continued: “Fiscal consolidation and vigorous growth reduced the government debt to GDP ratio to an estimated 45% last year, from a peak of 70% in 2004. Under conservative assumptions of a 1% of GDP fiscal deficit and average growth of 5%, Panama's government debt/GDP ratio will converge with the current 10-year 'BBB' category median of 35% by 2014 at the latest."

“Furthermore, net government debt, at 29% of GDP, is in line with the 10-year 'BBB' median. Given the moderate debt burden and Fitch's expectation that the non-financial public sector will maintain a deficit of close to 1% of GDP, the government's financing needs remain manageable at an estimated 2.6% of GDP this year, among the lowest of 'BBB' rated sovereigns and further supporting creditworthiness.”

“Evidence that the economy can sustain high growth without internal or external imbalances emerging would underpin confidence in sovereign creditworthiness, as would further measures to improve the management of public finances, including greater fiscal and funding flexibility. Successful execution of the government's public investment program, including the Panama Canal expansion project, without endangering Panama's favorable debt dynamics would also be positive for creditworthiness,” the ratings agency concluded.

The Colon Free Zone

Recent governments have sought to take full advantage of the country's financial stability by offering significant tax breaks for firms setting up in a growing number of 'free trade zones' occupying sites formerly used as bases by the US military. The largest of these is the Colon Free Trade Zone, situated at the northern end of the canal in close proximity to the major ports on the Caribbean coast, which offers firms exemption from tax on all import and export movements.

Companies in the Colon Free Zone, or in other Export Processing Zones, are treated in the same way as companies with external operations, ie they are exempt from the Dividends (Withholding) Tax, the Undistributed Profits Tax, the Business Tax, and from Stamp Duty on contracts executed in Panama to be performed elsewhere. However, a fiscal package introduced in 2005 aimed at reducing Panama's indebtedness included a 1% turnover tax to apply to all operations in the Free Zones, and a 1.4% turnover tax which may apply to some other types of companies

In addition, Free Zone companies benefit from reduced rates of income tax on earnings derived from re-exports, tax credits available for the employment of domestic labour and an absence of other bureaucratic requirements such as licensing and guarantees. This generous tax regime has attracted around 1,750 merchants generating exports and re-exports estimated to be worth $11 billion per year.

Seeking to capitalise on the success of the Colon Free Trade Zone, the Panamanian government in 2003 announced plans in partnership with the World Bank's International Finance Corporation to transform the American military's Howard airforce base into a special economic zone equipped with high-tech logistical and telecommunications facilities with similar tax advantages for firms locating there. It is hoped that the project will attract some $600 million in investment and create 20,000 jobs over the next two decades. A 'Technopark' has also been established at the former US Army base at Fort Clayton on the Pacific coast which has attracted the likes of Microsoft, Oracle and Cisco.

Panama has placed a great deal of emphasis on building up a modern, hi-tech telecommunications infrastructure, with firms having ready access to high-bandwidth fibre-optic networks, marking the country out as Central America's e-commerce hub. Its promoters are also keen to point out that unlike other countries in the region, Panama is less prone to natural disasters such as hurricanes and earthquakes, minimising the risks of frequent and prolonged down time.

Panama's Tax Regime

For firms carrying on business outside of the special zones, general taxation is imposed on a territorial basis, meaning that taxes only apply to income or earnings derived from business undertaken within the country's borders. The existence of a sales or administration office in Panama, or the re-invoicing of external transactions at a profit, does not of itself give rise to taxation if the underlying transactions take place outside Panama, so dividends paid out of such earnings are free of taxation.

Corporate income tax is levied at a rate of 30% on a sliding scale up to PAB 100,000, rising to 42% on income over PAB 500,000, for companies that are registered with the Official Registry of National Industry or that have government contracts. Taxable income is calculated on all Panama-sourced earnings less allowable deductions and there is a withholding tax of 10% on dividends paid out of taxed income. If less than 40% of taxed income is distributed, then Undistributed Profits Tax of 10% becomes payable on the undistributed balance; this therefore amounts to a maximum of 4% tax. In effect this is an advance withholding tax, and it is creditable against the 10% tax on later distributions of the taxed profit.

Personal income tax applies to Panama-sourced income and after personal allowances is levied on a sliding scale up to a maximum of 27% on income over PAB 200,000 a year. There is an alternative minimum tax of 6% of income for individuals earning more than PAB60,000, although this does not apply to employees without outside income. Entrepreneurs are subject to an alternative minimum tax of 1.4% of business income. Other taxes include social security contributions, with the employer paying 10.75% of salaries and wages plus a 1.5% educational tax, whilst the employee pays 7.25% plus 1.25%.

Real Estate tax is levied on a sliding scale based on an official valuation, at rates rising to 2.1% on values above USD75,000. Valuations under the 'cadastral' system were updated in 2005, and as from 2006 the tax is based on the new values at rate sup to 1% on values above USD75,000.

Capital Gains Tax is levied on real estate gains under Article 701 of the Fiscal Code and Articles 89 and 90 of the Income Tax Regulations. The rate of tax is 30% on the taxable gain after deductions, but the calculation basis is quite complex, at least for persons not otherwise paying much tax.

The tax on the transfer of real estate (not new homes) is 2%, payable by the seller, which is credited against capital gains tax (see Income Tax, above).

Improvements to real property authorized by construction permits issued after July 1, 2009, are exempt from real estate taxes for a period of 10 to 15 years.

In 2010, new President Ricardo Martinelli signed a bill to reform Panama's Tax Code, adopting several tax measures to lower the company tax burden, ensure fiscal sustainability, and simplify the tax system. In order to improve Panama’s international competitiveness, the bill lowers the corporate tax rate from the current 30% to 25%, though the timescale for this reduction is as yet uncertain. The bill however will introduce higher license fees on banks resident in Panama. Fees will range from USD75,000 for institutions with assets of up to USD100m, and a fee of USD1m for institutions with assets of more than USD2bn.

The bill will alter the country’s sales tax rate to 7% from 5%, and introduce sales taxation on fixed telephones and prepaid mobile phones. Public houses and restaurants that do not serve alcohol will be granted an exemption from paying sales tax under the bill. Childcare items have also been made exempt under the bill. In addition companies operating in the agricultural sector will see their exemption threshold increased from USD150,000 to USD250,000, and will not be required to file an income tax return.

Finally, the bill modernizes the tax code and abolishes more than 30 taxes. The code also contains provisions for the creation of an administrative court which will host tax appeals. Provisions in the bill will enter into force on July 1, 2010.

The Banking Sector

The Panamanian banking industry grew during the last quarter of the 20th century into a regional banking centre for Latin American and the Caribbean, due to a variety of factors including the absence of exchange controls, the rapidly increasing volume of trade being conducted through the country (and through the Colon Free Zone in particular), liberal banking legislation and tight secrecy provisions. At the end of 1997 more than 100 banks were licensed in Panama, from more than 20 countries and with assets of about $23bn; however the country responded to international pressure by tightening up on banking regulation, and a number of banks closed their offices in 2000 and 2001. By mid-2005, 80 licensed banks remained, of which 30 had international licences. Assets amounted to $7bn.

Thanks to new financial regulation, Panama is once again developing itself into an important centre for banking. The legislation introduced a new licensing system for the industry and stricter compliance procedures, whilst subsequent laws and decrees have established modern anti-money laundering, fraud and terrorist financing rules. These initiatives helped to secure Panama's omission from the FATF (Financial Action Task Force on anti money laundering) 'blacklist' of non-cooperative jurisdictions in 2001, and have transformed the nation into one of the world's most reputable international banking centres, home to around 80 banks by 2005.

By 2007, the banking sector had rationalised further as foreign giants sought a piece of Panama's fast-growing services economy. Four deals at the latter end of 2006 had a major impact on the competitive environment of Panama's banking industry; these included HSBC's acquisition of Banco del Istmo - Panama's largest bank - for $1.8 billion, and Citibank purchase of Grupo Financiera Uno, Latin America’s largest credit card issuer, for $1.1 billion. By the end of 2007 total consolidated assets in the banking sector reached $69bn. The majority of assets are domestic - as opposed to offshore - as demand by wealthy expats, particularly from the US, for loans on second homes increases seemingly unabated.

Pressure is however being maintained on Panama to adopt international standards of tax transparency and information exchange. Panama was among 35 jurisdictions identified by the OECD as far back as June 2000 as meeting the technical criteria for being a tax haven and threatened with listing as 'unco-operative'. This resulted in a written undertaking in April 2002 by the then minister of Economy and Finances, Norberto Delgado Duran to the OECD, that Panama would comply with OECD standards of tax transparency, in particular adopting the principles of exchange of tax information. The country has quite recently entered a number of Double Tax Treaties and Tax Information Exchange Agreements.

The US Free Trade Agreement

Recent Panamanian administrations have worked to finalize a Free Trade Agreement with the US, but the United States Congress is currently at odds with itself over the signed-but-not-yet-ratified Agreement. Anti-offshore hawk Senator Carl Levin insists that the deal should not be ratified until issues surrounding the Latin American’s nation’s ‘tax haven’ status are resolved, but leading figures on the Senate Finance panel argue that the importance of the deal to the US economy overrides concerns about tax transparency, at least in the short-term.

In a 2009 letter, Michigan Democrat Levin, along with Congressman Lloyd Doggett, a Texas Democrat, urged the President to make approval of the Panama FTA “contingent on Panama’s cooperation with efforts to combat international tax evasion.”

“In this time of economic distress, we can no longer afford to ignore the billions of dollars of tax revenue lost to the US Treasury due to the bank secrecy practices of Panama and other tax havens,” they wrote. “Implementing an agreement on trade while ignoring Panama’s status as one of the world’s recognized tax havens would not only undermine your efforts to address offshore tax evasion, but would also thwart the best opportunity our nation will have to obtain cooperation from a country that has resisted for years American efforts to encourage changes to its secretive banking and regulatory practices.”

Dogget and Levin claim that the US Treasury loses USD100bn a year in tax revenues to offshore jurisdictions. However, this figure is much disputed and even Internal Revenue Service Commissioner Doug Shulman admitted in recent testimony to the House of Representatives Appropriations subcommittee that such ‘tax gap’ calculations are nothing more that “wild estimates” using “pretty broad numbers.”

“American workers and ranchers in my home state of Montana and across the country have much to gain from the US-Panama Trade Agreement,” he said following a Finance Committee hearing on the matter. “Well over 90% of Panama’s products currently enter the United States duty-free under our trade preference programs. It is high time that US products get similar treatment in Panama. The time to move the FTA is now.”

“Both the current and incoming administrations in Panama have made clear that they are willing to take the necessary steps to change their tax laws and share tax information with the United States,” Baucus continued. “We should move forward on both fronts—expanding our trade ties and addressing our tax issues—before the opportunity to secure the best possible trade deal is lost.”

Senator Chuck Grassley, the ranking Republican on the Finance Committee, said during the hearing that he welcomed a report claiming Panama’s Vice President has committed Panama to negotiating a legally binding instrument this year to facilitate the exchange of tax information with the US. However, he argued that such an undertaking should not be a pre-condition of the trade agreement being sealed.

“I fully support concluding a Tax Information Exchange Agreement with Panama as soon as possible,” he said. “But I don’t see why our exporters should have to pay for that agreement with lost export opportunities, which is exactly what’s happening.”

“I urge the Administration to submit the US-Panama Trade Promotion Agreement to Congress for approval next month,” Grassley went on to add. “We can, and should, pursue both priorities simultaneously.”

The Congressmen's letter was sent just two days after US Trade Representative Ron Kirk signaled in a speech to business leaders that the administration is working with the Panamanian government to iron out tax and labor rights issues with a view to sending the agreement to Congress in the near future.

Living And Working In Panama

Panama classifies foreigners entering the country as Tourists, Temporary Visitors, Special Temporary Visitors, Tourist-Pensioners, Immigrants and Investors.

Short-stay visas are issued freely; the Tourist-Pensioner visa is given to those who can demonstrate a designated monthly income from interest on time-deposits in a Panamanian bank; the Investor's visa is for those who invest their own capital into local business activity. Immigrant visas cover long-stay working residents.

For those thinking of living, working or setting up a business in Panama, there is no distinction made between foreigners and nationals under Panamanian law.

Residency rules meanwhile are fairly simple and unbureaucratic. Whilst there are no statutory residency rules as such, an individual is considered resident if he is present in Panama for more than 180 days in any one tax year and residence has to be officially recognised by the Government.

The labour and employment market on the other hand, is more closely controlled by the authorities and the law sets maximum percentages for the employment of foreigners in a business according to its sector. Usually the figure is 5% although foreign companies are allowed to fill senior positions with expatriates, up to a maximum of 12% of the staff. However, the Ministry Of Labour, which is responsible for issuing work permits, may be flexible on this issue and is open to negotiation for the setting of higher limits in certain instances.

This relatively light system of tax and business regulation, a stable dollarised economy and a benign political system makes Panama an attractive proposition for any aspiring expat currently plotting his or her escape from the high tax countries of North America or Europe. Those seeking sunnier climes to retire to will also be happy to hear that Panama's Pensionado Visa Program offers a variety of tax breaks and discounts on such things as car imports, furniture, mortgages, utility and medical bills.

However, perhaps just as important is that residents can enjoy a good quality of life in Panama with its tropical climate, miles of sandy beaches and picturesque mountain scenery. As the country is still a relatively undiscovered destination, real estate remains relatively inexpensive with potential for appreciation. Panama also has first class infrastructure in terms of communications ensuring that international phone call will always connect, and internet access is reliable.

And if that doesn't convince you, the cost of living in Panama City is around half of that of the United States...