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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 have been 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 recently elected President) and US President Carter in 1977 set in train a twenty year transition period that has seen the administration and running of the canal pass back to the Panamanians.

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.

However, 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.

Recent governments have sought to take full advantage of this legacy 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.

In addition, 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.

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.

Thanks to new financial regulation, Panama is also developing itself into an important centre for banking. In February 1999 the government introduced a comprehensive banking law significantly tightening controls and regulations, and bringing the country's regulatory standards into line with those seen in the long established financial centres of Europe and America.

The banking 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 (in mid-2005).

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. 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. 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. The annual tax is imposed as follows:

• 1.75% from $30,000 (lowered to $20,000 in 2005) to $50,000; plus
• 1.95% from $50,000 to $75,000; and
• 2.10% on values above $75,000

Valuations under the 'cadastral' system were updated in 2005, and as from 2006 the tax is based on the new values at the following rates:

• 0.70% on any value exceeding US$30,000 up to US$50,000;
• 0.90% on any value exceeding US$50,000 up to US$75,000; and
• 1.00 % on any value in excess of US$75,000.

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.

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...