Perspectives

Panama Law 526 and Decree 32: Economic Substance

Mgter. Liz A. Prestán O.August 22, 2026Tax

Regulatory framework: the economic substance rules for certain foreign-source passive income introduced by Law 526 of May 28, 2026 were implemented by Executive Decree 32 of September 2, 2026, published in Official Gazette 30603-B. Article 20 of the decree provides that it applies to fiscal periods beginning on or after January 1, 2027.

Law 526 of 2026 and its implementing regulations require a closer look beyond an entity’s formal incorporation: who manages its assets, where decisions are made and how its activities are substantiated. This analysis explains the regime’s scope and the new requirements that multinational groups and wealth structures connected with Panama should assess.

Context: A Response to an International Tax Trend

Law 526 of 2026 is not an isolated initiative of the Panamanian legislature. It responds to an international regulatory trend that demands greater economic substance and seeks to strengthen the country’s competitiveness through a regulatory framework aligned with contemporary standards.

A growing number of jurisdictions that maintain foreign-source income exemption regimes, known as Foreign-Source Income Exemption or “FSIE” regimes, have been forced to incorporate, as a condition for maintaining that exemption, a requirement of real economic substance within their territory.

This pressure comes primarily from two fronts: the Forum on Harmful Tax Practices of the Organisation for Economic Co-operation and Development (OECD), and the European Union’s Corporate Taxation Code of Conduct Group. The latter requires, as a condition for a jurisdiction with an exemption regime on foreign passive income not to be classified as fiscally detrimental, that the entities benefiting from said exemption demonstrate real and verifiable economic activity within the territory where they are located.

Panama thus joins a list of jurisdictions that have already taken this same path, including Hong Kong, Singapore, the British Virgin Islands, and the Cayman Islands, adapting to its own regulatory framework solutions that already have a track record of implementation and international scrutiny.

The underlying decision: economic substance instead of a general tax

One point worth emphasizing from the outset is the fiscal policy choice underlying Law 526: the Panamanian legislature never questioned the territoriality principle that governs the national tax system. Taxing passive income from foreign sources across the board would have meant abandoning that principle, with a reputational and competitiveness cost that the country was unwilling to bear.

Therefore, the chosen formula was different: instead of taxing foreign passive income as a general rule, its exemption is conditional upon demonstrating real economic substance in Panama. Only when the entity fails to demonstrate the existence of such substance or fails to meet its reporting obligations does passive income become subject to a single, definitive tax rate of 15% on net taxable income, pursuant to Article 707-D of the Tax Code, as amended by Article 1 of Law 526. This solution allows Panama to align itself with international standards without relinquishing the elements that have made the country an attractive jurisdiction for establishing international structures and operations.

Expected impact and the risk of closer scrutiny

From the perspective of the Panamanian State, the expectation is clear: to consolidate its removal from Annex II of the European Union’s list of non-cooperative jurisdictions, improve the country’s international perception as a transparent jurisdiction, and thereby facilitate the expansion of the network of double taxation treaties and attract higher-quality foreign investment.

However, it would be naive to assume that the mere enactment of Law 526 definitively resolves the matter. The risk of additional or stricter substance requirements being demanded is real, for several specific reasons:

The Code of Conduct Working Group does not only evaluate the text of the law, but also its regulations and, above all, its effective application in administrative practice.
Panama must maintain a robust information exchange regime, both automatic and on request, as an implicit condition of credibility of the new substance framework.
The country has a history that weighs heavily on this assessment: in the 2019 review by the Global Forum on Transparency and Exchange of Information for Tax Purposes, Panama registered a 69% non-compliance rate in the exchange of information on request regarding accounting records, resulting in a rating of “partially compliant.” Moving towards a “fully compliant” rating is essential for the new economic substance regime to be received with credibility by the international community.

Scope of application: the three-step test

Law 526 does not create a generally applicable regime, but rather one limited by definition to a very specific obligated entity: the entity that is part of a multinational group and obtains passive income from foreign sources. Determining whether a structure falls under the regime requires, in practice, a three-step analysis.

First step: identification of the obligated party. It must be established whether the Panamanian entity is part of a group of two or more entities linked by ownership or control that operate or maintain tax residence in more than one jurisdiction, according to the definition of “multinational group” in Article 707-B, paragraph 4, of the Tax Code. An isolated Panamanian entity, without any connection to entities in other jurisdictions, falls outside the scope of the law, even if it generates passive income from foreign sources.

Second step: the consolidation criterion. Article 707-B conditions membership in the multinational group on the entity being included, or required to be included, in the group’s consolidated financial statements, or on its equity interests being traded on a public securities market. It is important to note that the law expressly provides for the opposite scenario: an entity excluded from the consolidated financial statements due to its size or significance is not, for that reason alone, exempt from classification as a member of the multinational group. In other words, the fact that an entity is small and is not included in the consolidated financial statements does not exempt it from having to demonstrate economic substance if it otherwise meets the related-party criteria.

Third step: classification of the income. Once the entity is confirmed to fall within the law, the nature of its passive income must be assessed. The exhaustive list in Article 707-C includes dividends, interest, royalties, capital gains, income from real estate and other income from movable capital. The required economic substance standard varies according to the type of income and the entity’s main activity.

What Executive Decree 32 of 2026 clarifies

The decree develops the substance requirements without making them a general obligation for every Panamanian company. Article 3 covers entities incorporated or domiciled in Panama that belong to a multinational group and receive the foreign passive income specified in the Tax Code, whether they also receive Panamanian-source income or only that foreign income. Legal form alone does not exclude a structure: the decree includes companies, fideicomisos, trusts and foundations, among other vehicles.

Personnel and premises suited to the activity

Under the general regime, Article 5 requires adequate human resources and sets a minimum of one duly qualified and remunerated employee or contractor, including through a service provider. That person may work full time or part time, but the time devoted must be sufficient for the activity actually carried out. Meeting the numerical minimum does not replace an assessment of the operation’s nature, scale and complexity.

The premises must be in Panama and have the material and technological resources needed. Shared use and different contractual arrangements are permitted, provided the right of use is documented and the space is proportionate to the activity. A registered address alone does not demonstrate compliance with these conditions.

Strategic decisions and operating expenses

Under the general regime, Article 6 requires the board of directors or equivalent body to hold at least two meetings with physical presence in Panama during the fiscal period. Strategic decisions must be documented, and the body must have the skills needed to direct and supervise the activity. Meeting frequency depends on the operation; satisfying the minimum does not replace the actual exercise of those functions.

Article 7 requires operating costs and expenses to be directly and verifiably linked to the principal activities. For this requirement, personnel remuneration and premises expenses are considered separately and may not be counted again as operating expenses. These items should be distinguished in the accounts and their supporting records retained.

Outsourcing of services: an option with strict limits

Article 11 of the decree develops the outsourcing permitted under Article 707-G of the Tax Code for the human resources and premises requirements and for operating costs and expenses. The arrangement must involve real, verifiable services in Panama.

Contract and capacity: the contractual relationship, the provider’s expenses, suitable personnel and the premises needed to deliver the service must be identified.
Performance in Panama: principal activities carried out outside the country do not count towards demonstrating economic substance.
Effective supervision: the entity must maintain mechanisms to monitor, control and supervise outsourced activities.
No double counting of time: hours actually allocated by the provider to one entity cannot simultaneously be credited to another.

There is also a decisive limitation: under Article 6, the management, administration and control functions inherent in the strategic decisions of the board of directors or equivalent body must be performed directly by that body. They cannot be outsourced, delegated or subcontracted to meet the substance requirement.

The special anti-abuse clause and its relationship with Article 20 of the Tax Procedure Code

Article 707-K introduces a specific anti-abuse clause for the economic substance regime, which empowers the Ministry of Economy and Finance to disregard, through a reasoned resolution, forms or mechanisms that lack valid commercial reasons and that have as one of their main purposes to obtain a tax advantage contrary to the purpose of the law.

Why introduce a special anti-abuse rule when Article 20 of the Tax Procedure Code already contains a general clause? The distinction lies in their scope. Article 20 concerns Panamanian-source income and tax obligations generally, while Article 707-K specifically addresses genuine or simulated compliance with economic substance requirements for foreign-source passive income. Both seek to prevent the abuse of legal forms, but their different scope and subject matter explain their coexistence.

Holding companies and wealth structures: what the regulations clarify

A differentiated standard for mere holding activities

Article 8 specifies the treatment of multinational group entities whose principal activity is holding equity interests or the acquisition, holding or non-habitual disposal of real estate. Subject to that article’s conditions, they must meet the human resources and premises requirement in paragraph 1 of Article 707-E, as well as reporting, information and incorporation or registration obligations. They are not automatically subject to the same full set of conditions as entities under the general regime.

This treatment requires the entity to limit itself to functions inherent in holding the assets. The decree identifies active involvement in the day-to-day operational decisions of investee entities, financing unrelated third parties and regulated financial intermediation as substantial commercial or investment activities.

For the human resources component, Article 8 provides a presumption of compliance where there is at least one remunerated director, officer or administrator who resides in Panama and has appropriate experience or qualifications, or where the entity has remunerated resident personnel with the necessary skills. Adequate physical premises and the right to use them must also be documented. A holding structure is not exempt from substantiating its organisation or from reporting.

An investment account does not replace the group analysis

The existence of a securities portfolio or investment account abroad does not, by itself, establish that an entity belongs to a multinational group. Ownership or control relationships and the legal consolidation criteria must first be examined. Conversely, calling an entity a “personal wealth vehicle” does not create an automatic exclusion if it meets the regime’s conditions.

Incidental interest and multi-tier structures

The decree does not establish an express, general exemption for incidental interest on savings accounts or liquidity instruments. Each type of income and the activity generating it must therefore be assessed before extending the mere-holding treatment to it. This remains an issue requiring particular attention in structures with different types of income.

Nor should it be assumed that substance demonstrated by a lower-tier entity automatically releases the other entities in the chain from their obligations. The assessment must identify the recipient of each item of income, whether it falls within the regime and which conditions apply. The ability to share premises or contract services does not remove individual obligations or permit the double counting of human resources.

Reporting, documentation and other relevant points

Article 9 requires the sworn income tax return and its annexes to report the information necessary to substantiate economic substance for each type of passive income. This includes activities, personnel and remuneration, premises, outsourcing, strategic decisions, risks and operating expenses. It also includes information on foreign taxes where a corresponding credit is claimed, and on intangible assets where applicable.

Article 10 requires supporting records to be retained at the entity’s domicile in Panama, physically or digitally, for five years from the end of the relevant fiscal period. Article 19 requires supporting documentation to be submitted in Spanish.

Credit for taxes paid abroad

For non-qualified entities, Article 12 develops the credit for foreign taxes applicable to the same income taxed in Panama. Payment or withholding must be substantiated, and duly legalised or apostilled documentation must be provided. The credit is limited to the Panamanian tax corresponding to that same income; credits relating to different income may not be offset, transferred to third parties or carried forward to subsequent fiscal periods. The decree also addresses cases where the foreign tax is paid or assessed in a different period from the recognition of the income.

Intangible assets and sector-specific exclusions

Articles 13 to 16 develop the treatment of certain income from intangible assets and require separate records for each asset to identify income, costs, expenses and the components of the calculation. Merely describing a payment as a royalty is insufficient: trademarks, image rights and marketing intangibles are excluded from the definition used for that calculation.

Article 17 allows the Ministry of Economy and Finance to request certifications from sector regulators to verify exclusions claimed under Article 707-N. The licence, registration or authorisation must be valid, and regulatory compliance must be capable of substantiation.

Entry into force and preparation for 2027

Law 526 takes effect from fiscal year 2027. Executive Decree 32 specifies that it applies to fiscal periods beginning on or after January 1, 2027. Publication of the decree therefore does not mean that the new regime’s obligations begin immediately.

The decree links reporting to the income tax return and its annexes but does not establish a separate filing date applicable to every entity. The specific timetable must be determined by reference to each entity’s fiscal period and the rules applicable to its income tax return and annexes.

Determine the scope: identify the group’s entities and classify the foreign income each receives.
Identify the applicable standard: distinguish the general regime, mere holding activities and any exclusions that can be substantiated.
Align the operation: review personnel, premises, corporate governance, meetings and provider contracts.
Organise the evidence: separate expenses, retain minutes and supporting records, and assign responsibility for reporting and annual review.

Conclusion

With the publication of Executive Decree 32, the focus shifts from awaiting regulations to preparing for compliance. For a structure within the regime, the challenge is to align its actual functions with the personnel, decisions, expenses and documentation it will need to demonstrate. An individual review helps distinguish genuine obligations from requirements that do not apply and prevents a formally sound structure from reaching 2027 without the necessary evidence.

Frequently asked questions

Have implementing regulations for Law 526 been issued?

Yes. Executive Decree 32 of September 2, 2026 implemented the economic substance rules for certain foreign passive income incorporated into the Tax Code by Law 526. It was published in Official Gazette 30603-B.

When does the decree apply?

Article 20 provides that it takes effect for fiscal periods beginning on or after January 1, 2027.

Must every Panamanian company and foundation meet these requirements?

No. It is necessary to establish whether the entity falls within the regime’s scope, including its membership of a multinational group and receipt of the specified foreign passive income. Legal form alone determines neither the obligation nor an exclusion.

Can all functions be outsourced?

No. The decree permits outsourcing certain activities subject to conditions relating to performance in Panama, provider capacity and supervision. Functions inherent in the strategic decisions of the board of directors or equivalent body cannot be outsourced, delegated or subcontracted to substantiate economic substance.

Does a holding company face the same standard as an operating entity?

Not necessarily. Article 8 provides differentiated treatment for mere holding activities that meet its conditions, focusing on human resources and premises, alongside reporting and incorporation obligations. This treatment is not a general exemption from compliance.

How long must documentation be retained?

Article 10 requires supporting records to be kept in Panama for five years from the end of the relevant fiscal period, physically or digitally. Article 19 requires their submission in Spanish.

Official sources and related reading

This article provides general information and legal analysis. It does not constitute legal advice for a particular case.