Panama is famous for its canal, colorful history and cool offshore tax regime. To that we can soon add a tax treaty with Israel.
On May 26, Finance Minister Yair Lapid published an order (KT 1198) giving effect to an Israel-Panama tax treaty commencing January 1, 2015. Here is a brief overview of the treaty: The treaty applies to residents liable to tax in either country. It does not apply to tolls, duties or similar payments upon crossing the Panama Canal. A “resident” includes a pension scheme established in Israel and a charity established in either country even if the charity is exempt in its own country.
As for trusts, the tax authorities shall endeavor to determine their residence taking into account all relevant factors, including: governing law, asset location, the settlor’s residence and the beneficiaries’ residence. It seems these factors may also apply to Panamanian foundations.
In practice, these factors seem vague, which may work to the Israel Tax Authority’s advantage in practice; Panamanian trusts with an Israeli link may be deemed to be Israeli resident until otherwise agreed, which is unlikely.
Israel is defined as the State of Israel, and when used in a geographic sense, it is the territory in which the government of the State of Israel has taxation rights, including maritime areas adjacent to the outer limit of the territorial sea in which Israel exercises its sovereign or other rights and jurisdiction. In other words, Israel will tax any Panamanian-owned offshore gas operation in the high seas off Israel.
With regard to business operations, a resident of one country (e.g., Panamanian company) may be taxed in the other country (e.g., Israel) if it has a “permanent establishment” (PE) in the other country.
A PE is generally a fixed place of business or a “dependent agent” with authority to conclude contracts. According to the treaty, a PE also includes a construction, assembly or installation project or supervisory services in connection therewith, or other services – if they last more than 270 days in any 12-month.
Income derived from real estate in either country may be taxed in that country.
Dividends paid to a resident of the other country will generally be subject to a 15 percent withholding tax, decreasing to 5% if the recipient is a pension fund. In the case of real-estate investment companies (i.e., REITs), distributions are taxed according to domestic law, but no more than 20% if the recipient holds less than 10% of the REIT’s capital.
Interest paid to a resident of the other country will also subject to a 15% withholding tax. But no withholding tax will apply to payments to a pension scheme or on bonds traded on a stock exchange in the payor’s country of residence.
Royalties paid to a resident of the other country will also subject to a 15% withholding tax, including payments for the use or right to use software.
Capital gains derived in one country by a resident of the other country will be taxed in the first country at its regular rates if they relate to: (1) disposition of real estate in the first country where the real estate is located, (2) disposition of shares “or comparable interests” deriving more than 50% of their value from real estate in that country, except for shares publicly traded on a stock exchange (unless they relate to a real-estate investment company, or were listed after the shares were acquired, or the shares were acquired following a takeover bid), (3) movable property of a permanent establishment; e.g., equipment.
Capital gains relating to more than 50% of other shares of a company may be taxed at 5% following a disposition or a change of residence from one country to the other country.
Pensions paid to an Israeli resident in respect of past employment may be taxed only in Israel.
To avoid double tax, Israel grants its residents a foreign tax credit for Panamanian tax on Panamanian income. Panama grants its residents an exemption from Panamanian tax on Israeli income.
Why would Israel want a tax treaty with Panama? Probably because of Article 25, which permits the exchange of information between the tax authorities of the two countries, but no “fishing expeditions.” However, there is nothing to require one country to enforce tax debts of the other.
As for tax planning, there is a “limitation of benefits” clause that disallows treaty benefits if a main purpose for establishing an entity was to enjoy those benefits.
Also, Israel can continue to apply its own domestic anti-avoidance legislation (e.g, relating to controlled foreign corporations, foreign professional corporations, artificial or fictitious transactions, etc.).
To sum up, the new Israel-Panama tax treaty will be a mixed blessing.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.