Panama court upholds transfer pricing penalty on operations within special tax-exempt area

By Rafael Rivera, Managing Partner and Tax & Legal Partner at BDO Panama, Panama City

The Supreme Court of Justice of the Republic of Panama issued its final decision on August 27 in one of the first tax disputes involving operations of a multinational operating within a special tax-exempt area in Panama (under the common denomination “Oil Free Zones”).

A USD 1 million penalty was imposed by the Panama Tax Administration (Direccion General de Ingresos) through Resolution No. 201-1429, dated October 24, 2014, against the taxpayer, Chevron Panama Fuels Limited (formerly denominated Chevron Products Antilles Limited). The taxpayer was a Panamanian-based branch of a foreign subsidiary of the Chevron group operating within an Oil Free Zone in Panama. 

The penalty was imposed for failure to comply with transfer pricing obligations for fiscal year 2012. Specifically, the failure related to the obligation to file tax form no. 930, including the summary of all the taxpayer’s operations with related parties during the fiscal year, and the obligation to provide Panama’s tax administration a full transfer pricing study, including both the functional and economic analysis of the taxpayer’s operations in Panama.  

The taxpayer challenged the penalty at the administrative level, including a reconsideration before the tax administration and a subsequent appeal before the administrative tax court (Tribunal Administrativo Tributario). Both motions were denied as the penalty was ruled to be issued in accordance with the applicable statutory provisions and regulations. Consequently, the taxpayer filed a lawsuit with the Supreme Court of Justice of the Republic of Panama seeking to annul and reverse the penalty imposed by the tax administration.

Court analysis

The discussion of the case was very much centered on the tax benefits and exemptions granted to taxpayers operating under the special tax-exempt area in Panama known as Oil Free Zones (following Section 701-D of the Fiscal Code). Basically, the regime allows taxpayers a special corporate income tax exemption on profits arising from re-exporting operations and other special transactions benefiting from the regime (i.e., sales to vessels crossing the Panama Canal and aircraft in international traffic, among others).

However, there is an additional layer of taxation assessed on those same profits. The so-called supplementary tax (Impuesto Complementario) adopts the form of an advance tax on undistributed profits equivalent to 2% of the net profits obtained by companies operating within these special areas both from taxable operations (i.e., considered local operations) and exempt operations (i.e., considered export or other special operations including as exempt). This supplementary tax shall be assessed and determined in the income tax returns filed by companies (including those established in the special areas).

According to the Supreme Court decision, Section 762-C of the Fiscal Code defines “related parties” for transfer pricing purposes, Section 762-D of the Fiscal Code requires that such “related parties” conduct their transactions under the same terms and conditions that would be agreed between “independent parties”, and finally Section 762-I of the Fiscal Code requires the filing of tax form 930 including a summary of all their related party transactions for the preceding fiscal period (i.e., at least six months after closing). For taxpayers failing to comply, a 1% penalty assessed on the total amount of undisclosed transactions is imposed.

According to the Supreme Court findings, the taxpayer, in this case, reported in its income tax return related party operations generating a substantial amount of revenue equal to approximately USD 595 million. However, the taxpayer did not file its tax form 930. According to the taxpayer, it did not file the corresponding tax form 930 because such operations were treated as exempt operations, in other words, not subject to corporate income tax in the Republic of Panama.

However, the Supreme Court of Justice sided with the tax administration, the decision upon appeal by the administrative tax court, and the opinion of the general attorney of the public administration. In so doing, it concluded that the income tax exemption applicable to export operations (i.e., benefiting from a corporate tax exemption) shall not be automatically construed as an authorization or exclusion to omit compliance with the transfer pricing requirements on related party operations, which evidently have a direct impact on the level of revenue, costs, and profits of the taxpayer, and consequently of the tax basis of the so-called supplementary tax. The Supreme Court thus dismissed the lawsuit filed by the taxpayer.

Final remarks 

For taxpayers operating under any special tax-exempt area in the Republic of Panama, it is important to note that a new text of Section 762-L of the Fiscal Code was enacted as of the approval of Law No. 69 of 2019. Under the new text, it is clearly established that as of fiscal year 2019, any and all taxpayers operating within the Colon Free Zone, Oil Free Zones, Panama Pacific Special Economic Area, Multinationals Headquarters Regime, City of Knowledge, or any other special area established in the Republic of Panama or to be established in the future, will be required to comply with the transfer pricing statutory provisions and regulations.  

–Rafael Rivera is Managing Partner and Tax & Legal Partner at BDO Panama, Panama City