Magnetic appeal: Strong legal and free trade zone frameworks shore up investment growth

Surging economic growth, a rapidly improving infrastructure network and having one of the world’s main trade routes have allowed the country to transform itself into a popular destination for foreign direct investment (FDI) over the course of the past decade. Simultaneously, the presence of an attractive regulatory framework providing numerous incentives, as well as a strong free trade zone system, have been equally as important in providing the assurances and encouragement needed to attract and keep investors. In total Panama has four kinds of free trade or special economic zones. The largest such areas are the Colón Free Zone (CFZ), the Panama Pacifico Special Economic Area (SEA) and the City of Knowledge, each of which were established under individual law, though a more generalised free zone legal framework also exists. FDI has been on the rise ever since dropping dramatically to $1.26bn in 2009 due to the global financial chaos of the time, following data from the National Institute of Statistics and Census. FDI has been on a steep upward trajectory, attracting $2.72bn in 2010, $3.13bn in 2011and $2.88bn in 2012. As of June 2013, the latest figures for 2013 available at the time of press, it totalled $2.04bn, which represents an increase of $322m over the first half of 2012.

General Incentives

Apart from the legal framework of the free trade zone system, numerous laws have been passed to incentivise investment. Law 41 of 2007 established incentives for multinationals headquartered in Panama, such as exemption from income tax for services provided within the business group but outside the country, as well as flexible labour and migratory regulations with regards to the hiring of mid- and high-level executives. The country’s investment stability framework, passed through Law 54 of 1998, has been in place for even longer. It ensures foreign investors are treated with the same rights and obligations given to domestic investors. Incentives have also been approved with an eye towards facilitating growth and development of specific industries. Industrial Promotion Certificates provide agro-industrial firms with a 35% reimbursement in payments (25% for industrial firms) and a preferential 3% importation tariff on technological and research-related equipment. Incentives also exist for call centres and exporters of agricultural goods; however, the biggest attraction for foreign and domestic investors alike has been the establishment of free trade zones (FTZs) and special economic areas in strategic areas of the country.

FTZ Framework

Though individual laws were passed establishing the three larger free zones, such as the CFZ or the Panama Pacifico SEA, the wider FTZ regulations are found under a general framework. Under FTZ regulations established by Law 25 of 1992, which was modified by Law 32 of 2011, only companies in the following activities may benefit from FTZ regulations: manufacturing and assembly, logistics and transportation services, centres of higher education and research, general services firms, and specialised health clinics.

Special licences are granted to the promoters and operators of free zones, who must invest a minimum of $250,000 in an area of at least 2 ha. Companies based in FTZs benefit from duty-free importation of goods and exemptions on income, sales and selective consumption taxes derived from royalties on export and re-export activities, though a 1% tax on capital and a 5% tax on dividends is applied. Law 32 also provided special consideration for the development of science and technology by extending incentives to firms developing and training human resources in science and technological processes. According to figures from the Ministry of Commerce and Industry, under the general FTZ framework above a total of 14 FTZs have been created, in addition to the three individual zones. These FTZs have thus far successfully attracted a total of 95 companies.

CFZ

Legally created in 1948, the CFZ is the largest such area in the country (and second largest in the world) and home to more than 3000 businesses. Moreover, it has been one of the principal contributors to economic growth and development of the country since the second half of the 20th century. In 2013 it was responsible for 8% of GDP and the creation of more than 30,000 direct jobs and 60,000 indirect jobs. To be based out of CFZ, companies must re-export a minimum of 60% of all imported goods and hire at least five Panamanians.

However, despite its size and significance to the wider economy, the CFZ is a dated model. Indeed, the establishment of more specialised zones, such as the Panama Pacifico SEA, which cater to specific industrial and economic needs, are now being touted as the way forward for the country.

Panama Pacifico

Law 41 of 2004 established another regime for providing legal and financial incentives for private companies operating in Panama through the creation of a new mixed-use FTZ known as the Panama Pacifico SEA. A $700m development, Panama Pacifico SEA has many of the same incentives found elsewhere, such as exemptions on income taxes and special regulations for labour and migration, but they are applied only to specific economic activities including but not limited to offshore services, logistics services and high-end technological manufacturing. Panama Pacifico SEA also provides companies based within its borders with a one-stop shop for processing work visas and permits, and aiding in business establishment.

Modern facilities catering to the needs of a specific industry is hardly a new concept, though Panama Pacifico SEA has gone a step further by not only providing real estate, infrastructure and services for companies based there but also providing the necessary residential and social aspects to create a holistic approach to developing a free zone.

Built on the site of the former US Howard Air Force Base, Panama Pacifico SEA covers a total of 1400 ha that include 1m sq metres of commercial office space and more than 20,000 homes, as well as hospitals, schools, hotels, an international airport and retail areas. Multinational companies already located in Panama Pacifico SEA include Dell, 3M and Citibank.

City of Knowledge

As its name implies, the City of Knowledge was created to foster the development of scientific, technological, educational and cultural industries in the country. Legally established in 1998 through Law 6, the City of Knowledge was also built on a former US military base in Fort Clayton. The 120-ha area is also just outside the capital of Panama City and is operated on a non-profit basis by the City of Knowledge Foundation. Educational and training institutes include international campuses of IESE Business School, Florida State and Georgia Tech working alongside multinationals such as HP and Caterpillar.

Numerous humanitarian and environmental agencies have also made the City of Knowledge their home. Current occupants include the UN Development Programme, the Spanish Agency for International Development and Cooperation, the World Wildlife Fund and UNICEF. Similar to the other free zone models, fiscal incentives include exoneration from income, import, sales and real estate taxes, as well as incoming capital via international wire transfers. There are no limits placed on the hiring of international personnel who all receive special visas and work permits.

Challenges

Though specialised zones may certainly be the way forward, particularly with regards to creating niche industries where logistics, manufacturing and industry can work together more effectively, bureaucratic processes remain an obstacle to their development, particularly among the general FTZ framework. Indeed, as Aida Maduro, the president of the Panama Industrial Association, told OBG, “The process of working through the current legislative framework to receive benefits of incentives can be quite exhausting for companies as the need to garner approval from numerous ministries and agencies can be quite taxing.” Apart from ensuring that all affected governmental agencies review and approve legislation prior to its enactment, Maduro went on to suggest that the creation of an inter-institutional committee to handle such affairs could help to streamline bureaucracy, such as the one-stop shop created for Panama Pacifico SEA.

Panama’s three individually established zones have indeed fared much better than many of the 14 established FTZs that fall under the general framework. The largest such zone, PanExport, has just 24 companies, for example. Whilst the CFZ will likely remain the largest FTZ in the country for some time, growth and investment generated by free zones should be concentrated in economic areas with particular needs and demands; take, for example, the high level of communications infrastructure needed to house the technological- and research-oriented institutions at the City of Knowledge. Undoubtedly a vital part of the country’s economic planning, free zones will continue to attract investment and play an important role in domestic economic development for many years.