Key Takeaways
- Permanent establishment (PE) is when local authorities deem a foreign business to have ongoing presence in the country and tax them accordingly.
- Companies operating in foreign countries without the right level of expertise and guidance are at risk of being seen as permanent establishments.
- Activities that can put companies at risk of PE include regularly working from the same location, or exercising significant economic influence.
- Operating through a co-employment agreement with the right EOR is one way to acoid these risks.
Business has never been more global. Companies of all sizes can take advantage of opportunities on an unprecedented scale, regardless of size or resources. Thanks to the rise of mobile communications, business can be done from virtually anywhere, making it easier than ever to outsource projects to independents to save on costs such as employee taxes and social security. However, global expansion has its risks. Any company entering a new market knows that the new venture could fail or underperform. That’s a risk that goes with every business decision.
Other risks involve matters of compliance that could result in fines for the company and damage to its reputation. One such risk that has been discussed a great deal over the past year is the misclassification of contract workers. Too often, companies treat their contractors as regular employees but continue to classify them as independents to avoid their obligations to the workers. Governments have begun to crack down on the practice dramatically.
Another risk is a permanent establishment. Permanent establishment risk refers to the risk of tax compliance in a foreign country determining that your business is operating in that country continuously rather than just sporadically. It can then declare the business a permanent establishment, and as such, liable for all corporate taxes.
Knowing what might trigger the tax authorities to declare your business can help you avoid fines and unplanned tax expenses. Good advanced planning can help you reduce the risk.
What is a Permanent Establishment?
Permanent establishments (PEs) are businesses with ongoing and stable operations in a country or state that may impose taxes outside of their original home base.
Permanent establishment is a tax concept that varies from country to country and is often included in trade agreements that contain tax treaties between countries but is generally understood to mean that a tax authority deems a business to have a stable and ongoing presence of either a foreign subsidiary or an overseas branch office in the country and is therefore subject to corporate taxes and possibly VAT.
A company’s auxiliary activities such as preparatory work that does not generate revenue do not trigger permanent establishment status. The final authority on status, however, is the local tax authority. The burden of proof is with the company to demonstrate that the activities are auxiliary and do not warrant a permanent establishment status.
If a company is deemed to have a permanent establishment, it will be subject to all of the taxes it would pay for profits generated in the country, according to the local tax rates. In addition, the company can be levied charges for interest on the taxes, depending on the country and the period of time over which the company’s activities took place.
Types of permanent establishment
There are three main types of permanent establishment, including the following:
- Agency-based establishment. In this case the company has an agent (or agents) working on their behalf in the foreign country, including exercising authority and making legally binding decisions like concluding contracts.
- Physical-based establishment. Here, if there is a fixed place, be it office, warehouse, factory or other physical location from which the company is regularly getting work done, the foreign business can be considered a physical establishment.
- Service-based establishment. If a company provides a service in a foreign country for over a certain period, it can become a permanent establishment.
Virtual permanent establishment
Virtual permanent establishments are emerging as a new category, signifying a new way of describing what it means to be a permanent entity. As more companies rely on remote work, this category has emerged in discussions as a way to address the blurred lines of work and what it means to have a permanent establishment.
Which activities can increase PE risk?
Many businesses operate abroad at various points without setting up corporate entities. A company might send an agent to a foreign country to close a deal for import or export, for example. Another organization might make an occasional visit to a foreign country to provide maintenance for a product it sold, such as software that needs occasional technical assistance or training.
Depending on the circumstances and the country, even those activities can be a risk. If the agent generates profits or sales, it could be enough to warrant tax authorities to take action. If the maintenance is long-term rather than sporadic, it may be deemed permanent.
Activities do not have to involve commerce or even concluding contracts. It may be enough for a company to have the word “sales” in the title of one of the workers.
The following are basic guidelines for the types of activities that can result in permanent establishment:
- The OECD determined that permanent establishment is linked to having a “fixed place of business” for activities that generate profits for the company. That framework serves as the basis for one of the biggest risk factors.
- Sending a dependent agent abroad to work on behalf of the company in ways that generate revenue.
- As the term “permanent” implies, the activity usually requires a particular time frame, which will vary from country to country. There are exceptions, however. In cases where profits are generated directly such as through sales or contracts, time may not be a factor.
While the OECD does not have the power to enforce a particular definition and it remains up to each country to adopt its own standards and definitions, the OECD has proven to be highly influential in this area. While the concept is not new, the OECD’s emphasis on the issue has increased the frequency of local tax authorities claiming jurisdiction over the business activities of foreign companies.
What is a fixed place of business?
According to the OECD guidelines, permanent establishment has a number of elements. It is fixed, done in a particular place, and for the purpose of business.
If your company operates from a particular, set location on a regularly recurring or continuous basis abroad, it could be deemed to have a fixed presence. If your workers return to the same location to carry out work on behalf of the company when they visit, or if there is a mailing address for your company or bank account, there is a risk that the venture could be considered a permanent establishment.
The idea of a place refers to a facility you company has access to when it does business in the country. The place does not have to be used exclusively for business, but if it remains in the control of the business and used for business, it could increase permanent establishment risks.
The third element is that the fixed location is used for the purposes intended to increase profits for the company. The element of profits are the main issue for the tax authorities, and may trigger a designation of permanent establishment even without a fixed place if they are gained through the company’s primary source of business.
Permanent establishment checklist
Are you at risk of permanent establishment? Here are five questions to ask yourself.
1. Does your company do business from a fixed location in the foreign country?
If you have an office, factory, or another location where you regularly work from in the foreign country, local authorities can consider you a permanent establishment and tax you accordingly.
2. Does your business have agents operating in another country, or does your business have employees assigned to work in that country?
If your business has agents in a foreign country making big decisions on your behalf, you could be at risk of being seen as a permanent establishment, since their roles can emphasize your local economic influence.
3. How much does the company manage workers in another country?
If you’re operating in another country, the extent to which you’re managing your workers matters. In some cases, being actively involved can signify permanent establishment.
It’s important to note here that misclassification can put you at further risk, as it can be seen as a way to try circumvent certain tax requirements.
4. Are you aware of all the relevant relevant tax treaties?
Any tax treaties in place will dictate when and how foreign entities in certain countries will be defined as permanent establishments. These treaties may include factors like exemptions of activities or safe harbors. This also relates to revenue origin, as some countries may offer special permissions to certain countries.
5. Are you making any strategic decisions from the foreign country?
Making major strategic decisions in the foreign country can be seen as a sign of established presence in the country.
How is permanent establishment regulated internationally?
When it comes to how international companies may be viewed as permanent establishments, there are a few things to keep in mind:
- Significant presence: Significant presence or economic influence in the foreign country can lead to a company being defined as a permanent establishment.
- Fixed place of business: Offices or other fixed places of work can represent a marker for local authorities to redefine the company’s status as a permanent entity.
- Agents: Even if you don’t have a fixed place of business in a foreign country, you might have agents working on your behalf and exercising authority. This can also spark some questions with local regulators.
Avoid the risk with a global PEO
For a company that has occasional but recurring business in a particular country, operating with a global PEO or EOR is a great way to mitigate permanent establishment risk. Additionally, the right partner can give you insights into how to attract the best local talent in any of the countries where you’re doing business.
Papaya Global offers EOR services in more than 160 countries through designated local experts, all of whom are vetted by our team and are required to meet strict SLAs. These vendors are extremely well-versed in local legislation and legal requirements, enabling businesses to focus on actual growth rather than the fine print of whether or not they’re at “permanent establishment” risk or any other compliance issue. Schedule a demo today.
Which Activities are not qualified as Permanent Establishment?
There are several exceptions that are not considered permanent establishments in terms of treaty agreements. these are the use of facilities for activities such as purchasing or storing, for your enterprise or another.
How profits should be attributed to a permanent establishment (PE)?
Attribution of profit is necessarily done by treating a PE as a separate and independent enterprise.
Is a subsidiary a permanent establishment of a parent company?
It is possible. In most jurisdictions, a subsidiary is a taxable legal entity in its own right, so it is subject to corporate income tax. But having a subsidiary does not automatically make it a permanent subsidiary
