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 under-perform. That’s a business 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 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 definition 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 Activities that 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 company 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 could be deemed permanent.
Activities do not have to involve commerce and 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 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.
How can you mitigate permanent establishment risks
The risk of a permanent establishment can be mitigated by limiting business activity in foreign countries. Ensuring employees’ presence and potential assets are limited, instead entering into agreements with local providers for them. In client agreements, avoid mentioning the permanent presence. It is also essential to have a clear division of responsibility between the foreign entity and local affiliates.
In addition to monitoring and managing their activities in foreign jurisdictions, companies can establish internal policies and procedures that ensure compliance with tax laws and regulations. Assuring that businesses are tax-efficient and mitigate PE risks, businesses can also establish regular consultations with tax and legal advisors.
Avoid the Risk with a Global PEO
The companies most at risk for permanent establishment status are those that bypass their tax burden by operating without a legal entity or any other reporting mechanism, either intentionally or because they believe their activity is merely auxiliary.
For a company that has occasional but recurring business in a particular country, or an ongoing project, opening a Global PEO could mitigate the risk. The goal is to maximize profits in a business venture while working within a planned budget. A PEO or an associated vendor serves as the employer of record, so all of the business activity is in full compliance with tax authorities and all necessary taxes are reported and paid.
A Global PEO provides a legitimate means for reporting taxes through a recognized entity in the local area. Papaya Global offers PEO services in more than 100 countries through our network of local venders, all of whom are vetted by Papaya. All workers receive payslips for the hours worked and all taxes are withheld, according to the local standards.
It is easier to grow across the globe than ever before, and there are employment options that were unavailable just a few years earlier. Take advantage of the new opportunities, but do so from an informed perspective. Don’t take risks that could upend an otherwise successful operation. Plan well, and your company could always remain in full compliance. Schedule a demo today.
How is Permanent Establishment Regulated Internationally?
In most cases, permanent establishments are defined by bilateral tax treaties executed between two jurisdictions (such as a country, state, province, territory, or autonomous region).
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
