Permanent establishment refers to an international tax concept that applies when a tax authority regards an entity as having a “fixed place of business” in the country and is therefore liable for corporate taxes.
When a company is considered to have permanent establishment in its host country, all of its profits made within the location will be subjected to the appropriate taxes and the accompanying rates.
What is permanent establishment risk?
Being able to identify the potential triggers for PE risks can help companies avoid any fines and unwanted tax expenses. According to the current treaty definition of PE, the creation of a PE in a foreign country can be established by two factors:
A fixed place of business
Refers to when an enterprise has a facility in a foreign territory that is used to conduct all business activities. According to the OECD, there are three components that ascertain whether the enterprise is at risk of PE according to the phrase “fixed place of business”.
Fixed A geographic place where business regularly operates
Place Having a facility at the disposal of the company
Business The business activity of the company that regularly operates at the site
A dependent agent
An enterprise is subject to PE in a foreign country when there is a person (other than the independent agent) conducting business on the enterprise’s behalf in the foreign territory
Some double tax treaties also encompass a Service PE that applies to when an enterprise from one territory performs services (such as consultancy services) through employees or other personnel engaged by the enterprise in the foreign territory over a defined time period.
Within a global mobility context, even short-term business activities can create a permanent establishment within the foreign territory
Entities must take care to ensure that they don’t run the risk of unwittingly creating a PE status. Failure to monitor PE risks can lead to consequences to the effect of:
Damage to the reputation of the company
Restrictions on immigration considerations for employees
Penalties and interest charges
Increased audits from tax authorities in the foreign territory resulting in additional costs incurred
Tightened reporting obligations imposed upon the entity
Indirect tax costs in the foreign territory if VAT registrations are incomplete
Examples of activities that increase PE risk
When employees of the entity make continuous returns to the foreign territory to perform work on behalf of the company.
When there is a mailing address or bank account attached to the entity in the foreign territory
Sending a dependent agent to the foreign territory to perform work that can generate revenue
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Ask yourself these questions before running any activities in a foreign territory
"Do my employees visit or work from a fixed location or facility when they travel to the host country?"
A strong indicator of a permanent establishment is having a fixed place of business.
"Do I regularly conduct company business from this specific location?"
Habitually performing business activities within the same location can put your company at risk for a PE. The timeframe however, varies in between countries.
"Is the facility I work from in the foreign territory always available to me?"
As long as a space is at your disposal for an extended period of time, you may run the risk of permanent establishment. The type of space can include a rented office and even a co-working space.
What types of activities exclude businesses from being a permanent establishment?
According to article 5(4) of the OECD manual, certain activities that are performed to support the main activities for an entity but does not generate revenue will be exempted from triggering PE status. Referred to as preparatory or ancillary activities, these include:
The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise
The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery
The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise
The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise
The maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character
The maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e)
Ultimately it is on the entity to prove that these activities are ancillary and therefore, not subject to permanent establishment status.
How can I manage permanent establishment risks?
Being able to identify and proactively manage PE risks protects your company from being vulnerable to unexpected tax payments as well as double taxations, fines and sudden interest charges. Avoiding corporate tax liabilities can really improve business operations in a way that it meets expansions goals and without losing money in the process. It also puts you in the position to make the right calls amidst tax disclosures in the foreign territory.
Here are three things you can do to manage PE risks for your business.
Set up a local business entity
Establishing a foreign subsidiary in the host country will allow your business to maintain full compliance with local tax authorities. It will also prevent any uncertainty surrounding your company’s tax status.
From a tax perspective, a foreign subsidiary will be liable for its own set of tax and compliance obligations that are independent to the parent company. Protecting it from any PE risks.
However, setting up a local entity can be a costly commitment that can take up to a year before it is fully mobilised.
Consult local tax experts
Obtaining up to date and detailed tax advice from local tax experts can help you gauge where your business stands and come up with a strategy on how to protect your company from running any risks that can put you in breach of any local tax regulations.
From reviewing contracts with your local business partners, navigating tax liabilities and more, enlisting a local tax expert can save you the trouble of running into any permanent establishment risk challenges.
By taking on the role of the legal entity, the EOR will be responsible for acting as legal employer of your workforce whilst staying compliant with the local tax laws of the foreign territory.
This solution allows business to quickly enter and operate in new international markets and hire international talent without prompting a permanent establishment status.
It also enables businesses to work with experts on the local regulations. This might include labour laws, employee compensation and benefits to ensure that their international workforce is being fairly supported.
Put your expansion plans into motion with Airswift
If international expansion is in the cards for your business, we want to be able to support you in every step of the way. Our global mobility experience of over 40 years has granted us the expertise in navigating various circumstances to help you ensure your expansion plans happen as smoothly as possible.
Whether you need help with refining your HR solutions or want to collaborate with an Employer of Record, our services can be customised to meet your specific needs.