While steering through overseas business expansion, there can be many benefits to one’s company. Business owners expanding their territories overseas can access larger global markets, improve brand outreach, and increase profits. However, the path to global success is not without roadblocks. Apart from business registration challenges, one crucial roadblock is PE risk which can attract tax penalties and cause reputational damage if mismanaged.
Permanent establishment or PE is an international tax concept. It indicates that a firm has a fixed overseas business place and is thus generating revenue in a foreign land, making it eligible for corporate tax in the host country. The OECD model is most commonly used to define PE in most countries, and it defines PE as “a fixed place of business through which the business of an enterprise is wholly or partly carried on.”
Not every business operation abroad will trigger permanent establishment issues because all operations do not bring revenue. It includes preparatory activities or ancillary activities. The implications aren’t only related to tax - sometimes, business owners may need to establish a local entity. This puts the entity under the purview of domestic business codes, employment laws, etc.
Thus, it is vital to understand the permanent establishment dos and don’ts to circumvent PE risks successfully.
Any company planning to do business abroad or employ international talent must know about permanent establishment risks. However, with workspace physical boundaries slowly vanishing, the sole location-related roadblock that hinders hiring global personnel is taxation. As more firms enter the global economy, tax authorities worldwide are strengthening tax regulations so that companies cannot evade taxes at any cost.
Several organizations function internationally without setting up a PE. Despite that, businesses face considerable risks gradually when hiring international talent. Hence, any organization planning a global expansion or hiring global talent must first understand the regional laws and risks of permanent establishment.
If neglected, permanent establishment risks can cause:
One complication with permanent establishments is that the tax treaties, rules, etc., vary according to the governing jurisdictions. Thus, coursing through PE risks can be confusing for companies engaging in overseas business operations in multiple nations.
Here is a checklist of the universally common elements that can trigger a PE risk:
Sales activities are a broad definition of PE, and not every operation can trigger PE risks. For instance, hiring foreign workers for activities like general development of the firm, lead generation, etc., are low-risk operations. But if a firm has staff directly linked with sales of products or services, it may trigger higher risks.
The definition of ‘supporting activities varies according to the company and the local tax authority. For instance, in many scenarios supporting operations like admin, accounting, etc., are not considered high-risk triggers. However, suppose an accounting firm hires foreign accountants to boost the revenue earning for the firm; it’s a high-risk trigger.
Essentially, permanent establishment risk factors aren’t clearly defined - they depend on specific situations and other factors. Mostly, local tax authorities decide whether or not a company should be classified as a permanent establishment.
The global pandemic and its consequent restrictions on traveling forced many professionals to shift back to their home countries. This worker displacement led to the rise of many temporary remote employees working from their homes due to government-imposed lockdowns. Naturally, the shift to the remote model pushed organizations to rethink their decisions on creating permanent establishments.
Many jurisdictions turned lenient towards enterprises having temporary remote workers to neutralize this situation. These jurisdictions ensured leniency as long as the location change was temporary due to the pandemic. For instance, Germany issued guidance stating that any interruption caused to installation and construction work due to the pandemic will not be held accountable for PE. Similarly, New Zealand issued guidance mentioning that the pandemic will not lead to the creation of PE in the country by the guest companies due to the confinement of national employees.
Fortunately, there are a few measures an enterprise can take to minimize the risk of PE triggers and yet create a global team to fulfill global expansion goals.
To steer your organization through the turnings of international tax compliance and ensure protection from permanent establishment risk factors, you can opt for the following:
Tax treaties for PE vary depending upon the jurisdiction where the company functions. Thus, the best way to cushion PE risks is to choose a local tax specialist who can offer a more profound knowledge of local tax compliance. Local tax experts help mitigate taxation concerns and guide the firm on strategic business expansion, reducing risks, etc.
In most cases, if a firm gets designated as a permanent establishment, it must be fully compliant with domestic laws. However, this outcome need not always be negative. For instance, in particular local tax regimes, a firm does not need to file taxes in the country where its headquarters is located. Thus, it can benefit from a foreign country’s tax scheme. This is where a local tax advisor can help you.
Besides, a local tax advisor can help business owners review the staff’s service contracts and business contracts with domestic partners and help them navigate the domestic tax liabilities and l tax obligations to avoid PE risks.
A firm can set up a foreign subsidiary (local entity) to remain fully compliant with the domestic laws and immune to permanent establishment risks. Foreign subsidiaries are distinct legal entities independent of the parent company. Hence, creating a foreign subsidiary simplifies the firm’s international tax status while offering clarity on tax payment for profits earned in a particular jurisdiction.
However, establishing a foreign subsidiary can be expensive and time-consuming. Also, these subsidiaries may be exposed to PE tax risk if the parent company conducts its business through the subsidiary.
Opting for an EOR or Employer of Record service to hire international talent can reduce the PE risks. Setting up a local entity can become a presumption to PE. But with EOR services, a firm can hire global talent without setting up a local entity. Although such a service cannot fully neutralize the permanent establishment risks, it is ideal if you need to hire staff for short-term projects.
If not managed well, PE risks can lead to inevitable grievous consequences. Here’s a list of potential threats:
Multiplier can help you with just the same. Our team at Multiplier can help you understand permanent establishment issues better and avoid such risks. With us, you can hire fresh talent abroad without setting up a local entity and draft domestically compliant contracts.
Not managing PE risks properly can lead to:
Three vital areas are reviewed to analyze the trigger source of PE. These are:
Certain activities mentioned in the PE rule applicability can ensure that a business isn’t classified as PE. These are: