Understand and Eliminate Permanent Establishment Risk Factors: International Compliance Guide 2023

When we seek to work overseas – either to gain access to a new market, or to employ the talent found in another country – there are a number of compliance risks we run. Our actions as a business may be required to adhere to the labour and tax laws of the jurisdiction in which we “do business”. Of course, the definition of “doing business” can differ from country to country, as can the risks associated with it.

Permanent Establishment (PE) describes the situation in which a company is considered by local tax authorities to be operating in an ongoing and taxable capacity whilst not officially incorporated in that country. Local tax authorities are the arbiter in this matter, and, if accused of PE, the onus is on the company in question to prove their innocence, or face often severe penalties – just one of many permanent establishment risk factors it’s important to be aware of.

Though the OECD have outlined broad parameters defining permanent establishment and its risks, the ultimate decision on whether a multinational is operating unlawfully is left to the individual country. In places like Canada and the USA, definitions surrounding PE may also differ state to state. As with the risks surrounding misclassification of international independent contractors, companies seeking to expand globally must be acutely aware of the risks of permanent establishment.

What are the risks of permanent establishment?

From the moment a company is deemed to have established a permanent, unincorporated presence in a foreign jurisdiction, they risk facing a severe and damaging set of consequences, which we call ‘permanent establishment risk factors’:

• Back taxes and interest: Companies found guilty of PE will typically be back-taxed for any unpaid taxes, stretching potentially as far as to the company’s first dealings in that country. These unpaid taxes include corporate tax, and may also include VAT. In worst case scenarios, there may also be interest on the unpaid tax.
• Penalties: Many countries around the world also choose to issue further financial penalties for PE, the severity of which may be dictated by the tax treaties of that country, in conjunction with the degree to which the offending company was aware of its wrongdoing.
• Damaged Reputation: Companies found guilty of permanent residence and penalised for it are liable to have their reputations damaged as a result, and on an international stage.
• Incorporation: Companies which wish to continue operating in a country after being found guilty of PE must legally incorporate themselves by setting up a local legal entity: a process which is typically both expensive and time-consuming.
• Increased Observation: Tax authorities alerted to the illicit permanent presence of a foreign company in their jurisdiction are likely to increase their level of observation of said company. This could result in heightened audits from the authorities, which may eat into a business’ resources.
• Increased Regulation: A company found guilty of PE is also likely to be required to adhere to stricter reporting obligations and regulations for the foreseeable future.

Which activities are likely to trigger permanent establishment?

Achieving watertight global compliance is made difficult by the widely varying – and often contradictory – rules and regulations governing tax and employment in different countries around the world. The same goes for avoiding permanent establishment. Doing so requires careful adherence to the differing definitions of PE in each country.

Common permanent establishment triggers

Here is a list of the most common permanent establishment risk factors, or “triggers” of PE, as outlined by the OECD (Organisation for Economic Co-operation and Development), with additional notes on unique distinctions and variations from country to country.

• Having a “Fixed Place of Business”
  • When a company operates out of a particular location or unit on a regular basis, then they are deemed to have a “fixed place of business” in that country, and thus be permanently established.
  • The facility in question does not have to be used exclusively for business. In Sweden, for example, even a home office might be considered a “fixed place of business”. Similarly, a Germany-based CEO who works half the year from her holiday home in France may find her holiday home categorised as a “fixed place of business” by the French authorities.
  • Other examples of “fixed places of business” may include:
    • A retail outlet or shopfront
    • A service centre
    • A warehouse used for distribution (storage only is not considered a PE trigger)
    • A building, construction, or mining site
  • Using a foreign address for your company’s location or bank account will also swiftly trigger PE and all its associated risks.
• Having sales agents whose work in that country contributes to revenue
  • A company need not necessarily have a “fixed place of business” in order to be deemed in breach of PE. If they work with sales agents who conduct international business in their name on a regular basis, then they may be deemed to have established a permanent presence in one or more foreign countries.
  • In some countries, it may be enough to trigger PE for a foreign worker to have the word “sales” in their job title.
  • The primary concern of local tax authorities is not whether agents are laying the groundwork for later business expansion – this would not be subject to PE – but rather whether they consistently make decisions and agreements which contribute to the profits of their foreign employer.
• Hiring employees abroad
  • Hiring employees abroad – either indefinitely or for fixed-term contracts – as well as independent contractors, may be viewed by some local tax authorities as an intent to establish a permanent presence in their jurisdiction.
  • If you withhold taxes or any other contributions from a foreign employee’s wage, you will be deemed to be a local employer, and thus will be subject to local tax laws.
  • In Argentina, for example, the distinctions between an employee and contractor are so slim that accidental misclassification of the latter are common; a mistake which would immediately trigger PE.
• Offering services to a foreign company which require your employees to be present for a long amount of time
  • If the services you offer – for example, R&D, consultancy, or software support – to companies situated overseas require that you send your agents abroad for extended periods of time, then you run a high risk of incurring PE.

It is worth noting at that time is a key factor in whether or not you can be deemed to be “permanently established” abroad. Unfortunately, the length of time required for a local tax authority to deem you in breach of PE differs per jurisdiction, and may be negated entirely in certain circumstances.

The best way to avoid and mitigate permanent establishment risk factors

In order to operate compliantly internationally, it is not always possible to avoid establishing an incorporated foreign presence. Whilst there are exceptions to the rules governing PE – such as carrying out overseas work which does not directly contribute to revenue (like customer support) – these rules differ and evolve so frequently that attempting to navigate them by yourself involves high amounts of risk.

Establish a foreign subsidiary

To avoid the risks of permanent establishment, the most obvious option available to business owners looking to expand globally is simply to establish a foreign branch or subsidiary in the country (or countries) of their choosing. Of course, doing so comes with its own complications, and typically involves a great deal of time, energy, and resources.

Work with an Employer of Record (EoR)

A far more reliable and cost-effective way to minimise the chance of incurring permanent residence risk factors is to engage the services of a trustworthy Employer of Record (EoR). By working with companies like Mauve Group, you have access to global compliance experts who help you to employ and expand internationally in a way that conforms with all necessary foreign labour and tax regulations.

Mauve Group also offers consultancy services, through which they provide expert global guidance that can help you de-risk your enterprise and understand the potentially heavy penalties associated.

In an era where working from anywhere (WFA) is increasingly the norm, and the markets and talent pools of foreign countries are more accessible than ever, it’s wise to work alongside compliance consultants and EoR experts you can trust, to ensure your business avoids risk and maximises its potential.