Permanent establishment risk factors and how to avoid them: international compliance guide 2024

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 that we run. Our actions as a business may be required to adhere to both international and local labour laws, as well as the 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 a 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 severe financial penalties – just one of many permanent establishment risk factors it’s important to be aware of.

Though the OECD has outlined broad parameters defining permanent establishment and its risks, the ultimate decision on whether a multinational is operating unlawfully is left to the tax jurisdiction – be it country, state, province, or another autonomous region. In places like Canada and the USA, for example, definitions surrounding PE may differ from state to state.

As with the risks surrounding the misclassification of employees and independent contractors, companies seeking to expand globally must be acutely aware of the risks of permanent establishment.

6 key permanent establishment risk factors to consider

From the moment a company is deemed to have established a taxable, unincorporated presence in a foreign jurisdiction, it risks facing a serious and potentially damaging set of consequences, which we call ‘permanent establishment risk factors'.

1) Back taxes and interest

Companies found guilty of PE will typically be back-taxed for any unpaid taxes, potentially stretching as far back as to the company’s first dealings in the source country. This can include corporate tax as well as VAT. In worst case scenarios, there may also be interest added to the unpaid tax, applied retroactively.

2) Financial penalties

Many countries around the world also choose to issue further financial penalties for PE, the severity of which may be dictated by the bilateral tax treaties between your residence country and the source jurisdiction. The cost of these financial penalties will likely also be influenced by the degree to which the offending company was genuinely aware of its wrongdoing.

3) Damaged reputation

Companies found guilty of permanent residence and penalised for it are liable to have their reputation damaged as a result, and on the international stage. Corporate reputation and financial performance tend to be interlinked, meaning that a damaged reputation could have a negative knock-on effect on your company’s turnover.

4) Mandatory 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. Equally challenging is the opposite decision: to abandon the successful integration into a new international market because you cannot afford to establish a legal entity there, following the back-taxes and financial penalties inflicted on your business.

5) Increased observation and auditing

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 a heightened frequency of audits from the authorities, which will likely eat into a business’s resources and may even have a knock-on effect on global employee morale and staff retention.

6) More intense regulatory measures

Finally, a company found guilty of PE is also likely to be required to adhere to stricter reporting obligations and regulations for the foreseeable future. In a similar vein to the risk of increased auditing, the intensity of these obligations may place unmanageable stress on both your employees and your resources.

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.

Exploring the 5 most common types of permanent establishment

Below, we’ve compiled 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. These are, in other words, the five different types of permanent establishment which you should be aware of, in order to avoid accidentally triggering them.

1) Having a ‘fixed place of business’

Also known as a ‘physical-based establishment’, this is when a company operates out of a particular location or unit on a regular basis and are therefore deemed to have a ‘fixed place of business’ under that tax jurisdiction.

The facility in question does not have to be used exclusively for business, though should have some connection to the company’s generation of revenue. 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’ can include:

• A retail outlet or shopfront.
• A service centre.
• A warehouse used for distribution.
• 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.

Types of physical locations which typically do not trigger PE must be considered ‘incidental, preparatory or ancillary’ in nature. These include:

• A storage facility used solely for storage and/or the delivery of goods to customers.
• A facility used to hold a stock of goods for use by another enterprise.
• A fixed place of business used solely for the acquisition of goods, information, and/or merchandise.

2) Having sales agents whose work in that country contributes to your 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. This is known as ‘agent-based establishment'.

In some countries, it may even 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.

3) Hiring employees abroad

Hiring employees abroad - either indefinitely or for fixed-term contracts, and including independent contractors - may be viewed by some local tax authorities as an intent to establish a permanent presence in their jurisdiction.

For example, if you withhold taxes or any other contributions from an international employee’s salary, you will be deemed a local employer, and thus will be subject to local tax laws.

In Argentina, to give a further 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.

4) Offering services to a foreign company which require your employees to be present in the source country for extended periods

If the services you offer to companies overseas - for example, R&D, consultancy, or software support - require that you send your agents abroad for extended periods of time, then you run a high risk of incurring PE. This is what is known as ‘service-based establishment'.

Interestingly, the nature of this type of permanent establishment serves to illustrate one of the key metrics used by tax authorities to identify PE: length of stay.

5) Overstaying your welcome...

Lastly, it is important to note that time is a key factor in whether or not you can be deemed to be ‘permanently established’ abroad. Certain overseas operations, even if they generate revenue for your company, may avoid triggering PE provided they fall within a particular time bracket – often under six months.

Unfortunately, though, 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 unique circumstances. As always, if you are unsure about whether or not your actions overseas are at risk of triggering a permanent establishment case against you, get in touch with Mauve for expert guidance.

How have permanent establishment risk factors changed in the post-COVID era?

It no longer comes as a shock to read of how the COVID-19 pandemic and consequent ‘lockdowns’ changed the world of work. But what about the effect these factors had on defining permanent establishment? The answer is unfortunately ambiguous and will continue to differ per jurisdiction.

However, it is clear that the shift away from office-based 9 to5s – and toward asynchronous work conducted from home offices – is having an impact. During the pandemic, the OECD stated that home offices in foreign countries were unlikely to be deemed ‘permanent’ enough to trigger PE.

Yet in the wake of the pandemic, as business becomes increasingly internationalised, it is likely that this evaluation will be reassessed. In short, it is always advisable to seek professional advice on permanent establishment where globally remote teams are involved.

How to avoid permanent establishment risk

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 (i.e., 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 chances of incurring permanent residence risk factors is to engage the services of a trustworthy Employer of Record (EoR).

By working with Mauve Group, you gain access to global compliance experts capable of helping you to employ and expand internationally in a way that ensures compliance with all relevant labour and tax regulations.

Mauve Group also offers consultancy services through which we provide expert global guidance on how to de-risk your enterprise and avoid the hefty associated penalties.

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 wisest to work alongside compliance consultants and EoR experts you can trust. Together, you can ensure that your business avoids compliance issues - such as the permanent establishment risk factors described above - while simultaneously maximising your potential.

To learn more, get in touch with Mauve Group today.