Quick Hits

• Tax connections: Establishing a PE can result in the obligation to file corporate taxes abroad.
• Local registration: Although PE is primarily a tax concept, it may coincide with requirements to register with local business authorities as a foreign entity conducting business in the country.

Understanding ‘Permanent Establishment’

A company’s business activities may create a significant economic presence that could trigger tax liability abroad. Usually, tax authorities look for revenue-generating activities in which the foreign company is engaged. Some countries have taken the position that if a key element of a product (including, in some instances, the use of intellectual property) is created on their soil that generates revenue—even outside of the relevant countries—the revenue is taxable. The business activities of a company that will trigger a PE are primarily governed by tax treaties between countries, or, in their absence, by local tax laws.

Key Triggers for Permanent Establishment Obligations

• Fixed place of business: Traditionally, having a physical office, branch, factory, or any other fixed place where business activities are conducted, establishes a PE. This may include construction or installation projects that last for a certain period. The modern global economy and the rise of remote work, however, have complicated this definition.
• Dependent agents: Engaging a dependent agent—whether an employee or an independent contractor who primarily works for the company and has the authority to enter into contracts on its behalf—may also trigger a PE. The agent’s financial dependence and exclusivity to the company are critical factors.
• Rendering services: Providing services such as consulting, engineering, or management in a foreign country for a specified duration (often 183 days within 12 months) may establish a PE. This duration may vary by country, with some having shorter periods.

Remote Work and Permanent Establishment Risk

The COVID-19 pandemic has significantly impacted the concept of PE, particularly with the rise of remote work. Initially, many countries considered remote work arrangements as temporary activities that did not establish a PE. But as remote work has become more permanent, tax authorities have increased their scrutiny of these arrangements. Factors such as whether an employee’s home is at the company’s disposal, whether the company pays for home office expenses, the use of the home address for business purposes, and other indicia of company/employer control over the address are often considered by tax authorities in their PE determinations.

Special Considerations and Examples

• Intellectual property: In some countries, such as Germany, creating intellectual property within the country and using it for revenue-generating activities abroad may establish a PE.
• Sales activities: While supporting sales activities may not trigger a PE, actively selling within a foreign market likely will.
• Country-specific rules: Some countries, such as India, have unique rules where employing individuals within the territory, even for non-revenue–generating activities, may trigger a PE.

Mitigating Risk and Maintaining Compliance

Businesses carefully evaluating their cross-border activities to avoid unintended tax obligations may want to consider the following:

• Remote work: Do the benefits of allowing employees to work remotely from another country outweigh the potential tax risks? Employers might also consider pushing back on paying remote work expenses to mitigate PE risks.
• Contract structuring: Businesses often attempt to mitigate PE risk by structuring contracts such that significant decisions and signatures occur outside the foreign country. Tax authorities might question this strategy, focusing on the substance over the form of the business activities.
• Preparatory and auxiliary activities: Activities considered preparatory or auxiliary, such as administrative tasks, research and development, or marketing support, generally do not establish a PE. However, sales activities that directly generate revenue in the foreign country may fall within a gray area.
• Tax professionals: Engaging tax advisors to navigate the complex and evolving landscape of international tax laws and treaties often makes good sense.

Conclusion

Understanding, strategically planning for, and managing permanent establishment risks are crucial steps for businesses operating abroad. While labor and employment attorneys and HR professionals may not specialize in tax law, they play a vital role in issue-spotting and ensuring that potential tax implications are addressed with the help of seasoned tax professionals. By staying informed and proactive, businesses can navigate PE complexities and considerations, avoid unintended tax consequences, and maintain compliance in the global marketplace.