Global employment brings new opportunities and upsides for companies around the world, but it also presents new and different risks. One of these risks is whether a company is unintentionally creating a taxable presence in a country, commonly known as a “permanent establishment” or “PE.”
As workers become increasingly mobile and companies are less restricted by geography, many tax authorities are paying more attention to whether foreign companies are inadvertently establishing a permanent establishment within their jurisdiction. Their goal is to enforce tax laws and prevent companies from evading tax liabilities by using distributed teams.
In this article, we’ll discuss what permanent establishment is and how to avoid permanent establishment risk.
What is permanent establishment?
Permanent establishment is a tax concept that is important for employers with globally distributed teams to understand. Generally, if a company has a permanent establishment in a particular country, that means the company has a taxable presence there—in other words, it is required to pay local taxes.
The criteria for whether a company has created a permanent establishment in a location varies depending upon the law of the relevant country and applicable tax treaties between countries. Despite these country-specific differences, there are some general principles or criteria that many of these laws or treaties have in common. These include the following tests:
1. Fixed place of business
One of the leading sources of guidance on this topic is the Organisation for Economic Co-operation and Development (OECD), which has developed a model tax convention that many countries have adopted or used to inform their own laws or agreements. The OECD’s model tax convention defines “permanent establishment” as “a fixed place of business through which the business of an enterprise is wholly or partly carried on.” The model convention identifies various activities excluded from this definition, so long as the activity is preparatory or auxiliary to other activities.
Notably, this fixed place of business test identifies three key elements of permanent establishment: (1) a physical presence; (2) that is fixed (not transitory); and (3) that provides a means through which company personnel conduct business.
2. Dependent agent activities
Many authorities (such as the U.S. Internal Revenue Service) may consider the activities of a company’s “dependent agent” when determining whether a foreign company has a PE within the country in question. This test typically focuses on whether the agent has the authority to enter into revenue-generating contracts on the company’s behalf and habitually does so in the relevant country. An agent’s infrequent or sporadic (non-habitual) execution of contracts in the foreign country generally is not enough to create a permanent establishment.
Additionally, independent agents that engage in these activities in the normal course of business (such as brokers or general commission agents) but that are both legally and economically independent of their foreign principal generally will not create a permanent establishment for the principal.
3. Extended provision of services
In some cases, a company’s employee may give rise to a PE finding by providing services in a foreign country for an extended period of time, such as 6 or 12 months. This provision of services test typically requires the company’s employee to be physically present in the foreign country in order for that country’s authorities to find that the company has established a PE.
What are the consequences of creating a permanent establishment?
There are a variety of negative consequences that can result from your company inadvertently creating a PE in a foreign country.
Generally, establishing a PE, even unintentionally, means your company will be liable for local corporate taxes, along with any penalties or interest that may be imposed by local tax authorities. Your company may be required to register or obtain authorization to do business in the foreign jurisdiction. Your company may also be subject to additional financial or other requirements applicable to employers in that jurisdiction, such as mandatory pension, insurance, or workers’ compensation contributions.
On top of these payments and penalties, your company may also be much more likely to be audited by local authorities going forward.
In addition to the consequences to your company, there can be financial and other implications for your employees that are working in the foreign location. For example, if local tax authorities determine that your company has established a PE in their jurisdiction, your employees working in that location can be subject to local income tax. A local authority’s PE finding can also have immigration consequences for your employees or may require certain withholdings from both your company and your employees.
How can you avoid permanent establishment risk?
With so many different PE tests and criteria, avoiding PE risk can seem like an impossible task. While there is no foolproof way to completely avoid this risk, there are things your company can do to mitigate it.
- Consult a qualified professional. Before you move into a new market, speak with a qualified tax or legal professional who can explain the local PE framework, assess your specific risk, and develop an informed plan for moving forward.
- Be strategic with in-country assignments. Consider how long your employee will be present in the foreign country, what types of job duties he/she will be performing, and where he/she will work from. When possible, minimize the length of time the employee is in country and the authority they have to bind the company and generate revenue. Avoid renting office space or having a dedicated company location.
- Evaluate your options. With the growth of remote work and distributed teams, companies have more options than ever to explore when it comes to working with talented individuals in foreign countries - like Oyster! Oyster’s global employment platform lets your company tap into the global talent pool and reap the benefits of a distributed workforce without all the hassle typically involved with international expansion.
Oyster compliantly employs team members, wherever they are, to directly service our customer companies. As the team member’s legal employer, the in-country Oyster entity or local partner holds the team member’s employment contract and is responsible for paying wages, salaries, and other earnings to team members while ensuring required withholdings are taken. Our local entities manage compliance with applicable local tax and employment laws and leverage their location-specific expertise to stay on top of developments in local law. Oyster handles the in-country employment and related business activities, allowing our customer companies to reduce their PE risk.
Disclaimer: This blog and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.
As an employer, it's also important to understand the risks of employee misclassification. Read all about what that means and how you can avoid it in this blog post.
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