When doing business in international markets, you may find yourself traveling to countries in which you have no legal entity to negotiate agreements, find suppliers, or other business activities. Sometimes businesses assume that if they don’t set up an entity and hire employees in the country, they won’t be considered a taxable entity, therefore avoiding taxes on business activities. However, that is not always the case.
Making business deals without having a legal entity can lead to Permanent Establishment (PE) risk. Gain a better understanding of permanent establishment and the hurdles that may come along with it.
What Is Permanent Establishment Risk?
Permanent establishment is a concept defined by a country’s tax laws or by their international treaties. In the OECD’s model convention on income tax, it defines permanent establishment as “a fixed place of business through which the business of the enterprise is wholly or partly carried on.” This definition is just a model, and every income tax treaty has its own variation on this theme.
Using the OECD’s definition of PE, there are three components regarding whether you have risk of PE based on the phrase, “fixed place of business.”
- Fixed: A geographic place where the business regularly operates
- Place: Having a facility that is at the disposal of the company
- Business: The business activity of the company that regularly operates at the site
What makes permanent establishment a risk? Sometimes, the short-term activities of an employee in a foreign country can trigger permanent establishment unintentionally. When a business has permanent establishment in a country, the income of the business and employees working there becomes taxable in that country. Without permanent establishment, the business and employees would not be taxed.
Checklist for Permanent Establishment Risk
To understand if your business requires permanent establishment, begin by asking yourself these questions:
- When your employees go to a country, do they work together at a fixed location?
Having a regular, fixed site to which the employees return is one component of permanent establishment.
- Is the facility you use at your disposal when you work there?
This does not have to be a place that only your company uses. It could be a co-working space or an office that you rent for the time you are in-country. If it’s yours to use, it may add to your risk of permanent establishment.
- Do you conduct the business of your company from that space?
The kind of business that your company conducts is an important aspect of permanent establishment. Generally, companies are exempt from PE if the activities are short-term and not habitual.
- Are your employees seconded to a business in the country?
In some instances, seconded employees, or employees temporarily assigned to work, can create PE for their home company. The IRS of the United States dedicates a lengthy publication to addressing how this question plays out.
Ensure Compliance with an Expert Partner Check
Every international income tax treaty is different. This means that every country has a different standard for whether a business implements permanent establishment. To truly mitigate your risk, partner with a global expert. Working with an organization that has experience in global compliance and regulations can help guide you through the process of understanding international agreements so you can avoid unexpected tax liability.
There are many risks involved with global growth and overseas compliance, especially when trying to navigate legalities and labor laws. We’re here to help. Contact us today and chat with one of our international business experts to find out what’s right for your business.
Frequently Asked Questions
What is a permanent establishment?
A permanent establishment is an international tax concept which involves a fixed place of business in another country which is subject to tax in that country.
How do I avoid permanent establishment risk?
Working with an experienced partner, such as a global Employer of Record, can help navigate the risks involved with setting up a permanent establishment. This helps ensure global compliance standards and regulations are met, and unexpected tax liabilities are avoided.
What happens if you have a permanent establishment?
Having a permanent establishment in another country means you will be charged tax within that jurisdiction. Different tax treaties between your home and host countries define your tax rate.