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For any business with globally distributed teams, it’s vital to understand Permanent Establishment Risk triggers in each country where they operate, and to take action to avoid penalties.
In this guide, we’re taking a deep dive into the intricacies of Permanent Establishment risk. We’ll also take a look at how it has been impacted by global talent mobility, and the consequences for global businesses.
First principles: what is a Permanent Establishment, and why is it risky?
In tax law, a PE is a fixed place of business that a company uses to conduct its operations. Importantly, a “fixed place of business” isn’t just a subsidiary or registered legal entity. In response to remote and cross-border work policies, many governments have made moves to include even remote employees’ home offices within the definition of PE. Setting that aside for the moment, there are three broad categories of PE:
- Physical-based establishments arise when a business has a fixed location where they conduct business (more on these later).
- Whenever a company empowers agents or salespeople to act in its name in another country, it may create an agency-based establishment.
- Companies can trigger service based establishments by offering managerial or technical services, even if only through a back-office.
Whichever category it falls into, a PE triggers tax liability. A business is obliged to pay corporate taxes in any foreign country where it has a PE. This can result in double taxation, if the business is also required to pay taxes on their profits at home. The only way out of that quagmire is through a taxation treaty between the two countries - something that every business should consider before they begin doing business in a foreign country.
Permanent Establishment risk factors: knowing where the threshold lies
To minimise risks like double taxation or corporate fines, companies need to know where the lines are, and how close they are to crossing them. Here are some of the “red flags” that tax authorities look out for:
Activities that carry a high risk of triggering PE
The strictness of each country’s surveillance and enforcement mechanisms vary, but these activities usually indicate that a company has a taxable presence.
- A branch or subsidiary in a foreign country.
Offices, factories or warehouses are also strong PE triggers. In some cases, even a remote employee’s home office can be deemed to function as a permanent establishment, particularly if this is a long-term arrangement.
- Employees working in a foreign country for an extended period of time.
This includes employees sent to perform contracts on a regular basis. Short-term or infrequent visits generally do not trigger PE. The precise time frames vary from country to country. For example, in China, the threshold is 6 months or 183 days within a 12-month period.
- Authorized agents or representatives.
Permanent Establishment can exist wherever a company conducts business through an agent or representative who has the authority to conclude contracts on its behalf. The OECD has stated that a PE exists if an agent “negotiates all the elements of a contract”.
How “working from anywhere” affects Permanent Establishment Risk
Determining the tax status of foreign companies was much more straightforward before global talent mobility permanently changed the world of work. 86% of companies surveyed by PwC indicated that mobility elevated permanent establishment risk. And the leniency that legislators showed through 2020 - 2022, in light of the pandemic restrictions, has now ended. Tax authorities across the globe are asserting a right to revenue from companies through their relationships with remote workers - from actual offices to something as simple as a home study..
As the legal landscape evolves to keep up with WFA trends, businesses with global teams will need to keep their fingers on the pulse to stay compliant.
Can independent contractors trigger PE risk?
At first glance, it may seem cut and dried: contractors aren’t employees, so a relationship between a freelancer and a foreign company cannot give rise to a permanent establishment. This misconception stems from the fact that a company is not responsible for tax contributions when they hire independent contractors.
But it’s not quite as straightforward as it may seem at first. As we mentioned earlier, one of the conditions that establishes a PE is the concluding of contracts and deals in the name of a company. If independent contractors are doing that, these activities can in fact establish a taxable presence for the company in question. To avert this risk, companies should ensure that any independent contractors in another country are classified correctly. Misclassifying employees as contractors carries its own severe penalties, but it can also lead to additional penalties associated with PE risk.
What failing to manage PE risk can cost businesses: a closer look at the associated penalties
As with almost every aspect of PE risk, the penalties that companies face vary considerably from country to country. And while some are more stringent than others, none of them take this matter lightly. After all, tax revenue is on the line, and international businesses should prepare to face increasing scrutiny now that pandemic-era leniency is well and truly a thing of the past.
Reputational damage: hard to quantify, harder to recover from
When regulators decide that a company has been (knowingly or unknowingly) evading PE rules, the first casualty is their corporate image. Nobody wants to be the foreigner who flouts the rules - and it’s a taint that can be hard to remove. Even if the business in question goes on to register a legal entity and resolve the issue, it may be subject to enhanced scrutiny by tax authorities going forward.
A backdated tax bill
In addition to the prospect of double taxation at home and abroad, companies may have to pay unfunded tax liabilities they accumulated while operating a de facto PE. On top of that, interest charges may apply, in addition indirect tax costs to cover missing VAT registrations.
Don’t let PE risk put a dampener on global expansion plans
The picture we have painted so far is sobering, to be sure. For business leaders facing turbulent times, PE risk brings an additional layer of unwelcome complexity and uncertainty. Some may choose to wait for the regulatory dust to settle on the interplay between remote work and PE rules. But for forward thinking businesses, this is not viable in the short or long term.
Thankfully, help is at hand. As a global Employer of Record, Playroll has the in-country legal support and expertise to help companies avoid the risks of PE until they’re ready to put down roots on their own terms. Employers of Record are increasingly common as a mechanism to hire compliantly in new territories, without establishing legal entities first, and with the necessary documentation and audit trail to keep businesses on the right side of regulations.
For any business with globally distributed teams, it’s vital to understand Permanent Establishment Risk triggers in each country where they operate, and to take action to avoid penalties.
In this guide, we’re taking a deep dive into the intricacies of Permanent Establishment risk. We’ll also take a look at how it has been impacted by global talent mobility, and the consequences for global businesses.
First principles: what is a Permanent Establishment, and why is it risky?
In tax law, a PE is a fixed place of business that a company uses to conduct its operations. Importantly, a “fixed place of business” isn’t just a subsidiary or registered legal entity. In response to remote and cross-border work policies, many governments have made moves to include even remote employees’ home offices within the definition of PE. Setting that aside for the moment, there are three broad categories of PE:
- Physical-based establishments arise when a business has a fixed location where they conduct business (more on these later).
- Whenever a company empowers agents or salespeople to act in its name in another country, it may create an agency-based establishment.
- Companies can trigger service based establishments by offering managerial or technical services, even if only through a back-office.
Whichever category it falls into, a PE triggers tax liability. A business is obliged to pay corporate taxes in any foreign country where it has a PE. This can result in double taxation, if the business is also required to pay taxes on their profits at home. The only way out of that quagmire is through a taxation treaty between the two countries - something that every business should consider before they begin doing business in a foreign country.
Permanent Establishment risk factors: knowing where the threshold lies
To minimise risks like double taxation or corporate fines, companies need to know where the lines are, and how close they are to crossing them. Here are some of the “red flags” that tax authorities look out for:
Activities that carry a high risk of triggering PE
The strictness of each country’s surveillance and enforcement mechanisms vary, but these activities usually indicate that a company has a taxable presence.
- A branch or subsidiary in a foreign country.
Offices, factories or warehouses are also strong PE triggers. In some cases, even a remote employee’s home office can be deemed to function as a permanent establishment, particularly if this is a long-term arrangement.
- Employees working in a foreign country for an extended period of time.
This includes employees sent to perform contracts on a regular basis. Short-term or infrequent visits generally do not trigger PE. The precise time frames vary from country to country. For example, in China, the threshold is 6 months or 183 days within a 12-month period.
- Authorized agents or representatives.
Permanent Establishment can exist wherever a company conducts business through an agent or representative who has the authority to conclude contracts on its behalf. The OECD has stated that a PE exists if an agent “negotiates all the elements of a contract”.
How “working from anywhere” affects Permanent Establishment Risk
Determining the tax status of foreign companies was much more straightforward before global talent mobility permanently changed the world of work. 86% of companies surveyed by PwC indicated that mobility elevated permanent establishment risk. And the leniency that legislators showed through 2020 - 2022, in light of the pandemic restrictions, has now ended. Tax authorities across the globe are asserting a right to revenue from companies through their relationships with remote workers - from actual offices to something as simple as a home study..
As the legal landscape evolves to keep up with WFA trends, businesses with global teams will need to keep their fingers on the pulse to stay compliant.
Can independent contractors trigger PE risk?
At first glance, it may seem cut and dried: contractors aren’t employees, so a relationship between a freelancer and a foreign company cannot give rise to a permanent establishment. This misconception stems from the fact that a company is not responsible for tax contributions when they hire independent contractors.
But it’s not quite as straightforward as it may seem at first. As we mentioned earlier, one of the conditions that establishes a PE is the concluding of contracts and deals in the name of a company. If independent contractors are doing that, these activities can in fact establish a taxable presence for the company in question. To avert this risk, companies should ensure that any independent contractors in another country are classified correctly. Misclassifying employees as contractors carries its own severe penalties, but it can also lead to additional penalties associated with PE risk.
What failing to manage PE risk can cost businesses: a closer look at the associated penalties
As with almost every aspect of PE risk, the penalties that companies face vary considerably from country to country. And while some are more stringent than others, none of them take this matter lightly. After all, tax revenue is on the line, and international businesses should prepare to face increasing scrutiny now that pandemic-era leniency is well and truly a thing of the past.
Reputational damage: hard to quantify, harder to recover from
When regulators decide that a company has been (knowingly or unknowingly) evading PE rules, the first casualty is their corporate image. Nobody wants to be the foreigner who flouts the rules - and it’s a taint that can be hard to remove. Even if the business in question goes on to register a legal entity and resolve the issue, it may be subject to enhanced scrutiny by tax authorities going forward.
A backdated tax bill
In addition to the prospect of double taxation at home and abroad, companies may have to pay unfunded tax liabilities they accumulated while operating a de facto PE. On top of that, interest charges may apply, in addition indirect tax costs to cover missing VAT registrations.
Don’t let PE risk put a dampener on global expansion plans
The picture we have painted so far is sobering, to be sure. For business leaders facing turbulent times, PE risk brings an additional layer of unwelcome complexity and uncertainty. Some may choose to wait for the regulatory dust to settle on the interplay between remote work and PE rules. But for forward thinking businesses, this is not viable in the short or long term.
Thankfully, help is at hand. As a global Employer of Record, Playroll has the in-country legal support and expertise to help companies avoid the risks of PE until they’re ready to put down roots on their own terms. Employers of Record are increasingly common as a mechanism to hire compliantly in new territories, without establishing legal entities first, and with the necessary documentation and audit trail to keep businesses on the right side of regulations.
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