What is permanent establishment? Insights and considerations

What is permanent establishment? Insights and considerations

April 22, 2022

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Multinational companies pay taxes wherever they do business. Seems simpleenough, right? Possibly on the surface, but if you really drill down intowhat it means to ‘do business,’ it becomes a little less clear.

Does it mean that you have an office or factory in each country where you paytaxes? What if you have a small sales team that works remotely? Or youprovide services to another company that is already established in thatcountry–where do you draw the line?

That’s where permanent establishment comes in.

Permanent establishment (PE) is the official tax term for ‘doing business.’There are three types of PE that your multinational business needs to be onthe lookout for to stay compliant.

What is permanent establishment?

Any company that expands its business across the borders of its home country(residence country) is on the hook for complying with the local laws andregulations for each new country it does business in.

For example:

  • A UK-based company that expands its sales team into other European countries like Sweden or Finland
  • US-based businesses that cross over into Canada to expand retail outlets
  • A textile company opening a manufacturing facility in China

And this includes following tax regulations, too.

Permanent establishment (PE) is an international tax concept that outlineswhich business activities qualify the company as having a ‘permanentestablishment’ in the country—for tax liability purposes.

There are differences from one locale to the next as to what constitutes apermanent establishment. PE is defined by the tax law of each jurisdiction(such as a country, state, province, territory, or autonomous region).

But in most cases, these ‘business activities’ refer to anything thatgenerates revenue. This might include business services provided by employeesor contractors, for example. It may also include profitable revenue fromcontract negotiations or real estate sales.

The 3 types of permanent establishment

Of course, if a company opens a manufacturing facility or call center inanother country, that’s a clear establishment of business in that country.

But that’s not the only way to trigger a PE designation.

This designation can be triggered by three types of permanent establishment:

  1. Physical-based establishment
  2. Agency-based establishment
  3. Service-based establishment

Establishing PE with a physical presence or fixed place of business

A fixed place of business is when a company buys or rents commercial space forthe purpose of conducting business. For example, buying a factory in anothercountry to take advantage of lower labor costs triggers PE.

Other examples of a fixed place of business include:

  • A retail storefront
  • A shared service center
  • A secondary warehouse to facilitate global distribution
  • A jobsite to mine natural resources

Establishing PE with an agency

Many different industries employ traveling agents. For example, a London-basedsales manager who frequently travels to Beijing to negotiate contracts maytrigger PE in China.

The specifics vary by country and are generally based on a limit on thenumber of days that your traveling staff can spend in one country.

In China, the duration for PE is a combined total of six months or 183days in any twelve-month period. Similar durationsare provided in Australia, Brazil and many other industrious countriesworldwide.

Other examples of potential agent establishment include:

  • Pharmaceutical representatives
  • English as a second language ( ESL ) instructors
  • Corporate trainers
  • Product placement sales representatives
  • Financial representatives

Global companies are still free to do business on a global scale and to travelto any country where business needs to be conducted. Temporary, preparatoryor auxiliary functions will not trigger PE.

Establishing PE with services

Companies like consultants and management firms that operate in manydifferent countries often fit the criteria for PE, as well. But this triggersPE for the service provider—not for the company that uses their services.

Examples of service establishment include businesses that provide servicesolutions for:

  • Information technology (IT)
  • Payroll
  • Talent Acquisition/HR
  • Financial

Are there risks associated with PE?

That’s a resounding yes! A PwC survey found that 86% ofmultinational companies are concerned with growing PE risks as the globalbusiness landscape continues to change.

When governments use permanent establishment as a barometer to levy localtaxes, it’s up to the individual organization to know where they stand andhow much they may be required to pay in foreign taxes based on PE statutes.Companies doing business abroad may one day wake up to a big surprise —and apotentially bigger tax bill—if they don’t take permanent establishment riskseriously.

In particular, it’s easy to blur the lines between temporary work and apermanent presence. Some of the biggest permanent establishment riskscome from signing contracts with another in-country business or employingcontract workers that perform revenue-generating activities in anothercountry.

With so many types of PE and risks associated with it, it‘s important formultinationals to fully understand what triggers PE and adhere to the taximplications.

A permanent establishment faux pas can cause severe financialrepercussions—and damage your business’ reputation.

The bottom line on the types of permanent establishment

Business doesn’t always look like a physical retail store or manufacturingplant.

This is why it’s so important to understand the various types of permanentestablishments and how they’re defined in the places your business isoperating.

The best way to ensure that your multinational company is covered from everyangle is to work with a reputable Payroll 360who can ensure youavoid hefty compliance fees and fines.

If you’re concerned about your PE risk, get in touch, and we’ll help youevaluate.

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