Permanent Establishment

If your company operates internationally or you’re thinking about international expansion, you need to understand permanent establishment to make sure that you don’t open yourself up to unnecessary taxation or legal liability.

At the same time, wrapping your head around the concept isn’t always easy, which is why a lot of people seek help from an Employer of Record (EOR). EORs are external companies that can work closely with you to make sure that you’re fully compliant with local and international law.

But not everyone wants to work with an EOR, and there are plenty of people who’d prefer to manage permanent establishment in-house. That’s all well and good, but you first need to understand what it is and how it works.

And so with all of that in mind, let’s take a look at everything you need to know about permanent establishment.

At its simplest, permanent establishment is a concept in taxation and business in which an organization has a fixed place of business in a specific country.

In other words, if your company is headquartered in the United States but has major distribution hubs in Spain and Germany, it may be classified as a permanent establishment by the European Union.

This can lead to some interesting situations in which companies try to structure themselves in such a way that they avoid permanent establishment so that they don’t have to pay tax.

For example, Google has historically tried to avoid being categorized as a permanent establishment in France, the United Kingdom and other countries, because if that were to happen, they’d have to pay a huge amount of tax.

Different countries have different rules when it comes to how they define permanent establishment, so be sure to check the legislation in your region if you’re ever unsure.

With that said, for a company to be considered as a permanent establishment, it usually needs to meet the following criteria:

• The company needs to regularly carry out business in the region
• The company needs to have a permanent physical location in the region
• The company needs to partly or wholly carry out their business from that region

These criteria are largely common sense, and so an easy way to tell whether your business might have permanent establishment in a region is to ask yourself whether your business has a permanent presence there.

Note that the word “permanent” is key here, and so if you’re only temporarily doing business from a region, that won’t count as permanent establishment.

The answer to this question depends upon your point of view. After all, there are plenty of benefits to permanent establishment, including: 

• It shows customers and business partners that you’re serious about your presence in the region
• It can provide access to local opportunities that you wouldn’t otherwise be able to enjoy
• It’s easier to hire staff members and to provide customer service when you’re physically present in the country
• It gives you much greater certainty and peace of mind when it comes to your legal status and future liabilities

However, establishing permanent residence also comes with its fair share of drawbacks, most notably that if you’re earning revenue from a region then you’ll be liable to taxation there. Worse still is the fact that you’ll have to pay this tax whether you knew about it or not, which means that if you’re judged to have permanent establishment but you haven’t budgeted for it, you might have to pay a hefty bill.

Another factor to consider is the fact that there are different types of permanent establishment, and not all of them are created equally. Just a few of the most common types of permanent establishment include:

• Fixed Place of Business: This is by far the most common type of permanent establishment, and it comes about when a company has a physical business presence in a different region. For example, if a national coffee chain went international and opened up a new coffee shop on the other side of the Atlantic, they’d be taxed as a permanent establishment.
• Sales Agents: This type of permanent establishment occurs when a company has a fixed team of sales agents working in a foreign region. A number of other factors can also come into play, such as the percentage of the company’s negotiations which are taking place in that country. For example, if a tech company was based in the United States but had a dedicated Asia-Pacific sales team, they might be classed as a permanent establishment in the APAC region.
• Service Teams: As with sales agents, organizations can be classed as permanent establishments if they’re providing managed services to companies or individuals in the region. Interestingly, they don’t even need to have employees out there on the ground. For example, if a British management consultant worked with clients in the United States, they could be classed as a permanent establishment even if they didn’t have any employees in the States. 

Of course, these are just a few examples of the different types of permanent establishment, but it’s by no means an exhaustive list. Each business is different, and so it’s important to consider consulting a professional if you’re not sure about whether or not you might be classified as a permanent establishment.

We’ve already touched on a few of the risks of permanent establishment, but it’s worth pausing for a moment here to take a closer look. Business is all about weighing up risks versus rewards, and so the hope is that by warning you about what to beware of, you’ll be better placed to expand internationally.

Here’s what you’ll want to be aware of:

• Taxation: Permanent establishment means paying taxes in the region you’re based in, and if you don’t factor that in then there’s a risk that you’ll have to pay a hefty bill for back taxes, along with any penalties and interest that have accumulated along with them.
• Legal Liabilities: When you’re permanently established in a country, you’ll be expected to follow local laws and legislation. This includes laws around employment, such as those which cover payroll, vacation time and insurance. This is another area where having an employer of record can come in useful, because many EORs provide their clients with HR and financial services to help them to comply with these kinds of legislation.
• Your Reputation: When you’re selling to customers in a region, you’re building a reputation there whether you’re aware of it or not. If you’re not set up to provide international customer service, you can bet that word will spread and people will stop buying from you. You can also face reputational damage if you fail to comply with taxation or legal liabilities, making permanent establishment a potential minefield.

Fortunately, there are plenty of things that you can do to mitigate these risks. You’ll want to consider the following:

• Get Some Help: Whether you’re working with an employer of record or hiring a lawyer who specializes in permanent establishment, it’s a good idea to find people who can help you to mitigate those risks or to avoid them altogether. Bear in mind that it’s always best to find suppliers and providers who work in that particular region, because they’ll be best placed to understand the specific regulations that your company will be governed by.
• Proactively Create an Office: If you suspect you’re going to be classed as a permanent establishment, you might as well commit to it. By creating a dedicated, permanent office for the region, you can make sure that everything is legit and above board from the get-go, avoiding nasty surprises further down the line.
• Be Strategic About Recruitment: Some people erroneously think that if they only hire temporary workers in foreign countries, they won’t be held liable as a permanent establishment. The problem is that it’s all too easy for temporary workers to become permanent ones, and if you have a large enough number of temporary workers or you’ve kept them on the payroll for longer than you meant to, you may find yourself being classified as a permanent establishment without realizing it.
  
• Not Planning Ahead: Ultimately, when people have issues with becoming a permanent establishment, it’s usually because they’ve been thinking in day-to-day terms without stepping back to plan ahead. If you’re taking the time to strategize and think about the future, you’re likely to become a permanent establishment by choice and not by accident.

PE risk mitigation is something that is not much discussed in the world of EORs. However, there are several EORs out there that are actively taking measures to mitigate PE risk on behalf of their clients as far as possible. Such providers regularly monitor developments in double taxation agreements (DTAs) and the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention guidelines to ensure up-to-date procedures for PE risk management and mitigation.

Generally speaking, the EOR model introduces a degree of separation between the foreign company and the employee, lowering the risk of PE. That in and of itself, however, does not guarantee the elimination of PE risk entirely. Accordingly, in the EOR’s capacity as the official employer in-country, the EOR should also declare all services performed in foreign territories with the applicable tax authorities. Again, such declarations cannot guarantee that the foreign company’s activities will fall outside the scope of local regulations, but it does ensure a further robust safeguard to mitigate PE risk that few – if any – other global PEOs are offering.

Now that you know more about permanent establishments, you’re much better placed to navigate this complex area of international business and to make sure that you’re complying with relevant jurisdiction without it costing you more money than it has to.

Of course, while this article gives you the basics and provides you with an overview of what a permanent establishment is, the reality is much more nuanced than we could hope to cover in a single article.

Because of that, feel free to reach out for help if you’re struggling. We’ll be more than happy to help!