Running a business is challenging, but carrying out business internationally comes with its own set of challenges. It involves frequent overseas travel, negotiating with vendors in a different country, hiring employees for foreign locations, etc. Businesses often erroneously deem that not having a physical entity in an international location absolves it from paying taxes in that country. The reality, however, is far from it. As a business owner or decision-making executive in your organization, it is imperative that you understand the permanent establishment (PE) risk, and how to avoid it.
What is a Permanent Establishment?
According to the Organization for Economic Cooperation and Development, a permanent establishment is defined as a fixed and physical place where the business of the organization is carried out, either partially or in full capacity. While this is just a guideline, the exact definition depends on a country’s tax laws and treaties.
What is Permanent Establishment Risk?
Sometimes short term business requirements dictate that employees travel to another country and carry out functionalities from there. This can trigger an unintentional PE situation in a foreign country, and this is referred to as permanent establishment risk.
This risk is particularly problematic as having a PE in another nation subjects the company’s income from that location to tax laws that are stipulated by the local government. It also comes under the prerogative of any double tax agreements that the nation might have with the home country.
Failure to comply with such specific guidelines can have far-reaching legal consequences for your organization. Whether an organization is at the risk of a permanent establishment is determined by the three factors that are mentioned in the OECD model, namely:
- Fixed: Whether there is a fixed location where employees are operating. In addition to a geographic location, it also requires a certain degree of permanency to become taxable.
- Place: This refers to a physical facility that the employees or company use. The building or the place where the work is carried out must be at the disposal of the company and merely the presence of the enterprise at that location does not mean permanent establishment.
- Business: The nature of the activity that is carried out at the above-mentioned location, either in full capacity or partially.
To understand if your organization is at this risk or not, there are certain indicators to which you can refer.
What are the Indicators of Permanent Establishment Risk?
To determine whether your organization is at risk of unintentional PE and thus needs to set up an entity in a foreign location, you need to consider the following:
1. Where do your employees work from when they are in another country?
If the employees work from a fixed and permanent location while in a foreign country, then that is one of the components of a permanent establishment.
2. Is the facility dedicated to your company?
A dedicated facility for the employees to carry out their activities points towards a permanent establishment. It does not matter if this facility is a shared one, as long as your organization has a place at its disposal, it can trigger a permanent establishment risk.
3. What is the nature of the business carried out at this location?
If the employees are carrying out work that is core to the business of the organization, then it is an indicator of a permanent establishment. Usually, a permanent establishment does not occur for work that is for a short term or is preparatory or auxiliary in nature and is not habitual.
4. Are employees seconded or in contract in a foreign country?
Even if the employees in the foreign country are seconded to another organization or on contract from a third party, a permanent establishment can be triggered for that third-party organization, depending on the laws in that location.
Avoiding Permanent Establishment Risks
To carry out business at an international level, it is imperative that you evaluate effectively and comprehensively the risks pertaining to a permanent establishment and take the necessary steps to safeguard your organization against them.
One means of doing this effectively is by engaging the services of a Professional Employer Organization (PEO) (also known as an Employer of Record (EOR)). While PEOs/EORs cannot always guarantee that the risk of PE will be mitigated, there are steps that their expert teams can take to ensure that you are safeguarded as far as possible.