The taxation of a business operating in multiple countries is almost always complex. A presence in another country may not always subject you to the country’s taxes. In contrast, sometimes you may be subject to a country’s tax law even if you don’t consider your presence there substantial enough to be taxable. That is where the concept of a Permanent Establishment (PE) comes into play.
A taxable presence in a country (outside a business’s home country) is considered a Permanent Establishment. It’s an international taxation concept that was created to counter a common issue – businesses operating in a country (or multiple countries) where the corporate tax rate is high but paying fewer taxes because they are headquartered in a country with a low corporate tax rate.
The problem still exists, but with bilateral tax contracts in place and the concept of Permanent Establishment, it’s not as blatant as it used to be. The idea behind a Permanent Establishment is to allow a country where a business is generating its income (or a substantial portion of its income) to tax the business at the same rate as it taxes other businesses/local businesses.
The types of Permanent Establishments may differ from country to country, and they may be different for different types of jurisdictions. Some of the most common types of presences that may classify your business as a Permanent Establishment in that country are:
- A fixed place of business in the country. This usually means a point of operation like an office, a manufacturing plant, land you use to extract natural resources, etc. A presence like this is usually tied to revenue generation from the country and leveraging the country’s resources. This gives the company a legal right to tax your business.
- Sales agents can also constitute a permanent establishment. Even if you don’t have a fixed presence in the country but are tapping into the consumer pool via sales agents, it may be your business’s Permanent Establishment in that country. But it’s not always straightforward and depends upon factors like the frequency of sales agents visiting a country, how it impacts local businesses, maturity in the host market, the revenue share of the host market, etc. It’s a bit tricky to navigate because if penetrating a new market is considered equivalent to a Permanent Establishment in that country, it may discourage essential products from entering.
- Providing services in a country repeatedly and substantially, even without a fixed presence, can trigger the creation of aPermanent Establishment in that country. This may include long-term service contracts held by foreign companies.
There are both risks and rewards associated with Permanent Establishments.
The most common Permanent Establishment risk is creating one without meaning to and not taking definitive measures to put things right when you know that your business activities in a country would be considered akin to setting up a Permanent Establishment there. It may lead to several complications and risks, including:
If you haven’t officially registered your business in another country as a new business entity or a branch of your existing business entity, yet you are conducting business in the country (legally), you may not be subject to local taxes – assuming your business is not yet classified as a Permanent Establishment. When it is, you may be taxed according to the bilateral tax agreement your home country has with the host country. You may have to pay taxes at the corporate tax rate for all or part of your revenue generated from the country, and if they are significantly higher than yours, the profits may see a substantial decline. Even though it’s rare, if there isn’t a bilateral tax treaty/agreement between the country you are operating from (home) and the country you are operating in (host), you may suffer from double taxation (at least to an extent).
If you have been operating in a country and your business activities warrant a Permanent Establishment classification, you can still fly under the radar for a long time. But when you are classified as one, you may have to face serious financial repercussions. Taxes at the local corporate rate would be just one part of it. You may have to pay fines and make back payments for the duration of your operations in the country. This may put your business in financial distress.
Operating in a country without adhering to the best practices and knowingly or unknowingly creating a Permanent Establishment without paying you due can also land you in legal trouble. The country’s regulatory bodies may start looking into your business activities with higher scrutiny and may impose restrictions on your business activities which may lead to financial losses. Being on the wrong side of the law can also damage your reputation and prevent your business from making necessary connections.
Declaring a Permanent Establishment in a country by registering your business or establishing a legal entity and adhering to the tax and operational implications offers a lot of benefits. It may come at the cost of profits, but with a legally recognized Permanent Establishment, you get the following rewards:
When you are a registered business entity or have a presence that adheres to the Permanent Establishment declaration best practices, you earn more credibility. Regulatory bodies, other businesses/vendors from the country, and consumers may consider your business more credible and legitimate. The local top talent pool may also become attracted to your business.
With a legally declared and managed Permanent Establishment, you can leverage every available resource at your disposal to grow a local presence or leverage the local resources. This is severely limited when you have to manage your business not to hit the threshold that would be considered equivalent to creating a Permanent Establishment, and you have to fly under the radar. Any tax benefit you may lose can be outweighed by higher revenues and profits you may have access to by fully realizing your expansion capabilities in a country. If you are on the fence, simplify your global hiring with an Employer of Record solution with Engage Anywhere. Engage Anywhere has the local knowledge, transparent pricing, and full cycle support to engage your business with a borderless workforce.