If you’re tapping into global talent or have workers based in another country, even temporarily, your business could be impacted by Permanent Establishment (PE) risk and corporate taxes. And, if you mismanage PE, you could incur fines, penalties, and reputational damage.
But this shouldn’t dissuade you from growing your business abroad, as there are many ways you can reduce PE risk while growing your business internationally.
This article will help you understand how to enjoy all the benefits of globalisation without suffering the consequences of mismanaged Permanent Establishment risk.
What is Permanent Establishment?
Permanent Establishment (PE) refers to a business that is considered by a local tax authority to be a permanent and ongoing setup. As a result, a business operating as a foreign company may be liable to pay corporate taxes or Value-Added Tax (VAT) on the revenue it generates there per local tax law.
There isn’t a universal definition for ‘Permanent Establishment.’ The criteria and benchmarks for creating a PE depend on the local tax authority and/or regulations. But the Organisation for Economic Cooperation and Development (OECD)’s Permanent Establishment definition1 is considered a global standard, and many jurisdictions create their regulations based on it:
‘[A Permanent Establishment is] a fixed place of business through which the business of an enterprise is wholly or partly carried on.’
While you may think of a ‘fixed place of business’ as an office or factory, PE is—unfortunately—much more complicated than that. You could unknowingly create a PE by using third-party companies to do your sales, marketing, and business development in a new market, hiring contractors, or even securing international talent through an Employer of Record (EOR) service.
Ultimately, Permanent Establishment and the associated tax liability depend on what you’re doing within a jurisdiction, for how long, and what the outcomes are as a global employer.
Many countries have entered into income tax treaties (also called Double Tax Agreements (DTAs)), which help businesses avoid double taxation and reduce financial risk from their foreign company. However, these treaties aren’t always available, particularly if your business creates a Permanent Establishment in a tax haven, where there are low or no corporate taxes to pay.
Because of all the above complexities, the best course of action is to seek professional international tax advice before you start any business activities abroad.
Global Tax Implications Across Jurisdictions
Given the lack of a single definition for permanent establishment and/or PE risk, it can be helpful to look at specific contexts in a couple of countries where it’s especially prevalent in terms of local tax law.
To that effect, here is what the landscape of PE risk looks like in various jurisdictions:
- Permanent Establishment in Spain – Companies are residents in Spain and subject to corporate income tax (CIT) if their registered or ‘effective’ head office is located there; otherwise, they’re subject to Non-resident income tax (NRIT) unless an ADT is in place.2
- Permanent Establishment in India – Foreign companies are considered residents in India if their Place of Effective Management (PoEM) is deemed within the country for a given year. Taxation for PEs depends on the extent of ‘business connection’ in the country.3
- Permanent Establishment in South Africa – Companies are deemed residents in South Africa on the basis of PoEM, but a DTA may exclude a company from residency. PEs are generally subject to tax only on income generated from South African sources, along with capital gains taxes on asset disposal that all non-resident entities are subject to.4
These are just some of the risks businesses face establishing PE in these specific countries.
Others in Europe and elsewhere have comparable risks, which may even overlap if a business has established itself across multiple borders. In these cases, working with an EOR is critical.
Industry-Specific PE Risks
Another variation between permanent establishment risks is the way they manifest in different industries. As the country-by-country breakdown shows, the specific kinds of business being conducted in a given jurisdiction play a major role in determining whether and how PE risks are present. So, the kinds of business a company engages in, dictated by industry standards, can determine PE risk.
For example, industries that rely heavily on physical branches or storefronts for direct sales, customer relations, or other operations with a taxable presence—like retail—face significant PE risks when expanding.
Similarly, businesses that depend on manufacturing and construction projects in fixed locations such as warehouses or plants are likely to face PE risk given the fixed nature of their operations.
It might be easy to assume that businesses employing internationally and relying on foreign workers’ home offices or co-working spaces face fewer risks. For example, IT and software development are often perfect for ‘digital nomad’ workers. However, these contexts could trigger PE risk if the countries that employees work in consider home offices as PE.
Types of Permanent Establishment
Across all contexts, Permanent Establishment generally falls under four primary categories. Here are the main types of Permanent Establishment risk that may apply to your foreign enterprise:
- Fixed place of business Permanent Establishment – Having offices and other physical, permanent places of business in a foreign country or jurisdiction is always a PE risk.
- Agency Permanent Establishment – Hiring a dependent agent to conduct revenue-generating sales activities abroad, especially regularly or frequently, generates PE risks.
- Service Permanent Establishment – Providing ongoing services in another country or jurisdiction, even without a physical place of work, is another major source of PE risk.
- Construction permanent establishment – Having a construction site or installation project in a country or jurisdiction, even for a specified period of time, raises PE risks.
Why Does Your Business Need to Understand Permanent Establishment Risk?
Understanding Permanent Establishment risk is crucial for any company that does (or plans to do) business activity abroad or employs international talent. As more and more companies enjoy the benefits of a globalised economy and workforce, tax authorities around the world tighten regulations to ensure businesses pay corporate taxes in appropriate jurisdictions.
Many businesses function internationally without creating PE, but the risks start increasing significantly when you employ people who permanently reside outside of your company’s host country. If you have employees abroad—or you are considering global expansion—you should be aware of how PE works and the impact it might have on your business.
This understanding is essential because the consequences of mismanaging Permanent Establishment risk could significantly hinder your growth and lead to:
- Fines, penalties, interest charges, and back-payments
- Increased tax exposure
- Reputational damage
- Increased tax audits
- Regulatory issues
- Complications with employee immigration
Having said that, Permanent Establishment risk shouldn’t put you off hiring great talent from across the globe or expanding your business internationally. We’re here to help you understand the risks of operating as a global company and manage them effectively.
What Triggers Permanent Establishment?
While countries and local tax authorities define PE differently, there are universally common factors that can trigger Permanent Establishment. Use our Permanent Establish risk checklist to better understand high and low-risk triggers.
High-risk PE Triggers
The most common high-risk Permanent Establishment triggers are:
- Having an office or other fixed place of business, including but not limited to:some text
- A warehouse, factory, mine, or other area used for production
- An office, storefront, or other area used for sales or management
- A co-working space or home office (in certain jurisdictions)
- Having someone based locally, such as a contractor, agent, or employee contracted through secondment or via EOR or Professional Employment Organisation (PEO) who:some text
- Has authority to sign contracts on your behalf
- Has an executive or senior management role
- Provides core business services (e.g., a lawyer at a law firm)
- Undertakes sales activities
The definition of ‘sales activities’ for PE can be pretty broad, and not every activity will automatically trigger PE. Generally, if workers abroad are doing business development, introductions, and/or lead generation, the permanent Establishment risk will be low.
However, if you hire or work with anyone who closes deals or makes direct product or service sales, your Permanent Establishment risk for corporate tax will generally be much higher.
Low-risk PE Triggers
Here are the most common low-risk PE triggers that may apply to your business:
- Conducting frequent business trips to another country
- Engaging a local supplier or having a local customer base
- Having supporting (non-revenue-generating) workers in a jurisdiction
The definition of ‘supporting activities’ is unique to each business and local tax authority. In many cases, supporting activities would likely be roles within accounts, finance, legal, admin, marketing, PR, or design, among others. But that also depends on the type of business you run.
If your business is an accounting firm, for example, hiring accountants abroad would be considered part of your core revenue-generating activities, making it a high-risk PE trigger.
PE risk factors and triggers aren’t clear-cut, and ultimately it’s up to the local tax authority to decide whether your business should be classified as a PE based on their specific criteria.
How to Avoid Permanent Establishment Risk
The only way to completely avoid the risk of Permanent Establishment is to restrict all business activities to the jurisdiction your company is based in. However, that would limit your growth significantly. All companies, large and small, should be taking advantage of the many benefits of expanding operations globally—increased revenue, reduced costs, and access to top talent.
The good news: there are some easy ways you can reduce PE risk and manage it effectively.
Seek Local Tax Advice
Working with a local tax professional is the recommended way to manage PE risk. By working with a local expert, you’ll gain a deeper understanding of your international tax obligations before you start any new activity abroad. This will allow you to expand strategically, mitigate risk, and grow your business sustainably.
Set up a Foreign Subsidiary
When hiring abroad, you have two main options to ensure compliance and reduce PE risk. The first and arguably most direct is to set up a foreign subsidiary, otherwise known as a local entity.
While it can be expensive and time-consuming, creating a foreign subsidiary allows you to pay taxes separately for all revenue generated within that jurisdiction. This is because foreign subsidiaries are separate legal entities and are responsible for their own assets and taxes. However, foreign subsidiaries may still expose you to PE tax risk if your parent company is found to be conducting business for itself through the subsidiary.
The other option, which is often easier, is to work with an EOR—more on this below.
For now, note that where DTAs or Tax Treaties apply, it may be simpler and more cost-effective to avoid creating a foreign subsidiary and opt for an EOR service to hire talent instead. This is especially true if you’re only hiring a handful of workers per country.
Compliance Considerations for Avoiding PE Risk
Whether or not a company’s activities within a country constitute a permanent establishment, there are tertiary PE risks related to the regulatory compliance burdens within that country.
For instance, consider three major kinds of regulations that can apply to PE businesses:
- Business transfers – When working with foreign subsidiaries and in other partnership models, you need to watch out for regulations on business transfer, such as the UK’s Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE).
- Employment law – Employees in foreign PEs may need special protections and other considerations distinct from their co-workers around the globe. For example, European labour laws differ slightly between countries and significantly from other continents.
- Data privacy – If a business collects data from residents in regulated areas, it will need to abide by local regulations irrespective of its PE status. One major example is the General Data Protection Regulation (GDPR), which protects EU residents’ privacy.
These are just a few of the regulations that apply to and complicate PE risk calculations.
Navigating the Regulatory Landscape
Another factor adding to the complexity of compliance is that, typically, multiple frameworks and regulations apply simultaneously. They may have overlapping controls or contradictory requirements, leaving companies without a clear understanding of what they need to do.
For example, a key component of many data privacy regulations, including GDPR, is restricting unauthorised access to personal information. However, data subjects’ ability to access their own information must also be upheld to the fullest. Ensuring both restriction and accessibility at the same time can be challenging. This challenge's complexity increases further with other global regulations, like the Payment Card Industry Data Security Standard (PCI DSS), which prioritises deleting information unless it's needed.
The best way to streamline compliance while also minimising PE risks is working with a compliant EOR—better yet, an EOR that offers robust compliance assurance services.
Hire International Talent Through an EOR
Working with an EOR service, like Omnipresent, can remove the requirement to file corporate taxes where there is no Permanent Establishment outside of the United States.
An EOR legally employs your chosen talent through a fully compliant local entity that handles all the necessary corporate taxes and contributions for you. This means you don't need to set up a local entity, which comes with a presumption of PE and an automatic obligation to file taxes.
An EOR can’t eliminate PE tax risk, but it's a better option for small teams or project-based staff who you may not need in a year or two. While Omnipresent isn’t a tax firm, our team is able to help you understand your broad risk levels before you hire new talent abroad. Omnipresent enables you to decide for yourself which structure works best for you, and whether you need specialist advice.
