January 24, 2022
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✨ NEW: Have multiple entities? Manage payroll for every country in one place
The world of work is changing. With remote work on the rise and digitization and modern-day technologies facilitating communication between remote team members which are distributed all over the world, it has become normal for companies to tap into a global talent pool. The same goes for the employee side: Being able to work remotely has removed any obstacles that formerly limited work to a specific place.
While physical boundaries no longer represent limits for companies wishing to hire abroad or for workers to take job offers with foreign employers or relocate to different countries while taking their jobs with them, the same cannot be said for taxes. In a world where physical boundaries in the workspace seem to slowly fade away, the only location-related hurdle that slams the break on creating a globally distributed workforce is taxation. Especially for international organizations with operations in multiple countries, it is crucial to be aware of any tax liabilities that may be triggered by their overseas business activities.
According to John Lee from the Work From Anywhere team, corporate taxation is cited as the biggest risk in the context of global mobility and permanent establishment is known for causing serious headaches, even among experienced business leaders.
But what exactly is a permanent establishment? Which business activities prompt permanent establishment? And more importantly: How can you mitigate permanent establishment risks? In this article, we will tell you everything you need to know.
Permanent establishment (PE) describes a situation in which your company is considered an ongoing and taxable presence in a foreign country where it is not officially incorporated. In short: The business activities with which you generate revenue give the local authorities a reason to declare your business liable for corporate tax. But not only that.
Once your business has a permanent establishment in a foreign jurisdiction, the implications go way further than just having to pay tax. Depending on the jurisdiction, you may have to set up a local legal entity which will then also force you to comply with local laws governing the conduct of business, employment and more.
There are two main criteria with regard to permanent establishment. First, the company has created a permanent business location in the foreign jurisdiction through which it conducts (at least a part) of its operations. Second, these operations generate revenue on a regular basis. Yet another criteria to consider is the time frame of the operations: A certain amount of time must have passed before a business is considered a permanent establishment.
One of the main problems with permanent establishment is that the rules and regulations that govern it vary between jurisdictions. Business operations which may not lead to permanent establishment in one country, may do so in the next one.
For organizations conducting business in multiple countries, navigating permanent establishment risk can be very tricky, especially as the laws keep changing with regard to what is considered a fixed place of business. However, the OECD has outlined the general principles that govern permanent establishment and many countries have adopted these guidelines in their national regulations.
According to this regulatory framework, the most common types of permanent establishment are:
Opening a local office, branch, workshop, factory or other fixed business location
Working with sales agents who regularly conduct business in the foreign company’s name
Having a building site (only if the site exists for longer than 12 months - this is the OECD time frame)
Other common scenarios where global businesses (often unknowingly) create a PE include:
Hiring employees abroad - usually their roles must be directly linked to revenue creation
Offering services such as consultancy, research and development, technical services etc. to a company based in a different jurisdiction which will usually include your employees being present at the foreign company’s office to provide the services
Relocation of permanent staff abroad (usually only for sales-related employees or staff in executive positions) - either because the employer requests the employee to relocate to conduct business abroad or because the employee asks to relocate
The fact that permanent establishment may be triggered by remote employee relocation makes it a major point to consider when drafting a Work From Anywhere (WFA) policy.
“PE risk is the biggest legal hurdle when creating a Work From Anywhere policy”, explains Bhagyashree Pancholy, lawyer and remote work compliance consultant. “Companies need to balance the benefit of having a remote team working from different locations with the legal and tax hurdles to form a solution that is sustainable”, she emphasizes.
Depending on the circumstances and local laws, one individual person may trigger PE. In Sweden, for example, a person’s home office might be enough to create a permanent establishment. What’s more, with the rise in online business activities, many jurisdictions have started to adapt their laws to also include virtual permanent establishment.
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In the context of global expansion, permanent establishment is often referred to as a potential risk. That is because once a company has a permanent presence in a foreign jurisdiction, the consequences can be severe and expensive. Again, the rules vary between countries, but in most cases PE will result in:
Back taxes and interests: Depending on how long the company has had a PE, the unpaid tax obligations can span several years. This includes corporate tax as well as VAT. In the worst case, your company will even have to pay interest on the tax they owe or face double-taxation of their profits if there is no tax treaty in place.
Penalties: Many countries inflict financial penalties on foreign companies who have created a permanent establishment and failed to properly incorporate.
Employment obligations: If employees are involved, the foreign company might have to fulfill local employment obligations such as registering with local authorities, contributing to statutory pension funds and more.
Incorporation: Prompting PE may mean having to set up a local legal entity which can be very expensive and time-consuming.
Negative impact on company reputation: Being subject to financial penalties for tax avoidance is likely to damage your company’s reputation.
Being aware of the possible consequences your company’s overseas operations may have is the first step towards mitigating the risk of creating a permanent establishment. Reaching out to tax specialists before starting to conduct business in a different country is the next step to ensure compliance with local tax laws. Depending on the intended scale of your business engagement in each country, the only way to avoid permanent establishment risk might be to set up a local subsidiary which operates independently from the parent company and functions as a tax entity in its own right.
However, especially in the early stages of international expansion, companies often don’t want to commit to a new market just yet. Also, many of the example scenarios we mentioned above are linked to global recruitment practices, i.e. companies building a global team by hiring employees abroad. Luckily, it’s possible to avoid permanent establishment in most of these cases (sales representatives and high-level executives who are directly involved in revenue creation excluded) by using an Employer of Record (EOR).
An Employer of Record allows you to hire talented full-time staff abroad without having to set up local entities in each new country. While they act as the legal employer of your foreign workforce and ensure full compliance with local employment obligations, you remain in control of your employee’s day-to-day activities.
Not sure whether or not the employee you want to hire abroad may create a permanent establishment? At Lano, we work with a network of top tier EOR partners in over 150 countries as well as with a team of legal experts who can help you find the best global hiring solution for your business. Get in touch with us today to discuss your global employment needs.
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