Multinational companies pay taxes wherever they do business. Seems simple
enough, right? Possibly on the surface, but if you really drill down into
what it means to ‘do business,’ it becomes a little less clear.
Does it mean that you have an office or factory in each country where you pay
taxes? What if you have a small sales team that works remotely? Or you
provide services to another company that is already established in that
country–where do you draw the line?
That’s where permanent establishment comes in.
Permanent establishment (PE) is the official tax term for ‘doing business.’
There are three types of PE that your multinational business needs to be on
the lookout for to stay compliant.
What is permanent establishment?
Any company that expands its business across the borders of its home country
(residence country) is on the hook for complying with the local laws and
regulations for each new country it does business in.
For example:
- A UK-based company that expands its sales team into other European countries like Sweden or Finland
- US-based businesses that cross over into Canada to expand retail outlets
- A textile company opening a manufacturing facility in China
And this includes following tax regulations, too.
Permanent establishment (PE) is an international tax concept that outlines
which business activities qualify the company as having a ‘permanent
establishment’ in the country—for tax liability purposes.
There are differences from one locale to the next as to what constitutes a
permanent establishment. PE is defined by the tax law of each jurisdiction
(such as a country, state, province, territory, or autonomous region).
But in most cases, these ‘business activities’ refer to anything that
generates revenue. This might include business services provided by employees
or contractors, for example. It may also include profitable revenue from
contract negotiations or real estate sales.
The 3 types of permanent establishment
Of course, if a company opens a manufacturing facility or call center in
another country, that’s a clear establishment of business in that country.
But that’s not the only way to trigger a PE designation.
This designation can be triggered by three types of permanent establishment:
- Physical-based establishment
- Agency-based establishment
- Service-based establishment
Establishing PE with a physical presence or fixed place of business
A fixed place of business is when a company buys or rents commercial space for
the purpose of conducting business. For example, buying a factory in another
country to take advantage of lower labor costs triggers PE.
Other examples of a fixed place of business include:
- A retail storefront
- A shared service center
- A secondary warehouse to facilitate global distribution
- A jobsite to mine natural resources
Establishing PE with an agency
Many different industries employ traveling agents. For example, a London-based
sales manager who frequently travels to Beijing to negotiate contracts may
trigger PE in China.
The specifics vary by country and are generally based on a limit on the
number of days that your traveling staff can spend in one country.
In China, the duration for PE is a combined total of six months or 183
days in any twelve-month period. Similar durations
are provided in Australia, Brazil and many other industrious countries
worldwide.
Other examples of potential agent establishment include:
- Pharmaceutical representatives
- English as a second language ( ESL ) instructors
- Corporate trainers
- Product placement sales representatives
- Financial representatives
Global companies are still free to do business on a global scale and to travel
to any country where business needs to be conducted. Temporary, preparatory
or auxiliary functions will not trigger PE.
Establishing PE with services
Companies like consultants and management firms that operate in many
different countries often fit the criteria for PE, as well. But this triggers
PE for the service provider—not for the company that uses their services.
Examples of service establishment include businesses that provide service
solutions for:
- Information technology (IT)
- Payroll
- Talent Acquisition/HR
- Financial
Are there risks associated with PE?
That’s a resounding yes! A PwC survey found that 86% of
multinational companies are concerned with growing PE risks as the global
business landscape continues to change.
When governments use permanent establishment as a barometer to levy local
taxes, it’s up to the individual organization to know where they stand and
how much they may be required to pay in foreign taxes based on PE statutes.
Companies doing business abroad may one day wake up to a big surprise —and a
potentially bigger tax bill—if they don’t take permanent establishment risk
seriously.
In particular, it’s easy to blur the lines between temporary work and a
permanent presence. Some of the biggest permanent establishment risks
come from signing contracts with another in-country business or employing
contract workers that perform revenue-generating activities in another
country.
With so many types of PE and risks associated with it, it‘s important for
multinationals to fully understand what triggers PE and adhere to the tax
implications.
A permanent establishment faux pas can cause severe financial
repercussions—and damage your business’ reputation.
The bottom line on the types of permanent establishment
Business doesn’t always look like a physical retail store or manufacturing
plant.
This is why it’s so important to understand the various types of permanent
establishments and how they’re defined in the places your business is
operating.
The best way to ensure that your multinational company is covered from every
angle is to work with a reputable Payroll 360
who can ensure you
avoid hefty compliance fees and fines.
If you’re concerned about your PE risk, get in touch, and we’ll help you
evaluate.
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