Permanent Establishment: Everything You Need to Know
Permanent establishments are common terms used by companies that deal with global businesses. Are you a global business owner or an intending business owner that is planning an international expansion? Then, knowing what permanent establishments are is so significant in your planning. In this sensational article, we will give you more insights on the concept of permanent establishment (PE), their taxing system and style, and finally the roles of an employer of record in setting you free from all associated risks.
What is Permanent Establishment?
In this section, we will introduce you to permanent establishment definition, their functions, various types, and common examples, and finally, we will open you up to some common risks that are associated with this concept.
What is permanent establishment should probably be the question that is bothering business owners that are just hearing about this new term. The permanent establishment just as the name implies refers to the establishment of a company or its subsidiary in a permanent location outside one home country. This means that the operations and activities of the company are executed in an established location with all necessary structures. Activities carried out in these locations will be subject to some sort of taxing and licensing due to the grounded infrastructures and recognized locations. Thus, the economical and transactional activities going on in the establishment are sufficient to generate enough revenue at the local level, thus making the company liable to the foreign legal and tax obligations and other government policies. Permanence in this scope implies that the company is not established for just a one-off exchange but a consistent revenue generation. Having gotten the idea around PE, you might be wondering what is the establishment of a business enterprise by someone who lives outside a country called? Foreign direct investment (FDI) is an establishment without the owner living within the country of business.
How it Works
The defining criteria for business operations to reach that point where they are called permanent establishments depends on the requirement of each country. OECD (Organization for Economic Cooperation and Development) helps in delivering a general guideline to help in defining how organizational activities can attain permanent establishment status. However, this global governing body has limited authority in enforcing their resolutions on individual nations or making foreign laws declaration. Nonetheless, the organization still plays a guiding role to its members in developing treaties between countries, policies relating to economic development, and laws on taxation.
Most nations, however, rely on certain uniform criteria to define what translates a company’s operations to being called a permanent establishment and how the PE works. These are:
1. Operating/running a business in a single and stationary environment
2. Consistent attributes of the workforce that contributes to the generation of revenue for the company.
3. Established presence that spans over or will be for a long term/duration.
4. Managerial control of the new subsidiary by the mother company from the headquarter in your home country.
What Types of PE are there?
Of the countless types of permanent establishments that are available, agency, service and stationed categories are the commonest and conventional ones :
1. Stationed-location/Fixed/Stable PE
This refers to a permanent establishment whose classification is based on the consistent revenue generation which is as a result of the presence of a branch or arm of the company, physical structure/building, fabrication and engineering firms, and plants, office site, extraction and processing sites, etc.
2. Agency Permanent Establishment
This is a category that requires that activities of staff before the operations can be acknowledged as a permanent establishment. Activities such as the consistent and regular sealing of business deals and contracts by the staff for the parent company in the new location are requirements to give the company the PE status.
3. Service PE
This is the third way of categorizing the activities of an organization in terms of permanent establishment. This classification suggests that the company is providing regular and consistent services via its representatives or other experts in the new location. The services can include consultancy, technical and managerial activities. For this particular classification, the presence of a stationed location is not a requirement but the duration and frequency of operation are important here.
Based on the duration, length, and frequency of operation, organizations with the permanency status spread across the globe. These include industries that are into production, mining, engineering, commerce, construction, and building activities. Other examples include the permanent establishment in US like leasing of properties by an organization/company to external individuals or establishments, installation projects, renovations, etc.
Risks of Permanent Establishment
Once an organization attains the status of permanency, there will be a lot of risks associated with the activities of the establishment. These activities involve withholding tax from employees’ income, conducting business operations from a particular location regularly, and the presence of staff that concludes revenue-generating deals in the name of the company.
Operations such as these will bring about the taxing of the business, of which, companies might not be aware. Apart from taxation and its costs, PE’s risks could also include regulatory problems, immigration issues for employees, and even damage to the company’s image and legacy.
Organizations can discover the permanency status of their business by researching the available taxation policies and obligations of the new location. Furthermore, this permanent establishment risk can be avoided when you engage the activities and services of local experts who are well entrenched in the knowledge of the local tax laws. This will foster adequate preparation for any tax requirements which may occur during the execution of the company’s programs and activities. Also, companies can limit the duration of their employees’ service to short-term engagements.
Taxes for Permanent Establishment
In this section, we will give you a comprehensive insight into the various taxation concepts relating to permanent establishments, the risks associated with them, the international treaties and laws guiding them, and the possible implications that may be faced.
The taxing of permanent establishments (PEs) is a result of the nation’s government’s need to monitor and get certain monetary payments from the revenue-generating activities of an international organization. Companies that engage in the global expansion are most likely to be affected by taxation and permanent establishment status. Interestingly, these companies are responsible for fulfilling the tax obligations of their home and the new country of activity.
The application or involvement of what is known as “Tax treaty/treaties” (which will be discussed later) could help in alleviating and mitigating taxation. This is however dependent on the new policies of the new country and the parent company’s home country since tax treaties are specific for each nation.
Tax treaties are international solutions developed by the OECD to assist businesses to avoid double taxation when carrying out their activities globally. These resolutions are available to save companies from being taxed by several countries, and thus, they can have multiple agreements with different nations. There exist over 3000 tax resolutions and agreements in the world today. Several of them have provisions for PE that are relatively lenient when compared to the commonest tax obligations. This helps to foster commerce and economic activities within the United Nations and the OECD Member States. It also helps to avoid creating unnecessary taxation burdens for the organizations conducting business from both ends.
Companies looking into global expansion will find it of great advantage to research existing tax agreements/treaties as well as their provisions for permanent establishments. Peradventure an organization intends to conduct long-term business in nations across the globe that are not part of the OECD and the organization is also without a taxation agreement its home country, then the organization must be aware that the taxation policies of the new locations will take precedence over the nation in which the headquarter is located.
One major tax implication for organizations and businesses is that they have to oversee multiple permanent/stationed subsidiaries and establishments in the various countries they might have expanded to. And as established earlier, provisions and requirements for PEs vary from one nation to another. As such, there are no hard and fast approaches to predicting the attainment of the PE status. Though tax treaties may hold ground, some of these global markets are definite in their approach to PEs. To ascertain and anticipate these tax implications, tax treaties, as well as local tax laws, can be assessed before entering a new market.
What is “fixed place of business” and what are the examples?
A permanent establishment can be referred to by a lot of terms and one of these terms is known as the “fixed place of business”. This refers to fixed locations where business operations can take place. Its examples include factories, sites of construction, oil and gas wells, mining sites, and offices of different types. This definition however excludes storage sites such as warehouses and containers used in purchasing wares and commodities.
The Organization for Economic Cooperation and Development and Permanent Establishment
As earlier defined, the OECD is an international body that was established to help in addressing international/global standards on policy issues about international economic and social factors. One of these issues is as concerning permanent establishments. This body does not possess the legal backing, however, to create and enforce international standards. Nonetheless, its members refer to its guidelines in the development of their economic policies and treaties.
Permanent Establishment in Different Industries
The OECD Model Tax Convention of 2014 defines PE and its provisions in different industries. While PE describes the presence of an establishment in a stable location with personnel who carry out various operations, the definition further extends to various industries like mining, construction, farming, etc.
The interpretation of Permanent establishment is open and specific to individual countries. So far some certain basic guidelines exist, these countries have their own PE definitions individually, basing their definitions on different business activities. The onus now lies on the companies that are interested in expanding internationally to examine the required criterion for a permanent establishment in diverse industries and regions. For example, Europe is quite strict when it comes to addressing PE issues for foreign enterprises.
Role of Tax Treaties in the PE Time Threshold
Another important factor that defines PEs is the duration and frequency at which the company is executing its operations. This is expedient in defining the companies that can be subjected to taxing.
Tax treaties, however, play a pivotal role in analyzing the global tax system between nations engaging in a certain form of trade. When it comes to the permanent establishments time threshold, it is less rigid to promote business and economic activities between the Member States with the same treaty. The time threshold could cover a continual period/an aggregate method. It is therefore important that companies get to discover the method with which the tax treaty covers to avoid unnecessary taxation.
PE in the Digital Age: How to Anticipate Virtual Permanent Establishment
The economic operations and activities of companies are being redefined in recent times, especially with the advent of the recent Coronavirus pandemic and the advancement in technological innovations. The physical operations, activities, as well as availability of staff, are important determinants of permanent establishments. However, this description of PE might not be relevant any longer since investors, company giants, businessmen, and women are sporadically expanding to the digital space. This move, not only gives room for economic growth, diversity, and expansion, but also wealth and the generation of revenue.
OECD has made provision for new business models and has included business models with digital presence under electronic commerce. Examples of such include manufacturing, financial services, delivery and logistics, retail distribution, and even digital products such as software, eBooks, music, and games. These areas can be established as PE, especially if the areas can engage in the sales of tangible and digital products or offer services via the internet. What qualifies them as a PE will now be their payment method. Payment methods from a foreign location mean that it meets the defining criteria.
PE tax treaties are often defined by member countries that are also expanding to capture e-commerce. Also, the host country’s tax regulations can have provisions for virtual PEs of which companies are not aware which might result in heavy taxing or withdrawal of business’ licenses. Furthermore, taxes on digital transactions in some nations can be withheld as corporate taxes or VAT. This implies that even when digital transactions that might not fit into permanent establishment’s jurisdiction take place, taxes can still be withheld on local payments. Also, companies can prepare a permanent establishment checklist to ascertain the needful requirements before entering a foreign market.
Using an Employer of Record to Help Mitigate Permanent Establishment Rules
The roles and responsibilities which EORs play in mitigating the risks associated with PEs cannot be undermined since global PEOs and EoRs like WeHireGlobally help in minimizing complications that accompany the establishment of fixed business locations internationally while also catering to employee’s welfare. WeHireGlobally is a global PEO with EOR solutions and a network of experienced professionals in 150+ nations that are helpful to you in tackling your PE issues. Leveraging WeHG EOR services will provide your organization with total taxation obligation compliance in the foreign location. Also, the risks associated with PEs can be circumvented by our catering for the sourcing, employing, and onboarding of staff and talents without establishing a foreign subsidiary.
Permanent Establishment: Everything You Need to Know
The need for global expansion can be regarded as a cause for a permanent establishment. Other causes include the work specifications, the duration of the activity/project, business growth and integration, etc.
Individuals with have their businesses can have permanent establishments. However, they will have to go through the path through which a corporate organization went through in earning the PE status.
The Income Tax Act is the provision for taxation of companies. This provision varies among different countries. In India for example, the PE is defined as a fixed place of business and determined in three ways: the existence of a fixed place, the presence of a dependent agent of the enterprise, and services carried out by an employee over a while.
A permanent Establishment certificate or a NO PE certificate is required to ascertain the taxability of a business. It helps businesses with permanent establishments according to the provisions of the host country, to know the percentage of business income that will be declared. This certificate is often issued by the Income Tax Department of a country, E.g, India. It is relevant if tax treaties exist to know the amount of revenue to be remitted to the proper authorities.