What is permanent establishment risk? A guide for companies with remote workers

Many companies aim for global expansion to dominate new markets, improve their business profits, and onboard new talent. 

But as beneficial as international expansion can be for your business activities, there are pitfalls. One major one is permanent establishment risk, which, if you don’t manage properly, can lead to hefty fines and damage your business relationships with other countries. 

In this article, we’ll go over what a permanent establishment is, the risks it brings to companies, and what you can do to mitigate it.

What is a permanent establishment?

“Permanent establishment” (PE) is a tax term for a foreign enterprise that has an ongoing presence in a country. It’s the same thing as “substance requirement.”

In both cases, the question is: are there indicators that your company is established enough in this country to be subject to its tax rates?

Companies generally try to avoid PE in countries where they have employees, as a permanent establishment obligates the company in question to pay corporate taxes and meet other standards of compliance.

What are the different types of permanent establishments? 

Not all permanent establishments are the same. The different types of permanent establishments when doing business abroad include the following:

Physical-based permanent establishments

As the name suggests, a physical-based permanent establishment is a business with an active physical presence abroad that rents or owns commercial space to run its activities. 

If you have any physical-based establishments overseas as part of your business, you’ll be liable for taxes in both jurisdictions. 

Common types of physical-based establishments include the following:

• Hotel chains

• Factories

• Food chains

• Data call centers

• Any warehouse your company rents abroad

• Offices

Example: An American retail company runs a customer support office in the Philippines. That means the company has to pay taxes in both the US and the Philippines. 

Agency-based permanent establishments

You might send one of your employees to complete an assignment overseas for an extended period. Depending on how long they stay in the country for their assignment, they could trigger a permanent establishment.

Common types of agency-based establishments include the following:

• Sales agents

• English-as-a-second-language teachers

• Financial advisors

• Pharmaceutical company representatives

Example: One of your firm’s sales managers goes to Brazil to land new deals with partners. They spend more than six months there during their assignment. Under Brazilian jurisdiction, this triggers an agency-based permanent establishment. 

Service-based permanent establishments

If your company regularly provides services to external countries, you could qualify as a service-based permanent establishment. Common types of service-based permanent establishments include the following:

• IT companies

• Financial services for overseas companies

• Management consulting companies

Example: Your company offers IT services to companies abroad and is growing its profits in a country overseas. As a result, you’ll have to pay taxes to that country, as well as your home country.

What triggers a permanent establishment? 

Permanent establishments work a little differently in different places. Each country has its own criteria to determine whether a business is classified correctly. That said, most countries follow a similar set of guidelines to determine a company’s status and whether it needs to respect their income tax laws.

• Does the company have a fixed place of business in the country? In this case, a fixed address does not necessarily mean a physical address. Certain registrations can qualify as a fixed place of business, as can other business operations, even if the company does not have an office. In the age of remote work, understanding the rules for fixed places of business can be challenging.

• Does anyone regularly conduct business as an agent of the company in the country? In other words, is there someone in the country who exercises decision-making power on behalf of the company? This does not only refer to executives who handle things like partnerships or investments. Salespeople who close deals and sign contracts can also trigger a permanent establishment.

• How much control does the company exercise over its workers in the country? This is where things can get tricky. Companies not only need to be aware of the classification of their contractors but also of the relationships they have with their employees. Working with an employer of record insulates companies from some of this risk, but businesses should speak with in-country global employment partners to understand their protections against permanent establishment risk.

• How does the company generate revenue in the country? When a business generates revenue in a country, the country usually wants a share of that revenue. Tax treaties determine where companies are obligated to pay taxes, but permanent establishments can change those rules. If employees in the country directly contribute to the company’s ongoing revenue, those activities could create a permanent establishment.

• How long has the company been doing business in the country? A permanent establishment is usually not triggered by a representative occasionally traveling to a country to close a deal. However, that does not mean companies can freely conduct business abroad simply because their employees are travelers and not residents. The longer the company does business in the country, the greater the permanent establishment risk becomes, and the more closely authorities will audit the organization.

• Does the company make strategic decisions from within the country? For example, does the board regularly meet in the country? Senior leaders convening could be an indicator of a permanent establishment. When hiring C-level executives and board members through an employer of record, locations of board meetings should be top of mind. 

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What is virtual permanent establishment?

Virtual permanent establishment is the same as permanent establishment. The “virtual” part of the name simply refers to the way in which the company establishes its presence in the country.

See also: Where do remote employees pay taxes?

Establishing a fixed place of business, even if a representative of the company has never physically been to the country, is one of the reasons permanent establishment can be so complex. This is another area in which the laws of different countries will treat the situation in different ways. However, do not assume that virtual permanent establishment risk is easier to avoid. Countries are becoming more vigilant about enforcement of permanent establishment laws in the remote work era.

What does co-employment have to do with permanent establishment?

Co-employment and permanent establishment are not the same. Co-employment refers to a situation in which two employers are simultaneously responsible for the same employee. Fortunately, co-employment is not a factor in determining permanent establishment risk.

Working with an employer of record does not directly affect permanent establishment risk, nor does an employer of record relationship necessarily lead to co-employment. As most companies using an employer of record do not have an office in the country, they have some distance from permanent establishment for that reason alone.

Be extremely cautious about employers of record who attempt to circumvent the rules of permanent establishment. If your business is caught operating deliberately out of compliance, you could be subject to substantial fines and penalties, which could even include a ban on doing business in the country. For example, if an employer of record offers to employ your workers in a different country than the one in which they will actually work, you could put your company at great risk.

You can avoid permanent establishment risk while still operating under the rules. Working within the system to remain compliant is always preferable to breaking the law and hoping to avoid detection.

What happens to companies under permanent establishment?

Primarily, a company under permanent establishment is required to pay corporate taxes in the country where permanent establishment was created. Other factors may come into play, such as new regulations for companies operating in the country, but permanent establishment is primarily an issue of taxation.

Businesses should be cautious to avoid being taxed twice on the same income in two different countries. In some cases, once permanent establishment is created, it can be difficult to avoid paying double. This is why it is essential to understand and plan for permanent establishment risk from the beginning. When permanent establishment is unavoidable, clear transfer pricing arrangements can help determine which revenue streams are generated in the country.

Businesses with employees in multiple countries must be extra cautious. All countries manage their own permanent establishment criteria and leverage their own taxes, so a company with poor management of permanent establishment risk could end up creating permanent establishment in multiple countries.

Global HR —

15 min

Permanent establishment risks for a remote workforce

Are you looking to expand globally? Learn about permanent establishment risks, how they can affect your business, and what you can do to avoid them.

What are the risks associated with permanent establishments?

While growing internationally is an excellent goal to have, companies must be aware of the risks associated with permanent establishments. Let’s discuss a few of them below.

Double-taxation liabilities

If you do business overseas, you’re liable to pay taxes for both territories. For example, let’s say you incorporate your company in the US but operate it from the Netherlands. In this case, you’ll qualify as a tax resident for both countries and will have to pay taxes such as value-added tax. 

The problem is that many times, companies aren’t aware they are creating a permanent establishment — and this can be a costly mistake that leads to tax penalties. 

Proper research into each country that you plan to do business in is essential to protecting yourself.

Increased chance of tax audit

Having multiple sources of income overseas can raise some red flags in the eyes of the Internal Revenue Service. You must ensure that you remain compliant with both domestic and international tax regulations to avoid trouble. 

Damage to your reputation

In the case that you fail to file your taxes in the country where you’re doing business, your brand reputation could take a serious hit. This might make you look bad in front of potential investors and customers. On top of that, it could negatively affect your business relationship with the other country. 

Best practices for managing permanent establishment risk

All this talk of the risks associated with permanent establishments might make you second-guess your decision to expand your company overseas. 

But thankfully, growing your business internationally doesn’t have to be a risky move. You can minimize your permanent establishment risk by following these best practices:

Hire a local tax specialist

It’s hard enough to navigate the US tax system, let alone tax laws in foreign countries. Make sure to hire a local tax specialist who can be there to explain the specific tax rules of the country in which you’d like to do business. They can provide useful advice for staying compliant. 

Establish tax-compliant policies

Once you’ve hired a local tax specialist and have a plan for how you’ll navigate taxes, ensure that you establish tax-compliant policies. These policies include an outline of the tax regulations in the country in which you plan to do business and how your company plans to respect them. 

Work with an international PEO

The role of an international professional employer organization (PEO) is to offer guidance and services for domestic companies that plan to hire internationally. They can assist you with payroll, tax regulations, and permanent establishment risk management when opening up to a new market. 

Employ workers in other countries without permanent establishments

With dozens of local entities in countries around the world and a commitment to the highest standards of compliance, Remote is your go-to resource for all your global employment needs. We are the experts on permanent establishments in countries around the world and can help your business make the smartest financial decisions as you grow your global team.

Contact us today to learn more about Remote’s employer of record, payroll and benefits, and contractor management solutions. If you’re ready to get started, you can sign up and start employing through the Remote platform right away.

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