UnderstandingWhat is Permanent Establishment and How to Avoid it

Global expansion is increasing. The effects of COVID-19 and the rise of the remote work culture is allowing companies to rearrange their growth strategies and operate on a more global scale. As your business expands internationally, you need to understand one of the most prevalent risks: Permanent Establishment. Whether you already have an international work force or are tapping into the ever-growing global talent pool, your business could be affected by Permanent Establishment and be liable to foreign governments for taxes, fines, and penalties.

However, the risk of Permanent Establishment should not dissuade you from growing your business internationally. Let's discuss how Permanent Establishment affects you, what triggers it, and how you can protect your business.

What is Permanent Establishment?

Permanent Establishment refers to a business that is considered by a local (international) tax authority to be a permanent and ongoing concern. The result: The business may be required to pay applicable corporate taxes and/or VAT on the revenue generated in that country.

Note that there is not one singular, universal definition for Permanent Establishment. The criteria for Permanent Establishment depends on the local taxing authority and regulations. Foreign authorities want to know at what level a company is operating in their country so they can accurately assess whether its corporate tax laws are applicable.

Which Business Activities Lead to Permanent Establishment Risk?

Local authorities weigh many factors to determine a company's Permanent Establishment risk. That's especially the case when determining whether the Permanent Establishment risk is intentional (e.g., it follows the company's business strategy) or is inadvertent (e.g., it may be amended to avoid additional taxation). Some of the factors may include:

  • Having an office or other fixed place of business in-country
  • Directly employing individuals that contribute to the creation and trade of products or services that translate to company revenue in-country
  • Withholding employee income and social security taxes
  • Employing individuals with long fixed-term contracts, i.e., creating a “prolonged worksite” status
  • Signing contracts with in-country businesses and profiting from those contracts
  • Receiving payments from clients operating within the same country and withholding taxes as a result
  • Hiring a dependent agent to conduct revenue-generating sales activities abroad

Even having someone based locally, such as a contractor, agent, employee on secondment, or an employee via an Employer of Record service can lead to Permanent establishment risk if that person:

  • Has the authority to sign contracts on the company’s behalf; or
  • Has an executive or senior management role; or
  • Provides a core business services (e.g., an accountant at an accounting firm)

How Can Your Business Avoid Permanent Establishment Risk?

In reality, the only way to completely avoid any risk of Permanent Establishment is to restrict all business activities to the country or jurisdiction your company is based in. However, that would limit your growth substantially, as all companies should be taking advantage of the many benefits of expanding operations globally, including increased revenue, reduced business costs, and access to top international talent.

Luckily, there are a few ways your company can reduce and Permanent Establishment risk.

Work with a local tax expert

By working with a local tax expert, you'll gain a deeper understanding of your company's tax obligations before you begin any new business activity abroad. You'll be better informed on how to expand strategically, mitigate risk, and grow your business safely and sustainably.

Establish a foreign subsidiary

You may consider setting up a foreign subsidiary (i.e., a local entity). While expensive and time-consuming, creating a foreign subsidiary will allow your company to pay taxes separately for revenue generated within that jurisdiction. This is because foreign subsidiaries are considered separate legal entities, responsible for their own assets and taxes.

Be careful, though… Foreign subsidiaries may still expose your company to Permanent Establishment risk if your parent company is found to be conducting business for itself through the subsidiary. It may be simpler and more cost-effective to avoid creating a foreign subsidiary and instead choose to engage an Employer of Record service provider instead. This is especially true if you're only hiring a small number of workers per country.

Hire international talent through an EOR

When the cost of establishing a foreign entity is too high, engaging an Employer of Record (“EOR”) service, like Listo Global, may be the best option for reducing Permanent Establishment Risk while achieving your company’s global hiring and expansion goals.

An EOR will act as your official and legal employer for international workers, allowing you to manage employees without worrying about their local tax payments and withholdings, or local corporate taxes. Instead, the EOR is responsible for remitting all employer and employee taxes in compliance with all local laws. With this solution, your company gets the benefits of entering new international markets and hiring talented foreign workers, all while reducing Permanent Establishment risk.

To learn more about hiring international talent through an EOR and to discover if EOR is the right move for your company, click the contact button above, or reach out at: ready@listoglobal.com.

Permanent establishment