(Or why you can’t just “hire a guy and start selling” in Europe)
As you consider expanding your business to new foreign markets, it is important to understand the implications of your choices on questions beyond simple commercial transactions. While it may seem simple at first to just try something and see if it works before looking at compliance in your target markets, tax and compliance structures may apply to you well before you would consider your company “established” in a market. One of the important concepts to consider is that of a Permanent Establishment. A Permanent Establishment refers to those activities that would make non-residents trading in a foreign State liable for income taxes on profits generated in that foreignState. This article intends to explain the importance of the Permanent Establishment concept and its implications on your market entry approach.
What is the origin of the concept of Permanent Establishment?
In a lengthy process intended to remove international trade obstacles and double taxation, the OCED/G20 members states adopted what is known as the OECD Model Tax Convention on Income and on Capital. As its very name indicates, it serves as a blueprint for clarifying, standardizing, and confirming the fiscal situation of taxpayers who are engaged in foreign trade. It provides a means for settling the most common problems that arise in the field of juridical double taxation. Also, it has facilitated bilateral negotiations benefitting both taxpayers and national administrations. It has been widely recognized and adopted as a guide to interpreting and applying its provisions by many other non-OCED/G20 member states.
The other sources of Permanent Establishment definition to consider are the specific tax treaties between states, which generally offer less restrictive criteria and provide for better tax rates, as well as the domestic tax laws of each State which governs Permanent Establishment via corporate tax rules. In contrast to the tax treaties, local corporate tax rules are far more aggressive in limiting Permanent Establishment exceptions and imposing higher tax rates.
So, what constitutes a Permanent Establishment? What are the relevant activities that will trigger creation of a Permanent Establishment? And what are the implications for those contemplating new market expansion?
There are several tests to apply when considering whether a company has a Permanent Establishment in a given country:
Place of business
As per the OECD model Convention, article 5 defines Permanent Establishment as “a fixed place of business through which a business of an enterprise is wholly or partly carried on.”
Permanent Establishment includes specifically:
- a place of management,
- a branch, or an office
- a factory or a workshop, and
- a mine, oil wells or any other place of extraction of natural resources.
However, some activities will not generate Permanent Establishment. For example:
- the use of physical locations for storage, display, or delivery of goods,
- maintenance of stock solely for storage, display, or delivery of goods,
- the maintenance of goods for processing by another enterprise,
- the maintenance of a fixed place for purchasing goods or collecting information,
- the maintenance of a fixed place for maintaining other activities for the enterprise that is preparatory and auxiliary,
- the maintenance of a fixed place for any combination of activities mentioned above provided that the overall activity is only preparatory or auxiliary.
A more aggressive interpretation may include having a business address, having a bank account in the foreign country, or any other indication that a physical place is being used to carry out business.
Time Test
Any building site or construction or installation project lasting more than twelve months will constitute Permanent Establishment. According to a similar UN model and many local tax laws, this period is only six months. Other authorities have even more restrictive rules, imposing any activity carried out within 183 days in a 12 month period.
Dependent / Independent Agents
Independently of the above conditions, a State will also consider Permanent Establishment to have been created when a dependent person or dependent agent, acting on behalf of the enterprise, can conclude contracts or plays the principal role leading to the conclusion of contracts without material modification by the enterprise and,
- the contracts are in the name of the enterprise,
- for the transfer of ownership, or granting the use of property, or
- the provision of services,
States will not establish Permanent Establishment if the agent is onlyinvolved in performing exempt activities mentioned above.
Importantly, the above will not be applicable for an independent agent who carries out the activities on behalf of the enterprise in the ordinary course of business. On the other hand, if the independent agent acts exclusively for the enterprise and or it is closely related, then the authorities will consider that Permanent Establishment is applicable.
Service / Digital revenue generating activities
With the surge in digital business, traditional tax conventions and tax laws have proven to be ineffective and no longer applicable. Large global digital companies rely on virtual presence and do not require physical space or agents to carry out their activities. Consequently, many States find that top digital companies are not paying their fair share of tax. As an example, the EU is proposing a new Council Directive to ensure that digital companies pay taxes equitably and sustainably. A commission has been established to reform corporate tax laws so that profits are taxed where significant interactions with users take place via digital channels.
The Commission defines digital presence if one of the following criteria is met:
- The entity exceeds €7 million in annual revenues in any Member State.
- It has more than 100,000 users in a Member State within a taxable year, or
- It has created more than 3,000 service contracts within a taxable year.
This new measure will secure a better link of tax revenues to where profits take place. Also, the Commission is contemplating setting taxes on revenues derived from digital activities, such as sales on digital online advertising space, intermediary activities, and the sale of data generated from user-provided information.
The Commission will deliver their proposal to the Council for adoption and the European Parliament for consultation. The EU understands that a broad consensus is the best route to harmonize policies and therefore, is working closely with OECD/G20 member States to reach a standard solution.
Considering expanding your business to Europe?
During the early planning stage, it is advisable to review carefully any applicable tax treaties and local corporate tax laws because they will dictate the specifics on Permanent Establishment. Engaging tax professionals early is an essential step to ensure compliance and avoiding unnecessary risks.
If your market entry plan includes:
- Hiring employees, subcontractors, or dependent agents for revenue-generating activities,
- Establishing a local sales office, a product warehouse, a customer support facility or any physical location used for revenue-generating activities,
- A construction or building project with a time threshold beyond the limits set by the tax treaty or tax laws,
- Selling goods and services via a digital platform (beyond the thresholds listed above)
Then you may well be subject to local tax and also need to comply with the local administrative regulations, which efforts and costs should not be underestimated.
How can Eurogility help?
Eurogility Market Entry as a Service can provide a solution during both the exploratory and business development phases. Our structures can delay the triggering of a Permanent Establishment and the associated expenses. As we work together to plan your market entry phases, Eurogilityalso focuses on finding the optimal tax and VAT reporting structureduring each stage, limitingcompliance risks and costs and allowing you to focus resources on the most value-added functions of your business. We would be happy to discuss your specific situation and European entry plans. Please contact us by email at info@eurogility.com.
Source documents:
OECD (2017), Model Tax Convention on Income and on Capital: Condensed Version 2017, OECD Publishing, Paris, https://doi.org/10.1787/mtc_cond-2017-en.
European Commission (2018) proposal for a Council Directive laying down rules relating to corporatetaxation of significant digital presence, Brusselshttps://ec.europa.eu/taxation_customs/sites/taxation/files/proposal_significant_digital_presence_21032018_en.pdf