Permanent Establishment Risks [What Companies Must Know]

If your company is considering a global expansion or hiring employees in other countries, you must understand permanent establishment (PE) risk.

However, with today's expanding global workforce, managing PE risk is more than just a tax issue — it's essential to international business strategy. 

Key takeaways:

• Permanent establishment risk arises when a foreign country views a business as having a taxable presence within its borders, often leading to corporate tax obligations.
• Mismanaging PE risk can result in serious consequences, including penalties, back taxes with interest, increased audits, and reputational damage.
• Remote employees can inadvertently create PE through extended stays, strategic roles, or contract-signing authority.

What Is Permanent Establishment Risk?

PE risk refers to the possibility that local authorities in a different country will view your company as a permanent and ongoing enterprise. If that happens, you'll be liable for corporate taxes in that jurisdiction.

PE scrutiny among international tax authorities has risen since the introduction of OECD Action 7, which aims to keep multinational businesses from avoiding taxes. Mishandling your company's PE risk while operating internationally can lead to various financial problems, which we'll explore in this article.

4 Types of Permanent Establishments

When operating globally or employing individuals internationally, there are four categories of potential risks to be mindful of.

1. Fixed place of business PE: Brick-and-mortar stores, offices, or another type of physical presence for conducting business
2. Agency PE: Employing a dependent agent — someone who acts on your company's behalf — to close customer contracts or somehow generate global revenue
3. Service PE: Providing physical or non-physical services (like SaaS products) in another country on an ongoing basis. You can be labeled a service PE even without offices or stores in your host country. For example, if you're a SaaS provider expanding into India, you'll likely want to hire independent contractors rather than full-time employees to avoid PE risk.
4. Construction PE: Carrying out a construction or installation project for more than a specified amount of time can trigger the PE label, and varies by jurisdiction. So, if your company plans on starting a construction project in Germany, you should carefully review the applicable tax treaties to learn the time it takes to instigate PE.

By understanding the different PE classifications, you can enjoy global business benefits without increasing your legal risks or tax exposure.

Understanding Permanent Establishment Risk

International expansion is growing more common among startups and established organizations alike.

However, multinational expansion must be approached carefully to avoid financial and legal trouble. Failure to understand PE risk can lead to various lasting consequences, including the following:

Penalties and Fines

PE fines and penalties can vary depending on the severity of your company's violations, and you may be financially penalized dating back to the inception of your business activities in the country.

For example, say your company hired a small sales team in the Czech Republic and you provided them with a physical office from which to conduct business. Technically, this means you created a PE. 

However, since your company didn't understand the PE risk, you failed to pay taxes on the revenue you earned. Eventually, local authorities assessed the situation and slapped you with a sizable penalty.

When it comes to what you can expect with PE penalties, one of the main questions tax authorities will use to weigh your case is, "Does it look like they were trying to get away with something?"

Unfortunately, an honest PE mistake can look far more deliberate to international authorities. That's why you need to be proactive about risk management.

Back Tax Payments

If your organization triggers PE and becomes liable for back income taxes, you'll also have to pay any interest accrued during that time.

On top of regulatory fines and penalties, tax arrears with interest can pose a significant threat to your cash flow. That's money that you could've used for growth initiatives and strategic advancements.

Depending on your company's financial situation, accidentally triggering PE and corporate taxation could be a major financial setback.

More Frequent and Aggressive Audits

If your company mishandles its PE risk, the authorities' interest in you won't just disappear once you pay corporate taxes. They'll increase the frequency and thoroughness of their audits, using the logic that if your company slipped up once, it could happen again.

It's worthwhile to get your PE risk squared away from the beginning, as opposed to dealing with heightened scrutiny. Audits are expensive, a logistical headache, and can interfere with your day-to-day operations.

Reputational Damage

When expanding internationally, your company's reputation is an essential factor. If you become known for bucking local rules and local tax laws, you'll find it harder to maintain growth and build lasting business relationships.

This not only affects relationships with stakeholders and customers, but it also negatively impacts your employer brand, making it challenging to hire top talent in the country.

Common Business Situations That Can Result in PE Risk

Some business decisions are especially likely to raise your PE risk.

A permanent office — this includes co-working spaces and home offices in some areas — could generate an unwanted PE label. You should also avoid management hubs, factories, warehouses, and mines.

Any of these will signal to local tax authorities that you're generating enough revenue to be on their PE radar.

High-Risk PE Behavior

An ongoing physical business location isn't the only thing that could make you a candidate for a PE classification.

Some other high-risk situations include:

• Engaging a local employee or contractor with authority to sign contracts on behalf of your company
• Home offices operating as permanent work locations
• Hiring local employees for senior management or C-suite positions or who provide core-level work for your company — a banker at a bank, for example — or perform work that generates revenue. This includes anyone in a sales role; however, some focused strictly on lead generation isn't a PE concern.
• In some locations, seconded employees — employees assigned to work in other countries for a specific period of time — can be a PE trigger.
• Establishing a board of directors that operates, holds board meetings, or makes strategic decisions in another country can prompt a PE label.
• Your PE risk can rise if your employees frequently travel internationally for revenue-generating business. Local tax authorities will want a percentage of corporate revenue generated in their country, whether or not the employees in question are full-time residents.
• Holding a significant degree of economic influence in a given area. For example, are many local businesses dependent on yours to function? That level of economic entanglement can be a considerable PE risk.
• Operating in other countries for extended periods of time. The longer you've been conducting business activities in a given location, the more closely you'll be watched by local tax authorities to ensure you're not a PE.

Luckily, there are lower-risk corporate strategies you can pursue.

Low-Risk PE Behavior

Hiring part-time contractors for "supporting activities" in lieu of full-time employees is a common way to manage PE risk. This goes back to the idea of core-level work that we talked about earlier.

For example, a marketer could be considered a supporting role for a dental office. The job is part of the business but not central to the core enterprise. However, a dentist couldn't qualify as a supporting role because they provide services crucial to day-to-day operations.

Similarly, if you run a marketing agency, a marketer or public relations professional won't qualify for supporting roles; that would be considered a misclassification. The same goes for a lawyer at a law firm.

Country-Specific Considerations

Permanent establishment definitions and enforcement vary across nations. Let's take a look at some country-specific rules to get further insight:

• United States: State-level variations can affect PE determinations.
• India: Service-based PEs are recognized with specific thresholds for duration and revenue.
• Singapore: Using a local server to conduct business or having a local employee with decision-making authority can trigger a PE.
• Germany and Australia: Strict interpretations may consider home offices as PEs under certain conditions.

Awareness of these nuances can help businesses tailor their strategies to specific markets when hiring internationally.

Implications for Remote Workforces

With the global expansion of remote work, companies must be careful about the risk of inadvertently creating a permanent establishment (PE) in foreign jurisdictions.

Here are a few factors to keep in mind:

• Employee autonomy: If a remote employee working from a foreign country has the authority to negotiate or sign contracts on behalf of the business, the company may be deemed to have a dependent agent PE in that country.

• Duration of stay: An employee working from a country for a prolonged period — often more than six months — can contribute to creating a fixed place of business PE, particularly if the home office is used to carry out core business functions.

• Nature of activities performed: Routine administrative tasks may not raise red flags, but other roles, such as sales, business development, or technical leadership, may be viewed as economically significant activities and increase the risk of PE. During the COVID-19 pandemic, the OECD acknowledged the necessity of remote work but stressed that regular activity in a country may still result in PE.

To mitigate PE risk, companies should adopt internal protocols for tracking remote work locations, reviewing employee roles for authority, and obtaining legal advice before hiring international employees.

Frequently Asked PE Questions

1. Do "groundwork-laying" activities such as business introductions trigger PE?

No, activities that set the stage for future business operations but do not generate revenue are not considered a PE risk.

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2. How long can a company conduct business internationally before triggering PE?

There's no universal agreement on this point. It varies from country to country based on each country's specific tax treaty.

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3. What should I do next if my company accidentally created a PE?

If you've accidentally triggered PE, register for a local employer ID and consult a tax specialist.

How to Protect Your Organization from Permanent Establishment Risk

One way that multinational companies safeguard themselves from PE risk is to set up a foreign subsidiary. This separate legal entity pays taxes on revenue earned in a given jurisdiction. Meanwhile, the parent company's corporate revenue in their home country remains untouched.

While this might make sense for larger companies hiring many employees, smaller companies are typically better off using an Employer of Record (EOR).

EORs can help with global employment by managing talent on your behalf, with an established local presence across many locations. They offer services and deep expertise in local tax codes and compliance mandates. They essentially act as a proxy employer for your global team.

Working with an EOR won't necessarily avoid corporate tax liabilities. However, they prevent businesses from unknowingly creating a PE and getting hit with compliance fines and back taxes.

An EOR like RemoFirst can help your organization with:

• Localized contracts: Hiring employees internationally requires compliance with specific employment laws. Every jurisdiction has unique requirements, but an EOR can provide locally tailored employment contracts.

• Compliant global payroll: Payroll laws and regulations vary by jurisdiction. An EOR can assist you in maintaining payroll compliance while paying employees in the appropriate currency.

• Global benefits administration: EORs can provide local benefits administration for a global workforce. This is important because different jurisdictions have different laws about the benefits that employees are entitled to.

• Hiring local contractors: Hiring full-time employees can sometimes be a PE risk. RemoFirst can help you hire and pay remote contractors in 150+ countries.

Working with an EOR like RemoFirst allows you to access top talent while minimizing your PE risk.

To learn more, request a demo, and we can discuss your company's specific needs.