Understanding Risk Factors for Triggering Permanent Establishment

For businesses operating internationally, understanding the risk of creating permanent establishment (PE) in a foreign jurisdiction is crucial. Permanent establishment is a concept in international tax law that determines whether a business is subject to corporate tax in a particular country based on its activities there. The following summarizes key risk factors that can lead to triggering PE.

1. What is Permanent Establishment?

Permanent establishment is defined by the OECD as “a fixed place of business through which the business of an enterprise is wholly or partly carried on.”

With regards to businesses operating in the US, the above definition is the standard the IRS holds for classifying a US permanent establishment, characterising it as “a fixed place of business in the United States through which the foreign enterprise carries on its business.”

If the foreign entity is regarded as having a PE, its subsequent net income connected with its business operation in the US will be taxed accordingly.

2. What are the types of Permanent Establishment?

PE occurs when a business has a sufficient presence in a foreign jurisdiction to warrant taxation on its income generated there. Common forms of PE include:

Fixed Place of Business PE: A tangible, ongoing presence such as an office.
Dependent Agent PE: Activities conducted by a person or entity acting on behalf of the business, especially if they have the authority to conclude contracts.
Service PE: Providing services in the foreign country for a specified duration, depending on local laws.

3. Key Risk Factors for Triggering Permanent Establishment

Several factors increase the likelihood of triggering PE in a foreign jurisdiction:

a. Fixed Place of Business

Maintaining a physical office, warehouse, or other operational site.
Using co-working spaces or shared offices, depending on the degree of regular use.

b. Employee Activities

Employees working in the jurisdiction, even remotely, may trigger PE.
Conducting activities such as sales, marketing, or negotiations in the foreign location.

The increase in remote work adds complexity to determining PE. While an individual’s private residence is generally not considered a place of business, a remote worker could establish PE through their role as a dependent agent.

According to OECD guidance, an employee’s home office does not constitute PE unless “it is considered to be at the employer’s disposal”. This occurs when the enterprise has exclusive legal rights to use the location for its own business purposes.

PE may arise when an employee works remotely, but this determination primarily hinges on whether the employee engages in revenue-generating activities. Examples of such activities include:

Having the authority to sign contracts on behalf of the company.
Holding an executive or senior management position.
Delivering core business services.
Engaging in sales activities.

Regarding triggering permanent establishment in the US, the IRS provides the following guidance:

“A foreign enterprise will also be considered to have a US permanent establishment as a result of activities undertaken on its behalf by a dependent agent who has and habitually exercises in the United States an authority to conclude relevant contracts that are binding on the foreign enterprise. A foreign enterprise will not, however, be deemed to have a permanent establishment in the United States merely because it carries on business in the United States through a broker, general commission agent, or any other agent of an independent status, provided that such person is acting in the ordinary course of his business as an independent agent.”

c. Dependent Agents

Agents or representatives who act exclusively or primarily on behalf of the business.
Agents authorized to conclude contracts on behalf of the company.

d. Duration of Activities

Time spent conducting business activities in the foreign jurisdiction.
Many jurisdictions have specific thresholds for service activities (e.g., 6 months in a 12-month period).

Regarding triggering permanent establishment in the US, this will depend on the existence of a tax treaty between the US and the foreign enterprise’s home country.

The tax treaty with the United Kingdom specifies that service activities in the US will create a PE only if the services are performed for more than 183 days in any 12-month period, and the services are provided through employees or other personnel engaged by the UK enterprise.

Even if employees are engaged through an EOR, the nature of the activities performed by those employees is critical. If the employees are conducting revenue-generating activities on behalf of the UK enterprise, the IRS may view the UK enterprise as effectively operating in the US through those employees.

e. Revenue Generation

Generating significant revenue in the jurisdiction, even without a physical presence.

f. Digital and E-commerce Activities

Operating online platforms accessible in the jurisdiction.
Local laws may impose digital tax rules for significant digital economic activities.

4. What activities are not risk factors for triggering Permanent Establishment?

In the US, the IRS evaluates whether an enterprise is engaged in taxable trade based on the extent of its business and revenue-generating activities. According to the IRS:

“A foreign enterprise will not be deemed to have a US permanent establishment if its activities in the United States are limited to certain activities—generally those of a preparatory or auxiliary nature.”

Whether an activity is classified as preparatory or auxiliary can depend on factors such as the existence of a tax treaty between the US and the foreign enterprise’s home country.

Under such circumstances, the IRS specifies that a permanent establishment would not be triggered by activities such as:

Using facilities solely for storing, displaying, or delivering goods or merchandise belonging to the enterprise.
Maintaining a stock of goods or merchandise solely for storage, display, or delivery.
Maintaining a stock of goods or merchandise solely for processing by another enterprise.
Maintaining a fixed place of business solely for purchasing goods or merchandise or collecting information for the enterprise.
Maintaining a fixed place of business solely for conducting any other activity of a preparatory or auxiliary nature for the enterprise.

5. Implications of triggering Permanent Establishment

Triggering permanent establishment has several implications for a business:

Corporate Tax Liability: The company may be subject to local corporate tax on profits attributable to the PE.
Compliance Requirements: Obligations such as filing tax returns, maintaining local books of accounts, and withholding taxes on payments.
Increased Costs: Costs associated with compliance, legal advisory, and potential double taxation.

6. Mitigating the Risk of triggering Permanent Establishment

Clients can take proactive measures to minimize the risk of triggering PE:

a. Structuring Employee Roles

Limit the authority of employees and agents to conclude contracts in foreign jurisdictions.
Clearly define job roles to avoid activities that may establish PE.

b. Use of Independent Agents

Engage independent agents instead of dependent agents to handle activities in foreign jurisdictions.
Ensure agents operate on behalf of multiple clients.

c. Monitor Duration of Activities

Track the time spent conducting services or maintaining operations in the jurisdiction.
Avoid exceeding any time thresholds specified by local laws.

d. Seek Expert Advice

Engage tax professionals and legal advisors to assess risks and implement strategies to avoid PE.
Stay updated on local and international tax laws.

7. Can a Permanent Establishment Be Avoided by Using a PEO or EOR?

No.

A PEO or EOR can be a highly effective way to begin operations in a new location, addressing challenges related to payroll, benefits, and insurance. However, it does not eliminate the risk of triggering PE, especially if a worker engaged through a PEO or EOR is performing clear revenue-generating activities.

While an EOR cannot fully mitigate PE risk, it remains a valuable solution for entering a new market without establishing a physical entity—an action that typically triggers tax filing obligations at federal, state, and local levels.

Under a PEO arrangement, the PEO acts as a co-employer, managing administrative tasks such as payroll, benefits, and compliance. The client is the legal employer under its physical entity, which typically triggers tax filing obligations at federal, state, and local levels. However, like an EOR, a PEO does not shield a business from PE risk. The nature of the activities performed by the employees remains the critical factor in determining whether PE is established.

Conclusion

Understanding the risk factors that trigger permanent establishment is essential for businesses looking to operate internationally or expand to the US. By identifying these risks and implementing mitigation strategies, companies can minimize tax liabilities, ensure compliance, and focus on their growth objectives.

With PE being used as a measuring stick, it is the responsibility of the client to know whether they are creating a taxable presence. This is why it is important to seek the advice of a tax expert who can discuss your potential risk factors and help you determine your liability.

If it has been established that PE has been triggered, businesses should understand whether a relevant treaty exists with their home nation and if there are any applicable PE criteria in said treaty. It is possible that tax credits may be available in the home nation of the organisation to help avoid double taxation.

Understanding Risk Factors for Triggering Permanent Establishment