Permanent establishment (PE) is one of the core principles used by a jurisdiction in order to determine whether a business has sufficient activity on its territory to create a taxable presence. With the substantial number of businesses trading in goods and services in jurisdictions where they have no legal entity, it is important to be aware of PE risks, and to mitigate those risks when arrangements are considered for negotiating contracts, finding
business agents, posting employees and participating in any other business activities across borders. Managing PE risks will involve assessing where PE risks might arise, and either ensuring that no PE is created, or managing the profits attributable to the PE, and also keeping up-to-date about the evolving definition of a PE in the relevant host countries.
Place of material negotiations
When determining the existence of a PE, the economic reality will be taken into account, including the place of material negotiations. In the case of agency arrangements, the business could structure its arrangements with local dependent agents in the host countries so that the activities of those dependent agents are limited to initial pre-contractual discussions and marketing, with all material negotiations handled by the home entity. The policy regarding the basis of remuneration of those dependent agents would need to be consistent with the new arrangements.
Hiring of independent agents
Agents acting wholly or almost exclusively for the organisation would not be considered to be independent agents. The business may consider the possibility of hiring independent agents that would also act for other businesses from outside the group.
A PE would be deemed to exist when services are performed in the host country by employees engaged by the enterprise or for a related entity for more than a specified length of time. Guidelines may be issued to prevent this kind of situation from arising.
The digital economy
Businesses without a physical presence, but with significant digital and economic presence, would need to be aware about the evolving definition of a permanent establishment. Some countries have been considering modifying the concept of PE to address the tax challenges of the digital economy.
Discussing proposed arrangements with revenue authorities
Tests to determine the existence of a PE carry an element of subjectivity and there is room for varying interpretation by different revenue authorities. Businesses may consider the possibility of discussing the proposed arrangements in advance with revenue authorities to determine whether a permanent establishment would arise under the planned arrangements.
Registering a PE
Depending on the host country and on the specific circumstances, activities previously considered to be of preparatory or auxiliary nature may nowadays correspond to core business activities. Furthermore, it may no longer be possible to avoid PE status by breaking up a cohesive and integrated business into several smaller business operations. Where a PE exists, the business organization would have an obligation to register the PE with the authorities and meet the applicable administrative, fiscal, employment, immigration and other compliance obligations. The profits that are attributable to the PE would be assessable for local tax. Administrative and compliance obligations would arise even if no or minimal tax is actually payable by the PE.
Optimal legal entity
The business organization may consider whether it would be nonetheless advantageous to set up a legal entity in the host country. The optimal legal entity type would be based on a combination of factors, including the nature of the activities and their planned duration. The incorporation of a branch may also lead to differences in the applicable tax rates as well as the benefit of previous losses.
Attribution of profit to the PE
Where a PE would arise, the business may consider managing the level of profit attributable to the PE by a proper sharing of value-creating activities between the PE and other entities located in other jurisdictions.
Optimising PE risks
Businesses operating across international borders need to be aware of PE risks and of the possibility of creating a PE inadvertently. Organisations need to keep apprised of evolving PE legislation and interpretation in the relevant host countries, and are strongly advised to have access to professional guidance in order to optimise PE risks.
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