Permanent Establishment: Expert Q & A

Permanent establishment is an important subject for any company operating or planning to operate in another country. We asked Tom Lickess, Radius’ director of international tax, to talk about the basics of permanent establishment and how related laws are changing in today’s connected economy.

Tom is Radius’ director of international tax. He provides advice on tax planning, dispute resolution, transfer pricing and more. He is a frequent contributor to the Radius blog and has been quoted as a permanent establishment expert in Forbes and other publications. Tom was instrumental in the development of the recently published Permanent Establishment Playbook: What PE Is, How It's Changing and How to Protect Your Organization.

Could you briefly describe the concept of permanent establishment?

In a nutshell, permanent establishment — commonly called PE — is the term tax authorities and experts use when determining whether an organization’s activities in a country are taxable in that country. In other words, if you have a PE in a country you have a so-called taxable presence there.

Generally speaking, a business that performs revenue-generating or other value-generating activities in a jurisdiction outside its home country from a fixed place or by use of a dependent agent may trigger a PE. It’s important to emphasize that these activities can include cross-border electronic transactions.

Whether an organization has a PE is a question of fact. However if there is a PE, the organization will usually be required to report and pay corporate income taxes on its business activities in the (offshore) country.

In your time as a tax professional, have global PE laws changed much?

Since the late nineties, PE laws have changed a lot and are continuing to change. A number of factors have contributed to this volatility, among them the rise of electronic commerce. PE domestic provisions and the OECD model tax treaty are just now catching up with the realities of cross-border e-commerce and the increase in the provision of services as we move away from a goods-only global economic model.

PE laws and tax treaties are also changing in response to public demands to hold large multinationals accountable for perceived tax avoidance through profit shifting. In some cases, multinationals will comply with the tax laws of every jurisdiction in which they operate, but they’ll still be subject to the widespread perception that they are not paying their “fair share.”

The OECD’s BEPS [Base Erosion and Profit Shifting] program is just one important global initiative designed to reset the playing field in order to assist tax authorities and legislators around the world in preventing multinationals from providing value in one country and then shifting their tax presences to another lower tax jurisdiction.

Corporate taxation has in a sense moved from the shadows of public life to the front page. Corporate tax court rulings involving Google, Facebook, Starbucks and other prominent companies are big news around the world. These cases are very much about PE — that is, they hinge on taxing company profits based on where economic activity is performed and value is created.

Because corporate tax has moved to the front page, organizations operating globally can no longer regard tax as a “black box” within the finance area. Finance directors and corporate boards must now give real consideration to the tax positions of their global operations to avoid reputational damage, double taxation and penalties.

Can you give an example of how PE legislation is changing?

Sure. I mentioned earlier that PE laws are changing in part to account for the provision of services. This includes the provision of technical services, which is of course increasingly common now and might include installing software for a client in another country. Technical services are not mentioned in most existing tax treaties and PE legislation (although they are included in an increasing number of domestic laws). This oversight particularly affects developing countries, which might not be able capture tax revenue from tech companies providing services to people within their borders. To address this, many countries are revising their tax laws to include technical services, or in more extreme instances are simply interpreting existing laws that don’t directly mention technical services as including them anyway.

To take another example, the OECD has recently updated its model convention, which lays out principles that inform most tax legislation, including tax treaties. It’s now more difficult in most jurisdictions to avoid triggering a PE by using an agent — in other words, by using a third party — to sign contracts.

How about an example of a specific country that has changed its PE laws?

The UK introduced a diverted profits tax, or DPT, a couple of years ago. Most people refer to it as the Google tax and it applies to both UK and non-UK businesses with activities in the UK. The DPT is part of a global trend I alluded to earlier — that of treasuries, legislators and tax authorities working to prevent large multinationals from implementing artificial or contrived tax structures with the aim of shifting profits to lower-tax jurisdictions.

Is there a quick and easy way to determine if a company has triggered a PE in a country?

Unfortunately no. It is ultimately a question of fact, with the initial onus being on the taxpayer under most self-assessment regimes.

Determining whether a company has triggered a PE is seldom clear cut. You have to take into consideration the laws and enforcement practices of the target or host country — including any applicable tax treaties — along with the company’s unique situation. The fact that PE laws are evolving, not to mention the fact that they may be written in a different language or format from that of the host country, makes this particularly challenging.

It’s actually not uncommon for a business to create a PE in another country without even knowing it has done so. As in so many areas, getting information and advice from a trusted third party that knows your situation and the PE laws and related options of the target country is essential.

One more question: You mentioned revenue generation as a PE trigger. Do nonprofit institutions like universities and charities need to worry about triggering a PE if they engage in activities abroad?

They do. Depending on the activities performed, a nonprofit may need to establish a legal presence and file taxes regularly. Generally, there’s a separate process to apply for local nonprofit status, so even though a nonprofit may trigger a PE and have to file tax forms on a regular basis, it may not actually have to pay taxes to local authorities.