Explanation of what creates a permanent establishment (PE)

10 May 2012
Any activity carried out by a business in a country that results in revenue being generated or value created is likely to be deemed by local tax authorities as a permanent establishment, or “PE.” Local tax authorities will in turn assess corporate tax on deemed revenue arising in-country. In most countries, in order to recognize a PE — or a taxable presence — the revenue-generating entity needs to be formally registered under some corporate identity, typically a branch, representative office or subsidiary.

In any given country, PE is determined by application of the local PE laws and any relevant double tax treaties entered into by that country. PE determination is a notoriously gray area, but some tests are commonly used by tax authorities when determining whether a PE exists due to the activities of a foreign organization. While such tests vary by country, the following are generally speaking indicators of a PE.

  • An organization operates out of a fixed place of business in the host country. This may include not only a formal office but also in some situations an employee’s home office.
  • An organization’s employee in the host country receives sales-related compensation such as commissions or bonuses. This may extend to stock options in some countries.
  • An employee’s job title or description indicates that he or she performs activities related to revenue generation or sales, and that employee operates in the host country for a prolonged period.
  • Sales are made to customers based in the host county and local contracts are negotiated by a locally-based employee or dependent agent. Note that even though the employee or agent may not have the authority to conclude contracts, if he or she is deemed substantially involved in negotiating the terms of the contract, a PE may be deemed to exist.

Here are some examples of situations that could a trigger permanent establishment in a host county:

  • Your company sends a technician to another country to conduct software installation and maintenance services over a prolonged period to service a new client. Local authorities may deem that the technical services you provide in the target country trigger a PE, since revenue can be attributed to those services.
  • You issue local pay slips to an employee in the host country, and the pay slips have a job title that includes the word “sales.” Local authorities may automatically deem that your organization has triggered a PE simply due to the word “sales” in the job title, regardless of the employee’s actual job duties.
  • You hire a client liaison manager to work in the host country, assuming such a position can’t be linked to revenue generation and therefore won’t trigger a PE. Tax authorities may deem these kinds of “relationship-building” activities as directly contributing to overall revenue generation. Your client liaison manager, therefore, may serve as one indicator to local tax authorities that your organization has triggered a PE.

A PE will generally not be deemed to exist where the activity performed is preparatory or auxiliary in nature, in other words if it does not form an essential part of the business as a whole. In practice, it is the responsibility of the taxpayer to prove that the local activities are preparatory or auxiliary and therefore do not trigger a PE. Businesses should note that PE laws are changing in virtually all countries, and it is increasingly difficult to apply this and other exemptions.

For a detailed look at PE, download our Permanent Establishment Playbook.