If a business based in country A starts to export to country B, it will become subject to country B’s tax laws. However, if country B has an income tax treaty with country A, and this treaty contains a permanent establishment threshold test, then the business based in country A will enjoy greater protection from taxation in country B as long as those activities do not trigger a specific threshold related to the amount of economic activity it has in country B. If this threshold is breached, a permanent establishment is deemed to exist and the business based in country A will have created a taxable presence in country B.
The concept was first used in international tax law back in 1889 when the first bilateral tax treaty was concluded between the Austro-Hungarian Empire and Prussia. It has since been developed into a model to tackle cross border double taxation and tax evasion and an extensive network of bilateral tax treaties has been gradually established. The OECD Model Tax Convention incorporates the PE concept and has been an important driver in the development of tax treaties.
A fixed place of business is typically defined as including the following types of physical locations:
• Place of management
• Branch or office
• Workshop
• Factory
• A mine, oil or gas well, quarry or any place where natural resources are extracted.
There are 7 good reasons to ensure you manage Permanent Establishment risk effectively
• Peace of mind
• Mitigation of potential damage to your reputation
• Opportunities for tax efficiency and/or improvements to your internal controls
• Less risk of nasty surprises in the form of unexpected tax payments such as penalties and interest
• Reduced risk of challenges by tax authorities if procedures to manage risk can be show to be in place. Such challenges will absorb valuable management time
• Avoid potential immigration issues for employees
• Circumvent regulatory issues in some industries in some countries.