Permanent Establishment and Overseas Workers

What Is Permanent Establishment and Why Is It Important to Multinationals with Employees Working Overseas?

For multinational companies with staff in a foreign country, one of the primary concerns is the creation of “permanent establishment” or PE in a foreign jurisdiction.  PE is premised on ‘business activity’ that is sufficient for the corporation to be viewed as having a stable and ongoing presence in the country, that results in some type of locally created revenue.  The primary  elements and tests that are used to determine when a PE is created include:

  • A fixed place of business and sufficient employee activity
  • Ongoing business activity for a period of time
  • Actual revenue creation within the country
  • Meeting definitions of PE within specific tax treaties or according to local tax laws


The importance of PE to a corporation is the fact that PE gives rise to taxing rights by the country where the business activity takes place.  What this means is that revenue created in country will be subject to local corporate tax, if there is PE. If PE is triggered then the foreign enterprise is taxed similar to a domestic corporation, since the revenue is created from sales and services that occur within the country’s borders.


This creates potential ‘double taxation’ for some entities, depending on the presence of a tax treaty between the business’s home country and the foreign location.  For this reason there is interest by multinationals to avoid PE in some cases, even as its definition and application are becoming broader.


The Role of the OECD in Defining PE Guidelines for Member States

The Organisation For Economic Cooperation And Development (OECD) has been instrumental in setting ongoing guidelines for what constitutes PE through commentary and revision of the OECD Model Tax Convention.  Although the OECD does not have any legal power to set international standards, its member states often look to its guidance in forming economic policy, treaties and definitions.  For example, the OECD language on PE is commonly adopted in a tax treaties between member states.


At least one other international body, the International Chamber of Commerce (ICC) has commented on recent revisions of the OECD Model Tax Convention’s definition of permanent establishment by stating: 


“…the definition of permanent establishment has become increasingly broader, a trend that seems to have been perpetuated by the existing draft content of the Commentary for the 2014 update of the OECD Model Tax Convention. What is at issue here essentially involves an “expansion” of the definition of the term permanent establishment (e.g. through what are referred to as service permanent establishments and agency permanent establishments)”


Service and Agency PE

The areas of service and agency PE are expanding in scope and can include situations such as providing technical or managerial services in country.  Even some ‘back office services’ may trigger PE in certain countries.


Each country defines ‘services’ differently for purposes of creating PE, and some may include supervisory services where others do not.  For example, although a Professional Employer Organization (PEO) provides hiring and payroll services as the employer of record, the PEO may still be seen as an ‘agent’ of the parent company, which would not prevent creating PE.


This is the core problem for businesses that are trying to understand when PE is created so that a company can make informed choices about business activity and potential taxation. This is the crux of the issue for any multinational, and clear guidelines are not easily found that work in every country.  There are a few accepted baselines for PE, but those may become broader as ‘business activity’ can be interpreted in new ways.


What Are the Elements of Presence in a Country That Might Trigger PE?

While it remains a grey area, the creation of PE may arise when there are several physical elements in place.  The language of Article 5 from the OECD Model Tax Convention has been adopted by many countries to define PE in the following ways.


Fixed Place of Business

The term ‘permanent establishment’ means a fixed place of business and can include specifically:

  • A branch
  • An office
  • A factory
  • A workshop
  • A mine, or gas/oil well


There are exceptions to the above PE situations, relating primarily to activities or facilities that only involve the storage, display or delivery of goods or merchandise.


The determination of PE will also depend on the activities of the employees at the site, and whether those activities result in revenue.  At the outset of an employee’s time in a new country many activities might be solely marketing related, with no revenue generation at all.  However, over time that could change and might raise the possibility of PE as the activity begins to bring in revenue.


Sales Agents

According to the OECD Model, sales agents that have the authority to conclude contracts in the name of an enterprise will also be sufficient to create PE.  The requirement is that the authority must be exercised habitually, rather than once or twice.  Also, the majority of the negotiation, drafting and signing of contracts must have occurred in the local country.


However, this does not include brokers, general commission agents or other independent agents.


Expansion of PE Definitions

There are a few areas of PE that are evolving and subject to changing interpretation.  The ongoing revisions of the OECD model deal with specific situations and terminology. 


A part of the ‘fixed place of business’ requirement is an additional caveat that the location must be at the ‘disposal of the enterprise’, and that they have the exclusive use of the office or facility.  Traditional examples include renting, owning or other legal access.  This would seem to eliminate scenarios where an enterprise is sharing a facility, are there temporarily or they do not use it regularly.


This also raises the time issue for ‘permanence’.  Most temporal definitions of PE are established in the specific tax treaties or in each country’s domestic tax laws.  Examples of PE time frames range from six months continuously (Australia), and six months or 183 days within a 12-month period (China).  The OECD Model contains a continuous 12-month time frame to establish PE.


How Tax Treaties and Domestic Tax Law Affect Determination of PE

All of these variables make it difficult to arrive at one international model for every business type, and companies are often left to look at the specific country of business activity for guidance.  In some cases, there will be a tax treaty in place between two countries that define PE, or else the creation of PE will be determined by a country’s domestic tax code.


The China Example

For example, a company that is doing business in China would be subject to its Corporate Income Tax (CIT) at a rate of 25% for all revenue created in China.  There would be an exemption from the tax for any business from a country with a tax treaty or Double Taxation Agreement (DTA) with China, as long as there was no evidence of a permanent establishment. 


In short, business activity sufficient to create a PE under the definitions of the DTAs would result in taxation.  The DTAs with China define PE in four areas;

  • Fixed Place PE
  • Construction Site PE
  • Agent PE
  • Service PE


A reading of these various ways to create PE reveals a very broad application of the permanent establishment criteria, obviously drafted by China to enfold as many scenarios as possible that would lead to taxation.


As an example, China recently changed its calculation of the time required for the ‘permanent’ element of PE, from a simple six months of continual activity to the new aggregate 183 days within 12 months.  This new approach captures more business activity as ‘permanent’, where employees or agents may be coming and going from the country.


Presumably, China can create an inclusive definition of PE in its DTAs with other countries since so many businesses want to operate in China and take advantage of its large marketplace and workforce.  In contrast, Australia’s domestic tax law parallels the traditional definitions created by the OECD in the application of PE to foreign companies.


How Can a Business Assess Whether PE Will Be Created?

When a business is entering a foreign market it needs some guidelines to know the type of business activity that will trigger PE.  As outlined, the creation of PE is a confluence of factors rather than just one element standing alone.  The type of business presence, employee activity, agency relationships and time spent in country will all factor into the outcome.


The simplest approach is for a company considering moving into a foreign market to answer a few basic questions:


Q.)  Is there a tax treaty between the company’s home country and the foreign jurisdiction?


-If yes, then the language and definitions in the tax treaty need to be analyzed and understood completely prior to entering the market.  Those definitions will control whether PE is created by specific activities for businesses in either country.


-If no, then the foreign country’s domestic tax code would control the definition of PE, and is probably less favorable for the company entering the country.


Q.)  Does the ‘fixed place of business’ definition being used go beyond the traditional office and factory sites to include constructions sites, agency relationships or service contracts?


-If yes, then the scope of application of those agency and service activities need to be studied with specific case examples of when PE is created.


-If no, then only traditional physical sites would qualify as a ‘fixed place of business’ as long as the office or facility is ‘at the disposal of the company’, which raises the next question.


Q.)  Is the facility at the disposal of the company, having continual and unrestricted legal access for use?


-If yes, then this would be one factor to trigger PE, by qualifying as a ‘fixed place’.


-If no, then PE would not be created, lacking a qualified ‘fixed place of business’.


Q.)  What types of employee activity are required to create PE in the new country?


-If PE is only created by standard revenue creation, then activities like marketing, temporary sales activity and arms length transactions would likely not trigger PE.  (Traditional revenue creation includes ongoing sales activity that results in contracts, or

 business profits from goods and services transacted in country by the company.)


-If PE is created by a broader definition of employee actions, then the likelihood of PE is greater. 


Q.)  Is the PE requirement of ‘permanence’ created by a standard continuous presence in the country for a period of time? ( ex: six months)


-If yes, then that time frame would be the clear cut-off for triggering PE with the identified business activity.  Any time spent that was less would not create PE.


-If no, then the use of a ‘China-model’ aggregate number of days within a year makes the calculation more complex, and it is easier to trigger PE without intending to.


Overview of the Possible Outcomes

Given the range of factual situations that could come into play with any business venture, it is difficult to know when PE will be triggered in all cases.  So much depends on the country involved, applicable tax treaties, type of business activity and the general attitude of the host country to taxing foreign corporate revenue.  The variety of PE-type business activities is revealed in this overview of the OECD Model Tax Convention, covering farms, home offices, subcontracting and international shipping.  Despite its importance to foreign trade, PE remains a concept open to interpretation.


Realistically, a country attempting to attract foreign investment and business activity might take a more relaxed attitude toward PE, while a country with an established history of foreign investment may be more strict in the application.


A Look at Outsourcing: The Professional Employer Organization and PE

The use of a Professional Employer Organization (PEO) is one option for managing global employees, where the PEO becomes the employer of record for its client’s employees. For the purposes of this article the terms GEO (Global Employer Organization) and PEO are considered the same.  The question is whether the use of a PEO to outsource employee hiring has an impact on the creation of PE by the corporate employer.


While there is no conclusive example, it does appear that the criteria for PE would still depend on the employee’s activities, rather than the use of a PEO.  In other words, the use of a PEO would probably be insufficient to shield the corporation from PE if the other PE-creating elements were in place.  The PEO might simply be seen as a co-employer with the company.  The real test would probably be whether the employees were under the managerial control of the corporation, while the PEO simply provided hiring, payroll and administrative services.


Returning to the China example, a PEO may be seen as a ‘secondment arrangement’ or service PE that would make revenue creation taxable to the parent company, if the company directs the daily work activity and maintains authority.  China uses the ‘control and management’ test to determine whether PE is established for the parent company. 


Although the PEO is always the registered employer of record, the PE status will primarily depend on what the employee activity entails.  If employee activity is temporary, sporadic or exploratory, and other elements are missing, then PE will not be triggered. 


Examples of where PE will likely be created include:

  • An engineer on the ground servicing a contract which results in revenue to the parent corporation
  • A sales representative that is concluding contracts on behalf of the company
  • Customer service representatives that staff a fixed office and attend to client needs
  • Most situations where there is management control by the parent company and not the PEO, and where revenue is created


A few specific examples of employee activity that will likely NOT create PE are:

  • Activity that is strictly marketing related, such as early sales contacts, attending trade shows or otherwise testing the market
  • Providing consulting or advisory services that are temporary, such as on site IT support
  • Contracts being concluded by third parties on occasion
  • Services performed by independent contractors are less likely to trigger PE
  • Sales transacted strictly over a website, unless the server is physically located in country



Given the above examples, the creation of PE depends on the facts that indicate:

  1. A fixed place of business, address, bank account or other physical presence
  2. Activity by employees in country that directly relates to revenue creation
  3. Sufficient time frame to trigger PE under the tax treaty or local law
  4. Actual control and direction of the employees’ activity by the parent company


Any company that is looking to expand into new a new market will need to assess its exposure to taxation through permanent establishment.  Many of the factors involved depend on the country and specific business activity.  If you are concerned about PE we are available to discuss your specific scenario at any time and what steps you can take to minimize the tax risks.