Where a UK company has employees working abroad on overseas assignments or has any other type of presence in a foreign country that country will want to impose taxation on profits made by the company in its territory. Most countries apply the rule that non-resident individuals or entities are taxable on income earned in their jurisdiction. This gives rise to the possibility of double taxation on the same profits. This problem may be resolved by granting unilateral double taxation relief in the national tax law of the home country or under the provisions of a double taxation agreement.
Most double taxation agreements limit the scope of taxation in the host country by providing that a business is only taxable in another state if it has a permanent establishment in that state. A permanent establishment is a fixed base such as a branch, office, factory, workshop, mine or oil well. It can also be formed by a construction project that continues for a certain length of time such as six, nine or twelve months (depending on the provisions of the relevant double tax agreement). It should be noted that this is a limit imposed by the agreement on the taxation by the source country – a double taxation agreement does not create any tax liability that was not already imposed under the domestic tax law of a state but aims to allocate taxing powers between the two contracting states.
Some double taxation agreements provide that a permanent establishment arises if staff that are employed by a company resident in the other contracting state are providing services in the host state through staff engaged for the purpose. Individuals operating as employees of a UK umbrella company or of their own UK Limited company should be aware of the possibility of the company becoming liable to tax in this way. Such provisions would normally provide that a business providing services through staff who are present in the state for more than 183 days will be considered as having a permanent establishment in that state, even though there may be no fixed base there, and will therefore be liable to taxation in that state.
The treaty may also provide for a permanent establishment where an employee is working for a service company. The provision in this case will create a permanent establishment where services are provided in the other contracting state by an individual and these services continue for a period of at least 183 days in a twelve month period and at least 50% of the revenue of the enterprise for whom the employee is working is earned by the services provided by the individual in that state. An employee using a service company must therefore be aware of the possibility that the company will be liable to tax in the host state on its profits earned there.
The use of a UK service company may therefore bring with it the risk of double taxation. The services provided by the individual in the foreign country may create a permanent establishment of the UK company in the other state. In cases where the UK does not have a double taxation treaty with the host country these risks are greater. The national tax law in the host country may not have a concept of permanent establishment and may tax all income earned on its soil whether or not the service provider has a fixed base and whether or not the services continue for 183 days. In this case there will be a tax liability in the host state and the service provider must claim a foreign tax credit against the UK tax liability for the foreign tax paid.
This is why the largest service and umbrella companies who specialize in international work have a network of local offices. By assigning the individual to their local company within the host country they avoid issues of permanent establishment on their UK company.
About the author: Peter Hann is an accountant based in Croydon, UK who specialises in international taxation.