Matter & Substance
  February 2, 2023

What Is a Permanent Establishment?

A permanent establishment (PE) is an international tax treaty concept important for any business undertaking activities in foreign countries to understand. Ultimately, whenever a company has a PE in a different country, it effectively creates a taxable presence in that foreign jurisdiction that could result in some or all of its related income being taxed in that foreign jurisdiction. Failing to understand this concept can result in unpaid tax liabilities and related legal issues.

How Is a PE Determined?

Under most tax treaties, a business in Country A creates a permanent establishment in Country B when:

  • Country A establishes a place of business in a foreign country

  • The place of business in Country B is “fixed"

    • Note: Ownership of the fixed place of business is not essential. The key considerations are access and occupancy—these places do not have to owned, but can be merely rented or leased.

  • The business is wholly or partly operated through that fixed establishment

Examples of a PE

Examples of permanent establishments include (but are not limited to):

  • Place of management

  • Branch or office

  • Factory

  • Workshop

  • A mine, oil, or gas well, quarry, or any other place where natural resources are extracted

  • A building site or a construction, assembly or installation project lasting more than 12 months

For example, a U.S. manufacturing company may produce and design goods in their home country (Country A) but may deploy personnel to a Country B office for an extended period to drum up sales and negotiate contracts. Alternatively, a U.S. company may send personnel or contractors to Country B to perform installation or service functions. Under U.S. tax treaties, the activities of company personnel or agents operating in Country B could trigger a PE in Country B for the U.S. company. 

Where a U.S. company’s activities trigger a PE in a foreign treaty country, that country may tax the profits of the U.S. company that are attributable to the PE. Under most treaties, the profits attributable to a PE are those the PE would have derived if it were a separate and independent enterprise performing the activities carried out by personnel or agents sent by the U.S. company.

Certain activities that a U.S. company carries out in a foreign treaty country are considered to be “preparatory and auxiliary” and will not trigger a PE in a foreign country. Such activities include the following:   

  • Use of a facility solely for the storage, display, or delivery of goods or merchandise owned by the corporation

  • Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purposes of storage, display, or delivery

  • Maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise

  • Maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise (or collecting information) for the enterprise

  • Maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other preparatory or auxiliary activity

  • Maintenance of a fixed place of business solely for any combination of the activities listed above

Further Considerations

However, even without a fixed place of business, a PE may be created if an agent in that country conducts activities on behalf of the enterprise. An agent in one country may be considered a PE of an enterprise of another country if:

  • The agent is dependent

  • The agent has authority to conclude binding contracts in the agent’s country

Under model treaty language, to avoid being a dependent agent, the agent must be both legally and economically independent of the enterprise and be acting in the ordinary course of its business in carrying out activities.

Once a PE is defined, there are different tax treaties that exist between your home and host country which will define your tax rate, preventing your company from being overtaxed.

For example, something that would not fall into a PE is something like a consulting service providing services outside of their own country. As they would be creating revenue exclusively in their host country, they would be taxed there exclusively.

We're Here to Help

For businesses with multinational reach, the complexities of foreign tax regulations on permanent establishments can seem difficult to manage. International expansion of a US-headquartered company requires in-depth examination of regional tax implications, which is why it’s important to get advice early. 

Before you begin experimenting with establishments in other countries, you should consult a professional. Although PEs might benefit your company in some countries, in others, it could cause exasperating and resource-draining situations. The rules vary by country, which is why it’s so important to engage with a professional who can help you make the best decision for the growth of your business.