Permanent Establishment (PE): Indicators and Mitigating the Risks

The concept of Permanent Establishment (PE) revolves around the tax administration in various countries when an organization conducts cross-border business. It poses risks such as double taxation on PE profits, varying value added tax (VAT) obligations, withholding requirements for payroll taxes and more. Considering how critical these risks are, there has been a surge in interest regarding PE rules.

Common Indicators of a Permanent Establishment (PE)

• A business is based out of a fixed or permanent place of business in the host country. This may also include an employee’s home office.
• An employee’s job description or title indicates the performance of revenue generation or sales-related activities, and the employee operates for an extended period in the host country.
• Local agreement between a dependent agent/locally-based employee and sales are made in the host country.

Implications When PE Risks Are Not Managed Properly

It is the responsibility of a corporation to prove whether its local activities are auxiliary or preparatory. For business activities related to PE and the associated risks are not managed properly, they may result in:
• Unfunded and corporate tax liabilities
• Damage to reputation
• Increased audit frequency from tax authorities
• Potential indirect tax cost if proper VAT registrations have not been made
• Interest charges and penalties
• Non-compliance with reporting obligations including social security and payroll
• Regulatory issues
• Immigration considerations for employees

One of the biggest challenges for a PE is that each country can create its own criteria and standards for a PE; therefore, taxes can vary significantly by country. This eliminates the possibility of a ‘general approach’ to PEs and increases the complexity of PE issues. In turn, using third-party employers can largely resolve PE-related risks.

How to Overcome PE Risks

Inadvertently creating a PE is a key risk area for multinational corporations. Effective control and proactive management of PE risks include the following:
• Carry out audit of the current setup
• Operational practice of documented policies and procedures
• Sufficient coverage through a rules-based review of the procedures and policies applied to each business line and territory
• Improvements to the internal control framework and identification of opportunities for tax efficiencies
• Reducing the risk of unexpected tax payments by minimizing the risk of errors including interest charges and penalties
• The ability to make relevant disclosures to tax authorities showing appropriate measures have been taken to manage PE issues