Growth is an integral part of a successful business. Whether you operate a big, medium, or small business, expanding abroad is a strategic move you may have been contemplating or are already executing. In either case, global expansion is a complex process you need to understand in-depth to smoothly, successfully, and sustainably establish your presence abroad.
To operate abroad, you must set up what is referred to as a permanent establishment (PE)—as with everything business, having an international presence abroad can be challenging. You must consider where you stand as a business and which types of permanent establishments are the best match for or are required from you in any given jurisdiction.
This guide helps you understand what a PE is, what the most common PE types are, and what the most common permanent establishment example of each kind is.
What is a permanent establishment?
A permanent establishment is a " fixed place of business" outside your home country where you originally operate. This permanent place of doing business out-of-jurisdiction could be your own or via a dependent, in-country agency authorized to do business on your behalf in a given jurisdiction — and is tax liable.
The significance of a permanent establishment cannot be emphasized enough. If anything, depending on your income, size of operations, and whether your home country has bilateral or multilateral treaties with your country of operation abroad, you may or may not be subject to a range of applicable taxes in your home country and your foreign jurisdiction.
Moreover, the permanent establishment concept has experienced radical changes beyond a conventional brick-and-mortar physical presence in any given jurisdiction. For example, many companies now operate using a more flexible business model where a platform is used to conduct business abroad — as in many service and app-based enterprises. This evolution in the permanent establishment concept has resulted in equally as radical changes in how companies are or should be, taxed at home and abroad.
The following sections provide in-depth information about the most common PE types and potential risks if any.
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The 3 types of permanent establishment
PE types are not set in stone and could be interchangeable, depending on how each type is qualified. There are three most common PE types companies are usually classified as when doing business abroad:
This is one of the most conventional and identifiable types of PEs. A physical-based establishment is where an organization performs specific, income-generating activities beyond a home country of operation in a given jurisdiction.
This characterization of a physical-based establishment is too broad. It needs to be narrowed down to more identifiable aspects of doing business, which varies from jurisdiction to jurisdiction. For example, where having a physical-based establishment in a given jurisdiction may require you as a business to have a minimum/maximum number of employees and contractors, certain bookkeeping records and practices, and more, a different jurisdiction may have similar or no requirements.
Examples of physical-based establishments include well-known and established presences and relatively new ones, such as
- Data centers
- Food chain subsidiaries, operation centers, or representative offices
- Hotel chain subsidiaries, operation centers, or representative offices
- Storage facilities for warehousing and merchandise processing purposes
This model of permanent establishment is one step removed from a physical-based establishment. That is, instead of having your physical presence in a given jurisdiction, you have a local agent (and hence "agency") to carry out activities on your behalf in your chosen jurisdiction of operation.
An agency-based establishment is already a well-known form of international presence many enterprises use for many reasons. Some include:
- Saving costs of establishing one's business presence abroad
- Tapping into local expertise in doing business, such as in culture- and language-related activities
- Trying a new market by having an agency-based company before establishing an owned, in-country presence
- Limiting or eliminating tax liability, depending on tax regulations and policies in home and foreign jurisdictions
The examples of agency-based establishments are similarly common, including
- Auto dealerships
- Education and language development centers
- Medical and healthcare management services
This is yet another step away from physical-based establishments. Unlike enterprises selling and buying physical goods, a service-based establishment is a foreign presence a company has established to "sell" services abroad.
Examples of service-based establishments include many conventional and new services. A few examples are
- Management consulting
- Financial services
- Online marketplaces
- Auto repair and maintenance
- Home repair and maintenance,
The concept of service-based establishments has substantially expanded in recent years. Thanks to an accelerating pace of digitization, growing internet speeds, and expanding use of mobile phones, many businesses now operate according to a platform-based model where services are no longer about "goods" or "consultations" sold online. Now, they have expanded to include services such as ride-hailing (e.g., Uber and Lyft) and community-based home rentals (e.g., Airbnb).
The service-based establishment concept is still manageable if you understand where you stand in a foreign jurisdiction. What you might consider "service" in your home jurisdiction might not be so in a different jurisdiction. The complexities you may run into defining your international business as a service is not a definition problem. You're up against understanding how to properly, correctly, and compliantly do business in a foreign jurisdiction.
This evolution in the service-based establishment is a good starting point to discuss possible risks associated with permanent establishments.
Are there risks associated with PE?
Tax regulations and laws are often intimidating for many enterprises. Fearing "unreasonable" taxes abroad, many enterprises — more so SMEs — refrain from expanding internationally or go to great lengths to avoid taxation altogether. This is hardly a sound business strategy, let alone a sustainable one.
Business means growth.
To grow, you need to understand the odds you may have while doing business abroad. Having a permanent establishment, in whatever form, is not risky per se, but failing to understand what risks are involved in each PE type is undoubtedly risky.
The "threshold test" concept is key to understanding PE risks.
In corporate tax language, a threshold test refers to whether a company has enough business activities to create enough taxable presence in another jurisdiction. This is a definition many organizations may still need clarification on. Given how complex taxation regulations have become and how the permanent establishment concept has evolved, companies wishing to do business abroad may easily slip into the slippery slopes of taxes and, worst cases, incur hefty penalties and accrue tax-related expenses.
Failing to manage PE risks correctly could result in negative consequences. A few of these include:
- Reputation damage
- Prohibitive tax commitments and penalties
- Indirect tax costs associated with incomplete tax registration procedures
- More regulatory scrutiny
- Lost management time and processing costs
- More scrutinized reporting procedures and requirements
- Immigration issues for expatriates
- Possible regulatory issues for some service industries, such as FinTech
Not a single business wants something even close to a tax headache, let alone a nightmare. That is why understanding where you stand as a business is critical so you can draw your tax lines and pass your threshold test.
Inviting aboard an established employer of record, such as Skuad, is an excellent first step to
- Understand your international presence positioning
- Save management time and costs that would be wasted if you were doing your homework alone (outsourced tax services are your cheat sheet)
- Avoid any possible regulatory penalties
- Avoid suffering a tarnished reputation among your employees, regulators, and business partners.
Getting PE right
PE is a complex concept constantly evolving with broad consequences for organizations doing business abroad.
Typically, PE falls into three most common types:
- physical-based establishment,
- agency-based establishment, and
- service-based establishment.
Understanding which type your international presence falls into is critical to smoothly and sustainably continuing your growth journey.
Of all three types, the service-based establishment is likely to outpace current tax regulations only because of how elusive and evolving it is. Thus, as an international business owner, you need to use local experts to help you understand which type your international business qualifies for. Otherwise, you're most likely to face several odds and incur regulatory fines for failing to comply with local tax laws, intentionally or inadvertently.
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