Permanent Establishment Q&A

Last week’s webinar Know Before You Go: International Expansion and Permanent Establishment Risk encouraged a lot of discussion.There were several interesting questions from attendees; here are some of the highlights, and answers:

Q: My company doesn't have any employees on the ground outside of the U.S. yet, but we use independent contractors in several countries. How much of this applies to independent contractors?

A: All of the principles covered in our permanent establishment webinar can apply to independent contractors just as they apply to employees. However, as a matter of practicality, the functions performed by and level of representation applied to employees tend to present a fact pattern more likely to create a permanent establishment than those of independent contractors.

Q: How do PE rules deal with electronic transactions? We provide software applications, and all of our sales are transacted over our website.

A: In most jurisdictions, tax legislation and tax treaties have not quite caught up technology and the way business is conducted electronically. Having said that, you should still look to the functions being performed on the ground in country. While the transaction between customers and parent company may take place over the web, are there still business development personnel on the ground in country promoting your company? If so, what is their role in driving traffic to your website? Tax authorities are also focused on the mechanisms that process transactions electronically. They will look to the location servers and data farms, as well as the electronic approval process that allows a transaction to be processed.

Q: You mentioned new proposed PE rules by the OECD. How do OECD Guidelines impact tax treaties and domestic tax legislation?

A: Once OECD Guidelines are published, they must then be incorporated into tax legislation within the OECD member country laws and/or incorporated into treaties to become effective. This process can obviously take some time. Despite this, OECD Guidelines do tend to be indicative of the direction and interpretation that tax authorities are using in the field well before changes to tax law take place.

Q: We are a U.S.-based startup medical device company that will go to market first in Europe. Presently, we don't need an office in Europe, but our team is traveling extensively as we set up distribution and manufacturing relationships. It would be helpful to open a bank account in Europe for easier access to Euros for travel expenses. It seems that we need some European address in order to open a bank account.  Would an address at Regus, or at another vendor's location, and a bank account be a permanent establishment?

A: Permanent establishment must take into account all factors looking at a company’s profile on the ground in a particular country. No one fact by itself will tend to represent a smoking gun. An address, even at a co-location facility, and a bank account in country can certainly contribute to the likelihood that you will create a permanent establishment.

Q: What if we have a U.S. sales manager employee that would want to stay in Australia for six months of the year; we also have a consultant in Australia and there's a proposal to hire another consultant in Australia... all to help boost sales. Would this trigger PE?

A: I recommend that you conduct an analysis of the activities to be conducted on the ground. You will need to look at the factors discussed in our presentation and apply them to both your U.S. employee as well as the independent contractors. PE is not so much about having bodies on the ground as what those bodies are doing. You should also reference the tax treaty between the U.S. and Australia for specific guidance on PE contributing factors, including the amount of time spent on the ground by a U.S. employee.

Q: To what extent does setting up a local subsidiary solve PE? For example, local sales people are paid by sub, U.S. parent ships product to the country. Is the income at the sub simply a transfer pricing issue or can PE still be asserted against the parent?

A: Setting up a subsidiary is by definition acknowledging and legally registering a PE in country. If you have a sub, you have a PE in that country. As you noted, then the question comes down to the level of taxable income attributed to the activities of the sub. While the taxable income attributed to the sub can be as simple as compensating the sub on a cost plus basis, taxing authorities still can attribute revenues of the parent to the activities of the sub and tax them accordingly. You will still need to look at the activities being performed by employees in country to determine whether you are at risk of having revenues otherwise booked by the U.S. parent being taxed by the local authorities.

Q: Would participating in a tradeshow in the country by the local employee to just promote the product/business create PE?

A: General marketing activities such as this are less likely to trigger a PE assertion by a local tax authority. Generally speaking, the further the activities are from a specific revenue stream, the lower the risk of PE exposure.

Q: We have a scenario in which we have partners who resell our products—we may hire local folks to support the partners as they sell the products, the contracts will be between our partner and the customer. Would our local nationals trigger PE if they are supporting versus selling directly?

A: I presume in this example that the U.S. parent will sell product to the local country resellers, and the local country resellers will on-sell to third party customers. Under this example, you will need to examine the activities performed on the ground by local support personnel to determine if a PE is created, and if some portion of the income from the sale of product from U.S. parent to local country reseller should be taxed in country.