Permanent Establishments: Tax Consequences for Internationally Operating Companies
In the digital age, it has become much easier for companies to offer their products or services abroad. This is possible, for example, via a branch office, a separate foreign company or via simple sales employees abroad.
However, caution is required here: A so-called permanent establishment for tax purposes is quickly established unintentionally in the foreign state - with far-reaching tax consequences, as the existence of a permanent establishment means, among other things, that the company's profits are also attributed, at least in part, to this permanent establishment, i.e. the country in which the permanent establishment is located. In other words, the foreign state receives a share of the tax pie and the company must submit tax returns abroad.
What is a permanent establishment?
The respective national regulations of the foreign country are decisive for the question of the existence of a permanent establishment. According to the German understanding, for example, § 12 AO (Fiscal Code) defines a permanent establishment as any business facility that serves the activity of the company and is intended to be permanent (at least six months). This also includes, for example
- the place of management
- branch offices
- warehouses or purchasing/sales outlets
Intensive use of a private residence by a managing director can also constitute a “business manager's permanent establishment” in Germany.
The situation is similar in many foreign countries, but the regulations differ considerably in detail.
Do double taxation agreements help?
Whether or not a permanent establishment exists abroad is therefore initially a question of national law. However, in all cases in which Germany has concluded a double taxation agreement (DTA) with the respective foreign state, the question of the existence of a permanent establishment is not yet finally answered. This is because the DTA may provide for concessions. Depending on the provisions of the DTA, it is therefore conceivable that a permanent establishment would exist under national law but is not recognized under DTA law.
The vast majority of DTAs are based, for example, on the “OECD Model Tax Convention”. It ensures that a country may only tax permanent establishment profits if an intensive business relationship actually exists with the country. This is the case, for example, if a construction or assembly project lasts longer than twelve months. Pure warehouses or purchase/sales outlets, on the other hand, are not yet permanent establishments under the OECD Model.
Therefore, if a company only has a warehouse in a foreign DTA, it does not have to worry about taxation abroad.
Profit allocation in the case of a permanent establishment abroad
If there is a permanent establishment abroad, company profits must be divided between the main location and the permanent establishment (or several permanent establishments in several countries). However, the double taxation agreements ensure that company profits that are attributable to a permanent establishment are generally exempt from taxation in the other country, i.e. double taxation is avoided.
Permanent establishment in Germany for foreign companies
Not only German companies face the risk of establishing a permanent establishment abroad. Of course, the same applies vice versa: foreign companies can often establish a permanent establishment for tax purposes in Germany more quickly than they would like.
Worse still, German law also recognizes a very low-threshold connecting factor for a German right of taxation in addition to a permanent establishment: the “permanent representative” pursuant to Section 13 AO. This is a person who conducts the business of a company on a long-term basis and is subject to the instructions of the company. This includes, for example, sales employees who recruit customers in Germany and win orders for the foreign company - very often also freelancers, so they do not have to be salaried employees.
(Freelance) employees in the area of “sales” can therefore quickly lead to a (limited) German tax liability for the foreign company, at least if the company is based in a country that has not concluded a DTA with Germany (e.g. Dubai, Panama, Hong Kong). This is always accompanied by a bookkeeping obligation and the obligation to submit tax returns. A single sales employee in Germany can therefore very quickly cause a great deal of administrative work.
WINHELLER advises on permanent establishments and the tax optimization of globally active companies
You can avoid tax risks and possible double taxation by planning ahead. In doing so, it is necessary to take into account both the respective national law and the relevant provisions of the double taxation agreement(s). This is the only way to conclusively clarify whether your company is at risk of having a permanent establishment or other connecting factor for taxation abroad.
We would be happy to support you with your international commitments and the resulting tax consequences. Please do not hesitate to contact us!
Your advisors for permanent establishments abroad and in Germany
Our experienced experts in international tax law will be happy to help you with any questions you may have about international permanent establishments. Feel free to contact us with your questions! The easiest way to contact us is by e-mail (info@winheller.com), by phone (+49 69 76 75 77 85 31) or via our online questionnaire on international tax law.
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