What is Permanent Establishment?
International hiring and remote work are booming for one obvious reason: you can hire the best of the best, not just the best of what’s available locally. But hiring globally without knowing local international tax and employment rules comes with some risks, including being deemed permanent establishment.
A permanent establishment is a fixed place of business that contributes to your company’s growth or revenue. In our digital age, that fixed place can be physical or virtual. Businesses that have a permanent establishment must pay taxes and follow employment laws in that jurisdiction. That’s not a bad thing, in of itself, but being suddenly liable for unexpected in-country expenses and subject to regulations you don’t understand is very bad for your business.
The OECD definition of permanent establishment sets out three types of permanent establishment:
- A fixed place of business
- A construction or project
- An agency
Complicating things, though, is that different tax treaties create different criteria.
Permanent establishment risks include obvious factors like opening a new office, but also less obvious ones, like building a team of senior decision-makers and salespeople in one country. Companies that hire internationally must understand these risk factors and constantly monitor and plan for them. That’s why so many work with an Employer of Record to mitigate their risks when hiring internationally.
Why It Matters
Being deemed a permanent establishment means that your company has been recognized as doing business in-country without registering and setting up to pay taxes: you have been operating as a kind of free rider. You will be liable for back taxes and may be levied with fines. It also comes with increased scrutiny from government auditors in the long-term and potential reputational blowback. In short, tripping into permanent establishment presents many risks for your business.
Permanent establishment issues include:
- Paying back taxes, interest, and penalties
- Having to set up in-country payroll, learn local labour laws and stay compliant with them
- Increased attention from tax authorities and reputational damage
- Organizational chaos as you navigate your new responsibilities
- Complications with employee immigration as you set up new local branches or engage an Employer of Record
What is the Permanent Establishment Test?
Types of Permanent Establishment
While the OECD defines three types of permanent establishment, many countries recognize a fourth type: service.
- Fixed Place of Business: Traditionally this type of PE refers to a branch office, warehouse, factory, mine or extraction site, and retail location, but also includes extensive e-commerce operations.
- Construction: This type of PE has the narrowest definition, specifically referring to physical construction projects. Many tax treaties exclude construction projects that have a shorter duration.
- Agency: Companies that have foreign employees, especially decision-makers.
- Service: Companies that provide ongoing service for a foreign enterprise may be deemed to have a permanent establishment in that country.
Permanent Establishment Risks
Determining if your company has inadvertently created permanent establishment can get murky. While there isn’t a single permanent establishment checklist that works in every country and for every tax treaty, there are some broad principles that are true in every jurisdiction.
Permanent Establishment Dependant Agent Risk comes from having an employee in-country who
- Can sign contracts and make decisions for the company (does not apply to people who simply sign contracts but do not draft/negotiate them) to generate revenue
- Is not “bearing entrepreneurial risk” for the company
Fixed Place of Business Risk comes from
- A physical office where all in country employees report
- Having a worksite where employees regularly report to and work out of
- An employee working at home creating a fixed place of business
Service Risk comes from
- Providing ongoing (6-12 months) services to other companies in the country in concert with other signs of PE
- Generally, just providing a service isn’t enough to constitute permanent establishment
How to Avoid Permanent Establishment Risk
The risks of permanent establishment are clear: unexpected tax bills, having to firm up your local business, and reputational risk. So how can you avoid them? There are three main strategies to mitigate permanent establishment risk:
Monitor PE risk on an ongoing basis
One way to mitigate your risks is to hire a local tax specialist to advise you and to have your HR and finance departments perform regular internal reviews of business activities. The advantage of this strategy is better and more complete knowledge of your business. Regular reviews encourage a culture of thoughtful and strategic decision-making in your business.
Create a Local Entity
Another strategy to mitigate your risks is to get ahead of them by creating a local entity. This is the best decision for companies that are skirting the line of creating a permanent establishment and plan to grow further.
Work with an Employer of Record
Employers of record (EOR) hire workers on your behalf and then lease them back to you. While they are the employer of record, or on paper, you direct their day-to-day work. EORs provide in-country payroll, onboarding, compliance, and a host of other services. This allows global businesses to build remote teams while mitigating the dependent agent and fixed place of business risks of permanent establishment.
A best-in-class EOR will also assist your company with monitoring other permanent establishment risks and connect you with local tax and legal experts.
Why Work with Canadian Payroll Services
Canadian Payroll Services provides Employer of Record services to global businesses looking to hire in Canada. Unlike GEOs that operate in hundreds of countries, we specialize in the Canadian market and deliver unmatched expertise in local payroll, employment, and tax risks. We can help you hire quickly and compliantly in Canada, without ever worrying about permanent establishment risks.
