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What is Permanent Establishment and Why Does it Matter?

permanent establishment

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‘Permanent establishment’ is an important international tax concept, meaning a fixed place of business in another country or state, resulting in an income tax liability in that jurisdiction. In this guide, we explain what permanent establishment is, and why any enterprise seeking to expand globally needs to understand it.

Key Takeaways

1. Permanent establishment (PE) is a key international tax concept which means a business can be subject to corporate income tax in a jurisdiction, even where they lack a subsidiary or legal entity there. 

2. A permanent establishment is a “fixed place of business through which the business of an enterprise is wholly or partly carried on”.

3. Businesses need to carefully consider how they might avoid the impact of having a permanent establishment in a location (so-called, ‘PE risk’). 

In October 2021, at an OECD-led meeting of 136 countries, it was agreed that there would be a global minimum corporate tax rate of 15 percent. The intention of this agreement is to combat corporate tax avoidance through companies setting up a subsidiary in a low tax jurisdiction, but in reality, sourcing their income in higher-tax jurisdictions. 

The intention of this reform is to stop large multi-nationals from abusing existing permanent establishment rules which mean, in the absence of a ‘fixed’ presence in a jurisdiction, they avoid having to pay income tax there. 

With the issue of permanent establishment so prominent on the international agenda, it is worth taking a look at how permanent establishment is defined, the concept of permanent establishment risk, and steps you can take to manage permanent establishment when expanding internationally. 

How is Permanent Establishment Regulated Internationally?

Permanent establishment (‘PE’) is defined by the tax law of each jurisdiction (such as a country, state, province, territory, or autonomous region), usually as a consequence of bilateral tax treaties entered into between the two jurisdictions. We can call the country where the enterprise is primarily based, the ‘residence country’, and the other country where activity is occurring the ‘source country’.

Tax treaties themselves, almost universally, define PE based on the concept as set out in either one of two models for international tax treaties: the OECD Model Tax Convention on Income and on Capital (the OECD Model) and the United Nations Model Double Taxation Convention between Developed and Developing Countries.

Summing up the overall purpose of international tax treaties, Michael Lennard, Chief of International Tax Cooperation and Trade in the Financing for Development Office (FfDO) of the United Nations, stated that they are about working out: “whether and to what extent, in respect of particular income profits or gains, the source country (the host country of an investment) will relinquish its taxing rights. If it does, the residence country of the investor may fully tax the profits of the investor”. PE is the principal mechanism in which a source country can ‘claw back’ tax from an enterprise based in the residence country.

Our focus here is on the requirements of the OECD Model, in particular article 5, which defines PE, as well as the commentary that accompanies it.  The OECD model is by far the most common basis for defining PE internationally, and is implemented in nearly 3000 tax treaties. In addition, more than 80 countries are signed up to the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS) and the associated BEPS Action Plan, which has recently altered the definition of PE.

Note that individual countries need to incorporate the definition of PE within their domestic law for it to have legal effect. To determine where your enterprise constitutes a PE you will need to seek professional advice on the laws of the source country.

Is Permanent Establishment the Only Mechanism for Taxing Foreign Companies? 

No. Partially in response to perceived tax avoidance using the concept of permanent establishment, many countries have introduced ‘digital services taxes’. While the details vary by country, generally speaking these taxes apply to the revenues of digital services companies that are connected to users located in a source country.  For example, the UK’s digital services tax applies applies a 2 percent tax on the “revenues of search engines, social media services and online marketplaces which derive value from UK users.”

The History of the Concept of Permanent Establishment 

Many concepts in international commercial and taxation law have their origins in the ‘common law’ (that is, case-based) legal systems of English-speaking countries. 

Not so with permanent establishment. 

There is no specific date when the concept of permanent establishment came into existence. Rather, it developed incrementally over decades, in the laws that regulated trade between different German states in the late nineteenth century and the early 20th century.¹ 

The original problem (which permanent establishment stood as a solution to), was how to deal with double taxation: In trade between or within two tax jurisdictions, which tax authority has the right to tax a business? If both tax authorities were to fully tax the business, the enterprise would face a crippling tax burden which would discourage international or inter-state business. 

In 1869, the tax treaty between the German states of Prussia and Saxony spelled out the concept of stehendes Gewerbe. At the time, this was used to refer to a ‘stationary place of trade’. The treaty provided that a business from one of the states could only be taxed in the other state where it had a stehendes Gewerbe there. 

It was in 1909 that the concept most closely resembling the modern concept of permanent establishment, Betriebsstätte, was codified in the Empire-wide double taxation law, which applied to business between German states. It is at this point that the key elements of permanent establishment were codified in law: a place of business, fixed in a particular geographical spot, with a degree of permanence.

What is the Definition of ‘Permanent Establishment’?

So what exactly does ‘permanent establishment’ mean? Article 5(1) of the OECD Model provides: “The term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on”. Taken together with the commentary to this article, we can establish three key elements:

  • There exists a “place of business”
  • The facilities must be “at the disposal” of the enterprise. This means, for example, despite regularly meeting at a customer’s premises, those premises will not be a PE, as they are not ‘at the disposal’ of the enterprise;
  • The place of business is fixed
  • There must be a connection between the premises and some geographical position, as well as a ‘degree of permanence’ to that location;
  • The business is wholly or partly carried on through that fixed place.

Some locations are specified as prima facie PEs. That is, they will be presumed to be a PE unless the organization can establish to the contrary.  This list captures:

  • A branch;
  • A warehouse;
  • A factory;
  • A mine or place of extraction of natural resources;
  • A place of management.

What is Permanent Establishment Risk and Why Does it Matter? 

Permanent establishment risk (or ‘PE risk’), is the risk that the presence of an enterprise in a foreign country has inadvertently created a ‘permanent establishment’ in that country. Meaning the enterprise may inadvertently be liable for corporate income tax and any attendant penalties and interest charges. 

In addition to the potential financial burden, there are several reasons why PE risk should be a serious concern for your business: 

  • Associated tax and tax registration liabilities
  • If a tax authority finds that a business has failed to account for its company tax liability, they may also find other irregularities. 
  • For example, in many countries, companies  are liable to register for, and pay, indirect taxes such as Value-Added Tax (VAT) or Goods & Services Tax (GST) on gross sales. 
  • This could also result in backtaxes, interest and penalties for the company. 
  • Associated employer liabilities 
  • If a company is investigated for PE, there is also a risk that the company will be found to have breached their obligations as an employer. This is because liability as an employer in a country is broadly analogous to corporate tax liability in a country: That is, it is a factual matter about the activities of the business which determine liability, not any official legal status of the business. 
  • To illustrate this point, consider a recent case from the UK employment appeal tribunal which considers employer liability in the UK with respect to a US employee who had been posted to the UK.  
  • If a business is found to have become a local employer, as well as a permanent establishment, they may be liable for:
    • A failure to register an employer ID;
    • A failure to withhold employee income and  payroll tax;
    • A failure to make necessary social contributions to employees such as, health insurance, pension, unemployment insurance, and worker’s compensation contributions; 
    • Breaching employee rights, such as minimum wage and equal employment opportunity rights. 
  • In line with failures to pay corporate income tax and indirect taxes, these employer failures could lead to backpayments, interest and penalties. 
  • Increased audit attention
  • Any business that has been found wanting by the authorities will have an increased likelihood of being audited in the future. This includes tax audit and any compliance audit from employment regulators. 
  • Reputational damage
  • A failure to pay taxes, and other associated compliance failures can significantly hurt the reputation of an enterprise in a country, both with regulators and (when published), the public. 
  • Inefficient tax planning
  • A failure to recognise and fund a corporate tax liability in advance, usually indicates ineffective tax planning in general. 
  • It is crucial that any business expanding overseas carefully considers how to manage its international tax liabilities. This might include thinking about the use of subsidiaries, joint ventures, holding companies and foreign investment trusts in order to best manage your tax footprint. 

Video: Permanent Establishment Risk — A Summary from PwC

Which Activities Exclude Your Business from Being a Permanent Establishment?

Given the consequences of an unmanaged permanent establishment risk, a business should carefully consider whether its activities exclude it from PE classification.

Even if an enterprise would otherwise meet the definition of a PE, certain activities are ‘exempted’ from the application of the PE rules. Under Article 5(4), if the location would be a PE, but it is used solely for an activity which has for the enterprise an “incidental, preparatory or ancillary” character, it is deemed not to be a permanent establishment. This includes:

  • The use of a storage facility solely for the delivery of goods to customers;
  • The maintenance of a stock of goods owned by the enterprise, held solely for processing by another enterprise;
  • The maintenance of a fixed place of business solely for the purpose of purchasing goods, or merchandise, or of collection of information for the enterprise;
  • Any other activity of an incidental, preparatory, or ancillary nature.
All these activities are often referred to collectively as “ancillary activities”. Note, a recent change to these exclusion rules has been introduced as a result of the BEPS Action Plan, known as the ‘anti-fragmentation’ rule. Historically, many businesses have used the ancillary activities exception to ‘fragment’ their business into separate entities, in order to claim that the business is ‘solely’ ancillary. This new rule provides that, even though activities might appear preparatory or auxiliary, when viewed in isolation, this is not enough. If the activities “constitute complementary functions that are part of a cohesive business operation“, that is not solely ancillary, the exception cannot be used.

Do Construction Projects Count as a Permanent Establishment?

Article 5(3) provides that “A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.” This means that even if a construction project would otherwise meet the definition of a PE, it still needs to meet a duration threshold. Note that, in the past, some businesses have attempted to get around this by contract or project-splitting: Splitting up a construction project that would have lasted longer than 12 months, into multiple smaller projects with the same effect. The new test requires that contracts have to be considered as a whole to determine whether a PE exists.

Can Permanent Establishment Be Avoided by Using an Agent?

It might be thought that the existence of PE could be avoided by using an agent in the source country. As the enterprise itself is not doing the actual work in the source country, one might think, no PE arises.  But this is not necessarily true. Article 5(5) provides that a “dependent agent” can constitute a PE if they habitually exercise their authority to enter into contracts in the name of the enterprise. Under BEPS Action 7, this definition has been extended to include not just someone who signs the contracts on behalf of the enterprise, but also to someone who habitually plays the ‘principal role’ in the formation of contracts, that are then formally concluded by the enterprise. Read more about the connection between ‘contracting’ and PE risk read How to Convert Contractors to Employees and What Are the Best Tools for International Human Resource Management?

How Will I Attribute Profit to a Permanent Establishment?

Under article 7 of the OECD Model, business profits are taxable in the resident country, unless there is a PE, and then profits attributable to that PE may be taxed in the source country. So how do we work out which profits are attributed to that PE? Once it has been established that PE exists due to relevant activities, and no exclusion applies, the attribution of profits is to be determined by treating the PE as if it were a “separate and independent enterprise”. Thus, after it has been established that a PE exists due to activities specified in Article 5(4) that are not preparatory or auxiliary in nature, the attribution of profits to the PE should be determined by an analysis of the revenues and expenses incurred by that PE, treating it as if it were a separate and independent enterprise. This is likely to be a complex task, so expert accounting advice is likely to be necessary.

What Does the COVID-19 Pandemic Mean for Permanent Establishment?

In response to COVID-19, the OECD Secretariat released an Analysis of Tax Treaties and the Impact of the COVID-19 Crisis.  This considered whether or not new remote working situations may inadvertently give rise to PE status. It considers the case of ‘home offices’ in foreign countries, due to the pandemic, and individuals overseas becoming ‘dependent agent PEs’ through their presence in another country. The OECD is of the view that a temporary home office overseas likely lacks the degree of permanence, and being ‘at the disposal’ of the enterprise, to count as a PE. In the case of an agent or employee overseas, the OECD is of the view that this is likely to lack the ‘habitual’ character to count as a dependent agent.

If I Have a Permanent Establishment, What is My Next Step?

Once you have established that your enterprise includes a PE in a source country, what next? You will likely need to consider:
  • Filing a tax return;
  • Attribution of Profits. You will need documentation justifying why profits were attributed in that way;
  • Working out which types of tax apply. In addition to corporate income tax, you need to consider the possibility of turnover (i.e., sales) taxes or withholding tax;
  • Compliance obligations. Having a PE in a source country may also result in a range of other non-tax compliance obligations.

Is There Any Way to Manage Permanent Establishment Risk?

Ultimately, it is a factual matter whether any individual business operation in a country will constitute a permanent establishment. Keep in mind also, that this may differ depending on the individual tax laws of that country. Some options to consider include:

  • Obtain early advice on the likelihood and effect of a PE
  • The existence of a PE is not always a bad thing. For example, according to tax laws in some countries, the existence of a PE will eliminate the need to file taxes in the country of headquarters (‘residence country’). If the target country has a lower corporate tax rate, this could be to the enterprise’s advantage.
  • Set up a local entity
  • By setting up a company in the target country, you can eliminate uncertainty about your tax situation in that country. You will be liable to pay corporate tax in that country just like any other local company. However, this usually carries a range of significant compliance obligations. For example, setting up a limited liability company in Germany (a ‘Gesellschaft mit beschränkter Haftung’ or ‘GmbH’), requires depositing EUR 25,000 of share capital, with half the amount provided on registration.
  • Pay attention to global mobility
  • By sending an employee of your company from the head office to manage affairs in the target country, you may inadvertently be creating a PE in the country.
  • Engage a PEO
  • A global Professional Employer Organization (global PEO) is a common mechanism for hiring globally. The global PEO acts as the ‘Employer of Record’ for your workforce in a country, and takes on a range of compliance obligations for those employees.
  • In itself, using a global Professional Employer Organization or ‘PEO’ will not reduce or limit the chance of a permanent establishment being created: Permanent establishment depends on the substance of a business’s activities rather than the legal form. However, where business activities in a country are short-term and non-habitual (i.e. a PE is not created), the use of a global PEO solution can provide a audit trail for tax and employment authorities demonstrating that your business activities are fully compliant.


PE is an important concept to understand for any enterprise that operates across borders. This is the principal means through which your enterprise may become liable for corporate income tax, value-added tax, filing tax returns, and compliance with a range of other obligations. The key steps you need to take are:
  • Work out whether activities that would be a PE, meet the ‘ancillary activities’ exception;
  • If you are a PE, establish what your tax and compliance obligations are in the source country;
  • Where income tax is owed, ensure you apply the correct model of profit attribution.
In carrying out these tasks, please note that under recent reforms, such as the BEPS Action Plan, there is a move towards preventing enterprises from ‘islanding’ parts of the business for tax purposes.

While we hope that this general information is useful, the definition of PE in different countries can differ, and you need to seek professional advice relevant to the specifics of your situation.

This is where you need professional advice. Horizons provides expert advice on how to set up your business operations in another country. We can advise on the best set up for your business to manage your ongoing tax and compliance obligations overseas. 

Note: This article provides general information only, for advice on your specific situation be sure to seek out professional advice. 

Frequently Asked Questions (FAQ)

The situation where a company has a place of business in a jurisdiction, which is fixed, and where business is carried out. 

This means, to avoid permanent establishment, businesses need to carefully consider the legal and business structures for an international expansion.

For example, businesses should consider whether they need employees or agents based permanently overseas who could constitute a ‘dependent agent’ permanent establishment. Or, alternatively, businesses need to consider whether they should set up a separate subsidiary overseas, which would be taxed separately. 

It can be. 

A subsidiary, as a taxable legal entity in its own right, will usually be liable for corporate income tax in the jurisdiction where it is located. It does not automatically become a permanent establishment of the parent company. 

However, a subsidiary can become a permanent establishment, for example, by acting as a dependent agent of its parent company. 

No, not in itself. However, it could, together with other information, constitute evidence that a business has a permanent establishment somewhere.

What is crucial is whether there is a fixed place of business through which business is carried out. 

Yes, under the concept of a ‘dependent agent’ permanent establishment, the presence of an individual overseas can constitute a permanent establishment of an enterprise.

This usually occurs where an individual habitually enters into contracts in the name of the company, thereby being deemed a ‘fixed presence’ of the company. 

If you are concerned about the presence of a permanent establishment overseas, you should seek professional advice on your situation. 

Depending on the circumstances, it may be possible to make your presence temporary (rather than permanent), or incorporate a subsidiary, in order to avoid creating an inadvertent permanent establishment. 

It can do. Where a remote worker in another jurisdiction meets the definition of a ‘dependent agent’ (see above), or operates from a business location that is fixed in nature, a permanent establishment risk arises. 

Businesses should seek professional advice about the impact of remote workers based overseas. 

Setting up a subsidiary in a desired location makes it relatively straightforward to attribute profits and calculate tax liability. 

Where there is no subsidiary, and a permanent establishment of an overseas company has arisen, a complicated accounting exercise is required to attribute profits to that permanent establishment. The ambiguity involved means that there is always a risk that the international enterprise will end up with a higher tax liability than it would have with a subsidiary. 

A permanent establishment is triggered wherever an enterprise has a fixed place of carrying out business in another jurisdiction (though some exceptions do apply).


¹For an in-depth discussion of the development of this concept, both in German law and internationally, see Skaar, Arvid A., (2020). Permanent Establishment: Erosion of a Tax Treaty Principle, Second Edition. Kluwer Law International. 

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