Think it’s Simple to Sidestep Permanent Establishment Risk? Think Again

Erez Greenberg December 22, 2020
Man balancing on high wire

When it comes to understanding permanent establishment laws, there’s no one-size-fits-all approach. In fact, the decisions that you make will vary depending on your own accounting process, your employee strategy, your location, and your overall tolerance to risk.

It’s important to recognize that there isn’t a magic formula for working out exactly when you need to establish a legal entity to satisfy compliance mandates. Instead, get a handle on the considerations involved, and you can make sure that you remain in control.

What Do I Need to Know About Permanent Establishment Risk?

Simply put, if your business has employees in any given country, you’re opening yourself up to tax obligations in that country, even if your headquarters or main office is elsewhere. International tax treaties exist between certain countries, and Permanent Establishment is one element that helps the host country decide how much tax they can claim from the company in the home location.

If a government decides that you are working continuously in their country without the right legal set-up, and that you unlawfully have what’s known as a Permanent Establishment (PE) in that country, you could be liable for unpaid taxes, compliance fines, and added penalties, too.

To understand more about the risk of PE, and the activities that increase this risk, you can see this article regarding permanent establishment risk and how the OECD guidelines determine a ‘fixed place of business’ including added advice on how to work on achieving compliance.

Understanding Why it’s Not All About the Employees

Many legal or tax advisors will tie the risk of Permanent Establishment to how many employees you currently have on your books. They might say that once you have a critical mass of 10 or 15 employees, you’re now risking being non-compliant with permanent establishment laws, even if you’re utilizing an Employer of Record / Global PEO, or even if you’re working with contractors.

However, this is not correct. The decision is usually not about the employees, but rather the finances. After all, you might have 15 employees in a particular country, but they aren’t making any revenue for your company at all. On the flip side, you might have a single lucrative sales employee in that country, who makes millions of dollars for you each year. In both of those situations, your risk level is not associated with a certain number of employees, but with the money that you’re making – your own bottom line, globally.

Of course, you may have other reasons for choosing to incorporate locally in a specific country, and this may well be to do with the cost of managing a certain number of employees from abroad. For example, you might find that you’re using EoR, and for your own internal checks and balances, having more than a certain number of employees working for you through an EoR is no longer viable. However, this is not directly related to permanent establishment risk, and shouldn’t be confused.

In fact, according to recent updates to the OECD model, known as BEPS Actions, in some cases, an agent who employs on your behalf in another country could still constitute a Permanent Establishment for your business, so it’s important to make sure that you’re fully informed.

Getting a Granular View for Your Business with Papaya Global

When it comes to making a decision on the level of Permanent Establishment risk that you’re taking on, there really is no right or wrong answer. For some, EOR works well, and can definitely be a smart route to expanding globally and sidestepping certain compliance risks. For others – it will not reduce risk, or perhaps not enough.

The truth is, when you’re setting up business functions in a new location, you’ll need to complete a thorough analysis on the costs and risks of setting it all up, in comparison with who you are as an organization, and what you’re going to gain. You’ll also want a forecast in place, to understand your volume and growth moving forward, and when the right time is for your business to put down roots.

At Papaya Global, we advise each customer according to their specific business structure, taking into account their revenues in a particular country, the number of employees they manage, and their long-term goals for expansion.

We are the only global payroll company that can manage contractors, EOR relationships, and local incorporation models via a single platform, making us uniquely placed to provide impartial advice on what route is smart for your business. Once you decide what works best for you, we can support you in automating your payroll across multiple geographies with zero errors, and far less manual effort on your part.

Thinking about expanding into a new location, and want to get better informed, so that you don’t make it harder for yourself further down the line? Let’s reduce your risk by putting it all on the table from day one. Schedule a call right here.

Papaya Global payroll platform lets you:

  • Automate payroll with zero processing errors
  • Manage global payroll, PEO & contractors via one platform
  • Make cross-border payments in 140+ countries