Permanent Establishment: The Hidden Risk of Working in Latin America

Industrial technology and engineering companies go where the projects are, whether that’s a copper mine in Peru’s southern Andes, a lithium operation in the Atacama or an offshore field in Brazil. Winning that first contract in a new country is exciting. But the way you deliver it, who you send, how long they stay and what they’re authorised to do, can create tax obligations you never planned for.

The concept behind this risk is Permanent Establishment (PE).

What is Permanent Establishment?

A PE is a taxable presence in a country where your company isn’t incorporated. If tax authorities decide you have one, they can tax the profits connected to your local activity, often going back several years, with interest and penalties added.

For a company still testing a market, that’s a serious problem. Setting up and maintaining a local entity means legal, accounting and compliance costs that may not be justified by one or two contracts.

The rules vary by country and depend on local tax law and any double taxation treaty with your home country. The most common triggers are:

• A fixed place of business. This could be an office, a site office or a workshop you use regularly to carry on your business.
• A dependent agent. This is someone in-country who habitually concludes or negotiates contracts on your behalf, even if they’re engaged as a consultant.
• Construction and installation projects. Many treaties treat a building site, installation or supervisory project as a PE once it exceeds a set period. Usually 183 days.
• Services over a day threshold. Many treaties in the region include a “service PE” clause, typically triggered when your personnel spend more than 183 days in the country within any 12-month period.

Where Industrial Companies Get Caught

• The local sales representative. Hiring a business development manager on a consulting agreement is a common first step. If that person negotiates terms and effectively closes deals, tax authorities may treat them as your dependent agent, and therefore triggering PE.  
• Installation, commissioning and training. Your engineers fly in to install equipment, commission a plant or train the client’s operators. Each trip seems short, but the days add up across all your staff and visits. A few months here and there over a year can cross the threshold, and because you’re now earning revenue in the country, the tax exposure is real.
• Local technical support. Engaging a local technician as a “consultant” for after-sales support can trigger both PE and employment risks. In many Latin American countries, labour authorities look at the substance of the relationship. If it looks like employment, you may face severance, social security and other obligations on top of tax.

How to Manage the Risk

There is no single answer. The right approach depends on the type of solution, the contract size and how long you’ll be on the ground. Common strategies include:

• Tracking days in-country for every person across every project
• Limiting local representatives’ authority to negotiate or sign contracts
• Working through an independent distributor or agent
• Structuring contracts to separate offshore supply from onshore services
• Using an employer-of-record arrangement for local staff
• Choosing between a branch and a subsidiary when incorporation becomes necessary

Sometimes incorporation is unavoidable, particularly when a client requires a local entity as a contract condition, whether the law demands it or not.

The Chicken-or-Egg Problem

Most companies don’t want the cost of a local entity until they have enough revenue to justify it, and that’s sensible. But the risk grows with every contract you win, because there’s more revenue that could be taxed retrospectively. The answer is to decide your trigger in advance: a set level of revenue, number of contracts or days on the ground at which you’ll commit to the market and incorporate. That way the decision is made on your timeline, not forced on you by a tax authority or a client.

Ax Legal helps industrial technology, engineering, and service companies to navigate the legal and commercial aspects of operating their business in Latin America. With deep knowledge of the industrial and natural resource sectors, we provide actionable and practical advice to help streamline our clients’ entries into Latin America, improve how they operate in the region, and to protect their interests.

Over the years, our team of legal and commercial advisors have developed a track record of working with companies of all sizes from Australia, Canada, the U.S., and Europe. The one common factor that connects our clients is that they are leaders in their field, providing innovative technologies and services to the industrial sectors.