Permanent Establishment when Servicing New Markets

Companies are generally selling their products and services across many international markets. Industrial technology companies rely on international markets since they often need to follow their clients to where the projects exist in the world. From a copper mine high in the Andes to the far reaches of Africa, there is no limit to where a new opportunity may present itself. 

Working in foreign jurisdictions brings some unique challenges and risks. It is important when looking at a new market to have a clear understanding of how to deal with the obligations and liabilities that arise when working in a country where they do not have a legal entity.

Permanent Establishment  

Permanent Establishment (PE) describes a situation in which a company is considered to have an on-going and taxable presence in a foreign country where it is not officially incorporated. The consequence is that companies are often forced to either incorporate a company or form an agency to pay taxes in-country on the revenue they earn there. 

The issue with being deemed a PE is that companies who are just starting to explore a market or have a limited client base may not be ready to incorporate due to the costs of maintaining the entity. These costs can include everything from legal fees for incorporating the company to on-going costs such as accounting and legal representation.

It is important to review the PE requirements for each country since there will be differences depending on the internal tax laws or the double taxation agreements they have in place. 

The standard criteria used in most countries for PE are:

• A fixed place of business, address, bank account or other physical presence.
• Activity by employees in-country that directly relates to revenue creation.
• Providing services in-country for more than 183 days.

Common Situations –  There are two typical situations we see where companies create Permanent Establishment for themselves.

Hiring Sales Staff – Companies will often hire a business development or sales employee disguising it as a consulting service before incorporating a company. Having an employee in-country such as salesperson can lead to PE since their role directly relates to generating revenue.

On-the-Ground Training/Implementations – The second scenario is when companies hire technical staff in-country to provide after sales support. Again, they will often disguise it as a consulting relationship but from a tax perspective many countries will view it as an employment relationship which is sufficient to trigger PE. 

Companies who need to send staff to implement the software/technology or provide training at the start of a new contract can create PE if they are in-country for more than 183 days in any given year. This is cumulative so a few months here and there throughout a one-year period is enough to trigger the PE. This is particularly important since you are now generating revenue in-country so being deemed as a permeant establishment at this stage would have tax consequences

Conclusion

Companies will shy away from having a local entity when first looking at a new market or servicing a new contract since they want to have sufficient traction and revenues before committing to the on-going costs of having a legal entity. It is the typical “chicken or the egg” dilemma. 

While hiring someone as a consultant in the beginning stages can be considered low risk, as the company wins contracts, the risk grows since there are now revenues that can be retrospectively taxed in-country. This is the reason why companies need to really understand how PE works since they will need to develop strategies to deal with the risk. Each market is going to have their own definition of what constitutes Permanent Establishment so legal advice will be needed. 

When looking at a new market, companies need to decide how much risk they are willing to accommodate to enter a market without a legal entity. Often factors such as the type of solution being provided, size of contract, and other considerations will determine whether a physical presence is really needed. 

Once you have a clear answer to these questions, companies can start to evaluate the different options available to minimize the risk of being considered a PE. In some cases, there will be no other option but to incorporate a company. This is particulary true in the cases where clients demand it as part of the contract regardless whether you legally require it or not. 

Ax Legal is an advisory firm that works with foreign companies in Latin America. Our team of legal and commercial advisors have a distinguished track record of helping foreign technology and services companies to grow and operate in Latin America. Over the years, we have worked with starts up, mid-size businesses, and publicly listed companies. The one common factor that connects are clients is that they are leaders in their field, providing innovative technologies and services to the industrial sectors.

To better understand how we can support you in the Region, please contact Cody Mcfarlane at cmm@ax.legal