Permanent establishment risks for a remote workforce

A remote workforce offers employers many benefits, including an international team, access to the best talent, and the opportunity to expand your business worldwide.

However, building globally also comes with certain risks. 

Among those risks is permanent establishment, a tax status that affects certain companies when they hire abroad.

Businesses that are planning to expand into other countries need to understand what permanent establishment is and how it can affect their bottom line.

This article addresses permanent establishment risk. We’ll go over what it is, how to manage it, the consequences, and how it applies to your remote workforce. 

Before we get started on the risks, let’s look at exactly what permanent establishment is.

What is permanent establishment?

Permanent establishment is a tax term for businesses that have an ongoing presence in a country.

Permanent establishment means your company is established enough in another country to indicate to the government that the company may be liable for taxes there. 

If you’re thinking, “We’re okay. We don’t have a site in another country, just remote employees,” you’ll need to think again. 

Not having a brick-and-mortar building isn’t enough to avoid permanent establishment.

There are four types of permanent establishment to consider:

• Fixed place of business permanent establishment: Having offices or any other physical places of business in a foreign country or jurisdiction.

• Agency permanent establishment: Hiring a dependent agent to conduct revenue-generating sales activities abroad.

• Service permanent establishment: Providing ongoing services in another country or jurisdiction, even without a physical place of work.

• Construction permanent establishment: Having a construction site or installation project in a country or jurisdiction for a specified period of time.

What is permanent establishment risk?

Permanent establishment risk occurs when a country determines that a business falls into one of the four permanent establishment types. When stable companies with a consistent presence generate sufficient revenue in another country, they are generally at risk of permanent establishment.

The considerations for permanent establishment vary from country to country. 

If your company is determined to be sufficiently established in a country, you might be subjected to corporate taxes as if you were a local taxpayer. This is in addition to the taxes you’re paying in your own country.

While you need to know the four types of permanent establishment, you must also be aware of the specific actions that put your business at risk.

What are the types of permanent establishment risks?

Each country has rules and regulations for permanent establishment. Not understanding these nuances is often what leads businesses into trouble. For example, you may provide consistent services in another country and establish your business there without realizing it.

Businesses with a remote workforce are at particular risk. For some countries, a home office is considered a fixed place of business, and the revenue is subject to taxation.

Managing permanent establishment risk in one country might sound feasible. However, when scaling a team in several countries, things can get complicated if you don’t have help.

That’s where Remote’s global expansion platform comes in. Remote has established entities in countries across the globe. Our knowledge and expertise will help you expand successfully without worrying about the following risks:

Tax and tax regulation liabilities

Not paying taxes to a country that considers your business established is your first risk. This typically occurs when a company expands into a new country and doesn’t know the local regulations. 

Your business is then liable for any back taxes and interest owed. Fines, penalties, and increased audits are other common consequences.

Associated employer liabilities

Businesses are responsible for adhering to local tax, labor, and employment laws for each country they expand to.

Failing to follow these regulations increases the likelihood of hefty fines and penalties. The business may also need to pay back benefits, wages, and taxes.

Damage to your company brand

Businesses that don’t follow local rules and regulations will develop a poor reputation over time. Countries will refuse to work with chronically non-compliant businesses. 

Impact on employees

Another permanent establishment risk is the negative impact not following the rules can have on your employees. If payroll is mismanaged, your employees may decide your business is not worth the hassle and opt to go elsewhere.

Employee immigration may also become restricted.

Now that you know the types of permanent establishment risks, let’s examine why these risks are higher for a remote workforce.

Why is permanent establishment risk higher for teams with remote workers?

Permanent establishment risk wasn’t a huge problem when most workers were on-site. 

Even if those employees lived on the other side of a country’s border, they’d probably still commute to work at your office. Since technology has made it possible to hire and onboard internationally, that’s changed as more and more work from home.

In some countries, simply having employees with home offices may be enough to imply you have a permanent place of business. Recent case law has added complexity to the issue, so having employees with home offices may not be sufficient to create permanent establishment risk in most cases.

Still, any team with a remote worker in another country runs the risk of having a permanent establishment in that country. Depending on the laws in the country where that team member works, your organization may qualify as a permanent establishment and be taxed accordingly. 

Your risk is likely to be higher for every new remote employee in another country your team hires.

Dealing with this kind of risk at scale can be challenging. Every country’s laws about permanent establishment differ, so the accommodations you make for one employee may not work for another. This risk depends entirely on the activities actually carried out in each country, and the activities considered vary from country to country.

Key considerations that determine permanent establishment risk with remote workers

How do you know when you’re in danger of taking on permanent establishment risk with remote workers? 

Here are a few indicators.

Home office or fixed place of business

The easiest test of a permanent establishment risk with your remote workforce is whether you have a fixed place of business. 

“Fixed” traditionally means a job site like an office, branch, factory, or workshop, although this is subject to a number of specific activity exemptions.

In the age of remote work and home office, the definition of “fixed place of business” can get muddy.

The Organization for Economic Cooperation and Development (OECD) clarified that employees temporarily working from home, such as during the pandemic, should not create new permanent establishment risks for their employers. Long-term use of home offices to carry out an employer’s work, however, could trigger permanent establishment risk.

This gets more confusing.

While many countries do follow the OECD recommendations for tax treaties, each country interprets the guidelines in its own way.

Sales and lead generation activities

Sales is another way to trigger permanent establishment risk, but not every sales activity will trigger permanent establishment. 

For example, lead generation work may not qualify as “sales” in some countries. However, if you have someone in a country who is engaged in direct sales, closing deals, or facilitating dealings leading to closing, that may well trigger a permanent establishment.

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Agency permanent establishment

If you’re working with an agent that habitually works for you, including sales, decisions, and deals for your organization in another country, that can create a permanent establishment in some countries. 

Generally, this is triggered by sales activities or revenue creation of some kind.

Managing relocations to avoid permanent establishment risk

If your business sends employees on long- or short-term assignments that cause those employees to relocate briefly, this may also trigger permanent establishment risk.

If your employee does business on your behalf for a set period of time, their physical presence in another country might create a tax risk for your company. Depending on the country, this could be measured in months or years.

Before you send employees out into the world, be sure you’ve checked the laws in the countries to which they will travel.

Why take the risk? 

Remote’s Global HR platform has established employers of record (EORs) in countries around the world. They manage the complexities of hiring a global workforce while keeping your business in full compliance with local rules and regulations.

Determining corporate tax residency

Where should your organization be registered as a local taxpayer and pay corporate taxes? 

In general, you should be paying taxes wherever your company is a fiscal resident. This is likely to be where it was incorporated. 

There is a bit more to it than that, though.

If your headquarters or principal place of business is someplace else, that state or country may also be your organization’s domicile or place of residence.

 For example, in the U.S., Delaware is a popular state to incorporate a business because of its business-friendly laws. However, most of the companies that incorporate there are headquartered in other states. These companies have two domiciles.

Corporate tax residency is distinct from dual residence.

Dual residence considerations

Dual residence occurs when a company satisfies residence requirements in more than one country. For example, a company might be controlled and managed in the United Kingdom but was incorporated in the U.S. This company is a resident in both countries and likely to be taxed by both, too.

The OECD has issued guidance on tax residence issues that might be triggered by remote work. For example, if members of a board are stranded in a country and conducting meetings virtually, this could potentially trigger dual residence. 

While these cases of dual residence are rare, it’s critical to know the rules that may create this issue for your company.

Double tax treaties and agreements

Sometimes, your organization is protected against double taxation by a treaty. 

Double taxation avoidance treaties are agreements between two countries designed to promote bilateral international commerce. These treaties tend to reduce or eliminate the risk of double taxation, where the same income is taxable in both countries.

While these treaties work to your benefit, they’re usually created with the good of the countries in mind. Such treaties are drawn up when two countries want to make sure their own business interests are being protected against over-taxation abroad or when they want to promote trade. 

The treaty language may vary depending on the countries involved, so companies navigating these treaties should approach each instance on a country-by-country basis.

Now that you’ve reviewed the risks and considerations for your remote workforce, read on to see how you can avoid permanent establishment risk.

How to avoid permanent establishment risk

Businesses can avoid permanent establishment risk by utilizing local support and deciding how to manage their operations internationally.

Local tax specialist support

Start by locating a tax specialist familiar with the country and region in which you plan to do business. Use their expertise to help you familiarize yourself with local tax, labor, and employment rules and regulations.

Legal entities

Establishing a legal entity is one way to conduct business without risking permanent establishment. Legal entities, however, are costly and time-consuming.

Legal entities are typically created by large-scale businesses and corporations with deep pockets and plans for a long-term commitment.

Professional employer organizations

A professional employer organization (PEO) is another option for businesses looking to expand. A PEO functions as an outsourced human resources department. PEOs might handle payroll, benefits management, requests for time off, compliance, and taxes. 

PEOs are only an option if you already own an entity in the country. When you work with a PEO, you and the PEO co-employ your workers in the country.

If you have an entity and want to enter into a co-employment relationship to manage certain HR functions for your team, a PEO may be the right option. See our guide to the differences between EORs and PEOs for more information.

EOR

If you want to expand but don’t want to establish a legal entity, you can look into hiring an EOR.

An EOR is a business that owns a legal entity in the country where you wish to employ a job candidate. EORs employ workers on behalf of client companies, taking on the burden of local legal requirements to ensure the client company can employ workers in the area. 

Working with an EOR saves you the time and costs involved in establishing a legal entity with each country of interest.

How remote contractor relationships can impact PE risk

Contractors are distinct from employees when it comes to wages, benefits, and management. 

You may think you’re safe from permanent establishment risk if you’re working with contractors in other countries. 

However, using international contractors can still expose your company to permanent establishment risk in certain cases.

It depends on what the contractors are doing for your company. If they’re making sales for you, especially if they’re closing deals, you’re at risk of having a permanent establishment.

If a worker is classified as a contractor, but you treat them like an employee, that puts you at a whole different kind of risk.

Risks of misclassifying employees as independent contractors

Misclassifying employees as contractors is a serious offense with serious consequences. Unfortunately, it remains a common practice, accidental or otherwise. 

Misclassification has severe consequences for employees. For example, a construction worker employee misclassified as a contractor lost about $16,269 per year.

MIsclassification negatively affects businesses too. If you misclassify an employee as a contractor, your business can be subject to fines, penalties, and business bans under various local laws. You may also face disputes and dissatisfaction from your employees.

What’s the difference between employees and contractors? The short answer is that employees are entitled to more benefits and protections than contractors. Depending on the country, these benefits may include:

• Minimum wage

• Overtime pay

• Vacation

• Family and medical leave

• Social Security or pensions

• Unemployment benefits

• Health insurance

• Safe workplace protections

• Termination protections

Contractors may be provided certain benefits and protections as well. In some countries, companies are required to pay contractors a minimum wage. 

Relationships with contractors may change over time. Companies should create regular review processes to determine whether any contractor relationships have turned into employee relationships.

How do I convert an independent contractor to an employee?

If you have incorrectly classified an employee as an independent contractor, don’t panic. You can easily convert employees to contractors using an EOR service like Remote.

Even if you have not made an error in classification, you may still want to convert a contractor to an employee in certain circumstances:

1. You may be out of compliance with local laws in the contractor’s home country.

2. You want your contractor as a permanent and exclusive member of your team.

3. You want to offer benefits to keep the contractor happy.

4. You want more protections for your company’s intellectual property.

5. You could save money by paying the contractor as an employee.

6. In some countries, contractors must become employees after a certain period of time.

7. Your competition might want to hire your contractor.

8. Your contractor may want to become an employee.

Converting a contractor can be tricky, especially if you’re converting more than one contractor in multiple countries. Remote handles international contractors as well as employees, allowing you to convert quickly and compliantly.

Why an EOR is a better option than building your own entities 

Why not set up your own entity in the country where you’re considering hiring? 

Two reasons: time and money.

Remote’s international expansion team has worked to create legal entities all around the world. Our experiences tell us it can take between 3-5 months to go through the full incorporation process in countries with the most favorable legislation. In more complex countries, incorporating can take up to a year or more.

It’s not just incorporation that takes time and resources, though. 

Each business entity you create needs constant support. You need to run the business, set up accounts, work with lawyers, and monitor regulatory changes in the country where you now own an entity. The total costs, not including the cost of personnel needed to set up the organization, can easily run more than $100,000 for the first year.

That said, it may make sense to open your own entity in a few situations. For example, if you plan to open a large office in a country with lots of employees so you can fully expand into that country’s market, the startup costs will likely be worth the investment. 

In these situations, you can use an EOR to hire employees on your behalf while you set up your entity, then transition those employees from the EOR to your entity once you finish creating it.

Should you consider an EOR or a PEO to manage permanent establishment risk?

EORs and PEOs help manage your international workers in different ways. An EOR hires employees on your behalf, while a PEO co-employs workers with you.

Why an EOR helps you minimize permanent establishment risk

An EOR allows you to hire employees in other countries, but working with an EOR does not eliminate permanent establishment risk altogether.

For the sake of compliance, the EOR is the employer. 

The primary benefit of an EOR is the local knowledge and expertise the EOR brings to allow you to hire compliantly in new countries. 

To manage permanent establishment risk, work with your EOR to understand the following:

• Where your risk exposure may lie

• Which risks may be material

Work together to develop a strategy to avoid permanent establishment risk or manage the level of profit attributable to your permanent establishment.

Global Payroll —

2 min

[Webinar Recording] Permanent establishment risk: Debunking the myths

In this permanent establishment webinar and insightful Q&A, we lay out the foundations of permanent establishment and how to mitigate the risks if you are building a global team. 

How Remote can help you manage permanent establishment risk

Remote is an EOR, allowing your company to employ workers in other countries where you do not own a local legal entity. 

Remote also offers global contractor payment and management, integrated seamlessly into our platform. We only offer EOR services in countries where we own legal entities. Remote provides you and your team with the best experience at the best price.

While working with an EOR does not eliminate your permanent establishment risk, our experts at Remote are at the forefront of international tax laws and can help your company navigate potential risk factors. 

Check out the Country Explorer to review the covered countries and learn more about employment laws and taxes around the world. You can also find out how to manage international payroll processing with ease with our Payroll Processing Guide. 

Manage permanent establishment risk and grow globally

Permanent establishment can be intimidating if you’re just getting started with a remote global workforce or if you’re beginning to scale your remote team. 

You may not know yet what will trigger permanent establishment in your employees’ home countries, and you might be worried about running afoul of tax laws. 

Don’t let that stop you.

Access to an international workforce is a powerful driver of growth.

While permanent establishment risk deserves your consideration, you can manage your risk by working with a trusted partner.

Remote offers expertise in local tax laws to help you mitigate your risk and stay compliant as you expand globally.

Get started today with Remote’s trusted EOR to help you make the most of your remote workforce.

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