Canada — 10 min
Tax and Compliance — 17 min
While the remote workforce offers many benefits — such as an international team and access to the best talent worldwide — building globally also comes with certain risks. Among those risks is permanent establishment, a tax status that affects certain companies when they hire abroad.
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 ok — we don’t have a site in another country, just remote employees,” then think again. In some countries, having remote employees working for you in specific locations — even home offices – can trigger permanent establishment. So can certain business activities, like sales. And while managing permanent establishment risk in one country is feasible, when you’re scaling a team in several countries, things can get complicated if you don’t have help.
This article will help you better understand permanent establishment risk: what it is, how to manage it, and how it applies to your remote workforce. Before we get started, however, it’s important to know exactly what permanent establishment is.
Permanent establishment is a tax term for businesses that have an ongoing presence in a country. If your company is established enough in a country, you might be subjected to corporate taxes as if you were a local taxpayer in the country as well as the taxes you’re paying in your own country.
There are four general types of permanent establishment risk:
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.
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. But since technology has made it possible to hire and onboard internationally, that’s changed.
Because remote teams often work from home, in some countries, simply having employees with home offices may be enough to imply you have a permanent place of business in that country. That said, recent case law has added new complexities to the issue, so simply 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 taxes 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. Nonetheless, note that this risk depends entirely on the activities actually carried out in each country, and the activities considered vary from country to country.
How do you know when you’re in danger of taking on permanent establishment risk with remote workers? There are a few indicators that can help you gauge your company’s risk:
The easiest test of whether you face permanent establishment risk with your remote workforce is whether you have a fixed place of business. This traditionally means a job site like an office, branch, factory, or workshop (subject to a number of specific activity exemptions). But 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), for example, reported in 2020 that employees working from home due to the pandemic should not create new permanent establishment risk for their employers. However, the OECD clarified that long term use of home offices to carry out an employer’s work could in fact trigger permanent establishment risk.
This gets more confusing because, while many countries do follow the OECD recommendations for tax treaties, each country interprets the guidelines in its own way.
Sales is another major way to trigger permanent establishment risk, but this can also get confusing, as 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 or who is closing deals (or even facilitating the dealings that lead to that closing!), that may well trigger a permanent establishment.
If you’re working with an agent that habitually works for you – making 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.
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 long period of time (months or years, depending on the country) their physical presence in another country might create a tax risk for your company.
Before you send employees out into the world, be sure you’ve checked the laws in the countries to which they will travel.
Where should your organization be registered as a local taxpayer and pay corporate tax? In general, you should be paying tax wherever your company is a fiscal resident, which is likely to be where it was incorporated (that’s where your company is domiciled). 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.
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. In these cases, the company is a resident (and likely to be taxed) in both countries.
If you’re reading this article, getting taxed twice is likely something you’re trying to avoid. However, it’s important to understand dual residence issues, particularly in light of the pandemic. 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. Such cases of dual residence are rare, but it’s critical to be aware of any rules that may create this issue for your company.
Sometimes, your organization is protected against double taxation by a treaty. Double taxation avoidance treaties are agreements between two countries which are designed to promote bilateral international commerce and 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 overtaxation 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.
Contractors aren’t employees, so 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.
That said, 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 in reality they’re working solely for your organization, you dictate their schedule, and you otherwise treat them like an employee, that can put you at a whole different kind of risk. Why? Because you may have misclassified your contractors as employees, which can lead to a whole host of issues. To avoid issues of misclassification, you may want to consider converting contractors to employees.
Misclassifying employees as contractors is a serious offense with serious consequences, but it remains a common practice, accidental or otherwise. In the United States alone, according to some estimates, nearly 10% of workers are misclassified and 10-20% of businesses have misclassified an employee. That can be a danger to your business. If you misclassify an employee as a contractor you can be subject to fines, penalties, and business bans under various local laws, as well as legal disputes with 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:
Family and medical leave
Social security or pensions
Safe workplace protections
However, contractors may be provided certain benefits and protections as well. In some countries, companies are required to pay contractors a minimum wage, for example. Relationships with contractors may change over time, so companies should create regular review processes to determine whether any contractor relationships have turned into employee relationships.
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 of 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.
5. You want more protections for your company’s intellectual property.
6. You could save money by paying the contractor as an employee.
7. In some countries, contractors must become employees after a certain period of time.
8. Your competition might want to hire your contractor.
9. 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.
An EOR, or employer of record, 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.
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 Remote-owned entities all around the world. Based on that work, 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 you would need to hire to set up the organization) can easily run higher 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.
Employers of record and professional employer organizations, or PEOs, both help you manage your international workers in different ways. An EOR hires employees on your behalf, while a PEO co-employs workers with you.
A professional employer organization is an agency that functions as an outsourced human resources department. PEOs might handle payroll, benefits management, requests for time off, compliance, and taxes. PEOs are helpful if you already own an entity in the country in question. When you work with a PEO, you and the PEO co-employ your workers in the country.
If you’re hiring internationally and you don’t have a legal entity in the country you’re hiring in, you must work with an EOR. If you do have an entity and want to enter into a co-employment relationship with a PEO 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.
An employer of record 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 where your risk exposure may lie, understand which risks may be material, and develop a strategy to manage that risk, either by avoiding permanent establishment risk or by managing the level of profit attributable to your permanent establishment.
Remote is an employer of record — we help your company employ workers in other countries where you do not own a local legal entity. We also offer global contractor payment and management, integrated seamlessly into our platform. We only offer employer of record services in countries where we own legal entities to provide 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. To see where Remote offers employer of record services today, visit our Country Explorer. Here you can see our covered countries and learn more about employment laws and taxes all around the world.
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. But don’t let that stop you — access to an international workforce is a powerful driver of growth!
Permanent establishment risk deserves your consideration, but you can manage your risk by working with a trusted partner with expertise in local tax laws. Get started now by talking with a trusted EOR that can help you make the most of your remote workforce.
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