In this article we explore some of the principles around creating an international tax presence and common problems on which we frequently advise to enable businesses to manage their tax risk.
A trading company carrying on activities in another territory outside of the UK will often have to consider whether it has any local corporate tax, employment tax or sales tax (VAT) obligations in that new country. We refer to this as creating a taxable presence or 'permanent establishment'.
Determining whether a business has created a tax presence in the new country requires consideration to the facts of the situation and to:
As with all things tax, it is often useful to glean some local insight as to how the legislation and international agreements are actually put into practice by the tax authorities.
To keep things simple, overseas tax authorities operate the same rules and principles and apply these consistently for all taxes… if only that were the case!
Unfortunately, in reality, the rules for when a permanent establishment is created differs by tax, by country and by agreement, so it can be a minefield for businesses to navigate without specialist support.
There are some fairly widely adopted approaches, which we have explored below, but it is imperative that in any foray into a new territory the nuances of each new country are considered against the facts of the particular activities.
Where a permanent establishment (PE) is created, obligations to register for local corporate income taxes, file returns and pay taxes usually follow.
Whilst each country will have its own local rules, many territories adopt the OECD model tax treaty for their agreements. Under the OECD model, a PE can include (but is not limited to):
Certain activities such as storing and displaying goods, and activities of a preparatory or auxiliary nature are frequently excluded from creating a PE where these activities are conducted in isolation.
A dependent agent can also create a PE where they are acting on behalf of the UK company and habitually exercise authority to conclude contracts in the name of the UK company.
In our experience this is commonly where we see most issues arising, as these arrangements are often detected late – perhaps as the authority of an individual evolves over time.
With the moral shift over recent years to ensuring companies that trade internationally do not avoid tax or reduce their tax burden by shifting profits between territories, the OECD has set out a global framework - BEPS (Base Erosion and Profit Shifting) of various preventative actions.
Action 7 focuses on PE’s and sees more countries moving towards considering the substance of a dependent agent scenario and looking more closely at where contracts are materially negotiated rather than where they are concluded.
We therefore expect to see an increase in overseas permanent establishments being created, as more oversees tax authorities challenge the position, and seek to get their slice of the global tax cake.
There are many different VAT systems around the globe and it is an increasingly popular source of taxation for governments. Whilst the individual rules of each country need to be considered, there are often consistent themes which apply across territories. This is particularly the case for the EU Member States where there is a common set of rules arising from the EU VAT Directive and EU Regulations, albeit that local differences in interpretation still arise.
To determine where supplies might be subject to VAT, the specifics of each supply must be considered. This will include understanding:
The VAT law refers to the concepts of ‘business establishment’ and ‘fixed establishment’ when considering ‘where’ the supplier and customer are located. These terms are different to the corporate tax concept of Permanent Establishment.
A ‘business establishment’ is the principal place of business. It is usually the head office or ‘seat’ from which the business is run. There can only be one business establishment.
A business though can have multiple ‘fixed establishments’. Fixed establishment is not defined in the primary law so case-law has provided definitions; a fixed establishment has both the technical and human resources necessary for providing or receiving services on a permanent basis. Whilst this appears straightforward whether or not a fixed establishment has been created is regularly a subject of dispute with tax authorities and local interpretations of the same facts can vary.
In considering the 'where' questions noted above, it is necessary to consider where the supplier and customer are located i.e. where they have business or fixed establishments. Where either has more than one establishment it is necessary to consider which establishment is actually making/ receiving the service; this is normally the one that is most directly connected with the supply. This is also a subjective test and open to alternative interpretation or minor differences in the factual position resulting in a change to the position. For this reason, businesses are encouraged to document their conclusions as to why they consider they are or are not VAT established in a particular country and whether or not that establishment is making or receiving the supplies in question.
Over recent years there has been a shift towards more informal and fluid employee mobility. This increases the risk of a taxable presence being created from an employment taxes perspective. As wherever an employee conducts their duties within another country this could potentially lead to a permanent establishment risk arising.
Where an employee conducts their duties overseas (unless they are on a formal secondment/assignment and providing their duties wholly for the host entity only), their will commonly be obligations for the UK employer to register for and withhold employment taxes and social security in the overseas country. In addition, they may also continue to have obligations in relation to the employee in the UK.
In theory, any kind of employee mobility scenario can give rise to a taxable presence risk in the overseas country. In particular, the following types of arrangements may require attention:
In some instances, international treaty agreements might override the local country requirements, but commonly this requires some compliance action by the employer enabling them to get relief under the international agreement. Relief is rarely given automatically.
Consideration should therefore be given to the risk of creating a foreign taxable presence whenever employees are moving to another country or are globally mobile. Issues to consider should include:
Employees may also have to register for taxes and social security personally in the overseas territory and ensure that they have appropriate permits or visas to legally be able to work in that territory.
Not dealing with employees correctly at the outset can frequently lead to unexpected costs, significant management time and effort in resolving the situation and potentially reputational risk both with employees and commercially.
Companies operating in another territory or trading cross-border need to have an awareness of the risks of non-compliance with local tax requirements.
It is important that the finance team within any company ensure that their wider business teams – especially commercial and sales team are alert to the potential for creating a taxable presence. Particularly, as treaty benefits typically need to be applied for in advance and are not automatic.
In many territories there is also no de-minimus level of activities that triggers a taxable presence and the repercussions for failing to register, file or pay can be serious – these commonly include fines and penalties but can extend to reputational damage, prosecution and being prohibited from operating in the territory.
In our experience, managing a business’s taxable presence, tax risk and overseas set up successfully is a bit like completing a jigsaw.
To be able to complete the jigsaw efficiently you need to:
It is not uncommon for finance teams to find out about the overseas arrangements after they have been put into place and so are left to pick up the pieces in scenarios where, had the tax requirements been known up front, the structuring could have been improved or might have been considered commercially unviable.
International activities are also a key focus of due diligence questions during a company sale process and any issues identified at this stage will likely have a detrimental impact on the sale price for the shareholders.
Expansion overseas has many rewards and benefits for those businesses that undertake it successfully. These can include:
However, having a high level understanding of what may create a taxable presence is a must!
With proactive management and planning it is possible to ensure that there are ‘no surprises’ in relation to tax presences or permanent establishments being created.
If the intention is to create a permanent establishment, it is recommended that the business is on the front foot, so that you understand the compliance requirements, can management them appropriately and thereby reduce management time and costs by not having to rectify the situation afterwards.
Navigating the requirements of different countries within the EU and for different activities requires specialist knowledge and an understanding of the latest changes.
Our specialists are passionate about helping businesses grow both within the UK and internationally, by working with our colleagues in the international Crowe Global network, we are able proactively support businesses with their international expansion strategy.