Article
What is a permanent establishment?
Jan. 7, 2019
And the risks of doing business globally under the TCJA and BEPS
Both the Tax Cuts and Jobs Act (TCJA) and base erosion and profit shifting (BEPS) has multinationals assessing the taxability of their global profits. The Organization for Economic Cooperation and Development (OECD) made it clear: Taxing jurisdictions will look to the potential expansion of permanent establishment (PE) rules under Action 7, “Preventing the artificial avoidance of permanent establishment status,” to bolster tax revenue in their countries. Additionally, new U.S. international tax rules under the TCJA are consistent with the OECD’s recommendations under BEPS (e.g., hybrid disallowance rules, anti-deferral of controlled foreign corporation income and the new interest expense limitation) and will require companies to evaluate the risks in doing business abroad. This article addresses some of the risks of doing business offshore and being classified as a permanent establishment.
US multinational corporations doing business in foreign countries (and foreign based multinational corporations doing business inside the US or foreign countries other than their own) are typically subject to the domestic tax laws of the countries where they engaged in business activities. However, if the corporation’s home country has entered into a tax treaty with the target country, the treaty will typically provide a higher threshold for taxation than the domestic tax laws applicable in the target country. That higher threshold is commonly referred to as a permanent establishment (PE). Following is a brief discussion of the rules that govern the determination of PE under generic treaty language.
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Permanent establishment
As mentioned above, where a corporation’s home country has entered into a tax treaty with a target country, the business operations of the home country corporation are protected from target country taxation as long as those activities do not create a PE in the target country. Typically, a tax treaty defines a PE using the following two general tests: