Permanent Establishment Risk

Posted on 17 April 2015

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When one draft, review or negotiate for an international trade contract, as or for seller (or exporter), it is essential to have fundamental knowledge on local taxation, to minimize the risk of ‘permanent establishment’ (PE).

In brief, when the seller is carrying on the business at another country, the latter tax regime may view the seller as PE, thus has the right to tax on the profit earns.

Unless there is a ‘Double Taxation Agreement’ (DTA), between the seller’s residing country and the trading country, which the agreement may grants the relief.

The definition

The definition of a PE, is varied among the countries, and subjected to the DTAs between the countries of the contract parties.

In general, a foreign enterprise of a contracting state would be deemed to have a PE in the other contracting state, if it carries on supervisory activities in that other state for more than six months, in connection with a construction, installation or assembly project in that other contracting state.

E.g. if a machinery manufacturer, entering a cross border sales with the customer in Country A, and provided after-sales on-site maintenance service for a period not less than six  month, then the manufacturer will have PE risk and the revenue is subjected to the local tax.

Therefore, the foreign enterprise may subcontracts the maintenance service to an independent agent or commission broker, to avoid its PE risk.

The tax rate

Eventually, if the foreign enterprise is found to have PE in any country, the income or gain arising would be assessed as business profit, and subject to the income tax rate or corporate tax rate.

In addition, it may lead the tax regime to collect Goods and Service Tax (GST) or Value Added Tax (VAT) on the customer.

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