The Permanent Establishment (PE) US Tax Implications

The Permanent Establishment (PE) US Tax Implications

When a US Person establishes a Permanent Establishment in a foreign country, they may inadvertently become subject to US taxes  on foreign income — even if the foreign income has not been repatriated to the United States. The key component from a US Tax perspective is whether or not the company is considered a Permanent Establishment or not — and whether or not the country where the Permanent Establishment is has entered into a US Income Tax Treaty with the United States. The latter concept of the tax treaty is very important, because many tax treaties exclude income earned from a foreign business from other contracting state, unless the business is considered a PE (subject to Triangular Treaty and Limitation on Benefits (LOB) Provisions). Let’s review the basics of a PE and the US Tax Implications of ownership.

What is a Permanent Establishment (PE)? 

The IRS has provided a working definition of Permanent Establishment as identified (primarily) in US Tax Treaties, as follows:

• • • In general, U.S. income tax treaties define a U.S. permanent establishment to include a fixed place of business in the United States through which the foreign enterprise carries on its business.

    • However, a foreign enterprise will not be deemed to have a U.S. permanent establishment if its activities in the United States are limited to certain activities — generally those of a preparatory or auxiliary nature. A separate IPS unit covers this exception.

    • A foreign enterprise will also be considered to have a U.S. permanent establishment in respect of activities undertaken on its behalf by a dependent agent who has and habitually exercises in the United States an authority to conclude contracts that are binding on the foreign enterprise.

    • A foreign enterprise will not be deemed to have a permanent establishment in the United States merely because it carries on business in the United States through a broker, general commission agent, or any other agent of an independent status, provided that such person is acting in the ordinary course of his business as an independent agent.

    • A separate unit covers how to determine whether a U.S. permanent establishment is created through the activities of a dependent agent.

Example of Permanent Establishment in Model Treaty

• • • 1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

    • 2. The term “permanent establishment” includes especially:

      • a) a place of management;

      • b) a branch;

      • c) an office;

      • d) a factory;

      • e) a workshop; and

      • f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources. 

    • 3. A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration or exploitation of the sea bed and its subsoil and their natural resources, situated in one of the Contracting States constitutes a permanent establishment only if it lasts, or the activities of the rig or ship lasts, for more than twelve months. For the sole purpose of determining whether the twelve-month period referred to in this paragraph has been exceeded: a) where an enterprise of a Contracting State carries on activities in the other Contracting State at a place that constitutes a building site or construction or installation project and these activities are carried on during periods of time that in the aggregate do not last more than twelve months; and b) connected activities are carried on at the same building site or construction or installation project during different periods of time, each exceeding thirty days, by one or more enterprises that are connected persons with respect to the first-mentioned enterprise, these different periods of time shall be added to the periods of time during which the firstmentioned enterprise has carried on activities at that building site or construction or installation project.

What is Not Considered a Permanent Establishment (Model Treaty)

• • • 4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include:

      • a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;

      • b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;

      • c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

      • d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;

      • e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;

      • f) the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs (a) through (e) of this paragraph, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

Tax Implications of a PE

In general, when a company operates overseas and it is owned by a US Person (Individual or Domestic Corporation), it will qualify as Controlled Foreign Corporation — and subject to taxes such as GILTI, Subpart F and more. The reason why a person does not want to own a Permanent Establishment is not so much the US Tax implications as much as the foreign tax implications — with a Permanent Establishment, the foreign country will tax the income sourced to that country and generated within its borders. Especially if the foreign country has entered into a tax treaty with US and/or may have a higher tax rate than the US — or different licensing fees for Permanent Establishments which do not qualify as taxes that can claim foreign tax credits — it may result in higher taxes and costs for the US owned Permanent Establishment. In general, companies want to avoid being a Permanent Establishment in Treaty Countries to avoid the costs, fees and tax implications when possible.

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