The ABCs of Permanent Establishments: What You Need to Know

Definition and Types of Permanent Establishments

Unlike US domestic tax laws, which do not typically adopt the permanent establishment concept for foreign taxpayer taxation, US income tax treaties incorporate this notion extensively. A "permanent establishment" typically refers to a fixed place of business in a target country (other than the company's home country) with a taxable presence where the taxpayer conducts business activities wholly or partly.

Fixed place of business

A place of business becomes a permanent establishment if it is in a physically fixed location, establishing a connection with a specific geographic point. This premise, facility, or installation must be used for the taxpayer’s business activities and be permanent rather than temporary, evaluated subjectively (intention) or objectively (duration and nature of activities). Fixed places of business typically include:

• places of management;
• branches;
• offices;
• factories;
• workshops;
• natural resource extraction sites (e.g. mines, oil or gas wells, quarries, etc.); and
• building sites, a construction or installation project, or installation or drilling rigs or ships used for the exploration of natural resources (but only if it lasts, or the activity continues, longer than a specified period of time, i.e. 120 days, 6 months, 183 days, 9 months, 12 months or 36 months, depending on the treaty).

IRS rulings typically conclude that activities lasting less than 1 year do not constitute a permanent establishment. Conversely, engagements extending beyond this period are likely considered permanent establishments.

Construction permanent establishments

For construction and project-based businesses, a "time test" determines whether the business creates permanent establishment status, applying on a site-by-site basis. This means that a contractor's time spent on unrelated sites does not contribute to the time test of a specific project site. A building site or project that forms a coherent whole, both commercially and geographically, is treated as a single unit.

The specified period of time triggering a permanent establishment begins when the contractor initiates work (including preparatory activities) and ends upon completion or permanent abandonment, with seasonal or temporary interruptions included in the duration.

Excluded activities

Not all business activities lead to the creation of a permanent establishment. The term “permanent establishment” generally does not include activities such as:

• using facilities solely for storing, displaying, or delivering goods;
• maintaining stock solely for storage, display, delivery, or processing by another company;
• maintaining a fixed place of business solely for purchasing goods or collecting information; or
• conducting any other preparatory or auxiliary activities do not constitute a permanent establishment if they are the enterprise's sole function.

Note: The IRS affirms that each of the US bilateral tax treaties with foreign countries can be different in its meaning of the term “permanent establishment.”

Dependent agent permanent establishments

A foreign enterprise has a permanent establishment in the United States if a dependent agent:

• acts on behalf of that enterprise; and
• has, and habitually exercises, in the United States an authority to conclude contracts in the name of the enterprise.

Most income tax treaties signed by the United States exclude this principle (so that a permanent establishment is not created) from the conduct of business through an independent agent as well as the use of a dependent agent for certain limited or preparatory or auxiliary activities.

Subsidiaries: Can They Be Permanent Establishments of Parent Corporations?

The ownership or control relationship between companies across countries does not influence the determination of a permanent establishment in either country. Whether a permanent establishment exists relies solely on defined factors, not on inter-company relationships. The conditions under which a subsidiary's activities result in a permanent establishment for the parent company are complex and subject to ongoing debate and review.

IRS Guidance Programs for Permanent Establishment Status

The IRS ordinarily will not advise on tax implications in the form of a private letter ruling (PLR) with regard to whether the taxpayer has a permanent establishment in the US for purposes of any United States treaty and whether business income is attributable to a permanent establishment in the United States.

However, a taxpayer can seek a pre-filing agreement (PFA) with the IRS so that the IRS examines whether the taxpayer has a permanent establishment under the relevant treaty – and what income is attributable to the US presence – before the taxpayer files the applicable tax return. The user fee is USD 218,600 for requests submitted beginning in 2017.

Foreign Permanent Establishments of US Taxpayers

Because the United States taxes US persons on worldwide income, the determination of whether a US person’s foreign activities constitute a permanent establishment in the foreign country is not relevant to the calculation of that person’s US tax liability. Where or not a US person has a permanent establishment in the foreign country may be relevant in calculating the US person’s foreign tax liability.

To minimize double taxation, the United States allows US persons to either deduct or credit certain foreign taxes in determining their US tax liability. In some cases, the US government may try to limit the amount of foreign tax paid by a US person by initiating a competent authority proceeding challenging a foreign tax authorities' determination that the US person has a permanent establishment. A competent authority proceeding is a meeting between two governments to negotiate the application of a treaty to certain residents of the treaty country (contracting state).

Developments to Watch

In South Dakota v. Wayfair (21 June 2018), the US Supreme Court addressed the ability of US states to require online sellers to collect state sales tax despite having no physical presence in that state. The Supreme Court determined that the required “taxable nexus” did not require physical presence by the online businesses in the taxing state. Although this decision only concerns US state sales tax collections, commentators have recognized that the Supreme Court’s reasoning may have implications for international issues of permanent establishments, particularly in the context of the digital economy.

Additionally, business trends that may have impact on the determination of permanent establishments in the future include working from remote locations and the rise of social media influencers who collaborate their business internationally with non-resident enterprises as their influences expand globally.

Explore Our Tax Research Platform for More Information

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