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Permanent establishment
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A tax permanent establishment is not an independent company, but rather an independent part of a company. A permanent establishment is therefore not founded; it is created automatically when certain criteria defined in tax law or social security law are met.

Table of Contents

The tax significance of the permanent establishment

The permanent establishment is important for tax purposes, especially, but not only, in cross-border situations. The term does not only apply to a company's profit taxes; a distinction is made at the national level between corporation tax, income tax and trade tax.

A business tax establishment is created when offices or manufacturing facilities are set up away from the company headquarters. The same applies to longer-term construction contracts in other municipalities or cities and not least due to the employment of employees in the home office. A company that operates in several cities and municipalities can have several permanent establishments within Germany, with the result that trade taxes are incurred at different levels. A permanent establishment can also be created in isolation with regard to wage tax and social security when employing employees abroad.

Internationally, permanent establishments are important in such a way that, contrary to the national interpretation of the term, the respective double taxation agreements (DTA) contain positive and negative lists and this regulates the distribution of taxation rights among the countries involved. In the course of the OECD's so-called BEPS project, the definition of a permanent establishment was expanded in terms of content, without the slightest change in the DTAs; in one fell swoop, around 1700 agreements underwent serious changes in terms of content.

DBA permanent establishment

One of the criteria by which a DBA business establishment is created has always been the employment, or even just the deployment of an employee in another country if this employee had the skills to conclude contracts. Now it no longer matters whether it is an employee or a freelancer and whether the person in question actually has the competence to conclude contracts. It is sufficient if the company usually concludes contracts based on the activities of the person deployed abroad. It is not important whether the company has a permanent business facility abroad, such as an office. This new perspective aims to prevent artificial avoidance of permanent establishment status.

Company for purchasing goods

In the past, facilities that were built exclusively for the purchase of goods or warehouses were not considered business premises, even if a large number of people were employed there. All the logistics centers located along the highways therefore paid no income taxes. Now every structure that is important to the company is examined to see whether it is purely auxiliary or secondary, or whether purchasing or inventory turnover is not even the main activity of the company. Even a commission warehouse at a foreign customer can qualify as a permanent establishment if it is of sufficient importance to the company.

Machinery and plant engineering

In mechanical and plant engineering, it regularly happens that core components are produced in one country and transported to the place of use in another country. Foundations are made there and the system is assembled, often with additional parts and helpers that were sourced locally. For commissioning, the system usually has to be electrically connected and integrated into the company's ERP system. Finally, the local employees must be trained before acceptance finally takes place. The project can take months or years. Depending on the regulations in the relevant DBA, the deadlines specified there for the creation of a construction or assembly facility may be exceeded. This results in a tax permanent establishment being created in the other country. Even the weather can play a role. Not every interruption to assembly is taken into account when calculating the deadline specified in the DBA.

Construction and assembly facility

If there is a construction and assembly establishment, all employees employed in the country will be personally taxable in this country retroactively from the first day. This can be very problematic if you had planned to finish more quickly and thus avoid setting up a permanent establishment. If it is only decided months later that a permanent establishment will be accepted from the start, you could have problems receiving the wage tax that was not initially withheld and also the social security contributions from the employees. Sometimes they are no longer employed by the company at all.

Then the employer or the client resident in the country also owes the employees' wage tax and social security contributions. In addition, he often owes the sales tax of the company he commissioned. Liability for income taxes usually does not apply. However, the client may be prevented from transferring the final installment abroad. In this way, for example, asserts its claims.

Two states with different interests are regularly involved in answering the question of whether a permanent establishment exists or not. It is therefore advisable to examine the project planning from a tax perspective at an early stage and to clarify the situation with the tax authorities involved in advance.

Distribution of the results

If a company has permanent establishments abroad, the company's uniform results under commercial law are divided for taxation purposes. The allocation of income and costs is based on the facts and therefore regardless of where they were incurred. Because it depends on the economic context. Since the countries involved can have different perspectives, partial double taxation is in the air.

The DTA only sets out the decision criteria as to when there is a permanent establishment and when there is not. When you come to a permanent establishment, the company's results must be distributed appropriately among the countries involved. Since the regulations for determining profits vary greatly from country to country, you cannot simply determine the results of the permanent establishment according to the standard of the parent company. The state in which the permanent establishment is established generally wants to see profits for the entire company determined according to its own standards. This is the only way to make a decision as to whether the assignment made is appropriate.

Company based in China

A German tax office would have a hard time if a Chinese company came along with accounting that was prepared according to Chinese standards and in Chinese characters. The Chinese company, in turn, would find it difficult to prepare the entire Chinese accounting again just because of its permanent establishment in Germany, but this time in German and in accordance with the German standard HGB or German tax law. This problem exists with practically all business establishments in all countries. It is therefore important to ensure in the accounting department that you have cost accounting, for example, preferably in English.

A solution can be supported and found by setting up company accounting in such a way that everyone involved no longer reads the data, but also understands it. Modern ERP systems can be equipped accordingly. In China and Russia, where such systems are not available on the market, we have programmed our own solutions.

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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