If you have a permanent establishment or representative abroad, there are changes that may affect you!
If you conduct business activities abroad you may be required to pay tax abroad. In short, this applies if you have a permanent establishment or representative in another country, or if an employee works abroad more than 183 days a year.
The 183-day rule is widely known, but the less well-known permanent establishment and representative rules are at least as relevant. Below I discuss changes now underway that may have considerable consequences.
In recent years there has been much controversy regarding companies that use tax structures to avoid paying tax. Starbucks and Apple are notable examples, but consider the Panama Papers and, more recently, the Bahamas Leaks as well. The OECD has decided to do something about this and has proposed 15 actions (referred to as BEPS actions because they address Base Erosion and Profit Shifting) to curb international tax avoidance. Article 7 targets avoidance of permanent establishment and representative status, and tightens the criteria so that more arrangements will fall within these categories! This means that your company is more likely to have a foreign tax liability.
The consequences are considerable: the presence of a permanent establishment or permanent representative in another country mean liability for payroll tax, sales tax, income tax and/or partnership tax in that country. So it is important to be aware of the possible tax consequences of the new legislation. These measures are designed to prevent tax avoidance, but, in practice, many unsuspecting companies that have nothing to do with tax structures will find that they now have foreign tax liability.
Any place of business that is sufficiently equipped to operate as an independent company will qualify as a permanent establishment. A broad interpretation of this concept would include a hotel room or a personal residence.
Most of the Netherlands’ tax treaties with other countries list a number of exceptions. For example, warehouses used purely for storage are not currently treated as a permanent establishment.
The proposed redefinition of the concept of permanent establishment will mean that more arrangements qualify as a permanent establishment. From now on, preparatory or auxiliary activities may be considered to constitute a permanent establishment and, as such, incur foreign tax liability.
Building, construction and assembly activities carried out over a period of 12 months or more will also qualify as a permanent establishment. Companies are known to employ the practice of ‘contract splitting’ or ‘activity fragmentation’ to evade this 12-month rule. They also negotiate contracts lasting less than a year so as not to exceed the 12-month period. A treaty abuse test has been proposed to address this problem. It will be more difficult to avoid permanent establishment status through artificial fragmentation of business activities. A permanent establishment will also be considered to exist if a business activity qualifies as a permanent establishment in conjunction with activities conducted by closely associated taxable entities.
At the moment, a company is not considered to have a permanent representative in another country (for tax purposes) if contracts negotiated by the representative are not concluded by the representative but by an authorised director at the head office.
A significant change in approach has been proposed in this regard. The redefinition of the concept of permanent representative will include a consideration of the importance of the role played by the representative in the negotiation of a contract, even if the representative does not conclude the contract.
In the future, a Dutch company that employs a sales manager who works in Germany, visits potential clients in Germany and converts them into actual clients and who sign contracts for the purchase of products produced by the company, will be considered to have a permanent establishment in Germany, which will create a tax liability in Germany.
This raises the question of how to calculate the profit attributable to a foreign business activity, which is something that will need to be discussed with the Dutch and/or foreign tax authorities.
The measures proposed by OECD stipulated that all countries were expected to amend their tax treaties in light of the new definition in 2016. The Dutch government stated its intention to implement the changes without delay.
What’s more, the Netherlands intends to include a multilateral provision, which will mean that, under Dutch legislation, the new definition applies to all tax treaties negotiated by the Netherlands. In other words, the Netherlands intends to adopt all of the new definitions outlined above in line with the new OECD standard with immediate effect. This raises many questions. For example: is the Netherlands entitled to change the definition in derogation of treaties arrived at through negotiation? What happens if the other country continues to apply the ‘old’ definition in relation to existing treaties and determines that the new definition applies only to new treaties and not to existing treaties? Or what if the other country has yet to implement the new definition? There are many questions and much uncertainty. It will all have to be worked out in practice.
Brief summary and conclusion
The proposed changes will mean that more arrangements (including the presence of a permanent representative abroad) qualify as a permanent establishment. Companies need to be aware of this and to take action where necessary. After all, the consequences can be significant. There is still a great deal of uncertainty regarding implementation. Legislators are advised to clarify matters!
If you have any questions or would like advice on your particular situation, we will be happy to help. Please contact: