Permanent Establishment Fiction
Deploying employed sales representatives abroad gives companies the opportunity to enter new markets step by step. Following an initial phase typically characterised by the direct sale of goods or services, the aim is to test the market further and expand sales volumes. At the same time, companies wish to keep their capital commitment, risk, and administrative burden manageable.
Employed Sales Representatives as Permanent Representatives of the Company
As a rule, a tax permanent establishment (Betriebsstätte) means a fixed place of business through which a company's business is carried on (see Art. 5 para. 1 of the OECD Model Tax Convention), for example a branch office, a production facility, or a workshop. However, if an employed sales representative acts for a company abroad and also holds authority to conclude contracts in the name of the company and exercises that authority, most double taxation agreements treat such a person as a so-called permanent representative (ständiger Vertreter). This means that a permanent establishment is deemed to exist in the foreign country even though the company has no fixed place of business there. As a result, companies must register for tax purposes in the relevant foreign state and must pay tax there on a portion of the profit generated from that business.
Risks of an Unintended Permanent Establishment
Since many companies are reluctant to take on the associated administrative burden, they often instruct their employed sales representatives merely to initiate contracts. The contracts are then actually signed in Germany by the management. If the contracts have already been negotiated in every detail by the sales representative and the signing at German headquarters is nothing more than a formality, this approach is frequently not accepted by foreign tax authorities. In such cases they still take the view that the sales representative is a permanent representative within the meaning of the double taxation agreement and that a permanent establishment has been created. In extreme cases this can result in criminal tax proceedings including back-tax demands, substantial fines, and high legal costs. Companies concerned should therefore discuss the possible tax consequences with their tax adviser before acting, and should check at least once a year whether actual practice within the company still corresponds to the management's guidelines.
Solutions
The following solutions are available:
- Document procedures carefully. Good documentation can demonstrate that the sales representative does not merely formally lack authority to conclude contracts, but that this is not overridden in practice by a de facto power to act.
- Use a self-employed commercial agent (selbstständiger Handelsvertreter).
- Register a tax permanent establishment abroad. This does entail administrative effort (registration, annual filing obligations in the foreign state). However, the share of profit taxable abroad is generally modest. This solution eliminates the risk of an unintended permanent establishment entirely.
Further Aspects
Beyond the permanent establishment issue, the companies concerned must clarify the tax, social security, and employment law questions connected with employing staff abroad.