Permanent Establishment Fiction
Deploying employed sales representatives abroad gives companies the opportunity to open up new markets step by step. After an initial phase that is usually characterised by the direct sale of goods or services, the aim is to test the market further and expand sales. At the same time, however, companies want to keep their capital commitment, risk and the administrative burden involved at a manageable level.
Employed Sales Representatives as Permanent Representatives of the Company
In principle, a tax permanent establishment (Betriebsstatte) means a fixed place of business through which the business activities of an enterprise are wholly or partly carried on (see Article 5(1) of the OECD Model Tax Convention), such as a branch, a production facility or a workshop. However, if an employed sales representative works for a company abroad and also has the authority to conclude contracts in the name of the company and exercises that authority, he is treated under most double taxation agreements as a so-called permanent representative. This means that a permanent establishment is fictitiously 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 also pay tax on a proportion of the profit from that business in that foreign state.
Risks of an Unintended Permanent Establishment
Because many companies are reluctant to take on the associated administrative burden, they often instruct 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 the German head office is a mere formality, foreign tax authorities will often not accept this approach. They take the view, even in such cases, 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 lead to tax criminal proceedings including back-tax payments, substantial fines and high legal costs. The companies affected should therefore discuss the potential tax consequences with their tax adviser before taking action, and should check at least once a year whether the actual practice within the company still complies with the management's specifications.
Solutions
The following solutions are available:
- Thoroughly document processes. With good documentation it is possible to demonstrate that the sales representative does not merely lack formal authority to conclude contracts, but that this is not overridden by any actual de facto authority to act.
- Engage a self-employed commercial agent.
- Register a tax permanent establishment abroad. This does entail administrative work (registration, annual declaration obligations in the foreign state). However, the share of profit taxable abroad is usually modest. This solution eliminates the risk of an unintended permanent establishment entirely.
Further Considerations
Beyond the permanent establishment issue, the companies concerned must also resolve the tax, social security and employment law questions arising in connection with the employment of staff abroad.