I often dream about working from Paris.

How hard could it be?  I’ve got a computer.  I can stay up late.  Most of my clients rarely insist on face-to-face meetings.  So what’s stopping me?

Well, for one thing, I don’t know that my firm would be too keen on inadvertently creating a permanent establishment abroad and subjecting itself to French taxes.

That’s pretty much exactly what just happened to a US company that outfitted an Israeli employee with all the tools necessary to work from home.  On July 3, 2012, the Israeli Tax Authority (“ITA”) ruled that an Israeli investment portfolio manager’s home office created a “permanent establishment” in Israel for the US company for whom she worked.  Thus, the US company was subject to Israeli taxes on its profits allocable to Israel.

“Permanent Establishment” (or “PE”) is a concept used throughout the world to determine whether a business has a taxable presence within a given sovereign jurisdiction.  Essentially, once your PE is established in Country X, you can expect to pay some kind of Country X taxes.

Typically, the factors giving rise to a PE will be described in a relevant tax treaty or, failing that, local law.  In this case, featuring an Israeli taxpayer and a US employer, the US-Israel Tax Treaty governed.  Accordingly, the ITA applied Article 5 of the treaty to hold that the Israeli employee created a PE for the US company in Israel.  The ruling relied primarily on the fact that the employee was subordinate to the head of the US investment team, the US company held all the risk regarding its clients, and that the company provided the Israeli employee with the technological and informational tools required for her work.

It should be noted that the ITA found an Israeli PE even though the US company provided no actual financial services in Israel, all its clients were located outside Israel, and the company did not even market to Israeli clients.  Indeed, the decision’s actual fiscal impact was somewhat vague since it did not explicitly state how the company’s profits should be allocated to its Israeli PE.  Instead, the ITA indicated that it would initially defer to the US company’s chosen method of allocation, subject to review.

While employing workers abroad has never been easier (from a technological and practical standpoint), employers seeking to accommodate key talent should also keep in mind whether an inadvertent PE might result.  Alternatives to direct employment include:  hiring the worker as an independent contractor, hiring the worker through the worker’s own loan-out entity, setting up a branch office abroad for the worker, and opening an actual subsidiary company to employ the worker.  Each option involves its own costs and benefits that should be considered along with the potential tax exposure.

Sadly, Paris will just have to wait.