H. Jacob Lager

Posts Tagged ‘Permanent establishment tax’

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Israel: Home Office Creates Permanent Establishment

In Foreign taxes on July 11, 2012 at 7:59 am

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.

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Control key ingredient for Spanish, Indian aggressive pursuit of permanent establishments

In Foreign taxes, Offshore Accounts on March 19, 2012 at 9:05 am

What might cause a business to be taxed in a foreign jurisdiction?  Control, according to a pair of recent decisions out of Spain and India.

No stranger to aggressive long-arm taxation (see Vodafone litigation), India’s Authority for Advance Rulings (AAR) just issued a February 7 ruling that deemed a French data network provider’s control over certain undersea cables in Indian territory a sufficient presence to justify permanent establishment status in India.  The ruling specifically noted that whether the French company owned or leased the equipment was irrelevant, so long as it has the power to control the equipment.  Similarly, the AAR further noted that a PE could be triggered by a mere computer or data server in India if a business is conducted through such equipment.

One month earlier, Spain’s Supreme Court teached its long-awaited decision in Roche Vitamins Europe Ltd., ruling that the company’s Spanish subsidiary created a permanent establishment via agency for Roche Vitamins Europe, a Swiss company.  Because all of the Spanish company’s activity was directed, organized, and managed by the Swiss company, the Court held that the subsidiary operated as a dependent agent as it carried on, under the two contracts, activities (manufacturing and distribution) that could have been performed directly through a fixed place of business.

The fact that the Spanish sub had no capacity to contract or negotiate for its Swiss parent did not prevent the court from broadly applying the dependent agency clause of the Spain-Switzerland tax treaty. Even though the sub did not “habitually [exercise] authority to conclude contracts that are binding for the” parent (as required by the treaty), the court nonetheless ruled that the parent’s control of the sub was sufficient to attribute to the Spanish PE the profits derived from the sub’s activities (manufacturing and distribution).

These two cases present strong reminders for multinational taxpayers to reexamine structures in which a group member performs, under one or more contracts, activities for nonresident related entities.  In particular, taxpayers should determine whether the evidence supports an argument that the local entity has sufficient autonomy and that its operations and/or assets are not subject to a foreign parent’s discretion.