In tax practice, permanent establishments often give rise to discussion.
If a taxable permanent establishment is only identified during an external audit, there is a regular threat of high back taxes and possibly also massive penalties for the taxpayer. The fact that the sales tax assessment does not necessarily correspond to the income tax assessment increases the complexity and the possible (avoidable) pitfalls.
The most important facts in brief
- Places of business are business facilities that serve the activities of a company (e.g. branch offices, warehouses, headquarters of the management etc.)
- Plant locations are part of the entire company. Turnover from the permanent establishment must be included in the advance VAT return of the entire company.
- The location of the permanent establishment determines in particular the place of taxation for other services.
Permanent establishment under income tax law
Both the German Tax Code (AO) and the bilateral double taxation agreements (DTAs) determine when a permanent establishment for income tax purposes is maintained. Accordingly, a permanent establishment regularly requires as a central feature a fixed place of business through which the business activities of the domestic company are conducted and which is set up for a certain period of time.
However, even without a fixed place of business abroad, a domestic company may maintain a foreign permanent establishment: firstly, for construction and assembly activities that exceed a certain duration. On the other hand, it is possible to use so-called permanent representatives who work abroad for the domestic company.
Unwanted permanent establishment
In the construction industry or in plant and mechanical engineering, the periods of 6, 9, or 12 months in national law and in individual double taxation agreements create the risk that companies unintentionally maintain a so-called construction and assembly plant abroad. This is particularly true because temporary and unforeseen interruptions do not hinder the rigid deadline expiry.
But the question of a permanent establishment can also arise from a contractual relationship with service providers, from an employment relationship with employees, or the involvement of subcontractors abroad. In this context, the international community of states is increasing of the opinion that a permanent establishment need not in itself be an absolute prerequisite for a right of taxation. Rather, the requirement is reduced to the physical presence of whatever personnel is available (keyword "home office") or to a part of the value-added through a de facto presence in the country concerned (keyword "service establishment").
The EU Commission has already presented concrete plans to tax a so-called significant digital presence ("digital permanent establishment") or to introduce a transitional digital tax (see EU draft directive of March 21, 2018). This may result in a foreign taxation right that is detached from the classic concept of a permanent establishment. The further course of action of the legislator in this regard should be followed with the greatest attention. Independent of this, however, there is the concept of a permanent establishment for VAT purposes, which is to be defined separately according to country-specific characteristics and, in accordance with European case law, is based primarily on a minimum level of human and material resources and a structure with sufficient stability. Both are to be assessed on the basis of economic activity (input and output).
Avoidable double taxation
A permanent establishment is subject to independent registration and tax return obligations in the country concerned. In addition to the tax base determined under foreign tax law and the amount of the foreign tax rate, the actual tax burden also depends on the legal form of the parent company in Germany: in the case of a sole proprietor, profits in the state in which the permanent establishment is located are subject to the foreign income tax rate. If the parent company is a corporation, the profits of the permanent establishments are subject to foreign corporate income tax.
In Germany, foreign permanent establishment profits are generally exempted from taxation under the progression clause, so that in principle there is only one-off taxation of the permanent establishment profits abroad. However, if there are no indications from a German tax perspective that a permanent establishment is to be assumed, additional taxation in Germany and thus double taxation of the cross-border business activity cannot be ruled out.
Against this background, it is strongly recommended that the establishment of a foreign branch office be analyzed in advance of the foreign engagement, both according to German and local tax law - for example, within the framework of our "Branch Office Quick Check". Qualification differences can then ideally be avoided by structuring the facts or in coordination with the tax offices involved.
Importance for expatriate taxation and invoicing
Irrespective of the so-called 183-day rule, the existence of a permanent establishment abroad regularly leads to local tax and social security contributions for the staff. Also in this context, the tax and social security consequences should be analyzed and, if necessary, designed in advance of a staff assignment.
Differentiation from the permanent establishment for sales tax purposes
According to its own definition, a VAT-taxable permanent establishment is any fixed business establishment or facility serving the activities of the entrepreneur. It must have a sufficient minimum level of human and material resources required to provide the services in question.
In addition, the fixed place of business or facility must have a permanent structure, i.e. it must have a certain number of employees, have the possibility or authority to conclude contracts, and make certain decisions (see section 3a. 1 para. 3 sentences 1 to 3 UStAE). The tax authorities have based their definition of a so-called permanent establishment within the meaning of Article 11 of the VAT Regulation (VAT Implementing Regulation (EU) No. 282/2011).
Tendencies - Criterion "minimum level of human and material resources
The case law issued in connection with the definition of a permanent establishment for VAT purposes deals in particular with the question of the required scope of personnel and material resources.
For example, in its judgment of 16 October 2014 (Case C-605/12, Welmory), the ECJ generally ruled that a fixed establishment exists "if that establishment has a sufficient degree of permanence and a structure which, in terms of staff and technical equipment, enables it to receive and use services for its economic activity".
In this context, the judgment of the FG Münster of September 5, 2013 (Case No. 5 K 1768/10 U) is interesting, according to which wind turbines as fixed installations constitute a branch office even if no staff of their own is employed at the wind turbines. In this case, the lack of personnel would be compensated by the strongly pronounced material equipment. Ultimately, it would depend on the respective business or activity whether, for example, personnel were required at all to provide the service, so that if the answer is no, both criteria "personnel" and "material resources" would not have to be available.
Hints for the practice
It is still not clear whether the definition of a permanent establishment for VAT purposes can be made independent of the business activity. It has already been confirmed in case law that it does not always have to be a matter of the company's own personnel and material resources, which could, for example, also be rented in each case.
There is no uniform definition of a permanent establishment across tax jurisdictions. In contrast to the definition of a permanent establishment for income tax purposes, it should be noted that the requirements for the existence of such a permanent establishment are basically "broader and different". In the case of a permanent establishment for VAT purposes, the consequences for VAT purposes exist in particular in the case of a different place of performance when a permanent establishment provides or receives a service, and thus possibly different invoicing, e.g. with local VAT reporting as a result of the reverse charge procedure not being applicable (due to the fact that it is then assumed to be a German permanent establishment).
A difference between the existence of a permanent establishment for income tax and turnover tax purposes may therefore arise in particular in the case of so-called construction and assembly sites.
In cases of construction and installation services (abroad), for example, a permanent establishment for VAT purposes is often not available due to a lack of sufficient stability or authority to conclude contracts. It is therefore advisable to conduct a corresponding individual case examination in order to enable possible cases to be handled before the conclusion of a contract and to identify or avoid possible VAT registration and declaration obligations abroad. This is particularly important since the VAT permanent establishment abroad - not only in other EU countries but also and above all in third countries - can again deviate from the German or European definition and is also automatically accepted and recorded by the authorities if an income tax-related permanent establishment exists. The latter also applies to some EU countries.