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International Tax Risks: Permanent Establishment

February 28, 2011 | No. 2011-10

KPMG’s TaxNewsFlash publications containing technical discussions of tax developments in the United States and around the world are released every day to tax directors and other tax professionals. This summary is intended for executives who need to be informed about tax developments—but without the technical details.

This edition follows up on last week’s discussion of corporate governance of tax risk with a focus on international tax risks. See TaxNewsFlash-Weekly Tax Summary for Corporate Executives 2011-09.

Broadly speaking, tax risk is a possible change in tax liability resulting from uncertainty as to the taxpayer’s facts or the application of the tax law to the taxpayer’s facts at the time a tax liability is quantified and reported. Exposure to tax, and therefore tax risk, is embedded in every aspect of a company’s business—including international operations.

The most significant sources of international tax risks arise from:

  • Determination of arm’s length transfer prices in cross border transactions
  • Compilation and adjustment of non-U.S. financial data for U.S. tax purposes
  • Cross-border corporate acquisitions, dispositions, and reorganizations
  • Carrying on business outside a legal entity’s country of residence (permanent establishment or “PE“ risk)

This article discusses permanent establishment tax risks. In this article, it is assumed that the business is carried on in a treaty country because if the business is in a non-treaty country, then permanent establishment is not relevant and the taxing threshold is lower.


The traditional objectives of tax treaties have been the avoidance of international double taxation and the prevention of tax evasion. The objective of avoiding double taxation generally is accomplished under income tax treaties through the agreement of each country to limit, in specified situations, its right to tax income arising within its jurisdiction by residents of the other country and either to exempt from tax, or provide a credit for income taxes paid on, income arising in the other country. A resident of one country carrying on business in the other country generally will be subject to income tax in that country if it has (1) a permanent establishment in that country and (2) income attributable to the permanent establishment.


Permanent Establishment Tax Risks

What is a “permanent establishment”?

Income tax treaties of developed countries typically include standard language defining the term permanent establishment that is based on the OECD Model Income Tax Convention. An enterprise of one country generally will have a permanent establishment in the other country if it has either a fixed place of business (e.g., a place of management, a branch, office, factory, etc.) in the other country or it has a dependent agent in the other country that has the authority to conclude contracts binding the enterprise and the agent habitually exercises that authority.

Although the definition is standardized, it is quite general and countries vary as to how they apply it to various fact patterns. For example, how long must an office exist before it creates a permanent establishment? Does performing services for a customer in its offices create a permanent establishment? Does an independent contractor create a permanent establishment?

What is the permanent establishment tax risk?

It is the risk that an enterprise will be subject to tax in another country as a result of conducting some activities in that country. This gives rise to an obligation to file a tax return and pay taxes in that country. It also raises the possibility that that the residence country will refuse to credit the resulting foreign income tax (or to exempt that income from domestic tax) if it believes a permanent establishment does not exist.

What steps need to be considered to limit the permanent establishment tax risk?

Ways in which a chief financial officer might limit permanent establishment uncertainty could include:

  • Involving the tax department in the opening and closing, expanding or contracting, or other modification of foreign offices and operations
  • Reviewing international travel and relocation of domestic and foreign personnel (including numbers of employees, duration of temporary assignments, and other aspects of expatriate assignments)
  • Evaluating intercompany and third-party contracts to determine that third parties do not have authority to enter into contracts in the name of the company
  • Reviewing intercompany product or service flows
  • Requiring periodic reports by foreign operations to determine that foreign tax filing obligations are satisfied
  • Oversight by internal audit

KPMG Observation

Tax and financial executives in multinational companies need to be aware of international tax risks, including permanent establishment, transfer pricing, and other risks, and be prepared to take steps to manage the risks both defensively and proactively.


For more information, contact a tax professional with KPMG’s Washington National Tax practice:

Hank Gutman, (202) 533-3044, 

Roger Wheeler, (202) 533-4124, 

Charles Cope, (202) 533-3176, 

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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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