Contractors’ Questions: Can my limited company avoid creating a Permanent Establishment (PE) in a foreign country?

Contractor’s Question: This ContractorUK article addresses the position of a UK limited company being considered as having a Permanent Establishment in a foreign country.

In that case, adds the article, the UK company may become liable to pay corporate taxes on the profits attributable to the PE in that country, “which can lead to increased compliance obligations and potentially higher tax burdens.”

So, how can I avoid creating a permanent establishment in a foreign country?

Expert’s Answer: As well as refreshing yourself about the five circumstances in which a UK limited company gains a Permanent Establishment (PE), you should keep in mind two additional aspects.

Which frameworks determine PE? 

First, Double-Taxation Treaties.

The specific rules and thresholds for establishing a PE can vary depending on the DTT between the UK and the foreign country where your limited company will be operating (i.e the work-country). It's essential to review the relevant DTT to understand the conditions.

Secondly, review local tax laws in the work-country. 

This review is important to run as in addition to DTTs, local tax laws in the foreign country can contain rules specifying when a PE is determined. 

How to avoid creating a Permanent Establishment

But your precise query is about how to avoid a PE from coming about.

To try to avoid creating a Permanent Establishment (pending the relevant DTT and local laws), you can take three key precautions:

• Limit activities: Avoid activities that could trigger a PE, such as signing contracts, or having a permanent physical presence in the foreign country.
• Insist on independent agents: Engage independent agents or distributors who act on their behalf, rather than having employees in the foreign country.
• Short-term projects only: Keep projects short-term to avoid exceeding the duration thresholds that can trigger a PE.

One question you’re not asking but which our overseas contracting advisory often gets ask about in this space is:

When you create a PE abroad, where do you pay corporation tax? 

 As I have previously advised, if your UK company creates a permanent establishment abroad, you will likely have to pay corporate tax in the country where the PE is and the UK.

Here’s how it typically works. The country where you create the PE will tax your UK limited company’s profits attributed to that PE's activities. This means that you will need to file tax returns in the work-country and comply with its tax laws and regulations.

As a UK resident company, you are subject to UK corporation tax on your worldwide income, including profits generated by the PE. However, as already alluded to, the UK tax system provides double-taxation relief to avoid taxing the same income twice.

DTTs: Two specific tax relief methods

You can benefit from this relief in two ways:

• Exemption method: You can exclude the profits and losses of all your overseas Permanent Establishments from UK corporation tax by election. This election is irrevocable and applies to all existing and future PEs, so take advice beforehand as there’s no going back.
• Credit method: You can claim a tax credit for the foreign tax paid on the PE's profits against your UK corporation tax liability. The credit is limited to the amount of UK tax payable on the same profits.

I’ve mentioned them here twice but to reiterate their importance -- DTTs between the UK and foreign countries can massively influence how double taxation relief is applied. And it is fear of taxation which I suspect is behind your question. Really check the small print, as the relevant DTT may provide for a specific relief method (exemption or credit), or allow you to choose. Good luck!

The expert was Kevin Austin, managing director of Access Financial.