Permanent Establishment (PE) and Dual Residence regulations are critical aspects of international taxation, as they determine how and where your Estonian company’s profits are taxed. These regulations can be complex, and understanding them is vital if you operate an Estonian company in other jurisdictions. In this article, we give you an overview of PE regulations, with a focus on how they apply to e-resident companies registered in Estonia.
Countries want to collect tax on their soil
Countries generally have the right to tax income generated within their borders, both from residents and non-residents. This principle is a cornerstone of international taxation. However, for non-residents, the taxation is dependent on the nature and extent of their business activities in the country. If these activities are insignificant or occasional, they typically do not create a tax obligation. The challenge for countries and companies alike is determining when these activities are substantial enough to be taxed. This variable threshold is where PE or Dual Residence tax rules become applicable to your Estonian company.
Dual Residence is when a company is considered a tax resident in two different countries by authorities. This can happen when different countries’ definitions of tax residency overlap for your company. For instance, Estonia automatically considers any company incorporated under its laws as an Estonian tax resident. You can even get a certificate for this from the Estonian tax authority. However, if the place of effective management (PoEM) is in another country with different tax residency rules, the company might have Dual Residence. One example of this is when a management board member of an Estonian company simply works remotely from home while being a tax resident as a natural person. Being an Estonian e-resident does not have an effect on the place of effective management criteria.
Dual Residence
Dual Residence is distinct from having a PE in another country. It refers to the company being considered a tax resident in two jurisdictions, potentially leading to conflicting tax claims from two tax authorities. Resolving these conflicts can be a lengthy process requiring coordination between the competent authorities of the involved countries.
The Place of Effective Management (PoEM) is generally understood as the place where key management and commercial decisions necessary for the conduct of the business are made. If a company’s place of effective management is in another country than Estonia, that country may claim the company as a tax resident, making it subject to that country’s tax obligations.
Triggers for Permanent Establishment
A PE can be considered to be established without you knowing of it in several ways:
Fixed Place of Business: Using a physical location in a country (like an office) to carry out core business activities can trigger a PE establishment. For example, if you use an office in your home country to conduct business for your Estonian company, this could be considered a PE, and profits generated through the work performed in this office would be subject to local taxation.
Dependent Agents: Even without a physical office, a PE can be established through the activities of people working on behalf of your company. If someone, such as an authorized employee or a board member, has the authority to conclude contracts in the name of your company in the country, this can create a “dependent agent” PE establishment. This is distinct from independent agents, who typically do not create a PE.
The OECD Model Tax Convention provides guidelines that help distinguish between dependent and independent agents. It clarifies that a PE is not created when business is conducted through independent agents like brokers or commission agents if they are performing their business in a regular way. This is a key consideration for e-residents or single shareholders of Estonian companies who conduct business abroad, as their activities could potentially create an agency PE.
Complying with PE Rules
Understanding and complying with PE rules is crucial to avoid unwanted tax risks for your e-resident company. Countries may have specific rules regarding the time spent in the territory or the type of activities conducted, which can lead to PE status. Non-compliance can result in penalties based on the taxes unpaid on profits earned through the PE.
When a company has a PE in another jurisdiction, the country of registration is referred to as a “head office” in relation to the PE. For tax purposes, the head office and the PE are treated as separate entities. The PE’s profits are taxed according to the rules of the country where it’s located. Generally, PEs in the European Economic Area (EEA) or Switzerland are exempt from tax, but PEs in other states might require proof of tax payment.
Registration and Reporting Obligations
Creating a PE often leads to separate registration, accounting, and reporting obligations in another country. The income of a PE is determined based on the arm’s length principle, ensuring that transactions between related parties reflect market terms. The price you set should be the same as if the company were selling to someone you don’t know. This principle is important because it makes sure the business is done fairly, and you do not optimize tax by charging higher fees for the services and goods provided by the head office.
Avoidance of Double Taxation
Estonia, like many countries, has rules and tax treaties to prevent double taxation. If a PE pays tax in its state of establishment, that profit generally won’t be taxed again in Estonia. For PEs outside the EEA or Switzerland, the tax paid can be credited against future Estonian corporate income tax liabilities.
If a non-EU PE hasn’t paid corporate income tax, its profits are taxed at the Estonian company level upon distribution of dividends. These dividends are declared in the Estonian company’s tax return and can be carried forward indefinitely. However, these exempted dividend payments are not considered for calculating the Estonian company’s right to distribute 14% dividends. This reduced rate dividend payment to parent companies is to be abolished in 2025 though.
In a nutshell
PE and Dual Residence regulations are an integral part of international business taxation that are not affected by the Estonian e-Residency programme. They are designed to ensure that countries get to collect tax from substantial business activities on their soil, which is quite hard to do in the digital globalized world.
Understanding these rules is crucial for e-resident companies operating across borders, to ensure compliance and avoid penalties. Founders should seek professional tax advice to make sure that they do not have any uncharted tax risks. If you are not sure about your liabilities you can check with your accountant. Unicount started providing accounting services at the beginning of 2023 to its virtual office clients.
Thanks for reading!
This article was written by Adam Rang, Communications Director at Unicount. You can get started with Unicount at Unicount.eu.
