This article discusses permanent establishments and dual residence – these issues arise most often in cross-border situations where a company is managed from abroad. Note that these are different concepts with different tax consequences.
Keep in mind!
- e-Residency is not the same as tax residency!
- You are not your company – both are taxed as separate persons.
- Tax treatment differs for Estonian residents, EU residents, residents of treaty countries and for third-country residents!
- Income tax and social tax should always be viewed separately!
- Your activities could create a permanent establishment i.e. a taxable presence for your Estonian company wherever you are located.
If you are new to international business or taxation, you have probably never heard of the term “permanent establishment” or a “PE”. A PE is a concept made up for tax purposes only. It should not be confused with the place of business, tax residency, place of effective management or a branch.
Before diving a little deeper into this topic, rest assured that permanent establishments are one of the most complex areas in international taxation, so nobody expects you to become an expert on the matter, but getting acquainted with the basics is still vital considering the nature of your business.
The formal definition of a “classical PE” provided by the OECD Model Tax Convention says that “a permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on”. Each element of this definition is crucial for a PE to exist. Most countries have modelled their domestic definition of a PE in line with the OECD Model Tax Convention and it is followed by a majority of effective tax treaties.
Secondly, another way of creating a PE is through people acting on behalf of the company creating a “dependent agent” or “agency PE”. As per international practise, such a dependent agent is described as „a person acting on behalf of an enterprise who has, and habitually exercises an authority to conclude contracts in the name of the enterprise in the other state“. As opposed to a “classical PE”, it does not require a specific fixed location in order to be triggered but instead relates to the nature of the agent’s activities.
However, each country has a slightly different approach to PEs and the specific domestic definition should always be checked. After looking into domestic law, be sure to also check the tax treaty between Estonia and the PE state. Tax treaties usually limit the existence of a PE compared to rules in domestic law.
Also, keep in mind that a PE can only be created to a company in another country i.e. not in the state where the company itself is established and there can only be one PE per one country. This means that your Estonian company could never have a PE in Estonia, but if your activities check all the boxes for creating a PE in Germany for example, then you would have an Estonian company with a PE in Germany.
Although a PE is a concept designed only for tax purposes, the tax administrations take this concept seriously, so a PE must be duly registered and it is usually taxed as a separate legal entity. The practical meaning of a PE is that it creates a taxable presence for a company outside the company’s country of establishment.
As a general rule, a PE must be registered with the local tax administration and separate (tax) accounting and tax filing must be arranged. Please refer to available information about PE registration and compliance in the jurisdiction where your activities might trigger a PE.
However, double taxation of the profits earned by business activities of a PE is avoided as Estonia exempts the PE’s profits from Estonian corporate taxation.
The second tax aspect commonly arising in cross-border business activities is dual residence. Since countries usually have the right to tax their own resident individuals and companies on their worldwide profits, then states have introduced broad definitions of who should be considered a tax resident. Where the definitions overlap, a taxpayer might be deemed to be tax resident in two countries – having dual residence.
Estonia has a simple rule which says that a company is tax resident in Estonia if it is incorporated under Estonian laws. If you have registered your Estonian limited liability company in the Estonian business register, then this means your company is an Estonian tax resident and subject to tax in Estonia. No other analysis is needed and the Estonian tax authorities will be happy to issue a Certificate of Residence to your company confirming the fact.
However, in addition to being a tax resident in Estonia, your company might have dual tax residence: some countries have different rules for deciding if a company is tax resident. It is common that in addition to the place of incorporation, the place of effective management triggers tax residence. If you run your company from a place with such rules, then the company might end up having dual residence – this happens when two states believe that the company is tax resident in their jurisdiction and will want to tax the company’s profits. If there are no domestic rules to help, then resolving this tax conflict is a lengthy proceeding requiring effort from competent authorities of both sides. It is worth looking into the local definition of a “place of effective management” to understand which activities result in corporate tax residence.
A company with dual residence is not the same as a company having a permanent establishment in another jurisdiction.
Also, keep in mind that rules for determining tax residency are different for companies and individuals!
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This article is part of a Business Guide
This article is a part of larger set of guidelines that e-Residency project team has requested for you and that has been compiled in cooperation with AS PwC. The full version of the Business Guide will be available for download shortly.
Articles in the Knowledge Base and the Business Guide are intended solely to provide general guidance on matters of interest for the personal use of the reader, who accepts full responsibility for its use. This information should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisers.