If you have not read yet about the difference between a permanent establishment and dual residence, do that before diving into this article.
Countries have the right to tax income generated in their territory by residents as well as by non-residents – this is a well-established principle of taxation. On the other hand, if the business activities of a non-resident in that territory are insignificant or occasional, then it would not make sense to try to levy a tax on this income. Therefore the question arises: when are the business activities material enough to create a taxable presence? Countries are constantly struggling to find the appropriate threshold for when the presence of a non-resident in their jurisdiction becomes sufficient to be subject to tax and the best internationally agreed solution so far are PE rules.
In real life a PE could be triggered for example in the following case: you use an office in your home country to carry out the core business activities of your Estonian company, i.e. consult your clients, provide IT services etc. The state where that office is located may decide that a PE exists, meaning profits from business activities carried out through that office would be taxed there.
Even if you steer clear of having an office or any other fixed place of business that could create a PE as described above, the nature of activities of people working to the benefit of your company could also create a PE.
Namely, a person acting on behalf of a company with the authority to conclude contracts in the name of the company and who from time to time exercises that authority (e.g. an authorised employee, or a board member), can create a so-called „dependent agent“ or „agent PE“. This is different from an independent agent because an independent agent would not create a PE.
The OECD Model Tax Convention states that a PE is not created when business is carried out through a broker, general commission agent or any other agent of an independent status if they are acting in the ordinary course of their business. Considering the assumptions, that you are a single shareholder, who sells their services and is an e-resident, not a resident of Estonia, it is likely that in essence you are your business and you make all key decisions and have the full authority to represent your Estonian company. As a result, there is a considerable risk of creating an agency PE in the territory where you act on behalf of your company and conclude agreements in the name of your company.
The takeaway is that you must understand that PE rules are relevant for you in the territory where you are located so that you are compliant with local legislation. Some countries might have clear timing rules allowing you to easily assess whether the time you spend there might lead to any registration obligations, other times you should pay more attention to the type of activities you carry out in any state, i.e. whether material agreements are negotiated and concluded there. If a PE is created and you fail to register it for tax purposes in a timely manner, then that might lead to penalties on the tax assessed on profits that the local tax authorities believe to have been earned by the PE.
If a company has a PE in another jurisdiction, then that company can be referred to as a “head office” from the perspective of PE. Also note that under private law, a company i.e. the head office, and its PE are the same legal person, whereas, for tax law, these are two different persons who should be taxed separately. The accounting and other compliance rules depend on the state where the PE is located. Generally, the profits of PEs located in the European Economic Area (EEA) or Switzerland are exempt from tax and for PEs located in other states, the profits are also exempt from tax but additional proof may be required to prove the tax was actually paid in the other state.
My Estonian company has a PE in the country where I live. What does this mean for tax purposes?
It is not necessarily a bad thing if your Estonian company has a registered PE in another state, it just means that your company has a taxable presence there. Also, it is actually quite common for businesses operating cross-border and with activities carried out in multiple locations. In practice, if a PE is created and has more material business activities, then it is often registered in the form of a branch (filiaal – in Estonian). For more information about a branch, contact your local legal advisor.
As mentioned above, separate registration, accounting and reporting obligations might arise when a PE is created.
The PE of the Estonian company will be taxed in accordance with the rules of the country where the PE is located and will be considered a “separate entity” for tax purposes. This means that the PE will pay taxes based on profits attributed to or earned by it. The income is normally determined by applying the arm’s length principle – a common concept in dealings between related parties to ensure that transfer prices reflect market terms.
So if the PE pays tax in the state where it is deemed to exist, then what happens in Estonia?
If your Estonian company’s PE pays tax in the state where it is created and registered, then don’t worry – generally, there are rules and tax treaties in place to avoid double taxation, i.e. this profit should not be taxed once more at the level of the Estonian company
Estonian domestic rules make sure that no double taxation arises for income that has already been taxed in another state at the hands of a PE. There is a distinction between where the PE is located: profits of PEs located in the European Economic Area (EEA) or Switzerland are exempt from tax and for PEs located in any other state, you get to credit the tax paid against any Estonian corporate income tax liability in the future.
Let’s have a look at an EEA or Swiss PE example with illustrative numbers and CIT rates:
If the non-EU PE has not paid any corporate income tax, then the profits are taxed at the level of the Estonian company upon distribution of dividends.
To keep track of amounts with such treatment, you should declare the profits of a PE in the Estonian company’s TSD return Annex 7 as soon as these are calculated in the other state. This right to pay exempt dividends can then be carried forward indefinitely until your company has sufficient profits, enough cash or until you simply decide to pay dividends.
Note, however, that the exempted dividend payments are not included for calculating the Estonian company’s right to distribute "14% dividends".
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. Download the full version of the Business Guide.
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.