If a foreign company has sales or any kind of operations in the U.S., whether via a subsidiary, an agent, or direct activity, they should evaluate whether they have any risk of having a “permanent establishment” in the U.S. As the criteria can vary between the various income tax treaties, the determination can become quite complex. Although the referenced training materials deal with audits of U.S. activity by a foreign entity, it is important to keep in mind that other countries also focus on this issue if a U.S.-based business has activity in a foreign jurisdiction. If a taxing authority determines that there is a permanent establishment, all profits associated with the activity will fall under the taxing nexus of that country. It is critical to determine any possible applications early, as an after-the-fact rendering by a taxing authority can be quite punitive.
In general, U.S. income tax treaties define a permanent establishment as having a fixed place of business through which the foreign entity conducts their business. However, there are exceptions if the activity in the U.S. is limited to activities that are preparatory and/or auxiliary in nature. In addition, the presence of a U.S. dependent agent that has the authority to execute binding contracts on behalf of the foreign entity and does so on a regular basis can also establish a permanent establishment, while an independent agent acting in the ordinary course of their business will generally not create a permanent establishment.
The new IRS training modules focus on the U.S.-U.K. treaty and state that each specific treaty should be closely reviewed, as most have varying definitions of what constitutes a permanent establishment. The bulk of the training material focuses on an audit of hypothetical cases and describes what information the auditor should request and how they should evaluate the results. They also mention on several occasions that if there are related transactions between a foreign entity and a U.S. operation, the auditor should confirm that all the charges are arm’s length – that is, the price (known as the transfer price) should equate to what a willing buyer would pay to a willing seller, whether it be for goods or services.
If you believe your business may have a permanent establishment issue, whether in the U.S. or abroad, or if you believe you may have any transfer pricing exposure, it is highly recommended that you seek out professional assistance at the front end. With both of these types of issues, an ounce of prevention is indeed worth a pound of cure. Feel free to contact us today for assistance.
You can find the new training modules for Permanent Establishments here:
- Creation of a Permanent Establishment (PE) through the Activities of a Dependent Agent in the United States
- Preparatory and Auxiliary Treaty Exception to Permanent Establishment Status
About the Author:
Transfer Pricing Specialist
David Marion joined Thompson Greenspon in 2014 as a transfer pricing specialist. Having worked with the IRS for more than 35 years, David’s experience is instrumental to interpreting regulations and providing other guidance for a variety of complex and often controversial international issues.
David has held a number of compliance-related positions during his tenure with the Examination and Large Business & International divisions of the IRS. As Manager of the International Technical Advisor headquarters group, he provided a wide variety of technical support across the country. During his 12 years of managing a large group of international examination specialists, David was intimately involved with many international cases, of which transfer pricing was the most prevalent issue.
In addition, as Foreign Payments Manager, David was also responsible for the IRS compliance program for international withholding. Within this position, David helped enforce policy consistency among various IRS centers.
As Competent Authority Manager, David gained extensive transfer pricing experience with Europe and Canada. He conducted numerous negotiations with foreign officials on behalf of taxpayers, of which 95 percent were closed successfully with mutual agreements.
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