Subsidiary or Permanent Establishment: A Strategy Guide

When setting up shop in a new jurisdiction, the question always arises: should we incorporate a subsidiary or just proceed as a branch (aka: a ‘Permanent Establishment’)? It often happens that a company never consciously decides to set up a Permanent Establishment rather than a Subsidiary; business simply grows and suddenly a foreign presence becomes substantial enough to trigger taxation. The company may realise this themselves first and address the related obligations proactively, or they may be less fortunate and a foreign tax authority takes note first and imposes tax assessments and potential non-filing penalties.

There’s much more value in your tax budget if you can use it for strategic planning rather than fending off issues, which is why we like to be involved sooner rather than later in expansion plans. As tax advisors, the ‘Sub or PE’-fork in the road is always a design item in the corporate plan. In this blog post, we walk through some basic principles of foreign taxable presence, the similarities and differences between subsidiaries and permanent establishments, certain practicalities, and our rules of thumb.

The Wheeler & Co. Case: Specialized Wheels entering the Dutch Market.

When embarking on a business venture abroad, tax considerations are paramount. We first look at whether you hit ‘taxable presence’ marks. These marks may differ between types of taxes (like Corporate Income Tax or Wage Tax or VAT) and between countries (i.e.: some countries have lower thresholds than others). However, from a certain ‘robustness’ on, the venture abroad is no longer just a tax-free probe but a taxable foundation.

Imagine that our case revolves around Wheeler & Co., a startup business from Brighton, England, that makes incredibly smooth wheels for rollerskates out of recycled plastics. At one point, Wheeler & Co. sees an opportunity in the vibrant Dutch rollerskating community after attending a breakout session at an international skater convention and wants to get involved.

Wheeler & Co. recruits Sophie, a Dutch resident of The Hague with a history in sales and an avid skater, to head the expansion and pursue market share in the Netherlands. Convinced that this won’t take long, Wheeler & Co. rents some space in a local storage and ships inventory to it, so that Sophie can display the Wheeler Ware and deliver quickly.

Wheeler & Co. calls the Archipel offices; as they want to get off to a clean start, they want to ensure that they observe their obligations and capture their benefits. They ask:

• Do we have to file and pay Dutch Wage Taxes?

Where Wheeler & Co. is Sophie’s employer and Sophie generally does her work in the Netherlands, Wheeler & Co. would indeed have Dutch Wage Tax obligations.

Based on Article 6 of the Dutch Wage Tax Act, a ‘Withholding Agent’ for wage tax purposes is any body with employees that are in scope of Dutch wage tax. Based on Article 2 of the Dutch Wage Tax Act, such an ‘Employee’ is any Dutch resident person that has entered into an employment arrangement with a Withholding Agent and works in Dutch territories.

Quickly jumping over many technicalities and details, this broadly means that ‘foreign’ companies must do Dutch wage tax compliance and withholding if they employ a Permanent Representative, employ Employees through a Permanent Establishment for Corporate Income Tax purposes, and/or have Dutch Employees and register as a Withholding Agent.

So, chances are that Wheeler & Co. has Wage Tax obligations in the Netherlands, for instance because they have a Permanent Establishment or Permanent Representative in the Netherlands.

• Do we have to file and pay Value Added Taxes?

When considering VAT, the first step is to determine if the company or person qualifies as a VAT-entrepreneur. According to Article 7, sub 1, of the Dutch VAT Act and Article 9, sub 1, of the EU VAT-Directive, a VAT-entrepreneur is anyone who independently carries out economic activities, aiming for sustainable income. Occasional activities do not qualify.

Sophie, employed by Wheeler & Co. in the Netherlands, plans to sell goods within the EU in a business capacity. This makes Wheeler & Co. a VAT-entrepreneur and establishes a ‘Fixed Establishment’ in the Netherlands. This establishment must have permanence and suitable resources to operate.

Note that the ‘Fixed Establishment’ concept for VAT purposes differs from the ‘Permanent Establishment’ for corporate tax. Meeting its thresholds, which are linked less to ‘brick and mortar’ and more to permanence of business, triggers the obligation of a VAT registration, a VAT Identification Number, and periodic VAT returns.

So, upon registration as a VAT Entrepreneur in line with their obligations, Wheeler & Co. receives a VAT number. Importing the goods from the UK into the EU incurs a 21% import VAT, payable upon entry. This VAT can be deducted in the periodic VAT returns as ‘input VAT’, though it may still be unfavorable to cash flow as the VAT needs to be paid in advance at the border.

Do we have to file and pay Corporate Income Taxes?

This depends on whether Wheeler & Co.’s presence in the Netherlands surpasses the threshold of a Permanent Establishment or whether Sophie’s setup makes her a Permanent Representative. The concept of a Permanent Establishment came to be as a measure to determine whether a foreign company’s presence is substantial enough to tax.

Under Dutch tax law, as per Article 3 of the Dutch Corporate Income Tax Act, the ‘Permanent Establishment’ (PE) threshold (including the Permanent Representative) which triggers Dutch domestic taxing points is generally linked to the PE-definitions stated in an applicable treaty.

In summary, a Permanent Establishment refers to a ‘fixed place of business’ where an enterprise conducts its operations, either wholly or partially. This includes places like management offices, branches, factories, workshops, and sites for extracting natural resources. However, certain activities, such as storage, display, or delivery of goods, and other preparatory or auxiliary activities, do not constitute a permanent establishment.

Now in Wheeler & Co.’s case, it may be up for debate whether the PE-thresholds are met. Much will depend on the terms of Sophie’s contract – can she conclude or ‘materially prepare’ contracts on Wheeler & Co.’s behalf? If so, there is an increased chance that Sophie is a ‘Permanent Representative’ which is a light form of a PE.

If Wheeler & Co. has a PE in the Netherlands for Corporate Income Tax purposes, its Arm’s Length profits need to be determined, and Wheeler & Co. will need to file (and pay) Corporate Income Tax returns in the Netherlands to pay up on the portion of its worldwide profits allocable to Sophie’s efforts.

In conclusion, in the wake of its spectacular Dutch market entry, Wheeler & Co. will also need to establish some Dutch tax compliance:

• Wage Tax: Monthly
• Value Added Tax: Quarterly or Monthly (opt-in)
• Corporate Income Tax: Annually

Note that the applying tax Treaties and Directives should ensure that whatever is taxed here is not taxed elsewhere. This means that the whole ‘Permanent Establishment’ – or more accurately: taxable presence – thing is mainly a matter of allocation: where is tax due. When a company, like Wheeler & Co., spans multiple countries, so do its tax obligations.

What exactly is a ‘Permanent Establishment’ aka a Branch? A Permanent Establishment is when you do business in another country where that business is not a business trip, errand run, or just an online sale, but has some permanence and physical presence.

And what is a Subsidiary? A subsidiary is a legal entity owned by another legal entity, for instance: a Dutch incorporated BV (Limited Liability Company) the shares in which are owned by a UK Limited. This separate entity would have its own Assets & Debts, and it would hold its own risks and liabilities.

Incorporating a Subsidiary is generally the superior conscious step over sprouting a Permanent Establishment when expanding abroad. Especially where minimum capital requirements are low and incorporation logistics and costs are limited, the blocker on foreign legal risks and costs quickly outweigh the marginally higher administrative burden of maintaining an additional legal entity.

However, in specific cases where such costs are very high and/or where no or a very poor treaty applies, one may find that a Permanent Establishment is the superior option. Either way, we are happy to advise and quarterback the process, both inbound and outbound.