German companies have several options for expanding abroad. One option is a permanent establishment abroad (also known as a “foreign permanent establishment”). In this article, you will learn what a foreign permanent establishment is, when it makes sense, its advantages and disadvantages, and tax implications.

What’s in this article?

• What is a permanent establishment abroad?
  
• What are the tax implications of a permanent establishment abroad?
  
• In which cases can a foreign permanent establishment be useful?
  
• What are the advantages and disadvantages of a permanent establishment abroad?
  

What is a permanent establishment abroad?

According to Section 12 of the German Fiscal Code (AO), a permanent establishment is any fixed business facility or installation that serves the activities of a company. This includes:

• Headquarters
  
• Offices
  
• Branch offices
  
• Manufacturing or workshops
  
• Warehouses
  
• Points of purchase or sales
  
• Construction work or temporary sites
  

Although a permanent establishment must be fixed in place, a fixed connection to the Earth’s surface is not required. For this reason, temporary locations can also function as permanent establishments. However, it is important that companies carry out their commercial activities in permanent establishments. In addition, the activity at the site must be permanent. The law requires a minimum of six months. Permanent establishments are not legally independent units but dependent parts of a company.

A permanent establishment abroad is a fixed place of business of a company outside its home country. For example, if a German company opens a branch in Switzerland or a production facility in France, this is a foreign permanent establishment.

If you’re looking to expand into a new market, check out Stripe Payments. With Payments, you can accept payments globally and offer your customers preferred payment methods locally. Stripe Tax can also help you expand by automatically collecting taxes worldwide and giving you access to the documentation you need for tax refunds.

Discover Stripe Connect if you own a marketplace or platform, are building this business model, or want to take advantage of the payout capabilities of Connect Payouts. With Connect, you can quickly build a profitable and scalable payments business. You can offer your customers a variety of local payment methods anywhere in the world, as well as instant withdrawals, financing, corporate credit cards, or sales tax calculation and collection.

What are the tax implications of a permanent establishment abroad?

German companies establishing a permanent establishment abroad have several tax obligations, both internationally and in Germany.

Double taxation

According to the world income principle, Germany taxes the entire income of a taxable company, regardless of where the income is earned. Accordingly, the income of foreign permanent establishments is also taxed. If the foreign tax authorities claim taxes on the income of the permanent establishment, there is a risk of double taxation.

To avoid this, there are double taxation agreements (DTAs). These are international treaties designed to prevent taxpayers from being taxed twice on the same income in the same period through similar taxes. In many cases with DTAs, the state in which the company is based exempts the company from taxation or offsets the tax amounts. Income is then taxed only where the permanent establishment is located or where the income is earned. Thus, if a German company earns income from a factory in Poland, the income is taxed in Poland.

Tax return

If a German company opens a permanent establishment abroad, it must also file tax returns there. The extent of these obligations depends on the laws of the respective country. In most cases, a separate profit calculation must be prepared for the foreign permanent establishment.

For foreign permanent establishments in Germany, it is also necessary to determine profits according to German regulations. This helps to determine which part of the profit is not taxed in Germany due to a double tax treaty. The determination of profits is carried out in accordance with the permanent establishment profit distribution regulation (BsGaV), which regulates exactly how profits, assets, and liabilities are allocated to the permanent establishment. If assets are transferred from Germany to the foreign permanent establishment, this could result in taxes being levied on previously untaxed increases in value. In addition, companies must report to the German tax authorities if they establish a foreign permanent establishment or use a cross-border tax strategy. The reporting requirements are summarized in Section 138 Paragraph 2 of the AO.

If you are planning to establish a permanent establishment abroad, you should obtain detailed information about the tax regulations of the target country in advance and check whether there is a DTA with Germany. If there is no DTA, the foreign tax can be deducted from the German tax. But even if there is an agreement, there might be problems. This is the case, for example, if the determination of profits leads to different results in the two countries or if the permanent establishment is recognized by only one of the two countries.

In which cases can a foreign permanent establishment be useful?

A foreign permanent establishment can make strategic or financial sense for German companies under certain circumstances. Some motives arise from the benefits of a foreign permanent establishment, which include cost or tax savings and access to markets and resources. In addition, a permanent establishment abroad can make sense in the following cases:

Project-related permanent establishments

A temporary permanent establishment can be created for temporary projects. This is suitable, for example, for construction and assembly work. One of the main advantages is flexibility, as companies can set up the permanent establishment only for the duration of the project and dissolve it when the project is completed. This temporary structure makes it possible to use resources efficiently and avoid long-term commitments.

In addition, project-based permanent establishments can offer tax advantages by allowing a clear delineation of income and expenses for a particular project. This simplifies tax reporting and helps avoid double taxation by allocating income directly to the appropriate country.

Proximity to strategic partners

An overseas operation can be useful if it is located near key partners, suppliers, or production networks. At its best, direct communication channels allow for more efficient collaboration and faster problem resolution. In addition, delivery routes can be shortened and costs reduced.

Research and development (R&D) projects

Innovation-focused companies can benefit from establishing foreign operations in countries that offer special R&D incentive programs. These programs, which often include tax incentives or direct grants, allow companies to reduce their research costs.

In addition, locating in countries with strong R&D infrastructures can help attract qualified professionals. Specialists from universities and research centers help make companies more innovative.

Market launch obstacles

In some countries, there are regulatory hurdles that make it difficult or impossible for foreign companies without a local presence to enter the market. In these cases, a permanent establishment is absolutely necessary.

What are the advantages and disadvantages of a permanent establishment abroad?

There are both advantages and disadvantages to a permanent establishment abroad for German companies. Here is an overview of the most important points:

Advantages

Market access and expansion

One of the major benefits of a foreign operation is direct access to new markets. A physical presence on the ground allows companies to increase their visibility and improve their competitive position. In addition, the proximity to customers makes it possible to tailor products and services to local needs.

Cost savings

Another advantage of foreign operations is the potential for cost savings. In many countries, labor and operating costs, rents, and energy prices are significantly lower than in Germany. In addition, some countries offer tax incentives or subsidies to attract foreign companies, which bring additional financial benefits.

Tax savings

For tax purposes, companies with permanent establishments abroad benefit from DTAs that prevent multiple taxation and experience a reduction in the overall tax burden. If the permanent establishment is located in a country with lower tax rates, the company also pays less tax than in Germany.

Access to resources

Foreign operations provide companies with access to raw materials that might be available in certain regions and are necessary for production. In addition, a local presence allows the use of local specialists with specific skills.

Disadvantages

Political and economic risks

Foreign operations involve potential political and economic risks. In target countries with political instability, unexpected changes in the law, changes in government, or social unrest can significantly affect business operations. In addition, economic risks—such as currency fluctuations, inflation, or sudden trade restrictions—can lead to financial losses. Companies should, therefore, minimize risks early on and conduct regular market analyses to be prepared for possible changes.

Tax complexity

The establishment of foreign permanent establishments leads to increased tax complexity for companies. It is important to consider the different tax rules and regulations of each foreign market. This complicates tax planning and reporting. In addition, companies should always ensure they are not taxed twice.

Administrative overhead

As companies enter foreign markets, they must comply with local legal requirements, which adds to the bureaucratic burden. Specific documentation, permits, and compliance requirements must be met for each foreign operation. In addition, corporate structures and processes often need to be adapted.

Costs and risks of incorporation

Setting up a foreign operation requires a large initial investment. Among other things, there are costs for setting up infrastructure, personnel, and legal advice. In addition, there is a certain amount of risk in entering a market, as companies can encounter unexpected market conditions, competitive pressures, or cultural differences. For these reasons, companies wishing to expand abroad should proceed cautiously and invest considerable effort in market entry strategies.

Monitoring and management challenges

A foreign operation can also pose challenges for monitoring and management. Companies face the challenge of efficiently monitoring and controlling business processes in different countries. In addition, communication barriers and time zones can make it difficult to collaborate across international locations.