The increase in the number of employees working from home since the Covid pandemic, combined with the fact that this home is often located abroad, has given new impetus to the question of whether, when and on what criteria an employee establishes a foreign permanent establishment for the company. Working from a home office abroad is made even easier by the fact that, under certain conditions, employees can spend up to 49.9% of their working time there without having to switch to the social security system of their country of residence (see Multilateral Framework Agreement on the Application of Article 16(1) of Regulation (EC) 883/04 in the case of habitual cross-border teleworking). This saves the employer from having to pay social security contributions for their employees to foreign funds at sometimes higher rates (e.g. France).
However, behind this ease of being in modern working environments lie tax risks for the employer.
From the perspective of the German tax authorities, the decisive factor for establishing a permanent establishment at the employee’s place of residence is whether the company gains control over the employee’s home. Although the tax authorities have provided sensible and, in practice, easily verifiable case studies for the absence of such power of disposal in their BMF letter of 5 February 2024 (amendment to the application decree for the German Fiscal Code), it should not be overlooked that the criterion of power of disposal applies to permanent establishments of foreign companies in Germany and that it cannot be assumed that foreign tax authorities apply the same assessment criteria for the establishment of a permanent establishment in their country.
The OECD Model Tax Convention and, with it, the majority of double taxation agreements concluded by Germany with other industrialised nations stipulate that a company’s profits can only be taxed in the country in which the company is based, unless it conducts its business activities in another country through a permanent establishment located there.
The permanent establishment is defined in the model agreement as a fixed place of business through which the business activities of an enterprise are wholly or partly carried on. Individual agreements, such as the DTA with France, contain wording to the effect that the activity in question must be carried on in the fixed place of business. The difference becomes clear when one imagines a gas pipeline or, more modernly, a server that a company uses to provide its services.
Particular caution is required when employees in management positions work from a home office abroad or when the employee in question is responsible for the company’s sales. In these cases, the concept of a permanent establishment is no longer linked to a fixed place of business in the sense of a tangible local presence (which may even be absent in these cases), but to the employee’s function within the company. Particularly in the case of so-called representative permanent establishments, i.e. employees working in purchasing and sales for the company, it is no longer sufficient to refer to the DTA to protect against the creation of a foreign permanent establishment. While newer agreements often follow the provisions of Article 5(5) of the OECD Model Tax Convention, according to which a person already establishes a representative permanent establishment if they play a leading role in the conclusion of contracts without themselves having the authority to conclude contracts, this may now also apply to agreements which, according to their wording, still require this authority to conclude contracts.
This is ensured by the Multilateral Instrument (MLI), a set of rules deposited with the OECD which, provided that a bilateral agreement (DTA) is declared by the two respective user states to be covered by the MLI, can “override” individual provisions of the DTA. A further prerequisite for this is that both states declare the relevant provision of the MLI to be applicable.
This mechanism can mean that an agreement which, according to its wording, requires the representative to have power of attorney for the creation of a representative permanent establishment, allows the representative to play a leading role in the conclusion of contracts on the basis of Article 12(4) MLI, which has been declared applicable by the countries concerned.
Conclusion
Before allowing an employee to work from a home office abroad, employers are advised to assess the risk of their company establishing a permanent establishment abroad. As the risk of this happening often depends on the employee’s role within the company, it is not possible to draw conclusions about employee B based on employee A. Each individual employee can establish a permanent establishment for themselves and in their role.
The most important points in brief
- An employee’s work in a foreign home office can establish a permanent establishment of the company abroad for income tax purposes
- Tax, social security and labour law must be strictly distinguished from one another: relief in one area (e.g. social security) does not say anything about the tax risk
- The respective DTA is no longer sufficient as a guide. The MLI must also be consulted.
