Permanent Establishment Risk for Foreign Companies

Permanent establishment risk: why it matters

Permanent establishment risk is the risk that a foreign company becomes taxable in Germany without intending to, because its activities in Germany create a permanent establishment (Betriebsstätte) or a permanent representative. Under German domestic law, a non-resident company is subject to German corporate income tax on business income if it maintains a permanent establishment in Germany or has appointed a permanent representative (§ 49(1) no. 2(a) of the Income Tax Act), and to trade tax if it operates a permanent establishment in Germany.

Tax treaties restrict Germany's taxing rights to profits attributable to a permanent establishment as defined in the treaty, which is often narrower than the domestic definition. The consequences of an unrecognised permanent establishment include German tax filings, profit attribution, trade tax, interest and penalties, often for several years.

The rise of remote work, cross-border sales teams and project business has made permanent establishment risk a recurring topic for foreign companies with employees, agents or projects in Germany. This article explains the main triggers under German law and typical treaty provisions, and how companies can manage the risk.

Fixed places of business

Under § 12 of the Fiscal Code (AO), a permanent establishment is any fixed place of business or facility that serves the activity of an enterprise. The statute lists typical examples: the place of management, branches, offices, factories and workshops, warehouses, purchasing and sales outlets, mines and quarries, and construction or installation projects lasting more than six months. Treaties following the OECD Model Tax Convention use a similar definition but generally exclude preparatory or auxiliary activities, such as storage, display or purchasing, and typically set a longer threshold of twelve months for construction projects.

The key elements are a place of business, a certain degree of permanence and the enterprise's power of disposal over the place. A permanent establishment does not require ownership or a lease; it suffices that the enterprise can use the premises for its business on a lasting basis. Office space provided by a customer, a desk at a group company or a room in a co-working space may qualify if the foreign enterprise's staff use it regularly for its business.

Permanent representatives and dependent agents

German domestic law also taxes non-resident companies that act through a permanent representative (ständiger Vertreter). Under § 13 AO, a permanent representative is a person who carries on the business of an enterprise on a lasting basis and is subject to its instructions, in particular a person who concludes or negotiates contracts or obtains orders for the enterprise, or maintains a stock of goods and makes deliveries from it. The domestic definition is broad and can include employees, group companies and agents.

Under treaties based on the OECD Model, a dependent agent creates a permanent establishment if it habitually concludes contracts in the name of the enterprise or, under the more recent wording adopted in some treaties following the multilateral instrument, habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. Independent agents acting in the ordinary course of their business generally do not create a permanent establishment, but an agent acting exclusively or almost exclusively for one enterprise may not be regarded as independent.

Sales employees in Germany who negotiate prices, agree terms with customers and effectively decide on contracts, even if the formal signature is given at headquarters, are a classic source of permanent establishment risk. Commissionaire and distributor structures need equally careful review.

Home offices of employees

Remote work has raised the question whether an employee's home office in Germany creates a permanent establishment of a foreign employer. The answer depends on the facts. A home office can be a fixed place of business, but whether it is at the enterprise's disposal is the decisive question.

German tax authorities and courts consider factors such as whether the employer requires or merely allows the home office, whether the employer bears the costs or provides equipment, whether the employee has an office available elsewhere, and what kind of activity is performed there. Occasional home working for personal convenience generally does not create a permanent establishment; a home office used as the base for a German sales or management function at the employer's request may do so.

Even where the home office is not a fixed place of business, the employee may be a permanent representative or dependent agent if he or she concludes or negotiates contracts. Managing directors working from home in Germany can also shift the place of effective management of a foreign company to Germany, with the consequence of unlimited German tax liability. Our article on employment contracts for foreign employers covers the employment law aspects of remote hiring.

Group companies, servers and digital business

Group structures raise their own questions. A German subsidiary is not automatically a permanent establishment of its foreign parent, but it can become a dependent agent if it habitually concludes contracts in the parent's name or plays the principal role in concluding them. Service companies that provide sales support, marketing or technical services for a foreign principal should therefore have clearly defined tasks and arm's length remuneration, and their staff should not commit the principal. Seconded employees who work at a German group company but remain on the foreign employer's payroll can also create a presence of the foreign employer if they act for it rather than for the German company.

Digital business models are not immune. A server located in Germany and operated by the foreign enterprise can be a fixed place of business, although a website alone is not. Data centres and cloud infrastructure owned or exclusively controlled by a foreign company deserve review, while hosting by a third-party provider usually does not create a permanent establishment of the customer. Treaty rules on preparatory or auxiliary activities often decide the outcome.

Construction and installation projects

Construction sites, installation and assembly projects create a permanent establishment under German domestic law if a single project, one of several simultaneous projects or a series of uninterrupted successive projects lasts more than six months (§ 12 sentence 2 no. 8 AO). Treaties usually provide for a longer period, often twelve months, and some contain specific rules for supervisory activities and for splitting contracts. The period starts with the beginning of work at the site, including preparatory work, and continues through temporary interruptions.

Foreign contractors in plant engineering, renewable energy projects, telecoms infrastructure and industrial maintenance frequently exceed these periods. In addition to income tax, they must consider German VAT, wage tax for their employees, the construction withholding tax on payments received for construction services unless an exemption certificate is obtained, and the rules on posting workers discussed in our article on posting workers to and from Germany.

Consequences of a permanent establishment

If a permanent establishment exists, the foreign company must register with the municipality and tax office within one month of opening it (§ 138(1) and (4) AO), file corporate income tax and trade tax returns, and attribute an arm's length share of its profits to the German permanent establishment. Germany applies the authorised OECD approach, treating the permanent establishment as if it were a separate enterprise, and requires documentation of the attribution of functions, assets and risks (§ 1(5) of the Foreign Tax Act). Profits attributed to Germany are taxed at the combined German rate of corporate income tax, solidarity surcharge and trade tax, usually around 30%, with the home country typically granting relief through exemption or credit.

If the permanent establishment is discovered only in a tax audit, back taxes for several years, interest and possibly penalties for late filing apply. Double taxation may result if the home country does not grant relief for years that are already closed. In severe cases, tax evasion proceedings can follow if the company's representatives deliberately ignored the obligations; see our article on voluntary disclosure under § 371 AO.

Managing permanent establishment risk

1. Map all German activities: employees, contractors, agents, projects, premises and equipment.
2. Assess each activity under § 12 and § 13 AO and the applicable treaty, including the treaty version modified by the multilateral instrument.
3. Review employment and agency agreements for authority to conclude contracts, and align actual practice with the documents.
4. Monitor durations of construction and installation projects against the six-month domestic and the treaty thresholds.
5. Where a permanent establishment cannot be avoided, consider establishing a German subsidiary, which may provide clearer profit allocation and limit liability.
6. Coordinate with VAT, payroll and social security, which follow their own rules on fixed establishments and employers.

Illustration: a Dutch software company hires a sales director who lives near Munich and works from home. She negotiates contract terms with German customers, and the contracts are signed in Amsterdam without changes. The company pays for her home office equipment, and she has no other office. The tax office may argue that she is a dependent agent and that her home office is at the company's disposal, so that the company has a German permanent establishment to which a share of its German sales profits must be attributed. A German sales subsidiary with a service agreement would have offered a clearer structure. Our international tax page outlines our cross-border advice.

How TRW & Co helps with permanent establishment risk

We advise foreign companies on permanent establishment risk in Germany: reviewing remote work and sales structures, project business and agency arrangements, structuring market entry through subsidiaries or branches, and preparing registrations and profit attribution documentation where a permanent establishment exists. In tax audits and disputes, we defend positions on the existence of a permanent establishment and the attribution of profits, and we pursue mutual agreement procedures to avoid double taxation. To discuss your activities in Germany, contact us. This article provides general information and is not tax or legal advice.