If your company is in the early stages of planning a global expansion, it is important to consider how entity taxation and access to workforce outside your home country can be connected when deciding how and when to execute your growth strategy. Operating in a new market directly as a foreign company or a subsidiary of a foreign company has different tax consequences and compliance costs. Using an Employer of Record (EOR) can help.
Permanent Establishment and Taxable Presence
Permanent Establishment (PE) is a key tax concept in the early stages of global expansion. It is used when a company creates a taxable presence outside their home country. A relevant factor in determining PE includes employment of a workforce in a new market regardless of the number of employees.
A company doing business directly with customers in a new market without a subsidiary ideally aims to avoid creating a PE in that new market, saving them tax dollars and compliance costs outside their home country. The determination of PE depends on the company’s activities in the new market and the tax treaties between countries, if any.
Income tax treaties with the U.S. identify the activities of a company in one country which do and do not create a PE in another country. Activities typically needed for expanding operations such as a fixed place of business and a workforce do create a PE in one country when carried out directly by a company outside of that country. Use of a subsidiary to own and operate the fixed place of business and hire the workforce in a new market shifts the tax responsibility from the foreign parent to the subsidiary.
Some businesses need access to employees prior to having a substantial operation or need for a fixed place of business; a subsidiary at this stage of growth could cause the company to incur additional or unnecessary expenses. However, delaying the use of a subsidiary until it would provide greater benefit to a larger scale operation could create an additional tax burden and tax compliance costs on the foreign parent.
Why You Should Consider an Employer of Record
When the need is simply to hire people in a new market, there is an alternative option to consider outside of a branch or subsidiary. An Employer of Record (EOR) employs talent directly on a company’s behalf in countries where the EOR has established legal entities.. Effectively, the EOR legally employs that talent on behalf of the hiring company, rather than the hiring company directly employing the worker. Hence, the EOR assumes the liabilities of operating a local business as well as the responsibilities of administering payroll and employment in the country. Knowing their business is operating compliantly and seamlessly, the company can then focus on the core business-growth activities that matter most.
The case study below illustrates how a U.K. company benefited from using an EOR while expanding to the U.S., helping them manage the costs and benefits of operating in the U.S. while having access to a workforce in the U.S. to grow their business.
A U.K. company began selling products directly to customers in the U.S. and discovered a growing demand for their product. Key considerations for their U.S. growth strategy centered on U.S. employees:
- When will employees be needed in the U.S. to support growth?
- How do they recruit, compensate and provide benefits in a U.S. regulatory environment much different from that in the U.K.?
- Does the need for “boots on the ground” in the U.S. impact the U.K. company’s U.S. tax consequences?
Phase 1: Initially their U.S. market growth was driven by ecommerce sales without the need for U.S. employees. Under the U.S. U.K. income tax treaty, the U.K. company’s shipping of product directly to U.S. customers did not create a PE, or taxable presence, for the U.K company in the U.S. for federal income tax purposes.
Phase 2: With market recognition growing for their product in the U.S., they identified a need to provide their U.S. customers with training. Independent contractors in the U.S. hired by the U.K. company would not create a PE under the treaty but this arrangement would not meet the needs of their U.S. business. Alternatively, hiring U.S. employees directly by the U.K. company would create a PE, requiring the U.K. company to file returns and pay federal income tax in the U.S. They did not want to trigger the U.S. tax consequences for the U.K. company, but they did not feel their U.S. operation was large enough to warrant the costs of establishing and administering a subsidiary. Therefore, an EOR solution was a great alternative to consider at this point in their U.S. expansion.
Phase 3: The U.K. company engaged an Employer of Record (EOR) to recruit, hire and manage y talent on their behalf, not only in the U.S. but also in other markets to support their entire global growth strategy. Using an EOR partner eliminated the PE exposure for the U.K. company in the U.S. and delayed the need to establish a U.S. subsidiary at this stage of growth saving unnecessary compliance and administration costs at that time.
Phase 4: With continued growth in the U.S., the U.K. company needed to establish a physical office and warehouse in the U.S. to be operated by their workforce which would trigger a PE. Additionally, as the EOR workforce grew, they were approaching a point where the cost could soon outweigh the benefit of the solution. After carefully managing their growth in a tax and cost-efficient manner, they had finally reached the point where it was beneficial to set up a U.S. subsidiary for their U.S. operations and directly employ their workforce.
Successful Expansion Planning is a Team Effort
Every company has different considerations in their expansion and growth strategies. Maximize your expansion success in a new market by including your whole team of advisors in the expansion planning conversations because many operational issues and solutions are closely linked to tax opportunities and consequences.