19 Jul Permanent establishment An example from the Czech Republic
Hiring an employee / Permanent establishment / Sales agent contract / Creation of a subsidiary
A French company wants to develop its business in the Czech Republic. It proposes to employ an employee to handle advertising and product promotion, who would work from his home in the Czech Republic.
It is considering other alternatives, including recruiting a sales agent or possibly setting up a subsidiary.
The question of permanent establishment in the Czech Republic arises.
I. The concept of permanent establishment.
The concept of permanent establishment is used in the vast majority of tax treaties. The Tax Treaty between France and the Czech Republic came into force in 2019 in France and 2020 in the Czech Republic.
According to Article 5 of this treaty, a permanent establishment is “a fixed place of business through which an enterprise carries on all or part of its activities”. This therefore refers to the performance of industrial or commercial activities, which are not of a preparatory or auxiliary nature (art. 5 §4 e), by a company in a State which is not its State of residence. Thus, the presence or absence of an establishment will determine the place of taxation of income arising from the company’s industrial or commercial activity.
Paragraph 5 of the same article also specifies that the representative of the company, other than a self-employed person, must not carry on an activity which enables him to conclude contracts in the name of the company.
Where the “dependent” representative can, on his own initiative, bind the company by habitually deciding on certain transactions that the latter merely ratifies, even if they are not contracts in the company’s name, there is a permanent establishment (Conseil d’Etat, 12/12/2020, Société Conversant International Limited v French tax authorities).
The case law in the Czech Republic should also be checked.
The consequence of having a permanent establishment is that corporation tax and VAT must be paid on turnover generated in the Czech Republic.
II. How to avoid being classified as a permanent establishment?
In our situation, the aim is to pay tax only in France and therefore not to fall within the scope of Article 5 of the Tax Treaty and the concept of permanent establishment in the Czech Republic.
The employee’s mission should really be limited to promoting the company, advertising and market research, and he or she should not be able to place orders or take care of deliveries or after-sales. Orders and deliveries must be made directly from France.
The employee must not therefore have the possibility of concluding contracts on behalf of the company himself, or of committing the company through the decisions he takes. They must not “habitually play the main role leading to the conclusion of contracts”.
Furthermore, he must not work from a fixed address or premises, since an office can be characterised as a permanent establishment (art. 5 §2 c Tax Treaty between France and the Czech Republic).
The customer must not have the impression that he is dealing with an entity other than the French company.
The only charges to be paid in the Czech Republic will therefore be, according to Article 15 of the Tax Treaty, “the salaries, wages and other similar remuneration which a resident of a Contracting State receives in respect of an employment relationship”.
A possible alternative would be to use a commercial agent or a subsidiary.
III. Commercial agents in the Czech Republic.
The European Directive (86/653/EEC) of 18 December 1986 on self-employed commercial agents applies in the Czech Republic, which is a member of the European Community.
A commercial agent is an independent professional. He negotiates and/or concludes contracts of sale, purchase, hire or provision of services on behalf of a third party.
A permanent establishment does not exist when a company uses a commercial agent and the agent is independent (art. 5 §6 Tax Treaty between France and the Czech Republic). The French company will therefore not be taxed in the Czech Republic on its profits (art. 7).
A sales agent located in the Czech Republic provides a good knowledge of the territory. It is remunerated by commission.
However, if the company opts for a sales agent, it needs to take care when drafting its contract. It must be determined whether exclusivity is granted, for example, and it is best to define it, specifying whether it covers a limited period, a precise territory and even how it can be terminated. In addition, it is necessary to specify how the contract is to be terminated and how sufficient notice is to be given (Article 15 of Directive 86/653/EEC), and to check how the customer indemnity at the end of the contract is to be assessed in the light of the law applicable to the contract (French or Czech?).
The European directive also provides that a fixed-term contract of this kind, if it continues to be performed by the parties after its term, is deemed to be converted into an open-ended agency contract (article 14).
IV. Setting up a commercial entity.
The company also has the option of setting up offices in the Czech Republic. In this case, it establishes itself by setting up a company or a branch. This has tax consequences, since a branch is considered to be a permanent establishment (art. 5 §2 b).
Both must be registered in the commercial register in order to have a legal existence.
In this case, it is necessary to refer to Article 7 of the Tax Convention which indicates how profits generated by an enterprise or by a permanent establishment are taxed: “The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business in such a manner, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment”. It is therefore in the Czech Republic that the profits of the newly created company and those of the branch, where they are attributable to it, will be taxed.