The Pit of Permanent Establishment – Part 2
Local Distributor / Agent Model
In “The Pit of Permanent Establishment – Part 1”, we looked at how a technology business could find itself creating a permanent establishment in a foreign jurisdiction by accident – just by starting to do business without obtaining appropriate tax and legal advice, and that this invariably resulted in adverse cost consequences for the business. In this article, we are going to consider one of the safer business alternatives to accidentally creating a permanent establishment – working with a local distributor or agent.
1. Working with a Distributor
1.1 If your business involves the sale of products, then when you start thinking about doing business in a new country, consider whether you could work with a distributor experienced in selling similar types of products to your product and to a comparable likely market demographic.
1.2 If your product is one which would require telecom type approval in the new country, a distributor with relevant experience should be able to help you with the local homologation approval process. It is also worth pointing out that if the distributor already provides maintenance, installation and/or helpdesk support for similar products, then it is likely that their staff could be trained relatively easily to support your business in a professional and cost-effective way.
2. Working with an Agent
2.1 If your business just wants an outlet for its products, but is less interested in the “bricks and mortar” support of a traditional distributor and does not need support with more complex local matters such as telecom type approval, then think about working with a local agent, who would essentially just provide a sales outlet for your business’ products in the new country.
2.2 A sales agent experienced in representing multiple businesses from a sales perspective, might also be a good option if you are looking to sell services in a new country (as opposed to products). Be aware though that the agency solution will not work if you are selling regulated services, which require a local telecommunications licence or other regulatory approval, which the agent does not have. If you want to provide local telecommunications services support to your customers, you will either have to set up a local business and obtain the relevant licences in your own name, or find a regulated communications provider to support your customers locally.
3. Advantages and Disadvantages of the Distributor/Agent Models
3.1 Provided the agreements are structured properly (and this will be the subject of a future blog), the advantages of working with an agent/distributor include (a) your business not creating a permanent establishment in country; and (b) a big cost saving against either creating a formal trading presence in your own name or creating an accidental permanent establishment.
3.2 The downside for some businesses is that they do not have such close control over the quality of the customer experience as they could do with a full local presence. You also need to be aware of the exposure to withholding tax liability.
4. Withholding Tax and Bilateral Tax Treaties
4.1 Withholding tax arises when an offshore seller receives compensation for products or services sold or otherwise introduced into a country in which it does not have an incorporated local legal entity or trading branch. It is a tax, which the buyer (including an agent or distributor) is obliged to deduct and pay to the local tax authorities before paying the seller (you) what you thought you were going to get for the supply of those products/services based on the wording of the relevant contract. Bear in mind that withholding tax may be applied at anything from 5 to 30% of the revenue value of the goods or services being supplied by an offshore provider.
4.2 Not all jurisdictions apply withholding tax. Withholding taxes do not apply to sales from one EEA country to another, for instance. One way in which companies may typically try to avoid withholding tax is to say that if withholding tax becomes due, the buyer must pay the withholding tax and then still pay the seller the full amount of charges due after payment of the withholding tax (sometimes called “grossing up”). Depending on the commercial bargaining power of the parties (or the apathy of the local tax authorities to collecting withholding tax), the buyer may agree this approach, but more often than not, it will not. In situations where grossing up of withholding tax liability has not been agreed, your business needs to understand in advance how to assess its liability to withholding tax and how it might be able to offset withholding taxes against its home jurisdiction income taxes. This is where the importance of bilateral tax treaties comes in.
4.3 Bilateral tax treaties are tax treaties between two countries, which explain how the parties will treat goods and services sold on a cross border basis from one country to the other. Where there is a bilateral tax treaty in place, you will find that withholding taxes paid in one country can be claimed back against local income taxes in the other country; typically less a clawback of around 5% but sometimes with no clawback at all.
5. UK Bilateral Tax Treaties
For information about which countries the UK has bilateral tax treaties with, visit https://www.gov.uk/government/collections/tax–treaties
If your business is interested in doing business in a new country, and would like support with a distribution or agency agreement, or with understanding the withholding tax provisions in your new market, please contact [email protected]