Business, branch or representative office in Luxembourg
A Luxembourg resident company developing activities in another country may consider establishing a permanent place of business, a branch or a simple representation office abroad. This decision could trigger different tax implications depending on in which country the permanent establishment will be based.
Indeed, all income generated by a Luxembourg resident company is taxable in Luxembourg, on a worldwide basis. If a Luxembourg company establishes a Permanent Establishment in a country with which Luxembourg has signed a Double Taxation Treaty, then the profits realised through this branch may generally be taxable in that country.
Permanent Establishment In Luxembourg
When a company has a fixed place of business in Luxembourg and benefits from the various fiscal opportunities created by Luxembourg Law it will be considered permanently established if:
- it has a person who can represent the company in Luxembourg,
- the representative undertakes this role on a permanent basis,
- there is a premises which can be considered a headquarters and stock, etc.is held at that premises.
Tax Implication of having a Permanent Establishment
If the branch is set up in a Double Tax Treaty (DTT) Country: then the branch's profits will be taxed in that DTT country following the rule and rate of corporation tax applicable to that country. The branch's profits will generally be tax exempt in Luxembourg and the assets held in the branch will also be tax exempt for Luxembourg wealth tax.
If the branch is set up in a non-Double Tax Treaty Country, then the branch's profits will be taxed in that non-DTT country following the rule and rate of corporation tax applicable.. The branch's profits will generally also be taxable in Luxembourg and the company will receive a Tax Credit on the Luxembourg Corporate Income Tax. The assets held in the branch will be taxed at the Luxembourg wealth tax rate.
Type of Permanent establishments (Fixed PE)
The OECD definition of what can be considered as a Permanent Establishment is "a fixed installation where a company has all or a part of its activity", for example:
- a headquarters;
- a branch;
- an office;
- a factory;
- a workroom;
- a mine, quarry or any other place used for the process of extracting natural materials;
- a building site, where work continues for more than six months.
Indeed, if a company carries on its activities and generates income through such premises, it will be taxable as a Permanent Establishment.. However, there a number of exclusions to what is considered Permanent Establishment in terms of the activity carried out at a premises or site. These are outlined below.
The term "Permanent Establishment" cannot be applied when the premises are used solely for:
- the purpose of storage, display or to facilitate delivery of goods or merchandise belonging to the enterprise;
- the maintenance of a stock of goods or merchandise belonging to the enterprise which is intended solely for the purpose of storage, display or delivery;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise.
The term "Permanent Establishment" cannot be applied as:
- the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information for the enterprise;
- the maintenance of a fixed place of business solely for the purpose of advertising for the enterprise, issuing information, doing scientific research or carrying out similar activities of a preparatory or auxiliary nature.
The Representative Person (Agency PE)
However, if a company is acting in a country through a person, it may constitute a Permanent Establishment if that person has, and habitually exercises in that country, an authority to conclude contracts in the name of the enterprise, unless his activities are wholly limited to the purchase of goods or merchandise for the enterprise.
The Broker or Commissionnaire
If a company appoints a broker, a general commission agent or any other agent with an independent status in a country where such persons are acting in the ordinary course of their business, then the company will not be deemed to have Permanent Establishment. The commissionaire can be a subsidiary of the company but should be independent of the company.
The Service Permanent Establishment (Service PE)
The OECD (Organisation for Economic Co-operation and Development) has recently defined another type of Permanent Establishment. The concept of Service Permanent Establishment, which favours source based taxation. The concept of "Service PE" reads as follows: “The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature.
The Service Permanent Establishment (Service PE)
The OECD has recently defined another type of Permanent Establishment. The concept of Service Permanent Establishment, which favors source based taxation. The concept of "Service PE" reads as follows: “The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than six months within any twelve–month period”.
Some emerging market economies, like India, which are predominantly capital importing nations, generally try and negotiate Service PE clause in Double Tax Treaties, so as to tax profits of foreign enterprises operating within their territories, even in circumstances where no Fixed or Agency Permanent Establishment exists.
Subsidiary or branch
If the company wishes to avoid the problems of being considered as having a Permanent Establishment, it can simply decide to set up a company in the chosen country and this will become a subsidiary company (it will no longer be considered a branch). This may have some legal and tax implications:
- Legally, the branch is not a separate entity of its head office. When a mother company establishes a subsidiary company, the two companies have separate assets/liabilities.
- The branch is managed by the same board of directors and has the same shareholders, while a subsidiary can be held by several investors and have a separate board of directors.
- The branch is considered as an extension of its head office; therefore the liabilities of one is common to the other, while for a subsidiary the limited liability may be a concrete advantage.
- The branch may be established in a country with which Luxembourg has not yet signed a Double Tax Treaty (see above for the tax treatment). In this situation it may be useful to consider incorporating a subsidiary which can generate dividends. These dividends could benefit from the participation exemption in Luxembourg (assuming certain conditions are met).
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