A routine contractor arrangement could already be creating a taxable presence abroad.
Like an iceberg in the water, enterprises hiring overseas talent face a massive risk sitting just beneath the surface of their workforce programs. It’s called permanent establishment risk, and it can carry serious consequences in the form of fines and added tax burden.
Fortunately, the right guidance and workforce structure go a long way to minimizing exposure to permanent establishment (PE) risk. This article looks at where that exposure can emerge in contingent worker arrangements and how enterprises can address it before it becomes a larger issue.
Let’s start by understanding what permanent establishment risk is and why it’s worth paying attention to.
What Is Permanent Establishment Risk? And Why Does It Matter?
Does your business operate in a place where it has not formally set up? If so, a local tax authority may decide it has a permanent establishment there, meaning it could owe corporate tax in that jurisdiction.
A jurisdiction is any place with its own tax rules. That could be a country, state, or province. So while permanent establishment risk is often discussed in global hiring, the same basic issue can arise whenever work crosses a tax border.
The risk is that the business may owe tax where it did not expect to be taxable. It may also face penalties if the tax authority decides the company should have registered, reported income, or paid tax in that location. In some cases, the same income can be taxed in more than one place.
For example, an American company may pay corporate tax in the USA. If its activity in Germany creates a permanent establishment, Germany may also tax the profit connected to that market. A tax treaty may reduce the final cost, but the company could still face extra filings and tax scrutiny.
How PE Risk Develops
PE risk develops when a company starts resembling an established business in a jurisdiction where it has not formally registered. The rules vary by location, but tax authorities commonly look for certain types of activity:
- Fixed place of business: The company has a physical location where business activity takes place. This could include an office, branch, or long-term worksite.
- Construction projects: A building site, installation project, or similar activity continues beyond the time limit set by local rules.
- Agency activity: A person or agency acts on behalf of the business in another jurisdiction. The risk is higher if they negotiate or conclude contracts for the company.
- Virtual permanent establishment: Some jurisdictions may treat a company as having a taxable presence if it has significant digital operations in a market. This could include local servers, a data center, or an online platform used to sell or deliver services to customers there.
Why PE Risk is Often Hidden
A common misconception is that PE risk only applies to direct employees. That is not how tax authorities always assess the issue.
Contingent workers — like contractors, consultants, or supplier-managed workers — still create exposure if their activity makes the enterprise look established in another jurisdiction. Worker classification is important in explaining how the worker is engaged, but it does not decide whether the business has created a taxable presence.
In the UK, for instance, the tax authority clearly states that workers do not have to be direct employees to create PE exposure. Any worker acting on behalf of the enterprise may create risk if their activity makes the enterprise look established in that market.
This becomes especially important with dependent agent PE. This is when a taxable presence is created by someone acting for the enterprise in another country. The critical issue is authority. If a contingent worker has the authority to sign contracts or agree to key terms, tax authorities may view that worker as creating a local business presence. Risk may also arise if they lead deals the enterprise usually accepts.
Minimizing risk requires reviewing every cross-border contingent worker arrangement against the rules of the jurisdiction where the work happens. The review should ask whether the worker is simply supporting the business from another location, or whether their activity makes the enterprise look like it is operating in that market.
The risk rises when the worker represents the company locally. That could mean agreeing to customer terms, signing contracts, or acting as the company’s regular contact in the market. A regular work location can also become evidence of permanent establishment if it becomes a base for carrying out the enterprise’s business.
The OECD Update Prompting Renewed Risk Assessment
The 2025 update to the OECD Model Tax Convention introduces new guidance on when remote work counts toward permanent establishment. The key change is to the Commentary on Article 5, used to interpret when a business may have a taxable presence in another country.
Because the convention shapes many cross-border tax treaties, the update is likely to have a significant impact on how PE status is assessed across jurisdictions.
New Guidelines for Assessing PE Risk
According to EY, the updates introduce two clear guidelines for determining PE risk.
The first is the 50% working-time benchmark. Here’s the main takeaway: if someone works from the same location for more than half their working time, that location may start to look like a fixed place of business for the enterprise. The risk is clearest where remote workers are based in jurisdictions where the enterprise has no formal presence. That includes contingent workers, who may sit outside traditional mobility reviews.
The second guideline is the commercial reason test. This asks whether a worker’s location supports business operations, such as interaction with local customers or suppliers. By contrast, remote work based on personal convenience, talent retention or office cost savings is less likely to support a PE finding on its own.
The Need to Audit Cross-Border Arrangements
The OECD updates prompt enterprises to audit their cross-border work arrangements before they become tax problems. Many organizations might find that the updates increase their risk exposure, or that their exposure was already high to begin with.
According to legal experts like Ogletree Deakins, these updates do not turn PE risk assessment into a simple box-checking exercise. Instead, they highlight the importance of “robust tracking and policy frameworks,” which are key to maintaining compliance and avoiding penalties.
As PE risk depends on what the worker does and where they do it, assessment must include direct employees and contingent talent. That audit should look at factors like:
- Where workers are based
- How much time they spend working from each country
- What activity they perform
- Whether there is a business reason for the location
- Whether local rules treat the arrangement differently from the OECD guidance
Local Rules Are as Important as the Broader OECD Framework
The OECD guidance is influential, but it should not be treated as a universal rule. EY notes that several jurisdictions have expressed reservations or different interpretations of the new updates, meaning local rules may still apply differently. India and Nigeria, for instance, disagree with parts of the commercial reason test. Israel also adds its own qualifications, including how it may calculate the 50% threshold.
Canada is another useful example. BLG notes that, while OECD guidelines aren’t binding in Canadian courts, they are a well-established tool for interpreting Canada’s tax treaties. For US employers with Canada-based workers, for instance, this should prompt a review of whether those arrangements create PE risk.
The impetus is that, while there are prevailing winds dictating a general direction, local expertise is needed to navigate the specific rules and risks in each jurisdiction.
Where contingent workforce programs typically fall short.
Many contingent workforce programs are built to answer a practical question: can this worker be engaged?
That review may be enough to move the assignment forward. But it may not answer the tax question sitting underneath it: could this person’s work make the enterprise look like it is operating in that country?
The result is a common governance and compliance gap that increases exposure. Most often, the gap forms due to a point made earlier. Responsibility for worker engagements is split between many parties, with each having its own priorities and jobs to get done. At the same time, exposure can surface throughout the worker engagement, such as during local payroll setup or onboarding. KPMG’s review of the OECD guidelines highlights that PE risk increases based on small details in how workers are engaged. These details are often overlooked in standard supplier reviews, even though they are central to the PE question.
To minimize exposure, enterprises need support from expert partners who understand the local tax landscape. They need partners who understand how to structure and review engagements so they are compliant without sacrificing speed and efficiency.
How EOR & AOR Partnerships Reduce PE Risk
EOR and AOR partnerships reduce PE exposure by taking over key employer and engagement responsibilities that would otherwise sit with the enterprise. They help organizations engage cross-border talent compliantly, without setting up a local entity or creating unnecessary permanent establishment exposure. Each serves a different part of the talent market.
An employer of record, or EOR, is used to engage contingent workers who need to be employed in another country. The EOR employs the worker through its own local legal entity and becomes responsible for the employment relationship. That reduces direct PE exposure because the local employment relationship sits with the EOR, rather than being held by the client organization.
An agent of record, or AOR, is used to engage independent contractors. The AOR does not become the employer. Instead, it helps manage the contractor relationship, including classification, documentation, and payroll. That contains risk by limiting the enterprise’s direct relationship with the contractor in that jurisdiction.
Enterprises increasingly rely on EOR and AOR to engage talent wherever it’s found. Tax experts at Thomas Reuters praises their reliability in helping reduce PE risk while also enabling enterprises to make “rapid pivots into new geographies without adding significant operational burden.”
Benefits of Partnering with an AOR or EOR
EOR and AOR partnerships offer enterprise workforce programs a clearer chain of responsibility. Instead of being dispersed among multiple teams, worker compliance and tax considerations sit with one dedicated partner with expertise in these exact areas.
That partner can then take responsibility for the core administration that shapes the engagement, including:
- Local employment or contractor administration
- Payroll and contractor payments
- Worker classification and documentation
- Tax withholding and statutory requirements
- Ongoing compliance support as local rules change
Handled together, these activities give leaders a clearer view of who is working where, how each worker is engaged, and which arrangements may need closer tax or compliance review.
They also make cross-border hiring more repeatable. Instead of working out the process market by market, teams can route each engagement through a partner built to manage local employment and contractor requirements.
Finding the Right Workforce Partner Supports International Compliance
Managing permanent establishment across a contingent workforce requires more than knowing where people work. Enterprises need a workforce structure that makes each cross-border engagement clear, compliant, and easy to review.
People2.0 helps organizations hire and place talent compliantly across jurisdictions and borders. Our in-region compliance experts bring local understanding to worker classification, employment obligations, payroll administration, and worker engagement.
Through our employer of record (EOR) services and agent of record (AOR) services, you can outsource critical back-office tasks to us, simplifying how you engage contingent workers or contractors, respectively.
If your organization is reviewing its global workforce plans, People2.0 can help pinpoint where PE exposure may sit. We can also help you reduce risk for each engagement and market. Reach out to explore how we can help you engage talent across borders.
FAQ
1. What is permanent establishment risk?
Permanent establishment risk arises when your business does enough work in another country for the local tax authority to treat it as taxable there, even if you have not registered a local entity. This can lead to unexpected tax obligations, reporting requirements, penalties, or closer scrutiny.
2. Can contingent workers create PE risk for an enterprise?
Yes, contingent workers can create permanent establishment risk if their activity makes the enterprise look established in another jurisdiction. Their employment status matters, but tax authorities may focus more closely on what the worker does, where they do it, and how closely the work is tied to the business.
3. Which contingent worker activities are most likely to create PE exposure?
PE exposure is more likely when a contingent worker represents the enterprise in a local market. This may include managing customer relationships, negotiating terms, concluding contracts, or regularly delivering business-critical services from that country.
4. How did the OECD’s 2025 update change PE risk assessment?
The OECD’s 2025 update added clearer guidance for assessing when remote work may contribute to PE risk. It introduced a 50% working-time benchmark and a commercial reason test, which place more focus on where work is performed and why the worker is based there.
5. How do EOR and AOR partnerships help reduce PE exposure?
Employer of record (EOR) and agent of record (AOR) partnerships help reduce PE exposure by taking over key employer or engagement responsibilities that would otherwise sit with the enterprise. EOR supports contingent workers through a local employment relationship, while AOR helps structure independent contractor engagements more compliantly.
Editorial oversight by Jeremiah Akin, Senior Manager, Global Brand and Content
