Corporate tax and finance practitioners often use the term "Permanent Establishment" (PE) and Transfer Pricing in the same breath. What's the connection?
For the uninitiated, PE is a tax treaty concept which refers to a fixed place of business or activity in another country that gives said country the right to tax profits attributable to that presence. Crossing the PE threshold triggers taxation in the other country. (If no treaty applies, the threshold under domestic law can be much lower and taxation much more expansive.) The business is then generally taxed on business profits attributable to the PE.
This is where transfer pricing comes into play. The allocation of income to the PE requires analysis of functions performed, assets employed, and risks assumed by the PE in line with transfer pricing principles and the arm's length standard.
For example, USCo, a US-based manufacturer, sends sales executives to negotiate and execute contracts to sell its products to a UK customer. The company engages Eide Bailly for a PE analysis, which concludes that the activities conducted in the UK likely constitute PE. USCo must then allocate profits to the UK PE by determining a transfer pricing policy between USCo's US operation and the UK PE - perhaps, for instance, a policy setting PE profits to a fixed percentage of local sales.
Whenever PE is an issue, proper transfer pricing is essential to avoid tax controversy and double taxation risk. Transfer pricing professionals should work hand-in-hand with international tax specialists so that the nuances of tax treaties and other cross-border tax and legal considerations are accounted for when allocating profits to PEs.
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