Permanent establishment risk from remote work and the OECD’s new guidance

Editor: Jessica L. Jeane, J.D.

The global economic environment was simpler when people and goods were less mobile. Seventy–five years ago, if you wanted an apple, you would likely go to your local market to buy a locally grown one, and the cashier was someone who lived nearby. Now, you can purchase an apple grown anywhere from an app on your phone and have it delivered on the same day. As the economic world changes, the tax system needs to adapt. This discussion focuses on the tax implications when employees work remotely from a foreign nation.

Corporate income taxes are typically assessed on companies whose activities give rise to a taxable presence within a given jurisdiction. This is a nuanced, facts–and–circumstances–based analysis, largely dependent on factors such as where the company was formed, what activities are conducted within a particular jurisdiction, where its employees are located (or are traveling to), where the seat of management is located, and where its property is located. In the international context, this analysis can become simpler if two jurisdictions have an income tax treaty in force that narrows the definition of a taxable presence to a “permanent establishment” (PE). While the definition can vary by treaty, a PE generally arises in a jurisdiction in two key ways:

1. Through a fixed place of business (such as a place of management, branch, office, or factory) through which the company wholly or partly carries on its business, or
2. Through the activities of a dependent agent who habitually exercises authority to conclude contracts on behalf of the company.

In this digital age, and increasingly so post–COVID, remote work has been on the rise. The PE risk is highest if the person working remotely is a high–level employee or someone in a C–suite role who typically can conclude contracts in the name of the company. These individuals might also own vacation homes that could create a fixed–place or dependent–agent PE for their employer.

Tax laws have been slow to adapt to remote-work arrangements. Recently, however, the Organisation for Economic Co-operation and Development (OECD) released the 2025 Update to the OECD Model Tax Convention. While inherently nonbinding, it includes updates to the Commentary on Article 5 (Permanent Establishment). The new language added to the Commentary devotes significant attention to cross-border remote work, providing helpful guidance in making PE assessments.

Updated 2025 OECD guidance

The goal of the recent Commentary update was to provide clear guidelines as to when certain remote and/or hybrid work arrangements create a “place of business of the enterprise,” or a PE, in order to minimize uncertainty for affected employers and employees.

The Commentary clarifies that a home (including a holiday rental or second home) from which an employee works can be considered a fixed place of business in determining whether a company has a PE in the situs jurisdiction. However, that home or other relevant place generally will not be treated as such if the employee works there less than 50% of their total working time over a 12–month rolling period. Even if the 50% threshold is met or exceeded, a PE does not arise automatically, as the analysis becomes facts–and–circumstances–based in determining if there is a commercial reason for the location.

Commercial reasons for residing somewhere include meaningfully engaging with local customers, suppliers, or local operations, or the existence of a seat of management within that jurisdiction. A home office is less likely to create a PE if the home (or other relevant location) is chosen for personal convenience, the company does not require the use of the home, and the activities performed there are preparatory or auxiliary in nature.

Whether an employee works from a home or coworking space may be an important factor in determining whether a fixed–place PE exists. A coworking space may more naturally be less risky than a home office unless there is a dedicated coworking space leased by the company for regular use.

Note: The OECD Convention is a tool used by nations to negotiate new tax treaties or update existing ones. The Commentary provides further interpretation of the OECD Convention, and collectively, these aid in treaty negotiations and resolving disputes. Neither the OECD Convention nor its Commentary constitutes a binding legal agreement, and they do not otherwise amend any existing tax treaties without further action from contracting nations.

PE or no PE?

Turning now to the broader implications of a PE determination, if no PE exists under an applicable treaty, a company generally is protected from the host country’s corporate income tax on business profits attributable to that jurisdiction. However, in some cases, the company may still be required to register with the local tax authorities and file a treaty–based return asserting that no PE exists. Further, if a company has an employee working in any particular jurisdiction, the employer should consider the applicability of any employment–related taxes (e.g., unemployment and social security—type taxes), as well as wage withholding, and other payroll–reporting obligations, as many jurisdictions, including U.S. states, tax employees based on where they are working. Employers should ensure they and their affected employees understand and comply with all local tax reporting and withholding requirements.

If a PE exists, in addition to any employment–related obligations as described above, the profits attributable to the local PE will be subject to any applicable local corporate income taxation. To comply with local tax laws, the company will need to register with the local jurisdiction; file corporate income tax returns (inclusive of making any estimated tax payments, if required); maintain books and records for the activities within the jurisdiction; potentially allocate profits to the branch; and support any transfer pricing positions. Incremental requirements could arise for indirect tax obligations (e.g., value–added tax) where applicable for a given jurisdiction and company’s activities.

In addition, if a company has a PE in a jurisdiction and the PE bears the wages or compensation of the employees working in that jurisdiction, those employees may lose treaty protection under the 183–day rule typically found in many treaties, regardless of the number of days they are present in the jurisdiction. Thus, associated complexities and compliance burdens may arise for the employee as well, including the potential for double–taxation exposure on the income earned abroad in the absence of available foreign tax credit or other relief (e.g., a foreign earned income exclusion for qualifying U.S. employees working abroad). Depending upon the particulars of the remote work arrangement, the company may consider adopting a tax equalization agreement between the company and the employee.

Foreigners working remotely in the US

When non–U.S. companies allow their workers to work remotely within the United States, consideration should be given to both federal and state tax implications of these arrangements. Under U.S. federal income tax law, a foreign corporation may be subject to U.S. corporate income tax at a rate of 21% if it is engaged in a U.S. trade or business and has income effectively connected to that trade or business (known as effectively connected income, or ECI). Generally, ECI is U.S.-source income, subject to limited exceptions.

Determining whether a foreign corporation is engaged in a U.S. trade or business is a broad facts–and–circumstances–based analysis and open to interpretation. Where an income tax treaty is in force between the United States and a foreign corporation’s country of residence, the corporation may be taxable on business profits only to the extent those profits are attributable to a PE, as defined under the treaty. If it is determined, based on a treaty, that a foreign company does not have a PE, the foreign company is generally not subject to U.S. federal income tax on any business profits attributable to a U.S. trade or business. However, the foreign company needs to consider filing a protective Form 1120–F, U.S. Income Tax Return of a Foreign Corporation, attaching a treaty–based return position (Form 8833, Treaty–Based Return Position Disclosure Under Section 6114 or 7701(b)) asserting that no income is attributable to a PE under the applicable tax treaty.

If a foreign company is found to have a PE, the business profits attributable to the PE generally will be subject to federal corporate income tax on a net basis at a rate of 21%. The company will also need to consider the U.S. branch profits tax, estimated tax payments, an expanded Form 1120–F filing obligation, and other IRS registration and reporting requirements.

Note: Applying the updated OECD Commentary may be helpful when interpreting the current treaty language to determine if a remote worker creates a PE. However, as already discussed, the OECD Convention and Commentary are not binding. The U.S. has its own model tax treaty convention, the 2016 U.S. Model Income Tax Convention (the U.S. Convention), used to negotiate its tax treaties. While the U.S. Convention is generally similar to the OECD Convention, they are not identical. Further, while the United States generally did not dissent to the OECD Convention’s remote–work guidance, it generally reserves its right to apply the pre–2017 version of Article 5 of the OECD Convention (the article governing PEs). This creates some doubt that the Commentary’s interpretation concerning remote work would be applied.

In addition, both model conventions and most bilateral treaties contain limitation–on–benefits (LOB) provisions to determine if a person (or company) is a “qualified person” with respect to that treaty, which is an analysis that needs to be considered for both the employer and the employee (though a citizen of a contracting nation generally would qualify under any LOB article).

U.S. state tax law adds another layer of complexity, as U.S. states are not signatories to federal tax treaties. Some states may provide for partial treaty protection, while others deny benefits altogether (e.g., California and Pennsylvania). This means, as an example, that a foreign corporation with a non–U.S. employee working remotely in California may be protected from U.S. federal taxation because the tax treaty says the relevant facts do not give rise to either a fixed–place or dependent–agent PE. However, as California expressly denies treaty benefits, the portion of the foreign corporation’s business income sourced or apportioned to California based on its own nexus, sourcing, allocation, and apportionment rules may be subject to California state income tax.

Tax implications for the remote worker: At the employee level, the tax impact depends heavily on the remote employee’s tax status for U.S. federal income tax purposes. An individual who is a nonresident alien (NRA) for U.S. federal income tax purposes will be taxed only on their U.S.-source income (e.g., wages for services performed within the United States are generally U.S.-source). A U.S. citizen or resident alien, on the other hand, is taxed on their worldwide income regardless of its source.

Apart from a limited statutory exemption for certain qualifying short–stay de minimis earnings, NRAs resident in countries with enacted tax treaties with the United States may find treaty relief from U.S. federal tax on U.S.-source income. While the language varies by treaty, generally, if the NRA employee is present in the United States for less than 183 days during the period specified by the treaty, the wages are paid by a foreign employer, and the wages were not otherwise borne by a U.S. PE of the employer, the NRA is exempted from U.S. federal income tax on their employment compensation. However, if the employment compensation is borne by a U.S. PE of a foreign employer, wages paid by a foreign employer to an NRA working remotely in the United States are generally subject to U.S. individual withholding taxes at graduated rates. The foreign employer, subject to certain exceptions, is generally also responsible for withholding Social Security and Medicare taxes, as treaty relief does not generally extend to these, though separate totalization agreements entered into between the United States and other nations may lessen the blow of dual social security taxation.

As with employer–level taxation, state taxation of an employee’s U.S.-earned income is nuanced. Whether a particular state conforms to or decouples from U.S. federal tax principles regarding treaty relief must be analyzed on a state–by–state basis. Further, state rules in determining residency may differ from U.S. federal tax principles, meaning that an individual who is not considered a resident of the United States for federal income tax purposes can be considered a resident of a state such as California and subject to California state income tax. If an individual is determined to be a tax resident of a state, all of that person’s worldwide income could be taxable in that state.

Similar considerations exist in the inverse scenario, where U.S. employers allow their employees to work abroad. These analyses should not be performed in a vacuum, and local tax advisers should be consulted to avoid doubt and ensure compliance with any and all filing requirements.

What about employer-of-record arrangements?

Some companies, wishing to forgo the complexities of establishing separate legal and employee infrastructures as well as streamline any local reporting and compliance requirements, may choose to operate under an employer–of–record (EOR) arrangement, where a local unrelated organization hires and pays employees on behalf of the underlying company (the client of the EOR). Care should be extended to these arrangements. Depending on the level of control, direction, and authority the company has over its EOR employees, a taxable presence or fixed–place or dependent–agent PE could arise, opening up the risk that the company’s business profits could be attributable to a PE. The risk of a PE arising in an EOR arrangement increases if the employee is concluding contracts on behalf of the company without much oversight, is a key sales representative within a jurisdiction, and/or exercises management authority.

A more mobile world

Remote work is here to stay as the workforce remains more mobile than ever. While the recent OECD guidance is helpful, its scope and effect are limited. Cross–border remote work arrangements should be reviewed in conjunction with local tax advisers (whether in the United States or abroad) to identify any tax risks and incremental tax compliance associated with such arrangements. To flag areas of risk for tax, payroll, and legal review, companies should track jurisdictions in which employees are working, the duration of their stay, their roles, and who ultimately incurs the compensation costs in order to maintain compliance with various taxing, as well as immigration, authorities.

Editor

Jessica L. Jeane, J.D., is director of tax policy, national tax, with Baker Tilly in McLean, Va.

For additional information about these items, contact Jeane at Jessica.Jeane@bakertilly.com.

Contributors are members of or associated with Baker Tilly.

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