What Is a Permanent Establishment in Germany?

A foreign company’s business activities in Germany can trigger tax obligations when its presence is significant enough to create a permanent establishment. This concept, defined by German domestic law and double taxation agreements, is the foundation for determining if profits generated in Germany are subject to German taxation. The rules distinguish between doing business with Germany and having a taxable economic nexus in Germany, making them important for compliance and managing tax liabilities.

What Constitutes a Permanent Establishment in Germany

The primary test for a permanent establishment is whether a foreign enterprise has a fixed place of business through which its commercial activities are carried on. This definition, rooted in both German domestic law and Article 5 of the OECD Model Tax Convention, forms the basis of Germany’s tax treaties. The concept requires a physical location with a degree of permanence, meaning it is not temporary or transitory.

This fixed place of business does not need to be a formal office. It can encompass a wide range of facilities, including a place of management, a branch, a factory, a workshop, or even a warehouse. The enterprise’s core business activities must be conducted through this location, as the simple existence of a facility is not enough.

Fixed Place of Business PE

The most common way a permanent establishment is created is through a fixed place of business. This requires a specific geographical point to be at the disposal of the foreign company, meaning the enterprise must have the power to use the location for its business activities on a more than temporary basis. Examples frequently cited in tax treaties include an office, a branch, or a factory.

For a location to be considered “fixed,” it must have a certain degree of permanence. While German domestic law suggests a minimum duration of six months, tax treaties often do not specify a precise timeframe. For example, if a U.S. company leases an office in Berlin for several years and its employees regularly work from there, this would constitute a fixed place of business.

Construction or Installation Project PE

A building site or a construction or installation project creates a permanent establishment, but only after it surpasses a specific time threshold. Under the Germany-U.S. double taxation treaty, this period is twelve months. This means a single construction, assembly, or installation project must last for more than one year to be considered a permanent establishment.

The clock starts when the contractor begins work on the site and stops upon the project’s completion or permanent abandonment. Time spent on different, unrelated projects is not aggregated. However, if a project is broken into several contracts to circumvent the time limit, tax authorities may view it as a single, continuous project.

Agency PE

A permanent establishment can exist even without a fixed physical location if the company operates through a dependent agent in Germany. An agency PE is created when a person acting on behalf of the foreign enterprise has, and habitually exercises, the authority to conclude contracts in the name of that enterprise. This agent is economically and legally dependent on the foreign company they represent.

This contrasts with an independent agent, such as a commission agent or broker, who acts in the ordinary course of their own business. Using a truly independent agent to conduct business in Germany will not create a permanent establishment for the foreign company. The factor is whether the agent has the power to legally bind the enterprise.

Home Office PE

The use of an employee’s home office in Germany generally does not create a permanent establishment for a foreign employer. This is based on the principle that the employer lacks a sufficient “power of disposal” over an employee’s private residence for it to be considered a fixed place of business. This generally remains the case even if the employer contributes to the costs of the home office.

An exception can occur if the home office is used to perform the actual management activities of the enterprise. For instance, if a managing director regularly uses their home office to conduct the core leadership functions of the business, tax authorities may deem it a permanent establishment.

Activities Not Creating a Permanent Establishment

Certain activities are specifically excluded from creating a permanent establishment, even if they are carried out through a fixed place of business. These exceptions cover functions that are “preparatory or auxiliary” in character, meaning they are too remote from the actual realization of profits to justify taxation in Germany. The overall activity of the fixed place of business must remain preparatory or auxiliary.

Exempt activities include:

• Using a facility solely for storing, displaying, or delivering the company’s own goods.
• Maintaining a stock of goods belonging to the enterprise solely for processing by another enterprise.
• Maintaining a fixed place of business only for purchasing goods or collecting information for the enterprise.
• Carrying on any other activity of a preparatory or auxiliary character, such as advertising or scientific research, provided it is not the primary business of the enterprise itself.

Tax Consequences of a German Permanent Establishment

Once a foreign company has a permanent establishment in Germany, the profits attributable to that PE become subject to German business taxes. The primary tax is the corporate income tax (Körperschaftsteuer), with profits taxed at the standard national rate of 15%.

A solidarity surcharge (Solidaritätszuschlag) is also levied. This surcharge is 5.5% of the corporate income tax liability, resulting in an effective combined rate of 15.825% on the profits.

A third tax is the municipal trade tax (Gewerbesteuer). This is a local tax levied by the municipality where the PE is located. The base rate is 3.5%, but this is multiplied by a municipal factor (Hebesatz) that results in an average effective trade tax burden of around 15%.

The existence of a permanent establishment also has implications for Value Added Tax (VAT). Having a PE almost invariably means the company must register for VAT in Germany, creating obligations for charging German VAT and filing regular returns.

Determining the Profits of a Permanent Establishment

German tax law requires that a permanent establishment’s profits be determined as if it were a separate and independent entity dealing with its head office at arm’s length. This “separate entity approach” means the PE must calculate its income as if it were a distinct German company.

The arm’s-length principle mandates that transactions between related parties be priced as if they were between unrelated third parties. For example, if the U.S. head office provides services to its German PE, it must “charge” the PE a fair market price for those services. This charge would be a deductible expense for the PE in Germany.

To implement this, German tax authorities strongly prefer the direct method of profit allocation. This requires the permanent establishment to maintain its own separate set of books and records that directly account for its income and expenses. This method is seen as the most accurate way to determine the profits generated by the PE’s specific assets and activities, while indirect methods are generally disfavored.

Administrative Obligations for a Permanent Establishment

Upon determining that a permanent establishment exists in Germany, a foreign company must undertake several administrative actions. The first step is to register the PE with the competent local tax office, known as the Finanzamt. This registration provides the PE with a German tax number for all subsequent filings.

A significant ongoing obligation is the requirement to maintain separate books and records for the permanent establishment. These records must be kept in Germany, be prepared in the German language, and follow German accounting principles. The bookkeeping must accurately reflect all business transactions attributable to the PE.

Finally, the company must fulfill its annual tax filing obligations. This involves preparing and submitting annual corporate income tax and trade tax returns for the permanent establishment. These returns report the calculated profit of the PE and its corresponding tax liability.