Taxation of Business Income and Permanent Establishment Issues

Foreign taxpayers engaged in an active trade or business in the host country are usually subject to income tax in that county. The tax applies on net income (gross profit less deductible costs ad expenses) arising from their activities in the host country. To be subject to tax, foreign taxpayer’s activities must be regular, continuous and substantial and create a taxable nexus or presence in the host country.

In the U.S. such presence is defined as US “trade or business”, and the US income tax applies to income which is “effectively connected” with such trade or business. In Italy, the required tax presence is defined as “permanent establishment”, meaning a fixed place of business or the regular presence of personnel (employees or agents) transacting business on behalf of the foreign taxpayer.

Foreign taxpayers engaged in business activities in Italy that cross a certain threshold may become subject to tax in Italy on income arising from their Italian business activities. The threshold for triggering Italian tax is referred to as “permanent establishment”. It usually requires a direct physical presence in Italy through an office or other fixed place of business, or regular activities performed by third parties acting on taxpayer’s behalf (such as employees or agents). The Italian tax code provides its own definition of permanent establishment and Italian courts are notoriously aggressive in enforcing the permanent establishment provisions of Italian tax code. As a result, taxpayers are often inadvertently caught in such provisions and suffer adverse tax consequences. We advise our clients on the best practices to avoid inadvertent exposure to Italian permanent establishment tax and help them move through the required due diligence to maintain protection from such exposure.

The U.S. equivalent of the Italian permanent establishment provision is the U.S. trade or business rule, according to which foreign taxpayers engaged in a trade or business in the United Sates (in acronym, ETB) are subject to tax in the U.S. on their income effectively connected with their U.S. trade or business (in acronym, ECI). The case-law interpretation of the U.S. trade or business requirement and effectively connected income concept is broad and the statutory and regulatory provisions provide linited guidance. We advise clients on issues arising under U.S. trade or business and effectively connected rules.

Under certain circumstances, the presence of employees, agents, distributors, independent contractors, or consultants may be sufficient to create a tax liability in the host country.

“In this area of international tax law, we advise foreign companies and individuals conducting business in Italy and the United States through a branch, office or other fixed place of business or through agents, employees, distributors, independent contractors, or consultants and help them properly identify, handle and comply with their income tax filing, reporting and payment obligations and responsibilities in the host country, including liability to file income tax returns, international information returns local income tax returns and properly compiute and pay income taxes due”.

Our services in this area include:

  • advising on permanent establishment and host country tax issues;
  • assisting on preparing income tax and international tax returns;
  • providing federal and state tax planning strategies.