The permanent establishment in the digital economy

A business can sell software, cloud services or advertising to customers halfway around the world without opening an office anywhere. And yet, sooner or later, comes the question that is worth a great deal of money: where should that income be taxed? The key concept is that of the permanent establishment, born in an economy of factories and warehouses and today put to the test by dematerialised business models. For anyone operating from or towards Switzerland, knowing when a taxable presence is triggered is essential.

What a permanent establishment is

A permanent establishment is a fixed place of business through which a business carries out, in whole or in part, its activity in another State. When it exists, that State acquires the right to tax the share of profit attributable to that presence. It is the criterion that double taxation treaties use to allocate taxing rights between the business’s country of residence and the country in which it operates.

The classic elements are three: a physical location (premises, installations), a character of permanence over time and the carrying out of the activity through that location. Alongside these stands the figure of the dependent agent who habitually concludes contracts in the name of the business: even without offices, this can give rise to a permanent establishment.

Why digital complicates everything

The digital model breaks the link between physical presence and value creation. A company can have thousands of users and significant revenue in a country without any premises, employee or warehouse on its territory. The questions become concrete:

• is a server located in Switzerland a permanent establishment?
• does a website, in itself, create a taxable presence?
• do the data and user base in a country generate a right to tax?

The prevailing answer is that a website is not a fixed place (it is software, not a location), while a server, being physical equipment at the business’s disposal, can under certain conditions constitute a permanent establishment, provided it performs functions that are not merely preparatory or auxiliary. The mere presence of customers or users in a country, by contrast, is not enough under the traditional framework.

The debate on the “digital nexus”

Precisely because the classic rules leave many online models uncovered, new connecting criteria have been debated at international level for years: a significant economic presence based on revenue, users or data, and forms of taxation of the digital economy that disregard physical location. Some countries have introduced unilateral taxes on digital services; in parallel, work continues towards a coordinated solution at OECD level.

For a business this means one practical thing: the rules are in motion, and what does not create a taxable presence today could create one tomorrow, with retroactive effects that are hard to manage if you have not monitored your exposure.

What it means for those operating from Switzerland

A digital business based in Switzerland that sells abroad must ask itself whether its cross-border activities (warehouses, staff, agents, infrastructure) generate a foreign permanent establishment, with a consequent reporting obligation in that country. Conversely, a foreign business that places servers, staff or depots in Switzerland may create a Swiss taxable presence.

The points to keep under control are:

• the mapping of the functions performed in each country (who does what and where);
• the role of any agents who negotiate or conclude contracts;
• the location of infrastructure and technical staff;
• the attribution of profits to the foreign presence, which must reflect actual functions, risks and assets.

Mistakes to avoid

• Taking for granted that “no offices means no taxation”: agents and infrastructure can be enough.
• Ignoring the unilateral digital taxes already in force in some markets.
• Underestimating the attribution of profits, which is often the real ground of dispute.
• Failing to update the analysis as the business and the rules evolve.

How we work at SIH ONE

We analyse digital business models to identify where a permanent establishment arises, we assess the risks of a taxable presence in Switzerland and abroad, we apply the double taxation treaties and we set up the attribution of profits in a defensible way.

Does your business sell digital services across borders and you want to know where you are really taxable? Discover our tax advisory services and secure your international structure.