The obligation to notify the local tax authority of the conclusion of a contract based on which a foreign company can set up a permanent establishment in the Czech Republic is often a neglected obligation. However, the Income Tax Act requires that it be fulfilled without delay, and the tax administrator may impose a fine in case of a breach of this obligation. The new guideline of the General Financial Directorate, issued at the end of 2019, deals with the setting up of permanent establishments in more detail.
The guideline states that the obligation to announce the conclusion of a contract with a foreign enterprise arises regardless of whether the permanent establishment is actually established in the Czech Republic. An example is a situation where a foreign enterprise provides services to a Czech company in the Czech Republic where a double tax treaty does not give the Czech Republic the right to withhold tax on remuneration in favour of a foreign service provider. If the remuneration for the services provided in the given calendar month exceeds CZK 100,000, the Czech company is obliged to submit a notice identifying the service provider. The fact that the threshold is very low and will ultimately lead to excessive administrative burdens is already apparent from Annex 12 to the tax returns of a number of our clients. Annex 12 shows on a separate line the volume of services purchased from foreign companies within the group. Reporting the income to these related persons via another form sent to the tax administrator every month is a duplicate fulfilment of the same obligation. It remains to be hoped that the provisions in question will soon be amended and that the threshold will be increased significantly.
However, the obligation to notify is not a focal point of the guideline. In particular, the guideline aims to harmonise the procedure for taxing the income of non-resident taxpayers on activities carried out through a permanent establishment, mentioning at the outset the need to respect double taxation treaties, which in many cases contain a completely different wording of Article 5 dealing with the definition and the moment of origin of permanent establishments. The definition of a permanent establishment in a double taxation treaty is always superior to that in a domestic tax regulation. The definition under domestic law is relevant only in the case of states with which a double taxation treaty is not concluded.
As for the moment of origin of permanent establishments, it is worth recalling that a permanent establishment does not have legal personality and therefore cannot be established. A permanent establishment is established at the moment the criteria as defined in the double taxation treaty (or in the domestic regulation if such a treaty does not exist) are met.
In practice, we most often encounter two types of permanent establishments: a brick and mortar permanent establishment and a service permanent establishment.
A brick and mortar permanent establishment is established when a foreign enterprise begins to use its premises in the Czech Republic, such as offices, halls, workshops or market stalls, regardless of the contractual relationship under which these premises are used by the foreign enterprise.
The establishment of a service permanent establishment requires the fulfilment of a time test, provided that the provision of the activity is not tied to a specific fixed location. Interpreting the definition of service permanent establishment raises problems in practice, in particular in relation to older double taxation treaties such as the one with Germany. Here, the definition of a service permanent establishment is completely absent and, therefore, with reference to Article 3 of the Treaty, it is proposed to use the definition of the Income Tax Act as a solution.
As an example of a service permanent establishment, the new guideline mentions the provision of management services, where the posted employees of a foreign parent company provide services to the Czech company in training personnel to produce a new product, and the provision of these services exceeds six months. Remuneration for management services provided by foreign companies in the group is one of the most frequently examined costs within tax audits. However, while we have been accustomed to the fact that tax administrators focus only on proving the true scope of services provided, there are more and more cases where the conditions of origin of a permanent establishment have been examined.
The reason for the change in the tax administrator's approach is often the amount of profit margin applied when determining the remuneration for management services provided. If the tax administrator is able to prove that the conditions for the establishment of a service permanent establishment have been fulfilled, the Czech Republic is entitled to tax the income derived from the services provided, as well as the wages of posted employees of a foreign company whose length of stay in the Czech Republic gave rise to a permanent service establishment.
Therefore, I recommend paying careful attention to the conclusion of contracts based on which employees providing management-type services are posted to the Czech Republic and, for a possible review of tax obligations for 2019, have prepared documents showing the actual scope of activities carried out by posted workers in the Czech Republic for the benefit of the Czech company. This is the only way to obtain reasonable assurance as to whether you have an obligation to report the conclusion of a contract.