Be aware of the dangers of a permanent establishment, false self-employment and teleworking

Do you work remotely or collaborate with people over the internet? It may not be as simple as you think. There are many unexpected obligations and legal risks involved. These include tax obligations (like payroll tax, corporate tax and social security), problems with having a permanent establishment, high administration costs, the risk of being considered a false self-employed person (or of being one yourself) or of falling into double taxation, and the constant threat of financial audits, etc.

This general duty of legal compliance is one of the most common challenges for perpetual tourists who deregister from their home country and travel the world with no permanent residence or only a residence of legal compliance. They often use an offshore company, such as a US LLC, to issue invoices and provide services to clients, individuals or companies around the world.

But regulations are complicated and involve a lot of bureaucracy which makes it hard to do business. Also, governments always seem to be watching you and want to take a cut of your profits just because you work “within their borders” and make money from it.

The real problem is that there are many obligations depending on where you work, how long you stay in the country and what your center of vital interests is (and much more!). Often there is not even an overview that allows you to predict where the State may attack you in the future.

In this article, we will mainly discuss the case of Perpetual Tourists who work through a US LLC, delving a little deeper into the treatment of said LLC.

Tax risks to consider

The tax treatment of a US LLC by tax authorities outside the US is a very complex issue  that depends on several decisive factors. The fact that the LLC is considered fiscally transparent or a fiscally independent entity in the US plays a fundamental role.

• Fiscally transparent entity: comparable to the treatment of a partnership.

• • Income and losses are attributed directly to the partners.

• • Members pay taxes on their share of income at a personal level.

• Independent taxpayer: Similar to a limited company (LTD, etc.).

• • Income and losses are taxed at company level.

• • The company pays corporation tax and, generally, business tax.

• • Distributions of profits to partners are subject to capital gains tax.

The LLC legal form does not exist in most of Europe, nor in LATAM, so it is classified based on a comparison of legal types. This depends on the specific structure of the statutes.

Find below some definitions to keep in mind (based on the example of how it is applied in Germany):

According to art. 10 AO (“Place of effective management”), “The management shall be considered the center of the ultimate management.” If the actual management is in Germany, the LLC will be considered a national company and, therefore, subject to taxation according to art. 1 (1) no. 1 of the KStG (“Tax liability of companies”). This states that “Companies, partnerships and asset pools that have their management or registered office in Germany are subject to unlimited corporate income tax liability”. However, as long as you, as the manager of your LLC, do not trigger a center of vital interests, the management cannot be in Germany.

According to Article 12 AO (“permanent establishment”), a permanent establishment is defined as any fixed place of business or facility that serves the activities of a company. This definition is quite broad and also includes temporary or mobile workplaces, especially if they are used regularly. This means that even repeated or longer stays in Germany can lead to the creation of a permanent establishment for Perpetual Tourists who can work from anywhere,. Even a temporary or project-related presence can qualify as a permanent establishment in certain circumstances. However, as a general rule, here too, a limit of 6 months must be applied or the center of vital interests of permanent workers must be taken into account.

The German tax authorities will consider not only the physical presence of the individual, but also the type and nature of the business activity and the length of stay. If the German authorities suspect that you have a permanent establishment in Germany or that you are going to become a taxpayer, you will have to be able to prove that you do not actually live in Germany (absence of a center of vital interests) or that you have not worked there (absence of added value there).

Thus, in Germany and in other countries, short and irregular stays are less likely to result in a permanent establishment than several months of consecutive work in the same place.

In any case, it is important to note that tax authorities in Germany and other countries do not actively pursue digital nomads or entrepreneurs who work remotely from the country offering their services remotely. Therefore, it is highly improbable that as a LLC owner who spends 4 or 5 months every year in Spain, Mexico, Italy, Argentina, Germany or any other country will be contacted by a tax official regarding the tax situation of you or your LLC. The greatest danger for digital nomads comes from a possible complaint. Returning to the case of Germany, more than 95% of the cases investigated in Germany regarding the center of vital interests are due to complaints from third parties.

The tax authorities could also check whether and how the provisions of the double taxation agreement (DTA) apply to the income of your LLC. To avoid double taxation, a clear separation and structuring of management functions is essential. It is important to bear in mind that LLCs disregarded and exempt from tax in the United States are not entitled to benefit from US double taxation agreements, since, fiscally speaking, that LLC is not considered a tax resident in the United States. Due to the lack of protection by the DTA, you should be especially careful when operating your LLC from another country.

The State uses various laws to catch as many unsuspecting people as possible in its nets, often creating fear and pressure, which benefits many tax advisors who can use these laws to retain clients more easily and advise them against emigrating or creating an LLC. While we always recommend that you act within the law, it is important to be aware of potential issues. However, we can confirm that none  of our clients who have followed our instructions have found problems with their LLCs.

Case study

Let’s say that you are the owner of a US LLC and you provide social media marketing services. You decide to hire a person in Spain or Mexico, who will invoice you 500 USD per month. In a scenario like this, there are some legal aspects that you should be aware of:

Fake self-employed workers

The main problem with hiring people, especially if they are based in European countries, is that the freelancer you hire for certain services may end up being considered an employee.

According to European legislation, there is a risk of generating false self-employment when freelancers work for a company on a regular basis and are subject to clear instructions as to how they should carry out the work. Thus, an activity carried out under instructions and in personal dependence is often understood as a situation of employment relationship. To avoid this, it is necessary to ensure that the contractual arrangements and the actual working conditions reflect the characteristics of self-employment. Therefore, the person must have a high degree of autonomy in the organisation of his/her work, without fixed hours and without direct instructions from you. This means that you cannot decide on holidays or working hours and that you cannot contractually exclude any additional activities.

Ideally, you should not be their only client: if they already have 2 clients with a ratio of at least 20% for one and a maximum of 80% for the other, false self-employment is usually no longer a problem. So you can simply set up a second LLC or another foreign company to pay or, better still, just ask a businessman friend to pay the bill. In the best case scenario, he can even deduct it from his taxes and get the money from your company in another way.

Why make things so complicated? The situation of false self-employment is not only a problem for the self-employed person himself (possible obligation to pay back social security contributions, etc.). It can also be a problem for you and your LLC, as it can lead to a permanent establishment that could make part or even all of the added value subject to local tax liability. So be careful and plan carefully who you work with. If in doubt, we advise you to choose a service provider who is also no longer resident in Europe and is not subject to tax or social security contributions, especially if you think it is likely that they would be considered a false self-employed person.

Your options for hiring permanent employees in a foreign company

Permanent employees in a high-tax country, even if they telecommute, should be avoided at all costs with an LLC. However, the situation is different for companies that have a double tax treaty with the country of residence of the employees. This provides a more relaxed definition of a permanent establishment than the national tax code and generally allows you to have employees in the country as long as their activities are not attributable to a specific permanent establishment on your part.

If you prefer to have permanent employees in Europe who telecommute, you can do so by setting up a company in a favorable EU country, for example. The most favorable countries in this respect are in Eastern Europe: Bulgaria, Romania or Lithuania are very popular in this sense. The Balkans or Georgia may also be interesting.

Employees must pay income tax where they live. Generally, your company will need to register in their country in order to contribute to social security and, in some cases, to withhold taxes.

One way of avoiding all this is to use the services of an employer of record.

Of course, you could also register a subsidiary company in the country where your employees are based. In most cases, this would be a bit like using a sledgehammer to crack a nut, but in certain specific cases it may make sense.

In any case, if you have employees who work from home, are Perpetual Tourists, live in tax havens or are not in Europe, you can generally rest assured that they will not trigger a permanent establishment that could make you pay tax in their country of residence. that you can be sure they will not trigger a center of vital interests anywhere.

Obligation to pay to social security and register as an employer

In addition to income tax, you often have to pay contributions to health, pension, long-term care and unemployment insurance. This is the case if the work is mainly carried out in a European country. As the employer, you would be obliged to calculate these contributions and pay them to the relevant social security authorities. If it is proven that the employee is a false self-employed person, social security contributions may be owed retroactively.

Depending on the country in which you employ your workers, you will need to comply with the requirements of national labor legislation.

As mentioned above, to be more flexible in this regard, you can use the services of a company that hires employees for you, also known as an Employer of Record. These are service providers who hire local employees on your behalf and take care of all the obligations and payments.

In addition to the high cost, which you would only recoup with fewer employees compared to the previous solutions , this type of employee leasing is limited to a maximum of 18 months in the EU. However, setting up another company could help you here too: you would simply have to transfer the contract to the other company every 18 months and the worker would remain permanently employed by the registered employer.

If you can’t avoid having one or two permanent employees and other solutions are too expensive for you, a registered employer allows you to hire them without complications. However, if you have more than 3 employees, it will almost always be cheaper for you to set up your own company and pay the taxes and social security contributions for the employees yourself. Otherwise, this model is very suitable for long-term project work of less than 18 months, as it is often considered a false self-employment arrangement.

The US LLC also helps you deal with all these issues

Registering an LLC is in many cases the best option, especially if you are a Perpetual Tourist or live in a country without taxes (on foreign income). This way, you don’t have to pay any taxes and you have a minimum bureaucracy as well as great legal security.

The US is considered one of the world’s largest tax havens for a number of reasons, both structural and regulatory.

Although the country has committed itself to international standards for the information exchange, its implementation is conveniently incomplete. For example, the US is one of the few OECD countries that has not fully adopted the Common Reporting Standard (CRS). Instead, it uses the Foreign Account Tax Compliance Act (FATCA), which directs the exchange of information in only one direction — more specifically, from foreign financial institutions to the US, but not vice versa —.

So how can an LLC help you avoid the problems of the false self-employed or the permanent establishment? Quite simply, it is legal and relatively easy to set up anonymous companies in the US..In particular, states like New Mexico offer favorable conditions for setting up mailbox companies that make it very difficult to identify the real owners. If you use this type of LLC to pay the freelancers or employees you work with, it will be virtually impossible for anyone to link you to the activities of that company. Nor will there be any way for the tax authorities of any country to know that a particular LLC belongs to you and, therefore try to attribute a permanent establishment to you in the place from which you regularly work.

Below is a schematic summary of the advantages of a US LLC schematically:

• Limited liability: total limitation of the owners’ liability.
• Tax optimisation: possibility of reducing taxes to 0% if you are correctly structured as a Perpetual Traveler.
• Flexibility: hybrid of a general partnership and a corporation.
• Anonymity: ownership can remain anonymous.
• Very low bureaucracy: few reporting requirements and simple accounting (no filings).
• No minimum capital: there are no minimum capital requirements.
• Tax transparency: taxes are “paid” where the owner lives.
• Low running costs: from the second year onwards, annual costs are only 1400 EUR if you incorporate with us.
• Easy incorporation: fast incorporation times (around 7 days).

• International acceptance: worldwide recognised legal form

• Access to US and EU banks: possibility to open business accounts also in Europe.
• No tax return for non-resident entities: no US income tax return required if there is no US income.
• Flexible structure: can be managed by both partners and administrators.
• Use of payment service providers: access to services such as Stripe, PayPal and others (ITIN is usually required).
• Ease of administration: registered agent and assistance with annual reporting.
• Virtual office: option to use a real physical office with mail forwarding
• No sales tax: there is no equivalent to the European sales tax on services in the USA .
• Very low compliance requirements: easy to comply with legal requirements.

Conclusion

As you can see, even when we leave our country of origin, States can try to come after us with their taxes. We need to be particularly careful if we work in a visible way or if we employ people in certain countries.

If you would like us to help you register an LLC, review your situation or create a plan to make sure you are doing everything right and will not run into any problems, you can hire our consulting service.