Surprises in tax matters are usually bad news and should therefore be avoided. As a rule, failure to file the required tax declarations results in an increase in the level of the applicable tax. Sanctions vary from country to country. In Finland, even if an omission of this kind is unintentional, the additional tax ranges from 1 to 30 per cent of the undisclosed revenue.

In situations where income should have been declared abroad, the enterprise liable to taxation may not excuse itself by reference to tax declarations made to the tax authorities in its own country of domicile. Income is often taxable in more than one state. Where a company has declared taxable income only in its own country of domicile in circumstances in which a proportion of such income had to be declared exclusively or additionally in another country, it may be possible to apply for reimbursement of overpayment of domestic tax. This is of course only possible as long as the deadlines for such applications have not already passed. If a mistake has been made, no time should be lost in taking corrective action.

Enterprises may choose the legal structure of their foreign operations at their discretion. They may elect to establish a foreign subsidiary or a branch office. The correct choice as between these options is an economic decision depending on the individual characteristics of the business at hand. It is, however, a mistake to think that one can avoid foreign tax liability by not registering one’s activities abroad.

It goes without saying that a foreign subsidiary or branch office is subject to taxation in the country of domicile of that entity. It is less evident that even without such formal legal structure, any legal entity will become subject to local taxation under the circumstances stipulated by the nationally applicable tax provisions, including the double taxation conventions. Such provisions are designed to correlate national income taxation with the nature and intensity of the domestic operations and business of foreign enterprises in factual terms. Therefore, the formal structure of the business or the entity’s formal status in the relevant public registries is of minor importance only and may often turn out to be irrelevant. There is no freedom of choice as to the country in which a company becomes taxable.

Whether an unregistered operation is subject to taxation is a question that can only be answered after the scope and individual characteristics of the operation have been analysed. As operations are always subject to change, there is always some risk that the operation may become liable to pay income tax without realising that this is the case. Where this situation arises, the company might be fined, since failing to file tax declarations, even if done unintentionally, is an offence.

The foundation and registration of a branch office or subsidiary simplifies taxation and reduces the risk of disputes with the tax authorities. Establishing a taxable entity is therefore always advisable where it cannot be clearly established whether the operations are already taxable, or might become taxable in the near future due to growth.

The term permanent establishment can be considered the most important and most frequently disputed term in international taxation. An operation becomes taxable abroad if it maintains a permanent establishment. As mentioned above, this depends only on facts, not on formalities.

Bilateral conventions on the avoidance of double taxation are in place between Finland and most of its important trading partners. Such conventions mostly follow the guidelines laid down in the OECD model convention. When it comes to the detail, however, there are important variations from country to country.

The model convention states that a permanent establishment is identified by reference to two fundamental criteria:

As a permanent establishment always requires a fixed place of business, the use of transport vehicles for the transport of goods on public roads cannot be considered to constitute permanent establishment. However, the permanent use of a private car park or a toll-free warehouse for distribution would qualify as a fixed place of business. In most circumstances, offices or branch offices, factories or workshops, building sites or construction or installation projects of defined duration are considered a fixed place of business. The company carrying on business from such fixed place does not necessarily need to be the owner or the party who has leased it.

A fixed place of business is a taxable unit only if material business activity is carried on at that place. Activities which have only a preparatory or auxiliary character are not treated as material business activities in this context. Examples include the use of facilities only for the purpose of storage, display or delivery of goods belonging to the enterprise, or purchasing goods or collecting information.

There is no general list of activities that would be considered preparatory or auxiliary. For example, the storage of a company’s own goods is auxiliary, but the storage of goods for a company’s customers is usually a material part of the business. The activity in question has to be seen in its relation to the overall activities of the enterprise.

The concept of double taxation in the OECD model treaty provides that as a rule permanent establishment exists if the enterprise employs a person to carry out sales activities and this person is also authorised to conclude contracts in the name of the employer. If the employee has no such authority, on the face of the matter no permanent establishment is formed. Nonetheless, a permanent establishment might be deemed to exist even in this case, since it is not possible to avoid the status of permanent establishment by formally restricting the employee’s power of representation in relation to the employer.

Whether or not a certain activity is preparatory or auxiliary can only be assessed on a case-by-case basis, depending on one hand on the kind of business it is in general terms; and on the other hand, on the activity in the local market. In a given case, even the presence of somewhat dependent foreign agents might be considered to give rise to a permanent establishment.

Particularly where the employment of sales agents is concerned, it is usually an uphill struggle to try to ensure that a permanent establishment is not created for tax purposes. In some cases, the effort expended in this regard may prove more onerous, in terms both of the drain on management resources and cost expenditure, than would the establishment of a branch office or subsidiary in Finland.

A distinction must be made between profits from domestic and foreign operations if an enterprise whose global income is taxable in its country of domicile also becomes subject to taxation abroad in respect of part of its profit.

Depending on the development of the business and the tax burden, an enterprise might wish to influence the amount of taxable profit achieved abroad and/or at home. To a certain extent, tax planning is possible in this regard. However, makeshift or ad hoc solutions are often doomed to failure, especially when these are attempted after the fact.

In case of a foreign subsidiary, as well as in case of a permanent establishment, the enterprise has to arrange separate bookkeeping for the foreign business unit, following locally applicable provisions on the taxation of income. Contrary to what is commonly assumed, it is not possible for a company to minimise taxation by reimbursing its foreign operation’s costs as accrued at year’s end. It is also not permitted for the foreign head office to take responsibility for costs for services, for which the permanent establishment invoices the customers. The tax liability follows the enterprise’s bookkeeping only to the extent that the latter has fulfilled its legal function of giving an objective and accurate picture of the domestic and foreign operations and the profit generated by each of the business units.

Tax planning is planning in advance. One of its core elements is the division of domestic and foreign tasks and responsibilities, which is usually done simultaneously with the foreign investment decision. In some sectors it is possible to provide certain services either from the head office or locally. It might be possible to make arrangements allowing for certain products, distribution channels, industrial customers, projects or fairs to be handled by the head office in such a way that these activities subsequently generate direct income from the country in which the permanent establishment is situated. Profits from such operations are then taxable only domestically.

It is critically important for tax planning to be mirrored in the business operations as they are carried on in practice. In order to achieve successful tax planning, it is essential to make use of market conditions in the exchange of services between the group’s domestic and foreign business units, and to create written documentation in respect of these conditions in advance. Companies that form a group employing more than 250 employees must file information on their internal pricing simultaneously with starting their business in Finland.

Why does a foreign place of business demand so much more effort and tax planning than a domestic branch office? The reason becomes clear once one becomes familiar with the difference in the fiscal interests in each case.

Where the places of business are in the same country, distinguishing the profit portions of each unit makes no practical difference for the national tax authorities, since in any event the tax must be paid to the domestic tax offices under domestic tax regulations. If one of the places of business is situated abroad, the distinction between the domestic and foreign portions of the total profit will influence the state tax income at both ends. It is clear that both sides have to protect their national fiscal interests.

This fact can easily lead to situations in which both national tax authorities claim the right to tax certain profits. Expending a reasonable amount of effort in tax planning and creating written documentation in respect of the internal exchange of services will help minimise the risk of disputes with tax authorities.