Surprises in tax matters are usually bad news and should therefore be avoided. As a rule, the omission to file required tax declarations results in an increase in the level of the relevant taxation. Sanctions differ from country to country. In Finland, even where such omission is unintentional, the additional tax ranges from 1 to 30 per cent of the turnover that had not been notified to the tax authorities.

The liable enterprise may not excuse itself by reference to tax declarations made to the tax authorities in its own domicile, if taxes should have been declared abroad. Income is often taxable in more than one state. Bilateral conventions regarding avoidance of double taxation provide mechanisms such as partial tax exemptions, reduced source taxation or tax credit for foreign tax payments. Where a company has declared tax only in its own domicile, although part of it had to be declared exclusively or additionally also in another country, then it might be possible to apply for reimbursement of overpayment of domestic taxes, provided that the deadlines for such applications have not already passed. If a mistake has been made, there is no time to lose for where taking corrective measures is concerned.

Enterprises may choose the legal structure of their foreign operations at their discretion. They may choose 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 misunderstanding to believe 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. In relation to these provisions, the formal structure of the business entity is irrelevant, since the provisions are designed to take account of the nature and intensity of the operation of the business in factual terms. 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 of operation has been analysed. As operations are always subject to change, there will often be some risk that the operation becomes liable to pay tax without realising that this is the case. Where this situation arises, the company might be fined, since it is an offence to fail to make a tax declaration, even if this is done unintentionally.

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.

Between Finland and most of its important trade partners, there are bilateral conventions regarding the avoidance of double taxation. 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 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 would be 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 material business activity is carried out from this place. Activities which have only a preparatory or auxiliary character, e.g. the use of facilities only for the purpose of

would not be considered to be material business activities in this context.

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.

According to the concept of double taxation in the OECD model treaty, there is as a rule a permanent establishment if the enterprise uses an employee for sales activities with power of attorney to conclude contracts in the name of the employer. If the employee has no such power to conclude contracts, the employment does not in itself mean that a permanent establishment exists. 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 power of attorney of one’s employee.

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 rather dependent foreign agents might be considered a permanent establishment.

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

The OECD model treaty provides special rules for the taxation of international passenger and freight traffic by sea and by air. With some exceptions, relating to Norway and the Netherlands, these rules are followed in the Finnish taxation treaties. According to the OECD model treaty, such profits are taxed only in the Member State in which the place of effective management of the enterprise is situated.

‘International traffic’ means any transport of passengers or goods by ship or aircraft, operated by an enterprise the effective management of which is based in a contracting state. There is, however, an exclusion for situations in which a ship or aircraft is operated solely between places in only one contracting state. For services connected with international traffic, as defined above, it is often debatable whether or not such services are a supplementary part of tax-free international traffic or a separate service which is taxed at the place of permanent establishment. This evaluation is subject to national interpretation in each contracting state and there is no uniform practice. As a rule in most cases, auxiliary operations such as sale of passenger ticket, loading and unloading services, or connecting transport would be considered to form part of the international transport. The Finnish view is that this is the case also for the leasing of containers for international transport if this operation is of supplementary importance only.

However, auxiliary traffic operations may be considered stand-alone services, and consequently subject to taxation at the place of permanent establishment, if the service provider does not operate ships or aircrafts, but only provides ground services such as cleaning, catering, passenger and freight handling.

A distinction between profits from domestic and foreign operations has to be made if an enterprise, which is taxable with its worldwide income at home also becomes subject to taxation abroad in respect of part of their profit.

Depending on the development of the business and the tax burden, an enterprise might wish to influence the amount of taxable profit abroad and/or at home. To a certain extent, tax planning is possible here. However, homemade solutions will often fail. This is the case especially for corrective measures after the facts.

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 compensating the costs of its foreign operations as accrued at the end of the year. 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 does not follow the enterprise’s bookkeeping unless the latter has fulfilled its legal function of giving an objective and correct picture of the domestic and foreign operations and the profit generated in each of the business units.

Tax planning is planning in advance. Therefore, a core instrument of tax planning is the division of domestic and foreign tasks and responsibilities. In some sectors it is possible to generate certain services in the head office or locally on an alternate basis. It might be possible to make arrangements so that certain products, distribution channels, industrial customers, projects or fairs are 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.

However, the conditions for tax planning in the transport and logistics branch are different from those applicable to businesses engaged in sales of goods. Where sales of goods are concerned, at least in certain setups, it is possible to sell directly to foreign B-2-B customers, even without the participation of the local sales office. Conversely, in providing local storage and distribution services, there is practically no choice regarding the place where the service is provided: the goods are in fact in storage abroad in the country of the permanent establishment, which uses its personnel and material resources in administration and distribution. Under such conditions one cannot regulate the taxable foreign income by attributing certain contracts in total, with their costs and turnover, to the domestic head office. Such a procedure is not permitted, and a company cannot avoid the profit generated in the permanent establishment being taxable abroad by such means.

It is decisive that tax planning is mirrored also 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 domestic and foreign business units of the group, and to create written documentation of these conditions in advance. In the storage services example given above, the parent company could of course debit the subsidiary with an agent commission for the acquisition of customers, for the transfer of know-how, software, and marketing support, provided that the supply of such services and the related compensation is agreed in advance.

Why is it that a foreign place of business demands so much more effort and tax planning than a domestic branch office? The reason becomes evident 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 and in accordance with domestic tax regulations. If one of the places of business is situated abroad, the distinction between the domestic and foreign portion 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 easily leads to situations in which both national tax authorities claim the right to tax certain profits. A reasonable amount of effort in tax planning and creating written documentation of the internal exchange of services will help to minimise the risk of disputes with tax authorities.