No Such Thing as "Dipping Your Toes" with International Expansion

Part one of our four-part case study series.

Can a company hire a sales rep on the ground in a foreign country, no questions asked?

Company X, a U.S.-based high tech startup, was growing fast, and saw huge untapped market potential for its products and services throughout Europe. Like in many other companies, the management team decided to hire a handful of sales representatives in a select few countries to test out the market. With its lack of language barrier, familiar culture and easy access to the rest of the European Union, Company X chose the United Kingdom as its first destination.

This is an all too common scenario—companies expanding internationally want to “dip their toes” into the market with low commitment, and perceived low risk, by just having a few employees on the ground initially, without creating a formal legal entity and having to pay local taxes.

But certain circumstances can put a company legally on the hook, through permanent establishment (PE). Any business activity that generates revenue in a country can create PE (and with it, significant tax liability), so it is important to know the key risk indicators.

In Company X’s situation, the company attempted to avoid PE by calling its sales rep in the U.K. a consultant, and having him involved in prospecting and negotiations, but NOT actual contract signing. Unfortunately, U.K. authorities easily made the case for PE by looking at

• Level of employee participation: The on-the-ground rep shepherded the sales contract from the start, and was involved throughout, up until the actual signing. By all accounts, the rep helped generate revenue.
• Locale of contract conclusion as a technicality: Without the formal ability to conclude contracts in country, Company X had the U.S. parent “rubber stamp” the document and sign off. However, this does not change the fact that the U.K.-based rep was substantially involved in identification of the customer and negotiation of the contract.

These circumstances are not unique to sales reps. When Company X put software developers on the ground in the U.K. to further expand business, the company deepened its PE risk, as the developers created intellectual property to be sold for a profit.

Even just one international employee can create huge liability
Don’t fall prey to the assumption that one overseas employee is no big deal. Company X did, and had to setup a proper entity after the fact, owing big bucks to the government in back taxes and noncompliance penalties.

NEXT: Can’t I just hire a contractor? Learn how Company X’s take on this strategy caused major problems…