5. Business Presence Issues
a. How the Use of One or More Independent Contractors Creates a Permanent Establishment in Country and the Ramifications
A foreign entity with a permanent establishment in the United States may be subject to U.S. federal taxation. As a general rule, foreign corporations are subject to federal income tax on income that is effectively connected with a U.S. trade or business78 Such income may, however, be subject to exemption if a tax treaty so provides.79 A common tax treaty exemption limits federal income taxation to amounts attributable to a permanent estab-lishment maintained by the foreign entity in the United States. Such an exemption exists, for example, under the tax treaty between the United States and Canada.80
Under the terms of this and other treaties containing such an exemption, a permanent establishment exists if the foreign company maintains in the United States either (1) a “fixed place of business” or (2) employees or “dependent agents” who have, and habitually exercise, authority to conclude contracts on behalf of the foreign company. By contrast, no permanent establishment is created if business is carried out through a broker, general commission agent, or other independent agent acting in the ordinary course of their business.
Court decisions interpreting these provisions are sparse. However, consistent with the language of the applicable treaty, courts customarily distinguish between an independent agent or contractor, retained to perform a specific project without au-thority to contract on behalf of the foreign principal, and a dependent agent who has such authority.81 In other words, independent agents or contractors who operate in the normal course of their own business and merely represent the products or services of the foreign resident generally do not create a permanent establishment of the foreign resident. On the other hand, when an agent is both legally and economically dependent on the foreign company, the presence of the agent is likely to give rise to a permanent establishment.82
b. How the Employment of One or More Individuals Creates a Permanent Establishment in Country and the Ramifications
As discussed in the preceding section, tax treaties between the United States and many other countries provide an exemption from U.S. federal taxation for income derived by a foreign corporation from a U.S. trade or business if the foreign corporation lacks a per-manent establishment in the United States. Treaties differ in their definition of “perma-nent establishment,” and the factors indicating the existence of a permanent establish-ment vary. Very commonly, however, the presence in the United States of a fixed place of business of the foreign entity or of employees of the foreign entity who habitually exercise the authority to bind the foreign company contractually will reflect the existence of a permanent establishment.
It is important to recognize that the federal government has no authority to enter into tax treaties with other countries that affect individual states. Each state has its own laws and criteria that determine when and under what circumstances a foreign company is considered to be transacting business in the state and thereby potentially subject to state taxation and regulation. It is commonly agreed that when a company exploits the state’s marketplace – for example by employing individuals in the state to sell its products, produce its goods or perform services on its behalf to customers – state taxa-tion and regulation is likely to be invoked.