Entrepreneurs and self-employed professionals planning to move their residence to Spain should consider more than just the pleasant climate and quality of life. Far more important are the tax rules applicable in both countries. A key issue in this context is the concept of a “permanent establishment”, which plays an important role in international tax law and, in particular, under the Double Taxation Agreement (DTA) between Germany and Spain. For entrepreneurs and self-employed professionals, it is essential to understand how and where their business profits are taxed in order to avoid unpleasant tax surprises.

The Concept of a Permanent Establishment under the Double Taxation Agreement (DTA)

Under Article 7(1) of the Double Taxation Agreement between Germany and Spain, business profits are generally taxed in the country in which the business is established. This means that if you live in Spain and conduct your business activities from there (for example, an online business operated from Spain for clients worldwide) without any actual business substance in Germany, even the profits of a business registered in Germany may be subject to taxation in Spain rather than necessarily in Germany.

An exception applies, however, if the business has a permanent establishment in the other contracting state. In this case, the profits attributable to that permanent establishment may be taxed in the respective other country – for example, in Germany (e.g. a business with several employees and an office in Germany).

What Constitutes a Permanent Establishment?

Under the DTA, a permanent establishment is defined as a fixed place of business through which the business activities of an enterprise are wholly or partly carried on. This includes, in particular, a place of management, a branch, an office, a factory or a workshop.

In addition, a building site or construction or installation project lasting more than twelve months also constitutes a permanent establishment. It is important to note that the term “construction or installation project” is interpreted broadly and is not limited to the construction of buildings, but also includes roads, bridges, canals and similar infrastructure projects, as well as excavation and dredging work. Even preparatory activities, such as setting up a construction planning office, may give rise to a permanent establishment if they constitute a significant business activity.

The so-called “dependent agent permanent establishment” is also highly relevant. A permanent establishment may arise where a representative of the company, such as an employee, acts on behalf of the company in the other contracting state and habitually exercises authority to conclude contracts. This may result in the creation of a permanent establishment. Brokers, commission agents or other independent agents acting in the ordinary course of their business are generally excluded. Likewise, employees working from a home office in another country without authority to represent or conclude contracts on behalf of the company do not automatically create a permanent establishment. Further information can be found in our article: Home Office: Working in Germany, Living in Spain.

What Does Not Constitute a Permanent Establishment?

There are also business facilities that are not considered permanent establishments, even if they constitute a fixed place of business abroad. Under Article 5(4) of the DTA, these include, among others, facilities used exclusively for the storage, display or delivery of goods. Stocks of goods maintained exclusively for these purposes also do not constitute a permanent establishment. Fixed places of business used solely for preparatory or auxiliary activities are likewise excluded from the definition.

Special rules also apply to parent companies and subsidiaries. The mere fact that a parent company is resident in Spain and a subsidiary is resident in another country (Germany) does not in itself create a permanent establishment abroad. Each company is treated as a separate entity for tax purposes. This means that a subsidiary resident in Germany does not constitute a permanent establishment of its Spanish parent company – and vice versa – provided that it conducts its business independently and does not perform essential business activities on behalf of the parent company (Article 5(7) DTA). Further information can be found in our article: Subsidiary or Branch?

 

Beware of Unintentionally Creating a Permanent Establishment

Businesses operating across borders should exercise particular caution to avoid unintentionally creating a permanent establishment. While business profits are generally taxed in the country in which the business is established, certain activities may inadvertently create a permanent establishment in another contracting state. This would result in a tax liability arising in that country as well. In practice, allocating profits between the countries can often be challenging. A careful assessment is particularly important when evaluating project-related activities or the role of representatives acting on behalf of the company. Entrepreneurs should therefore document precisely where and how their business activities are carried out in order to establish whether or not a permanent establishment exists.

Taxation of Permanent Establishment Profits for Income Tax Purposes

If a permanent establishment is properly established abroad, for example in Spain, the provisions of the Double Taxation Agreement (DTA) between Germany and Spain apply. Profits attributable to the Spanish permanent establishment are then exempt from taxation in Germany, but are taken into account for the purposes of determining the applicable tax rate under the progression clause (§ 32b EStG). This means that the profits are not taxed in Germany but may increase the tax rate applicable to other income that is taxable in Germany. In Spain, by contrast, the full profits attributable to the permanent establishment are subject to taxation, and the administrative requirements are comparable to those involved in establishing an S.L.

In the reverse situation – where a permanent establishment exists in Germany and the taxpayer is resident in Spain – the so-called tax credit method applies: the profits of the permanent establishment that have already been taxed in Germany are also taken into account for Spanish income tax purposes, but the German tax attributable to those profits is credited against the Spanish tax liability.

Problems may arise, however, where no permanent establishment is recognised for tax purposes because, for example, the requirements of Article 5 of the DTA are not met. This may particularly affect cases in which a self-employed person (autónomo) resident in Spain continues to maintain a business registration in Germany but only occasionally carries out activities there and has no fixed place of business. In such a case, Germany may seek to tax the profits because the business remains registered there, while Spain may attribute the same profits entirely to the self-employed activity carried out in Spain because it considers that no permanent establishment exists abroad. There is then no clearly attributable permanent establishment within the meaning of the DTA, and a tax credit may not be available. The result may be effective double taxation of the same profits. In such cases, the appropriate solution may be to deregister the German business properly and in good time in order to avoid creating an unintended “permanent establishment”.

Conclusion

For entrepreneurs and self-employed professionals moving their residence to Spain, it is essential to understand the tax implications of a permanent establishment. Anyone living and working in Spain should also be aware of the worldwide income principle and ensure that their income is correctly declared in both countries. It is advisable to obtain comprehensive information and, where appropriate, professional tax advice in advance in order to optimise the tax position and avoid unpleasant surprises.

Our firm will be pleased to assist you in analysing your specific situation, carrying out the necessary administrative procedures on your behalf and preparing and filing the corresponding tax returns. If you are interested in our services or have specific questions regarding this topic, please do not hesitate to contact us by email or telephone.

Author:

Rike Füllgraf
Tax Advisor
info@sspartners.es
Tel: (+34) 951 12 13 06
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