The current pandemic has brought many disruptions on social, economic and personal levels, as well as an array of tax issues. While many governments undertook measures related to tax relief deferrals, there is another angle worth exploring.
Imagine a business, for instance a multinational group, having employees from all over the world operating normally prior to the pandemic. However, one day governments adopt emergency measures, leaving some of these employees, for one reason or another, stranded in different locations. What would be the tax consequences for the enterprise? Would the employees become tax residents in a different country?
On 3 April 2020, the Secretariat of the Organization for Economic Cooperation and Development (“OECD”) published a guidance (“OECD Report ”) addressing these tax issues. The Report focuses on four topics: (1) the creation of permanent establishments, (2) the residence status of a company, (3) cross-border workers and (4) changes to the residence status of individuals.
The objective of double tax treaties is to allocate taxing rights among countries. In doing so, one state is qualified as the residence state of a taxpayer and the other state as the place where income has arisen, or simply - the source state.
Generally, a source country would tax if the business activities of a non-resident taxpayer exceed a minimum threshold of physical presence. This would lead to the existence of a permanent establishment (“ PE”). A PE may appear under three scenarios: (1) prima facie PE through fixed place of business; (2) agency PE; and (3) construction site PE. It should be noted that having a PE triggers filing requirements and tax obligations in the country where the PE is located.
(a) Prima facie PE through fixed place of business
The starting point for determining if a PE exists, is the presence of a fixed place of business through which the enterprise wholly or partially carries its activities. To that end, the PE must have a certain degree of permanency and be at the disposal of the enterprise.
Under the current circumstances, some cross‑border employees are restricted from leaving their residence country and are forced to continue their work from home. As a result, their activities might seem substantial enough to create a taxable presence in their state of residence, in the form of a PE.
Yet, the OECD Report sheds light stating that even though an enterprise may carry out part of its business at a location, such as an employee’s home office, that alone should not lead to the conclusion that the location is at the disposal of that enterprise. In addition, the employees working remotely do so as a result of government instructions, not of the enterprise, and thus, under the above circumstances, no PE is triggered from the COVID‑19 measures.
(b) Agency PE
Tax treaties allocate taxing rights to source states if a person, acting for an enterprise, has the authority to conclude contracts in the name or on behalf of that enterprise and the said person uses this authority habitually and not merely in isolated cases. In such circumstances the existence of an agency PE would be triggered, leading to tax obligations in the source state.
In the current circumstances, the activities of an employee that is temporarily working remotely for a non-resident employer, will not give rise to an agency PE since they are very unlikely to be regarded as “habitual” in light of the temporary nature of COVID-19 pandemic. The OECD Report further specifies that the presence an enterprise maintains in a country should be more than merely transitory in order to qualify as taxable presence. However, an exception to that rule might apply where an employee was habitually concluding contracts on behalf of its enterprise from its home country before the COVID-19 pandemic.
(c) Construction PE
Last but not the least, source countries could also have taxing rights if a PE is present within their borders in the form of a building site, construction, or installation project that lasts more than 12 months (6 months under the United Nations Model Double Taxation Convention 2017).
The report poses that temporary interruptions should not be included in determining the duration of a site and, therefore, the COVID-19 situation would not result in the construction site ceasing to exist.
Under tax treaties an enterprise is qualified as a tax resident of a given state if it is taxed by that treaty state on the basis of domicile, residence, place of effective management, or any other criterion of similar nature. However, should a taxpayer be considered as a tax resident of more than one jurisdiction, tax residency for treaty purposes is determined on the basis of the effective place of management under the corporate tie‑breaker rule contained in most tax treaties.
In the current state of affairs, the inability of board directors to travel may result in potential revision in the “place of effective management” of an enterprise. Ultimately, such a change may lead to a reconsideration of a company’s residence under relevant domestic laws and affect the habitual resident country for tax treaty purposes. OECD takes the stance that under the current circumstances, it is unlikely that COVID-19 would create any changes to an entity’s residence status for a tax treaty purposes, considering the temporary change in location of one or more board directors and the extraordinary and temporary nature of the situation.
However, assuming that there would be double residency of an entity, tax treaties provide tie breaker rules that ensure the entity is resident in only one of the states. Competent authorities consider all relevant facts and circumstances to determine the “usual” and “ordinary” place of effective management, not only those related to an exceptional phase such as the COVID-19 crisis.
Generally, tax treaties stipulate that income derived from employment is taxable in the person’s state of residence unless the employment is (physically) exercised in the other state.
The the place of exercise test applied in such cross-border scenarios stipulates that the country of employment may exercise a taxing right if the employee is present for more than 183 days (within a period of 12 months), the employer is a resident of the source state, or the employer has a permanent establishment in the source state that bears the remuneration.
Under the current circumstances, cross‑border workers may be unable to physically perform their duties in their country of employment, which may lead to a different tax treatment under the applicable tax treaty due to not meeting the number of days that a worker may work outside the country of employment.
Additionally, many governments worldwide enacted stimulus packages to take on the burden of unpaid salaries on behalf of numerous companies that have and are suffering economically. In cases where a government subsidizes the keeping of an employee on a company’s payroll, the OECD submits that the income should be attributable to the place where the employment used to be exercised.
The OECD illustrates two scenarios under which tax residence issues for individuals could arise:
(i) A person is temporarily away from his or her home country (either on vacation or to work for a few weeks) and gets stranded in the host country by reason of the COVID-19 crisis and attains domestic law residence there; and
(ii) A person is working in a country (the “current home country”) and has acquired residence status there but had to temporarily return to his or her “previous home country” because of the COVID-19 situation. The individual may either never have lost their status as resident in the previous home country under its domestic legislation, or may regain residence status upon their return.
Under the tiebreaker rules, residence would be regarded as follows:
(iii) In the first scenario, treaty residence would be given to the home country, because it is more likely that the permanent home would be in the home country, and even if another home is located in the host country, the other tiebreaker tests (center of vital interests, place of habitual abode, and nationality) would yield a result favorable to the home country.
(iv) In the second scenario, the result may not be as clear, because if the individual’s personal and economic relations in the two countries are close and the tiebreaker rule was in favor of the current home state, there is a risk that moving to a previous home country during the pandemic would favor such previous home country. In this case, the OECD suggests that the test of habitual abode should be used. Habitual abode refers to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life and are therefore more than transient. The OECD proposes that tax administrations consider a more normal period of time when assessing a person’s resident status.
The report submits that the current tie-breaker test, which consists of a hierarchy of tests, should be sufficient to determine the treaty residence of an individual. The report concludes that it is unlikely that the COVID‑19 crisis will affect the tax treaty residence position of individuals.
In terms of managing the risk, business should:
Evaluate the composition of the Board: It should be noted that the residence tests generally assesses where and by whom the company is actually managed and controlled. In this case, if the key decision-makers of an enterprise remain in a certain jurisdiction, residence will likely be there.
Ensure that the Company's bye-laws allow for any alternative arrangements . Make sure that Articles of association or any other constitutional documents allow for virtual meeting, taking into account quorum and voting provisions.
Adapt the above as the circumstances change. The position may need to be revisited depending on the duration of the restrictions. The approach of tax authorities may also adapt over the period of emergency state.