On 3 April 2020, the OECD Secretariat published guidance on implications of the COVID-19 crisis on cross-border workers and other related cross-border matters following a detailed analysis of the international tax treaty rules.
The COVID-19 pandemic has resulted in governments worldwide taking unique unprecedented measures, including travel restrictions and imposing strict quarantine regulations. During these difficult times, countries have introduced many temporary support measures for both businesses and individuals as a result of the economic disruption caused by this pandemic. These measures may include employment support, such as paying unpaid salaries for workers or assisting with sick pay for companies that are suffering as a result of the pandemic.
The travel and quarantine restrictions currently in place have affected many individuals whose duties often require them to undertake cross border travels and they are now unable to physically perform them in the country of employment, as a result, they may have to work remotely from home or may be laid off because of the exceptional circumstances. Also, in cases where cross border situations exist, individuals may be stranded in a country that is not their normal country of residence which may create tax issues in regard to which country has the right to tax them. The travel and quarantine restrictions may also affect the residence of companies for tax purposes, where their management is carried out in another country due to the restrictions.
Taxing rights are governed by domestic legislation, but these are often trumped by international tax treaties between the relevant countries. At the request of concerned countries, the OECD has provided guidance after careful analysis on how the above issues are affected by the treaty rules. The overall view of the OECD Secretariat is that these exceptional circumstances should not affect the tax residence of individuals and companies under the international tax treaty rules and encourages coordination and co-operation between countries on tax issues, to mitigate the potentially significant compliance and administrative burden for individuals and businesses arising due to the unplanned tax implications of the crisis. The key areas of the guidance have been discussed below.
Creation of a Permanent Establishment
For many businesses a major concern would be whether any of their employees that are stranded in a country other than the one where they perform their regular duties or if having to work from home during the pandemic, will potentially create a Permanent Establishment (PE) for them and subsequently create new filing and tax obligations. For reference, a non-UK resident or a UK resident could have a PE where there is a fixed place of business through which the business of an enterprise is wholly or partly being carried on or where an non-independent agent acting on the behalf of the enterprise has, and habitually exercises, the authority to conclude contracts in the name of the enterprise.
The OECD guidance provides that the current situation under COVID-19, will not likely cause any changes to determine whether a PE is created. As a result of the temporary and unprecedented situation where employees have changed their locations in performing their duties, be it from their home or from another country, should not be a reason for a PE to be created for their employer. Additionally, no PEs will be created for any business where employees or agencies end up concluding contracts in their homes as a result of the quarantine.
It should be noted that the threshold for domestic law requiring tax registration may be lower than what is applicable under a tax treaty and certain businesses may trigger tax registration requirements in some jurisdictions. To add to that, a double tax treaty will not cover all applicable taxes, which may create further unnecessary tax obligations for businesses or individuals. It is the responsibility of the tax administrations of each jurisdiction to provide the necessary guidance on how their own tax filing and requirements to mitigate unduly compliance obligations during the COVID-19 crisis and businesses should also seek to ensure they will not be negatively impacted.
Working from home: in general terms, a PE requires both a degree of permanence and also to be at the disposal of an enterprise in order for that place to be deemed a fixed place of businesses through which the activities of said enterprise are wholly or partly being carried on. Therefore, following OECD commentary, even if part of the activities of an enterprise can be carried out in an individual’s home, a PE will not be created since that place cannot be deemed to be at the disposal of said enterprise simply due to the place being in use by an employee of the enterprise. Where an individual uses their home to carry out business activities periodically, that does not deem the place to be at the enterprise’s disposal either. For a PE to be created in this case, the enterprise must require the individual to use that location for carrying on their business and it must also be used continuously.
Currently, as a result of the COVID-19 crisis, most individuals who work remotely have to do so as a result of government directives and not as a business requirement. Hence, a PE is not created as such activity does not have sufficient degree of permanence or a continuous base where such activities are to be carried, unless over time that becomes the norm.
Agency PE: some businesses may also be concerned whether a dependent agent PE is created, which would be the case where an employee habitually concludes contracts on behalf of an enterprise. The key factor in this case is whether the agent performs their activities in a habitual manner. Where employees or agents work from home, or other countries, as a result of the government directives then this is unlikely to be deemed habitual. A PE requires a degree of permanence and also to not be temporary or transitory. Where that is the case, then no agency PE is create. A simpler approach may be to consider whether the employee or agent was habitually concluding contracts on behalf of their enterprise in their home jurisdiction prior to the COVID-19 crisis and government restrictions.
HMRC approach: some tax authorities have published guidance that no PE is created for corporations as a result of the COVID-19 situation, and HMRC has also done the same very recently. The published guidance mentions that the treaties are already flexible around the extraordinary situations currently affecting companies and they emphasise on the fact that a relative degree of permanence is required, and the ‘habitual’ condition must also be met. At the end of the day, a UK PE would be a matter of the specific facts and circumstances and not a default position as a result of the COVID-19 crisis, and even where one is created in the UK, the amount of profits to the be taxed in the UK would be dependent on the activity level and relative value of that activity in the UK.
Residence status of a company (place of effective management)
As a result of relocating or being unable to travel for senior or executive officers of companies, during this COVID-19 crisis, businesses may be concerned about a change in their ‘place of effective management’. Such a change may result in a company changing its tax residency, however, under these extraordinary circumstances, it is very unlikely that an entity will change its residency status under relevant tax treaties. This is due to location changes of senior or executive officers being temporary, which is not reason enough to trigger a residency status change, even more so when applying the tie breaker rule in double tax treaties.
Even though it may be relatively rare, companies may be deemed as resident in two separate countries at the same time under the specific domestic laws of each one. This would be the result of changes to the place of effective management of a company due to the COVID-19 crisis. Where a situation of dual residency of a company exists, the relevant double tax treaties would provide a tie breaker rule that ensures the company will only be deemed resident in one of the two countries. The tie-breaker rule requires the tax authorities of each jurisdiction to review dual residency situation on a case by case basis and reach a mutual agreement over which country will receive the residency of said company. In determining the residence status, the tax authorities need to assess all facts and circumstances over the relevant period in question, which includes, but not limited to, considering the following points:
- The location where meetings of the company’s board of directors are held;
- The location where senior or executive officers usually perform their activities;
- The location where senior management of the company perform their day-to-day activities; and
- The location where the headquarters are located.
In short, determining the residency status of a company will require careful examination of all relevant facts and circumstances that will provide sufficient evidence in establishing the usual and ordinary place of effective management, and not simply rely on the unique and temporary period during the COVID-19 crisis. From a practical perspective it is important to retain appropriate documentation to evidence the situation, e.g. including in board minutes the fact a director had to dial-in because of travel restrictions but had intended to be there in person.
HMRC Approach: as per the existing legislation, HMRC wants to reassure businesses that they would not become UK resident simply because a few board meetings are held in the UK or because a few decisions were taken in the UK during a specific short period of time, and thus a holistic view of the facts and circumstances of the situation must be taken. While many businesses are aware about central management and control issues and trying to ensure that they do not create a UK residency for it, that by itself is not a determinative factor. HMRC also provides examples that state that a few UK board meetings will not result in central management and control being attributed in the UK, and that HMRC will be reviewing the facts of the particular situations. The guidance also states, that in cases where a company does end up with a UK residency, if it is also resident in another jurisdiction where the UK has a double tax treaty, the tie breaker provisions will be necessary to determine where the residency will fall. It should also be noted that the place of effective management can only be in a single jurisdiction, unlike central management and control, and tie breaker provisions may result in non-UK residency based on that, even if there is UK central management and control. Where people are still worried about having board meetings in the UK and their implications, for ease of mind, they could simply ensure that they have more non-UK directors than UK ones by either appointing more non-UK directors or appointing substitute directors, who are non-UK resident, to replace any directors who are now stranded in the UK.
Cross border workers
As a result of the COVID-19 crisis, many governments are providing support to businesses to enable them to keep paying their employees’ salaries. For instance, the UK government is providing support to businesses that cannot maintain their current workforce as a result of the COVID-19 crisis, and 80% of their monthly wages will be covered, up to £2,500 per month. As per Article 15 of the OECD Model, income that received by the employees from their employers will be attributed to the jurisdiction where their employment used to be exercised. This is especially relevant for cross border workers who while working in one jurisdiction they were resident in another, and now their remuneration will be attributed in the jurisdiction they used to work in.
Article 15 (Income from Employment) of the OECD Model deals with determining which jurisdiction is entitled to tax the employment income of an individual, depending on jurisdiction where they are resident and the jurisdiction where their employment duties are performed, where those two are different.
The initial commentary of Article 15 states that any remuneration received should be taxed in the jurisdiction where the employee is resident, and where their employment is exercised in another jurisdiction, subject to certain conditions, that would be the jurisdiction that gets to tax the employee. The jurisdiction where employment is exercised is defined as the place where an employee is physically present when performing their duties for which they are paid for. Employment income received for a worker who is resident in one jurisdiction but performs his employment in another, can only be taxed in the residence jurisdiction if:
- The employee is resident in the other jurisdiction for less than 183 days in a period; and
- The remuneration was paid by an employer who is not resident in that other jurisdiction; and
- The remuneration is not borne by a PE the employer has in that other jurisdiction.
Support packages provided by governments to employers and employees aimed to keep them on the payroll during the COVID-19 crisis, are deemed to be most similar to termination payments and as per Article 15, those should be attributed to the jurisdiction would have normally worked. Where the both jurisdictions end up having a taxing right, the jurisdiction where employment is exercised must provide relief for double taxation, either by exempting the income altogether or giving credit for the tax paid.
In certain bilateral treaties there are certain special provisions in regard to employment income issues of a cross border worker, which would include limits on the number of days that such a worker can work in another jurisdiction other than the one they regularly work, before causing a change in a jurisdiction’s taxing rights. Generally, if the jurisdiction where employment was performed loses its taxing rights after application of Article 15, then there will be certain compliance difficulties for both the employee and employer. These unique situations require extreme co-ordination between different jurisdictions to minimise any administrative or compliance costs on both employers and employees regarding such involuntary and temporary changes and the OECD is working with countries to that end.
Changes to residence status of individuals
Statutory residence rules for individuals while complex and wide ranging, are unlikely to affect individuals as a result of the COVID-19 crisis. Several tax authorities have already published guidance on determining the tax residence of individuals as a result of the COVID-19 impact, and HMRC have provided details on whether one can disregard any days spent in the UK as a result of exceptional circumstances. Exceptional circumstances in this case applies to events occurring while an individual is in the UK and as a result of situations outside their control, they cannot leave the UK.
Two different situations that could be explored are where an individual could be away in a different country from their home while on holiday or work and get stranded there due to the quarantine and travel restrictions and as a result get residence there under domestic law. On the other hand, an individual could have moved to a new jurisdiction for work and became resident there, but as a result of the current crisis, they were forced to return to their previous home country. The issue in this case is that the individual might still have their residence status in their original home country or regain the residence status when they return.
In both cases discussed above, it was the result of extraordinary circumstances that forced them into that situation thus being deemed resident in another jurisdiction is not very likely. Even where that ends up being the case due to domestic legislation, where the person ends up staying there for a certain number of days, applicable tax treaties between the two jurisdictions should prevent a tax residency as a result of this temporary dislocation.
For tax treaty purposes, individuals can only be resident in a single jurisdiction at time which will get to tax their employment income. Article 4 (Residence) of the OECD Model helps in determining the tax residency of individuals. As a starting point, domestic law should be applied since an individual may end up being tax resident in only one jurisdiction so there would be no further issue. However, where residency exists in two jurisdictions, tie breaker rules need to be applied that include a hierarchy of tests to determine which jurisdiction can claim residency. The hierarchy of tests to be considered are the following:
- The individual will be deemed resident in the jurisdiction where they have a permanent home available to them. If there is one in both jurisdictions, then residency lies where their personal and economic relations are closer (centre of vital interests).
- If the jurisdiction with the centre of vital interests cannot be determined or if there is no permanent home, residency will lie in the jurisdiction where they have a habitual abode.
- If the individual has a habitual abode in both jurisdictions, residency will be determined to be in the jurisdiction where they are a national.
- If the individual is a national of both or neither of them, the tax authorities of the relevant jurisdictions need to settle the residency question by mutual agreement.
Habitual abode may commonly be the determinant factor, and it can be defined as the location the individual lived habitually and being customarily present, which aims to look further than the number of days spent in each jurisdiction by examining the routine of their life. Usually, this examination needs to be undertaken for a sufficient period of time, but given the exceptional circumstances as a result of the COVID-19 crisis, the tax authorities need to analyse the situation under different periods of time than would have ordinarily be deemed as ‘sufficient’.
The current travel restrictions resulting from the COVID-19 crisis have created several issues for both companies and individuals from a tax perspective. However, as explored above, both the OECD and local tax authorities are working to ease the burden on businesses and individuals and provide guidance to help them.
While PE issues as well as residency of both companies and individuals should be continuously reviewed under the current situation, it is helpful to know that the OECD agrees that most companies and individuals will be unaffected for tax purposes. However, individuals, and their employers, who have been stranded to a different jurisdiction should ensure they keep good records and also keep up to date with new guidance on these issues since at the end of the day, the tax authorities will be making a determination based on the facts and circumstances of the specific situation.