While the world is making attempts to fight the Covid-19 pandemic and contain its impact on human lives by imposing travel restrictions, one cannot lose sight of the income tax issues that can arise due to travel restrictions and quarantine requirements.
The inability to travel has forced many people to stay where they are, resulting in individuals becoming tax residents of such countries if they cross the threshold of prescribed number of days’ stay. Such taxpayers are likely to meet the tax residency test for many jurisdictions.
India: Income Tax Law
Under Indian income tax law, there are several provisions which stipulate physical presence-based tests not just to determine tax residency for individuals, but also tax exposure for foreign entities—be it tax residency on account of their place of effective management (POEM) being in India or tax exposure on account of their permanent establishment (PE) in India. Many other jurisdictions have similar physical presence thresholds.
There have been many occasions where nonresident Indians came to India (as their usual practice) prior to the Covid-19 outbreak, to manage their family affairs and investments, and because of the Covid-19 outbreak, their Indian stay (for testing whether they have become “resident” for Indian income tax purpose) has crossed the prescribed threshold number of days for FY2019–20. This is critical from a tax perspective because if one becomes a resident, the scope of income which can be taxed in India widens and there are other requirements for local tax filings, etc.
Involuntary Period of Stay
In this situation, a question arises—whether the length of such involuntary period of stay would be disregarded while determining the Indian income tax implications.
While Indian tax law does not carve out the period of involuntary stay, there has been a court judgment in which it was held that the period of involuntary/forced stay was to be excluded to compute the period of stay in India since the passport of the taxpayer was wrongly impounded by the authorities for a period of time making it impossible for the taxpayer to leave the country to maintain his nonresident status.
Notably, the court also acknowledged that it is at a taxpayer’s discretion as to whether he wants to be an Indian tax resident or not: “It naturally follows that the option to be in India, or the period for which an Indian citizen desires to be here is a matter of his discretion. Conversely put, presence in India against the will or without the consent of the citizen, should not ordinarily be counted adverse to his chosen course or interest, particularly if it is brought about under compulsion or, to put it simply, involuntarily. There has to be, in the opinion of this Court, something to show that an individual intended or had the animus of residing in India for the minimum prescribed duration.”
OECD Issues Guidance
On a global front, providing some hope to such a category of taxpayers, the Organization for Economic Co-operation and Development (OECD) has, based on an analysis of the international tax treaty rules in light of the Covid-19 pandemic, issued a guidance document on the issues related to tax residency status of individuals and foreign companies, creation of PEs, etc (Guidance). OECD commentaries, interpretations of international tax laws are widely respected and followed not only by OECD member countries but also non-member countries.
In the Guidance, with respect to the PE exposure, the OECD has stated that the exceptional and temporary change of the location where employees exercise their employment or the temporary conclusion of contracts in the home of employees or agents because of the Covid-19 crisis should not create PEs for the businesses.
The OECD has also encouraged local tax administrations to provide guidance on the application of the domestic law threshold requirements, domestic filing and other guidance to minimize or eliminate unduly burdensome compliance requirements for taxpayers in the context of the Covid-19 crisis.
Similarly, with respect to the concern of foreign entities about a potential change in the POEM of a company as a result of a relocation, or inability to travel, of CEOs or other senior executives, the Guidance has stated that such a change in location is an extraordinary and temporary situation due to the Covid-19 crisis and should not trigger a change in residency, especially once the “tie-breaker rule” contained in tax treaties is applied.
The OECD has also taken note of the fact that some jurisdictions have already issued their own guidelines to disregard such involuntary stays of individuals in their jurisdictions.
Further, with respect to the tax residency status of individuals, the Guidance states that even if a person becomes a resident of a country as as result of the number of days’ physical presence criteria in a country’s domestic tax rules, this temporary dislocation should not make such person a tax resident of that country, if a tax treaty is applicable.
Businesses have already taken a huge economic impact on account of this pandemic. The economic effects have already been felt in the last quarter of FY2019–20 and the first quarter of FY2020–21. The world will not be the same when things are back on track when national lockdowns are lifted. Hence, this Guidance is very much welcomed as it seeks to address several practical tax issues arising due to the unprecedented situation.
Having said that, it is worth noting that this Guidance is not legally binding and thus, local tax authorities should issue similar circulars/guidelines/instructions/orders, etc to tackle such unforeseen tax issues.
The Guidance recognizes and emphasizes the point that adverse tax situations should not arise for business enterprises due to “forced working condition” caused by the Covid-19 pandemic and lockdowns.
It is only fair and reasonable for tax authorities to take proper cognizance of this Guidance while determining the tax position of foreign business enterprises in the host country. It is worth mentioning that some jurisdictions (like Australia, Ireland, the U.K.) have already issued useful guidance and administrative relief on the impact of Covid-19 on the domestic and tax treaty determination of the residence status of an individual. Hence, one would expect that soon, other nations will also introduce their own relaxation measures.
Looking Ahead
From a tax perspective, nations should issue clarification and guidance to the effect that the period of “involuntary” stay will be disregarded while determining whether a person qualifies as a tax resident.
Suitable safeguarding measures, checks and balances can be incorporated to ensure that such a relaxation is not misused or abused. Such steps will ensure that potential future litigation is avoided.
Taxpayers should also keep their supportive documentation (i.e. travel tickets, itineraries, email correspondence with travel agents, etc.) prepared well in advance so that it can be demonstrated that the period of involuntary stay was indeed, “involuntary.”
All in all, a reasonable and pragmatic approach will need to be adopted by tax authorities to neutralize the adverse effects of the Covid-19 crisis and not place taxpayers in an adverse situation.
Sanjay Sanghvi is a Tax Partner and Raghav Kumar Bajaj is a Principal Associate at Khaitan & Co, India.
The views of the author(s) in this article are personal and do not constitute legal/professional advice of Khaitan & Co. For any further queries or follow up please contact us at ergo@khaitanco.com.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
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