With governments encouraging workers to stay away from the office to help limit the spread of Covid-19, many employers have found that remote working means employees logging on from further afield than the suburbs.
The imposition of various lockdowns and travel restrictions early in 2020 meant that some employees suddenly found themselves stuck in a jurisdiction where they did not usually work. Early in the pandemic, tax authorities made reassuring noises about the temporary nature of disrupted work patterns. A sympathetic outlook reasoned that companies ought not to become taxable overseas simply because employees were stuck in the wrong place.
This initial view was taken by tax authorities with a temporary disruption to normal working patterns in mind. Back in March 2020, many employers would have assumed that office working life would have resumed as normal by the autumn. That is not the position many countries find themselves in now, with many employers pushing a return to the office out to early 2021 and beyond.
More importantly, discussions surrounding working from home suggest that remote working will play an ongoing role in the lives of employees even when Covid-19 related disruption has ceased.
So we need to distinguish the pragmatic response taken earlier this year to tax risks in a time of crisis from the longer term trend of increased working away from the office.
What are the Issues?
If an employee works for a company from a location outside the jurisdictions where the company operates or is resident (for the sake of brevity, referred to as a “second jurisdiction”), it can create tax issues for both the individual and the company. Whether an issue arises generally depend on the role of the individual, the amount of time spent there by the employee, and the local laws of that jurisdiction.
Payroll Taxes and Employee Liabilities
The employee may face an additional income tax liability on their earnings. In the absence of a tax treaty, the second jurisdiction will generally have the right to tax income earned while the employee is located in that jurisdiction. However, tax treaties tend to give the jurisdiction where the employee is tax resident primary taxing rights, with “residence” being determined by reference to the number of days spent in the relevant jurisdiction.
For example, if an employee working in a second jurisdiction remains U.K. resident and there is a tax treaty in place, the U.K. company will continue to deduct income tax and national insurance contributions from the salary of an employee working overseas and no tax liability in the second jurisdiction should arise. If an employee does become subject to tax in the second jurisdiction while being U.K. resident, they may be able to get a credit for the tax paid in the second jurisdiction (albeit that claiming the credit may be administratively burdensome).
If the employee is deemed to be resident in the second jurisdiction, they will be liable to taxation there and will have to declare their earnings to the relevant tax authority. Double taxation may arise where there is no tax treaty in place.
Additionally, social security obligations generally arise in the jurisdiction where the employee is present. The social security regime is largely harmonized within the EU, so mobile EU resident individuals should only have to pay social security in one country. However, from January 1, 2021 this no longer includes the U.K. (as an ex-EU member state), so U.K. employers will need to consider whether reciprocal social security agreements are in place between the U.K. and other relevant jurisdictions on a case-by-case basis.
With employment tax liabilities usually come employer reporting and compliance obligations. This may take the form of local employee or employer registration requirements, the need to operate payroll, or make year-end submissions. Further complexity is added where the second jurisdiction requires withholding to be operated, and businesses may need to take steps to ensure there is no “dual withholding” on their employee’s remuneration.
Accidental Foreign Branches
A corporate tax liability can also arise to the company due to an employee working from a second jurisdiction. Where there is a tax treaty in place between the company’s jurisdiction of residence and the second jurisdiction, the income arising to the company from the employee’s activities should not generally be subject to tax in the second jurisdiction unless the employee’s activities constitute a “permanent establishment” (PE) of the company.
What constitutes a PE depends on the relevant treaty, but generally if an employee’s activities involve them working in a fixed place of business, acting as a dependent agent, or performing services over 183 days in a 12-month period, a PE risk arises.
- Fixed place of business
Under the Organization for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital 2017 (MTC), a PE means a fixed place of business through which the business of an enterprise is wholly or partly carried on (OECD MTC, Article 5(1)). According to the OECD Commentary on these articles there must be a certain degree of permanency to the place of business (OECD Commentary, Paragraph 6). A period of six months can constitute “permanency” (OECD Commentary, Paragraph 28).
Whether or not a home office abroad will constitute a fixed place of business depends on the facts, but where it is used on a “continuous basis for carrying on business” as opposed to on an “intermittent” basis, the requirements may well be satisfied (OECD Commentary, Paragraph 18).
- Dependent Agent PE
The activities of an overseas employee may create a PE if the employee is habitually contracting on behalf of the company (OECD MTC, Article 5(5)).
- Services PE
Some treaties include a provision whereby a PE may be established if an employee performs services in a jurisdiction for more than 183 days in any 12-month period (OECD Commentary, Paragraph 144).
Crucially, whether the employee’s activities are temporary or habitual will be a primary factor in any PE analysis.
Where the employee’s activities do constitute a PE, the company will gain a taxable presence in an unintended jurisdiction. The company will then have to register for tax purposes in the second jurisdiction, file tax returns and pay corporation tax on profits attributable to that PE. Keeping up with filing obligations, calculating attributable profits and drafting multiple tax returns makes this administratively burdensome for the company.
- Companies can become resident in the “wrong” jurisdiction
A further issue can arise for a company if an employee’s activities make it difficult for the company to sustain its intended jurisdiction of tax residence. Company residence focuses on the location of the company’s strategic management and looks to where central management and control is exercised. Where a tie-breaker provision applies in the relevant treaty between jurisdictions, the company will be regarded as resident in its “place of effective management.”
Virtual board meetings can be a particular source of risk where directors dial in (and therefore exercise strategic management) from the “wrong” jurisdiction, especially if this is done repeatedly over a significant period of time. An unintended change in tax residency exposes a company to the risk of losing access to a specific tax treaty and a potential exit charge when the company ceases to be resident in the original jurisdiction.
What was the Initial Response?
In March and April 2020, several tax authorities reassured companies that:
- days spent by an employee in a jurisdiction due to Covid-19 related exceptional circumstances can be disregarded when determining individual tax residency;
- where an employee was forced to undertake work in an unexpected jurisdiction, this alone would not necessarily lead to the establishment of a PE; and
- a temporary change in location of the directors due to the Covid-19 crisis is an extraordinary and temporary situation and as such should not trigger a change in residency.
In terms of individual taxation, HM Revenue & Customs (HMRC) have outlined circumstances under which days in the U.K. can be disregarded due to Covid-19 related exceptional circumstances. The Australian Taxation Office have said that foreign residents in Australia temporarily due to Covid-19 will not become an Australian tax resident if they usually live overseas permanently and intend to return there as soon as they are able. The Irish Revenue Commissioners provide that where departure is prevented due to Covid-19, they will consider this “force majeure” for the purpose of establishing an individual’s tax residency.
Conversely, the Spanish General Tax Directorate confirmed in their binding resolution V1983-20 that days spent by the taxpayer in Spain due to Covid-19 restrictions will be taken into account for the purposes of the residency test.
In relation to PE risk, the Australian Taxation Office will not apply compliance resources to determine if a foreign company has a PE in Australia if it did not have a PE in Australia before Covid-19, and the presence of employees in Australia is because they are temporarily restricted in their travel due to Covid-19. The Canadian Revenue Agency similarly stated that they would not consider a nonresident entity to have a PE in Canada solely because its employees perform their employment duties in Canada only as a result of travel restrictions in force. This relief expired on September 30, 2020. HMRC consider that a nonresident company will not have a U.K. fixed place of business PE after a short period of time as a degree of permanence is required.
On an international level, the OECD reassured taxpayers in April that “the exceptional and temporary change of the location where employees exercise their employment because of the Covid-19 crisis […] should not create new PEs for the employer.”
Similar statements were made regarding company tax residence, with HMRC taking a “holistic” view of the facts and the OECD distinguishing between a company’s “usual” and “ordinary” place of effective management and one that only pertains to an “exceptional and temporary period.”
Many of the above policies emphasize the temporary nature of the relief and specifically require the employees to have been limited by travel restrictions. The situation has progressed since the initial stages of the pandemic and companies should ensure that temporary working arrangements have not become permanent in the intervening months.
Tax authorities may well make a distinction between an employee being prevented from traveling out of the jurisdiction, and an employee actively choosing to remain in the jurisdiction despite opportunities to return. In the latter case, there is a greater tax risk for both the individual and the company.
If an employee is prevented from returning due to travel restrictions, a record should be kept of this so that there is evidence of the exceptional circumstances, and the situation should be kept under review. Care should be taken if the employee in question conducted business from the second jurisdiction before the pandemic, as this may make it more difficult to demonstrate the exceptional nature of the current circumstances.
Companies should revisit any analysis undertaken earlier in the pandemic concerning the overseas working arrangements of their employees. The temporary arrangements in place early in the pandemic should be kept in place no longer than necessary. A company may wish to consider the following practice points.
- Maintain a dialogue with employees concerning their working arrangements.
- Update policies and guidelines relating to remote working from other jurisdictions.
- Particularly identify employees who have strategic roles and those who habitually contract on behalf of the company.
- Monitor how and where employees are undertaking their duties.
- Keep careful records of when an employee began working abroad and how long they have been doing so.
- Seek local tax advice where an employee is working in a jurisdiction where the company is not resident and does not have a PE.
- Consider exploring special inpatriate regimes which may lead to tax efficiencies.
- Agree temporary overseas working arrangements with employees where appropriate, and include provisions:
- ensuring that additional income tax or social security liability will be the responsibility of the employee; and
- that place a time limit on how long an employee can work from abroad for.
- Consider incorporating subsidiaries if there is sufficient interest from employees to work in another jurisdiction.
- Consider allocating profit to activities in other jurisdiction where activities are being undertaken there.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Gregory Price is a Partner and Victoria Braid is a Trainee Solicitor with Macfarlanes LLP.