COVID-19: An international tax issue pandemic?

Key points

What is the issue?

The COVID-19 pandemic may cause issues for international businesses and businesses with an international workforce or management team. Travel restrictions could result in companies inadvertently creating permanent establishments in other jurisdictions and, for certain companies, there is a risk of a migration of tax residency.

What does it mean for me?

Tax authority scrutiny of potential permanent establishments has increased significantly over recent years and multinationals should be aware of the potential risks of changes to working patterns arising from the current circumstances.

What can I take away?

Although the COVID-19 situation is hopefully temporary, its impact on our way of working is likely to be long-lasting. Businesses therefore need to constantly monitor the risks associated with an internationally mobile workforce and management team to avoid any unplanned tax consequences.

Introduction

The last few weeks have seen the largest peacetime changes in working patterns ever. The focus from a tax perspective has been on the measures brought in to address the urgent needs of businesses and their employees:

• supporting workers
• managing cash flow
• seeking opportunities, and
• navigating this tumultuous period.

There are deferrals of VAT payment obligations and self-assessment income tax payments, as well as the much-publicised package of support for employees, employers and the self-employed. That is understandably the immediate concern. 

However, looking further down the line, it is important for international businesses – especially those with an internationally mobile workforce – to consider the implications that prolonged changes in working patterns could have on a group's tax position.

Working from home, 'remote' or 'agile' working, have become increasingly prevalent over the last few years. However, the COVID-19 outbreak has, over a very short period, seen a huge volume of employees, contractors and agents move from working in an office, to voluntarily working from home, to being forced to work from home (where feasible). These changes have also prompted questions as to whether, in the long-term, the paradigm of the working environment may well change for many people from office-based to remote-working.

In a purely domestic context, such changes may not cause many immediate tax concerns for a business. However, for multinational groups, there are a number of issues to consider.

Permanent establishment risk

An employee of a company in (for example) the UK, starting to work from home in the UK, is unlikely to cause particular concern. However, a change in working patterns resulting from 'home working' for an employee or agent acting in one jurisdiction, but employed or engaged from another jurisdiction, may increase the risk of a permanent establishment (PE) arising in the employee's jurisdiction.   

While the rules on PE vary to an extent from jurisdiction to jurisdiction, typically and consistent with the OECD model convention, a PE in a jurisdiction arises where an entity has:

• a fixed place of business, or
• a dependent agency.

Many businesses operate in a manner such that neither condition is met. For example, an employee may be itinerant, without an office leased by the employer and with a role and responsibilities that do not trigger a dependent agency relationship (broadly, habitually concluding contracts or playing the principal role leading to the conclusion of contracts).

Barring a change in the roles or responsibilities of a worker, it is unlikely that a change in working patterns resulting from prolonged home-working outside of a company's 'home' jurisdiction should cause a dependent agency PE risk to arise.

Nevertheless, an employee starting to work from home (or from another jurisdiction) for a prolonged period (either through choice or enforced), may give rise to a PE in the employee's home jurisdiction as a result of there being considered to be a "fixed place of business".

In the OECD Model Tax Convention: revised proposals concerning the interpretation and application of article 5 2012 (para 27), an OECD Working Party highlighted the question of whether a home office was 'at the disposal of the employer' as a key consideration in determining whether it amounts to a PE. The OECD Model Tax Convention 2017 commentary on article 5 (para 18) highlights the following factors to consider in this regard:

• whether the work done in the home office is intermittent or incidental (not the case where there is prolonged working from home, either voluntarily or enforced)
• whether the home office is used on a continuous basis for carrying on business activities (increasingly likely where home-working is chosen or required), and
• whether it is clear on the facts that the enterprise has required the individual to use that location to carry on the enterprise's business (eg by not providing an alternative office) – typically this would not be the case where a business has an office, although this could conceivably be relevant where an enterprise has precluded or forbidden access to its office as in the current circumstances.

There is limited UK jurisprudence or (until recently – see below) HMRC guidance on home offices potentially giving rise to a PE. However, as many jurisdictions base their tax laws and practice in this area on OECD guidance (and the issue inevitably has an international element where an employee of a UK business is operating or forced to operate outside the UK), it can be helpful to look to how tax authorities in other jurisdictions have addressed this issue.  

For example, the Swedish tax agency issued a statement in 2015 which set out when a home office could be considered a PE for the purposes of Swedish law (Statement No. 131 160469-15/111, 16 March 2015), including:

• if it has been agreed that the employee should work from home
• if the employee has an office in another country where they can perform work
• the amount of work the employee conducts from home
• the permanency of the work performed from the employee's home, and
• the type of work performed from the employee's home.

Each of the above criteria may conceivably be more likely met in the current environment.

Guidance was also issued by the Austrian Federal Ministry of Finance in June 2019 (EAS 3415). The guidance states that if an employee uses a company computer/telephone to carry out the work from home, this can amount to a fixed local system or facility (which, pursuant to the guidance, if it serves to carry out the business is considered a PE).

Conversely, the guidance also highlights that what is translated as "real home work" (eg simple manual tasks and low skilled typing) will not typically lead to a PE. The guidance sets out various factors to consider when questioning whether a home office amounts to a PE:                     

• What proportion of their work does the employee carry out from their home office?
• Does the employee claim expenses in connection with the use of the home office?
• Is the work carried out by the employee more than merely auxiliary/preparatory?

Once again, in the current situation, there is an increased risk that these criteria would be met.

As a final example there have been cases in Denmark considering the issue. For example, in May 2019 it was held that the home office of a Danish employee of a UK company was deemed to be a PE for the UK company, with the ruling being based on:

• regular work for the company being performed from the home office
• it was the employee's primary work location and was therefore a fixed business location
• the employee was the general manager of the company; he was therefore making significant decisions and completing work that was not purely preparatory or auxiliary in nature.

Again, there would appear to be a significantly increased likelihood of such criteria potentially being met in the current environment. The consistent trend is tax authority attention being drawn to the permanence and regularity of the work carried out by the employee from their home office, which inevitably is increasing currently (and may continue to do so with any 'paradigm shift' in working patterns).

As current circumstances increasingly dictate that many people's home offices will become their primary places of work rather than an alternative option for 1 day a week, it is likely that tax authorities will scrutinise behaviours more vigorously. The issue potentially bites both for employees that were already operating in a jurisdiction but who find themselves tethered to a specific location (typically, home), and conceivably employees that find themselves 'stranded' overseas – for example those who had returned to their jurisdiction of nationality to renew a visa or switch to a different form of visa.

Where there is found to be a PE of a non-UK company trading in the UK, this would result in the income, profits and gains attributable to such PE as being within the charge to corporation tax under CTA 2009 ss 5 and 19. The individual(s) resident or working in the UK and giving rise to the PE would be treated as the UK representative(s) of the non-UK company, with the effect that any corporation tax liabilities of the non-UK company would be recoverable from such individual(s) under CTA 2010 s 970. Equivalent provisions exist in other jurisdictions that would impact UK companies with PEs overseas.

To address some concerns, the OECD has recently provided guidance on the PE risk associated with COVID-19 (OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis, paragraphs 4-13). In its view, the exceptional and temporary change of the location where employees exercise their employment because of the COVID-19 crisis (such as home working) should not create new PEs for the employer, since a PE should have a degree of permanency and be at the disposal of an enterprise for it to be considered a fixed place of business.

Where a dependant agent PE is concerned, an employee's or agent's activity is unlikely to be 'habitual' if they are home working for a 'short period' because of force majeure or government directives impacting their normal routine. However, the guidance notes that domestic law provisions relating to permanent establishment may be stricter than the OECD's.

HMRC has also published (at INTM261010) its views on whether the presence of individuals in the UK as a consequence of COVID-19 could establish a UK PE for foreign companies. Broadly, HMRC also considers that a non-resident company will not have a UK fixed place of business PE after a "short period" of time as a degree of permanence is required. Similarly, while the habitual conclusion of contracts in the UK could create a UK dependant agent PE, it is a matter of fact and degree as to whether that habitual condition is met.

Further, even where a UK PE exists, it does not follow that a significant element of the non-resident company's profits would be taxable in the UK; the attribution of profits to the UK PE would depend on the level of activity in the UK and the relative value of that activity. Unfortunately, the guidance is of limited comfort, without any indication as to what constitutes a "short period" and the need to assess whether a pattern of conduct is habitual is a "matter of fact and degree".  Some other tax authorities have gone further and been more helpful.

For example, the OECD commentary notes that the Irish tax authorities have issued guidance disregarding to an extent the presence of an employee, director, service provider or agent in Ireland (and where relevant, in another jurisdiction) for corporate income tax purposes where the presence of such individual is shown to result from travel restrictions related to COVID-19.    

Where a PE arises (and potentially even where one does not), there is also a possibility of operations being carried on from home in a different jurisdiction giving rise to a fixed establishment for VAT purposes.

Employers with an international workforce should actively review their circumstances and assess whether changes in means or location of working could give rise to registration, filing and/or payment obligations in territories, even where a PE risk review has previously been undertaken. Care will need to be taken in particular if the current position extends longer than anticipated and/or if when normality resumes, companies find that there has been a paradigm shift in the working patterns of their employees.

Residency risk

While changes in working patterns most obviously create residency issues from a PE perspective, there is also potential for the overall tax residency of group companies to be impacted by changes.

Under UK domestic law, a non-UK incorporated company would be considered UK resident if its "central management and control" is exercised in the UK (see The question of place, Tax Adviser, edition 5506). This is a question of fact and typically HMRC's approach is to:

• ascertain whether the directors of the company actually exercise central management and control
• if they do, establish where such management and control is exercised, or
• if they do not, establish who does exercise central management and control of the company, and where.

Many multinational groups – or companies with an internationally diverse management team – will have protocols in place to ensure that board meetings are the forum through which central management and control is exercised, and that such management and control is properly exercised in the appropriate jurisdiction. There is a potential challenge for groups where there are entities or structures relying on board presence that do not equate to the natural physical location of directors.

The current situation, if prolonged, will likely put such protocols under pressure. Directors who would previously have travelled to a quarterly board meeting in the appropriate jurisdiction may no longer be able to do so, with attendance instead by phone or online. Similarly, the means by which central management and control is exercised may potentially cease to be in the forum of board meetings if the means by which management and control is exercised changes – for example, shifting towards the location of a dominant board member, major shareholder or ultimate beneficial owner.

Residence is wholly a question of fact, which is determined on a case by case basis by considering and analysing the specific circumstances over a period of time. As such, it is expected that temporary or one-off changes in practice may typically not cause a shift in residency in most cases. However, the position will become increasingly uncertain if working practices remain disrupted for a prolonged period.

HMRC has provided some recent guidance in this regard (at INTM120185), noting that it is sympathetic to the disruption that COVID-19 is causing and the corporate residence challenges it poses. In particular, it states that "we do not consider that a company will necessarily become resident in the UK because a few board meetings are held here, or because some decisions are taken in the UK over a short period of time".

It goes on to say that – even where central management and control does abide in the UK – a company will not necessarily be UK resident; it may instead be resident in another jurisdiction by virtue of a 'tie-breaker' clause in a relevant double tax treaty (as discussed below). The key point to note, again, from HMRC's guidance is the fact that each case will be decided on its own facts, albeit that the guidance is somewhat more helpful than that issued in respect of permanent establishment risk.

Where the board of a company is truly international, there is a potential that various jurisdictions may seek to assert that a company is or has become resident in that territory. A company can be resident in more than one country, under the domestic law of the respective countries, as residence conditions may vary by jurisdiction. In such circumstances, a relevant double tax treaty between the two countries may include a 'tie-breaker' clause in order to determine which country is ultimately awarded taxing rights.

A residence tie-breaker test is an objective test which is usually determined on the basis of the location of 'effective management'. A head office function is often given as an example of this 'effective management'. This is therefore a slightly different test to central management and control. However, where the head office is closed and ceases to be the place of effective management, again there may be a different analysis from the historic position.

The OECD has also issued guidance as to whether the COVID-19 situation would create any changes to an entity's residence status under a double tax treaty (OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis, paragraphs 14-20). In its view, all relevant facts and circumstances should be examined to determine the "usual" and "ordinary" place of effective management, and not only those that pertain to an exceptional and temporary period such as the COVID-19 crisis. It further notes that a temporary change in location of the chief executive officers and other senior officers should not trigger a change in residency, especially when the 'tie-breaker' rule is applied.

Notwithstanding the advice of HMRC and the OECD, groups and companies with an internationally diverse board should be considering their residence and management protocols and procedures to determine if there are any risks of inadvertently migrating corporate residence, with the potential tax implications that would follow.  

Transfer pricing risk

The arm's length principle is the international standard that OECD member countries and many other countries have agreed should be used for determining transfer prices for tax purposes. Countries (such as the UK) that apply the arm's length standard generally have rules that provide that when transfer pricing arrangements between associated enterprises do not reflect market forces and the arm's length principle, the taxable profits of associated enterprises may be adjusted as necessary to correct any such distortions, thereby ensuring that the arm's length principle is satisfied.

An arm's length return for a related party transaction for transfer pricing purposes depends critically on the functions that each enterprise performs. Once again, it is possible that previously internationally mobile individuals (including "weekly commuters") undertaking their functions from a different jurisdiction than normal could impact a group's existing transfer pricing position or policies.

For example, in the context of intangible asset transactions, BEPS guidance provides a framework for determining which members of a multinational group should share in the economic returns generated by those intangibles based on the value they create through functions performed, assets used and risks assumed in their development, enhancement, maintenance, protection and exploitation (DEMPE).

Economic substance risk  

A number of jurisdictions have enacted economic substance requirements to address concerns that companies were being used to artificially attract profits that were not commensurate with economic activities in those jurisdictions. In particular, the UK's Crown Dependencies (Jersey, Guernsey and the Isle of Man) and Overseas Territories (Bermuda, Cayman Islands and BVI) have recently introduced such requirements, in response to having been placed on the EU 'blacklist' of non-cooperative tax jurisdictions.

Under these rules, certain companies are required to demonstrate they have substance in a particular jurisdiction by being directed and managed, conducting Core Income Generating Activities (CIGA), and having adequate people, premises and expenditure in that jurisdiction. Other jurisdictions, such as the Netherlands, have substance requirements that must be met in order, for example, for tax rulings to be obtained.

Given the current travel restrictions imposed on otherwise mobile company officers, it is clear that these requirements may be difficult to meet. There is therefore the potential for undermining substance in territories if functions are not maintained where anticipated (or are maintained inconsistently with rulings).

Some territories have specifically addressed the impact of COVID-19 on their economic substance requirements:

• The Jersey Comptroller of Revenue has confirmed (Economic Substance, Corporate Tax residence and the implications of Corona Virus (COVID 19) – 11 March 2020) that if companies have to adjust their operations owing to the COVID-19 outbreak, the Comptroller will not determine that a company has failed the economic substance test under the Taxation (Companies-Economic Substance)(Jersey) Law 2019. This treatment extends only to any required adjustments made to the company's normal practice in order to mitigate threats of the virus (for example, where virtual board meetings need to be held while directors are prevented from travelling due to restrictions being in place).                         

• The Chief Minister of Guernsey has endorsed a similar assurance (Measures to Combat Coronavirus and Complying with Substance Requirements (issued by GSCCA) – 16 March 2020) to companies struggling to comply with their economic substance obligations, in particular their ability to meet the "directed and managed" test, and to demonstrate that all CIGA are taking place in Guernsey. The guidance recommends that companies should maintain and retain relevant records detailing their policy of restricting company officers' travel, and the length of time this was in place. This would therefore demonstrate that the COVID-19 outbreak prohibited, for instance, the company holding an adequate number of board meetings on the island.

While these are welcome announcements, the residence issues outlined above of adopting such arrangements should also be considered. Companies should keep under review any substance requirements to which they are currently subject, as well as any relaxation of the economic substance requirements in jurisdictions in which they do business, to ensure they qualify for any concessionary treatment.

Other issues

There are, of course, numerous other tax issues that the current circumstances could cause international businesses and their workforces. For example, individuals stranded in the UK (or another jurisdiction) and unable to leave the country may risk becoming tax resident in a jurisdiction unintentionally (although it is the OECD's view that an individual's residence will likely not change by virtue of such temporary dislocation – see OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis, paragraphs 28-36).

Payroll and social security obligations also potentially need to be considered. Employees will want to understand if they can receive tax deductions for expenses they incur in enabling them to work from home. At a more operational level, if employees require materials or equipment to be sent from their office cross-border to their homes in order to work, there could be customs and VAT costs involved.

Businesses will clearly be focused on their immediate requirements in managing and operating in the current situation. However, they need to review the potential implications of the circumstances impacting their tax position internationally.

An earlier version of this article was published by Tax Journal on 23 April 2020.