On 3 April 2020, the OECD Secretariat issued guidance ‘OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis’ (OECD guidance) on international double taxation agreement (tax treaty) issues that may arise as a result of the COVID-19 pandemic. The OECD’s guidance is particularly useful as it provides some clarity during this time of unprecedented uncertainty, with organisations across the world rapidly adapting to new methods of managing their businesses and people.
In recent months the COVID-19 pandemic has forced governments worldwide to restrict travel, resulting in many cross-border workers being unable to physically perform their duties in their country of employment or being stranded in a location that is not their country of residence. This has disrupted the lives of individuals and activities of businesses alike. A number of key tax issues have arisen including the risk of a company creating a permanent establishment (PE) in a new jurisdiction and changes to the tax residence status of individuals forced to work in a different location other than their normal place of work. These issues have an impact on the right to tax between countries, which is currently governed by international tax treaty rules that delineate taxing rights.
Therefore, at the request of multiple concerned countries, the OECD has issued guidance, which specifically deals with concerns relating to:
- creation of permanent establishments;
- residence status of companies (place of effective management);
- cross-border workers; and
- residence status of individuals.
The OECD analysis sets out the view that COVID-19 measures are generally exceptional and should not normally affect a company or individual’s residency status for the purposes of tax treaties in a particular jurisdiction. It is also important to note that further consideration will be required if cross-border issues emerge during the COVID-19 pandemic and no tax treaty exists. The OECD’s guidance refers to the OECD Model Tax Convention on Income and on Capital 2017 (OECD Model) as well as the Commentary on the 2014 version of the OECD Model (2014 OECD Model).
Creation of Permanent Establishments
Certain businesses have raised concerns that if their employees are dislocated in countries other than where they regularly work during the COVID-19 pandemic, a PE may inadvertently be created in those countries, resulting in unintended domestic tax compliance and filing obligations. According to the OECD, any change to the location where employees exercise their employment or any temporary conclusion of contracts in the homes of employees or agents because of the COVID-19 pandemic should not create PEs for employers or businesses.
The OECD guidance also contains the important caveat that the threshold presence required by domestic law to register for tax purposes may be lower than those applicable under a tax treaty, and therefore trigger corporate income tax registration requirements. It encourages local tax authorities to provide guidance on the application of domestic law threshold requirements, domestic filing and other relevant issues to minimise burdensome compliance requirements for taxpayers in the wake of the COVID-19 pandemic. Fortunately the Australian Taxation Office (ATO) has released guidance (ATO guidance), first published on 9 April 2020 and last updated on 8 May 2020, on international tax issues including transfer pricing documentation, thin capitalisation and safe harbour, central management and control (CM&C), permanent establishment, significant global entity (SGE) penalty and PAYG withholding. The ATO’s guidance on is particularly useful and should be applied in conjunction with the OECD’s guidance.
Broadly, an entity will be deemed to have a PE in another jurisdiction if it has a fixed place through which the business of the enterprise is wholly or partly carried on. The general requirement is that the PE must have a certain degree of permanency and be at the disposal of an enterprise. According to paragraph 18 of the Commentary on Article 5 of the OECD Model, even though part of the business of an enterprise may be carried on at a location such as an individual’s home, this should not lead to the conclusion that the location is at the disposal of that enterprise simply because it is used by an employee.
For a home office to be a PE for an enterprise, it must be used on a continuous basis for carrying on the business of the enterprise and there must be a general requirement that individuals use that location to carry on the enterprise’s business. During the COVID-19 pandemic, individuals who work from home remotely are typically doing so because of government directives and not an enterprise’s requirement. Working from home does not create a PE for the business or employer because such activity lacks a sufficient degree of permanency or continuity and because, except through that one employee, the enterprise has no access or control over the home office.
Travel restrictions currently imposed by governments worldwide may result in certain individuals not being able to return to their usual country of employment. This raises the question as to whether the activities of an individual temporarily working from home for a non-resident employer could give rise to a dependent agent PE. Under Article 5(5) of the OECD Model, the activities of a dependent agent such as an employee will create a PE for an enterprise if the employee habitually concludes contracts on behalf of the enterprise. According to paragraph 33.1 of the Commentary on Article 5 of the 2014 OECD Model this means that the presence which an enterprise maintains in a country should be more than merely transitory if the enterprise is to be regarded as maintaining a PE, and thus a taxable presence, in that country.
An employee or agent’s activity in a country is therefore unlikely to be regarded as habitual if they are only working at home for a short period of time because of government directives extraordinarily impacting their normal routine. A PE should only be considered to exist where the relevant activities have a certain degree of permanency and are not purely temporary. This should be contrasted to situations where an individual was habitually concluding contracts on behalf of an entity in their home country prior to the COVID-19 pandemic.
Foreign companies with expatriate employees that have returned to Australia may inadvertently trigger the creation of a PE in Australia that generates compliance and tax filing obligations. According to the ATO’s guidance however, where a foreign incorporated company that is not an Australian tax resident did not otherwise have a PE in Australia before the COVID-19 pandemic and the presence of employees in Australia is because they are temporarily relocated or restricted in their travel, then the ATO will not apply compliance resources to determine if there is a PE in Australia.
In some countries where a complete lockdown is imposed due to the COVID-19 pandemic, there may be a temporary interruption of activities on construction sites. In general, a construction site will constitute a PE if it lasts more than 12 months under the OECD Model or more than 6 months under the UN Model. Paragraph 55 of the Commentary on Article 5(3) of the OECD Model explains that a site should not be regarded as ceasing to exist when work is temporarily discontinued and that seasonal and temporary interruptions should be included in determining the life of a site. Examples of temporary interruptions in the OECD’s Commentary include a shortage of material or labour difficulties.
As per the OECD guidance, the duration of such an interruption of activities should be included in determining the life of a site and therefore affect the determination of whether a construction site constitutes a PE. This guidance does not appear to be concessional and the temporary interruption due to the COVID-19 pandemic could potentially deem a construction PE to exist, which would not have been the case otherwise. The unintended consequences of a deemed construction PE extending beyond the 6 or 12 months threshold due to COVID-19 pandemic interruption could result in the PE having to determine the attributable income of the PE, lodge income tax returns and comply with other domestic tax law requirements.
Residency status of companies
A company is generally considered to be a tax resident of the country where it is incorporated, however it may also be a tax resident of a country in which it has a place of effective management, amongst other things. There are concerns that the current COVID-19 pandemic may result in a potential change to the “place of effective management” of a company owing to key senior executives being relocated or unable to travel, with the consequence that the company may have a change in tax residency. According to the OECD guidance, a temporary change in location of key senior executives because of the COVID-19 pandemic should not trigger any changes to an entity’s tax residence status under a tax treaty.
According to the ATO’s guidance, if the board of a foreign-incorporated company that is not an Australian tax resident, temporarily makes arrangements for board meetings because of travel restrictions, including holding board meetings in Australia or having directors attend board meetings from Australia, then the ATO will not apply compliance resources to determine if its CM&C is in Australia. On 6 May 2020, the Australian Securities and Investments Commission (ASIC) announced that a company’s annual general meetings may be conducted online as a result of disruption owing to the COVID-19 pandemic, for a period of six months from the date of the announcement. Ultimately the OECD guidance notes that all relevant facts and circumstances should be examined to determine the “usual” and “ordinary” place of effective management, and not only those pertaining to a temporary period owing to the extraordinary nature of the COVID-19 pandemic.
A potential change of circumstances may also trigger an issue of dual residency (for example in cases where the change in the place of effective management results in a company being considered resident in two countries simultaneously under their domestic laws). Whilst the occurrence of dual tax residency is relatively rare, to resolve situations in which an individual may be exposed to double taxation because of dual residency, tie-breaker tests in Article 4(2) of the OECD Model are applied to ensure that a company is a tax resident in only one country. Most tax treaties include a tie-breaker test under which a dual resident is deemed to be a resident of only one of the two jurisdictions for the purposes of taxation. Where there are tax treaties containing provisions like the tie-breaker rule, competent authorities deal with the dual residency issue on a case-by-case basis by mutual agreement.
In situations where the applicable treaty contains the pre-2017 OECD Model tie-breaker rule, the place of effective management will be the only criterion used to determine the residence of a dual-resident entity for tax treaty purposes. According to paragraph 24 of the Commentary on Article 4 of the 2014 OECD Model, the place of effective management is the place where key commercial decisions that are necessary for the conduct of the entity’s business are made. Paragraph 149 of the Commentary on Article 29 of the current 2017 version of the OECD Model further notes this may be the place where the most senior people (for example a board of directors) make key management decisions necessary for the conduct of the company’s business.
Residency status of cross border workers
According to Article 15 of the OECD Model salaries, wages and similar remuneration are generally taxable in an employee’s country of residence, unless the employment is exercised in another country. The Commentary on Article 15 explains that this refers to the place where the employee is “physically present when performing the activities for which the employment income is paid”. There are however, conditions attached to the place of exercise test with tax treaties generally limiting a source country’s taxing right where inter-alia the employee has been present for less than 183 days in the source country.
Governments worldwide have announced economic responses to the COVID-19 pandemic, which include wage subsidies to employers designed to retain workers despite restrictions to the exercise of their employment. According to paragraph 2.6 of the Commentary on Article 15 of the OECD Model, these payments should be attributable to the place where the employee would otherwise have worked which in most circumstances, will be the place the person used to work before the COVID-19 crisis.
On 30 March 2020, the Australian Government announced the creation of the JobKeeper Payment Scheme where businesses impacted by the COVID-19 pandemic receive a fortnightly payment of $1,500 (before tax) per eligible employee until 27 September 2020, with the aim of encouraging employers to retain employees. The OECD guidance states that the wage subsidy payments that employees receive during the COVID-19 pandemic should most closely resemble eligible termination payments (ETP). JobKeeper payments are however, outside the usual realm of ETPs, as they are conditional upon wage conditions being satisfied pertaining to amounts that are “salary, wages, commission, bonus or allowances”, which are payments not included in an ETP. Nevertheless, where such wage subsidies are paid and a source country has a taxing right, a residence country must relieve double taxation under Article 23 of the OECD Model, either by exempting the income or by taxing it and giving a credit for the source country tax.
A change of place where cross-border workers exercise their employment may also affect the application of the special provisions in some bilateral treaties that deal with the situation of cross-border workers. These provisions often contain limits on the number of days that a worker may work outside the jurisdiction he or she regularly worked in before triggering a change in his or her status. More widely, if the country where employment was formerly exercised should lose its taxing right following the application of Article 15 of the OECD Model, additional compliance difficulties would arise for employers and employees. That is, employers may have withholding obligations, which are no longer underpinned by a substantive taxing right. Furthermore, employees may have a new or enhanced liability in their country of residence. In light of these exceptional circumstances, the OECD is continuing to work with countries to mitigate the unplanned tax implications and potential new burdens arising due to effects of the COVID-19 pandemic.
Residency status of individuals
The restrictions imposed by governments worldwide in the wake of COVID-19 pandemic could lead to adverse tax outcomes for individuals. The two possible scenarios contemplated in the OECD guidance are when:
- A person is temporarily away from their home i.e. on holiday, for work purposes etc. and becomes stranded in a host country by reason of the COVID-19 pandemic and attains domestic tax law residence; or
- A person is working in a country i.e. their “current home country” and has acquired residence status, but they temporarily return to their “previous home country” because of the COVID-19 pandemic. They may either never have lost their status as resident of their previous home country under its domestic legislation, or they may regain residence status upon their return.
For the purposes of a tax treaty, an individual can only be a resident in one country at a time (their “treaty residence”). However, an individual can also be considered to be a tax resident of two jurisdictions at the same time under the domestic tax laws of two or more different countries, in which case they are commonly referred to as a dual resident. In such instances, tax residency is determined under the aforementioned tie-breaker rules in Article 4 of the OECD Model.
In the first scenario, the tie-breaker rules in any applicable tax treaty would award tax residence to the home country on the basis that such individuals would not have a permanent home available to them in their host country. In the second scenario, similar tie-breaker rules would apply, but the situation would be more complex depending upon the individual’s attachment to their previous home country. Again, it is unlikely that such a person would regain residency status for being temporarily in their previous home country. The test of “habitual abode” (a key factor in the tie-breaker test) would be applied in favour of the previous home country, given that it relates to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life. The OECD guidance notes that even if a person becomes a tax resident under such rules, if a tax treaty is applicable the person would not become a resident of that country under the tax treaty due to their exceptional dislocation. The OECD guidance recommends that competent authorities wait for normal circumstances to resume before assessing a person’s resident status.
Many countries have begun issuing useful guidance on the impact of the COVID-19 pandemic on the domestic and tax treaty determination of the residence status of an individual. In Australia, the ATO’s guidance states that where a person that is not an Australian resident for tax purposes is in Australia temporarily for some weeks or months because of the COVID-19 pandemic, he or she will not become an Australian resident for tax purposes. According to the ATO, usually the place where the employment is exercised is significant when deciding the source of employment income. The COVID-19 pandemic has however created a special set of circumstances that must be taken into account when considering the source of the employment income of a non-resident who usually works overseas, but instead performs that same employment in Australia as a result of the current situation. Under such circumstances, the ATO will accept that if a working arrangement is short-term (three months or less) employment income will not have an Australian source. The UK and Ireland have provided similar guidance with Ireland’s guidance providing for “force majeure” circumstances where an individual is prevented from leaving Ireland on his or her intended day of departure because of extraordinary natural occurrences.
The OECD’s guidance is welcomed and provides a pragmatic approach designed to prevent taxpayers facing unforeseen tax difficulties because of the COVID-19 pandemic. It is important to note however, that the OECD’s guidance is only applicable where there is a tax treaty in place and that not all treaties align with the OECD Model and contain variations with respect to wording, conditions and time periods. Furthermore, in the absence of a tax treaty, domestic legal provisions may be less flexible than standard treaty provisions. Conditions may need to be in place to rely on the “force majeure” concept upon which some of the OECD guidance was based.
As employers navigate their compliance obligations, they should focus on high exposure scenarios such as non-treaty country combinations or PE exposure in high corporate tax rate jurisdictions. In addition, companies should consider careful application of treaty positions and consistent monitoring of jurisdiction-specific relief mechanisms. Individuals and companies should also maintain a proper record of the facts and circumstances of the relevant presence, particularly with respect to involuntarily remaining in a country, or outside a usual place of residence.
The COVID-19 pandemic presents exceptional conditions; therefore, tax administrations will have to wait for the resumption of more normal circumstances before assessing residency status in their regular manner. Whilst the ATO’s guidance provides a degree of reassurance for taxpayers during the present disruption and is critical for businesses that have been impacted, unresolved issues remain. These include the genuine impact on the taxability of construction projects and Australian companies with employees stranded but still working in foreign jurisdictions, which may create a foreign PE. There is currently no guidance from the ATO on these matters. If the current situation were to extend for more than half a year, the OECD’s guidance would also need to be revised.
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