As noted in our Short Read of 7 April 2020, the Organisation for Economic Cooperation and Development (“OECD”) Secretariat issued preliminary guidance on several tax issues arising from the COVID-19 pandemic on 3 April 2020 (the “April Guidance”).
The April Guidance was issued as an urgent response to requests from concerned jurisdictions which as a result of the COVID-19 pandemic had taken unprecedented measures that affected the mobility of individuals such as restricting travel and implementing strict quarantine requirements. These unprecedented measures imposed or recommended by governments, including travel restrictions and curtailment of business operations, have been in effect in most jurisdictions in various forms and stages during most of 2020 and this situation is expected to continue in 2021. The updated guidance issued on 21 January 2021 (“updated guidance”) is intended to provide more certainty to taxpayers during this exceptional period.
This updated guidance again represents the OECD Secretariat’s views on the interpretation of the provisions of tax treaties and cannot be relied on to create instances of double non-taxation. Each jurisdiction may adopt its own guidance to provide tax certainty to taxpayers. However, the updated guidance does reflect the general approach of jurisdictions and illustrates how some jurisdictions have addressed the impact of COVID-19 on the tax situations of individuals and employers. The guidance considers some additional fact patterns not addressed in detail in the April Guidance, examines whether the analysis and conclusions outlined in the April Guidance continue to apply where the circumstances persist for a significant period, and contains references to country practice and guidance during the COVID-19 period. Furthermore, this guidance is relevant only to circumstances arising during the COVID-19 pandemic as long as public health measures are in effect. In this Short Read, we summarize the updated guidance and highlight any changes to the April Guidance.
Permanent establishments (PE)
In general, a state cannot tax profits of an enterprise of another state unless that enterprise carries on its business through a permanent establishment situated therein. Because of the current unprecedented COVID-19 pandemic, businesses may be concerned that their employees will create a PE for them in another jurisdiction because of a change in working location, which would trigger new filing obligations and tax obligations. The OECD Secretariat has provided updated guidance for the following situations, hereby again making clear that the threshold presence required by domestic law may be lower in domestic situations.
A PE generally must have a certain degree of permanency and be at the disposal of an enterprise to be considered a fixed place of business through which the business of that enterprise is wholly or partly carried on. In the April Guidance the position was already taken that an employee who because of the extraordinary nature of the COVID-19 pandemic (i.e. force majeure) stays at home to work remotely (i.e. home office) should not create a PE for the business / employer to the extent that it does not become the new norm over time. This conclusion is warranted either because such activity lacks sufficient degree of permanency or continuity or because the enterprise has no access or control over the home office (and the enterprise in normal circumstances provides an office which is available to its employees). This position is reiterated in the updated guidance. This applies both in case the temporary work location is the individual’s home and where the temporary work location is a temporary dwelling in a jurisdiction that is not their primary place of residence. In the updated guidance the Secretariat notes that further examination of the facts and circumstances will be required to determine whether the home office is now at the disposal of the enterprise following a permanent change to the individual’s working arrangement. Paragraphs 18 and 19 of the Commentary on Article 5 of the OECD Model indicate that whether the individual is required by the enterprise to work from home or not is an important factor in this determination. Paragraph 18 explains that where a home office is used on a continuous basis for carrying on business activities for an enterprise and it is clear from the facts and circumstances that the enterprise has required the individual to use that location (e.g. by not providing an office to an employee in circumstances where the nature of the employment clearly requires an office), the home office may be considered to be at the disposal of the enterprise. As an example, paragraph 19 notes that where a cross-border worker performs most of their work from their home situated in one jurisdiction rather than from the office made available to them in the other jurisdiction, one should not consider that the home is at the disposal of the enterprise because the enterprise did not require the home to be used for its business activities. In conclusion, individuals teleworking from home (i.e. the home office) as a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of the COVID-19 virus would generally not create a fixed place of business PE for the business/employer.
Another question that may arise is whether the employee temporarily working from home for a non-resident employer could qualify as a dependent agent PE. The activities of an employee may create a PE for an enterprise if the employee habitually concludes contracts on behalf of the enterprise. In line with the April Guidance, according to the updated guidance, an employee’s or agent’s activity in a jurisdiction is unlikely to be regarded as ‘habitual’ if they are only working at home in that jurisdiction because of an extraordinary event or public health measures imposed or recommend by government. This may work out differently if the employee already was habitually concluding contracts on behalf of the enterprise in his home state before the COVID-19 pandemic. According to the update guidance, this may also work out differently if the employee continues to work from home for a non-resident employer after the COVID-19 pandemic, on a habitual basis and continues to conclude contracts on behalf of the enterprise.
Construction site PE
A building site or construction or installation project of an enterprise in another state will in general constitute a permanent establishment only if it lasts longer than a certain period (under the OECD Model more than 12 months). In line with the April Guidance, according to the updated guidance, the duration of a temporary interruption of activities on those sites or projects due to the COVID-19 pandemic should be included in determining the time those sites or projects last, and therefore will affect the determination whether a construction site constitutes a PE. 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 (temporary interruptions should be included in determining the duration of a site). This updated guidance notes, however, that the Commentary does not include a bright line test on the meaning of ‘temporary’ interruption. Jurisdictions may therefore have different views of the duration of a ‘non-temporary’ interruption and on other conditions that make the interruption of a different nature than the examples of interruptions in paragraph 55 of the Commentary. Accordingly, some jurisdictions may consider ‘stopping the clock’ for determining whether the PE threshold has been satisfied during certain periods where operations are suspended as a public health measure to prevent the spread of the COVID-19 virus
Place of effective management
The updated guidance also addresses the concern of a potential change in the ‘place of effective management’ as a result of a relocation, or inability to travel, of board members or senior executives. The updated guidance reconfirms that it is unlikely that the COVID-19 situation will create any changes to an entity’s residence status under a tax treaty. If the change in circumstances may trigger an issue of dual residence, the updated guidance indicates that all relevant facts and circumstances should be examined to determine the ‘usual’ and ‘ordinary’ place of effective management, and not only those circumstances that pertain to an exceptional period such as the COVID-19 pandemic. It is therefore concluded that an entity’s place of residence under the tie-breaker provision included in a tax treaty is unlikely to be impacted by the fact that management of an entity cannot travel as a public health measure imposed or recommend by at least one of the governments of the jurisdictions involved.
Residence status of individuals
With respect to individuals the updated guidance distinguishes two main situations: (i) persons temporarily away from their home (perhaps for work or vacation) who get stranded in a host country, and (ii) expatriates returning to their ‘previous home jurisdiction’ because of COVID-19. According to the updated guidance it is in both situations unlikely that individuals would acquire residence status in the jurisdiction where they are stranded or to which they return, as the case may be, due to the COVID-19 emergency. If nonetheless the latter jurisdiction would claim residence, and if a tax treaty is applicable, the person is unlikely to become a resident of that jurisdiction under the tiebreaker rule of the tax treaty. The updated guidance however also addresses situations in which this conclusion is less obvious (for example if the individual rents for a sufficiently long period of time an apartment in the previous home jurisdiction and rented out the dwelling in the home jurisdiction). The updated guidance therefore concludes that because of COVID-19 tax administrations will have to consider a grace period where imposed health measures do not apply when assessing a person’s residence status, thereby restating that a person’s place of residence is unlikely to change under the tiebreaker rule. This may work out otherwise if the change in circumstances continues and the COVID-19 measures are lifted.
Income from employment
Due to COVID-19 governments may have stepped in to subsidise the keeping of an employee on a company’s payroll during the COVID-19 pandemic despite being unable to work. The updated guidance reconfirms that this income in cross border situations should be allocated to the place where the employment used to be exercised. In case this payment may resemble a termination payment, the guidance makes clear that it should be allocated to the place where the employee used to work before the COVID-19 pandemic.
The updated guidance also contains a separate section dealing with the so-called 183-day test of article 15(2)(a) of the OECD Model. With respect to this test, it is concluded that if an employee is prevented from travelling because of COVID-19 (for example because of being in quarantine or flights are banned by the government), it would be reasonable to take those days not into account for purposes of the 183-days test of article 15(2)(a) OECD Model. Some jurisdictions however take a different approach.
The guidance further makes clear that 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, and that may contain limits on the number of days that a worker may work outside the jurisdiction he or she regularly works. In this respect, some jurisdictions have agreed to treat the COVID-19 pandemic as force majeure, and accordingly to not include teleworking in the home jurisdiction in the calculation of the maximum workdays outside the work jurisdiction for purposes of the treaty.
Finally, the updated guidance also addresses that additional compliance difficulties may arise if the jurisdiction where employment was formerly exercised loses its taxing right following the application of article 15 of the OECD Model. Employers may have withholding obligations that are no longer underpinned with a taxing right, where the employee may have a new liability and filing obligation in their jurisdiction of residence. In that regard, the updated guidance calls for coordination between jurisdictions to mitigate compliance and administrative costs, and where relevant to apply a MAP.
The updated guidance confirms the views that were included in the initial guidance issued in April of this year and adds some useful clarifications, for example in relation to the application of the 183-days rule of article 15(2)(a) of the OECD Model. In the guidance jurisdictions are also encouraged to mitigate compliance and administrative costs as much as possible. Please do not hesitate to contact us if you may have any questions in relation to the updated guidance.