Model A has generally been considered unacceptable from a company policy perspective in “normal” times, except with respect to short business trips. Border closures have forced this scenario on many businesses, however. Model A presents a range of tax compliance challenges, namely:
- Permanent Establishment: The employee may create a permanent establishment (PE) in country A for the employer in country B, requiring an attribution of profits to a branch in country A and triggering corporate tax compliance obligations. The OECD guidance on home office working states that this is a low risk while it is temporary and exceptional, but not necessarily in the long term.
- Employer obligations: The employer in country B may have wage tax withholding and social security obligations in country A. Some of these requirements in certain countries may be temporarily relaxed during the crisis, but not permanently.
- Residency: The employee may change tax residence status, which could have an impact on net pay as well as pension and social security status.
- Indirect Tax: Employer in country B may have VAT exposure in country A.
- Substance: If the employee is in senior leadership or a board member, location of decision making may impact corporate residence (place of effective management) and substance of HQ location. This could have knock-on effects for the transfer pricing / value chain model.
- Immigration: The employee may not have the right to work in country A if they are a foreign national (employer in country B cannot provide a work permit for country A).
- Labour and industry regulation: The employer in country B is exposed to labour law and other local regulations in country A for which it is not prepared or compliant. This is particularly problematic for highly regulated industries, e.g. financial services.
It is for all of the above reasons that traditional mobility policies have entailed transfer or assignment of employment to the location of physical work. This aligns with current international tax rules which are generally based on employees paying tax where they live and work, which is withheld by an employer in the same country, which claims a tax deduction for their cost against the revenue they have generated. These principles are unlikely to change in the medium term.
Model B has occurred over the past few months where employees have needed to begin roles at foreign affiliates but have been unable to physically move to that location. Many organisations have cancelled or postponed any international transfer or assignment of employment between group entities unless and until borders reopen. Business units have, however, needed these people to begin their roles, wherever they happen to be in the world. Understandably, the business did not care whether they worked from home in country A or country B, provided they got the job done. In some cases, these employees have had their titles, reporting lines and compensation changed, even if their legal employer and location did not.
This model has always existed to a small extent, certainly for specific projects and regional/global roles, and, I suggest, is more likely to survive the current crises than Model A. Indeed it seems likely to become the go-to “work around”.
This model presents far fewer of the tax compliance risks described in Model A. Certainly, there remains a permanent establishment risk, even where the individual is not legally an employee of the foreign affiliate. Should that individual create a permanent establishment for Company B in country A, profit attribution would be required (applying transfer pricing principles).
It also poses a potentially more complex question around transfer pricing, even where no PE is created. Where these arrangements are temporary (as currently under lockdown), Finance and Group Tax may not require the costs to be charged from the employing entity to the affiliate beneficiary of the employee’s services. But in the longer term a transfer pricing position should be taken in such cases if they become permanent:
- The employing entity may not be able to claim a corporate tax deduction for the employee’s costs if they are not productively contributing to that entity.
- The employing entity should be compensated, at an arm’s length basis, for the provision of their employee’s services to the foreign affiliate. The appropriate methodology would need to be determined and documented, i.e. cost-plus or other.
If international telecommuting becomes more common post-COVID-19, as we expect, and hundreds of employees wish to live and work in one country for the benefit of a group company in another country, then robust guidelines for implementation to cater for the transfer pricing implications will be essential.