On 3 April, the OECD issued guidance on the COVID-19 tax situation which effectively supplements the Commentary to the Model Tax Treaty.
There is a big focus, of course, on permanent establishments (PE) and corporate residency / place of effective management (POEM), given that employees and directors are "in the wrong country" carrying out their duties. The guidance is quite clear that, if these changes in location are exceptional/extraordinary and temporary, then there should not be a PE or POEM problem.
Under the PE test, the OECD reminds us of two important points:
- A home office needs to be at the disposal of the employer (owned or rented) in order to constitute a fixed place of business PE; and
- The temporary conclusion of contracts by dependent agents should not create a PE (i.e. it is not habitual, as the test requires).
However, this guidance is predicated on the assumption that the COVID-19 border closures have caused a change of normal location. If the company had a PE or POEM problem before the lockdowns and the border closures have exacerbated it, then I would not expect too much sympathy from the tax authorities.
With regards to individuals, the OECD guidance considers two main issues, explored below.
Individual residency status under the treaty tie-breaker tests
It is not up to the OECD to interpret domestic residency rules, so an individual will be judged resident of a state (or not) under existing local rules (some of which have changed - see below), and if they establish dual tax residency because of border closures then the treaty tie-breaker tests come into play as usual. In this case, the OECD comments that a person who acquires residence in a state where they are temporarily located, under extraordinary circumstances, should not be considered exclusively resident of that state for treaty purposes.
This guidance is clearly very limited in scope. It is unlikely that someone who is temporarily stuck somewhere would acquire tax residency in the first place. But perhaps it is comforting to business travelers camping in a hotel for three months longer than they intended. The more common problem will be medium-term moves that become longer-term, or commuters that become work-from-homers, between countries that have conflicting residency rules and/or no split-year rules. Each case will need to be considered on its own merits in the usual way - is there a permanent home available in one or both or neither state? If both or neither, where is the center of vital interests? If the center of vital interest test becomes relevant, then family units that are unable to relocate will be most impacted. Employees repatriating back to family should tie-break to the 'home' country I would expect.
Source of earnings when employment performed away from normal host state
For this topic it is best to break out four categories:
i) Government wage subsidies should be sourced to the country (i.e. may be taxed under Art. 15 of the treaty) where the individual would have normally worked before border closures. This is a textbook 'originating cause' source rule.
ii) Other regular employment income should be taxed where the employment is actually performed (even if this is not the usual location of employment). This is just restating the normal work-day apportionment rule - earnings from employment have an originating cause every day, in the country where that work is physically done, regardless of the location of the employer or the payroll. Some countries have announced they will be flexible on this rule - see my notes further below.
This strict work-day sourcing rule has perhaps the most far-reaching consequences for workers locked-down in the wrong country. For example:
- New international local hires that cannot physically move to the host county are on-boarded remotely and start performing work for a foreign employer
- Intended secondees and international transfers begin their new roles for foreign affiliates under new contacts but do not physically move
Quite apart from the sourcing issues, what are the wage tax withholding and social security obligations of the foreign employer? It is a minefield, to be blunt, but see iii) below.
So what to do about these cases? Ideally, postpone the change of employment entity / hire until the person can physically move. If that is not possible, employ them in a local entity in the new role (and new compensation if relevant) for the benefit of the foreign entity - in which case the transfer pricing implications need to be considered. Should there be an SLA and cross-charge? For a few weeks, maybe not. But will the local entity accept the cost? And can they be easier transferred abroad later (labour law may play a role here)?
Of course these cases also have corporate tax implications (see above), but these are perhaps less of a risk - which makes a pleasant change!
iii) The administrative burden of having employees working in a country they were never intended to work in can be a nightmare. Are you really going to register your Romanian subsidiary for Latvian wage withholding because one employee is stuck there for two months? The OECD is "working with countries to mitigate the compliance and administrative costs" of these unintended outcomes. Good luck to them (really).
I should note here the complexities experienced around shadow payroll at this time (as if it were not complex enough). When a secondee is posted but does not physically move, and remains paid at home, should compensation be shadowed in host, given there are no workdays? Probably not, although some countries will insist on reporting all employees. And certainly many countries want social security regardless of workdays - but in both countries? These and other questions are keeping expat payroll managers busy.
iv) Frontier workers (daily cross-border commuters) are excluded from this OECD treaty guidance because many countries have separate treaties with very specific rules applicable to this population, including non-returning day tests. I cover this topic further below.