Advocaten / Avocats / Lawyers

Wednesday, 08 April 2020

What is the impact of the COVID-19 crisis on the application of double tax treaties?

As a result of the COVID-19 crisis, many cross-border workers are unable to physically work from their country of employment, some have to work from home, others are laid off, and some individuals are stranded in a country that is not their country of residence.

On April 3rd, the OECD Secretariat issued guidance on the potential tax issues that may arise in these situations. The full document of the Secretariat can be found here. We have summarized the main takeaways.

1. Concerns related to the creation of permanent establishments (“PE”)

The main question here is whether the COVID-19 crisis may trigger (i) a material PE (the fixed place of business being the home office of employees living abroad), or (ii) an agency PE (for employees living abroad and having the capacity to represent the enterprise), or (iii) a construction site PE for Belgian entities?

Home office – risk of having a material PE abroad?

In general, a PE must have a certain degree of permanency and be at the disposal of an enterprise to be considered as a fixed place of business through which the business of that enterprise is wholly or partly carried on.

For a home office to be considered as a material PE for an enterprise, it is usually required that (i) the home office is used on a continuous basis for carrying on the business of the enterprise; and (ii) the enterprise itself required its employees to use that location to carry on the enterprise’s business. During the COVID-19 crisis, employees are working from home (i) for a limited duration; and (ii) because of government directives.

Considering the extraordinary nature of the COVID-19 crisis, and assuming that the use of home offices does not become the new norm over time, teleworking from home should not create a foreign PE for the Belgian employers having employees teleworking abroad.

Dependent agent – risk of having an agency PE abroad?

In principle, the activities of a dependent agent such as an employee create a PE for an enterprise if the employee habitually concludes contracts on behalf of the enterprise. To assess if a so-called agency PE exists, the employee should perform these activities in a “habitual” way. The relevant activities must have a certain degree of permanency and not being purely temporary or transitory.

An employee’s activity in his or her home country is unlikely to be regarded as habitual if he or she is only working at home for a short period because of force majeure and/or government directives extraordinarily affecting his or her normal routine. Therefore, this should not trigger any agency PE (assuming that the employee was not habitually concluding contracts on behalf of the enterprise in his or her home country before the COVID-19 crisis).

Construction site PE

Many activities on construction sites are temporarily interrupted by the COVID-19 crisis and the duration of such an interruption should be included in determining the life of a site (which triggers a PE if it lasts 12 months under the OECD Model). Therefore, the COVID-19 crisis will certainly affect the determination whether a construction site constitutes a PE.

2. Concerns related to the residence of a company – risk of dual residency?

The COVID-19 crisis may raise concerns about a potential change in the “place of effective management” of a company as a result of a relocation, or inability to travel, of CEO or other senior executives. This may change the company’s residence under relevant domestic laws and affect the country where a company is regarded as a resident for tax treaty purposes. Is there a risk of dual residency?

In case of dual residency (if both states consider that the company is tax resident in their own country), the tax treaties usually contain a so-called “tie-breaker rule” to determine the residency of a dual-resident entity for tax treaty purposes:

  • In situations where the relevant treaty contains a tie-breaker rule like the 2017 OECD Model , competent authorities would have to deal with the dual residency issue on a case-by-case basis by mutual agreement considering all the facts and circumstances over the determination period. The OECD Commentary illustrates a range of factors to be considered including amongst others the place where the meetings of the company’s BoD are usually held, the place where the CEO usually carries on his activities; etc.
  • In situations where the relevant treaty contains the pre-2017 OECD Model tie-breaker rule, the place of effective management will be the only criterion used. According to the OECD Commentary, the concept of “place of effective management” was interpreted by some States as being ordinarily the place where the most senior person(s) made the key management and commercial decisions necessary for the conduct of the company’s business. 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.

Thanks to the tie-breaker rules, it is unlikely that the COVID-19 situation will create any changes to an entity’s residence status for tax treaty purposes because the change in location is an extraordinary and temporary situation.

3. Concerns related to cross-border workers

Would the tax situation of cross-border workers benefiting from a remuneration subsidized by governments during the COVID-19 crisis be affected?

According to the Article 15 of the OECD Model, employee’s remuneration is taxable in the employee’s state of residence, unless the employment is exercised in the other state (the source state). This latter may exercise a taxing right only if the employee (i) is physically present there when performing the activities for which the employment income is paid; and (ii) is there for more than 183 days or the employer is a resident of the source state, or the employer has in the source state a permanent establishment that bears the remuneration.

Some governments are granting wage subsidies to employers to keep workers on the payroll during the COVID-19 crisis. According to the OECD Secretary, the remuneration subsidized by governments during the COVID-19 crisis should be assimilated to termination payments (in principle taxable where the employee would otherwise have worked) and therefore taxable in the country where the employee used to work before the COVID-19 crisis.

Would the tax situation of cross-border workers required to work from home during the COVID-19 crisis be affected?

A change of place where cross-border workers exercise their employment may also affect the application of special provisions included in some bilateral treaties  dealing with the situation of cross-border workers. Some treaties often contain limits on the number of days that a worker may work outside the jurisdiction he or she regularly works before triggering a change in his or her status. If the country where employment was formerly exercised loses its taxing rights, additional compliance difficulties would arise for employers and employees:

  • The employer may have withholding obligations, no longer underpinned by a substantive taxing right; and
  • The employee would also have a new or enhanced liability in her or his state of residence.

The OECD is working with countries to mitigate the unplanned tax implications and potential new burdens arising due to effects of the COVID-19 crisis.

4. Concerns related to a change to the residence status of individuals

For the purpose of a tax treaty, an individual can be resident in only one country at a time (his or her “treaty residence”). If the person is resident in both countries being tested, the tie-breaker rules are applied.

In the context of the COVID-19 crisis, two main situations could be imagined:

  • A person is temporarily away from its home (perhaps to work for a few weeks) and gets stranded in the host country and attains domestic law residence there;
  • A person is working in a country (the “current home country”) and has acquired residence status there, but temporarily returned to his or her “previous home country” because of the COVID-19 situation. This person may either never have lost his or her status as resident of his or her previous home country under its domestic legislation, or may regain residence status upon return.

In the first scenario, the tie-breaker test would mostly award treaty residence to the home country because it is probably unlikely that the person would have a “permanent home” available in the host country. If they did, the other tie-breaker tests (centre of vital interests, place of habitual abode, and nationality) would in any case award residence to the home state. The temporary dislocation should therefore have no tax implications.

In the second scenario, the fact that the person moved to the previous home country during the COVID-19 crisis may risk tipping the balance towards the previous home country. The state of residence for tax treaty purposes would usually be decided using the test of “habitual abode”, which refers to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life.

Because the COVID-19 crisis is a period of major changes and an exceptional circumstance, it is again unlikely that the person would regain residence status for being temporarily and exceptionally in the previous home country.

The OECD Secretary also pointed out that some countries (e.g. the UK, Australia, Ireland) already issued useful guidance and administrative relief on the impact of COVID-19 on the domestic and tax treaty determination of the residence status of an individual.

If you have any questions on this subject, please contact the authors of this article or send us an e-mail via covid19@tiberghien.com.

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