Coronavirus - impact on tax

A major concern for almost all businesses at the moment is the economic impact of the coronavirus (Covid-19). Radical measures have been put in place by governments across the world to try and control the spread of the virus, affecting businesses and their employees. These measures have included closing businesses and schools, cancelling major events, restricting free movement and even quarantining towns and cities. Financial markets have been hit by the impact of the virus on the world economy and businesses around the world have evoked contingency planning to ensure that they can continue to operate as normally as possible.

The changes that businesses and their staff have implemented to ensure business continuity as far as possible raise a number of legal issues. The ability to deliver goods and services has been affected, raising contractual questions. The ability of staff to work from their normal place of business has been affected, raising a number of employment law issues. It is also the case that these impacts have potential unexpected tax consequences that businesses should be aware of.

Employment tax issues

The ability of employees to travel to and from work has been heavily affected by travel restrictions introduced by governments, including the UK, to slow down the spread of coronavirus. As a result, many employees are working remotely, whether from their home or from another country in which they find themselves during the lockdown. Some employers may have chosen to require their employees to work from home even before any lockdown was announced. Employees who are perhaps seconded to other countries badly affected by the virus may already have relocated back to their home or may wish to do so or may have been requested to do so by their employers. These scenarios may give rise to potential tax issues.

Where an employee working from home works in a different jurisdiction to their normal workplace, then this may affect the taxing rights of the countries concerned. This may particularly affect cross-border secondees or workers who commute from one country to another (particularly in continental Europe). Much will depend on the length of time that a person spends working in a particular country and on the particular tax rules of the jurisdiction concerned. From a UK perspective, persons working under contract arrangements with a foreign employer may be particularly affected.

An employee who is both UK resident and UK domiciled for tax purposes will be taxed on their worldwide income under UK law (subject to double tax relief). This is irrespective of who their employer is and where they perform the duties of their employment. However, an employee who is UK resident but not UK domiciled, and who claims the remittance basis of taxation for a particular tax year, will only be taxed on ‘chargeable overseas earnings’ for a tax year to the extent that those earnings are remitted to the UK. For these purposes, overseas earnings will generally be the earnings from an employment with a foreign employer and where the duties of that employment are performed wholly outside of the UK. Clearly, if an employee is unable or unwilling to travel outside the UK, then their overseas earnings will be reduced and higher amounts of UK tax may be due. Depending on the circumstances, it may also result in a requirement for the foreign employer to register an account for UK PAYE.

Where a UK employee ends up working longer in the UK than expected, this may also upset any Appendix 5 agreement in place between the UK employer and HMRC. An Appendix 5 agreement is a non-statutory method of dealing with the issue of double taxation through payroll, where an employer is required to deduct foreign tax in addition to UK PAYE from the salaries of employees who are sent to work abroad. Its aim is to give provisional relief for double taxation to employees who must pay both UK tax and foreign tax from the same payments of earnings. In most cases where an employee is abroad for less than 6 months, no overseas tax may be due under the terms of the relevant DTA. However, this is not always the case, particularly where the employer has a permanent establishment in the overseas country. In these circumstances or if no DTA exists, then overseas tax may be due from day 1. It is in these circumstances or where the 183 days period is exceeded but the taxpayer remains UK resident, that HMRC will allow the relaxation of some PAYE requirements under Appendix 5.

Where an employee of an overseas subsidiary is sent to work in the UK for a UK company, the UK company ordinarily would be obliged to operate PAYE on the employee’s earnings (even though the employee continues to be paid by an overseas entity) and the employee would have to make a claim for double tax relief if they are taxed on the same income in their country of tax residence. However, if the employee is covered by a Short Term Business Visitor arrangement with HMRC (STBVA, also known as an Appendix 4 agreement) (which may be the case where the employee is resident in a country with which the UK has a relevant double tax treaty and is expected to stay in the UK for 183 days or less in any 12 month period), the UK company should not be required to operate PAYE on such an employee’s earnings, subject to it periodically reporting certain information to HMRC. The extent to which PAYE can be disregarded and the level of reporting obligations which apply depends on the number of days the overseas employee spends in the UK in the tax year. Accordingly, where such an employee spends longer in the UK than anticipated (e.g. because of coronavirus travel restrictions, illness or a self-isolation period), this could tip them into a different reporting threshold under the UK company’s STBVA. UK companies operating STBVAs will need to monitor the relevant employees carefully and fulfil any additional reporting requirements under their STBVAs to ensure that the PAYE relaxation continues.

Employees who are normally based outside the UK may also find themselves spending longer than intended in the UK as a result of the coronavirus, with the potential consequence that the additional time spent in the UK could affect their tax own residence. According to guidance published in HMRC’s Residence, Domicile and Remittance Basis Manual at RDRM11005, any days spent in the UK by an individual due to specified coronavirus-related circumstances can be treated as exceptional and normally disregarded (subject to a cap of 60 days being able to be disregarded for exceptional circumstances) when determining whether that individual is resident in the UK under the statutory residence test (SRT). These circumstances are where the individual is:

• unable to leave the UK as a result of being quarantined or self-isolating in the UK (where self-isolation is on the advice of a health professional or public health guidance)
• advised by official government advice not to travel from the UK as a result of coronavirus
• unable to leave the UK as a result of the closure of international borders, or
• asked by an employer to return to the UK temporarily.

It should be noted that the exceptional circumstances disregard does not count for all SRT purposes; for example, days on which the individual does more than three hours of work while in the UK due to relevant circumstances will still count towards the work tie.

If these scenarios result in a different and higher tax liability for the employee concerned that may raise the question as to who should shoulder the burden of the higher UK tax? Unless the employee has contractual arrangements which entitle them to a net salary, it is hard to see the burden being shifted to the employer in law. However, some employers may consider that the reputational risk outweighs the strict legal position in this scenario.

Similar considerations will no doubt apply in other jurisdictions, where for example there is an agreed split of taxes between jurisdictions for cross-border workers and the extra time spent working in a particular jurisdiction results in the conditions of that agreement no longer being met.

Employees required to work from home for extended periods may also incur additional employment related costs in doing so. If the employer meets these expenses, care will need to be taken - both from a direct and indirect tax perspective - to ensure that the necessary tax compliance measures are put in place.

In the UK, there is a small exemption for an employer contribution to homeworking costs (generally up to £6 per week from April 2020) and certain other expenses may be exempted from treatment as employment income (such as reimbursed phone bills). However, much will depend on the particular circumstances and reimbursed expenses that are not exempt should be reported to HMRC. In other circumstances, payments by an employer will amount to employment income and the employee would need to show that they incurred the costs ‘wholly, exclusively and necessarily’ for the purposes of their employment (which is notoriously difficult) to claim a tax deduction.

From a VAT perspective, where expenses are incurred by employees but reimbursed by employers, any VAT incurred may be claimed as input VAT by their employer in some circumstances. In general, it is necessary that there is sufficient evidence that the supply is legitimately paid for by the employer for the purpose of the business. In such situations, HMRC will not take the point that the input VAT may technically be that of the employee rather than the employer.

Corporate residency and PE issues

Restrictions on travel may also impact on corporate residency if businesses do not take care to recognise the risks. Under UK law, a foreign corporation will not be UK tax resident unless its central management and control takes place in the UK. In accordance with case law, a company is centrally managed and controlled in the place where the highest level of control of the company takes place. This may be where its directors (or equivalent) meet and take strategic decisions.

Many foreign entities with senior UK directors rely on holding physical board meetings abroad in order to ensure that central management and control does not take place in the UK. But what if the UK directors are unable to travel to board meetings abroad?

With directors unable to leave the UK, or perhaps stranded in unhelpful jurisdictions, care should be taken to ensure that any contingency plans put into operation for their participation in a board meeting do not have the effect of making the foreign entity resident in the UK or elsewhere, with attendant tax consequences.

If the business of a planned board meeting is entirely routine, the best option may be to simply postpone the meeting until UK resident directors are able to travel abroad to attend as originally planned. However, in some cases there may be commercial reasons why a delay is not possible, and the board meeting will still need to be held. Issues to consider in such cases include whether the attendance of the UK resident directors is required. If the UK resident directors must attend, is there any scope for them to do so from a nearby jurisdiction outside the UK? Is there scope to appoint directors from other jurisdictions to take the place of the UK directors? (Note however that local advice should be sought to ensure that this would not result in the entity being deemed to be resident in that jurisdiction.) Could they attend as observers, but not provide their views or vote on the matters under consideration?

Where no other option exists, it should be generally possible for a minority of directors (as a one off occurrence) to participate in a board meeting from the UK by telephone or video conference call. The tax risk associated with this course of action will vary according to circumstances, including any history of board meeting participation from the UK, the relative weight of the expertise and experience possessed by the UK directors compared to the other directors and the physical locations of the chair of the meeting and the remainder of the board.

If a minority of directors are intending to participate from the UK, care should be taken to ensure that the meeting takes place in accordance with the articles of association (or equivalent) of the entity, that the meeting is quorate in the absence of the UK directors, that the chair of the meeting is outside the UK, that the call via which the meeting takes place is initiated from and terminated outside the UK, and that the minutes of the meeting are taken and kept outside the UK. In addition, the minutes should record the specific circumstances which have prevented the UK resident directors from leaving the UK, and evidence should be retained to deal with any future tax authority query.

HMRC has released guidance at INTM120185 which emphasises that HMRC consider that a company will not necessarily become resident in the UK because a few board meetings are held here, or because some decisions are taken in the UK over a short period of time. HMRC will take a holistic view of the facts and circumstances of each case. The guidance stops short of providing any particular concession or safe harbour, simply indicating that HMRC take the view that their existing powers provide sufficient flexibility to deal with changes in business activities necessitated by the response to the COVID-19 pandemic. However, since each case turns on its own facts and circumstances, the guidance recognises that it is difficult for HMRC to provide definitive guidance as to where central management and control may abide in cases where businesses are forced to make changes in response to the COVID-19 pandemic.

For fund entities that are corporate UCITS or alternative investment funds established outside the UK, the tax residence safe harbour may be available to prevent any directors that are present in the UK from onshoring the relevant fund for UK tax purposes for UK corporation tax purposes. However, it should be noted that the safe harbour only applies for direct tax purposes, and therefore will not affect, for example, the VAT or payroll tax position. In addition, it does not apply to offshore management companies or general partners of funds structured as limited partnerships, so care may need to be taken concerning such entities.

In addition, it is possible that the enforced location of officers and other significant employers in a jurisdiction may give rise to permanent establishment (PE) risks for an non-resident company. There is currently an increased international interest in the PE rules as a result of the OECD BEPS project together with increasing mobility of international staff. The risk of inadvertently creating a PE is therefore a key risk area for MNEs. Where a PE exists, it may bring into tax the profits of the local activities of that foreign company. In general, a PE will exist if the foreign company has a fixed place of business in the jurisdiction or a dependent agent (one acts on behalf of the non-resident company and habitually exercises an authority to conclude contracts in its name).

In the UK, HMRC has released guidance at INTM261010 indicating that it is sympathetic to the business disruption taking place, but takes the view that it has sufficient flexibility with regard to the question whether a PE has been created in the UK. In particular, HMRC considers that a non-resident company will not have a UK fixed place of business PE after a short period of time as a degree of permanence is required. Similarly, whilst the habitual conclusion of contracts in the UK would also create a dependant agent PE in the UK, it is a matter of fact and degree as to whether that habitual condition is met. Furthermore, the existence of a UK PE does not in itself mean that a significant element of the profits of the non-resident company would be taxable in the UK. The guidance does not provide any particular concession or safe harbour, but reinforces the point that the creation of a PE requires a degree of permanence that may be lacking where persons are temporarily located in the UK.

From a VAT point of view, the mere temporary presence of a person in the UK is less likely to create a risk of requiring UK VAT to be paid on supplies. It would generally require sufficient human and technical resources permanently present for making or receiving the relevant supply for there to be a fixed establishment in the UK from which a supply might take place. Therefore, it would seem unlikely that the temporary and unavoidable presence of an individual would create a fixed establishment. However, it may be necessary to monitor the particular situation closely and consider any changes to the longer term intentions in order to apply these rules.

From a transfer pricing perspective, a PE of a non-resident company will require an analysis of the appropriate profits attributable to the PE based on transfer pricing principles. Moreover, the sustainability of any existing operating models which heavily rely on individuals commuting from one jurisdiction to another may need to be revisited in light of the current disruption. This includes the potential permanence of working from home and remote working arrangements, a possible behavioural change from the crisis which will impact the location of functions, risks and assets which underpin the allocation of profits through the transfer pricing model.

As above, these are all potential areas of risk that companies should consider as a result of the travel restrictions imposed, but it is useful to note that there have already been some tax authorities that have issued revised policies that take a pragmatic approach to individuals being located in jurisdictions temporarily (eg Australia and Ireland). From a practical perspective, tracking, monitoring and documenting the facts of the situation will be important to understand where the risks may be and to demonstrate these are extenuating circumstances.

Aborted transactions and VAT

Government recommendations on social distancing, self-isolation in the case of sickness, and business closures has resulted in many typical business and social activities being postponed or cancelled altogether by both customers and suppliers. Clearly this will result in a number of contractual issues that that parties will need to consider. Our article, Coronavirus - impact on business contracts, considers some of these issues.

What are the tax consequences where contracts are affected in this way? In general, where the contract is cancelled, any supplies from a VAT perspective will no longer take place, requiring (depending on the terms of the particular contract) a refund of any payments and the issue of cancelling invoices. What, however, if the contract is not simply cancelled? In some cases, the expected supply will no longer actually take place and any consideration paid may be recharacterised as compensation and outside the scope of VAT. This will, however, require a careful case by case analysis based on the particular facts and the nature of the anticipated supply.

Where payment for an anticipated supply has been made but the customer no longer takes up the anticipated services, then it is possible that the correct analysis is that the supplier has actually complied with the contract and made the anticipated supplies, simply by holding out the opportunity of the services to the customer. Where payment for an anticipated supply has been made but the customer no longer takes up the anticipated services, it is possible that the correct analysis is that the supplier has actually complied with the contract and made the anticipated supplies, simply by holding out the opportunity of the services to the customer. HMRC’s position on unfulfilled supplies and retained payments was set out in Business Brief 13/2018. In this case, output VAT will still be due on the supply based on HMRC’s guidance although the government has suspended any VAT due from 20 March until 30 June 2020 and is allowing VAT-registered UK businesses until 31 March 2021 to pay any liabilities that have accumulated during that period

Payments by a supplier to the customer, where the supplier is no longer able to perform the contract, are likely to be viewed as compensation payments and outside the scope of VAT. This is equally true where the amounts are specified in the contract as liquidated damages. However, again, careful consideration of the particular contractual arrangements and any termination agreement are required to determine the true nature of any payments made from a VAT perspective. Some businesses may choose to make goodwill gestures to their customers even where contracts are legitimately rendered unenforceable. Again, care needs to be taken that VAT is correctly accounted for. For example, any business goods given away would need to be accounted for as a deemed supply, unless they meet the requirement for small gifts.

Any input VAT incurred on aborted transactions would, generally, be attributable to the anticipated supplies even if those supplies do not take place.

From a direct tax standpoint, costs incurred on aborted business transactions should remain deductible business expenses.

Where third party business transactions are aborted, this may have a direct or indirect consequence on the intragroup arrangements and associated transfer pricing issues. For example, a termination cost may be incurred, or compensation payment may be received which will need to be allocated among group entities in accordance with functional and risk profiles determined by the transfer pricing model.

Transfer pricing

There are a range of issues that could arise for transfer pricing purposes, due to the impact of the coronavirus pandemic.

Intra-group contracts

The starting point for a transfer pricing analysis will be the terms and conditions of a legal contract, and therefore clauses in intra-group contracts relating to termination or force majeure could be important in considering whether, and if so how, the coronavirus epidemic will impact arrangements between group entities. Third party contracts in similar circumstances may provide an arm’s length example of how intra-group arrangements may also be renegotiated in this current environment, whether that means changes to payment term durations, the related party fee itself or the need for compensation payments.

Allocation of losses

Given the broader financial impact that coronavirus has had and will continue to have, one of the key transfer pricing questions will be how this affects profit (or loss) allocation among group entities. The crisis will clearly result in a significant reduction in sales for some industries as well as an increase of other exceptional costs.

Local subsidiaries of multinational enterprises (MNEs) characterised as undertaking ‘routine’ functions for transfer pricing purposes (such as ‘limited risk distributors’, ‘contract manufacturers’, ‘contract R&D services providers’ and other routine service providers) in affected regions are often remunerated with a stable level of profit. Whether or not they should continue to receive this level of profit during the crisis is likely to become a contentious point for many organisations. The financial consequences directly resulting from the crisis and who bears the loss (eg principal, IP owner or limited risk entity) should be carefully analysed and documented.

Tax audits may arise a few years after the event and therefore, a detailed analysis on a contemporaneous basis will help to evidence any losses that have arisen due to coronavirus and to demonstrate the pricing was arm’s length. This will also ensure information is preserved particularly if individuals leave the organisation in the interim.

Impact on rulings with tax authorities

Advance pricing agreements (APA) entered into with a tax authority(ies) will be underpinned by a set of critical assumptions which will need to be carefully reviewed and monitored in light of any operational and/or financial adjustments required as a result of the coronavirus circumstances. Where an APA is in the process of being agreed, these assumptions should be carefully drafted (eg reference to a discussion with the tax authority(ies) should be included where exceptional circumstances may arise to assess the impact on the transfer pricing policy of the arrangement in a practical way, rather than the APA immediately becoming invalid as a result of these exceptional circumstances).

New financing transactions

There may be an increased need for intra-group funding and/or parental guarantees on third-party lending for group entities operating in the affected regions or where activities/supplies have been shifted away from these areas to other regions to fund additional capacities. It is important to ensure the business circumstances and current economic environment at the time of the loan arrangement are considered in pricing the transaction, and the business decisions taken are appropriately documented to support the transfer pricing analysis. This is particularly relevant in light of the recent OECD Guidance on Financial Transactions released on 11 February 2020.

Impact on overall operating model

Broadly, any movement in functions and management of risks as a result of coronavirus would impact the transfer pricing analysis for the group.

Where operations have ceased, significantly reduced or relocated from affected regions leading to a reorganisation of the commercial or financial relations between associated enterprises including the termination of existing arrangements, this may be considered a business restructuring in the context of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (July 2017).

While some of these actions may be taken in the short term to manage the immediate impact of coronavirus, MNEs may decide to restructure their business or reassess their governance and risk control procedures in the longer term to either manage reliance on certain geographic regions or improve the sustainability of the operating model, to better address any crisis or disruption that could occur in the future. This will require transfer pricing policies to be redesigned and documented to demonstrate the commercial rationale and resulting tax consequences (eg assessing whether exit taxes are due). An analysis of ‘options realistically available’ for MNEs to appropriately assess the impact of supply chain changes to group entities both for short and long term changes will be important in this context.

See our Coronavirus feature page for updates on how to navigate this period of global uncertainty.