OECD guidance on the treaty implications of COVID-19

Update: On 21 January 2021, the OECD published updated and expanded guidance on this topic which can be found here.

The imposition of travel restrictions and the general lockdown put in place by many governments around the world as a result of the coronavirus pandemic has created uncertainty and concern over the tax position of international businesses. In particular, the dislocation of employees and directors, with many required to work from home, has given rise to questions over the impact on the residence of companies and the possibility of the inadvertent location of a permanent establishment (PE), as well as the residence of individuals and employees for tax purposes.

Against this background, the OECD has published analysis of the tax treaty position covering company residence, PE issues and the taxation of cross-border workers.

Permanent establishments

The OECD guidance confirms that “it is unlikely that the COVID-19 situation will create any changes to a PE determination. The exceptional and temporary change of the location where employees exercise their employment because of the COVID-19 crisis, such as working from home, should not create new PEs for the employer. Similarly, the temporary conclusion of contracts in the home of employees or agents because of the COVID-19 crisis should not create PEs for the businesses”.

The guidance points out that, in general, a PE must have certain degree of permanency and be at the disposal of an enterprise in order for that place to be considered a fixed place of business through which the business of that enterprise is wholly or partly carried on. For a home office to be a PE for an enterprise, it must be used on a continuous basis for carrying on business of an enterprise and the enterprise generally has to require the individual to use that location to carry on the enterprise’s business. In the case of COVID-19, it is the exceptional circumstances and government restrictions that require the individual to work from home, rather than the enterprise.

As regards a dependent agent PE, the guidance emphasises that for the activities of a person such as an employee to create a dependent agent PE for an enterprise, the employee must habitually conclude contracts on behalf of the enterprise. An employee’s or agent’s activity in a State is unlikely to be regarded as habitual if he or she is only working at home in that State for a short period due to the COVID-19 pandemic impacting his or her normal working routine. In particular, the guidance points to paragraph 33.1 of the Commentary on Article 5 of the 2014 OECD Model Tax Treaty which provides that the requirement that an agent must “habitually” exercise an authority to conclude contracts means that the presence which an enterprise maintains in a country should be more than merely transitory. Similarly, paragraph 98 of the 2017 OECD Commentary on Article 5 explains that the presence which an enterprise maintains in a country should be more than merely transitory if the enterprise is to be regarded as maintaining a PE in that State under Article 5(5).

The guidance also points out that a construction site will normally constitute a PE under the OECD Model if it last more than 12 months and that 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). Accordingly, it is not generally expected that the temporary discontinuance of construction work due to COVID-19 should not affect the PE analysis in relation to construction sites.

However, the guidance does recognise that individual jurisdictions may have lower thresholds for entities to register for tax purposes and not all taxes are covered by applicable tax treaties. Accordingly, the OECD therefore encourages tax authorities provide guidance on the application of the domestic law threshold requirements, domestic filing and other guidance to minimise or eliminate unduly burdensome compliance requirements for taxpayers.

Corporate tax residence

Equally, 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 senior executives and directors. The concern is that such a change may have as a consequence a change in company’s residence under relevant domestic laws and affect the country where a company is regarded as a resident for tax treaty purposes. The OECD guidance is, however, clear that it “is unlikely that the COVID-19 situation will create any changes to an entity’s residence status under a tax treaty. A temporary change in location of the chief executive officers and other senior executives is an extraordinary and temporary situation due to the COVID-19 crisis and such change of location should not trigger a change in residency, especially once the tie breaker rule contained in tax treaties is applied”.

In this case, the guidance is aimed more at the treaty tie-break provisions, rather than considering whether and how a company may become dual resident (other than suggesting that such a situation is relatively rare).

The guidance points out that should a company become dual resident as a result of the activities of senior executives in a jurisdiction, then under the 2017 Model, the tie-breaker requires the competent authorities to reach mutual agreement on a case-by-case basis. This determination will take into account all the facts and circumstances, but the guidance highlights that paragraph 24.1 of the OECD Commentary lists relevant factors as including: where the meetings of the company’s board of directors or equivalent body are usually held; where the chief executive officer and other senior executives usually carry on their activities; where the senior day-to-day management of the company is carried on; where the person’s headquarters are located; etc

Under the pre-2017 OECD Model tie-breaker rules, the place of effective management will be the only criterion used to determine the residence of a dual-resident entity for tax treaty purposes. According to paragraph 24 of the Commentary on Article 4 of the 2014 OECD Model, the place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management. Therefore, 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.

Of course, the application of the tie-breaker rules will only be of assistance where there is a double tax treaty in place between the relevant jurisdictions. In some cases, for example in relation to many fund structures, there will be no double tax treaty between the place where directors may be physically located and the location of the fund.

Cross-border workers

The guidance here mostly concerns wage subsidies paid to workers by governments during the pandemic. In particular, the guidance recognises that where a government subsidises the keeping of an employee on the payroll, the income should be attributable, based on the OECD Commentary on Article 15, to the place where the employment used to be exercised. In the case of employees that work in one state but commute there from another state where they are resident, this would be the state they used to work in.

Article 15 provides generally that “salaries, wages and other similar remuneration” are taxable only in the person’s state of residence unless the “employment is exercised” in the other state (ie the place where the employee is “physically present when performing the activities for which the employment income is paid”). But there are conditions attached to the place of exercise test.

Some stimulus packages adopted or proposed by governments are designed to keep workers on the payroll during the COVID-19 crisis despite restrictions to the exercise of their employment. The OECD argues that payments that employees are receiving in these circumstances most closely resemble termination payments. These are attributable to the place where the employee would otherwise have worked. In most circumstances, this will be the place the person used to work before the COVID-19 crisis. Where the source country has a taxing right, the residence country must relieve double taxation.

However, the guidance also notes 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. These provisions apply special treatment to the employment income of cross-border workers and may 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. More widely, if the country where employment was formerly exercised should lose its taxing right following the application of Article 15, additional compliance difficulties would arise for employers and employees. Employers may have withholding obligations, which are no longer underpinned by a substantive taxing right. These would therefore have to be suspended or a way found to refund the tax to the employee. The employee would also have a new or enhanced liability in their state of residence, which would entail returning that income.

On this point, the OECD argue that exceptional circumstances call for an exceptional level of coordination between countries to mitigate the compliance and administrative costs for employees and employers associated with involuntary and temporary change of the place where employment is performed. 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.

Tax residence of individuals

Again, the OECD guidance seeks to make clear that the temporary and exceptional dislocation of an individual should not, in general, affect their tax residence. However, the guidance does recognise that there may be difficult issues in applying the guidance in some cases.

Taking as an example a person is working in a country (the “current home country”) and who has acquired residence status there, but they temporarily return to their “previous home country” because of the COVID-19 situation. They may either never have lost their status as resident of their previous home country under its domestic legislation, or they may regain residence status on their return. In this scenario, it is unlikely that the person would regain residence status for being temporarily and exceptionally in the previous home country. There are however rules in domestic legislation deeming a person to be a resident if he or she is present in the country for a certain number of days. But even if the person becomes a resident under such rules, if a tax treaty is applicable, the person would not be a resident of that country for purposes of the tax treaty. Such a temporary dislocation should therefore have no tax implications.

For the purpose of the allocation of taxing rights over employment income under a treaty, an individual can be resident in only one country at a time (their “treaty residence”). The rules are set out in Article 4 of the OECD Model. The starting point is domestic law. If the person is resident in both countries, the tie-breaker rules in Article 4 of the OECD Model are applied. There is a hierarchy of tests, starting with the question in which state does the person have a permanent home available to them. In this scenario, the OECD guidance recognises that the application of the treaty rules may produce an uncertain result because of the person’s attachment to the previous home country.

In cases where the personal and economic relations in the two countries are close but the tie breaker rule was in favour of the current home state, 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. This would usually be decided using the test of “habitual abode”. According to paragraph 19 of the OECD Commentary however, the habitual abode of a person is where the individual lived habitually, in the sense of being customarily or usually present; the test will not be satisfied by simply determining in which of the two Contracting States the individual has spent more days during that period. “Habitual abode” refers to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life and are therefore more than transient. Also, the determination of habitual abode must cover a sufficient length of time for it to be possible to ascertain the frequency, duration and regularity of stays that are part of the settled routine of the individual’s life. Because the COVID-19 crisis is a period of major changes and an exceptional circumstance, in the short term tax administrations and competent authorities will have to consider a more normal period of time when assessing a person’s resident status.

Comment

The guidance released by the OECD relates to the interpretation of existing treaty rules and principles to the extraordinary circumstances of the coronavirus pandemic. However, the OECD does also exhort governments to provide solutions to the problems where the treaty interpretations cannot be of assistance.

It is also worth noting that the OECD quotes the example of Ireland, which has gone beyond mere treaty interpretation in taking the position that the presence of an individual in Ireland (and where relevant, in another jurisdiction) will be ignored for corporate income tax purposes for a company in relation to which the individual is an employee, director, service provider or agent, if such presence is shown to result from travel restrictions related to COVID-19.

For the position of the UK in relation to corporate tax residence and PE issues, see “COVID-19 – corporate residence and PE issues”.

See our Coronavirus (COVID-19) feature for more information generally on the possible legal implications of COVID-19.