The COVID-19 crisis forced governments to take actions as e.g. implementing quarantine requirements, raising tax technical concerns (such as PE issues). The OECD responds to these based on an analysis of international tax treaty rules which ideally should serve as a guideline for Swiss companies.
The COVID-19 pandemic has affected our society in unprecedented ways, ranging from travel restrictions to strict quarantine requirements. As a result, many cross-border workers are unable to physically perform their duties in their country of employment, being obliged to stay at home and telework. This unprecedented situation is raising multiple tax issues with an impact on the right to tax between countries, notably where cross-border elements are involved, for example with individuals who are stranded in a country that is not their country of residence. As a response to such issues arising from the current situation, the OECD Secretariat has published a guidance based on an analysis of the international tax treaty rules on 3 April 2020, addressing four main concerns. They are thereby referring to concerns related to the creation of permanent establishments, to the residence status of a company (place of effective management), to cross border workers and to a change to the residence status of individuals.
Concerns related to the creation of permanent establishments
Some businesses may be concerned that their employees’ working from home while they are dislocated to countries other than where they usually work might create a “permanent establishment” (PE) in those countries. A PE would trigger new tax obligations. The OECD concludes that the COVID-19 situation leads to increasing PE issues is unlikely.
In general, a PE must have a certain degree of permanency and be at the disposal of an enterprise, to be considered a fixed place of business. In addition, home office during the COVID-19 crisis typically is a consequence of government directives; i.e. it is force majeure, not an enterprise’s requirement. As such a PE classification is unlikely, provided the current situation will not result in setting a new permanent norm.
Similarly, the activities of an employee temporarily working from home for a non-resident employer will not give rise to a dependent agent PE since they are unlikely to be regarded as “habitual” given the temporary nature of the COVID-19 situation. The OECD specifies that the presence that an enterprise maintains in a country has to be more than merely transitory for the enterprise to qualify as a taxable presence in the form of a PE. An exception, however, may apply if the employee was habitually concluding contracts on behalf of its enterprise from its home country before the COVD-19 pandemic.
As regards construction sites that are affected by the COVID-19 crisis, the OECD comes to the conclusion that temporary interruptions should be included in determining the duration of a site. This means that, according to the OECD, a construction site will constitute a PE if it lasts more than 12 months – including any deferral or disruption.
Concerns related to the residence status of a company (place of effective management)
The relocation, or inability to travel, of senior executives may raise questions about a potential revision in the “place of effective management” of a company. Such a change may result in a reconsideration of a company’s residence under relevant domestic laws and affect the habitual resident country for tax treaty purposes. Once again, the OECD comes to the conclusion that changes to an entity’s residence status under a tax treaty will unlikely be a consequence of the COVID-19 crisis. While the potential change of circumstances might trigger an issue of double residency, these cases are relatively rare in reality. However, assuming that there would be double residency of an entity, tax treaties provide tie breaker rules that ensure the entity is resident in only one of the states. Competent authorities consider all relevant facts and circumstances to determine the “usual” and “ordinary” place of effective management, not only those related to an exceptional phase such as the COVID-19 crisis.
Concerns related to cross border workers
The OECD Model guides the taxation of employment income, distributing the right to tax between the employee’s state of residence and the place where they perform their employment. It says that all remuneration is taxable in the person’s state of residence unless the employment is exercised in the other state. In some cases, governments have started to subsidize wages to employers, which is designed to retain employees during the COVID-19 crisis despite limitations to their current working conditions. Where this applies, the employee’s income should be attributable to the place where the employment used to be exercised. Given that an employee is resident in one state but commutes to work in another state (cross border worker), the income they receive from the employer should be attributable to the state they used to work in.
Concerns related to a change to the residence status of individuals
The OECD presents two possible scenarios where the residence status of individuals may be in question. Firstly, a person may be temporarily away from his/her home and gets stranded in the host country due to the COVID-19 crisis and attains domestic law residence there. Secondly, a person may be working in his/her current home country and have acquired residence status there but temporarily return to his/her previous home country due to the COVID-19 situation. In both scenarios, it is unlikely that the person would acquire or regain residence status in the country where he/she is temporarily, respectively has returned to. Even if the person is or becomes a resident under certain rules in domestic regulation, the person would not be a resident of that country for purposes of the tax treaty. In other words, a temporary dislocation due to COVID-19 will not have any tax implications. For the purpose of tax treaties, a person can only be resident in one country, which is determined based on domestic law in addition to tie-breaker rules. The latter contain a hierarchy of tests, the first of which is the question about the location of a person’s permanent home. The OECD concludes that, because the COVID-19 crisis is a period of major disruption and exceptional circumstances, tax administrations and competent authorities will have to consider a more normal period of time when determining a person’s resident status.
Implications for Swiss companies
Switzerland is an OECD member country and its tax treaties generally follow the pattern of the OECD model tax convention. With that in mind, it is fair to assume that above position enshrined by OECD should be regarded as a harmonized framework and thus directly applicable for Swiss tax purposes to proactively encounter unwelcomed situations of double taxation that would hit the companies even stronger during this temporary turbulent state. Should however such temporary nature of habituate become the new reality as a response to the crisis, any such change in business models requires a thorough tax analysis to avoid bad surprises popping up in the future.
EY’s subject matter experts are evaluating various business models on an ongoing basis and are there for you. Please contact us anytime. Latest update on Swiss and international tax COVID-19 measures can be found here.