OECD analysis of Tax Treaties and the impact of COVID-19
Deloitte Malta tax alert
6 April 2020
At the request of concerned jurisdictions, the Organisation for Economic Co-operation and Development (‘OECD’) Secretariat has issued guidance on issues arising out of the application of tax treaties due to the impact of the COVID-19 crisis. The report published by the OECD Secretariat delves into concerns revolving around the creation of permanent establishments (‘PE’), the residence status of companies, cross-border workers and changes to the residence status of individuals.
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The creation of a PE
The first primary concern deals with the question as to whether employees dislocated to countries other than the country in which they regularly work, and thus, working from their homes during the COVID-19 crisis, would create a PE for their employer in those countries, which would trigger new filing requirements and tax obligations. In the view of the OECD Secretariat, to the extent that this does not become the new norm over time, this result would be unlikely due to the exceptional and temporary nature of the change in the employee’s location. The same result is expected in relation to the temporary conclusion of contracts in the home of employees or agents because of the COVID-19 crisis.
In addition, a construction site PE would not be regarded as ceasing to exist when work is temporarily interrupted, in line with the current wording of the OECD Model Tax Convention on Income and on Capital (2017) (‘OECD Model’) Commentary.
This interpretation of the concept of PE does not change different thresholds required by domestic legislation in each State and in particular, it is noteworthy to keep in mind that not all income taxes are covered by an applicable tax treaty. The OECD Secretariat encourages tax administrations to provide guidance on the application of the domestic law threshold requirements, domestic filing and other guidance to guide taxpayers in the context of the COVID-19 crisis.
The residence status of a company
Another arising problem concerns a potential change in the effective management of a company because of relocation, or the inability to travel of senior executives. The OECD Secretariat is of the view that it is unlikely that the COVID-19 crisis will create any changes to an entity’s residence status under a tax treaty because a temporary change in the senior executives’ affairs in this case is an extraordinary and temporary situation, especially where the tie-breaker rule is applied in tax treaties.
The potential effect of these changes could be a trigger of double residency, which, according to the OECD Secretariat, is a relatively rare case. Nonetheless, it is of the view that the tie-breaker rule in tax treaties would deal with this challenge in the following ways:
- Where a 2017 OECD Model article 4(3) is applicable – the tax administrations should settle the matter using Mutual Agreement Procedure. Notable factors to be analysed would be: 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 and where the person’s headquarters are located.
- Where a pre-2017 OECD Model article 4(3) is applicable – the place of effective management should be the sole decisive criterion, being 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. According to the relevant OECD Model Commentary, some States interpreted this as being ordinarily the place where the most senior person or group of persons took the key management and commercial decisions necessary.
The notion of cross-border workers raise several concerns when it comes to the application of article 15 of the OECD Model. The OECD Secretariat expresses its view that stimulus packages adopted by Governments, which are designed to keep workers on the payroll during the COVID-19 crisis, most closely resemble termination payments Commentary that should be attributable to the place where the employee would otherwise have worked in line with the guidance provided in the OECD Model Commentary.
Most tax treaties in force provide that salaries are taxable only in the employee’s State of residence unless the employment is exercised in the other State and the employee is there for more than 183 days or the employer is a resident of the source State, or the employer has a PE that bears the remuneration in the source State. The application of this rule in the current context may lead to employers having new withholding obligations and employees having new or enhanced liabilities in different States. The OECD Secretariat calls for an exceptional level of coordination between countries to mitigate the compliance and administrative costs for employers and employees associated with involuntary and temporary change of the place where employment is performed.
Changes to the residence status of individuals
The analysis of the OECD Secretariat provides useful guidance issued by States such as UK, Australia and Ireland to tackle the impact of the COVID-19 crisis on the domestic and tax treaty determination of the residence status of individuals by ensuring that the extraordinary nature of the current times do not, on their own, change the tax residence status of individuals.
The analysis envisages two situations that may be relevant:
- A person is temporarily away from their home and gets stranded in a host country by reason of the COVID-19 crisis and attains domestic law residence there.
- A person is working in a country and has acquired residence there, but temporarily returns to his/her previous home country because of the COVID-19 crisis. In this case, the individual may either have never lost his/her status as resident of the previous home country or he/she may have regained the residence status upon the individual’s return.
In the first case, whilst it is unlikely that the person would acquire residence status because of the current turbulent times, there are domestic law provisions deeming individuals resident upon the presence of such person for a certain number of days. In this case, an applicable tax treaty, if existing, would address this issue by virtue of the tie-breaker test looking at a hierarchy of factors (permanent home, centre of vital interests etc.). In second scenario, it is also unlikely that the person would regain residence status in the previous home country. In this case, an applicable tax treaty would also address the situation by identifying the individual’s connecting factors for the application of the tax treaty.