COVID-19 Tax Guidance Update on Tax Treaties
Last April 2020, the Organisation for Economic Co-operation and Development (“OECD”) issued the ‘OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis’ (“the Analysis”). The Analysis is a practical COVID-19 tax guidance. It provides governments around the world with guidelines on how to treat unintended or adverse tax consequences that taxpayers face as a result of COVID-19 as discussed in our article about tax impacts of COVID-19 and the implications for tax treaties and salaries tax, and our latest COVID-19 directives from the IRD.
COVID-19 Tax Guidance
As most of the public health measures imposed or recommended by governments, including travel and quarantine restrictions, have remained in place, the OECD decided to release on 21 January 2021 an ‘Updated guidance on tax treaties and the impact of the COVID-19 pandemic’ (“the Guidance”). The Guidance reviews the current situation and revisits & updates the Analysis.
The Guidance, like the Analysis, discusses how COVID-19 measures by governments may potentially cause non-intended consequences for taxpayers, such as the creation of permanent establishments (“PE”), the change of residence for companies and individuals and the taxing of income from cross-border employments.
More specifically, the Guidance considers some additional fact patterns that are not addressed in detail in the Analysis, examines whether the views stated in the Analysis still apply given the pandemic persistence and provides references to countries’ practices and their guidance during the pandemic.
Concerns related to Permanent Establishment (“PE”)
The term PE refers to a fixed place of business through which the business of an enterprise is wholly or partly carried on (the so-called “Fixed Place PE”). A PE may also include a dependent agent, who habitually concludes contracts, in the name of an enterprise (the so-called “Agency PE”).
Due to the public health measures implemented by governments, businesses are concerned about whether their employees’ dislocation to jurisdictions other than the one in which they regularly work as well as working from home arrangement during the COVID-19 period, could create a Fixed Place PE. In addition, a question also arises whether the activities of an individual temporarily working from home for a non-resident employer could result in an Agency PE.
Fixed Place PE
Generally speaking, a place must have a certain degree of permanency and be at the disposal of an enterprise in order for that place to be considered as a fixed place of business through which the business of that enterprise is wholly or partly carried on (i.e. a Fixed Place PE). The Guidance provides that, considering the extraordinary nature of the COVID-19, teleworking from home because of the public health measures imposed or recommended by governments would not create a Fixed Place PE for the business / employer.
This conclusion is on the basis that there is a lack of sufficient degree of permanency or continuity or the fact that the home office is not at the disposal of the enterprise, i.e. the enterprise still provides an office which is available to the relevant employee when the situations returns back to normal.
However, the Guidance further states that where a home office is used on a continuous basis for carrying on business activities for an enterprise and it is clear from the facts and circumstances that the enterprise has required the individual to use that location, the home office may be considered to be at the disposal of the enterprise.
For Agency PE, it will be important to evaluate whether the “agent” performs the contract activities in a “habitual” way. Similarly, the agents’ activities in a jurisdiction are unlikely to be regarded as habitual if they are only working at home in that jurisdiction because of an extraordinary event or public health measures imposed or recommended by government.
That being said, the Guidance emphasised that if such agent continues to work from home for a non-resident employer after the COVID-19 on a habitual basis and continues to conclude contracts on behalf of the enterprise, an Agency PE may have been created.
Due to the impacts of COVID-19, we have seen clients trimming down their operations by closing their offices premises and continuing implementing the “home office” working arrangement. As these changes in operation are no longer on a temporary basis, there is a possibility that such changes may create a Fixed PE or Agency PE that did not exist before.
If your business has implemented any changes in your operation model recently due to the COVID impacts, you should carefully review whether such changes would create any adverse tax impacts. Where necessary, professional advice should be sought.
Concerns related to change of residence
The Guidance re-affirms the position stated in the Analysis that the COVID-19 situation will unlikely create any changes to a company’s or an individual’s residence:
The Guidance explains that a temporary change in location of board members or other senior executives is an extraordinary and temporary situation due to the pandemic and that such change of location should not trigger a change in treaty residence, especially not once the tie breaker rule contained in tax treaties is applied.
Under the provisions of tax treaties, an individual is a tax resident of a country where he / she is labile to tax therein by reason of his / her domicile, residence or any other criterion of a similar nature. If an individual has dual-residencies, further factors should be considered in determining his / her tax residence, i.e. the place of permanent home, the centre of vital interests, the place of habitual abode and the nationality. An individual should be a tax resident of one jurisdiction only under the provisions of tax treaties.
The COVID-19 tax guidance states that as the COVID-19 pandemic is a period of major changes and an exceptional circumstance, tax authorities will have to consider the period as one where public health measures do not apply when assessing a person’s residence status.
In this context, if an individual’s temporary presence in a jurisdiction results in dual residencies, based on the tie-breaker provision (which requires consideration of factors to be assessed in a more normal period), that person’s place of residence should unlikely change.
However, the OECD added that a different approach may be appropriate if the change in circumstances continues when the COVID-19 restrictions are lifted. Therefore, one should be mindful if there has been any changes in their business operation and/or working arrangement that are no longer temporary in nature (e.g. closing down a business operation / an office premises permanently).
These changes may create unintended adverse impacts to one’s tax residence status and thus their tax exposure. Again, professional advice should be sought where necessary.
Concerns related to cross-border employees
Article 15 of the OECD model tax treaty stipulates that salaries, wages and other similar remuneration are taxable only in the person’s jurisdiction of residence, unless the employment is exercised in the other jurisdiction. Notwithstanding that, the person will only be taxable in the other jurisdiction if he / she is present in the other jurisdiction for more than 183 days, or the employer is a resident of the other jurisdiction, or the employer has in the other jurisdiction a permanent establishment that bears the remuneration.
The Guidance considers the following three fact patterns and provides the OECD’s views thereon:
- Where an employee is resident in one jurisdiction and who formerly exercised an employment in the another jurisdiction receives a COVID-19 related government subsidy from the work jurisdiction to maintain the relationship with the employer, that payment would be attributable to the work jurisdiction where the employment used to be exercised.
- Where an employee is prevented from travelling because of COVID-19 public health measures by one of the governments involved and remains in a jurisdiction, it would be reasonable for that jurisdiction to disregard the additional days the employee has to spend in that jurisdiction under such circumstances for the purposes of the 183-day test. Some jurisdictions may however take a different approach or may have issued specific guidance outlining their approach to such circumstances. Taxpayers in this situation are encouraged to contact their local tax authority;
- Where an employee is working remotely from one jurisdiction for an employer of the other jurisdiction (i.e. teleworking from abroad), such change of the location where the employment is exercised can impact where their employment income is taxed. New taxing rights over the employee’s income may arise in other jurisdictions and those new taxing rights may displace existing taxing rights. As payroll taxes are often withheld at source, addressing the change will result in compliance and administrative costs for the employer and employee. Some jurisdictions have issued guidance and administrative relief to mitigate the additional burden.
In view that tax authorities have their own practices and interpretations on their domestic laws and may also have issued specific guidelines to taxpayers, cross-border employees that are not currently working in their regular working jurisdiction due to the COVID-19 restrictions should carefully review their situations, particularly when their presence in the host jurisdiction already exceeds the taxable threshold.
Although the Guidance encourages these cross-border employees to contact their local tax authority, it is strongly recommended such contact should be conducted with cautions, or with assistance from tax professional, where necessary.
In addition, as mentioned above, many businesses might have undertaken restructurings to their operations due the COVID-19 impacts which may unintentionally create new PEs in other jurisdiction and even change in their tax residence status. Such changes will also have implications on the application of article 15 of most tax treaties as the treaty protection only applies to situations where the employer is not a tax resident in the source jurisdiction and the remuneration is not borne by any PE in the source jurisdiction.
Impacts to businesses and individuals in Hong Kong
It is worth noting that theCOVID-19 tax guidance represents the OECD Secretariat’s views on the interpretation of the provisions of tax treaties only. Each jurisdiction will have its own practices and interpretation and adopt its own guidance to provide tax certainty to taxpayers. In other words, the Guidance is not binding to tax authorities. Besides, the COVID-19 tax guidance is only applicable where there is a double tax treaty in place.
Hong Kong implements a territorial taxation regime under which only Hong Kong sourced profits and income is taxable. There is no tax residence concept under the charging provisions in the domestic tax laws. In other words, a business or an individual needs not to be a Hong Kong tax resident before they can be liable to Hong Kong profits tax or salaries tax.
COVID-19 Tax Guidance & Business profits
A person will be liable to Hong Kong profits tax if the following three conditions are met:
- Carrying on a trade, profession or business (collectively referred to as “business” in this context) in Hong Kong;
- Deriving profits from such business; and
- Such profits are arising in or derived from Hong Kong (i.e. profits having a Hong Kong source).
There is no particular threshold in order for a person to be considered as carrying on a business in Hong Kong. The Hong Kong Inland Revenue Department (“IRD”) has even stated that extensive activities are not required before a person may be considered as carrying on a business in Hong Kong.
In view of the Hong Kong domestic laws and the IRD’s assessing practice, it can be envisaged that where any directors, employees, sole proprietor or partners of a partnership business are staying in Hong Kong unintentionally for a prolonged period due to the COVID-19 restrictions and perform any business activities here, such activities may already trigger profits tax liabilities in Hong Kong.
Besides, Hong Kong has 44 double tax treaties that are currently in effect. Hong Kong’s tax treat network cannot be said to be comprehensive as compared to other developed economies (though efforts have continuously been made by the Hong Kong government to expand the network).
Accordingly, the domestic tax laws will apply in the absence of a double tax treaty. That would certainly aggravate one’s tax exposure in Hong Kong. In view of the above, professional advice should be sought in case of a prolonged stay in Hong Kong in order to identify and mitigate any tax risks due to the COVID-19 impacts.
COVID-19 Tax Guidance & Employment income
Salaries tax is imposed on employment income that is arising in or derived from Hong Kong regardless of one’s tax residence status. An exemption will be available if an individual’s visits to Hong Kong do not exceed a total of 60 days in a year of assessment.
If such presence threshold is exceeded, the individual will be liable to Hong Kong salaries tax either on his / her whole income (in case of a Hong Kong sourced employment) or on an apportionment basis (in case of a non-Hong Kong sourced employment). The threshold can be extended to 183 days in case a double tax treaty is in place.
The IRD so far has not issued any formal COVID-19 tax guidance to taxpayers explaining how it will practice the Hong Kong tax laws in relation to issues arising from the impact of the COVID-19. As such, if one spends more than the above-mentioned threshold in Hong Kong, he / she may need to discuss the adverse tax consequences with the IRD on a case-by-case basis.