The new coronavirus (“COVID-19”), which emerged in the city of Wuhan, China in December 2019 and spread around the world in a short time with the contribution of interdependence between countries, continues to have significant effects in many areas of life. One of these areas is international tax law, and potential disputes should be expected in the near future regarding taxation rights, which are demarcated by Avoidance of Double Taxation Treaties (“DTT”).
Some articles in DTTs that define the taxation rights of the countries refer to the current physical presence and number of days. Practices limiting the movement of persons such as travel restrictions and lockdowns under COVID-19 precautions, have led many employees to operate on behalf of a resident enterprise outside the country where they are supposed to work at normal times, and all face-to-face meetings to be held on digital media. In order to satisfy some doubts about the impact of this extraordinary situation on the principles set out in the tax treaties, the OECD Secretariat has published an analysis in April 3rd, 2020 entitled “Tax Treaties and the Impact of the COVID-19 Crisis”. The main purpose of the text is to protect employees and employers from unforeseen tax burdens resulting from exceptional circumstances and to reduce compliance costs.
This article aims to evaluate the impact of the precautions taken during the COVID-19 crisis on the periods in DTTs, the OECD approach and the steps taken by the countries.
I. HESITATIONS REGARDING THE CONCEPT OF PERMANENT ESTABLISHMENT
Article 5 of DTTs defines the concept of “permanent establishment”, and other articles that examine different types of income, such as commercial income and self-employment income, make reference to commercial activities through that permanent establishment while determining the taxation right of the source country. While the physical areas such as place of management, branch, office, factory, etc. are determined as permanent establishments, in some cases the existence of a PE depends on the time spent in the source country.
It is stated in Article 5/3 of DTTs that a building site, construction, assembly, installation project or relevant supervisory activities constitute a permanent establishment only if they last more than a certain period time. Such period usually ranges from six to twelve months. Many construction activities have come to a standstill due to the COVID-19 crisis. Under these circumstances, some hesitations emerged whether the time period when the activities are interrupted should be taken into account in the calculation of the time required for the construction sites to constitute a permanent establishment.
The response of the OECD Commentary on the Articles of the Model Tax Convention to this hesitation does not fit in taxpayers' pre-COVID-19 plans. In Paragraph 55 of the commentaries of Article 5, it is stated that temporary or periodic interruptions in the periods should be taken into consideration while determining the life of a construction site.
“Seasonal or other temporary interruptions should be included in determining the life of a site. Seasonal interruptions include interruptions due to bad weather. Temporary interruption could be caused, for example, by shortage of material or labor difficulties. Thus, for example, if a contractor started work on a road on 1 May, stopped on 1 November because of bad weather conditions or a lack of materials but resumed work on 1 February the following year, completing the road on 1 June, his construction project should be regarded as a permanent establishment because thirteen months elapsed between the date he first commenced work (1 May) and the date he finally finished (1 June of the following year).”
Another hesitation may realize in the concepts of “Service Permanent Establishment” and “Home Office”. Some companies are concerned about the creation of a permanent establishment that will expose them to new certification requirements and tax obligations as their employees regularly work from home in countries other than the country in which they work.
In some DTTs (DTT signed between Turkey and Germany can be cited as an example), it is stated that consultancy services performed by an enterprise in a contracting state through its employees or other personnel assigned for this purpose and continuing for a period or periods exceeding six months in any twelve-month period shall constitute a permanent establishment. In other types of treaties, the activities and periods referred are included in Article 14, which regulates the taxation of income from self-employment activities.
One of the most important criteria in the determination of the source country's right to taxation in services permanent establishment or self-employment activities is the calculation of 183-days period. The document “Tax Treaties and the Impact of the COVID-19 Crisis”, published by the OECD, did not specifically address how COVID-19 would affect the 183-days rule. However, it is understood from the statements that OECD considers that the temporary work of employees in an area or country due to unusual reasons should not create a workplace on behalf of the employer. According to OECD's approach, it can be assumed that a permanent establishment exists only if the place for the relevant work has a certain degree of continuity, i.e. only if it does not have a temporary nature. Therefore, the fact that an employee works from home in the other country because of force majeure and the closing of borders per se does not constitute a permanent establishment.
However, OECD did not mention in its document about the impact of COVID-19 on the calculation of 183-days covered by self-employment activities. Generally, OECD countries use the “physical presence” method in the calculation of 183-days. This method is quite straightforward in terms of application. In OECD Model Tax Convention, Paragraph 5 of Article 15, which regulates dependent personal activities, describes how to calculate 183-days and can also be adapted to Article 14 because it reflects the general OECD approach.
“Although various formulas have been used by member countries to calculate the 183 day period, there is only one way which is consistent with the wording of this paragraph: the “days of physical presence” method. The application of this method is straightforward as the individual is either present in a country or he is not. The presence could also relatively easily be documented by the taxpayer when evidence is required by the tax authorities. Under this method the following days are included in the calculation: part of a day, day of arrival, day of departure and all other days spent inside the State of activity such as Saturdays and Sundays, national holidays, holidays before, during and after the activity, short breaks (training, strikes, lock-out, delays in supplies), days of sickness (unless they prevent the individual from leaving and he would have otherwise qualified for the exemption) and death or sickness in the family. However, days spent in the State of activity in transit in the course of a trip between two points outside the State of activity should be excluded from the computation. It follows from these principles that any entire day spent outside the State of activity, whether for holidays, business trips, or any other reason, should not be taken into account.”
As can be understood from the above explanation, the periods spent due to the cessation of activity in the other state are included in the calculation of 183 days. For example, if an Irish resident company’s employee who came to Turkey for 4 months to perform engineering services stops working for 3 months due to COVID-19 and does not return to Ireland, withholding tax deductions may be made from the payments to the Irish resident company as the idle 3 months will be taken into consideration in the calculation of 183-days. However, as mentioned above, due to the uncertainty in the current reaction of the OECD, it was not possible to make a complete evaluation.
II. HESITATIONS REGARDING THE TAXATION OF EXPAT WORKERS
In Paragraph 2 of Article 15 of DTT, meeting any of the following conditions is deemed sufficient for the income derived from the employment contract to be taxed in another state;
a. The recipient is present in the other State for a period or periods exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned, or
b. the renumeration is paid by, or on behalf of, an employer who is a resident of the other state, or
c. the renumeration is borne by a permanent establishment which the employer has in the other State.
In the document titled “Tax Treaties and the Impact of the COVID-19 Crisis” published by the OECD, the amounts paid to the employee due to stimulus packages granted by the governments in some countries aiming at maintaining employment are resembled to payments related to termination of the employment contract and it is emphasized that the source country should not lose its right to taxation. In Paragraph 2.6 of Article 15 of the OECD Commentary, it is explained that the mentioned payments should be attributed to the country in which the employee would continue to operate if such a situation had not occurred. In most cases this country refers to where the employee was working before the COVID-19 crisis.
How to calculate 183-days was explained in detail in the section titled “Hesitations Regarding the Term Permanent Establishment”. Accordingly, short interruptions and all other days spent in the state where the activity is carried out will be taken into consideration while calculating the time period. According to the Article 15 of DTTs, if the expats resides in the same contracting state for less than 183 days, the right of taxation would belong to country of residence if the other conditions are also met. The disadvantage of expats is that they cannot benefit from the related article of DTT, due to the fact that their physical presence is in the other contracting state. Since the expression “in any 12-month period beginning or ending within the relevant fiscal year” is included in the aforementioned clause, it is highly likely that this negative effect will extend to more than one year.
III. HESITATIONS REGARDING RESIDENCY
Another issue that the COVID-19 crisis may affect is the concept of residency. Residency is firstly determined according to the internal legislations of the countries. When a person is deemed to be resident of more than one state, the Article 4 of DTTs which regulates the concept of residency is examined. According to the mentioned article:
“a) A person shall be deemed to be a resident only of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (center of vital interests);
b. if the State in which he has his center of vital interests cannot be determined, or if he has not a permanent home available to him in either State, he shall be deemed to be a resident only of the State in which he has a habitual abode;
c. if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident only of the State of which he is a national;
d. if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.”
OECD’s stance on the effects of the COVID-19 crisis on residency is clearer than the other issues. According to the approach of OECD, relatively short periods of residency, is unlikely to affect the center of the individual’s vital interest. In addition, even if the next criterion is considered, according to the Paragraph 19 of Commentary on Article 4, while determining the house in which the person has stayed habitually, not only limited number of days spent in a certain period is taken into account, but also frequency, duration, and continuity of the residency which are parts of the individual’s established routine are taken into account.
Two types of problems may arise regarding the concept of residency. These are:
- The person may have travelled abroad for a vacation or a short-term work and be stuck in quarantine in the country of travel because of the lockdown or travel restrictions. In that case, generally, the person is not deemed as a resident of that state according to the local legislation of the country of destination. However, even in rare cases where residency may occur according to the domestic legislation, COVID-19 is not expected to affect the country in which the person is a resident since the right of taxation under the provisions of DTT would belong to the country where the person can stay permanently and where she/he has vital interests.
- Secondly, the person may have had a residency status in the country where she/he has been working for a while, but after COVID-19, she/he may have gone back to the country she/he used to stay due to the family reasons. In this case, deciding on the residency status is more difficult and uncertain than the first case. The main reason for this is that, the bond with the country where the person was born, or spent many years, but has not lived for a while is much stronger. In such cases, habitual abode is referred in order to determine where the person is resident,. As stated above, temporary accommodations should not be taken into consideration in the determination of the residency status.
Therefore, it is not expected that COVID-19 would affect the country where a person is tax resident.
IV. PRECAUTIONS TAKEN BY SEVERAL COUNTRIES
In order to eliminate the hesitations mentioned above, revenue administrations of some countries have made explanations. The Irish Revenue Administration published a guideline and stated that the presence of employees, directors, service providers who remain in quarantine due to COVID-19, and are working for a company which is resident in another country are disregarded in deciding on whether the limited taxpayers are going to be taxed or not. In addition, according to the statement in the same guideline, if a person cannot leave Ireland due to a force majeure, the time spent from the scheduled departure day onwards will not be taken into consideration in determining residency status.
In the guide published by Her Majesty's Revenue and Customs, it is stated that the fact that the meetings of an institution’s board of directors are taking place within the borders of UK due to COVID-19 cannot lead to the claim that the central management is in UK and therefore the company should be counted as tax resident. In the statement, it is added that even if the central management of a company is located in UK, this does not mean that the company will be a taxpayer because the company may also be resident in another country that has signed a DTT with UK, and in such cases, as a result of applying the tie-breaker rules, the company may not be considered as a UK resident. In addition, a detailed guide has been published on whether the time spent in the UK due to unforeseen extraordinary situations will affect the tax residency of real persons.
Australia has made the most comprehensive explanations about the hesitations described above. The Australian Tax Administration has published a source of frequently asked questions regarding the management of taxation rules in response to COVID-19 crisis. In the mentioned resource, following points draw attention:
“Individuals who are not Australian tax residents and are in Australia temporarily because of COVID-19 will not become Australian tax residents provided that they usually live overseas and intend to return there as soon as they are able to. Their paid leave from a foreign employer and foreign employment income earned while working in Australia solely as a result of COVID-19 will not be assessable in Australia. Non-resident companies that are required to hold board meetings in Australia, or directors attending meetings from Australia, solely due to COVID-19 will not be deemed to have the central management and control (one of the corporate residence tests) in Australia. The unplanned presence of employees of nonresident companies in Australia due to COVID-19 travel restrictions will not by itself give rise to a determination that the company has a permanent establishment in Australia. Further, where a nonresident employee of a non-resident company works in Australia as a result of COVID-19 travel restrictions, the employer will not be expected to register for PAYG withholding.”
Other countries that have taken steps in this regard are Germany, Luxembourg, Belgium, France, and Switzerland, which have geographical proximity and therefore have many mobile workers. Belgium and Luxembourg introduced a rule called “24-days Rule” in 2015. For example, Belgian employees working in Luxembourg will be able to work outside of Luxembourg for 24 days a year, but can benefit from exemptions in Belgium. Belgium’s and Luxembourg’s tax authorities have acknowledged that the COVID-19 crisis created a force majeure event in which days worked in Belgium (for example home office activities) are not counted under the 24-days rule. In addition, Belgium’s and France’s tax authorities have also applied this force majeure approach for French workers on the border who live and work in different countries, and have to work from their homes in France instead of Belgium due to COVID-19. With a joint press release dated March 19, 2020, the situation of working from home due to COVID-19 has been clarified. Germany, Belgium, France, Switzerland, and Luxembourg reached an agreement and considered the necessity of mobile workers to be at home as a force majeure and guarantee that this will not affect taxation.
On the other hand, the Swiss Federal Tax Administration has declared that working from home in another country will not create a permanent establishment due to COVID-19, as a forced residency does not present continuity. However, if working from home takes longer than six months, each case should be examined on an individual basis. Besides, in most cases, even in long-term activities, the permanent establishment does not occur because the employer does not have the disposal over the premises and this space is not used exclusively for business purposes.
The lockdown and travel restrictions caused by COVID-19 health crisis have brought about a number of problems in all areas of life. In the area of international tax law, there has been some hesitations about how the terms of the DTTs should be implemented. In order to prevent real persons and corporates from facing double taxation in the future, incremental increase in their tax burdens or grappling with bureaucratic processes such as refunds, the OECD has published a document which includes some recommendations. However, the relevant document does not solve the problems on its own, in fact it does not address some hesitations such as the 183-days calculation. The guidelines mentioned above and published by the countries' own revenue administrations shed light on the implementation, and no steps have been observed so far which has taken by Turkey in this regard. It will be useful for Turkish Revenue Administration to share its opinions that would guide the implementation as soon as possible.
By Pınar Solyali, Senior Tax Manager, Nazali Tax & Legal