The rapid
outbreak of Covid-19 has had a significant commercial impact globally. As
globalisation has led to the world becoming one market (reducing borders and
increasing economic interdependence), the virus knows no borders and the impact
is being experienced by all of us.
Nearly 162 countries and their
governments are enforcing lockdowns and travel restrictions and taking other
measures to control further spread of the virus. The business community across
the world is operating in fear of an impending collapse of the global financial
markets and recession. This situation, clubbed with sluggish economic growth in
the previous year, especially in a developing country like India, is leading to
extremely volatile market conditions. In fact, 94% of the Fortune 1000
companies are already seeing Covid-19 disruptions1.
Amongst many tax issues (covered
separately in this Journal), this article focuses on cross-border elements in
the new equations. Such cross-border elements include unintended Permanent
Establishment exposure, incidental (and / or accidental) tax residency,
taxation issues relating to cross-border workers and so on. Transfer Pricing
issues have been covered separately in this Journal. In such a background, this
article attempts to throw some light on the impact of the Covid-19 outbreak on
these aspects.
IMPACT
ON CREATION OF PERMANENT ESTABLISHMENT
As the work scenario has changed
across the world due to Covid-19, with most employees working from their homes
while others may have got stuck in foreign countries because of the lockdown,
it has created several questions for companies as to the existence of their
Permanent Establishments in such countries.
The various treaties provide for
several types of PEs such as Fixed Place PE, Agency PE, Construction PE and
Service PE.
Fixed Permanent Establishment
(‘Fixed Place PE’)
A Permanent Establishment is ‘a
fixed place of business through which the business of an enterprise is wholly
or partly carried on’. This is commonly referred to as ‘basic rule of PE’, or
fixed place PE. A fixed place PE exists if the business of the enterprise is
carried out at a fixed place within a jurisdiction, typically for a substantial
period depicting permanence.
For a home office to be
considered the PE of an enterprise, the home office must be used on a
continuous basis for carrying on its business and the enterprise must require
the individual to use that location to carry on the said business.
It is worthwhile to note that the
Hon’ble Apex Court recently in the case of E-funds IT Solutions Inc2
which also relied on the ruling in the case of Formula One3,
held that ‘a Fixed Place PE can be created only if all the tests for the
constitution of a Fixed Place PE are satisfied, i.e., there is a “fixed place
at the disposal of the foreign enterprise”, with some “degree of permanence”,
from which the “business is carried on”’.
The OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis4 in paragraphs 5, 8 and 9 provides that under existing
treaty principles it is unlikely that a business will be considered to have a
fixed place PE in a jurisdiction as a result of the temporary presence of its
employees during the Covid-19 crisis. It has stated that ‘individuals who
stay at home to work remotely are typically doing so as a result of government
directives; it is force majeure, not an enterprise’s requirement.
Therefore, considering the extraordinary nature of the Covid-19 crisis, and to
the extent that it does not become the new norm over time, teleworking from
home (i.e., the home office) would not create a PE for the business / employer,
either because such activity lacks a sufficient degree of permanency or
continuity, or because, except through that one employee, the enterprise has no
access or control over the home office’.
A typical
remote work from home scenario in the present crisis is a result of force
majeure, i.e., government travel restrictions or work from home directives
which have been imposed during the pandemic and as such should not result in
the creation of a Fixed Place PE in a foreign jurisdiction. However, time is of
the essence to show how courts and tax authorities interpret Fixed Place PEs
under Covid-19.
Agency Permanent Establishment
The concept of PE has taken birth
in the context of two tax principles, i.e. the residence and source principles
of taxation. As per the source principle, if a tax resident of a particular
country earns income through another person (a separate legal entity) in
another country and where such other person can conclude contracts, then such
person creates an Agency PE in the latter country. The issue which needs to be
addressed is whether the activities of an individual temporarily working from
home for a non-resident employer during the present pandemic could give rise to
a dependent Agent PE.
In the case
of Reuters Limited vs. Deputy Commissioner of Income Tax (ITA No. 7895/Mum/2011)
the concept of Agency PE was discussed in detail wherein it was held that ‘A
qualified character of an agency is providing authorisation to act on behalf of
somebody else as to conclude the contracts’. This means 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, and thus a
taxable presence, in that country.
OECD in its Secretariat Analysis
of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘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
because of force majeure and / or government directives extraordinarily
impacting his or her normal routine’.
Construction Permanent
Establishment
The concept of Construction PE
provides that profits generated from construction works will be taxed in the
country in which the permanent establishment (construction site) is placed or located.
In general, a construction site
will constitute a PE if it lasts more than 12 months under the OECD Model, or
more than six months under the UN Model. However, the threshold may vary in
different tax treaties. It appears that many activities on construction sites
are being temporarily interrupted by the Covid-19 crisis.
In this regard, it has been seen
that the Indian tax authorities do not assume that interruptions of works at
site are to be excluded from the project period. OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘it
appears that many activities on construction sites are being temporarily
interrupted by the Covid-19 crisis. The duration of such an interruption of
activities should however be included in determining the life of a site and
therefore will affect the determination, whether a construction site
constitutes a PE. 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).’
However, it is questionable
whether this case can be applied to the current pandemic situation which was
simply unpredictable. It is a natural event, but not seasonal. It is not even
predictable with a sufficient probability, as in bad weather. It is simply not
calculable; it is a classic force majeure scenario.
Service Permanent Establishment
Globalisation has led Multinational
Enterprises (MNEs) to increase cross-border secondment of technical, managerial
and other employees to their subsidiaries located in low-cost jurisdictions
such as India. The rationale behind seconding such employees is sometimes to
help the subsidiaries avail the benefit of the skill and expertise of the
seconded employees in their respective fields, and sometimes to exercise
control.
Secondment of employees has
become a really significant area, given that some bank staff or companies’
staff on assignments or secondments may be trapped in their non-native country
due to the travel restrictions, while others may have come back earlier than
expected; such situations might create a Service Permanent Establishment
(Service PE) for the companies.
Forced quarantine may delay the
intended secondment of an employee abroad or make a person employed on a
foreign contract decide to return to India due to reasons beyond control. In
this case, work for a foreign employer will be performed from India. This may
result in the creation of taxability of the employee’s income in India and in
some cases may even create risk of a permanent establishment. It is pertinent
to note, of course, that each case should be analysed on its own merits.
The concept of PE has been
defined extensively in various places but the interpretation of the same
continues to be complex and subjective. The distinct nature of each transaction
makes the interpretation of the law and the judicial precedents worth noting.
There can be no thumb rule which can be inferred from the jurisprudence or OECD
guidelines at present to the current crisis. Whether the virus-induced duration
of interruption would be included in the deadline in individual cases will
depend upon the specific circumstances.
We have
experienced in the recent past that India has been the frontrunner in
implementing the recommendations of OECD G-20 nations which are being discussed
under the initiative of BEPS Action Plans. Examples of this are introduction of
the concept of Significant Economic Presence (SEP) and Equalisation Levy (EL)
in the statute. However, it is important to see whether the same enthusiasm is
shown while implementing the recommendations on Covid-19-related aspects.
IMPACT
ON RESIDENTIAL STATUS OF A COMPANY (PLACE OF EFFECTIVE MANAGEMENT)
A company is generally tax
resident in the country where it is incorporated or where it has its ‘Place of
Effective Management’ (‘POEM’). The residential status of a company dictates
where a company will be taxed on its worldwide profits.
The OECD MC has defined POEM as ‘the
place where key management and commercial decisions that are necessary for the
conduct of the business as a whole are in substance made and that all relevant
facts must be examined to determine POEM’.
In India,
POEM has been recognised by amendment in section 6(3) of the Income-tax Act,
1961 under the Finance Act, 2015 which states that a company is said to be
resident in India in any previous year, if it is an Indian company, or its
place of effective management in that year is in India. The Explanation to
section 6(3) provides that POEM means a place where key management and
commercial decisions that are necessary for the conduct of the business of an
entity as a whole are, in substance, made. POEM is also an internationally
recognised residency concept and adopted in the tie-breaker rule in many Indian
treaties for corporate dual residents and is also adopted in many jurisdictions
in their domestic tax laws.
Due to Covid-19, management
personnel / CEO may not be able to travel to the habitual workplace on account
of restrictions and may have to attend Board meetings via telephone or video
conferencing which will create a concern as to the place / jurisdiction from
which decisions are being taken.
It is pertinent
to note that the Central Board of Direct Taxes (‘CBDT’) had issued POEM
guidelines vide Circular No. 06 dated 24th January, 2017. In
the context of cases where the company is not engaged in active business
outside India, the Guidelines state that the location of the company’s head
office is one of the key determinant factors.
In this connection, CBDT has
considered a situation where senior management participates in meetings via
telephone or video-conferencing. In such a situation, CBDT states that the head
office would normally be the location where the highest level of management
(e.g., the Managing Director / Financial Director) and their direct support
staff are located.
OECD in its Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 states 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’.
Although the OECD Guidance
provides relief in this respect, however, taxpayers should be mindful of the
specific clarifications issued by respective tax jurisdictions on this aspect.
Recently, the US IRS has announced5 cross-border tax guidance
related to travel disruptions arising from the Covid-19 emergency. In the
guidance, IRS stated that ‘U.S. business activities conducted by a
non-resident alien or foreign corporation will not be counted for up to 60
consecutive calendar days in determining whether the individual or entity is
engaged in a U.S. trade or business or has a U.S. permanent establishment, but
only if those activities would not have been conducted in the United States but
for travel disruptions arising from the Covid-19 emergency’.
Similarly, jurisdictions such as
Ireland, UK and Jersey, Australia have issued guidance providing various
relaxations to foreign companies in view of Covid-19.
While the OECD Secretariat has
done an analysis on treaty impact, it may be worthwhile exploring a
multilateral instrument (on the lines of MLI) for avoiding conflict of
positions while granting treaty benefit to the taxpayers.
IMPACT ON RESIDENTIAL STATUS OF AN
INDIVIDUAL
Generally, number of days
presence is considered as a threshold (the total number of days that an
individual is present in a particular jurisdiction) for determining individual
tax residency. An exception to this principle is where citizens are taxed
irrespective of their presence.
Due to the Covid-19 outbreak,
travel is restricted, which gives rise to two main situations:
i. A
person is temporarily away from his home (perhaps on holiday, perhaps to work
for a few weeks) and gets stranded in the host country because of the Covid-19
crisis and attains domestic law residence there.
ii. A person/s is working in a country (the ‘current home country’)
and has acquired residence status there, but they temporarily return to their
‘previous home country’ or are unable to return to their current home country
because of the Covid-19 situation.
According to
the OECD, in the first scenario it is unlikely that the person would acquire
residence status in the country where he is temporarily staying because of
extraordinary circumstances. There are, however, rules in domestic legislation
considering 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.
In the second scenario, it is
again unlikely that the person would regain residence status for being
temporarily and exceptionally in the previous home country. But even if the
person is or becomes a resident under such rules, if a tax treaty is
applicable, the person would not become a resident of that country under the
tax treaty due to such temporary dislocation.
However, in litigious countries
like India, and in the context of recent legislative amendments where NRIs have
been targeted for ?managing’ their period of stay in India, the very thought of
having to substantiate to the authorities that as per any tie-breaker test, a
person is non-resident in India is daunting.
With a view to remove genuine
hardships to individuals, CBDT has issued a clarification through Circular No.
11 of 2020 dated 8th May, 2020 in respect of determination of
residency u/s 6 due to Covid-19. The circular is applicable to individuals who
came on visit to India on or before 22nd March, 2020 and have
continued to be in India in different scenarios. This circular applies only for
determination of residency for FY 2019-2020.
Accordingly, in case of
individuals who have come on a visit to India on or before 22nd
March, 2020 and are falling under the following categories, relaxation will be
provided while determining their number of days’ presence in India for the
purpose of section 6 for FY 2019-20, as explained hereunder:
a. Scenario 1: where an
individual (who is on a visit to India) is unable to leave India before 31st
March, 2020 – the period of stay between 22nd and 31st
March, 2020 (both inclusive) shall not be counted for determining presence in
India.
b. Scenario 2: where an individual
has been quarantined in India on account of Covid-19 on or after 1st
March, 2020 and such individual has departed on an evacuation flight before 31st
March, 2020 or is unable to depart – the period starting from the start
of the quarantine period up to 31st March, 2020 or date of actual
departure shall not be counted for determining presence in India.
c. Scenario 3: where an
individual (who is on a visit to India) has departed on an evacuation flight
before 31st March, 2020 – the period of stay between 22nd
March, 2020 and date of his departure shall not be counted for determining
presence in India.
It has also
been stated that another circular will be issued in due course for determining
residency for FY 2020-2021. These pro-active clarifications bring relief to
many individuals facing difficulties in determining their residential status
amidst the measures taken by various governments to contain the impact of
Covid-19. It should be noted that this circular provides relief only from the
residence test u/s 6 of the Act. The issue of an individual’s forced stay in
India playing a role in constituting residence for a foreign company, HUF,
etc.; or determination of a business connection or Permanent Establishment of a
non-resident in India; and other such implications are not covered in the
circular. The US has recently issued a clarification which states that up to 60
consecutive calendar days of presence in the USA that are presumed to arise from
travel disruption caused by Covid-19 will not be counted for purposes of
determining US tax residency.
IMPACT ON CROSS-BORDER WORKERS
Cross-border
workers are persons who commute to work in one state but live in another state
where they are resident.
As per the
Income from Employment Article of the DTAAs, income from employment is taxable
only in a person’s state of residence unless the ‘employment is exercised’ in
the other state. However, there are certain conditions for not taxing
employment income in a state where employment is exercised (presence of employee
in that state not exceeding 183 days; and remuneration is paid by an employer
who is not a tax resident of that state; and such remuneration is not borne by
the employer’s PE in that state).
The issue which will come up here
is the taxation of wages and salaries received by such cross-border workers in
cases where they cross the threshold of 183 days due to travel restrictions.
OECD in the Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 has stated that income should be
attributable to the state where they used to work before the crisis.
THE WAY FORWARD
The issues discussed above are
some of the common issues on which clarification / guidance should be issued by
the respective tax jurisdictions in order to protect taxpayers from unnecessary
hardship. We expect that CBDT will also consider these issues and come out with
relevant relief measures. Though the OECD guidelines have a persuasive value,
they are not binding in any manner, especially to non-OECD member countries. In
fact, taxpayers may have certain other issues on which they may need
clarifications; therefore, a mechanism should be put in place where they can
describe the facts and get redressal from the tax authorities. It is
recommended that companies / individuals must maintain robust documentation
capturing the sequence of facts and circumstances of the relevant presence
inside or outside of India during the Covid-19 crisis to substantiate the bona
fides of their case before the tax authorities if and when they arise in
future.
‘Presume not that I am the thing
I was’ – Shakespeare‘Come what come may, time and the hour run
through the roughest day’ – Shakespeare
____________________________________________
1 https://fortune.com/2020/02/21/fortune-1000-coronavirus-china-supply-chain-impact/
dated 21st February, 2020
2 ADIT vs. E-funds IT Solution Inc. (Civil Appeal No. 6802 of 2015
SC)
3 Formula One World Championship Ltd. vs. CIT (IT) [2016] 76
taxmann.com 6/390 ITR 199 (Delhi)(SC)
4 https://read.oecd-ilibrary.org/view/?ref=127_127237-vsdagpp2t3&title=OECD-Secretariat-analysis-of-tax-treaties-and-the-impact-of-the-COVID-19-Crisis
5 https://www.irs.gov/newsroom/treasury-irs-announce-cross-border-tax-guidance-related-to-travel-disruptions-arising-from-the-covid-19-emergency
