Menu
Tax Notes logo

Displaced Employees and COVID-19: The New Tax Obligations

Posted on Sep. 28, 2020

Global Roundtable is a regular series appearing in Tax Notes Federal, Tax Notes State, and Tax Notes International that brings together experts from each discipline to help advance the discussion of tax issues.

In this installment, the authors examine the effects on tax residency from quarantine and other restrictions imposed by the COVID-19 pandemic. 

This article is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.

Copyright 2020 Monte Silver et al.
All rights reserved.

Supermodels Need a Home, Too

Monte Silver
Monte Silver

Monte Silver is a U.S. tax attorney residing in Israel. He focuses on representing Americans living overseas.

In September, supermodel Bar Refaeli and her mother entered into a plea bargain, bringing to an end years of civil and criminal tax proceedings between the dynamic duo and the Israeli tax authorities. While the more interesting facts of the case have been covered in the tabloids, the case centers on tax residency and individual mobility.

For the average U.S.-based tax professional, the issue of tax residency seldom arises in federal practice. After all, a U.S. citizen or green card holder pays U.S. income tax on worldwide income, regardless of where he resides. In other words, U.S. citizens and green card holders living abroad must fully comply with U.S. tax and disclosure laws. But all other countries impose worldwide tax only on their residents. If an Israeli or Spanish citizen no longer resides in her respective home country, she ceases to be liable for taxes there.

As one can imagine, for non-Americans with high levels of income, the issue of residency is critical, especially when the person is willing to move abroad. For example, Rafael Nadal has said he values family and friends over tax rates and has decided to remain in high-tax Spain. On the other hand, Novak Djokovic moved to Monaco, where the tax rates are zero. The combination of good planning and a client who is willing to relocate can work wonders.

The basic facts of the dynamic duo’s case are not complicated. Bar (we informal Israelis use first names) had a problem. Starting in 2006, international companies handsomely compensated her for modeling, and as long as she was a resident of Israel, she remained subject to high tax rates. Given her international work and lifestyle, the conceptual solution was easy: Spend as much time outside Israel as possible and claim that she resided outside the country. And that’s what she did. Almost. After claiming to have left Israel in 2006, she earned millions of dollars in income which she did not report, contending that she was no longer liable for Israeli taxes.

The Israeli tax code, like the code in most countries, has two residency tests: quantitative and qualitative. First, if a person is in Israel for 183 or more days in a year, she’s an Israeli resident for tax purposes. Second, regardless of day counting, residency exists if the person meets the “center of life” test. (See Israeli Income Tax Ordinance, 5721-1961, section 1.) This involves a facts and circumstances inquiry. Residency is determined by examining the location of the person’s (i) permanent home, (ii) family members, (iii) permanent work, (iv) material economic interests, and (v) involvement in organizations, associations, or institutions.

So where did Bar reside?

Well, it turns out that Bar cut corners. The facts were not even close. As to the quantitative test, the civil court found that Bar was in Israel more than the requisite number of days up until 2010. Even in that year, she spent more days in Israel that in any other single country, leading the court to hold that the center of life test was met in 2010 as well.

Seeking to establish that her center of life was in the United States, Bar repeatedly pointed to her high-profile romance with Leonardo DiCaprio. However, the court rejected that argument and held that while she was living with him, his home was not her permanent residence, a fact strengthened by the actor’s failing to appear in court to testify on her behalf.

On the other hand, Bar’s ties to Israel and her family are known to be very close, a fact that emerged in the proceedings. First, the court found that she managed her personal, business, and social life from her parents’ house, which the court held was her permanent home. Second, her mother, Tzipi, managed her business affairs. Third, Bar continued to work in Israel during the years in question. Fourth, Bar’s legal and tax professionals were all Israel-based. Fifth, Bar remained enrolled in Israel’s public health system and used its services.

Not only did the civil court find that there was no reasonable basis to claim nonresidence, but the facts got uglier, giving rise to criminal liability. After moving out of her parents’ house, Bar lived in a series of luxury apartment towers in Tel Aviv. And in each case, Bar refrained from signing any lease in her name to avoid having a “permanent home” in Israel. Rather, Tzipi signed the leases and stated that the apartments would be used by a different family member, when in fact it was Bar who lived there. In 2011 Tzipi even bought an apartment in her name when it was clear that Bar would live there. (That case also involved issues of the dynamic duo’s tax evasion, which are beyond the scope of this article.)

At the end of the day, in the civil proceeding, Bar and Tzipi repaid the taxes due with interest and penalties. In the criminal proceeding, Tzipi took the fall for her daughter, claiming that she was solely responsible for the wrongdoings; she was sentenced to 16 months in prison. Bar was sentenced to nine months of community service. The two must pay $1.5 million in criminal fines.

Looking back at the mental and financial strain of years of civil and criminal proceedings, not to mention the damage to Bar’s reputation and Tzipi’s jail time, was the greed worth it? Probably not.

Are there lessons to be learned here? Yes. If you’re thinking of relocating to avoid taxes, be sure that you’re willing to pay the price of leaving friends and family behind. Trying to have your cake and eat it too can have unpleasant consequences.

Will COVID-19 Highlight How Multinationals Really Conduct Business?

Jeffery M. Kadet
Jeffery M. Kadet

Jeffery M. Kadet was in private practice for over 32 years, working in international taxation for several major international accounting firms. He now teaches international tax in the LLM program at the University of Washington School of Law in Seattle.

The IRS appears to have noticeably ignored something that is becoming increasingly evident with the COVID-19 work-from-home requirements and the elimination of most business travel.

Multinationals have pervasively adopted profit-shifting structures over the past several decades that required little or no change in the location of physical business operations. They have moved profits earned from activities conducted within the United States and other mid- and high-tax countries to entrepreneurial group members in zero- or other low-tax jurisdictions. Those MNEs include not only U.S.-incorporated entities, but also former U.S. MNEs that have inverted, and some private equity and other investment acquisitions made through foreign acquisition vehicles. Moving the corporate seat outside the United States allowed these entities to avoid subpart F and, eventually, U.S. taxation on foreign profit repatriations before the enactment of the Tax Cuts and Jobs Act. To some extent, it allowed them to avoid the subpart F and global intangible low-taxed income regimes even after the TCJA passed (generally from 2018).

One element common to many profit-shifting structures is the transfer from the U.S. parent or other U.S. group member of relevant intangible property to the entrepreneur through licenses or cost-sharing agreements. The IRS has attacked those structures primarily by questioning the transfer pricing at which the intangible property was transferred. By so doing, the IRS has:

  • relied on a subjective and fact-intensive issue with mixed results at best in the resulting litigation; and

  • legitimized the basic structure and the cost-sharing agreement or license that has allowed continual year-by-year outsized profits to be recorded within the entrepreneur’s accounting records.

My old colleague David L. Koontz and I have written over the last six years a few articles that presented a better approach that the IRS could use to attack those structures. Rather than simply focusing on the subjective value of relevant intangible property at one point in time (for example, the date on which the intangible property was transferred), the IRS should examine how the relevant group members (U.S. group members and the foreign entrepreneur) conduct the group’s business. To that end, we argue that when value drivers, and control and decision-making, are located in the United States, and when no foreign group member CEO or other management is responsible for managing the entrepreneur, including any disregarded entity subsidiaries, the chances are good that the foreign group member entrepreneur will be conducting a trade or business in the United States and thus have some amount of effectively connected income.

When those factors exist, there is also a high likelihood that the manner in which the group members conduct joint business activities creates a partnership under the entity classification rules. The existence of a partnership makes the application of the ECI rules much easier. It may be noted as well that when the taxpayer is the foreign entrepreneur, many early years may still be open for IRS adjustment even when the corresponding years of the U.S. group are closed. Moreover, in some instances, deductions and credits may be disallowed and the branch profits tax may apply.

Many multinationals will have those factors, including those in the pharmaceutical and other traditional manufacturing industries, the FAANGs, gig economy players, online travel service providers, and those offering cloud-based products and services.

Despite the many adverse effects of the COVID-19 pandemic, MNEs in manufacturing have had to maintain their supply chains, many of which use contract manufacturers in Asia. Groups operating through internet platforms, whether selling products or performing digital services, have also continued their operations. They have done so despite the inability to travel and the stay-at-home requirements that have been a feature of life since the March designation of COVID-19 as a pandemic.

Why have MNEs been able to so easily, relatively speaking, maintain and even expand their businesses? In short, modern communication and management tools have allowed their centralized managements and operating personnel, many of them being within the United States, to manage, direct, and conduct their worldwide businesses with little or no interruption.

Where there’s a supply chain, personnel in the United States often perform most or all production functions short of the physical manufacturing conducted by contract manufacturers. These production functions can include identifying sources of raw materials and components; negotiating terms, including pricing, with these sources; identifying and negotiating with contract manufacturers; determining production quantities, timing, and costs; controlling inventory levels; and performing quality control. U.S.-based personnel are sometimes also involved in sales negotiation and contract execution for major customers and resellers worldwide that purchase from the foreign group member entrepreneur.

For an internet platform business providing digital services, the same group of primarily U.S.-located personnel conduct all DEMPE functions (development, enhancement, maintenance, protection, and exploitation), including the day-to-day operation of the platform, on behalf of all group members that provide those digital services to customers and users within their respective geographic markets.

Is this really pervasive and something that the IRS should examine and that MNEs and their outside auditors should be concerned about? Lee A. Sheppard recently focused on these questions because of revelations included in a July 15 decision of the General Court of the European Union.1 In short, the decision indicates that Apple made representations to the General Court that suggest a U.S. trade or business in a pretty black-and-white fashion. These representations caused Sheppard to comment, for example, in regard to the manufacture of Apple products:

ASI [Apple Sales International] didn’t negotiate its own procurement contracts. The General Court noted that “contracts with third-party original equipment manufacturers, which were responsible for the manufacture of a large proportion of the products sold by ASI, were negotiated and signed by the parent company, Apple Inc., and ASI through their respective directors, either directly or by power of attorney” (para. 300). And “the negotiations in question were led by directors of the Apple Group and that the contracts were signed on behalf of the Apple Group by Apple Inc. and ASI through their respective directors, either directly or by power of attorney” (para. 300).

Regarding Apple’s sales being potentially attributable to an office or other fixed place of business within the United States (a requirement for ECI treatment), Sheppard highlighted that in Apple’s representation to the Court, “all the sales and distribution decisions were made in Cupertino” and not in Ireland or elsewhere.

Apple is just one example. Many MNEs have within the United States both a centralized worldwide management and many critical business functions that earn the profits being recorded by entrepreneur foreign group members. Apple and similarly situated MNEs should be very concerned.

U.S. State Tax Experience With Employees Working Remotely

Walter Hellerstein
Walter Hellerstein

Walter Hellerstein is the Distinguished Research Professor Emeritus and the Francis Shackelford Professor of Taxation Emeritus at the University of Georgia Law School, a visiting professor at the Vienna University of Economics and Business, and chair of the Tax Notes State advisory board.

In light of the gigabytes of information and related commentary crossing our screens on a daily basis addressing the tax issues raised by “displaced employees and COVID-19,” it is difficult to fathom what one can add to the ongoing dialogue. Nevertheless, with expectations appropriately lowered for what follows, I have briefly described the U.S. subnational states’ experience in addressing analogous issues in the past with the aim of identifying lessons they may offer for addressing these issues in today’s pandemic world.

When an employee works at home in a state other than the state of the employer’s physical location associated with the employee’s work, it raises three sets of tax issues:

  • What is the source of the employee’s income associated with his or her work at home for personal income tax purposes?

  • Does the employee’s work at home create nexus for the employer in the employee’s state of residence?

  • Does the employee’s work at home affect the source of the employer’s income?

Personal Income Tax Issues

States have long confronted the problem of determining where an employee earns personal income associated with labor performed at the employee’s home for an employer physically located in another state. One need look no further than the venerable debate over whether employees residing in states other than New York and performing work at home for their New York employers are earning income in their states of residence or in New York when they are working physically at home for their own convenience.2

Indeed, a recent Arkansas ruling reminds us that the issue arises wholly apart from the employee’s motivation for working from home.3 The taxpayer worked in Arkansas as a computer programmer until 2017, when she moved to Washington. She continued working for her Arkansas employer, doing exactly the same work but working remotely from her home in Washington state.4 In addressing the question of the source of the nonresident employee’s income, the ruling concluded that “although your client is performing her job duties from a physical location in Washington, she is carrying on an occupation in Arkansas” and “the income she earns from the conduct of that occupation is subject to Arkansas income tax.”5

Even if one concurs, in whole or in part, with the position of states like New York and Arkansas that nonresident employees working from home are earning income at their employer’s location,6 it is difficult to dismiss the position of other states that employees working at home are earning their income where they are physically performing their labor. In support of this position, one may invoke the law and regulations of virtually every state with personal income taxes that generally link the source of employees’ income to the physical location at which they are performing their duties, although often with de minimis limitations based on the time spent or wages attributable to such physical presence to avoid undue administrative burdens on nonresident employees and their employers with regard to filing and withholding obligations.

My purpose here is not to explore these questions further,7 but simply to identify the broader issues they raise, namely, the potential tension between the physical and economic location of labor for state tax purposes in the digital age.

Nexus Issues

The flip side of whether an employee working at home for an employer physically located in another state earns income in her home state or in the state of her employer’s location is whether the employee’s work at home creates nexus for the employer in the employee’s home state. The New Jersey Appellate Division’s opinion in Telebright8 instructively addresses the second question and its relationship to the first. In Telebright, the court held that a Maryland-based corporation had nexus with New Jersey based on the presence of a single employee who “telecommute[s] full-time from her New Jersey residence,” where she “develops and writes software code from a laptop computer.”9 In the course of its opinion, the court remarked on “the fact that Telebright’s full-time employee works from a home office rather than one owned by Telebright is immaterial for purposes of the first prong of the Complete Auto test,”10 because “she is producing a portion of the company’s web-based product here.”11 Moreover, in support of the court’s resolution of the issue of the employer’s nexus, the court explicitly linked its conclusion to the source of the employee’s income, observing that Telebright “already withholds and pays New Jersey state income tax from her salary.”12

Once again, my purpose here is not to elaborate upon the specific nexus questions raised by cases like Telebright, but simply to identify the tension they reflect between the physical and economic location of labor in the digital age. If an employee who works full-time from her home office in state A, where she “perform[s] her job duties” for an employer located in state B, how do we determine whether the employee is “carrying on an occupation” in state B (as in the Arkansas ruling) or is “producing a portion of the company’s web-based product” in state A (as in Telebright), or both, and whether, and under what circumstances, the employee’s activities in state A create nexus in state A for the state B employer?

Payroll Factor Issues

Finally, at least for those states that continue to employ a payroll factor for apportioning corporate income,13 the question may arise as to whether an employee’s work at home affects the source of the employer’s income. Most of the state statutes, including those that are based on the Uniform Division of Income for Tax Purposes Act (UDITPA), follow the Model Unemployment Compensation Act in attributing payroll to a particular state.14 Under the model act and UDITPA, the compensation is attributed to a state if:

  1. the individual’s service is performed entirely within the state; or

  2. the individual’s service is performed both within and outside the state, but the service performed outside the state is incidental to the individual’s service within the state; or

  3. some of the service is performed in the state and: 

  1. the base of operations or, if there is no base of operations, the place from which the service is directed or controlled, is in the state; or

  2. the base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the individual’s residence is in this state.15

This test does not fractionate the compensation of any individual employee who renders services in more than one state, but attributes an employee’s compensation to a state on an all-or-nothing basis.

Under this test, the question of whether the compensation of an employee who works from home would be attributed to the state of the employee’s residence, the state of the employer’s base of operations, or the state from which the employee’s service is directed or controlled would depend on a detailed inquiry into the precise facts associated with the employee’s work from home.

Conclusion

The key takeaway from this brief foray into the states’ experience with employees working remotely is that there is nothing new about the “new tax obligations” associated with displaced employees and COVID-19. The states have been addressing these issues for many years, although admittedly in an environment in which the issues were less pressing and widespread. So what overarching conclusions emerge from an overview of the states’ previous responses to these challenges? I would identify two. First, regardless of the precise question at issue (source of the employee’s personal income; nexus for the employer; allocation of the employer’s income), the resolution of the question involves the theoretically perplexing inquiry into the determination of the geographic location of economic activity that has physical and virtual ties to more than one jurisdiction. Second, in light of the difficulty of producing a generally accepted response to the theoretical inquiry, at least in the short run, the most important lesson from previous efforts to address these questions may simply be that whatever response jurisdictions embrace as a matter of principle, they should pay as much if not more attention to the practical administrative concerns of implementing whatever theoretical approach they adopt.

Why More Employers Are Getting SALT-y on Remote Work Arrangements

Jeffrey A. Friedman
Jeffrey A. Friedman
Richard D. Pomp
Richard D. Pomp

Richard D. Pomp is the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law, and Jeffrey A. Friedman is a partner in the Washington office of Eversheds Sutherland (US) LLP.

Large-scale remote work experiments have been commonplace for a while, particularly for white collar or knowledge-work positions that can be done from any location with internet access. However, an unprecedented number of U.S. workers were drafted into a massive experiment this year as the COVID-19 pandemic shuttered the offices of nonessential businesses across the country. Employees and their employers are just beginning to fully grasp the potential tax implications of this new, and perhaps not-so-temporary, work environment.

We provide an overview of the key state and local tax issues created by remote employees, including employer withholding and personal and corporate nexus.

Sourcing and Apportioning Nonresident Wage Income

The pandemic exacerbates many long-standing tensions arising out of nonuniform sourcing and apportionment rules for nonresident employment compensation. We expect to see an uptick in litigation in the coming years arising out of the trailing nexus issues created by states seeking to cling onto their nonresident commuter income tax bases, despite these employees having abandoned their prior in-state locations.

Most states impose an income tax on both residents and nonresidents. Typically, individuals are taxed by their states of residence or domicile on their worldwide income, with credits provided for income taxes paid to other states on the same income. Nonresident employees are taxed on a “source basis,” the amount of their wages attributable to their services performed in a state. Such wage income often is determined by looking to the percentage of an individual’s working days in the state compared with the individual’s working days everywhere.16

States use different methods in determining a nonresident’s in-state working days. And, in at least five states, a nonresident employee does not need to be physically present in the state for her wages to be subject to tax.17

Most notably, New York uses the “convenience of the employer” rule. This rule applies to employees who are assigned to a New York work location but also work at their homes (or other locations) outside New York. The convenience of the employer rule includes as New York working days those days worked outside New York if the employee’s non-New York location was for his convenience, and not required by his employer.18 This approach has been challenged without success.19 But COVID-19 should be the exception. If the New York office is closed and taxpayers are told to work remotely, they are not doing so for their convenience.

Treating individuals as still working at their now abandoned (at least temporarily) offices leads to unfair and illegal results. Solely for purposes of the COVID-19 pandemic, through December 31, Massachusetts issued an emergency rule that continues to treat a nonresident — ordinarily working in that state, but who now works remotely for the same employer — as nonetheless continuing to generate in-state taxable income.20

This approach — trailing nexus on steroids — seems to be constitutionally defective. The due process clause requires that a taxpayer’s income have a minimum connection to the taxing state.21 Treating a remote worker’s income as having a source at the worker’s former office location when that worker is prohibited from working there cannot be described as minimally connected (or connected at all) to the taxing state.

The resulting tax also seems to be unfairly apportioned, violating the commerce clause.22 Not surprisingly, Massachusetts’ position is opposed by New Hampshire, which does not tax wage income earned from personal services.23 (Presumably, Massachusetts will tax a nonresident who is temporarily working remotely for her New York-based employer from her vacation home on the Cape.)

Employer Withholding Tax Obligations

Withholding collects a tax already owed. Consequently, any uncertainty about whether a remote employee can be taxed by a state where her services were previously — but not currently — performed, raises issues about the withholding obligation.

While a significant majority of states have not yet issued COVID-19 guidance related to withholding, some states have recently required withholding for temporary, pandemic-related, remote work arrangements, which implicitly means that remote employees will continue to be taxed on their wages based on the location of their primary work location prior to the pandemic.

  • Massachusetts,24 Mississippi,25 and South Carolina26 are among several states that now require businesses to continue withholding for employees previously working in the state who are now temporarily working remotely. These states have adopted a temporary trailing nexus policy, in whole or in part, during the COVID-19 pandemic. The guidance issued by these states has important nuances that may affect an employer’s withholding obligations, such as exceptions to, and duration of, the policy.

  • The New Jersey Division of Taxation distinguishes between someone who works in New Jersey but lives in another state, and someone who lives in New Jersey but works in another state. The division said it would not require employers to withhold on employees previously assigned to a New Jersey office but now teleworking out of state.27 However, the division will source wage income “as determined by the employer in accordance with the employer’s jurisdiction.”28 That is, if a New Jersey teleworker is subject to New York income tax withholding as a result of the convenience of the employer test, New Jersey will not tax the New Jersey-source wages during the “temporary period of the COVID-19 pandemic.”29

  • Illinois,30 Minnesota,31 and Maryland32 have indicated that employers with remote employees now working in these states would be subject to wage withholding obligations. In other words, these states have implicitly said that they will enforce their general source-based taxation rules. However, because these states have entered into reciprocity agreements with some of their neighboring states, employers may not need to change state withholding for many employees.33

  • Ohio passed legislation providing that pandemic-related remote work does not count toward the 20-day withholding threshold for municipal income taxes in teleworking locations.34 Legislation has been introduced to repeal this new law35 and a think tank has filed a lawsuit challenging it.36

Much of the available state guidance is premised on the assumption that employers know where their employees are working remotely. To comply with state withholding obligations related to temporary and, perhaps more importantly, longer-term telework, an employer should consider reviewing the accuracy of employee records and evaluate the company’s remote work and travel policies. Imposing a withholding requirement when the employer cannot determine where the remote employee is working is problematic.

Corporate Income Tax and Sales/Use Taxes

The presence of a single remote employee working for an out-of-state corporation might create nexus for the employer, triggering filing and perhaps payment of a corporate income tax. These employees may also create sales tax collection obligations even for employers that do not meet post-Wayfair nexus statutes.37

In 1975 the U.S. Supreme Court held that a single employee operating out of his home was sufficient for Washington to impose its business and occupation tax on the employer.38 More recently, in 2010 the New Jersey Tax Court held that an out-of-state company was subject to New Jersey corporation business tax because it permitted one of its full-time software developers to work remotely from her New Jersey home.39 In both of these cases, however, the employees were residents of the taxing states and not working there temporarily due to a pandemic.

The District of Columbia,40 Indiana,41 North Dakota,42 and South Carolina43 indicated that they will not impose corporate income tax nexus because of the temporary presence of employees with pandemic-related telework arrangements. Oregon also stated that the presence of teleworking employees in Oregon between March 8 and November 1 will be ignored for determining corporate tax nexus if the employees are regularly based outside Oregon.44 However, many states have not issued any guidance, leaving taxpayers to speculate (and be second-guessed) about their compliance obligations.

More to Come

As states and localities continue to adjust to the changes in the pandemic work environment, more guidance will be forthcoming. States might modify or reverse their tax positions as the economic consequences of the pandemic become clearer and if “temporary” telework arrangements continue into 2021, and perhaps become permanent.

Tax Risks of a Remote Workforce in a Post-Crisis World

Aleksandra Bal
Aleksandra Bal

Aleksandra Bal is an indirect tax and technology specialist based in Amsterdam.

This article was written in her personal capacity. It represents her views and should not be attributed to any organization with which the author is affiliated.

The COVID-19 pandemic has fundamentally changed the way people work and do business. Travel restrictions and closed office spaces caused many people to work from places where their employers usually do not operate. Some employees were involuntarily stranded abroad, while others were asked to work from home rather than come to the office. Many companies were afraid that this unexpected remote employment could trigger additional tax liabilities and social security obligations. They had to carefully consider questions such as: In which country is the salary of employees working from home taxable? Is there a risk that employees working in their home jurisdiction could create a taxable presence for the company abroad? Should employees residing and working abroad be subject to payroll obligations in their home country?

The OECD issued guidance in April clarifying that employees temporarily working outside their employer’s country of operation because of COVID-19-related measures are not likely to trigger new income tax obligations. The guidance also suggested that an employee’s home office should not create a permanent establishment for the employer because remote working arrangements lack the required degree of permanency and an employee’s home is generally not at the employer’s disposal. Similarly, an employee concluding contracts on the employer’s behalf in his home country for a finite period should not be considered a dependent agent that creates a new economic nexus. Finally, the OECD concluded that a temporary change in the location of senior executives and board members should not trigger a change in a company’s tax residency.

The OECD guidance assumed that any work dislocation would be exceptional and temporary. It intended to assure to companies that government-imposed restrictions would not expose them to new tax liabilities abroad and was based on the understanding that employees will return to their normal place of work once the COVID-19 measures cease. However, it is quite likely that remote working will become the new normal once the world emerges from the COVID-19 crisis. The office will act as a meeting space while home becomes the place where work activities will actually be performed. Many companies are planning to implement remote working arrangements as a permanent element of their human resources policy or to reduce physical office space to cut costs. In these circumstances, the guidance provided by the OECD can no longer be relied on, and the questions posed in the first paragraph of this article need to be revisited.

Let’s consider PE risks created by employees working from home or concluding contracts on behalf of their employer outside the jurisdictions where their employers typically operate. According to article 5(1) of the OECD Model Convention on Income and Capital, a PE is a fixed place of business through which the business of an enterprise is wholly or partially carried on. To qualify as a PE, the place of business must have a certain degree of permanency and cannot be of a purely temporary nature. The OECD commentary on article 5 clarifies that a home office may give rise to a PE if it 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 to carry on the enterprise’s business (for example, by not providing an office to an employee in circumstances in which the nature of the employment clearly requires an office). Thus, the answer to the question whether an employee’s home office creates an economic nexus for the employer will always require a case-by-case analysis.

Even if a company does not have a fixed place of business in the form of an employee home office, an employee concluding contracts on behalf of the company outside its home jurisdiction may create a dependent agent PE. According to article 5(5) of the OECD model, persons habitually concluding contracts on behalf of the enterprise or habitually playing the principal role leading to the conclusion of such contracts that are routinely concluded without material modification by the enterprise can constitute a PE for the enterprise (unless the activities of such persons are preparatory or auxiliary in nature). The extent and frequency of the activity necessary to conclude that an agent is “habitually” concluding contracts or playing the principal role leading to the conclusion of contracts will depend on the nature of the contracts and the business of the principal. It is not possible to lay down a precise frequency test, so a case-by-case analysis is necessary.

If remote working or contracting arrangements give rise to a PE, profits attributable to this PE will be taxable in the country in which the PE is located, typically the employee’s home country. Although potential double taxation could be eliminated by tax treaties, the employer would be faced with administrative obligations and the burden of determining profits that the (home office or dependent agent) PE would be expected to make if it were a separate and independent enterprise, taking into account the functions performed, assets used, and risks assumed.

Another risk is that tax authorities might claim that remote working arrangements were never meant to be temporary. They might consider the PE to exist from the time when working from home was first implemented because of COVID-19 — not when the government restrictions were lifted and the company permitted its employees to continue working from home.

To conclude, while new tax liabilities were not likely to arise as a result of temporary remote working arrangements in the COVID-19 period, this may not be the case in the post-crisis period. Because many companies might opt not to revert to pre-crisis working arrangements, they should pay careful attention to the location of their remote workforce and the activities that it performs.

Pandemic Planning: Managing the Tax Risks of Displaced Employees

Anshu Khanna
Anshu Khanna

Anshu Khanna is a partner with Nangia Andersen LLP in San Francisco. She specializes in international tax.

The displacement of international workforces during COVID-19 has unintended and far-reaching tax consequences for both employees and employers. Global companies face tax risks concerning permanent establishment, place of effective management, and transfer pricing. According to the OECD’s “Analysis of Tax Treaties and the Impact of the COVID-19 Crisis,” the unintended, extended stay of displaced employees is a force majeure and hence should not entail adverse tax consequences.

Summary of OECD Analysis

Individuals — Tax Residency

Globally, individual tax residency is predominantly based on the number of days spent in a specific jurisdiction. During COVID-19, an individual’s residence status can become one of two scenarios: One, an individual is temporarily away from her home country for work or vacation, becomes stranded in a host country, and gets domestic law residency; two, an individual is working in her home country, but is stranded outside it and cannot return to her country. In this case, her residency is affected according to the home country’s domestic laws. The OECD suggests that in both scenarios the individual would not acquire residence status in her temporary location for exceptional circumstances. Although there is a domestic law that deems a person a resident based on the duration of her stay, residency would not result from temporary dislocation under a tax treaty’s tiebreaker rules if a treaty applies.

Corporates — PE

Under most tax treaties, a PE may be created in another country regarding a fixed place of business, agency or service, or construction site. The OECD analysis explains that a temporary change of location where employees exercise their employment because of the pandemic should not create a new PE for the employer, because the arrangement is primarily caused by a force majeure. To trigger a fixed-place PE, some degree of permanence and a disposal test must be met. Even though part of the business of an enterprise may be carried on at a location, such as a home office, that in itself does not mean the location is at the disposal of that enterprise.

Regarding the dependent agency PE, again relying on the force majeure principle, the conclusion of contracts at home and the exercise of authority by displaced employees is not habitual — it’s only transitionary or temporary because of COVID-19.

A construction site constitutes a PE if it lasts for more than 12 months under the OECD model. The OECD clarifies that a COVID-19 situation would not result in the construction site ceasing to exist; its temporary interruption would be included in the determination of site duration.

Corporates — Place of Effective Management

If a displaced individual is among key management personnel or is the director of an entity that makes management decisions, an extended stay can trigger place of effective management (POEM) rules in the other jurisdiction and create double residency under domestic laws and tax treaties. POEM determination is subjective and largely a fact-based exercise. The POEM test should be applied rationally for the historical period (including the entire current year) and not confined only to temporary lockdown periods. The OECD guidance suggests that a temporary or exceptional change in the location of directors and key management personnel caused by something like COVID-19 should not alter the POEM of the entity.

Corporates — Transfer Pricing

Companies’ transfer pricing depends on employees performing functions in the jurisdictions to which the associated returns are allocated. Employees stranded in foreign countries, or working from home countries — that is, outside their primary jurisdictions — alter the value chain and create transfer pricing consequences. However, neither the OECD nor any country has issued specific guidance regarding transfer pricing.

Since the onset of COVID-19 and the release of the OECD guidance, many countries have announced guidance and administrative relief regarding tax residency, PE, and so forth. The table lists the policies adopted by countries with large international trade and relatively high tax rates.

Suggested Action Steps for Companies

As tax revenues for governments start to fall, countries will react differently. Global companies should take the following action steps:

  • Document the entire factual matrix of bona fide presence of displaced employees in and outside the state, their work profiles pre- and post-pandemic, underlying reasons for dislocation, intention to return to their original location, pre-COVID-19 travel schedule, communiqués with regulators regarding border sealing, and so forth.

  • The interpretation of PE is complex and subjective. Extensive documentation is needed to demonstrate that activities carried out by displaced employees are not core business activities or that their home office or place in another country is not usually available to the enterprise.

  • Regarding place of effective management, the company should document activities of key management personnel and that the “new” or “changed” decision-making process is only because of existing travel limitations or safety concerns, allowed as an extraordinary measure that will be reversed when restrictions are lifted.

  • Assess the transfer pricing impact on group operations, supply and value chains, business model, and functional analysis. Document reasons and effects of the changes.

  • Monitor country by country and assess situations on an ongoing basis. Plan to move people out based on countries’ travel restrictions, visa issues, PE risks, health and safety concerns, and so forth. It’s a huge undertaking, so it’s advisable to focus more on high-exposure situations like PE and high corporate tax and non-treaty countries.

In this evolutionary phase, documentation is critical. Global companies need to document their rationales very clearly. Also, they must keep a sharp eye on changing regulations and clarifications from different countries and institutions such as the OECD.

Select Countries’ Policies

Country

Guidance Regarding PE

Guidance Regarding Tax Residency

Guidance Period Coverage

Guidance

U.S.

During the COVID-19 emergency, services or activities performed by individuals temporarily present in the U.S. will not be considered to determine if the nonresident or foreign corporation has a PE.

For a nonresident U.S. individual at the close of the 2019 tax year, a period up to 60 calendar days will be excluded for determining the substantial presence test (residency test) as per the COVID-19 medical condition travel exception.

 

60 consecutive calendar days selected by an individual starting on or after February 1, 2020, and on or before April 1, 2020.

IRS, Rev. Proc. 2020-20, 2020-20 IRB 801 (Apr. 2020).

Canada

Nonresident entities (resident in treaty partner countries) will not have a PE in Canada solely because of its employees performing their duties in Canada due to travel restrictions.

Will not consider the days an individual is present in Canada and unable to return to the country of residence solely due to travel restrictions to count toward the 183-day limit for deemed residency or factual test of residency.

Not specified.

Canada, “CRA and COVID-19” (updated Sept. 2, 2020).

U.K.

Not specified.

If person was in the U.K. at the end of a day as a result of exceptional circumstances outside her control, this is considered an exceptional day and would not be considered when totaling an individual’s residency days for the residency test.

Maximum number of days spent in the U.K. that may be ignored is 60.

U.K. HMRC, “Residence, Domicile and Remittance Basis Manual” (updated Aug. 17, 2020).

Ireland

Presence resulting from COVID-19-related travel restrictions will be disregarded in the state for corporation tax purposes for a company to which the individual is an employee, director, service provider, or agent.

An individual will not be regarded as being present in the state for tax residence purposes for the day after the intended day of departure provided the individual is unavoidably present because of force majeure circumstances.

Not specified.

Irish Tax and Customs, “COVID-19 Information and Advice for Taxpayers and Agents” (Sept 7, 2020).

India

Not specified.

For individuals unable to leave India because of the nationwide lockdown from March 22, 2020, such extended days in India for the year 2019-2020 (up to March 31, 2020) shall not be taken into consideration.

Similar relaxations are expected for the current fiscal year.

 

Nonquarantined individuals: The period from March 22 to March 31 or the date of departure, if earlier than March 31, will be excluded.

Quarantined individuals: For individuals quarantined on or after March 1, the period of stay from the date of quarantine until March 31 or the date of departure (if earlier than March 31) will be excluded.

Indian Central Board of Direct Taxes, Circular 11 of 2020 (May 8, 2020).

Australia

Australian Taxation Office FAQs clarify that the impact of COVID-19 will not, by itself, result in a foreign company having an Australian PE based on satisfaction of conditions regarding entities’ earlier PE incidence, and when employee presence is temporary and a result of COVID-19.

Foreign residents temporarily residing in Australia due to COVID-19 will not become an Australian resident for tax purposes if: (i) they usually live overseas permanently; and (ii) they intend to return home when they are able.

Not specified.

Australian Taxation Office, “Residency and Source of Income” (last updated Aug. 3, 2020).

FOOTNOTES

1 See Sheppard, “What About Cupertino?Tax Notes Federal, July 27, 2020, p. 565.

2 The controversy is examined in detail in Jerome R. Hellerstein, Walter Hellerstein, and John A. Swain, State Taxation, para. 20.05[4][e] (2020).

3 Arkansas Department of Finance and Administration, Legal Op. No. 20200203 (Feb. 20, 2020), discussed in Walter Hellerstein, “Where Does a Telecommuter Work?Tax Notes State, June 22, 2020, p. 1405.

4 Id.

5 Id.

6 See Hellerstein, Hellerstein, and Swain, State Taxation, supra note 2, para. 20.05[4][e] for an extended analysis of this issue.

7 I have, however, explored them in considerable detail in id., para. 20.05[4].

8 Telebright Corp. v. Director, New Jersey Division of Taxation, 38 A.3d 604 (N.J. Super. Ct. App. Div. 2012).

9 Id. at 606.

10 The reference is to the “substantial nexus” requirement of Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977); see Hellerstein, Hellerstein, and Swain, State Taxation, supra note 2, at para. 4.12[1].

11 Telebright, 38 A.3d at 611.

12 Id.

13 See generally Walter Hellerstein, “The Transformation of the State Corporate Income Tax Into a Market-Based Levy,” 130(5) J. Tax’n 4 (2019).

14 Hellerstein, Hellerstein, and Swain, State Taxation, supra note 2, para. 9.17.

15 UDITPA section 14.

16 Special rules are often applicable to professional entertainers and athletes, commissioned salespersons, and some transportation workers. See, e.g., 830 Mass. Code Regs. section 62.5A.1(5)(b), (c), (e).

17 See Arkansas Department of Finance and Administration, supra note 3.

18 N.Y. Comp. Codes R. & Regs. tit. 20, section 132.18(a). This regulation provides that “any allowance claimed for days worked outside New York State must be based upon the performance of services which of necessity, as distinguished from convenience, obligate the employee to out-of-state duties in the service of his employer.” Other states with similar tests include Connecticut, Delaware, Pennsylvania, and Nebraska. If the arrangement is for the employee’s convenience, not necessity, then the adopting state provides that those days will be deemed to occur in the “home office” state for purposes of nonresident source taxation.

19 See Zelinsky v. Tax Appeals Tribunal, 1 N.Y.3d 85 (2003), cert. den. 541 U.S. 1009 (2004); Huckaby v. New York, 4 N.Y.3d 427 (2005), cert. den. 546 U.S. 976 (2005); Carpenter v. Chapman, 276 A.D. 634 (1950); Manohar and Asha Kakar, State of New York, Division of Tax Appeals, Small Claims Determination, No. 820440 (Feb. 16, 2006).

20 830 Mass. Code Regs. section 62.5A.3: Massachusetts Source Income of Non-Residents Telecommuting Due to COVID-19 (Emergency Regulation).

21 Allied-Signal Inc. v. Director, Division of Taxation, 504 U.S. 768, 777-778 (1992) citing Miller Brothers Co. v. Maryland, 347 U.S. 340, 344-345 (1954).

22 South Dakota v. Wayfair Inc., 585 U.S. ___, 138 S. Ct. 2080, 2091 (2018), citing Complete Auto v. Brady, 430 U.S. at 279.

23 New Hampshire Attorney General, Comments on Proposed Regulation 830 CMR 62.5A.3 (Aug. 21, 2020).

24 See 830 Mass. Code Regs. section 62.5A.3, supra note 20.

25 Mississippi Department of Revenue, “Mississippi Department of Revenue Response to Requests for Relief” (Mar. 26, 2020).

26 South Carolina DOR, SC Information Letter No. 20-11 (May 15, 2020) (extended to Dec. 31, 2020, by SC Information Letter No. 20-24 (Aug. 26, 2020)).

27 The division also appropriately notes that New Jersey’s reciprocity agreement with Pennsylvania would apply in many cases. See New Jersey Division of Taxation, Telecommuter COVID-19 Employer and Employee FAQ (last updated May 27, 2020).

28 Id.

29 Id.

30 Illinois DOR, FY2020-29 (May 20, 2020).

31 Minnesota DOR, COVID-19 FAQs for Individuals (last updated Aug. 20, 2020). Minnesota provides that a nonresident teleworker temporarily in Minnesota may need to apportion income based on the percentage of days worked in the state.

32 Comptroller of Maryland, Tax Alert 4-14-20B (Apr. 14, 2020).

33 To illustrate, Maryland has reciprocity agreements with Virginia, the District of Columbia, West Virginia, and Pennsylvania. Residents of those states who earn wages, salaries, tips, and commission income for services performed in a state covered by the agreement are exempt from income tax in the source state. Delaware is the only bordering jurisdiction with which Maryland lacks a reciprocity agreement. Similarly, Illinois has reciprocity agreements with Iowa, Kentucky, Michigan, and Wisconsin, but not with Indiana and Missouri. Illinois will waive penalties and interest for out-of-state employers who fail to withhold tax for temporary telework arrangements in Illinois.

34 Ohio H.B. 197 (effective Mar. 27, 2020). For municipal income tax purposes, this bill treats income earned by an employee required to work at a temporary worksite due to the pandemic as being earned at the employee’s principal place of work.

35 Ohio S.B. 352 (introduced Aug. 11, 2020).

36 Buckeye Institute v. Kilgore, Columbus City Auditor, Case No. 20-CV-4301, Franklin Ct. of Common Pleas.

37 See Richard D. Pomp, “Wayfair: Its Implications and Missed Opportunities,” State Tax Notes, June 10, 2019, at p. 917.

38 Standard Pressed Steel Co. v. Washington Department of Revenue, 419 U.S. 560 (1975).

39 Telebright, 38 A.3d 604.

40 District of Columbia Office of Tax and Revenue, “OTR Tax Notice 2020-05 COVID-19 Emergency Income and Franchise Tax Nexus” (Apr. 10, 2020).

41 Indiana DOR, Coronavirus Information (last updated Sept. 4, 2020).

42 North Dakota DOR, COVID-19 Taxpayer Guidance (last visited Aug. 31, 2020).

43 SC Information Letter No. 20-11, supra note 26.

44 Oregon DOR, COVID-19 Tax Relief Options (last visited Aug. 31, 2020).

END FOOTNOTES

Copy RID