Nick Farmer – International Tax Partner
DD: +44 (0)1784 497153
The Covid-19 pandemic has resulted in significant disruption to many businesses, and as financial performance and operating structures become affected, multinationals will face a range of tax challenges. The tax analysis that previously applied will become stretched and new tax obligations may arise. Governments across the world have announced new tax measures, and taxpayers will need to assess them carefully to see if they are eligible for the various concessions, incentives and rebates that are on offer.
With all the changes affecting how the business is carried on, tax may not have been top of the agenda, but it is time to start addressing its impact on what has occurred to date and the decisions that are now being made, and this will include:
Employees may well be performing duties outside their usual jurisdiction, which could affect previously agreed income tax and social security calculations;
Changes to operating activities may inadvertently create a permanent establishment where one didn’t previously exist;
How group companies are being managed and controlled throughout this time could affect the corporate tax residence position;
The functions, assets and risks that underpin the allocation of profits around multinational groups may have changed and need to be updated;
Where existing business transactions and contracts have been varied or aborted there are likely to be tax implications to consider;
Funds may need to be raised and deployed tax efficiently, or existing arrangements updated, to reflect the new trading environment.
The following commentary explores some of these issues in more detail and how they affect internationally active businesses. The message coming through loud and clear is that multinationals need to be proactively considering their international tax position, and keeping clear records to evidence how they are operating and dealing with these issues during this difficult time. It is likely that tax authorities will be asking questions at some point in the future.
It should be noted that with tax playing an important role in the response to the Covid-19 pandemic, the OECD has provided a considerable amount of tax content at www.oecd.org/tax/. This includes an ‘Analysis of Tax Treaties and the Impact of the COVID-19 Crisis’, providing guidance on concerns related to the creation of permanent establishments, the residence status of a company and those related to cross border workers. It also includes a database covering the global ‘Tax policy measures implemented in response to Covid-19’. This content can be accessed at: www.oecd.org/tax/treaties/
Restrictions on global mobility of employees may affect the usual taxing rights between countries. Groups will need to monitor where their employees are working across this time especially if they end up working for longer in one country than expected. This could affect previously agreed income tax and social security calculations and existing agreements that are in place with global tax authorities. For instance, some UK companies may have Appendix 5 agreements in place to avoid double taxation on payroll taxes, and the relevant calculations may now need to be revisited. Additionally, UK companies may also have an Appendix 4 Short Term Business Visitor (STBV) scheme in place for overseas employees working in the UK, and employers will need to understand the time spent in the UK and reasons for it to assess the impact on their PAYE position.
From a global mobility perspective, we have also seen the relaxation of the Statutory Residence Test day count rules for individuals unable to travel to or from the UK. The day count rules are used to determine an individual’s residence status and how they are taxed in the UK. HMRC have confirmed specific coronavirus related circumstances that will be regarded as exceptional, and a claim can be made which, if allowed, will reduce the number of days spent in the UK.
A Permanent Establishment (PE) will generally arise if a company has a fixed place of business in another country. A PE can also be created where there is a dependent agent (e.g. employees) in another country with the authority to conclude contracts. With staff working from different locations, often through a home office, there is a concern that this could create a PE and give rise to an obligation to report and pay tax on those activities. In these instances it will be necessary to review the domestic tax law of the relevant country to understand the threshold for registering a local tax presence. If there is a tax treaty in place between the countries involved, this will usually clarify the taxing rights. In this respect, the OCED has provided an analysis of tax treaties and the impact of the covid-19 crisis, and views it as unlikely that a home office would have the degree of permanence to create a fixed place of business, or be regarded as being at disposal of the company, and the exceptional and temporary changes caused by Covid-19 should not create a treaty PE.
It should be noted that not every situation is covered by a tax treaty (e.g. US State taxes), or for that matter a tax treaty that can be analysed in accordance with the OECD guidelines. Multinationals are advised to review where they have staff working outside their usual jurisdiction and the application of the local tax rules and treaty taxing rights. It is also relevant to monitor guidance that is being provided by local tax administrations. For instance, Ireland has helpfully clarified that it will disregard the presence of a person if it results from travel restrictions due to Covid-19. In the UK, HMRC have clarified that it does not consider that a non-resident company will automatically have a taxable presence by way of permanent establishment after a short period of time. Similarly, whilst the habitual conclusion of contracts in the UK would also create a taxable presence in the UK, it is a matter of fact and degree as to whether the habitual condition is met. Furthermore, the existence of a UK PE does not in itself mean that a significant element of the profits of the non-resident company would be taxable in the UK, and the outcome would be dependent on the exact facts of each situation.
Corporate tax residence
There is also a concern that changes to the location from which the management and control of a company takes place may affect its corporate tax residence. This could occur where directors are unable to perform board duties in the usual manner and have to make key decisions from another country. In these situations it will be appropriate to consider the tax treaty position, if one is in force between the relevant countries, and how this may be interpreted. The OECD have provided guidance that temporary changes should not affect the location of the effective management of a company, as it is necessary to consider how meetings have been held over the determination period. It is felt that all relevant factors must be considered, and not just the exceptional and temporary position, in order to determine where a company has it place of residence.
Some countries have also provided local guidance on this issue. From a UK perspective, HMRC do not consider that a company will necessarily become resident in the UK because a few board meetings are held here, or because some decisions are taken in the UK over a short period of time. The existing HMRC guidance makes it clear that it will take a holistic view of the facts and circumstances of each case. The Australian tax office has also helpfully indicated it will not apply compliance resources to consider the management and control position of foreign-incorporated companies in light of the current travel restrictions.
Best practice would suggest that at this time groups should identify where the place of management of each company is likely to reside and whether there could have been a change in its tax residence. It is of course unclear how long this crisis will continue, and if companies are being managed from another country over an extended period of time, this could give rise to corporate residence challenges from tax authorities later on down the line. It is therefore worthwhile considering how this risk may be mitigated, such as by carefully monitoring the composition of the board at each meeting so that the majority of directors are located where the company has its usual place of tax residence. As always, companies should ensure they main a record of the facts and circumstances for production if required at a later date.
As business becomes disrupted, and new operating models are established, the transfer pricing position will need to be reassessed to ensure it is still fit for purpose. Changes to the global economy will be impacting the analysis, and the previous transfer pricing policies may need to be adjusted to reflect the new reality of how a group is performing in light of the functions, assets and risks of the relevant entities. This will be required as groups still need to seek to maintain compliance from a tax perspective, and the transfer pricing operated during the Covid-19 pandemic will need to be supportable.
There is of course no precedent for these circumstances, and the analysis that needs to be performed will not be straightforward or necessarily conventional. This will include assessing the critical changes that have occurred to many aspects of the business. Factors such as changes to productivity and sales, delivery and supply chain variations, restrictions on staff movements, intellectual property valuations, additional head office services, and how risk is being assigned across the group should all be reviewed. How government plans are impacting on the transfer pricing will also need to be considered, including the incentives and reliefs that are being made available and being used by the local companies. The bottom line is that groups will need to undertake this sort of analysis so that they can adequately demonstrate that a reasonable assessment has been made that the profits or losses being reported are the result of arm’s length pricing.
It should be remember that getting to grips with transfer pricing isn’t just a tax issue, it helps groups to understand where profit and losses are being made and can save cash, and reconfiguring the analysis now will help make the group stronger in the long run. The judgments on profit allocation will need to be commercially justifiable, and the transfer pricing documentation should be updated with explanations supporting the lower or higher allocated profits. Paper trails will be useful to justify the position, and help proactively build a case for change, and this should be captured in real time as it may be difficult to remember exactly what happened in the future. To date there has been no additional guidance from HMRC or the OECD but it hoped that this will come, but in the meantime the transfer pricing policy should be updated to reflect the fundamental changes that have been made to the business operations.
Immediate government support is available in many countries through the ability to defer tax payments, although the rules in each country do vary considerably as to the particular taxes that can be deferred and the companies that are eligible. On top of this another option is to apply for funding, whether this be directly from government or through a guaranteed loan schemes. In this respect, it is worth considering the funding alternatives that are available to the group in different countries as it may be preferable to borrow at a subsidiary rather than parent company level, and this will depend on the exact terms of the schemes that have been put in place by the relevant governments. The UK has loan schemes for businesses with an annual turnover up to £500m, with the government providing an 80% guarantee where businesses would otherwise be unable to access the finance they need.
In conjunction with this, multinationals need to identify where any surplus cash is held around the group and how this can be deployed tax efficiently. There are different mechanisms that may be appropriate, from funding through debt or equity, to cash payments of dividends, interest or royalties, or for services being provided between the group companies. The tax and accounting rules in each of the relevant countries would need to be assessed in advance to ensure that the movement of cash is undertaken in the most tax efficient form.
It will also be important to review existing funding arrangements and to consider whether these should be amended, and whether this could free up cash around a group. This may be relevant due to changes in the risk profile of companies or the lower market interest rates that are available. In advance of making any changes, the implications should be considered from a legal, accounting and tax perspective. Additionally, it is worth being aware of how the funding position interacts with debt limitation rules and withholding taxes. Some countries have made recent changes to address this issue, such as the US where the interest expense limitation has been increased from 30% to 50% of the taxpayers adjusted taxable income. The US have also introduced more flexibility for net operating losses, where these can be carried back for five-years to obtain cash tax refunds. The UK has not yet changed its corporate interest restriction rules or loss restriction rules, but it is hoped that this relaxation may come as a next step in helping multinationals combat the pressures arising from Covid-19.
HLB Webinar: Navigating COVID-19 governmental tax relief and incentives
Watch HLB International’s recent webinar covering issues for multi-national businesses featuring Nick Farmer.