COVID-19 has sparked a seismic change in the workplace as many companies have found that working from home ("WFH") has not diminished employee productivity and that employees prefer its greater flexibility. Given that—and the potential for saving on overhead costs—many companies have announced plans to adopt long-term WFH policies and close or realign office space. The OECD and several countries including the US, UK, Ireland, and Australia have issued guidance that excepts employees temporarily dislocated outside their employer's country from creating unintended permanent establishments ("PE")—but long-term WFH employees are not similarly excepted. The US, in particular, has thus far only officially extended PE protection for temporary dislocations of up to 60 calendar days that begin within the emergency period of February 1, 2020 through April 1, 2020.
While many employees that WFH do so from the same country as their employer, that is not always true, and so companies would be wise to perform their due diligence. To that end, this post analyzes some PE issues that a company should consider before it adopts a long-term WFH policy.
Treaties or Domestic Law
When analyzing a long-term WFH policy, a threshold issue is to determine which sources of law apply. Generally, domestic laws govern which transactions give rise to taxable income in a country in the first instance. For example, the Internal Revenue Code provides that the US may assess tax on a foreign taxpayer's income effectively connected with a US trade or business. On the other hand, entities that qualify for the benefits of a bilateral tax treaty can choose to apply the treaty instead of domestic laws. Under the OECD Model Income Tax Convention ("OECD Model Treaty")—the principles of which are reflected in most bilateral tax treaties—a taxpayer has a taxable presence in another country only if it has a PE in that country. The choice of applying domestic law versus an applicable treaty to determine taxable presence is critical: for instance, although a PE is generally a higher threshold than a US trade or business, there may be some cases where a US trade or business has no effectively connected income even through a PE may have attributable (and taxable) profits under the same facts.
Article 5 of the OECD Model Treaty and Service PEs
Under Article 5 of the OECD Model Treaty, companies can form a PE in a country in one of two ways. First, a company resident in one country may form a PE by a having fixed place of business ("FPOB") in another country, which subject to certain exceptions includes a place of management, branch, or an office, among other things. Important to the FPOB analysis is that the location (1) must be used longer than temporarily and (2) merely needs to be at the disposal of the enterprise, which includes non-exclusive space. Second, a PE may arise for a company through the actions of a "dependent agent," even if it doesn't otherwise have a FPOB. Specifically, a dependent agent PE may arise in a country where a person acts on behalf of an enterprise and habitually concludes contracts binding on it.
Moreover, certain tax treaties also provide an objective test for a third category of PEs based on performing services in another country for a given period. For example, the US-Canada Income Tax Convention states that even if an enterprise does not have a FPOB or dependent agent PE, a PE still exists if an individual performs services in either country for more than 183 days per year and accounts for more than fifty percent of an enterprise's revenue.
OECD Model Treaty commentary provides that carrying on company activities at an employee's at-home office does not always indicate that the location is at the disposal of an enterprise. But where an at-home office is continually used for company activities and it is clear that the company requires the employee to use that location—which may be the case where an employer does not provide an employee with any office space—the at-home office may be deemed to be at the disposal of an enterprise and give rise to a PE. As a result, a company with an employee that works or commutes from abroad should be cautious about instituting a mandatory WFH policy and should consider maintaining space for him or her in its building.
Use of Foreign Offices
Although WFH is suitable for many office tasks, inevitably there are duties that need certain facilities, devices, or services found in a traditional office environment. But even if a multinational entity group wants to adopt a more flexible work arrangement, it will still need to be cautious about making office space in foreign countries available to remote employees. For example, consider an employee that generally works from an at-home office in Country A but works for and maintains an office at the parent company's building in Country B. If the parent company also allows that employee to access the facilities of a subsidiary located closer to the employee in Country A to perform tasks as needed, the parent company may form an unintended PE in Country A. According to OECD Model Treaty commentary, such a PE may be formed anytime the activities of an employee are regularly conducted at the facilities of a subsidiary or other related company.
In addition, a company should pay special attention to where employees are located when they negotiate and approve contracts—a consideration that will become especially important if the company has implemented a long-term WFH policy. As discussed, the OECD Model Treaty provides that a PE may arise where a dependent agent, i.e., employee, habitually exercises an authority to conclude contracts that bind a company. Unlike a FPOB PE, a dependent agent PE may arise from an employee's at-home office even if the employee is not required to work there. In addition, companies need to be mindful of more than just where employees are located when they sign contracts. According to the OECD Model Treaty commentary, a contract may also be deemed concluded for purposes of a dependent agent PE simply by accepting an offer, or by fully negotiating the elements and details of a contract in a way that binds an enterprise.
Potential Silver Lining
Although adopting a long-term WFH policy may generate new PE risks, the overall impact of COVID-19 may reduce other PE risks. Reductions in business travel, use of virtual meetings and contract negotiations and fewer employee secondments may reduce the prevalence of both dependent agent and FPOB PEs that may have previously arisen from a pre-pandemic highly mobile workforce.
The guidance that the OECD and various countries have issued that excepts COVID-19 displaced employees from forming PEs does not apply to companies that adopt long-term WFH policies. Thus, before doing so, companies should perform functional analyses of its employees activities, at-home office locations, and the spaces it makes available to them to prevent forming unintended PEs.
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