What are the potential consequences of travel restrictions on personal, employer, and company taxes?
If a company has employees stranded in a country because they can’t return home, a number of tax consequences might result, some of which might be managed, but all of which should be considered.
Restrictions on cross-border movement that cause employees to spend unexpected time in a country can have a variety of consequences for an individual. Many of these consequences will derivatively affect their employers. At the most basic level, an employee working in a country for a minimal period of time may not be liable for a country’s income tax, but in most countries, this presence threshold is low. Overstaying a planned presence by two or three weeks could make that employee liable for income tax, particularly if the employee uses that time in-country to work.
Longer presences – whether an employee works during that presence or not – can have more severe impacts: stay in a country long enough, and the country will likely consider you to be a resident. Many countries use a strict day count (often either 90 or 183) to determine when a presence is long enough to confer resident status. Acquiring resident status will expand the income the country will seek to tax from what is earned in-country to worldwide income.
This becomes of particular relevance if that country has higher tax rates than the individual’s usual country of residence, and can be an expense for an employer if the employer reimburses employees for foreign tax expenses. Companies in businesses that involve projects count very carefully how long project employees are in a country; Covid-19 travel restrictions or quarantine requirements can affect these, unless the country has implemented rules to excuse workers caught by those measures. (Some countries are doing so.)
Social security or national insurance tax:
Employees who work abroad on a temporary basis, but are unable to return to their own country of residence because of movement restrictions, may become liable to the social security or national insurance tax requirements of the temporary location. This has a derivative effect on their employer, who then becomes liable for withholding those contributions and paying employer contributions, which in many countries are larger, often much larger, than employee contributions.
There are social security (“totalization”) agreements that can mitigate this, but if social security taxes become applicable, the employer will need to register as an employer and establish arrangements to report and pay these taxes.
Recognizing this, some countries have announced or implemented relaxation of social security contributions and employer compliance responsibilities for employees stranded in-country by Covid-19 restrictions on travel.
Employers are in a country when employees are in the country:
Just as employees have two potential tax statuses in a country (sufficiently present to be a taxpayer and resident), so do employers, as a result of having employees. At an initial level, in-country employees cause the employer to be conducting business in the country, which is the threshold at which countries begin to expect tax compliance. Income tax presence and VAT presence vary from one country to another, but in either case the initial threshold is low, and employees working in a country while travel restrictions prevent them from leaving can create this issue (even if the original purpose of the trip was a holiday).
A business presence can require registration as a taxpayer, and normally requires, at least in theory, registration as an employer, with attendant return filing and tax payment compliance responsibilities. More significant presence definitely will do both.
In many countries, services provided to a customer or client by an individual (such as an employee) on behalf of an employer can be deemed to be a permanent establishment (PE) if the services last beyond a threshold period (usually either 90 or 183 days). Restrictions on movement of a nonresident individual who is providing services in a country on a foreign employer’s behalf, and which result in his or her remaining there for longer than intended, could result in the creation of a PE in that country. The activities of that individual should therefore be monitored and reviewed if this is to be avoided.
Corporate residence can be affected by directors and high-level managers:
Many countries have a place of effective management (POEM) test to determine the tax residence of corporations. This is where the high-level management of corporations takes place, such as board meetings, and where key operational and financing decisions are made. A change in the tax residence of a company as a result of restrictive movement of key personnel would cause a country’s income tax to apply to worldwide income. Although it may seem unlikely that travel-restricted or quarantined personnel would conduct a sufficient amount of strategic work to change a company’s residence, virtual meetings using telecommunications and other long-distance communication capabilities may raise questions about where the place of “effective” management actually is. This could lead to more than one country claiming to have become the residence of a company, and at best would be a tax-conflict nuisance, if not a major expense, particularly if countries newly claiming to be the place of residence are higher-tax countries.
Double taxation relief:
All of the situations described above create or increase the exposure of people and companies to income tax by more than one country. Restricted movement of people shifts the balance between the countries over how much of the income each country taxes. The negative effect of these tax consequences can be mitigated if there are double taxation agreements between the countries involved. Alternatively, foreign tax credits under domestic legislation for tax paid abroad may provide some relief from double taxation.