Employees who are returning to work in their home countries because of the coronavirus pandemic may well be presenting their employers with a number of local tax risks.
A potential risk relates to the creation of a permanent establishment (PE) for local tax purposes. This could mean your profits may be taxed in the employee’s home country, as well as in the UK, depending on the employee’s activities.
This article looks at the definition of a PE, and how employers can determine whether one has arisen.
What is a PE?
Under UK law, a PE is either:
- a fixed place of business (FPOB) in the UK through which the business of the enterprise is wholly or partly carried on; or
- an agent acting on behalf of the enterprise that has, and habitually exercises in the UK, authority to do business on behalf of the enterprise.
Most countries adopt a similar approach for defining a PE, where they follow OECD guidelines and state that a PE must exist for at least six months.
What is an FPOB?
Examples of an FPOB include:
- places of management;
- branches;
- offices;
- factories;
- workshops;
- installations or structures;
- natural resources exploration;
- mines, oil or gas wells, quarries or other locations for extraction of natural resources; and
- building sites, construction or installation projects.
Increasingly, employees’ own homes are also being considered as fixed places of business.
Figuring out whether an FPOB exists involves looking closely at:
- the nature of the physical presence;
- its duration; and
- the personnel involved in the activities.
In general, an FPOB would be:
- a physical location;
- fixed in position;
- of more than a temporary nature;
- at the disposal of an enterprise; and
- where the enterprise’s business is wholly or partly carried on.
What is a dependent agent PE?
Under UK law, an agency PE may exist if the non-UK resident enterprise has an agent (who is not of an independent status) in the UK to act on its behalf and the agent has, and habitually exercises, the authority to contractually bind the overseas enterprise. An agent can include employees and, again, other countries adopt a similar approach.
To be considered non-dependent would mean that the agent is independent of the overseas entity, both legally and commercially, and acting in the ordinary course of their own business. This would involve asking the following questions:
- Who bears the entrepreneurial risk of the transaction, the agent or the non-UK resident enterprise?
- Is there any reliance on the agent’s special skills by the non-UK resident enterprise?
- Is the agent acting in the ordinary course of its own business?
- Do they perform the same role for other third parties?
Exceptions: when a PE does not arise
Under general principles, a PE should not arise where either:
- that FPOB is maintained there for the purpose of carrying on activities for the company, or
- an agent carries on activities there for and on behalf of the company
In either scenario, these activities must also be only preparatory or auxiliary to the enterprise’s business as a whole.
Each case should be assessed on an individual basis but, generally speaking, preparatory or auxiliary activities are those that are sufficiently remote from the generation of an enterprise’s profits.
What does it mean if there is a PE?
Having a PE means that profits are potentially taxable in two countries.
Only the taxable profits directly attributable to the activities of the local PE should be chargeable to local tax, which therefore requires a profit attribution exercise. However, consideration must also be given to whether there is a double tax treaty (DTT).
The DTT definition of a PE may differ from the domestic law definition. If they do differ, then the treaty’s definition should be used to the extent that it relieves local tax rather than imposes it.
If local tax is suffered, then it needs to be considered whether relief is available against any tax suffered in the enterprise’s home jurisdiction to prevent or minimise any double taxation.
Therefore, separate and accurate accounting records would need to be carefully maintained in respect of the UK PE’s activities, to support any tax return submitted to HMRC.
The allocation of income and expenses attributable to the PE’s UK activities may not be simple and will depend on the relevant circumstances surrounding the PE’s activities.
What do employers need to consider given the coronavirus pandemic?
Businesses will have to balance their commercial needs and objectives with the tax risks of employees being forced to work in their home country.
Some countries are not necessarily seeking to impose their PE rules on a strict basis, but employers should still consider:
- which employees are working remotely overseas;
- where they are operating from;
- what activities they are undertaking, theoretically and in practice;
- whether such employees are creating an FPOB or agency PE; or
- whether such activities are considered preparatory or auxiliary in nature.
Tax authorities employ increasingly sophisticated ways of reviewing tax affairs. So, a requirement to register and pay local employment taxes could trigger a review over whether a local PE registration is required, and vice versa.
Local advice should always be sought but if the initial conclusion is that employees’ activities are likely to give rise to a PE, employers should seek to ensure they are compliant.
For more information or advice on your global tax risks, please contact Ryan Broomfield.