The international tax rules generally restrict countries from taxing business income accruing to non-residents within their jurisdiction unless the income is attributable to a permanent establishment (PE) that the non-resident has in that jurisdiction. This is the crux of Article 5 of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention (MTC) and a provision replicated in many domestic tax laws and double tax treaties.
It is fairly settled that a non-resident will have a PE in another jurisdiction if it has a fixed place of business there through which it partly or wholly carries on its business.
What constitutes a place of business varies and is determined on a case-by-case basis. A boardroom in an office building and a Formula One circuit have both been held by courts to constitute a PE.
Furthermore, the non-resident’s place of business must be fixed – in that it must be a clearly defined area with a certain degree of permanence. Thus, a contractor hired to provide training to staff of a client and who provides their services from different rooms in the office building has been held not to have a fixed base in a country.
Finally, the place of business must be available to the non-resident for the purposes of its business activity. It must be at the disposal of the non-resident to decide what personnel and machinery it can employ in that location for its business venture. Its presence in that location should not be intermittent or incidental; there must be a sustained degree of permanence and continuity to its presence.
Alternatively, a PE will also be held to exist in a jurisdiction if a non-resident has in that jurisdiction a dependent agent who habitually acts on its behalf and concludes contracts for it in that jurisdiction (a DAPE). An employee can be such an agent depending on seniority and level of decision-making responsibility.
Nonetheless, a fixed place of business or a dependent agent will not constitute a PE for a non-resident if the nature of their activity in that location is preparatory to its core business activity or auxiliary or incidental to it.
Where the activities of a non-resident in its host country are not a precursor or a minor supplement to its core activity, income attributed to business activities in the PE will be taxable income in that jurisdiction.
Employees and their Home Offices as PEs
The possibility of an employee’s home constituting a PE was first explicitly discussed in the OECD commentary in 2017. The commentary stated, without equivocation, that the discussion on an employee’s home potentially constituting a PE for a non-resident employer was not an extension or amendment of the PE Article, but a clarification of its interpretation. In other words, the MTC allowed for and anticipated that a home office could constitute a PE.
The clarification inferred that the carrying on of business by a non-resident in the home of an employee, in a different country, will most likely be incidental and fleeting and in such instance will not constitute a PE.
However, where a sustained and continuous presence of the business is maintained in the home of the employee, and it is clear that the home office is at the disposal of the non-resident employer, a PE will be created.
The commentary went further to state that the home of an employee may be considered to be at the disposal of the employer where the employee is required to work from home by the employer and no office space is made available.
Credence was given to this interpretation upon the outbreak of the Covid-19 pandemic (and subsequent lockdowns imposed by governments around the world) by the guidance provided by global tax authorities stating that no PE was created for non-residents by employees working from a different jurisdiction. The reasons included that the home office as a place of business lacked the degree of permanence required to constitute a PE, and the fact that employees were not required by the employer to work from their home as evidenced by the provision of an office space.
However, with the end of the pandemic and lifting of the attendant travel restrictions, the home office trend has become very common. As such, there is a palpable risk for businesses that the presence of their employees in a different jurisdiction may well extend their tax footprint and create a taxable presence, albeit unintended.
We will now consider the recent views expressed by tax authorities across Europe on this issue.
In Poland, the homes of employees of a German recruitment company who performed cross border customer support, project management and business continuity services were held to constitute a PE for the employer contrary to the view of the German tax authority. The facts show that the employer had assigned the homes of the employees in Poland as their workplace and that computer equipment had been provided in the home of the employees. Equally instructive was the view of the tax authority that the activities of the employees in Poland were not exclusively preparatory or auxiliary.
In Denmark, the home of an employee who headed the sales and business development of a German company who was responsible for the marketing and selling of the company’s product in Denmark and other Scandinavian countries was held to constitute a PE in Denmark. Interestingly, the employee’s home was listed as one of the places of employment, and the seniority of the employee meant that his tasks were not merely auxiliary or preparatory, but instead formed the core of the non-resident’s business.
In another case involving the Chief Executive Officer (CEO) of two Norwegian companies, the Danish Tax Authority also held that the home of the CEO constituted a PE. The CEO worked circa three days a week from his home in Denmark (albeit 35% of his total working hours) and two days a week from the companies’ office in Norway (65% of total working hours). In ruling that the companies had a Danish PE the tax authority highlighted the importance of the job function of the CEO, his shareholding in the companies and the fact that it was to their benefit that the CEO could also work from his home as decisive.
Conversely, the Spanish General Directorate of Tax opined that the home office of an employee of a UK company in Spain did not constitute a PE for the company because the employee’s home was not at its disposal. The employee in this case had unilaterally decided to work from Spain despite there being an office available in the United Kingdom.
Lastly, the Dutch tax authority has also held that the home offices of three Dutch residents were not at the disposal of a non-resident employer and thus did not constitute a PE. Persuasive in this case was the fact that the decision to work from home was a personal preference of the employee and was not a requirement of the employer. Furthermore, the employer had no other employees or business undertakings in the Netherlands; it did not reimburse the cost of the home office to the employees and the functions of the employees did not include entering or concluding contacts on its behalf in the Netherlands.
The above decisions indicate that the question of whether a PE is created by an employee for a non-resident employer is fact sensitive and will be decided on a case-by-case basis.
Although we expect that a PE will only be created where the employer agrees to the working patterns, the availability of an office in a different jurisdiction may not be enough to avoid a PE even in scenarios where the employee has unilaterally decided to work from home. A tax authority is highly likely to prefer a substance over form approach in deciding whether an employee’s home constitutes a PE.
This, it is submitted, is the best approach as a decision based solely on the preference of the employee will make it all too easy for non-residents to circumvent the PE article while carrying out business through the homes of employees and Revenue Authorities are not going to accept that.
Finally, although the potential tax burden that might arise from a PE is restricted to profits attributable to the activities of the PE (in this case the employee), the regulatory and compliance requirements under local law might be cumbersome.
We are advising a number of companies whose employees have not fully returned to the office post pandemic and have come across the full range of scenarios, from employees who went to extraordinary lengths to hide their cross-border move from their employers to employers who have arranged for their employees to work from a new country. Where a PE exists, we can arrange registration with HMRC and, if required, a disclosure, or where no PE exists provide an opinion to that effect.
For further information, please contact Miles Dean or Chimezirim Echendu in our International Tax team.
Head of International Tax
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