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Corporate tax residence, taxable presence and COVID-19

Overview

Companies with an international footprint will need to ensure that their tax residence (and other taxable presence) is not affected by travel restrictions imposed in response to the COVID-19 pandemic. HMRC has published guidance on these issues, which is somewhat helpful if less definitive than the approach of a number of other jurisdictions. Careful thought will be needed where senior executives/management are unable to travel, and so are required to carry on their role or participate in key management or commercial decision-making in a different jurisdiction from usual. Similarly, businesses should avoid establishing or expanding a fixed place of business, as this could create a permanent establishment ("PE") for tax purposes or increase the allocation of profits to such a PE. Included at the end of this article are some practical steps that businesses might wish to take to mitigate these risks.

One of the many issues which businesses with a cross-border footprint will need to consider as a result of the measures taken to contain the global spread of coronavirus (COVID-19) is the maintenance of corporate tax residency, and more generally controlling the location of their taxable presence.

HMRC has now updated its International Manual to set out its approach to corporate tax residence and to permanent establishments in light of the disruption to business caused by the current COVID-19 pandemic. The guidance can be found here. Although HMRC is "very sympathetic" to the disruption to international travel and business operations caused by the pandemic, it has not followed the approach of a number of other jurisdictions by giving definitive comfort on the impact of the pandemic, as it considers that existing legislation and guidance provides sufficient flexibility to deal with the change in business practices necessitated by the response to COVID-19.

In addition, the OECD Secretariat has published its analysis (which can be found here) of the impact of COVID-19 on the international tax treaty rules. Its conclusions are discussed below.

The following discussion focuses primarily on the UK position. It is important to be conscious that similar issues could arise in other jurisdictions – for example, UK companies should manage their risk of becoming resident in other jurisdictions or establishing a new PE in other jurisdictions by reason of key employees or directors being located there. These issues should be looked at by businesses in the round.

Corporate Tax Residence

Broadly, a company is UK tax resident if it is incorporated in the UK or if its central management and control ("CMC") is situated in the UK (provided it is not resident elsewhere for the purposes of a double tax treaty with the UK). Therefore, a non-UK incorporated company could become UK tax resident if it is determined that its CMC is in the UK and it is not resident in another jurisdiction under an applicable tax treaty.

The CMC test has developed through case law and the outcome depends on all the facts and circumstances. It looks at the highest level of control of a business and seeks to determine where key strategic decisions are taken. CMC will often be located where the Board of directors habitually meets to make such decisions. Importantly, the test has regard to the decision-making procedures of a company over a period of time. Therefore, occasional board meetings held in the UK or convened with UK-based directors dialling in would not necessarily result in CMC abiding in the UK.

In addition to avoiding the risk of becoming UK tax resident, non-UK resident companies will also be concerned to ensure that they remain tax resident in their country of current residence and maintain the required level of "substance" in that jurisdiction, which varies from country to country. This is often an area of particular sensitivity for holding companies or group finance companies, when located in a different jurisdiction from the core operating activities of the group.

Companies will typically have safeguards or protocols in place to ensure that, under normal business conditions, residence is maintained and the required levels of substance are met. Such safeguards may for example include directors who do not live in the company's intended country of tax residence travelling to such country to attend board meetings in person and a majority of the directors being based in the country of intended residence. Some companies may also exclude or limit participation in board meeting by telephone or other electronic means from different locations, except in exceptional circumstances.

The current travel restrictions imposed by governments (including the UK) as a result of the coronavirus make adhering to such protocols in order to maintain residence and substance in (and only in) the company's intended jurisdiction of tax residence considerably more challenging.

From a practical perspective, companies will need to continue to convene board meetings in accordance with their constitution (which they may need to change, where permitted by local law, for the current circumstances – for example, by allowing participation in board meetings by telephone or other electronic means) to ensure that board decisions are not taken ultra vires.

It is worth noting that some jurisdictions (including Luxembourg, Ireland, the Channel Islands and Australia) have recognised the impact that coronavirus could have on normal business practices and have relaxed their corporate residence practices and/or economic substance tests.

Given that HMRC considers that existing legislation and guidance is sufficiently flexible to deal with changes in business activities arising as a result of the COVID-19 pandemic and so is not planning similar COVID-19 dispensations in this area, the question is whether (and to what degree) it could be problematic if UK-based directors dial in to board meetings of non-UK resident companies, when they would usually travel in order to attend in person, or otherwise participate in the decision-making process, especially if such practice continues for a period of time.

Whether a company's CMC abides in the UK is a question of fact: where and by whom is the company actually managed and controlled? In order to answer this, it will be important to consider a number of different factors, including:

  • The number of occasions on which board members based in the UK participate in decision-making, for example by dialling in to board meetings (and relatedly, whether or not there are regular instances of directors participating in board meetings from the UK in the past, prior to the coronavirus outbreak). HMRC's guidance notes that occasional instances of participation in board meetings from the UK would not necessarily result in CMC abiding in the UK. However, the risk is that an "exceptional circumstance" of UK-based directors dialling in to board meetings becomes the norm. An unpredictable factor here is how long the current travel restrictions remain in place.

  • The composition of the Board. HMRC guidance notes that although the location of board meetings (or the location of those directors participating in such board meetings) is important in determining where CMC abides, it is not conclusive. HMRC is concerned in determining which individuals on the Board actually exercise control over the company and from where such individuals exercise control. Therefore, if there are relatively few UK directors on the company’s Board or if such UK directors are not determinative in making key strategic decisions, it is less likely that UK-based directors dialling in to board meetings from the UK would cause the company’s CMC to abide in the UK.

However, even if the CMC of a non-UK incorporated company does abide in the UK, this does not necessarily mean that the company will be UK tax resident. If the company is also considered to be tax resident in another territory with which the UK has a double tax treaty ("DTA") which includes a corporate residence tie breaker, the provisions of the DTA may result in the company being treated as non-UK resident. Most of the UK's DTAs include either a place of effective management ("POEM") or competent authority/mutual agreement based tie-breaker. The mutual agreement procedure tie-breaker is more prevalent following its adoption as the standard approach in the OECD BEPS Multilateral Instrument. It is generally less predictable than the traditional POEM tie-breaker, including by reason of the wider range of factors competent authorities are entitled to take into consideration to make their residence determination and because there is no certainty as to when (and if) the competent authorities will reach an agreement or the means for challenging any agreement (or failure to agree) between them: in the absence of an agreement, the company would be resident in both jurisdictions.

The OECD has recently published its analysis of the impact of COVID-19 on the tax treaty residence tests. The analysis stresses that in determining a company's residence under either a POEM or competent authority tie-breaker, tax authorities will consider all relevant facts and circumstances over the determination period to establish where board meetings are usually held and where the CEO and other senior executives usually carry on their activities, and not only those instances that pertain to an "exceptional and temporary period such as the COVID-19 crisis".

Permanent Establishment

A non-UK resident company could also become liable to UK corporation tax if it creates a UK taxable presence by way of a permanent establishment ("PE") through which a trade is carried on. A non-UK resident company could create a UK PE either by having (i) a fixed place of business in the UK or (ii) a dependant agent in the UK that has and habitually exercises authority in the UK to do business for the non-UK resident company.

HMRC's guidance notes that a non-UK resident company will not have a fixed place of business in the UK after a short period of time (as a degree of permanency is required) and that whilst the habitual conclusion of contracts in the UK would create a dependant agent PE in the UK, it is a matter of fact and degree as to whether the "habitual" condition is met.

The OECD's recent analysis takes a similar view to HMRC. It states that it is unlikely that employees working from home or from a country other than the country in which they regularly work would create a new PE for the company employing them.  The OECD regards the change of location in where employees exercise their employment duties as exceptional and temporary and highlights that a PE must have a degree of permanency in order to be considered a fixed place of business through which the business of a company is carried on.

Similarly, the OECD notes that the conclusion of contracts in the home of employees or agents because of COVID-19 disruption should not create PEs for businesses. However, the OECD urges tax administrations to provide guidance on the application of the domestic law threshold requirements in order to provide clarity for businesses and avoid unnecessary filing and compliance requirements for taxpayers in the context of the COVID-19 crisis.

While we have not had such clarity from HMRC, the guidance from HMRC does acknowledge that the existence of a UK PE for a non-UK resident company would not in itself mean that a significant element of the profits of the non-UK resident company would be taxable in the UK. Calculating the attribution of profits to a UK PE is complex and HMRC acknowledges that such attribution depends on factors such as the level of activity and the relative value of that activity.

Practical steps to manage the risk

In terms of next steps, businesses should:

  • Look at the composition of the Board. To the extent commercially realistic in these testing circumstances, consider whether additional local directors should be appointed and/or whether directors located outside the company’s jurisdiction of residence should be removed. You should bear in mind that residence tests generally look to where and by whom the company is actually managed and controlled, so if the guiding minds of the company remain in a certain jurisdiction, or if the Board rubber stamps decisions already made in that jurisdiction, residence will likely be located there.

  • Consider the location of meetings of the Board. Do you have a majority of directors located in the "right" jurisdiction, and should you limit the number of directors participating from other jurisdictions? Again, bear in mind the additional weight given to the location of the real decision-makers and the importance of the Board not rubber stamping a decision. Should the role of those dialling in from the UK be limited – for example, by having them brief the non-UK board members but then not allowing them to participate in the decision-making process? Greater weight will likely be given to meetings where key strategic decisions are made – and so particular care may be needed for those meetings.

  • Take into account activities outside the meeting of the Board. Residence tests look at where key decisions are made, and therefore give the greatest weight to the meetings of the Board, but if key decision-makers are located outside the company's jurisdiction of residence, care will be needed to ensure the activities of those decision-makers outside the meetings of the Board do not affect the company’s residence status.

  • Ensure that the Company's bye-laws and protocols permit the proposed alternative arrangements. Do the Articles or other constitutional documents permit virtual meetings? Do they require particular participants to attend for the meeting to be quorate (for example, a certain number of investor directors)? Do they include particular voting provisions, such as weighted votes or casting votes, and how will those voting provisions work in practice?

  • Revisit the above as the circumstances develop. The position may need to be reconsidered depending on the duration of the travel restrictions, or ill health of the decision-makers. The practices of tax authorities may also adapt over the period during which restrictions are in place.

  • Consider whether any employees are working from home in the UK when they would usually perform their employment duties in another jurisdiction. Whilst employees working from home in a new location cannot be helped in current circumstances (and should not in itself create a UK PE issue), care should be taken to (i) avoid the signing or finalisation of contracts in the homes of such employees and (ii) prevent such individuals from being involved in substantive business actions and decisions.

As noted above, similar issues may arise in other jurisdictions – for example, in the case of UK companies having key employees or directors located outside the UK. Equivalent thinking may be needed in other jurisdictions, and the issues considered together.

The issues discussed in this note are very fact-specific, and the tests of residence and PE do need to be applied to the particular facts and circumstances of the company or group concerned. Careful consideration will therefore be required to determine the best course of action for companies to take to navigate these challenging times and such action may need to change as the situation develops and as guidance from governments and tax authorities is updated. Please do not hesitate to get in touch with a member of our tax team for more detailed advice on any of the issues raised in this article or if you would like to discuss how we can help.  

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