In the current and unprecedented COVID-19 environment the temporary displacement of employees has given rise to many concerns from employers that it may unintentionally be creating “permanent establishment” issues for them in foreign jurisdictions. This is particularly cogent where their employees are working through the pandemic in a different country to where they ordinarily work.
For example, due to COVID-19, it is common for:
- employees of foreign-resident employers to be temporarily working in Australia when they would ordinarily work outside Australia (Inbound Employee Scenario); and
- employees of Australian-resident employers to be temporarily working outside Australia when they would ordinarily work in Australia (Outbound Employee Scenario).
This article highlights some of the key Australian ”permanent establishment” issues and related action items for employers related to the above scenarios with particular regard to guidance from the Organisation for Economic Co-operation and Development (OECD) and the Australian Taxation Office (ATO) on this issue. It does not cover the separate issue of any tax residency considerations the scenarios may give rise for the employees themselves.
Australian “permanent establishments”
Of particular relevance to the Inbound Employee Scenario for foreign-resident employers – under Australia's domestic income tax laws, a foreign resident (ie. non-resident of Australia) is generally assessable on income derived from Australian sources and other income that is specifically included on some basis other than having an Australian source.
The Australian domestic tax law does not specifically tax income or profits of foreign-resident entities attributable to “permanent establishments” in Australia and the "double tax agreements" (DTA) entered into between Australia and other countries generally only limit the rights of the state parties to tax such amounts.
In broad terms, whether the relevant income or profits of a foreign-resident entity can be subject to “assessment based” Australian income tax which are calculated on a ‘net’ basis (ie. as distinct to “withholding based” taxes) is largely impacted by whether a DTA is in place between Australia and the relevant jurisdiction of which the foreign-resident entity is a tax resident.
Broadly, to be subject to “assessment based” Australian income tax (and associated filing requirements etc.) in circumstances where a DTA is applicable, the relevant income or profits of the foreign-resident entity which relate to the employees temporarily working in Australia due to COVID-19 under the Inbound Employee Scenario, must be:
- from Australian sources (or otherwise subject to Australian income tax); and
- attributable to a “permanent establishment” in Australia.
The definition of “permanent establishment” used in any given DTA is generally based on and similar to that provided in the Model Tax Convention on Income and on Capital (Model Tax Convention) prepared by the OECD. The OECD also publishes extensive commentaries accompanying the Model Tax Convention setting out the consensus views of members, including Australia, on its interpretation (OECD Commentaries).
Courts in Australia have confirmed that the Model Tax Convention and Commentaries may be relevant supplementary means of interpretation of Australia's tax treaties (ie. DTAs) pursuant to the Vienna Convention of the Law of Treaties (ie. see Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338).It is therefore useful to have regard to the OECD Commentary (including the OECD guidance referred to below) when considering any Australian “permanent establishment” issues.
The OECD Commentary on the Model Tax Convention notes that the general definition of the term "permanent establishment" contains three conditions which must be met (and is generally consistent with Taxation Ruling 2002/5 released by the ATO):
- the existence of a "place of business", ie. a facility such as premises or, in certain instances, machinery or equipment;
- this place of business must be "fixed", ie. it must be established at a distinct place with a certain degree of permanence; and
- the carrying on of the business of the enterprise through this fixed place of business. Usually, persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated.
DTA not applicable
Broadly, to be subject to “assessment based” Australian income tax (and associated filing requirements etc.) in circumstances where a DTA is not applicable, the relevant income or profits of the foreign-resident entity which relate to the employees temporarily working in Australia due to COVID-19 under the Inbound Employee Scenario, must be from Australian sources (or otherwise subject to Australian income tax).
This will be particularly relevant to foreign-resident employers who are tax-residents of a country which does not have a DTA in place with Australia such as Hong Kong and have employees temporarily working in Australia due to COVID-19 when they would ordinarily work outside Australia.
The OECD and has released some general guidance on this issue in the context of where a DTA is in place, which in broad terms notes that:
- the exceptional and temporary change of the geographical working location of employees from the country in which they ordinarily work to a different country due to the COVID-19 pandemic should not create a “permanent establishment” for the employer in that different country; and
- the temporary conclusion of contracts by employees in that different country because of the COVID-19 pandemic should not create “permanent establishments” for the employer in that different country – however this could be different if the employee was habitually concluding contracts on behalf of the employer in that different country before the COVID-19 pandemic.
While the ATO has not provided a formal response to the aforementioned OECD guidance, it has released some limited guidance in the form of "frequently asked questions" (which is particularly relevant for the Inbound Employee Scenario) where it states that the effect of COVID-19 will not, in itself, result in a foreign company having an Australian “permanent establishment” if it meets all the following:
- the foreign-resident company did not have a “permanent establishment” in Australia before the effects of COVID-19;
- there are no other changes in the foreign-resident company’s circumstances; and
- the unplanned presence of employees of the foreign-resident company in Australia is the short-term result of them being temporarily relocated or restricted in their travel “as a consequence of COVID-19” (ATO Conditions).
Further, the ATO states in the guidance that:
- if a foreign-resident company didn’t otherwise have a “permanent establishment” in Australia before the effects of COVID-19 and the presence of employees of the foreign-resident company in Australia is because they are temporarily relocated or restricted in their travel as a consequence of COVID-19, then the ATO will not apply compliance resources to determine if the foreign-resident company has a “permanent establishment” in Australia; and
- it will continue to monitor the evolving effects on business and issue further guidance if there are further developments as a result of COVID-19.
Importantly while not expressly stated, the ATO guidance appears to be limited to the scenario where the foreign-resident company is a tax-resident of a country which has a DTA in place with Australia.
Key Australian income tax considerations for employers
Generally speaking having regard to the aforementioned OECD / ATO guidance, if an employer has arrangements in place with an employee during COVID-19 which fall within the:
- Inbound Employee Scenario:
- where a DTA is applicable, then if the ATO Conditions are satisfied, the foreign-resident employer should not have an Australian “permanent establishment” as a result of the Inbound Employee Scenario for Australian income tax purposes and therefore the Inbound Employee Scenario should not trigger any Australian income tax consequences for the foreign-resident employer;
- where a DTA is not applicable, then the relevant income or profits of the foreign-resident entity which relate to the relevant employee would be subject to Australian income tax if they have an Australian source (which would potentially be the case given the relevant employee is working in Australia); and
- Outbound Employee Scenario: irrespective of whether a DTA is applicable then the Australian income tax consequences for the Australian-resident employer during the period of which the employee temporarily works outside Australia should not be materially different to what they would be when the employee ordinarily works in Australia. However, such a position would need to be reconsidered in light of the existence of any foreign tax implications which may be created by any employment arrangement under this scenario (of which foreign tax advice should be sought as relevant).
However, from an Australian income tax perspective it is important to note that the issue of “permanent establishments” give rise to many complex considerations that will be impacted by the specific set of facts and circumstances of each employment arrangement. Furthermore the ATO’s position set out above is predicated on the basis that each of requirements of the ATO Conditions (including that the foreign employer did not have an Australian “permanent establishment” prior to the COVID-19 pandemic) are satisfied and that a DTA is applicable. Hence, we would anticipate that this will be a key focus and area of contention of the ATO in any Australian income tax disputes related to this particular issue.
Moreover in Australian income tax disputes, the Australian income tax laws place the burden of proof on taxpayers rather than the ATO. Consequently, all employers who have arrangements with employees as referred to in the above scenarios during COVID-19 (Arrangements), should ensure that they retain relevant evidence to support their position from an Australian income tax perspective, which should assist in responding to any queries from the ATO down the track as applicable. For illustrative purposes, such evidence could potentially include:
- board and committee papers and minutes referencing the Arrangements (including the COVID-19 related reasons and temporary nature);
- internal "Human Resource" records for affected employees documenting the Arrangements and temporary nature (such as any notes recorded in an employee’s individual employment file);
- records of communications (such as any emails / letters or file notes of telephone / video discussions) between the employer and affected employees documenting the reasons for the Arrangements (ie. as a consequence of COVID-19), the nature of the arrangements (including temporariness) and related reasons for requesting prolonged or varied Arrangements; and
- written review(s) as referred to at Action item 4 below (and as applicable, a written record of any action taken).
As applicable, evidence should show that reference was made to relevant information and guidance issued by Government and Non-Government Organisations (eg statements and guidance issued by ‘Chief Medical Officer’ and World Health Organisation). Further, to the extent that prolonging the Arrangements is necessary due to indirect COVID-19 reasons (eg travel restrictions or ‘Occupational Health and Safety’ obligations for particular categories of workers) this should be documented as part of the above mentioned evidence in the context of the affected obligations.
Moreover, given the general nature of the ATO guidance (which is subject to change), if an employer has any uncertainty about whether any Arrangements it has in place could trigger “permanent establishment” issues then they should consider approaching the ATO for guidance (ie. whether it be in the form of a ‘letter of comfort’ or something more formal). Practically, earlier engagement with the ATO may be a more prudent approach than engaging later in time when the ATO may have developed a firmer approach than currently outlined in the ATO guidance.
Importantly, while the focus of this article is Australian “permanent establishment” issues, if employers have Arrangements in place with an employee during COVID-19, then they should also consider any other implications under Australian law such as under Australian payroll tax, employment (including employment taxes) and superannuation law as well as any implications under any relevant foreign law.
Action items for employers
To assist in managing the aforementioned issues from an Australian income tax perspective, employers should ensure they action the following:
Action item 1
Carefully monitor and keep track of the geographical working location of employees during the COVID-19 pandemic (with a particular focus on employees working in a different country during the pandemic than where they ordinarily work).
Action item 2
Seek Australian income tax advice (and any relevant foreign tax advice) if due to COVID-19 they have employees temporarily exercising their employment:
- inside Australia when they would otherwise work for the foreign-resident employer outside Australia (ie. Inbound Employee Scenario); or
- outside Australia when they would otherwise work for the Australian-resident employer in Australia (ie. Outbound Employee Scenario).
Action item 3
Retain relevant evidence, as referred to above, to support their position from an Australian income tax perspective (and a foreign tax perspective as relevant).
Action item 4
- monitor and carefully consider official guidance in respect of “permanent establishment” issues related to COVID-19 (ie. from the ATO, OECD and other relevant foreign authorities);
- review whether any Arrangements they have in place with employees are meeting the key elements of the ATO and OECD guidance including in respect of:
- temporariness; and
- "as a consequence of COVID-19";
- act as relevant if the review suggests that the position has weakened against the guidance criteria.
Action item 5
Consider whether there would be utility in approaching the ATO for relevant guidance in respect of the Arrangement in the context of “permanent establishment” issues (and any other relevant Australian income tax issues), and approach the ATO as relevant.