The current COVID 19 crisis characterized by generalized home office and travel restrictions creates unprecedented tax situations as well as upheavals to come after the crisis. This is especially true for permanent establishment and companies’ tax residence concepts on which the OECD Secretariat issued recommendations.
On April 3, 2020, the OECD released a report based on the commentaries on the OECD Model Tax Convention on Income and on Capital which, although not binding on States, provides useful guidance.
Employees or executives working from their home in another country different from their employer’s country raises the question of whether such situations will create a permanent establishment in these countries.
The OECD report answers that such scenario is unlikely in the light of the permanent establishment criteria.
Teleworking from home would first not create a fixed place of business. The OECD highlights that such situation is force majeure as well as the extraordinary nature of the COVID 19 crisis. It also points out that in this situation the enterprise has neither access nor control over the home office and provides, in addition, an office to its employees under normal circumstances. It therefore concludes that both the degree of permanency and the disposal of the location by the enterprise criteria, which characterize a fixed place of business, would not be fulfilled.
Although not addressed in the report, the same question arises where the employee is not working from home but in the premises of a local subsidiary of the enterprise’s Group. However, in such a case, the purely temporary nature of the situation may also prevent the characterization of a permanent establishment
The report addresses then the question of the dependent agent, namely a person acting on behalf of the enterprise who habitually concludes contracts in the name of the latter or habitually plays the principal role leading to the conclusion of contracts routinely concluded without material modification by the enterprise. For example, does the director of a Luxembourg company, placed under quarantine in Metz, who has a leading role in the conclusion of contracts constitute a dependent agent of this enterprise? The decisive criterion here is the habitual nature of such activity, excluding thus any temporary or transitory activity. Based on this criterion, the OECD concludes that there should be no permanent establishment “for a short period because of force majeure and/or government directives extraordinarily impacting his or her normal routine”.
Finally, the OECD confirms that a construction site should not be regarded as ceasing to exist due to the temporary interruptions as a result of the COVID 19 crisis. The French and the English versions of the report appear, however, contradictory regarding whether or not the interruptions should be taken into account when determining the duration of a construction qualifying as a permanent establishment (more than 12 months, but only 6 months under the UN Model of Convention). This should result from an error in the French translation. In any case, the report does not seem to deal with the case of a construction site, initially planned for a period of less than 12 months, which finally lasts longer solely because of the COVID 19 crisis interruptions.
After the crisis, it is likely that teleworking will continue and that business trips remain limited, so that what was temporary and not habitual yesterday may become the new standards tomorrow.
Yet, the characterization of a permanent establishment relies on concepts highly linked to temporal and frequency aspects (degree of permanency and habitual nature) the appreciation of which depends on factual circumstances and on the activity/the contracts at stake as well as on the practices of the tax administrations which are not always consistent
The OECD report itself expresses a reservation regarding teleworking from home: there should be no permanent establishment “to the extent that it does not become the new norm over time”.
Hence, could new permanent establishments arise if tomorrow teleworking becomes habitual and, moreover, if it is organized by the enterprise itself or if flex-office develops?
Likewise, the limitation of business trips for sales representatives may lead to the development of contracts’ negotiations and conclusions from their State of residence. Will it be necessary to rethink the organization by limiting sales representatives’ powers and autonomy, in such a way that the enterprise does not routinely review and approve the contracts as negotiated by them?
Finally, would a French director of a foreign company taking important decisions from its home constitute a place of management qualifying as a permanent establishment?
Tax residence of a company
The tax residence of companies determines the application of both double tax treaties and European directives on passive income. The residence of a company refers to the place where it has its effective management. In the event of a conflict between two Contracting States to a double tax treaty, Article 4-3 of the OECD Model Tax Convention 2017 provides that such conflict is resolved by mutual agreement between the competent authorities of both States. This option is, however, not reassuring as the experience shows that the duration of mutual agreement procedures is not compatible with the pace of business.
The report states that the definition of “place of effective management” is where the meetings of the company’s board of directors or equivalent body are usually held, and where the chief executive officer and other senior executives usually carry on their activities. It encourages the tax administrations to consider all facts and circumstances observed during the crisis to determine, in case of conflict, the “usual and ordinary” place of effective management of the company. The OECD calls for moderation when appreciating extraordinary circumstances. Such approach could lead, for example, to consider that a chief executive officer of a foreign company, placed under quarantine in France where he joined his family, does not create a risk that the tax residence of the company he manages is attracted in France.
If, after the crisis, the restrictions to business trips continue (either because of Groups’ policy or due to the reluctance of professionals to travel as they used to before), Groups will have to rethink their organization in order to secure the tax residence of the Group companies. This issue, that concerns both foreign and French Groups, covers in fact multiple concrete situations such as holding companies, companies centralizing IP assets or treasury management, and as far as financial and real estate activities are concerned, asset management companies.
In France, in the absence of legal definition, the tax administration gives a definition of the place of effective management close to the one given by the OECD: the place where key management decisions that are necessary for the conduct of the company’s business are taken. The place of effective management will normally be the place where the person, or the group of persons of highest rank (for example, the board of Directors) take the decisions. A company may have more than one place of management, but it can have only one place of effective management.
The French Supreme Administrative Court (CE 7-3-2016 n°371435) went further by judging that the place where board of Directors’ meetings are held may constitute an indication but is not sufficient. In the case at stake, a holding company whose headquarter was in Belgium had no longer premises in this country. The Supreme Court ruled that the services necessary to the holding activity were in France and that key management decisions were, in fact, prepared and agreed in their principle during previous board meetings held in France.
Securing companies’ tax residence will thus require a balancing act between general principles essentially based on the physical location of management activities and new teleworking methods. Will it be necessary to rethink the composition of governing bodies? Will it be necessary to forbid voting by telephone, encourage proxies to local administrators?
The recommendations of the OECD report are welcome. To date, France has however not yet announced any specific tax measures regarding these items. In our view, such discussion shall be continued in a post-crisis environment: companies will have to review their governance policy in order to target risk situations regarding tax residence and permanent establishment characterization. This discussion must not remain between specialists, on the contrary, the involvement of operational teams, and firstly, management is essential.
§33.1 of commentaries on Article 5 of the OECD Model Tax Convention dated 2014 and §98 of the 2017 version.
The English version indicating that “the duration of such an interruption of activities should however be included in determining the life of a site and therefore will affect the determination whether a construction site constitutes a PE”, while the French version states the opposite.
§28 à 31 et 98 of the above-mentioned commentaries.
§24.1 of the commentaries on Article 4 of the OECD Model Tax Convention 2017.
Cf. French administrative guidelines : BOI-INT-CVB-DZA-10-20120912.