The traditional ‘gateways’ to taxation, around the world, have been ‘residence’, ‘source’, and ‘permanent establishments’. These have been under pressure, for some time now, as technology makes all these more ambiguous. Covid-19 has recently exacerbated this, in some dramatic ways. Lockdowns, closed borders, people trapped in the country they were in, people retreating home, people staying where they think its safe, ‘tree changers’, ‘sea changers’, more online sales and ‘working from home’ has caused a boom in various technologies allowing people to work from anywhere and businesses to be run from anywhere. It is worth digging in a bit further, on this.
See below for further detail.
In Australia, being resident exposes the taxpayer to Australian tax on its income and gains from all sources – unless excluded by a ‘Double Tax Agreement’ (DTA). Most DTAs, allow the country of residence to tax business profits, except to the extent that the taxpayer carries on business through a ‘permanent establishment’ (PE) in the other country. Broadly PE’s have to do with a physical business presence in that country. One can see how that starts to evaporate, in a digital world, and how Covid has just exacerbated this problem.
For corporates, ‘residency’ can include where the company carries on business, but it has other ‘control’ facets, such as where control of that business, or the company’s affairs is exercised, and where there is voting control. Voting control, of course, just extends residency issues to shareholder level.
Australia’s current corporate residency definition, involves an amalgam of these, and is in the following terms (in s6 of the 1936 Tax Act).
or resident of Australia means: …
(b) a company which is incorporated in Australia, or which, not being incorporated in Australia, carries on business in Australia, and has either its central management and control in Australia, or its voting power controlled by shareholders who are residents of Australia
On 10 September 2021, The Tax Institute included a brief discussion of the effects of Covid on these ‘PE’ and corporate ‘residency’ issues (in their weekly email: TaxVine, No 34 of 2021). Both the OECD and the ATO have issued guidance, but in at least the latter, it doesn’t go much beyond ‘if it’s only temporary, we won’t go looking to change previously established ‘gateway’ concepts like PE and residency.’
The Institute’s discussion was this.
On 3 April 2020, the OECD Secretariat issued guidance on the application of international tax treaty rules to circumstances where cross-border workers were stranded in a jurisdiction that was not their jurisdiction of residence. The urgent guidance contained a disclaimer that the opinions expressed in the guidance did not necessarily reflect the official views of OECD member countries.
The OECD guidance dealt primarily with the exceptional and temporary change of the location where employees exercise their employment because of the COVID-19 pandemic and offered the view that such arrangements should not create new PEs for the employer. Similarly, the guidance note suggested that temporary conclusion of contracts in the home of employees or agents because of the COVID-19 pandemic should not create PEs for the businesses.
With global upheaval continuing throughout 2020 and into 2021, the guidance note from the OECD was refreshed on 21 January 2021. The expanded guidance considers some additional fact patterns not addressed in detail in the earlier guidance and examines whether the analysis and the conclusions outlined in April 2020 continue to apply where the circumstances persist for a significant period. The revised guidance contains references to country practice and guidance during the COVID-19 period but is said to be relevant only to circumstances arising during the COVID-19 pandemic when public health measures are in effect. There will be growing uncertainty as to what the correct position is, and should be, as countries wind back public health measures at different rates, with some public health measures likely becoming permanent fixtures.
The Australian Taxation Office (ATO) has offered some assistance, affirming the principles set out in the OECD guidance and acknowledging that COVID-19 has resulted in overseas travel restrictions and that foreign companies may be concerned about potential effects on their business and tax affairs because of the presence of employees in Australia. The ATO’s approach, which currently applies until 31 December 2021, is to not apply compliance resources to determine if a taxpayer has a PE in Australia if a number of reasonably narrow conditions are satisfied.
- the taxpayer in question did not otherwise have a PE in Australia before the effects of COVID-19;
- the temporary presence of employees in Australia continues to solely be as a result of COVID-19 related travel restrictions;
- those employees temporarily in Australia will relocate overseas as soon as practicable following the relaxation of international travel restrictions; and
- the taxpayer has not recognised those employees as creating a PE or generating Australian source income in Australia for the purpose of the tax laws of another jurisdiction.
The above criteria will become more and more difficult to satisfy as public health measure ebb and flow depending upon the severity of outbreaks and public health measures. The bigger question, as we move into a post-COVID world, is to what extent, if any, should some or all of these principles apply to arrangements that can no longer be described as ‘exceptional’ or ‘temporary’? What should organisations be considering when determining what policies to adopt with respect to their operations and their workforce? Does there need to be some adjustments to the concept of a PE, like what happened as the digital age developed, to take into account a long-term shift in the way business is carried on?
The need for timely guidance and leadership on these issues will continue, both at the OECD level and from the Australian Government and the ATO.
Corporate tax residency
The corporate tax residency rules provide a foundational gateway to determining a company’s Australian tax liability. The ATO’s interpretation following the High Court’s 2016 decision in Bywater Investments Ltd v FCT  HCA 45 departed from the long-held position on the definition of a corporate resident. Following submissions from a number of representative bodies in response to the ATO’s revised guidelines on corporate residency, the Government requested the Board of Taxation review the definition in 2019–20. The Large Business and International Technical Committee led The Tax Institute’s submission to the Board.
In the Federal Budget 2020–21, the Government announced that it would make technical amendments to clarify the corporate tax residency test.
The law will be amended, in line with the Board’s key recommendation in its review, to provide that a company that is incorporated offshore will be treated as an Australian tax resident only if it has a ‘significant economic connection to Australia’, which will be satisfied where both the company’s core commercial activities are undertaken in Australia and its central management and control is in Australia.
However, we are yet to see the draft legislation implementing the amendments to clarify the operation of the corporate tax residency test. In a post-COVID world, with more directors and ‘controlling minds’ likely to remain dispersed across the globe, it becomes more important than ever that Australia’s test for corporate tax residency provides sensible outcomes for Australian and international businesses. The test must be clear, practical and, most importantly, have regard to the way in which business is carried on in a post-COVID environment. The rules and their application must reflect an environment where a business wants the best people in control and making decisions for the company, and the physical location of those people is only of secondary importance.
The OECD has also acknowledged the residency issue in the context of tax treaties and, in particular, has considered the application of the tie-breaker rule in the Model Treaty. In the OECD guidance mentioned above, the Secretariat made reference to the concept of ‘place of effective management’ as being ordinarily the place where the key management and commercial decisions necessary for the conduct of the company’s business are made. The direction to examine all relevant facts and circumstances in order to determine the ‘usual’ and ‘ordinary’ place of effective management may become more problematic in a post-COVID world.
So, where might all this go…?
These international tax gateways, have been begging to be reconsidered for some time. The OECD/G20 BEPS project has been considering its response to the increasingly geographic ambiguity of digital business – and is sitting on so called ‘Pillar 1’ and ‘Pillar 2’ proposals (which, to be really candid, I don’t fully understand).
But what system might we have, if we were to start with a blank canvas – now. For instance, how might Australia tax a multinational corporate, with high sales and low mass (physical presence) in most countries around the world (eg Google or Facebook)? A system that is begging to be chosen, is one based on where the customers are – splitting global revenue on the volume of gross sales, in each of the countries, around the world, with international costs split, in proportion to sales – ditching, effectively, ‘source’ of income, PE and ‘residence’ – save, probably, for the residence of the customer. Determining the location of the customer, however, will present its own problems.
Still, one should be careful what you wish for. Australia currently sells vast amounts of minerals and petroleum products, overseas, without having to pay foreign tax, because the income is (mainly) sourced in Australia – where the mining and drilling has been conducted.
Perhaps this ‘share of international profit, based on where the customers are’ approach could be reserved for taxpayers who could not make out a case, for the traditional residence/PE/source rules applying – a kind of ‘default’ basis.
Have your say…
If you’ve got any bright ideas, you might share them with the ‘LinkedIn’ world by ‘commenting’ on this article, or on each other’s comments. Let’s see where this leads – I’ll watch with interest (it might get traction or it might not).