Adjusting to a post-COVID world
As individual countries, and gradually the world, start to emerge from COVID-enforced hibernation, there is much to suggest that many aspects of life will never be the same again.
The temporary dislocation of people experienced during the pandemic will become permanent to some degree. There will inevitably be long-term structural changes in the way people want to, and will, work.
The tax consequences for both individuals and businesses arising from these changes will need to be considered carefully and there may need to be a policy response to the extent that Australia’s tax settings no longer provide sensible outcomes in a post-COVID environment. Although some would argue that a sensible outcome has never a been pre-requisite for setting tax policy.
There are some significant implications for the global tax system and for organisations that move to embrace concepts such as flexible working, and for those who encourage employees to work not just out of the office but, in some circumstances, out of the country.
The last 20 years saw the rise of ‘offshoring’, but in many circumstances this was limited to the cost centres of an organisation where significant savings on labour-related costs could be achieved.
As we move into a post-COVID world, it is readily apparent that such arrangements can now be applied to key revenue-generating parts of a business. Countries will continue to compete fiercely for talent, but now more than ever, it is not a fait accompli that the talent will have to physically be in the country to be effective and productive.
Two areas of particular interest to The Tax Institute’s Large Business and International Technical Committee in a post-COVID world are permanent establishments (PEs) and corporate tax residency.
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.
We need to be proactive in ensuring that our tax rules and administration systems can not only deal with these changes in a sensible and timely manner, but actively incentivise businesses to structure their affairs in a way which will be beneficial to Australia in the long term.
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.
No one knows what tomorrow will look like. No one could have imagined quite how quickly a global pandemic could redefine the way governments, organisations and individuals across the globe carry on business. But the response from businesses and communities has also been rapid and has demonstrated our extraordinary capacity to adapt.
There will inevitably be temporary changes in an organisation that become permanent in a post-COVID world. We need to be proactive in ensuring that our tax rules and administration systems can not only deal with these changes in a sensible and timely manner, but actively incentivise businesses to structure their affairs in a way which will be beneficial to Australia in the long term.
This article is an extract from the September edition of The Tax Institute’s Tax Vine newsletter.