Lockdown and Tax

Posted in Blog, Coronavirus, Global mobility, Immigration, International relocation, Tax consultancy, Taxation, Travelling, Work permits

For a tax treaty to be applicable, one usually must be a resident in at least one of the contracting countries.

Nowadays, in the COVID-19 crisis, many of us live in Lockdown or something very similar. In any way, we are restricted in our travel. Many want to leave their homes but cannot. Others wish to return home, but are locked in a foreign country due to lack of flights and closed down borders. 

These travel restrictions have a significant impact on international workers in many different aspects. Personal income tax, social security tax and immigration rules are important examples. 

There are individuals with an entry permit that is due to expire because of cancelled flights. Others are at the end of a posting and thus are facing expiring permits.

Yet another significant group that is often overlooked when international issues arise is those whose taxation rights depend on physical presence in a particular country. These are the commuters and frequent business travellers. 

Let’s have a look at the current state of these rules and regulation, before we have a look at the issues in more detail. These are the highlights in the tax and social security treatment of this group.

When someone is living and working in the same country, he is subject to tax and social security laws of this particular country. But when part of the employment activity is performed elsewhere, the right to levy a tax on income earned in that country shifts to that particular foreign country. 

Therefore, when a German resident is working in Poland, Poland gets the right to levy a tax on the income that was earned during Polish workdays. Germany, in this case, needs to provide relief for the avoidance of double taxation. 

Including income earned during each working day in taxation in a particular country can be an overkill. Therefore, the 183-day rule has been introduced in many tax treaties. For a tax treaty to be applicable, one usually must be a resident in at least one of the contracting countries. Once a treaty applies and contains a 183-day clause, the work state is, generally speaking, NOT allowed to tax the income when all of the following requirements are met:  

  • the worker has not been physically present in a certain reference period in the host state for 183 days or less;
  • worker’s compensation has not been paid by or on behalf of an employer in the host state;
  • the income is not borne by a permanent establishment of the employer in the host state. 

Over the past decade, we have seen that more and more individuals who work internationally ended up in a position where they needed to pay tax in the host state. This is partially caused by the introduction of the economic employer concept. The definition of the word ’employer’  is mainly inspired by the level of authority and economic ties, rather than a contractual arrangement. Also, a reinforced focus on international cost allocation has led to employees being taxed in a working state more easily. Just think of the initiatives against Base Erosion and Profit Shifting (BEPS) for example, where the proper cross charging of cost becomes an essential element. 

Employees might be even happy to pay tax in the foreign country. Many home countries offer a higher relief for the avoidance of double tax than the host country levies in tax. In other words, commuting or travelling for business resulted in a tax benefit to these employees.

How does the COVID-19 crisis affect commuters and business travellers? 

Well, in a couple of ways:

First of all, by determining tax residence. A large group of countries determines tax residence (amongst others) based on the total number of days spent there. In countries with a residence definition that is based on the number of days of presence, a stranded international worker may trigger adverse tax consequences. He can do it by overstaying his term in a host country, or may just not hit the number of days of presence to be considered a resident in a particular home country. And while not being considered a tax resident may sound positive, it may also deny access to the protection of tax treaties – which is not desirable. 

Second, when an individual works internationally and all of a sudden performs from home, the balance of taxation on his income may shift from host location to home location. Being present in the home country typically prevents the employee from being taxable in the host location. In his respect, often a distinction needs to be made between workers that could not travel because of being ill, or workers that could not travel because of quarantine measures and travel restrictions. 

Some countries take the position that, when someone falls ill, the income earned over this period is allocated for tax purposes in the same way as income earned while working. And when an employee is bound to his home location due to falling ill on the COVID-19 virus, from this perspective, there will be no tax consequences. When both home and host country take an approach that days of illness are disregarded for allocation purposes, nothing material will change for the employee. However, when no country or only one country does not follow this position, the employee may end up in a situation of a tax windfall, or a situation of double tax.  

When someone does not fall ill but is quarantined, such specific regulations mentioned above do not apply. In this case, the employee would fall back to the main rule of taxation in (solely) the country of residence.  

As is often the case in international tax, things are not as easy. Tax treaties may be interpreted differently by countries and the outcome becomes quite unpredictable. One country may look at the physical location during illness to allocate taxation rights while the other country looks at where the employee would have been working in that period had he not fallen ill.

From an HR policy point of view, questions may arise. When someone’s net changes significantly as a result of travel restrictions, would you compensate the employee for the shortfall in net income, or is this a risk the employee needs to bear by himself? 

Social security

The Dutch, Belgian and German social security authorities published unified policies in the interpretation of the EU directive that apply for the duration of the current crisis. In this interpretation, things will not change for those commuters that would be facing a change in their social security position as a result of having to work from home. 

The above information provides a general overview of the issues that could be at stake when working patterns change as a result of the COVID-19 crisis. The tax position of your commuters and business travellers may be significantly affected by the crisis. It is essential to investigate the exact impact on an individual basis. Be prepared for some unexpected outcomes, as this highly unusual situation is also not a situation that lawmakers had in mind when signing tax treaties in the past. An extensive study of treaties may be required.

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