COVID-19 – Comments on permanent establishment risks

Prepared by Flavia Barone, Carmela Ettorre, Cristina Carmosino and Fabrizio Tenuta

It is now clear that the COVD-19 health emergency is having significant impacts on mobility of people and, consequently, on relationship and working life of each of them.

In the present emergency context, limitations on movements of people could have very significant impacts for companies operating cross border, since their employees or directors use as ordinary way of carrying out their work the so called “teleworking” or “smart-working”, i.e. working from their home, sometimes located in a Country different from the one in which they ordinarily carry out their work, as well as the performance with peculiar modalities – due to limitation to movements – of transactions which in an ordinary scenario would have been carried out in a different way. It is undeniable that similar cases may have significant impacts with regard to the potential existence of a permanent establishment (PE) or, if performed by the key management of a company, may reflect on the localization of the place of effective management of the company, with all the consequences that may arise from a tax perspective in both the cases.

In this context, OECD issued on 3 April a document highlighting some concerns and providing some first suggestions.

Although it has been clarified that OECD clarifications may legitimately used as supporting interpretation instruments by both taxpayers and tax authorities, it may not be ignored that the complexity and sensitivity of the matter requires a specific analysis on a case by case basis which even in an emergency context takes into account aspects and characteristics of each situation.

With reference to the current situation, OECD points out some specific aspects, particularly impacted.

Home Office

OECD reminds that in order that a PE is deemed to exist the place of business must be fixed, i.e. must have a certain degree of permanence, and must be at disposal of the company. Although the home of an individual may in principle be considered at disposal of a company (see Commentary to article 5 of OECD Model, paragraph 18 and following), this should not be the case when the home office is used only in an intermittent way. In addition, the utilization of his home to carry on the business of the company should be explicitly required to the individual by the company. In the current emergency situation, limitations to movements of individuals are imposed by Government as a matter of force majeure so that, except the case in which teleworking becomes the ordinary way to work, in order that the home office may be deemed as a PE of the company all the abovementioned conditions seem missing, being not present either the certain degree of permanence or the continuity of the business activity performed within the home office or the request of the company to exercise the business from such home office, considering that in lack of specific measures aimed at limiting the freedom of movement, the individual would have an office in which perform his work.

Agent PE

Similar thoughts may be performed as regards the agent PE. The agent PE is deemed to exist where an employee habitually concludes contracts in the other State on behalf of the enterprise or or habitually plays the principal role leading to their conclusion. In the case an employee works from his home in another State for a short period of time due to force majeure as the COVID-19 emergency is and in this situation concludes contracts on behalf of his company it is unlikely that said activity may be considered as “habitual”. The Commentary to article 5 of the OECD Model clarifies that the power to conclude contracts may be considered as habitual in case the presence in the other State is not merely temporary or transitory. However, OECD points out that different conclusions may be reached in case the conclusion of contracts on behalf of the enterprise within his home was already carried out before the COVID-19 emergency.

Construction PE

The health emergency has entailed the suspension of activities in many construction sites across the world. OECD, making reference to the Commentary on this point, is of the opinion that being the suspension temporary, the period of interruption of activities must be included in the computation of the minimum duration of construction sites in order to be considered as PE in the Country in which they are located, since temporary interruptions do not entail that the construction site ceases to exist.

Place of effective management

The current global crisis and the consequent impossibility to travel affecting the management of companies may lead to concerns on the localization of the place of effective management of the company and therefore on its tax residence.

OECD clarifies that the exceptionality of the current circumstances should not lead to change in the tax residence of a company considering the temporary nature of the situation and the applicability, in those remote cases in which a double residence matter may arise, of tie breaker rules. Double Tax Treaties (DTT) drafted on the basis of the 2017 OECD Model provide the subscription of mutual agreements in order to solve double residence matters on which the Commentary makes reference to the place in which “usually” BoDs are held and key decisions are taken. DTTs drafted on the basis of previous OECD Model make exclusively reference to the place of effective management as place in which key decisions are taken. However, 2017 Commentary clarifies in this respect that many Countries have interpreted the clause as referring to the place in which “ordinarily” are taken the key decisions of a company. A temporary change in the localization of BoD members and of the senior management of a company in an extraordinary and temporary situation connected to COVD-19 measures should therefore not lead to a change in the tax residence of companies and entities even considering the tie breaker rules included in DTTs.

As already mentioned, given the numerous gradients in which the interpretation on the existence of a PE and on the localization of the tax residence of a company can be expressed, considering that at present it is not known what the approach of the Tax Administrations of different Countries will be in dealing with international tax issues in the context of the COVID-19 emergency (except for Irish Tax Administration, mentioned in the OECD document), a specific analysis to assess the risk of existence of a PE or potential changes of the tax residence of a company would be more than appropriate.

Concerns related to individuals

Due to restrictions imposed by the Coronavirus pandemic, many cross-border workers are unable to physically perform their duties in the country where they are currently working. The exceptional nature of the current period has brought changes in the ways of carrying out the work, as well as the employment agreement itself, with people who remain at home without pay, or in extreme cases, may be dismissed due to exceptional economic circumstances.

The OECD, in the document issued last April 3rd, noted that this unusual situation is raising many tax issues, especially in case of cross-border items, for example, when there are cross-border workers or individuals stuck in a country that is different from the State of residence. These situations have or could have an impact on the taxation right attributable to States.

The taxation right is currently governed by the rules contained in the international double tax treaties. In this regard, article 15 of the International treaties drawn up according to the OECD Model, regulates the taxation of employment income, attributing the taxation right partly to the employee’s state of residence and partly to the place where he/she carries out his working activity.

Specifically, article 15 of the Conventions drawn up on the basis of the OECD model, establishes that “salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State”. 

Exclusive taxation in the recipient’s country of residence assumes that 3 requirements are met:

  1. the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the fiscal year concerned, and
  2. the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
  3. the remuneration is not borne by a permanent establishment which the employer has in the other State.

In case the sourcing State exercises the power of taxation according to article 15, the State of residence has to guarantee with the tax exemption or the tax credit the off-set of the double taxation.

The OECD therefore raises the question of the change in the place of performing the working activity during the Coronavirus period. The first issue would concern so-called cross-border workers, whose tax discipline is sometimes outlined by the application of special provisions contained in some bilateral agreements. In these cases, the change in the place of exercise of the activity, where the specific legislation contained limits in the number of days spent in each countries, could affect the methods of determination and taxation, outlined by the aforementioned treaties, of the employment income.

Generally, the OECD focuses on the possible consequences, for employees and employers, which would have with reference to the application of art. 15 of the Conventions, should the contingent situation change the existence of the requirements established by the same art. 15.

This could lead, on the one hand, to the loss of the right to benefit of the exemption pursuant to art. 15, with consequent tax obligations, on the other hand, may have to generate tax credits following the application of withholding taxes not suspended in the other State, and in some cases double taxation with consequent additional charges related to the cash liquidity of the employee while waiting the reimbursement of the tax credit.

The OECD suggests that the tax authorities adopt, at this stage, a substantially more flexible line, in order to allow the suspension or the reimbursement of the withholdings wrongly applied. According to the OECD, exceptional circumstances require an exceptional level of coordination between countries to mitigate enforcement and related administrative costs for both employees and employers, associated with the involuntary and temporary change of the place where the working activity it is carried out.

The OECD is also available  to work with countries to mitigate the unplanned tax implications and potential new burdens resulting from the effects of the COVID-19 crisis.

Particularly relevant is also the determination of the residence of individuals during this emergency period.

According to the OECD, despite the complexity of the rules and despite their application to a wide range of people, the COVID-19 situation is unlikely to affect the tax position in terms of residency established by the Treaty.

Some countries have already provided useful indications and administrative measures on the impact of COVID-19 on the application of the treaty, for the determination of an individual’s tax residence. The UK, for example, has issued a guide to determine if the days spent in the UK can be ignored for the purpose of determining residence due to exceptional circumstances.

Australia has also published a guide stating that where a person who is not resident in Australia for tax purposes was temporarily in Australia for a few weeks or months due to COVID-19, he will not become resident in the state for tax purposes.

The Irish guide, instead, foresees circumstances of “force majeure” in which a person was prevented from leaving Ireland on the day scheduled for departure due to extraordinary natural events.

The main possible scenarios could basically be two:

  1. A person is temporarily away from home (perhaps on vacation, perhaps to work for a few weeks) and remains stuck in the host country due to the COVID-19 crisis. If the country’s internal regulations provide that residence status can be acquired on the basis of physical permanence in the country for a certain number of days, then, there could be significant tax implications.
  2. A person works in a country (the “current country of origin”) and has acquired residency status there, but temporarily returns to his “previous country of origin” due to the COVID-19 situation. These people may never have lost their status as residents in their previous country of origin under national law, or they could regain their residence status upon their return.

In both scenarios, the OECD recommends that Countries evaluate the tax residence on the basis of international treaties, in order to avoid possible cases of double residence due to temporary location, determined by the application of individual national regulations.

Indeed, the OECD emphasizes that an individual can only be resident in one country at a time and that the rules are laid down in article 4 of the OECD model.

Even if the starting point, in the determination of the tax residence is the national law, this can be exhaustive only if the person is resident in one country only, while in the case of double residence, the tie-breaker rules of article 4 of the OECD model apply.

This article, in paragraph 2, try to resolve the tax conflict regarding the tax residence of an individual using four criteria (the so-called tie-breaker rules).

The four tie-breaker rules find application according to a precise order of priority, which gives priority to the exclusive power of taxation on the world-wide income of the State in which the person has at his disposal a permanent home, subordinate to that in which the subject has his center of vital interests and again to that in which he has a habitual abode, and finally to that of which the natural person has the nationality.

In the event that none of these criteria allows to solve the problem of double residence, then the only applicable remedy is that of the friendly procedure, referred to in art. 25 of the Convention itself.

Therefore, in the event that a person is, according to the legislation of the Contracting States, resident in both States, art. 4 paragraph 2 of the double tax treaty applies to resolve the conflict between the two legal systems and establish the state of effective residence.

The application of tie-breaker rules automatically excludes national legislation, implementing its subordination with respect to the lex superior of conventional source. Nor could the legislator affect this situation with internal source legislation which, while safeguarding the concept of residence applicable pursuant to art. 4, paragraph 2 of the OECD Model, provided for different methods relating to the assessment of the substantive situation.

In the first of the above scenarios, it seems likely that the tie-break test mainly grants residence of the treaty to the country of origin. This is because the person is unlikely to have a “permanent home” available in the host country. But if there was, for example, an apartment held for rent for a sufficiently long period, and if the home of the country of origin had been rented, then there would be the possibility of being treated as residents of the host country also under the Treaty. Where the person had a permanent residence in both states, it seems likely that the other tie-break tests (center of vital interests, habitual place of residence and nationality) would have assigned the residence to the state of origin. In this case, the OECD does not suggest any corrective measures.

In the second case, applying the same rules of the treaty, there would be a more uncertain result because the link between the person and the previous country of origin is stronger and the fact that the person moved to the previous country of origin during the COVID-19 crisis may risk reversing the balance towards the previous country of origin.

In this case, the habitual residence test would not be able to satisfy the required requirement simply by determining in which of the two Contracting States the person spent more days during that period. Therefore, in the opinion of the OECD, since the COVID-19 crisis is a period of great changes and an exceptional circumstance, in the short term, tax administrations and competent authorities will have to consider, for the purposes of assessing residence, a period of time that is not influenced by exceptional events like this, but that is “normal” for the person.

The OECD then makes a final suggestion with reference to the extraordinary treatments linked to the loss of work or to the interventions of individual States in support of employee income. The opinion is to consider these incomes in the same way in which the treatments provided on the occasion of the termination of the employment relationship should be taxed, that is, to tax them in the country in which the employee work to which they refer was performed.

Ultimately, the position that the OECD suggests to the STAs to adopt is to maintain a certain neutrality towards the influences provoked by COVID – 19 in the application of the international treaties.

In our opinion, however, a separate reflection would deserve the application of the Italian legislation with reference to the determination of the income from dependent work on the basis of conventional wages.

The Italian legislation on the taxation of employment income performed abroad, with article 5 of Legislative Decree n.314/97, provided for the repeal of article 3 paragraph 3 of the TUIR which provided for the exemption for employment income performed abroad on an ongoing and exclusive basis.

Article 36 of Law no. 342/2000 supplemented the provisions for the determination of the employee income of the person residing in Italy with the addition of paragraph 8 bis to article 48 of the TUIR, now 51.

In particular, it established the taxation of employee income, produced abroad on a continuous and exclusive basis, by a person

tax resident in Italy, based on conventional values defined by decree by the Ministry of Labor. For paragraph 8 bis to apply, the activity must be provided on an ongoing and exclusive basis and for a period exceeding 183 during the year.

For the application of this rule, a specific agreement between employer and employee is required, which provides for the continuous and exclusive provision abroad, not applicable to employees on business trip. The tax base considers a conventional remuneration, therefore also the benefits do not suffer any autonomous taxation, because their amount is included in the conventional remuneration.

Therefore, if the contingent situation linked to the emergency, causes one of the requirements provided for by art. 51 paragraph 8 bis, because for example the worker posted abroad, has to work from Italy, then, the problem would arise of having to subject the income produced abroad to taxation in Italy, determining the tax base, not more on the basis of conventional wages but even on the basis of actual income.

This would imply a huge burden in terms of taxes and administrative obligations, not to mention that the approach would go in the opposite direction to that suggested so far by the OECD and by the EU itself in the field of social security and social security.

Let’s Talk

For a deeper discussion, please contact:

Alessandro Caridi

PwC TLS Avvocati e Commercialisti


Nicla Cimmino

PwC TLS Avvocati e Commercialisti


Flavia Barone

PwC TLS Avvocati e Commercialisti


Carmela Ettorre

PwC TLS Avvocati e Commercialisti