In our previous blog, we discussed some measures which were suggested by the Organisation for Economic Co-operation and Development (“OECD”) to ease the cash flow crunch being faced by taxpayers due to the COVID-19 situation. In continuation with the same, this blog will focus on the key issues highlighted by the OECD, which should be considered by nations while granting these benefits.
In addition to the above, restriction on movement of people due to lockdowns imposed in various countries is also likely to give rise to other issues. The OECD has analysed tax treaty provisions to determine the potential impact of such restrictions on exposure to permanent establishments (“PE”) and the ‘place of effective management’ (“POEM”) of companies. This analysis is also discussed in this blog.
A. Factors impacting tax policies
As a body, which plays the role of setting good standards for tax administrations, the OECD has discussed a number of issues and concerns, which should be carefully considered by tax administrations around the world while selecting the measures to be introduced for easing the pain of cash flow and compliance burden of taxpayers. These are discussed below:
- Whether to adopt a targeted approach and only apply measures to taxpayers that are the most affected by Covid-19?
One of the key decisions, which needs to be taken by tax administrations, is whether the benefit or relief should be extended to all or to a select group of taxpayers, which is identified as being most impacted by COVID 19. In the latter case, the tax administrations should consider how best to provide clear criteria and requirements for evidence to reduce burden and stress on both taxpayers and the tax administration. This can also be used selectively in respect of some measures discussed in the previous blog. E.g. Australia has given the option to taxpayers to approach the tax authorities for reliefs. This could be one of the ways to achieve the targeted approach.
While this proposition has merit when limited resources need to be used most effectively, providing benefits only to those who are able to demonstrate any impact of COVID-19 may be challenging and will increase the administrative burden leading to tax litigation. The tax administration will need to act more proactively in identifying the most suitable measures for the most impacted sectors. The impacted sectors could make appropriate representations for just the targeted benefits that they need, knowing full well that the ability of the administration to give concessions is limited.
- The consequences that may arise for taxpayers due to actions of tax administrations
The OECD recognises that the decision to defer tax reporting or filing may impact refund of taxes to the taxpayer. This may have a negative impact on the cashflow of taxpayers and increase their problems rather than alleviate them. E.g. in cases where withholding tax or advance tax payments have resulted in higher amount of tax paid than what is actually payable for the relevant year. The refund would not be due till the return is filed and processed. Hence, in case of such taxpayers, the deferral of return filing date may not be a solution.
The fact that OECD has identified this issue, indicates clearly that this issue is faced in many jurisdictions. Also, in a cross-border situation, this may potentially lead to unavailability of timely foreign tax credit since this may lead to timing differences.
- The duration of measures building up to unsustainable debt burden
Tax authorities will also have to take a call on the duration of the measures being announced in response to the COVID-19 situation. While short-term measures may not provide the certainty that taxpayers are looking for, given their own views on the impact on cash flows, etc., longer term measures may result in debts building up to unsustainable levels or deferred payments leading to severe cashflow problems at a later date.
- The possibility of fraud
The OECD warns governments of potential increase in fraud cases, where the measures include giving tax concessions for various situations. E.g. where someone sets up a new company with fictitious staff and seeks government support; or someone seeks to dispose of assets before tax debts can be collected; or where deferred payments (such as payroll taxes or VAT) are siphoned off in fraudulent schemes. It would therefore be necessary to have risk mitigation measures in place that can counter such frauds.
Thus, it may be a good idea to give taxpayers the option to select from several measures announced by the tax administration.
B. Concerns with regard to PE and POEM
This may be a major unwarranted and unintended side effect of the travel restrictions imposed by various countries. Presence of employees and other representatives of foreign companies may give rise to exposure to PE or POEM of companies in offshore jurisdiction(s), resulting in potentially additional tax burden and hence, litigation. The OECD has examined these issues and has provided some guidance on them at the request of concerned countries.
The OECD is of the view that exceptional and temporary changes, resulting from the COVID-19 situation, should not create a PE for employers in other jurisdictions nor should temporary conclusions of contracts by employees or agents in another jurisdiction create PE for enterprises. As has been laid down in various Indian judicial precedents, a PE is defined as a ‘virtual projection’ of the entity in a foreign jurisdiction, where it conducts business for a sufficiently long duration. The OECD has suggested that tax authorities should provide guidance on the application of the domestic law threshold requirements, domestic filing requirements and in other respects to minimise or eliminate tax litigation arising from these temporary disruptions, leading to PE exposure in the context of the COVID-19 crisis. Relief will also need to be given for determination of POEM in India, so that the foreign company does not become a tax resident of India. There is no treaty provision for POEM and hence the domestic law will prevail. This may arise on account of forced presence of a decision maker of a foreign company in India due to COVID-19 imposed travel restrictions. Such forced presence in India may also create exposure to PE due to elongated presence of a service provider in India or the employee of the foreign company living in a fixed place in India, carrying out the core business activity of the foreign company in India.
The OECD is of the view that the COVID-19 situation should not create any change to an entity’s residential status (i.e. POEM) under the relevant tax treaty. As per the OECD, a temporary change in the location of chief executive officers and other senior executives is an extraordinary and temporary situation due to the COVID-19 crisis and such change of location should not trigger a change in residency, especially once the ‘tie breaker rule’ contained in tax treaties is applied. The OECD has advised that all relevant facts and circumstances should be examined to determine the ‘usual’ and ‘ordinary’ POEM, and not only those that pertain to an exceptional and temporary period such as the COVID-19 crisis.
It is therefore pertinent that tax administrations become sensitive to these unusual circumstances that are likely to arise in case of companies with globally mobile employees or executives and provide clarifications to make sure that litigations do not arise at a later date.