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Where were you when the music stopped?

David Sandison David Sandison

Think of COVID-19 what you will, there is no doubt that the reactions to it by various governments around the world are going to have massive, possibly unprecedented, economic implications in due course; and if you believe that these same governments are not going to be out hunting for tax revenues when it is over – or even beforehand, good luck with that.

How the global economy will play out however, is for fortune tellers to foretell and minstrels to recount. But the “lockdown” itself brings immediate tax challenges to businesses in Singapore and elsewhere. It also raises some interesting questions about the fitness for purpose of current (and long-held) internationally accepted tax principles in this new age of technology, as it begins to dawn on us that there is actually a lot you can do from anywhere. Some of these principles may be well past their sell-by date.

This article looks at some of the immediate tax issues thrown up for companies and individuals, and throws down some food for thought on traditional tax concepts that are now being put under the microscope.

As you will be aware, the imposition of self-isolation and lockdown law has caused the music to stop in the game of musical chairs of international trade. Some people will have been trapped abroad; but far more likely, many will have been trapped at home.

So why is this important in a tax context? Well, from the point of view of a company, the answer comes in three words, but two concepts: Tax Residence, and Permanent Establishment (PE). Both of these concepts have a bearing on where the company may be taxed. From the point of view of an individual, there may be personal tax implications, not to mention immigration complexities (which we won’t cover in this article).

Focus on company matters

To understand the residence and PE implications, it is necessary to determine what gives a jurisdiction taxing rights over business profits.

With a few notable exceptions (Singapore being one of them), most countries impose taxation by reference to whether a person is tax resident there or not. So, a company that is tax resident in, say, the UK is, in principle, subject to tax in the UK, whether its income is earned in the UK or elsewhere. So it is important to know where a company is tax resident.

On the other hand, all jurisdictions have the right to tax income that is generated within their borders, or is “sourced” there, although some may exercise the right to exempt it or tax it favourably. It is therefore vital, in every case, to know whether a source of income has been created in a particular jurisdiction.

No prizes for pointing out that this can give rise to double taxation; but resolving those situations when they do arise, is not the point of today’s discussion.

So what determines residence?

The importance of residence from a Singapore perspective is an interesting one, given that it does not impose tax by virtue of a person’s residence in Singapore. However, it can be important in obtaining access to Singapore’s tax treaty network, or to qualify for certain tax reliefs and exemptions available only to residents.

Internationally, residence for companies can be determined in two ways: it can be where the company is incorporated, but only some countries apply this concept; it can be determined by where its “central management and control” is located. Or it can be both. Singapore judges residence only by the latter.

Determining where a company is incorporated is a straightforward question of ascertainable fact. The question of “management and control” however, is far more subjective and “fluffy”. Without going into great detail (the question merits a thesis on its own), it is generally taken to be where the real control of the company and its business is based; and real control can only be exercised by people genuinely in charge of the strategy or direction of the company, not by third-party hired hands (e.g. nominee directors) employed for the purpose of rubber-stamping decisions actually made by others, elsewhere.

Determining residence is a problem at the best of times in the modern world, especially where certain jurisdictions can collect more taxes by successfully arguing that a company is resident in its jurisdiction. Global businesses involve diverse geographical activities and input from experts and decision-makers spread around the globe.  It is managed, as well as it can be, by ensuring board membership for staff close to the business operations; but the anchor point is almost invariably where board meetings, at which important strategic or major business decisions are really made, physically take place.

So there is already some daylight showing through the cracks in this model, in today’s connected world, where meetings can be held by phone or video conference, or email round robin. Secure signatures can be embedded in portable document format.

The lockdown is bringing these issues into focus. It is not a particular problem if all the board members are based in the same jurisdiction as that of desired residence of the company, even though they may be under physical lockdown. Such companies would generally have little concern over residence. It is companies that rely upon physical board meetings, where board members need to fly in from their home country, to the selected location, that are going to face the problems.

Permanent establishment

Arguably, a source can be created by any in-country activity for however short a period. Fortunately, tax treaties universally adopt a pragmatic solution to what would otherwise be an administrative nightmare. This is that they only allow a country to tax activities carried on within its borders by a company resident in a tax treaty-partner country if the presence creates a PE there. Although the definition of what constitutes a PE is rarely crystal clear from any treaty, it involves (no rocket science here) a degree of “permanence” of staff and\or location; but it can also include the local presence of people other than employees based in the country, who have an authority to conclude contracts on behalf of the non-resident, do so habitually, and largely for that person.

The tax residence of a company (central control and management) should not be mixed up with where it carries on its day-to-day business (PE). These can be completely different. So, a company can be tax resident in Australia, but conduct some of its activities in say, Singapore. On the other hand, they can be one and the same, depending on the level of the Board members’ (executive) involvement with the running of the business.

So, when you have key people in your organisation, stranded in a particular location that they are not generally intended to be in, you can end up with both residency and source issues; and at least one of them.

Focus on individual matters

The obvious implications for individuals are that they get inadvertently caught up in being taxed in the country they are stuck in, as well as taxed in their country of residence or from where they would normally be exercising their employment.

In a Singapore context, there are broadly three stages to determine the tax position of individuals who come to Singapore in the performance of their employment duties for non-resident companies. The first is the 60-day rule. Where such employees (which excludes directors of the company) spend 60 days or less in Singapore in a calendar year exercising their employment, they are exempt from Singapore personal tax under domestic law. Where they spend between 61 and 183 days (inclusive) in Singapore, then they may be protected from Singapore tax under a tax treaty; but not always. There are further conditions to consider. However, once they have been here for more than 183 days, that treaty protection falls away and they will be taxable in Singapore for all of their income from the date of their first arrival. The only question is whether they get taxed at tax resident rates, or as non-residents – which may lead us back to the treaty.

Singapore’s stop-gap measures

In the current crisis, a number of countries have introduced “stop-gap” measures for dealing with hopefully, the temporary situation. Some may be complementary with each other, some may clash. However, Singapore has introduced its own measures which we discuss briefly below. On the face of it, the measures seem pragmatic. They acknowledge that “permanence” cannot be implied when the intention was plainly temporary or involuntary. But a closer look suggests they are not that dramatic in the context of the normal rules. The measures cover companies and individuals. Obviously, Singapore has no control over how other countries may approach these issues when the shoe is on the other foot.

Focus on company measures

Corporate residence

Essentially, the residence measures look at residence from two perspectives: a claim to be tax-resident; and a claim to be non tax-resident, for 2020. For both of these, it is necessary to show (through documentary evidence) that the company:

  • has been unable to hold its Board meetings in the usual place, as a result of the COVID-19 travel restrictions;
  • was tax resident as now claimed, in the previous year; and
  • has not subsequently experienced or implemented any changes to its economic circumstances.

Perhaps the most revealing (and likely unintended insight) from the pronouncements is in relation to the breathing space granted to a company which claims non-residence, but which “has to hold its Board of Directors meeting in Singapore due to the travel restrictions….” All well and good if the Board comprises non-residents trapped in Singapore. Life must go on. Or life can be deferred, or meetings held by video conference. But what if the Board members are all trapped at home in Singapore, but usually skip somewhere else for Board meetings? Does that not raise questions about where the real management and control resides? It could also raise questions about the source of the income of the company if the directors are also responsible for carrying on the day-to-day business of the company (the residence-PE loop).

Permanent Establishment

The PE measures are all about accepting that a PE has not been created in Singapore as a result of these unforeseen circumstances for businesses that normally operate outside of Singapore, and with only sporadic incursions.

Essentially, the IRAS will accept that unplanned stays do not result in the creation of a PE in Singapore provided it can be shown with documentary evidence:

  • the foreign company did not have a PE in Singapore in the previous tax year;
  • there are no other changes to the economic circumstances of the company; and
  • the extended presence of the employee(s) in Singapore is temporary, unplanned and due solely to travel restrictions relating to COVID-19.

Interestingly, the IRAS consider “temporary” as meaning not more than 183 days in 2020, from the date of first arrival.  It is submitted that this is hardly a concession, given that 183 days is commonly associated with a PE “trip-wire” under normal circumstances.

Focus on individuals measures

The measures relating to individuals are split into two situations. In the first part, they deal with Singaporeans and Singapore Permanent Residents (PRs) exercising overseas employment who are now “working remotely from Singapore”. The other deals with non-resident foreigners trapped in Singapore when the music stopped.

For Singaporeans and PRs working remotely from Singapore, IRAS are prepared to accept they are not exercising employment in Singapore as long as they leave by 30 September 2020, or such other date as may appear appropriate in the uncertain circumstances. This is provided the duties they perform here are part and parcel of the same employment arrangement, and it is a COVID-19-induced temporary arrangement.

Foreigners trapped in Singapore and working remotely as a result of the virus control measures will not be regarded as exercising employment in Singapore for the whole of their enforced stay. So far, so good. However, the “concession” carries a condition that this applies only if the extended stay is for a period of not more than 60 days…. In short, this means that if the original intended stay was 50 days, but the employee was trapped here, he has earned himself a 60-day extension and could be around for up to 110 days. The somewhat difficult-to-prove condition is that the work performed during the extension period is not connected to the original business assignment in Singapore, and would have been performed elsewhere in the absence of the travel restrictions.

Generally, this concession adds little for an employee who could have been protected for up to 183 days under a treaty.

Implications for “accepted” norms of taxing businesses with international operations

As noted above, all countries are given the right to tax value-add activities that are conducted within their borders. Sometimes, under domestic law, they will give themselves the ability to tax even a one-day visit. Fortunately, tax treaties have stepped in to prevent a complete administrative bloodbath, by requiring a presence to have a degree of permanence or regularity before a business becomes ensnared in the tax administration of another country; and few will dispute that this is an acceptable approach. It may have some rough edges in practice (such as defining more precisely when a PE is “tripped”); but it is generally acceptable nonetheless.

Where the right to impose tax becomes increasingly murky however, is in relation to tax residence. Not only is the question of residence elusive at the best of times, but the current global confusion, which has spurred the inevitable reach for (and in many cases acceptance of) technology, has shown it to be largely a concept of vanishing significance.  

These remarkable times are now (or should be) causing us to re-examine some fundamental concepts that were formulated when steamships and wax seals were the norm. It may now be time to consider addressing the following innocent questions:

  1. Where is a company actually tax resident?
  2. Why should tax be imposed by reference to residence rather than source as it is in most countries? It is after all the crossover between the two that gives rise to double taxation and the fundamental need for tax treaties in the first place.
  3. What if, as a matter of incontrovertible fact, a company does not have any real control centre, and it actually is spread across the globe? Is the company resident nowhere? Or everywhere?

There do not seem to be any convincing answers - other than self-perpetuated tradition, and the fact that there is no compelling motive for most tax-revenue-thirsty jurisdictions whose systems are based on worldwide taxation to change the status quo. With COVID-19 pressing pause on the record player, tax revenues are expected to fall. On the other side of the equation, governments have increased spending to keep businesses dancing. Will governments take this brief moment to consider addressing these questions?

There are more challenges ahead, undoubtedly. The Chinese word for crisis, we are repeatedly and possibly incorrectly told, means both danger and opportunity. Nevertheless, this crisis presents an opportunity to grab the nettle and re-examine some fundamental tax issues, and make sure we do not waste this unanticipated time for reflection. “Because that is the way it has always been done” is not an acceptable answer.