Report on a session that took place as part of the 24th Annual US and Europe Tax Practice Trends in Munich on Friday 12 April 2024

Co-Chairs

Elizabeth J Stevens, Caplin & Drysdale, Washington, DC
Christian Wimpissinger, Binder Grösswang, Vienna

Speakers

Michaela Engel, Noerr, Munich
Seth J Entin, Greenberg Traurig, Miami
Raul-Angelo Papotti, Chiomenti, Milan
John Stokes, Organisation for Economic Co-operation and Development, Paris
Andreas Weithaler, ALDI SÜD Holding, Salzburg

Reporter

Heather Fincher, Kostelanetz, Washington, DC

Introduction

The Covid-19 pandemic instigated a lasting shift in preferences for remote work, especially for those whose primary professional interface is a laptop. As remote employment relationships become more prevalent, employers and employees face a variety of critical tax issues. Using case studies drawn from recent experience, this panel of in-house and external advisers explored some of the most relevant tax issues stemming from cross-border working arrangements.

Panel discussion

A company perspective: ‘workation’

Andreas Weithaler kicked off the discussion by providing insight into ALDI SÜD Holding’s remote work abroad policy, called ‘workation.’ For ALDI, the drive for global mobility is a response not only to the desire of the workforce, but also the demand for more flexibility within the business. Using the technology available today, people are taking advantage of opportunities to work from anywhere and everywhere, and companies are responsible for developing policies that guarantee compliance with the relevant tax and employment-related rules.

The main challenge facing ALDI is complying in a globalised world with antiquated laws that were created when the internet and computing did not exist as they do today. Christian Wimpissinger agreed, pointing out that many of his clients actually prohibit remote work to avoid permanent establishment (PE) issues. But ALDI is forging a path forwards: its workation policy allows people to work up to 30 days remotely from a location other than Austria. Not every country is automatically authorised for workation however. Only those countries for which a comprehensive analysis of the national legal situation has been carried out in advance are eligible, which means that it has been determined as to whether workation can be implemented without risk for the employees and the company. In order to avoid issues related to PEs, the company hands out a list of ‘dos and don’ts’ to everyone applying for workation. The lists clarify who is eligible and covered by the policy and include other strict terms, for example relating to the use of a power of attorney abroad, as well as negotiating, signing and ending contracts. Accurate practical execution is ensured by the human resources (HR) team handling the practical processing, ie, from application to approval, according to a standardised process.

For ALDI and its employees, the workation initiative is a success. Weithaler remarked, ‘Our people love it. It’s the new normal.’

An update from the Organisation for Economic Co-operation and Development (OECD)

In John Stokes’ update, he explained that the OECD has been working in earnest since 2011 to address issues associated with global mobility. In 2017, the OECD’s work in this regard was manifested in commentary to Article 5 of the OECD Model Tax Convention, providing new guidance on when a home office may give rise to a PE. But what was right back then may not be right now, Stokes explained, especially given that the Covid-19 pandemic has accelerated the mobility trend since then.

Last September on ‘stakeholder day’, OECD delegates met with a number of stakeholders from business, non-governmental organisations (NGOs) and a variety of other backgrounds to discuss issues related to global mobility. Stokes summarised the two key takeaways from this event: (1) confirmation is an increasingly important topic to work on and (2), among the large number of issues associated with global mobility that need to be addressed, the most pressing is related to the home office PE. On home office PEs, the ideas put forward by stakeholders varied as to the form of the solution. For instance, should the OECD update its Model Treaty or the commentary? Should it provide a safe harbour based on the employees themselves or by stating the circumstances in which a home office does not constitute a PE? Stokes emphasised that the OECD’s work in this area is complex, particularly due to tensions among different jurisdictions and their competing priorities.

OECD Working Party One met in February 2024, and Stokes stated that everyone is now agreed on the key issues that need to be addressed. With home office PEs as the highest priority, the current focus is on developing solutions. But Stokes pointed out that the process will be iterative, as the OECD is keen to address other priorities associated with remote working in parallel, for example the administrative burden posed by managing payroll across multiple jurisdictions, the creation of micro-PEs and handling the allocation of profits. The OECD intended to identify possible solutions to the challenges presented by home office PEs by the end of 2024.

Case studies

Scenario one

Advisory services: a non-Italian executive of a non-Italian company provides advisory services to Italian alternative investment funds (AIFs). The executive’s home is in a foreign country (other than Italy), where his minor children live, and he has additional children and family members living in Italy. The executive spends less than 60 days a year working in Italy and, including personal travel, he spends less than 183 days in total in Italy.

Raul-Angelo Papotti highlighted a recent change in Italian law concerning the tax residence of individuals. Personal and family ties should prevail over business interests for the purpose of determining the place of domicile of an individual (ie, one of the criteria to determine Italian tax residence).

Papotti explained that the AIF scenario is typical of situations involving private equity where there is no local Italian advisory service. Executives fly in and out of the country for a few days at a time to communicate financial promotions in relation to AIFs, but without conducting or transmitting orders. Due to the increasing numbers of individuals moving to Italy for the Italian charm, lifestyle and tax incentives, the same executives are staying longer on Italian territory for personal reasons. Now, following the amendments to the Italian tax residence criteria, such executives may be considered Italian tax residents if their physical presence, habitual abode or domicile (as newly defined) are on Italian territory for at least 183 days in a calendar year (184 days in a leap year).

Michaela Engel compared this situation with German law. Germany’s beer gardens, outdoor activities and culture draw many visitors to the country, but German tax residency does not only depend on the number of days a person spends in the country, but instead is triggered when a person has regular access to a flat or home located in Germany. Wimpissinger expressed caution that these types of domestic law differences can have dramatic consequences. For example, when someone lives in Austria, has an apartment in Germany and is an Austrian resident under the relevant tax treaties, the individual will still be subject to German domestic inheritance taxes.

Scenario two

A manager or employee abroad: Max, an employee of a non-German company with no offices in Germany (‘A-Co’), works mainly from his apartment in Germany. About five days a month, Max works from A-Co’s offices abroad, while staying in different hotels.

Engel launched a lively discussion into whether Max creates a German PE for A-Co by describing recent German guidelines. The guidelines provide that an employee’s home office is generally not regarded as a PE of the employer. This is true even when the employer pays (or reimburses) the rent or in situations where the employer does not make any other workspace available to the employee. But Max’s home office may be regarded as a PE if A-Co has a key and regularly uses the home office. But why is this the case? Max’s private home needs to be sufficiently at the disposal of A-Co, and the guidelines define this narrowly. Germany’s domestic trade tax has probably influenced this decision: every German municipality in which an employer has a PE can impose an additional layer of tax, which could result in thousands of additional PEs per company, due to the establishment of employee home offices, from a broader perspective.

PE implications may also arise from Max’s role with, and the activities performed for, A-Co. The panellists discussed three examples in this regard.

First, if Max negotiates the terms and conditions of contracts for A-Co, but does not have the authority to conclude the contracts, is an agency PE created? The panellists raised questions on the interpretation of an agency PE that can differ among jurisdictions.

Second, if Max is one of two managing directors jointly authorised to represent A-Co, does he create a PE for A-Co? Engel explained that if Max carries out management activities for A-Co from his home office in Germany and is found to be at least one centre of management for the company, then he may create a PE. The panellists commented that this type of analysis can lead to profit allocation, exit tax and other potential issues when working in jurisdictions that determine PE based on the place of management.

To illustrate this point, Wimpissinger provided an example, referring to the double income tax treaty that exists between Austria and Germany that grants taxing rights over managing directors’ salaries to the company’s resident country. If A-Co is an Austrian resident and Max’s home office in Germany triggers a PE, then both Germany and Austria can assert taxing rights over his salary. This results in multi-jurisdictional payroll issues for A-Co. Separately, Papotti mentioned new regulations in Italy related to allocating profits pursuant to an investment management exception.

Third, if Max is a software developer and develops software from his home office, does he create a PE for A-Co in the country where his home office is located? Maybe not in jurisdictions like the United States, when such activities are not a core part of the business. But, Engel added, if Max is also a managing director of the company, then the German management PE could also relate to the software development, which raises additional questions as to the ownership allocation of the intangible assets created.

Scenario three

Executives of a holding company and subsidiary: executives of two non-US corporations, a holding company (‘non-US holding’) and its operating subsidiary (‘non-US sub”), spend significant time in the US and either work from home or from one of the company’s rented office spaces.

Seth J Entin initially clarified that the presence of the two executives in the US does not impact the US tax residence for either corporation. Domestic law is binary: is the company incorporated in the US or not? Next, Entin summarised the applicable analysis in the context of the US for each company in three steps, noting that taxpayers can achieve interesting and positive results under US domestic law (steps one and two) before even getting to the PE aspect (step three).

First, is there a trade or business in the US (USTB)? To illustrate, if an executive of non-US holding, Exec A, coordinates the overall strategy, sits on the board of directors of the operating subsidiaries and manages non-US holding’s US and non-US passive investments, then US common law typically concludes that non-US holding is not engaged in a USTB. However, if an executive of non-US sub, Exec B, supervises 300 employees who are located outside the US, then Exec B’s management activities in the US on behalf of non-US sub generally would result in a USTB. Entin highlighted that having a USTB automatically triggers a US filing requirement for the non-US sub, regardless of whether the USTB gives rise to any taxable income.

Second, is any of the income effectively connected with the conduct of the USTB (otherwise known as effectively connected income or ECI)? Entin walked the audience through the labyrinth of domestic rules addressing how the non-US sub’s income could be roped into the US tax system as ECI. Importantly, the analysis begins by identifying the nature and type of income in order to categorise it before applying the appropriate sourcing rules and ECI analysis.

For example, if non-US sub sells artificial intelligence (AI) chips, then the analysis can turn on the interaction between the place of sale, the place of manufacture, the activities of Exec B or any US office and sometimes the activities of a non-US office. If the non-US sub leases out technical equipment, then the most important question is where the property is used. But if the non-US sub performs technical services, then income is sourced based on the place of performance. In some cases, Entin explained, Exec B’s activities could cause income allocation to the US, although this would require a nuanced and reasoned analysis of Exec B’s functions in the framework of the overall non-US sub organisation according to rather sparse regulations and case law.

Finally, if a treaty applies, is there a PE and are any profits attributable to that PE? Entin remarked that the US authorities have not stepped up to the plate on the home office issue, before observing that a home office clearly could give rise to a USTB. And, as part of a PE analysis, there is a risk that the US authorities could take the position according to a substance-over-form argument that Exec B’s home office is used regularly and is, therefore, at the disposal of non-US sub. In response to an audience question from Stuart Chessman, Entin took this analysis a step further by explaining the additional risk at the state level, as tax treaties do not apply to state tax purposes, and some states may impose additional tax regardless of whether a tax treaty applies, while others impose tax on the income determined at the federal level, taking into account any applicable tax treaty relief.

Final remarks

Weithaler said that the number of issues raised in the global mobility context far outnumber what the panel discussed and extend beyond tax law to areas such as social security, labour law and immigration. What is needed is harmonisation across all of these areas of law to enable economically sensible and necessary ways of working internationally in a globalised world that avoids complex administration and excessive compliance risks.

Stokes explained that the solutions to all of the themes discussed are neither easy nor straightforward, but the OECD is confident that it has an understanding of what the problems are. That provides it with the basis it needs to reach some resolutions.

Papotti commented that in Italy, the push is to attract business and people to the country. Taxpayers may obtain advanced clearance on the applicable Italian tax treatment (and in regard to the fact that activities performed in Italy by employees do not create an Italian PE) by filing specific ruling requests with the Italian tax authorities.

Entin said that the US rules on USTB and sourcing are antiquated and do not contemplate the internet era. Under these rules, the analysis begins with a classification of the income, which in our day and age can be difficult, but is necessary in order to apply the rules, and can sometimes yield counterintuitive results.

Engel noted that the times in which we live are challenging and as long as we lack clarification, she advises clients to ask for a ruling from the relevant authorities or, at the very least, contact the tax authorities in order to submit a declaration on the situation as it is, so that they avoid being hit by severe penalties.