COVID-19 and the various measures implemented to fight the pandemic have significantly disrupted how many taxpayers do business across the globe, including the ability for directors, management and staff to work and travel in the usual way.
This disruption might justifiably give taxpayers cause for concern in relation to the tax residence of companies, particularly when considered in light of the seemingly increased focus on this topic of late. For example, the increased dual residency risk for NZ companies with certain connections with Australia, and the changes to tax treaties as a result of the Multilateral Instrument, including but not limited to the NZ-Australia treaty.
Against that backdrop, it is reassuring to see the recently released public statement and associated Q&A document on COVID-19 tax residence issues from New Zealand Inland Revenue (IR). The Q&A document covers a number of issues and is a living document that is frequently updated.
This statement is complemented by OECD guidance on tax treaties which was released in early April 2020. This guidance covers treaty issues (relating to tax residency and permanent establishments) that may arise as a result of COVID-19. In addition to this, for those dealing with Australia, the Australian Tax Office released similar guidance in March.
This guidance collectively addresses potential issues in applying the following New Zealand corporate income tax concepts:
- company tax residence
- fixed and permanent establishments
We have commented on each of these below.
The IR statement also covers the tax residency consequences of the COVID-19 travel restrictions for individuals, which we separately comment on here.
Company tax residence
IR guidance on New Zealand’s domestic rules
Under New Zealand’s domestic tax rules, a company is considered a New Zealand tax resident if the company:
- is incorporated in New Zealand;
- has its head office in New Zealand;
- has its centre of management in New Zealand; or
- director control is fully or partially exercised in New Zealand.
IR’s guidance seems to focus on the director control test, in the scenario where directors of a non-resident company (for example, a foreign subsidiary of a New Zealand headquartered group) are not able to leave New Zealand due to COVID-19 travel restrictions. The guidance states that a factual consideration of how a company is managed in reality is necessary, and that if the directors are stranded in New Zealand that will not change where the “real business” of a company is carried on. Therefore a company will not be a tax resident in New Zealand, provided that the director control exercised in New Zealand is only “occasional”.
The guidance does not specifically comment on, for example, company executives being stranded in New Zealand and/or the centre of management test. However, we would hope that similar principles would be applied by IR.
Dual residence risk
One topic on which IR’s guidance (quite reasonably) does not comment is the reverse scenario, i.e. directors of a New Zealand incorporated company attending board meetings from overseas, which could potentially give rise to overseas tax residence for the company (depending on the relevant tax residence tests in the particular overseas jurisdiction). Where the company is resident overseas in addition to being resident in New Zealand, this is referred to as dual residence (i.e. becoming tax resident under the tax laws of more than one country).
In the context of Australia, it is worth noting that Australian Taxation Office guidance (see Deloitte’s comments on this here) indicates that temporary changes arising from COVID-19 travel restrictions should not cause a company to become Australian tax resident in the absence of any other change in circumstances. This may help to mitigate Australia/New Zealand dual residence concerns during the crisis. We would also expect that tax authorities elsewhere could take similarly pragmatic views.
Nevertheless, given the potential for COVID-19 to change the way in which directors and management carry on business, this possible risk is something that should continue to be closely monitored. Where control of a company is being exercised from overseas (e.g. directors are attending board meetings overseas, or where senior management are located in different countries) it will continue to be as important as ever to ensure that any adverse tax consequences of dual residence are able to be managed.
OECD guidance on tax treaty "tie breakers"
In the event that a company is resident in both New Zealand and another country, an applicable tax treaty may provide a "tie breaker" test. Depending on the tax treaty, this could be a mutual agreement procedure between two tax authorities, or could also be a factual “place of effective management” test.
In either case, the OECD’s guidance (which would presumably generally be followed by IR and other tax authorities) is that regard should be had as to how the company was usually managed, and not only the circumstances relating to “an exceptional and temporary period such as the COVID-19 crisis”. This means that if there is a temporary change in the way a business is managed during the crisis, this may not impact on the application of tax treaties.
A related issue is how the COVID-19 disruption might impact on the “fixed establishment” test.
Under New Zealand’s domestic tax rules, an entity that carries on business in New Zealand through a “fixed establishment” (i.e. a taxable presence) in New Zealand may be subject to tax on the profit attributable to that fixed establishment.
IR’s guidance states that having a presence in New Zealand for only a short period of time during the COVID-19 disruption will not cause a non-resident entity to become subject to tax in New Zealand. The guidance notes that the following requirements must be met for an entity to have a fixed establishment:
- there must be a degree of permanency, i.e. not of a purely temporary nature; and
- the business must be carried out there on a regular basis and partly or wholly undertaken at that fixed place.
IR goes on to state that whether there is a fixed establishment is determined having regard to the facts and circumstances of each case, meaning that it will be relevant if the company did not have a presence in New Zealand prior to COVID-19, and that the presence of employees in New Zealand is only short term due to the current travel restrictions.
IR’s statement also refers to (and therefore appears to endorse) the OECD’s similarly pragmatic views on the creation of a permanent establishment (PE) due to COVID-19 restrictions. PEs are a related concept to the fixed establishment, and are relevant for allocating taxing rights between countries under New Zealand’s tax treaties. The OECD’s guidance broadly concludes that temporary changes to the location of employees or the manner in which business is carried on will not give rise to a permanent establishment. The guidance specifically states that:
- temporarily using a home office/working from home in a different country will not create a PE, either because it is not sufficiently permanent or because the business has no access or control over that one employee’s home office – and further the business provides an office available in “normal circumstances”; and
- temporarily concluding contracts in a different country due to a travel restriction or requirement to work from home will not be sufficient to give rise to an ‘agency PE’ because it will not be “habitual”.
Inland Revenue’s statement notes that Inland Revenue competent authority assistance is available if other countries are not applying this guidance in the same way.
The release of the guidance is welcomed. It is pragmatic and helpful for taxpayers and provides a degree of certainty as to how the corporate residence and fixed and permanent establishment tests are likely to be applied in the context of the COVID-19 disruption.
However, although the guidance provides some flexibility for taxpayers, some caution will still be required. The over-arching theme of the guidance is that only minor or temporary changes in the way businesses manage their operations will be disregarded (e.g. IR’s statement on tax residence indicates that the control of a foreign company by directors stranded in New Zealand must still only be “occasional”).
There is also still a level of uncertainty in that it is hard to predict when – or whether – the ability to travel internationally will return to normality, and how this will impact on the way businesses operate going forward. For instance, it may be that in future it is increasingly less practical for directors to travel internationally to attend board meetings, or that cross-border remote working practices for employees will become more common and directors refuse to travel. Therefore, although we would hope that Inland Revenue will continue to be pragmatic, there is likely to only be limited flexibility within the current rules. This means that in many cases, tax residence and fixed (or permanent) establishment issues will still need to be carefully considered and monitored.
Some of the corporate tax residence issues arising as a result of the COVID-19 disruption may also be worth broader consideration from tax policy officials. For instance, it could be argued that in an era when directors might be spread across the world, the director control test has become out of step with modern corporate governance practices and the ability to attend board meetings remotely. In the meantime however, taxpayers will need to take care to ensure that they are aware of the consequences under the current tax rules of having directors, management, or staff in different locations around the world.
If you would like to discuss further or have any concerns in relation to your business, please get in touch with your usual Deloitte advisor.
The content of this article is accurate as at 11 May 2020, the time of publication. This article does not constitute professional advice. If you wish to understand the potential implications of current events for your business or organisation, please get in touch. Alternatively, our COVID-19 webpages provide information about our services and provide contacts for relevant experts who can help you navigate this quickly evolving situation.