Tax Articles

Disruption in Cross-Border Assignments: Tax Impact on Individuals

By Atty. Fulvio D. Dawilan

In my article in this column four weeks ago, I discussed the tax impact of travel restrictions and quarantine measures undertaken in almost all jurisdictions, specifically the effect on cross-border transactions undertaken through assignments of employees and agents. I limited my discussion on the possibility of creating permanent establishments arising from the sudden disruption in the scheduled work arrangements or duration of projects. But as requested by some readers, I promised to discuss the other ramifications, especially with respect to the tax impact on the stranded individuals themselves.

The sudden imposition of travel bans and closure of air and sea ports forced workers to stay in jurisdictions they did not intend to be. This unintended presence or absence in a state could change the dynamics in the determination of the tax status of the affected individuals. In the Philippine domestic laws, the tax classification of individuals could be affected by the number of days they are present or absent in the country. Besides, the tax treaties concluded by the Philippines with foreign countries include the days of presence in the country of foreign individuals in the determination of whether or not they are obligated to pay tax. Any disruption therefore of their presence in the country may have unintended tax consequences not previously considered in the equation.

And this disruption gave birth to a range of issues. We address a few of these situations from a Philippine tax perspective - limiting the discussion in the meantime to inbound employees (foreign individuals) and to the application of tax treaties.

The application of treaty rules on stranded employees proceeds from the rule found in a number of tax treaties to the effect that salaries, wages and other similar remuneration are taxable only in the person’s state of residence unless the employment is exercised in the Philippines. Also known as the place of exercise test, this means that if the individual is physically present and performs the employment services in the Philippines, the income from such services may be taxed in this country. Stated differently, the source of income is the Philippines if the service is rendered within the country and conversely, the source of income is outside the Philippines if the employee is physically present and performs the services there. It is only when the source of income is within the Philippines will its tax authority have the right to impose tax on the individual’s income. By the way, this mirrors the rules provided in our domestic laws where the Philippines has the right to tax foreign nationals only on their income derived from within the Philippines.

The tax treaties, however, provide three conditions for the income not to be taxable here, despite the physical presence and performance of employment services in the Philippines. Breach of anyone of those conditions will invalidate the exemption. One of those conditions that will give the Philippines the right to tax income sourced from the country is when the employee is here for more than 183 (90 in the case of the Philippines – US tax treaty) in any twelve month period (taxable year in some treaties). If less, the Philippines does not have the right to tax provided the other two conditions are present.

What does the disruption of the work arrangement due to COVID-19 have to do with the taxation of affected individuals? Needless, to say, the distraction in pre-planned work schedules in and out of the country altered the result of the application of the place of exercise test and the duration of stay in the country, and consequently modifying the tax impact on cross-border assignments.

The OECD Secretariat, in its Analysis of Tax Treaties and the Impact of the COVID-19 Crisis (Version 3 April 2020), issued guidance attempting to address these issues. To put emphasis on the supposed application of tax treaty rules, the Secretariat analyzed two situations: (a) a person is temporarily away from his home (perhaps on holiday, perhaps to work for a few weeks) and gets stranded in the host country by reason of the COVID-19 crisis and attains domestic law residence there, and (b) a person is working in a country (the “current home country”) and has acquired residence status there, but temporarily returned to his previous home country because of the COVID-19 situation. In the first scenario, the analysis concluded that it is unlikely that the person would acquire residence status in the country where the person is temporarily because of extraordinary circumstances. Similarly, in the second scenario, it is also unlikely that the person would regain residence status for being temporarily in the previous home country. In both cases, such a temporary dislocation should have no tax implications. A number of countries have issued their respective guidelines espousing the same tax treatment.

An interpretation from a Philippine perspective could be different, in the absence of a guideline issued by our tax authority. In the first situation, the person will become taxable in the Philippines. With a prolonged stay in the country and at the same time rendering the service here, the source of the income is the Philippines coupled by a possible breach of the number of days allowed for exemption. As such, the related income becomes taxable in the Philippines. In the second scenario, the Philippines may lose its right to tax the individual due to his physical absence and the reduction of days the individual is present in the Philippines.

While the failure of employees to work in their place of employment is already a complicated issue, the absence of rules to guide the employees, their employers and the tax authority lends further complexities on taxation matters. In the absence of rules, we might be unduly imposing obligations on those who should be free from tax. But we may also be losing taxes that are rightfully due to us. As in some countries, our tax authority should issue guidelines in the proper evaluation of tax status of individuals unintentionally affected by the disruptions in the cross-border assignments.