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International tax focus: Will COVID-19 travel restrictions affect corporate tax residence

Businesses are currently dealing with a multitude of issues as a result of the measures taken to stop the global spread of the coronavirus (COVID-19). One that might not currently feature at the top of the list is the maintenance of corporate tax residency. This has the potential to fall through the cracks when faced with bigger and more urgent issues. But it is an issue tax and legal teams need to be alive to and monitor over the coming weeks and months.

Corporate tax residency dictates where a company will be taxed on its worldwide profits (subject to any available exemptions). A company is generally tax resident in the country where it is incorporated or where it has its ‘place of effective management’. Place of effective management is typically the deciding factor where a company would otherwise be dual resident by virtue of being incorporated in one country and managed in another, either because:

  • a double tax treaty makes place of effective management the deciding factor; or
  • it is the most important factor taken into account by tax authorities when they have to agree who gets taxing rights under a double tax treaty mutual agreement procedure; or
  • certain domestic tax benefits may only be available to locally managed companies (e.g., with respect to use of losses, tax grouping).

Each country may have a slightly different interpretation of this test, often based on case law rather than precise statutory rules (and some countries may use somewhat different labels, such as the UK “central management and control” test). In general, however, these tests typically look at the highest level of control of a business and are invariably equated with the control exercised by the board of directors through decision-making at board meetings.

Many groups will be concerned to ensure that companies within their group stay tax resident in their country of incorporation, and often retain the required level of ‘substance’ there. This may relate to (holding, finance) companies that are intended to be tax resident outside the country where the group has its main business: e.g., a UK or German group may want to avoid risking any Netherlands or Luxembourg company becoming tax resident in the UK or Germany.

Groups typically will have procedures in place to safeguard this, and to maintain any required levels of substance. This will include guidance for directors that do not live in the country of intended tax residence, to travel to such country to attend board meetings in person. Such protocols will typically also exclude participation in board meetings by telephone or other electronic means from different locations, save in exceptional circumstances. Sometimes residence protocols are embedded within the relevant company’s articles of association themselves, although we would typically not recommend this.

Impact of COVID-19 travel restrictions

COVID-19 is making adherence to the necessary protocols almost impossible in the short term and there is the very real possibility that current travel restrictions and business disruption will continue for a number of weeks or months to come. This means companies having to grapple with issues such as whether board decisions are ultra vires because they are taken at board meetings convened otherwise than in accordance with the company’s articles, whether an “exceptional circumstances” let-out applies (in the articles or a separate protocol) and whether the place of management and therefore tax residence is in fact at risk of shifting from one country to another as a result of prolonged non-compliance with a protocol.

Absent a change in law or some sort of amnesty, the basic fact remains that a company with its effective management in country X is likely to be regarded as tax resident in country X, and it is not relevant that this was not the intended result or that the directors were prevented by circumstances outside their control from exercising CMC outside country X. Effective management, and therefore tax residence, is a pure question of fact.

Because determining tax residence involves viewing the facts in the holistic sense, a one-off board meeting convened in the “wrong” country or with majority remote participation from the “wrong” country – relying on an exceptional circumstances let-out – is unlikely to prejudice the intended tax residence of the company. And the current position with COVID-19 is almost certainly exceptional.

But a number of exceptions may well add up to a rule and tip resident status towards the “wrong” country. In other words, exceptional circumstances do not give companies a get out of jail free card; limiting departures from normal board protocols to exceptional circumstances is intended to ensure that those departures will be one-offs, but it does not help if those exceptional circumstances and departures become the norm.

It is worth noting that some jurisdictions have recognised tax issues surfacing as a result of the COVID-19 travel restrictions. Jersey and Guernsey, for example, have issued guidance (see here and here) confirming that companies will not fail the economic substance tests in these jurisdictions where their normal operating practices are temporarily not possible, for example by holding board meetings virtually rather than physically in Jersey/Guernsey, because individuals are unable to travel or are self-isolating as a result of COVID-19.

However, this is not at the top of the agenda to address for most tax authorities around the world and guidance on this issue from major economies is so far not yet available, although it is understood that requests for guidance on this issue are being made. See our COVID-19 Guide to global tax measures for updates on guidance published by tax authorities on this issue in key jurisdictions.

Inadvertent change of tax residence

The worst-case scenario from a tax perspective is an unintended shift in the location of the tax residence. This means the company in question could unintentionally become subject to a different country’s tax rules and therefore face unexpected tax or increased tax on corporate income and gains (as well as new filing obligations), may lose the ability to use interest deductions to shelter group taxable profits in the intended jurisdiction of tax residence, may cease to meet the qualifying conditions for benefiting from a special tax regime in that jurisdiction or may lose tax treaty benefits/protection.

The shift in tax residence could also result in exit tax charges inadvertently being crystallised.

Practical next steps

Where the planned board meeting is due to cover routine business, the best approach may be to delay the meeting until the relevant individuals are able to travel as normal. But there may be regulatory or commercial reasons why a board meeting cannot be delayed, or the current restrictions may just prevail for too long to make deferral an option.

Groups should be giving consideration to changing, or at least stay alert to the possible need to change, the composition of boards so as ensure there are enough local directors in situ to attend and make decisions at board meetings. These directors may need to be local professional directors, although care will need to be taken that they can realistically be seen as true decision makers: whether from within or outside the group, the local directors need to be suitably qualified professionals capable of making their own decisions in the best interests of the company. They may be briefed by executives or other employees within the relevant group who are based elsewhere, but the local directors' decision-making needs to be genuine and take place at the relevant board meetings; they cannot be seen as just rubberstamping decisions made by others. The other executives or employees may join the board meeting (in a non-decision making capacity) by phone or videoconference to talk through a briefing paper or presentation, but care should be taken to avoid perceptions of them still making the actual decisions. To the extent dialling-in is inevitable, it is often better to dial in from a variety of jurisdictions rather than all directors dialling in from a single ‘wrong’ jurisdiction.

Position in country of incorporation

On a final note, in many countries a locally incorporated company will automatically be locally tax resident unless it is managed in another jurisdiction that asserts taxing rights by virtue of the company being managed in that other jurisdiction and country of incorporation loses the double tax treaty contest. This, however, requires a critical mass of decision-making demonstrably to take place in that other jurisdiction and so also here a pattern of directors dialling in from multiple jurisdictions (with no majority in any other single jurisdiction) is unlikely to displace local tax residence.

A majority of directors joining board meetings from a single other jurisdiction (with a corporate tax residence test that takes into account location of management) for a sustained period of time as a result of travel restrictions may, however, risk prejudicing local tax residence and should be carefully monitored.