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Tax Residency – the Impact of COVID-19 Travel Restrictions

Financial, Executive and Professional Risks (FINEX)|Mergers and Acquisitions
COVID 19 Coronavirus|Mergers and Acquisitions

By Stefan Farahani | April 27, 2020

Travel restrictions caused by COVID-19 may give rise to a tax residency risk for some companies.

Whilst HMRC has provided helpful guidance most tax authorities have remained silent. Tax residency risk may be insurable for a modest premium.

Residency Issue Posed By COVID-19

The determinant factor for tax residency is often where the “central management and control” (or a derivative thereof) is located. For example, Australia, France, Germany, Ireland, Spain, Singapore and the UK all have tax residency tests based on this principle. This is where a company’s board makes its key decisions which, in most instances, will be ascertained by looking at the location of the board meetings. Present travel restrictions will impact non-resident directors’ ability to travel to attend such board meetings. This may also affect the ability of professional directors in continental Europe to attend such meetings if they live in one jurisdiction and provide professional services in another. Given the longevity of travel restrictions is currently unknown, it may give rise to corporate tax residency risks.

Present travel restrictions will impact non-resident directors’ ability to travel to attend such board meetings.

Having finance companies, IP rich holding companies or property holding companies resident in low tax jurisdictions has generally been tolerated by governments and tax authorities, provided that the entities in such jurisdictions have real substance and board-level decision-making takes place there. Where governments have sought to apply tax to non-resident companies they have expressly sought to tax offshore gains (e.g. on UK real estate post 5 April 2019) rather than tighten the rules on determining residency itself. Travel restrictions imposed by COVID-19 will arguably demonstrate the sliding scale between those entities which do indeed have permanent substance in only the low tax jurisdiction and those where such substance is of an entirely transient nature. In reality, most off-shore companies sit somewhere in between these two extremes.

Guidance from Tax Authorities

Governments and tax authorities have generally been supportive of taxpayers facing difficulties caused by COVID-19 (for example by extending the deadlines for tax payments and introducing reliefs and exemptions). Indeed, the UK’s HMRC has provided a clear statement that “HMRC is very sympathetic to the disruption that is being endured…. We do not consider that a company will necessarily become resident in the UK because a few board meetings are held here, or because some decisions are taken in the UK over a short period of time. HMRC guidance makes it clear that we will take a holistic view of the facts and circumstances of each case.”1 Similarly the Irish tax authority has issued clear guidance that “Where an individual is present in the State and that presence is shown to result from travel restrictions related to COVID–19, Revenue will be prepared to disregard such presence in the State for corporation tax purposes for a company in relation to which the individual is an employee, director, service provider or agent.”2

Such guidance is extremely helpful to taxpayers and provides a good level of comfort. However, given the fact-based nature of residency tests, guidance cannot provide certainty as to their tax residency position – indeed, HMRC notes that “Each case turns on its own facts and circumstances which makes it difficult for HMRC to provide definitive guidance as to where CMC may abide in cases where businesses are forced to make changes in response to the COVID-19 pandemic”3. Nonetheless, the clarity that the UK and Irish tax authorities have provided to taxpayers is a positive step and hopefully it inspires other tax authorities to provide similar helpful guidance. Companies need to make rapid decisions in difficult circumstances – if further guidance is to be issued, it needs to come sooner rather than later otherwise companies will need to seek certainty via other means.

Where Uncertainty Remains

In jurisdictions where tax authorities decide not to provide clarity and reassurance to taxpayers, one might infer that, contrary to the UK position, they intend to closely review the residency of companies during this period. Time will tell whether or not such tax authorities will take a flexible approach to companies facing difficulties relating to corporate tax residency. It is not a far stretch to proffer that certain tax authorities will see the travel restrictions caused by COVID-19 as the chickens coming home to roost for entities that have engaged residency-based tax planning.

In addition to a focus on low tax jurisdictions we would expect tax authorities to take a keen interest where a shift in residency could trigger large exit charges on unrealised gains. As the facts which underpin residency (such as the location of board meetings) are typically well documented, tax authorities will be able to undertake thorough reviews in the fulness of time. Companies are currently focussed on cash preservation and cost savings – an unexpected tax liability would be highly undesirable.

Risk Mitigation

We understand that companies are actively engaging with their tax advisors to make sure they fully appreciate the nuances of the rules and guidance in their respective jurisdictions. This early engagement with the advisor community is to be encouraged.

Risk mitigation in order to avoid shifting residency might include properly documenting the COVID-19 situation, restricting non-resident directors to being observers/not voting, restricting overseas dial-ins and even considering whether hosting a board meeting in a different/unrelated country may be appropriate. Any such measures will need to be considered in the light of the corporate governance framework and constitutional documents of each company.

However, questions of tax residency are necessarily fact dependent and the present situation will leave many companies open to a residency-based challenge from tax authorities. Whilst taking the steps above may reduce the risk of a successful challenge by a tax authority, they cannot protect against the associated costs of a dispute nor provide absolute certainty of the tax position.

Achieving Certainty

Willis Towers Watson has significant experience in arranging insurance of tax residency risks.

Insurance may be an appropriate solution where COVID-19 travel restrictions result in an interruption to the normal affairs of a company (including, for example, one or more board meetings) but where on balance the tax analysis suggests that tax residency has likely not migrated.

Insurer appetite for tax residency risks remains high. This is expected to continue to be the case for businesses with a robust residency position that have been subject to disruption caused by COVID-19. Rachel Hine of Certa Insurance Partners comments “Whilst tax authorities appear generally sympathetic to Covid-19 residence issues, their guidance only provides taxpayers with soft comfort. Tax insurance can provide peace of mind to allow businesses to focus on the many other challenges they face during these unprecedented times.”

The insurance would provide the added layer of certainty by protecting against a risk of challenge by a tax authority. In particular, the insurance would protect against:

  • any tax resulting from the challenge (including funding any tax which is payable in order to make an appeal);
  • interest;
  • penalties; and
  • advisor fees associated with defending a challenge by the tax authority.

In order to provide terms for a residency risk, insurers will typically want to review and/or understand:

  • the board minutes;
  • any correspondence with the relevant tax authority relating to residency;
  • residency certificates (where relevant);
  • the residency status and professional experience of the individual directors;
  • any operational handbook that the company has on residency (if any exists); and
  • any tax advice the company has received in relation to residency.

Pricing will depend on the specific facts and the jurisdiction in question, but in most instances we would expect pricing to be between 0.75% and 2.75% of the policy limit purchased.

Restrictions on travel may also give rise to permanent establishment risks which may also be insurable.


Footnotes

1 https://www.gov.uk/hmrc-internal-manuals/international-manual/intm120185

2 https://www.revenue.ie/en/corporate/communications/covid19/compliance-with-certain-reporting-and-filing-obligations.aspx

3 https://www.gov.uk/hmrc-internal-manuals/international-manual/intm120185

Authors

Practice Leader Mergers & Acquisitions,
FINEX Global

Executive Director, Transactional Risks Team

Director of Tax and Investment Structuring,

Transactional Risks Team


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