The pandemic has led a significant portion of the global workforce to opt for remote work. Without needing to report to a particular office each day, employees enjoy the opportunity to work in different countries. What better way to achieve work-life balance than to start your laptop in the country of your choice, allowing you to be closer to your family or take the opportunity to experience something different from what would have been possible otherwise?
I would dare say that when people are considering their ideal remote workplace, taxation is not a priority. This is completely understandable, as their employer, salary, and method of compensation will not change, so a change in tax status may not be obvious.
From a tax perspective, however, working in a different country can have significant consequences for both employer and employee.
Many countries tax income based on where the services are actually performed. So while an employee may receive their salary from an employer in one country, the employee’s new country of residence may seek to tax any income earned while providing professional services in that country.
Additionally, many countries treat a person as a tax resident if that person is physically present in the country for a certain number of days in a given year. The United States, for example, treats an individual as a tax resident based on a three-year formula known as the substantial presence test. If, according to this formula, the individual’s cumulative presence over a three-year period is equal to or greater than 183 days, he will be considered a US tax resident. This will subject the individual’s worldwide income to US tax and can lead to a myriad of required disclosures, many of which carry substantial penalties if compliance requirements are not met.
The United States, like many jurisdictions, will allow an income tax credit as a deduction from a taxpayer’s US income tax for income taxes paid to another country, known as foreign tax credit. The United States will allow a foreign tax credit for foreign income taxes paid or accrued in a foreign jurisdiction to the extent that the income is deemed to be of foreign source.
With respect to wages or service income, US tax law generates income where the services are provided. Therefore, if a US taxpayer provides services in a foreign country, the corresponding income is considered foreign source income for US tax purposes, even though the individual may be paid by a US employer.
Another issue that is often overlooked is social security taxation. Social security contributions may need to be paid in the country where the services are rendered, particularly if the employee works in that country for more than a certain number of days in a given year.
The United States has aggregation agreements with various other countries that address the issue of Social Security taxation and stipulate which country has the right to collect Social Security taxes, depending on the jurisdiction of the employer. and how long the employee will work in a particular country. Employees working in a country that does not have an aggregation agreement with their home country may find that Social Security or similar taxes are owed in two jurisdictions.
Depending on the functions performed, services rendered by employees in the country may subject a foreign employer to tax in that country, as the presence of the employee may give rise to a “permanent establishment”. The concept of a taxable permanent establishment exists in many countries and bilateral tax treaties, and may subject a portion of an entity’s profits to tax in a country where it has a permanent fixed presence. An employee working continuously in a country is often deemed to give rise to a permanent establishment in that country.
In May 2022, the Danish tax authority ruled that a German company has a permanent establishment in Denmark under the Germany-Denmark tax treaty, by virtue of an employee working from home in Denmark. The decision stemmed from an earlier decision from October 2021, when the Danish tax authorities refused to confirm that no permanent establishment existed when a foreign company employed a sales representative working from home in Denmark and carried out activities of sales for customers in countries other than Denmark.
Once an entity is deemed to have a permanent establishment in a country, the entity will need to determine the amount of profit, if any, that should be attributable to that permanent establishment for purposes of reporting and paying income tax. Income. For example, if an employee regularly enters into sales contracts on behalf of an employer, a portion of the entity’s profits from those contracts may be attributed to a permanent establishment and taxed accordingly.
An employee who performs back-office functions on a regular and continuous basis in a country may also give rise to a permanent establishment in this country. However, the amount of income or profit attributable to the permanent establishment may not be as large as the sales activities. For example, back-office services typically require a mark-up (usually 5% to 10%) above costs to determine the profit attributable to those services.
Employers whose employees work in another country will need to assess the need to register for payroll tax purposes in that country. It is often the employer’s responsibility to determine if there are any withholding requirements, in which case the employer will be required to withhold income and employment-related taxes from the employee’s pay and remit the appropriate amounts to the country’s tax authority. Failure to do so may result in interest and penalties.
Cross-border income tax and payroll issues have been a factor for companies operating internationally for many years. However, the recent surge in remote work arrangements caused by the Covid-19 pandemic has exacerbated cross-border tax considerations, the impact of which needs to be carefully considered by employees and employers now more than ever.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Marc Chaves is co-lead of Marcum LLP’s international tax services practice and partner in the Miami office. He assists clients with domestic and international tax planning and structuring, mergers and acquisitions, and corporate reorganizations, with a focus on helping multinational corporations manage cross-border tax issues, corporate credit planning, and corporate reorganizations. foreign tax and repatriation, and ASC 740 reports.
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