With no clear end in sight to teleworking during the pandemic, tax advisers are trying to prevent their clients from being surprised by a potential spate of new state and international taxes.
Workers stranded or sheltered in states or countries they don’t normally work from can expose companies to corporate income tax and a number of employment tax obligations. The odds of that are higher as stay-at-home orders drag on and employees work longer in those locations and risk creating a new taxable presence, tax advisers say.
Companies need to know where their employees are, how long they’ve been there, and which jurisdictions have said they’ll forgive unexpected cross-border tax liabilities during the pandemic. Without that information they risk compliance problems and unexpected tax bills, advisers warn.
“It’s not so simple as tracking information,” said Pilar Mata, tax counsel for Tax Executives Institute’s state and local tax committee. “It’s, ‘Do I have the systems necessary to do that?’ ‘Is it a short term or long term change’?”
Employees teleworking from a different state than they normally work in, and one the company doesn’t already do business in, can create a new economic nexus—meaning the company could owe income tax there.
“This telework issue is causing companies to look at what their footprint is in each state,” said Richard Cram, director of the Multistate Tax Commission’s National Nexus Program in Washington.
Employers would also need to withhold state income tax from paychecks.
Tracking a company’s state tax liabilities from remote workers is complicated by the fact that states have different time thresholds at which an individual becomes taxable.
Companies have always had to keep tabs on where their employees are, to be sure they’re complying with all international and local tax laws, “but the realities of today’s Covid environment have exponentially exacerbated the problem,” said Stephen Kranz, a partner at McDermott Will and Emery in Washington.
State tax obligations triggered by teleworking employees could also create a nasty surprise for foreign companies.
Bilateral tax treaties generally prevent companies from treaty partner countries from incurring federal tax obligations unless they meet high standards for creating a permanent establishment in the U.S. But treaties don’t protect foreign companies or their employees from state tax obligations, said Dan De Jong, a senior manager in KPMG’s state and local tax practice in Washington.
The widespread lockdowns have also left workers stranded across country borders, raising potential international tax issues for their employers.
An employee performing certain key functions—an executive or even a mid-level worker—in a jurisdiction can create a permanent establishment, or taxable presence, there for their employer. That means the company could face corporate income tax, as well as a number of obligations related to employment tax.
Companies are generally not concerned that their remote workers have already created permanent establishment, said Dominic Stuttaford, head of tax, Europe, Middle East, and Asia, at Norton Rose Fulbright in London. Sheltering in place for a few weeks is unlikely to appear to tax authorities to be a “permanent” business establishment, he said.
“But what happens if this continues for longer?” he said. If stay-at-home orders continue, “there’s more money for tax authorities to go after, and you’ve lost the temporary nature of the lockdown.”
Eventually there will be a “tipping point,” when a tax authority could argue that a temporary worker creates a permanent establishment, he said.
Tax treaties can help. They usually contain a clause determining what creates a permanent establishment—for example, presence in the jurisdiction for more than 180 days. The coronavirus lockdowns haven’t lasted that long—yet.
“But if you have employees stranded without a treaty, it causes real issues because then you don’t have a threshold day,” said Cathy Schultz, vice president of tax policy at the National Foreign Trade Council.
In addition to permanent establishment, if a company has a worker newly taxable in a jurisdiction, it should also worry about employment tax obligations like withholding from the employee’s salary and social security contributions. The company could also become subject to value-added tax in the jurisdiction, if the employee working there earns enough revenue for the company to put it over a registration threshold, Stuttaford said.
Companies are pressing governments to issue guidance on these issues, Schultz said—and some have. For example, there have been a series of agreements between Netherlands, Belgium, Luxembourg, Austria, and Germany to overlook the tax implications of cross-border work because of the pandemic.
But that’s happening “on a government by government basis,” Schultz said. “Not as many so far put out guidance as we would hope.”
The Organization for Economic Cooperation and Development released guidance April 3 that helps governments interpret permanent establishment clauses in tax treaties in the context of the pandemic. Under a treaty, companies shouldn’t incur new international tax liabilities when their workers end up elsewhere—in part because these circumstances are unusual and temporary, and not a “permanent” place of business, the OECD analysis said.
But that leaves an open question on how non-treaty countries will interpret these issues.
Within the U.S., companies are hoping for federal legislation declaring no state tax consequences for individuals working elsewhere during the crisis.
A number of states—including New Jersey, Mississippi, and Minnesota—have indicated they’ll be lenient when they consider the tax implications of remote workers during the pandemic. But many haven’t.
“Both employees and employers confront an uncertain landscape and the threat of significant administrative complexity as a result of the state tax law implications of extended telework,” said Sarah Shive, senior director of government affairs and counsel at the Information Technology Industry Council.
The best solution would be a federal approach that makes it clear what tax obligations cross-border workers incur, and prevents negative consequences for teleworking before employees can safely return to the office, Shive said.
—With assistance from David Hood