With more employees working from home than ever before, a recent tax case on permanent establishment (PE) involving a German company could be significant for international businesses’ future contracts with local representatives.
A German company selling goods online was looking to establish a market presence for its products in Denmark. It employed a Danish national to carry out a number of tasks, including:
- Evaluating the Danish market and its potential for future growth
- Operational and strategic development of the business in the Danish market
- Identification of potential partners and strategic partners
- Website development
- Coordinating the core functions of purchasing, pricing, accounting, logistics, product management and customer service
- Conducting marketing activities, investigating customer needs and growth potential and negotiating contracts with customers (though not having the authority to sign the contracts).
While it could have been argued that, in a business context, some of the activities above point towards them being ‘preparatory and auxiliary’ in nature, this was not a line of argument that was pursued in the case. The employment contract of the Danish employee was drafted for only a six month period (the bare minimum threshold for a PE to be created).
The company was to provide all equipment and necessary technical knowhow to the Danish employee for the employee to perform all the commercial functions and activities for and on behalf of the German company in Denmark. The employee’s base was to be his own home (and a home office agreement was in place between the German company and the Danish employee). The German company had no other office or branch location in Denmark.
The employee was to perform all the “core” business activities from his home, with occasional trips to the head office in Germany (limited to 3 days a month) with the rest of the time being spent in Denmark.
The Danish Tax Board (DTB) placed heavy reliance on the OECD commentary on PE in arriving at its decision. In particular, it focussed on the conditions that must be met in order for a home office to create a PE.
Under Article 5(1) of the OECD Model Convention, the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried out. For a PE to exist, there must be:
- A place of business
- The place of business should be “fixed”, and
- From where the business activities are conducted.
For the first test, the DTB’s view seems to have been that since the use of the employee’s home office was not random or irregular, and the office was meant to be used for a continuous period of time, the home office could be considered to be a place of business. This was underlined by the fact that the German company did not have any other place in Denmark that it could refer to as its place of business.
The second condition is that the place of business should be fixed, and should not be used on a temporary basis. Establishments have not normally been considered to exist in situations where a business has been carried on in a country through a place of business that was maintained for less than six months. While the ruling considers this rule, the DTB concluded that the place should be considered as being fixed, even though the employment contract was for a six month term, because the activity of the German company consisted of building a market for the goods of the German company in Denmark: an activity which pointed to further and continued activity in Denmark on a permanent rather than temporary basis.
On the final condition, given the activity of the Danish employee was not merely preparatory or auxiliary (but formed a core part of the German company’s business), the DTB had little doubt that the condition was met. Therefore, the DTB concluded that the German company created a fixed place of business PE in Denmark.
The OECD has released guidance on the implications of the COVID-19 outbreak for businesses in terms of tax residency and PEs. Please read our previous article here.
Notwithstanding the current pandemic, there has always been a heightened risk of a PE to exist if employees are present in a country for six months or more and engaged in business activities for and on behalf of a foreign enterprise. This is a widely recognised and accepted risk in international tax law.
If home working arrangements are written into employment contracts, or exist to the extent that they can be deemed to have become permanent fixtures (eg exceed the 6 month threshold), there may be a material risk that the tax authorities could seek to allege that they create a PE. Of course, each case depends on the facts - would a PE have been found to exist if the presence of the employee in Denmark was only to carry out preparatory or auxiliary activities? Similarly, what if the physical presence in Denmark was for slightly less than the six month threshold, or if there was an employment contract stating that the arrangement was to be temporary and limited?
Businesses need to be careful that any similar home working arrangements that have evolved under the COVID-19 lock-down arrangements in different countries do not become the norm in the post-pandemic business world. Where home working arrangements are only temporary, there should be little difficulty, but businesses should document arrangements carefully, so that the temporary intent (of an employee working from home) can be demonstrated in case of any tax authority challenge down the line.
For any questions, help or advice on these issues or other international tax matters, please get in touch with Julia McCullagh or Arjun Bhatia.
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