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Cross-border employment: tax issues

/ 10 October 2022

David Simpson

If there’s one area of tax that has gone from being a niche area to one where questions arise daily, it’s cross-border employment. Most often it is in the context of UK companies hiring local people in a foreign jurisdiction or foreign companies remotely taking on UK-based employees; we also see numerous temporary cross-border assignments which present their own challenges.

Such queries often originate from a company’s payroll department. However, having employees based in another jurisdiction will also raise corporate income tax issues and it’s important that the finance team is also involved in these types of discussion.

Tax presence and permanent establishment

The most important question to ask is whether such an employment will create tax presence for the employing entity in the other jurisdiction. With most jurisdictions, that involves assessing whether a permanent establishment (‘PE’) has been created.

For a term which is internationally defined, the answer is often elusive. This is particularly the case in the increasingly common situation where the foreign employee works from home.

Different jurisdictions look at this differently. Wearing a UK hat, a foreign entity probably doesn’t have a UK PE where the individual is inward-facing to the organisation and works from home, but the answer could be different where they engage with clients or the company has organised a workspace, such as a WeWork desk. Other jurisdictions would disagree with even that simple analysis.

If a PE is found to exist, the employing entity will need to register and file a corporate income tax return in the foreign jurisdiction and undertake the difficult exercise of attributing profit to the PE on which it will be charged foreign tax. If the employing entity has had to register for payroll taxes in the foreign jurisdiction, it will already be visible to the local revenue authority and this should be borne in mind in assessing the PE position.

Registering for payroll taxes

Generally speaking, the foreign employer will need to register for local payroll taxes even where a PE does not exist; it is often a shock for US/UK entities to discover the level of the social security contributions required in continental Europe.

Again, the approach to be adopted is ultimately country-specific. The UK is noteworthy here. If the foreign employer does not have any other presence in the UK, which will often be the case with a home-based employee, then the employer is under no obligation to operate income tax at source deductions (‘PAYE’). Furthermore, unless the employer is based in the EU, it is also not liable to operate social security deductions.

Anti-avoidance rules

As the requirement to register for payroll taxes (and its implications for visibility as regards corporate income taxes) is rarely welcomed by potential employers, it is also worth noting that anti-avoidance rules are also country specific. The IR35 off-payroll rules in the UK – a changing area following the Chancellor’s Mini Budget in September 2022) – reflect a UK concern. The use of intermediaries to block the creation of an employment relationship is generally acceptable elsewhere, whether that be through a corporate or via other legal forms available in the host country for entrepreneurial activity, such as a French BNC.

Differences for temporary postings

Whereas the social security position normally follows the income tax rules for permanent employees, they need to be considered entirely separately for temporary postings. For postings across the UK and EU, the social security co-ordination rules remain in place (even post-Brexit) which generally mean that the social security regime of the posting entity, rather than social security regime of the host, will apply.

A similar outcome is available to UK companies under the social security agreement with the USA and other treaty partners. However, completely different (and generally less helpful) rules will apply where the posting is outside the UK or EU or is not covered by a social security agreement.

Social security agreements are much less common than double tax agreements. The UK for instance has over 100 of the latter but only around 20 of the former.

The income tax position of the employee will generally be governed by one of those 100+ tax treaties. The employee will generally remain outside the scope of the host regime if three conditions are met:

  1. They are in the host country for less than 183 days in a calendar year/rolling 12 month period (depending on the treaty wording);
  2. They are paid by the foreign employer;
  3. The cost is not ultimately borne by a permanent establishment in the host country.

Failure of any of the conditions means that the taxing rights are with the host country, which will usually require the foreign employer to operate local payroll for the local activities of the posted worker.

While this is conceptually straightforward, the requirement to operate local payroll for temporary postings can be an administrative nightmare for countries which operate the credit method for relieving double taxation, such as the UK. For instance, where an employee is posted from the UK to a foreign permanent establishment, the conditions for treaty exemption will not be met. As a result, the UK company will usually need to deduct tax in the host country and in the first instance, they will also be required to continue to operate UK PAYE on that income.

HMRC (i.e. the UK revenue authority) offers an administrative workaround, but this is clunky, needs prior authorisation and not all employers have the technology to apply it. Where it cannot be deployed, the employee is left to reclaim the double tax suffered through their own tax return. The mechanics tend to be a lot simpler for employers based in jurisdictions which use the exemption method to deal with double taxation.

The tax rules around cross-border employment are complex and varied. Even where your company has engaged an employee in one jurisdiction, you cannot assume the same rules will apply where it hires an employee in another jurisdiction. You cannot even assume that the rules are reciprocal between countries.

If there is one common theme, it is that your finance and payroll teams both need to be involved and that they should seek professional advice well in advance of the potential hire.

For specialist guidance on any international tax complexities you may encounter, our tax team would be pleased to help. BKL’s membership of AGN International means that where local advice is also needed, we can connect with accountants and tax advisers in over 80 countries.

To find out more, please get in touch with your usual BKL contact or use our enquiry form.

David Simpson

Partner, International Tax

T +44 (0)20 8922 9275
E david.simpson@bkl.co.uk

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