World - Tax;Many unhappy returns

GLOBALISATION has created a legion of border-hopping executives who jet around the world seeking new markets and deals. It has also created increasingly complex tax regimes that seek to govern the border-hoppers’ activities. A new approach to taxation being adopted by OECD countries is creating a big headache for both peripatetic businesspeople and the firms that employ them.
The OECD’s guidelines to its model income tax treaty, which are the basis for much national legislation governing the tax treatment of workers moving across borders, state that a person’s activities should be taxed wherever they take place. This edict, however, has been subject to certain exceptions. For instance, if an executive spent less than 183 days in any 12-month period in a foreign country, then income earned there could be taxed by his home state, providing he could prove that his costs were being paid by, or on behalf of, his company based at home.
Now, however, the OECD is getting tougher. At its instigation, member states including Belgium, Germany and Britain have started to apply a test to determine whether an executive is “economically employed” within their borders. Instead of looking primarily at which entity pays an employee, the test asks, among other things, which bit of a business bears the risk or responsibility for the individual’s work. It also wants to know who effectively manages the person during their stay in the country. If it is the foreign-country office, then the employee should be taxed there.
“The question is: do you become an integral part of the host-country office?” says Rachel Halpert, a tax specialist with Ernst & Young, a consulting firm. If the answer is yes, then even a short stay in a foreign country can now trigger a tax liability there.
Take the example of an American-based, international hotel chain that sends a front-desk manager on a temporary, three-month posting to one of its properties in Britain. During his time there, the manager is still paid by the American parent company and makes social security and other tax payments in America. But his work definitely benefits the British operation and he is overseen by British staff. Under the OECD’s former guidelines, the clerk would have been spared British tax; but under the new regime's approach he must file a British tax return as well as an American one.
This could have a big impact on companies that rotate staff among countries to get work experience as part of training programmes, and on banks and consulting firms, which often send executives to work abroad on short-term projects. Tax authorities are stepping up attempts to catch these “new” taxpayers. Belgium, for instance, now requires foreign executives to register with its authorities before a business trip begins if they will be in the country for a total of more than 60 days during a year, or more than 20 days in a single visit. Even foreign directors who fly regularly to another country for short board meetings could find themselves caught in the net.
Dealing with the hassles of filing in two jurisdictions and then seeking relief under one of the many dual-taxation treaties that exist between different countries will be a bother, but executives will need to get their papers in order or face stiff fines. Companies may also find themselves on the hook for unpaid payroll and other taxes, as well as penalties for not ensuring that their employees are in compliance with local tax laws. Tax authorities in Britain and Belgium have already imposed penalties of up to 100% and up to 309% respectively of the payroll taxes owed by what tax experts refer to as “accidental expatriates”. Many other countries are following suit, stepping up the frequency with which they audit companies and hitting transgressors with big fines.
Another issue should set off alarm bells in boardrooms worldwide. If an employee suddenly becomes liable to pay foreign tax under the revised OECD approach, the tax authorities may interpret this as creating a taxable presence for his employer too. As a result, companies may have to pay corporate taxes on the income attributable to their accidental expats.
India has enforced these rules aggressively, arguing that employees who come from abroad trigger a corporate tax presence for the employer sending them over. Even outsourcing arrangements can create problems. Last year, for example, Indian authorities found Morgan Stanley, a big American investment bank, liable for tax because it seconded staff to an Indian subsidiary that provided support for the bank’s front-office operations. The bank appealed; the ruling stood (though Morgan Stanley was ultimately spared an extra tax bill thanks to other aspects of its Indian set-up).
So how can companies avoid tussles with taxmen? First, they must ensure that they and their frequent flyers know the relevant foreign immigration and tax laws. They also should rigorously track executive travel, thus making it easier for, say, an in-house team to warn an executive of the fiscal consequences of a stay abroad.
All of this means an extra burden for companies, but the risks of not complying are rising fast. As economies slow and tax receipts fall, governments are especially keen to ensure that foreign firms pay their dues. Last week, for instance, America’s Government Accountability Office, an arm of Congress, reported that in 2005, 28% of large foreign companies operating in America paid no income tax there. Politicians immediately called for closer scrutiny of companies’ tax affairs. You have been warned.