We have recently informed you of the impact of movement restrictions on the tax residence of individuals in many countries (you can find the information here: https://www.telfa.law/news/tax-residency-during-lockdown-2/ ). We should be aware that this situation may also have an impact on the status of entities other than natural persons – especially those whose management was “grounded” in an unexpected place of stay, significantly different from the one planned at the beginning of the year. Assuming a negative scenario, our business already upset by the starting recession may take further blows in the form of an obligation to settle income tax in another country – often at higher rates – or the need to pay the exit tax on assets transferred outside of the current jurisdiction (since 1 January 2019, also applicable in Poland). When should we start to be afraid?
Tax resident status according to Polish legislation
Polish legislation makes the status of a Polish tax resident subject to fulfillment of one of two conditions: having a registered office or management on the territory of our country. And while the criterion of the registered office does not give rise to major doubts, the second concept is not so clear. As there is no legal definition provided, we are forced to seek answers in case law and doctrine statements. These, in turn, favor a broad interpretation of the management as a place where decisions relating to a given entity are actually made – which is in fact the circumstances that may have significantly changed due to the COVID-19 pandemic in many cases.
Running a business is an art of continuous decision making. In the era of universal access to teleconferencing or videoconferencing, it is natural that people who are outside the place of business of their company are still present in managing its activities. Unfortunately, one should be aware that each subsequent week of such state of affairs will raise more and more doubts regarding its place of residence.
How to resolve the residence conflict? Two solutions
In a situation where an entity meets conditions for being a resident in two different countries, its status is usually determined by an agreement on avoidance of double taxation (provided, of course, that such an agreement has been concluded between the countries concerned). And just like in the case of natural persons, also the wording of the OECD Model Tax Convention on Income and on Capital (the so-called “Model Convention”), which provides a template of provisions for the large majority of contracts concluded by Poland, will usually be of key importance in determining residence of legal persons.
Until 2017, the entity's “place of effective management” was a recommended criterion for resolving the dispute. According to this approach, tax residence is directly related to the country where key decisions regarding the management of the given entity are made. In a situation where there are several places matching this description, one should consider all available facts and circumstances related to the entity's activity and choose the one which best corresponds to the scope of the definition. An entity may have several places of management, but only one of them is the place of effective management.
For years, however, there has been an increasing number of voices that among non-natural persons, cases of dual location of registered office are so rare and the situation of each entity is so specific that each case should be considered separately. Finally, they were reflected in an amendment to Article 4(3) of the Model Convention of 2017, according to which the recommended method of resolving the residence conflict is a mutual agreement of competent authorities of the contracting states. Following the OECD recommendations, the decision is to be based on a number of factors characteristic to activities of the entity, such as the place of holding management board meetings, the place of performing everyday activities by persons from the top management, the place where the ordinary management activities of the entity are carried out, the location of its registered office or the place where books of account are stored.
The situation worsens a lot if no such agreement is reached – then such an entity will not be entitled to any tax credits or exemptions resulting from a relevant agreement on double tax avoidance (unless such a mechanism is agreed by the authorities of the contracting states). However, it should be remembered that in such a situation the taxpayer may seek protection through judicial and administrative proceedings.
The MLI Convention accelerates changes to agreements
Although the Model Convention was amended three years ago, most of the agreements on the avoidance of double taxation concluded by Poland still assume resolving the conflict of residence of legal persons on the basis of the “place of effective management” criterion. The process of changes in this respect is accelerated by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting of 2016 – the so-called MLI Convention.
A design of the MLI Convention enables a special procedure for modifying agreements on avoidance of double taxation concluded between its signatories, not requiring the parties to enter into separate agreements. Similarly to the Model Convention, also the MLI Convention contains a number of recommended provisions, which are model provisions ready to be included in any bilateral agreement – including the provision ordering the settlement of the conflict of residence of entities other than natural persons by agreement between the competent authorities, in the shape identical to that proposed in the Model Convention. Apart from a few obligatory changes, which are a sine qua non condition for the ratification of the MLI Convention itself and for reporting a given agreement to be covered by the Convention, in the remaining scope (including, inter alia, the key provision for us, contained in Article 4 (1) of the MLI Convention), interference in the current wording of the agreements between countries depends only on their consistent decision, expressed in the form of the so-called “MLI Positions”.
What is the attitude of signatories of the MLI Convention to the new way of resolving the residence conflict? When reading Polish agreements on the avoidance of double taxation, we may observe the lack of one dominant position – for example, in the agreements with Denmark, Great Britain or Ireland, the parties agreed to replace the old provision with the new one, while in the agreements with Austria and Belgium the condition of the “place of effective management” remained unchanged.
What about remote management?
It is not a secret that from year to year, more and more activities related to running a business are carried out remotely. Meetings in the form of tele- or videoconferencing, project management using specially designed platforms, data collection on network drives – all this results in the fact that the physical presence of managers in the company's registered office often turns out to be unnecessary, and not only in the time of the pandemics. The direction of these changes was emphasized by the recent amendment to the Code of Commercial Companies and Partnerships, which allowed holding meetings of management boards and supervisory boards of companies in a remote form.
It is not difficult to notice that the tax residence regulations – both domestic and those contained in the Model Convention – do not directly refer to the possibility of managing the entity remotely. Although vague premises, such as the “place of effective management”, can be interpreted taking into account changes in management style, there are no clear guidelines.
It is all the more pity that the OECD abandoned the project of the Technical Advisory Group (the so-called “Business Profits TAG”) from 2001 entitled “Impact of the Communications Revolution on the Application of “Place of Effective Management” as a Tie Breaker Rule”. It raised the issue of increased mobility of people related to running a business and the fact that, in connection with the development of telecommunications technologies, management bodies no longer need to be concentrated in one place to make decisions. At the same time, the key importance of the entity's economic relationship with a given country was emphasized. In the extraordinary situation that we have recently faced, such solutions would certainly save many complications and anxieties to those entities whose place of tax residence is no longer as clear as before the pandemic.
Pandemic as a reason for changing residence? OECD explains, some countries calm down
Similarly, as in the case of natural persons, regulations resolving the issue of residence of other entities do not provide for mechanisms aimed at neutralizing the impact of difficulties caused by force majeure on their tax status. In line with applicable regulations, the place of tax residence of such an entity is closely related to the place of stay of persons belonging to its management. And running a business is often associated with the need to travel internationally, which further increases the risk of an unplanned stay abroad. Adding to this uncertain time horizon of the restrictions on movement, representatives of many companies may be anxious about further developments.
Does this mean that, when being outside the usual place of company’s residence, managers should refrain from taking actions for fear of being considered as having the “place of effective management” in the place of their stay? OECD calms down and points out in an analysis examining the impact of the pandemic on international tax treaties issued in April that the current change of management's place of stay is an exceptional and temporary situation and therefore should not affect the change of place of tax residence.
It is worth emphasizing that even before we received this guideline, some countries have already decided to issue similar recommendations. The example of Ireland is exemplary, in which The Revenue Commissioners, being a counterpart of our tax office, decided to issue very practical guidelines in the field of corporate tax laws. According to them, if the presence of a given natural person in Ireland is caused by restrictions on movement resulting from the pandemic, then such a stay will be ignored by the authorities and will not result in a change in the tax residence of the company with which that person is associated. The authority went even one step further, ensuring that analogous cases of a person's absence in Ireland will be treated similarly. At the same time, it recommended collecting evidence to confirm reasons for such stays.
The British HM Revenue & Customs office applied a similar assumption. Although the authority did not propose to change the criterion of having the place of central management and control in the United Kingdom for recognizing a company as a British tax resident, it announced a pragmatic and holistic approach to the situation of each entity. Therefore, a situation of the company will not change only because several board meetings will be held or several decisions important for the company will be taken in Great Britain – says HMRC.
Although the premises for assessing the place of tax residence of natural persons and other entities are obviously different, in practice, the place of residence of natural persons included in management of corporate entities is of key importance for them too. Also in this case, it is most of all advisable to follow changes in the law and (hopefully) calming guidelines formulated by the states key for our tax status. Following the position of the Irish tax office, it is also worth collecting evidence confirming the reason for our stay in a given country. Dates and scope of currently planned management meetings should also be thought over carefully – so that matters that do not require immediate handling and settlement are postponed to as far as possible.
Aldona Leszczyńska – Mikulska, attorney-at-law, partner in charge of the Private Client team at GWW Law Firm
Jan Wnorowski, trainee attorney, member of the Private Client team at GWW Law Firm