Tax Issues arising from the COVID-19 Pandemic
The COVID-19 pandemic has caused significant disruptions to people’s lives, resulting in changes to the ways in which businesses operate and the locations where people work. Such changes also give rise to certain tax issues, including those relating to tax residence of companies and individuals, permanent establishment (PE), employment income of cross-border employees and transfer pricing. The Inland Revenue Department (IRD)’s general approach to these issues is set out below.
It will be noted that the IRD’s approach in relation to the tax issues is generally in line with the Updated Guidance on Tax Treaties and the Impact of the COVID-19 Crisis (the COVID-19 Tax Treaty Guidance) and Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic (the COVID-19 Transfer Pricing Guidance) released by the Organisation for Economic Co-operation and Development (OECD) in January 2021 and December 2020 respectively, to which further references may be made. These Guidances should be read together with the Commentaries on the Model Tax Convention on Income and on Capital (MTC) and OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
It has to be stressed that the views expressed below are for general information only. The treatment for each case will be determined on its own facts and circumstances.
- Tax Residence of Companies
- Tax Residence of Individuals
- Permanent Establishment
- Income from Employment
- Transfer Pricing
Tax Residence of Companies
Restrictions on international travel due to the pandemic may give rise to a change in the locations where senior management hold their meetings or conduct the business of an enterprise and concerns have been raised about the effect of such change on the tax residence of a company. The IRD does not consider that such a temporary change during extraordinary time would in itself alter the tax residence status of a company. In assessing the company’s residence status, the IRD will take into account all relevant facts and circumstances.
If a company is considered to be a resident of Hong Kong and another jurisdiction simultaneously, the tie-breaker rules under the relevant tax treaty would need to be considered to determine the jurisdiction where a company is regarded as a resident for the purposes of the treaty. As stated in the COVID-19 Tax Treaty Guidance, a company’s place of residence determined by the tie-breaker rules under a tax treaty is unlikely to be affected by the fact that the individuals participating in the management and decision-making of the company cannot travel as a result of a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved.
Tax Residence of Individuals
An individual may have to temporarily remain in the host jurisdiction because he is prevented from returning to his home jurisdiction as a result of travel restrictions or other public health measures imposed under the pandemic. Generally, such an individual would unlikely become a resident of the host jurisdiction, and even if he did, he would normally remain a resident of the home jurisdiction under the tie-breaker rules in the relevant treaty. A different approach may, however, be appropriate if the change in circumstances continues after the public health restrictions are lifted.
Whether a non-Hong Kong resident person has a PE in Hong Kong within the meaning of a tax treaty or Part 3 of Schedule 17G to the Inland Revenue Ordinance (IRO) (as the case may be) is a question of fact and degree. In determining the issue, the IRD will examine all the relevant facts and circumstances, including the international travel disruption caused by public health measures imposed by governments in response to COVID-19 pandemic. Given the extraordinary nature of the COVID-19 pandemic, the IRD is prepared to adopt a flexible approach when determining the issue, having regard to the relevant principles in the COVID-19 Tax Treaty Guidance.
As explained in the said Guidance, the exceptional and temporary change of the location where employees exercise their employment because of the COVID-19 pandemic, such as working from home, should not create new PEs for the employers. Similarly, the temporary conclusion of contracts in the home of employees or agents because of the pandemic should not create PEs for enterprises, though a different approach may be appropriate if the employees or agents were habitually concluding contracts on behalf of the enterprises in their home jurisdictions before the pandemic.
It is important to note that the above views are relevant only to circumstances arising during the COVID-19 pandemic when public health measures are in effect. Where an individual continues to work from home after the cessation of the public health measures, further examination of the facts and circumstances would be required to determine whether a PE exists.
Income from Employment
Where an employee resident in another jurisdiction and exercising an employment in Hong Kong is stranded in Hong Kong because of the COVID-19 pandemic; and would otherwise have left Hong Kong and qualified for exemption from salaries tax in Hong Kong under Article 15 of the MTC, the additional days spent by the employee in Hong Kong under such circumstances would be disregarded for the purposes of the 183-day test in Article 15(2)(a). This approach covers situations where the employee is prevented from travelling due to quarantine requirements, certified sickness caused by COVID-19, travel ban imposed by government and cancellation of flights necessitated by government public health measures. It does not, however, cover the situation where the employee, like members of the public, is simply urged to avoid non-essential travel.
It should be mentioned that at the domestic level, the IRD has no discretion to exclude the days of physical presence in Hong Kong for the purposes of counting days under section 8(1B) of the IRO.
The IRD will generally follow the COVID-19 Transfer Pricing Guidance which maintains that the arm’s length principle remains the applicable standard for the purpose of evaluating the transfer pricing of controlled transactions in the face of the pandemic, though due regard must be given as to how the outcomes of the economically significant risks controlled by the parties to the transactions have been affected by the pandemic.
In view of the effect of the COVID-19 pandemic on the economic conditions, it may be appropriate to have separate testing periods for the duration of the pandemic or to include loss-making comparables when performing a comparability analysis. A limited-risk entity could be accepted to have incurred losses if the losses are found to be incurred at arm’s length. The receipt of government assistance may also affect the price of a controlled transaction.
The IRD will uphold existing advance pricing arrangements (APAs), unless a condition leading to the revocation, cancellation or revision of the APA has occurred. Where material changes in economic conditions lead to the breach of the critical assumptions, taxpayers should notify the IRD not later than one month after the breach occurs.