A personal risk for corporate travelers

December 27, 2012

Business travelers are becoming important targets for tax authorities and companies ignore the tax risks of a mobile workforce at their peril.

By Victoria Sheasby

The art of taxation,” said Louis XIV’s Finance Minister, “consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

As a country’s own citizens and taxpayers tend to hiss loudest, governments around the world are looking for foreign geese to pluck as they try to recoup the tax revenues lost during the global financial crisis: tax receipts across OECD countries fell to their lowest level in two decades after the crisis, adding pressure to already overstretched government finances.

Against this backdrop, the highly paid globetrotting executive, brokering deals and business across borders, has become a popular target for tax authorities globally. “Short-term business travelers are a vulnerable constituency,” says James Egan, Leader of Ernst & Young’s Global Immigration practice.

Travel in the information age

Advances in technology and information exchange have given the authorities muscle. Responding to perceived vulnerabilities in border controls after 9/11, governments invested hugely in border technology and smart passports.

They now have accurate, up-to-date and traceable data on the comings and goings of foreign nationals within their borders. And they have found this data as useful for tracking economic activity as for immigration.

Today, information is routinely shared between immigration and tax authorities. By tracking both individual business travelers, and also the “flying squads” who frequently travel on high-value business, tax authorities gain unprecedented insights into corporate business activities.

In some countries, the links between immigration and tax agencies is explicit. Employees heading to Belgium must complete the country’s mandatory “Limosa” declaration before they start work, which captures individual and company ID, employment duration and the type of work to be undertaken.

Tax authorities in other countries, including France and the United Kingdom, are known to be studying the system closely. The information exchange does not stop at a country’s borders. By exchanging data with their counterparts overseas, tax agencies can compare risk profiles for companies operating in their jurisdiction.

Shifting destinations

Globalization is also increasing the revenue opportunity. Although difficult to quantify, revenues that tax authorities can collect are substantial. The United States reckons it is owed considerable sums in underwithheld taxes, penalties and interest by domestic short-term business travelers.

Given the revenue opportunity, it is not surprising that some countries are focusing on tightening up their regulations as well as better enforcement. Mexico, India, Sweden and Australia all introduced new requirements for business travelers in 2012, which are likely to result in higher costs for employers.

Meanwhile, the application of an arbitrary 60-, 90- or 183-day residence rule is losing its importance. Tax authorities are increasingly adopting the OECD’s concept of the “economic employer” to determine tax and other liabilities, rather than a residence rule.

Using the OECD model, authorities determine who benefits from the business activity carried out in their country and, irrespective of the number of nights executives have clocked up in local hotels, tax the entity deriving the benefit of the employee’s activity.

In a worst-case scenario, tax authorities can decide that a lengthy business trip has triggered the creation of permanent establishment (PE) – the legal equivalent of opening up an office in the host country.

Creating a PE is the biggest tax risk companies face from sending employees on business or assignments overseas, bringing with it a host of expensive regulatory, filing and tax obligations. “The threshold for triggering a PE is becoming lower,” says James Egan. “And there’s nothing a CFO hates more than having a new PE thrust on him.”

While the authorities have upped their game, companies have responded more slowly to the increased risks they face from more aggressive enforcement. “Five years ago, we were educating corporations, and they didn’t want to know,” says Jay Sternberg, Principal of Ernst & Young’s Human Capital practice in New York. “Fast forward to today, and the education has worked. The majority understand the issues. But I’m not sure they are all ready to do anything about it.”

Overall, 65% of companies polled for Ernst & Young’s 2012 Global Mobility Effectiveness survey stated that they do not currently track short term business travel within their business. In the experience of Andreas Tschannen, Executive Director, Tax Services, at Ernst & Young in Switzerland:

“Long-term assignees are very well prepared. Companies have established policies and track their employees. But for business travel and short-term assignees, there is very little in place.”

The consequences of failing to address the issue can be severe. One UK corporation was forced to pay £40m in back taxes and penalties after failing accurately to report home-paid income in the United Kingdom.

In China, a manufacturer was forced to pay US$33m in back taxes and penalties following the largest payroll audit ever undertaken by the Chinese authorities. And in India, a European multinational faced penalties of €5m for failing to report full home-paid compensation for employees assigned to work there.

Time to act

“Companies need to do a risk analysis of the number of travelers they have, where they are going, how long they are staying and what business they are doing,” says Sternberg.

Once they understand the scale of the population, they need to establish a mechanism to track short-term business travelers and capture data on their activities.

“This is where the whole issue has become difficult for companies to deal with,” explains Kevin Cornelius, Human Capital Leader at Ernst & Young Switzerland, “because these issues do not traditionally fall into any one department. What a lot of companies are struggling with is who is really responsible for managing the risks, issues and administration.”

Involving all functions appropriately is key to managing financial risks as well as administrative ones. Given the number of moving parts, many companies choose to use a proprietary system, such as Ernst & Young’s Traveler Risk and Compliance (TRAC) system, which alerts companies to tax, payroll and PE implications of business travel. “Although you can’t take all the risk off the table,” says Egan, “you can mitigate it.”

A moving target for business travellers – tax traps for the unwary

  • Brazil: At Ernst & Young’s 2012 Human Capital conference, the 400 delegates named Brazil as the most challenging destination for short-term business travelers. Relatively complex entry systems and procedures combined with the aggressive pursuit of tax and social security revenues are two challenges often cited by those doing business in Brazil.
  • China: Three decades of growth have made China the world’s second-largest economy. Everyone wants a piece of the action, and China is set to become the top business travel destination by 2015. It is also very complex, with immigration and tax rules differing between provinces and special economic zones. The requirement to file returns on a monthly basis represents a compliance burden.
  • United States: The United States remains a challenging environment, thanks to differing federal and state tax rules, and some states are becoming markedly more active. California and New York are leading the way, taking a more aggressive approach to applying rules on permanent establishments.
  • Belgium: Limosa, Belgium’s mandatory registration system for all employees on assignment, allows the authorities to track business travelers, their length of stay, business activities and any consequent tax and social security liabilities. Introduced in 2007, it is probably the most comprehensive registration system of its kind and is being widely studied by other tax authorities as a potential model for themselves.

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