The growing tax risks of business travelMay 27, 2011
Once upon a time, tax authorities around the globe took little notice of business travelers except to collect taxes on lodging and other purchases. Only when the business traveler spent more than half the year in-country did host governments demand an income tax return.
As for business taxes, all countries required corporate tax returns from in-country subsidiaries of multinational companies, but they would not bother the parent firm unless it set up a physical place of business or the traveling employee signed a contract that bound the parent firm.
Relying on that tradition, companies today often assume, erroneously, that business travelers trigger personal tax liability only if they spend more than 183 days of a calendar year in the host country.
In fact, the 183-day test is just one part of a threetiered test contained in most US treaties. In addition to days of presence, the test takes into account the source of the business traveler’s remuneration and the location of the legal entity to which the costs of the business traveler are charged.
Similarly, companies often assume that in order to trigger corporate tax liability, a traveling employee must sign a contract that binds the home country firm.
On the contrary, as expressed in treaty language, the triggering event can be any of several business activities that the host country considers as creating a permanent establishment (PE), i.e., the legal equivalent of opening up a physical place of business such as a branch office.
The days of lax monitoring of business travelers are long gone. Today, international business travelers can trigger tax liabilities even before they check into their hotels.
Often they have no clue that they have already hit the tripwire that starts the tax tally ticking: personal income tax, social security tax and fringe benefits taxes, plus withholding obligations for all of those.
Similarly, tax authorities around the world are rapidly changing the definition of PE, greatly increasing the number of companies whose business travelers are triggering corporate tax liability.
Companies are having great difficulty tracking the issue now that governments are making such fine distinctions among business travelers, even travelers from the same company.
They are asking about each visit:
- How much is the business traveler earning per day during this trip?
- How many times has this business traveler visited the country during the current tax year?
- What are his business responsibilities during this trip, and if he participated in any contract negotiations, what exactly was his role?
Clearly, answering all of these questions in an accurate, systematic manner is an administrative challenge that spans several departments within the corporation.
How are global firms reacting to the more aggressive approach of tax authorities?
Multinational corporations have reacted in various ways to the rapidly changing enforcement in this area, from studiously ignoring the issue to proactive compliance.
The traditional approach is still common: reduce as many tax liabilities as possible, with the top priority being to minimize PE exposure and the resulting business taxes, and the second being to make sure personal tax obligations are not triggered by employees.
In the aftermath of the global financial crisis, this strategy has required a more concerted effort by the company’s human resources and tax departments each year.
Some companies are taking the opposite tack, especially on the personal tax issue.
With governments seemingly determined to tax every employee who spends part of a day in their countries, these companies consider it less risky in the long run to start filing and paying from day one, although it is by no means inexpensive to keep employees current with their new multinational tax obligations.
Even on the more expensive and complex PE issue, some firms consider the management of the PE trigger to be too risky. After all, if global companies intend to grow their businesses in a foreign country, they are going to trigger a PE eventually.
By filing as soon as they generate any business activity, they eliminate any chance of disputes with the tax authorities over when PE was established. This approach also requires a major, coordinated HR-Tax effort to generate the required documentary evidence of travel, compensation and work product.
A third group of companies is surprisingly oblivious to the problem. They are often unsure whether Tax, HR or some completely different function such as travel or security should be responsible for managing the issue. We have seen this problem — lack of a clear owner — lead to inaction and a heavier controversy burden.
They may be “getting away with it” now, but they will regret it if rapidly accumulating personal and corporate tax liabilities are discovered years later. No one wants to fall asleep in the back seat of a taxi with the meter running.
Tax authorities are certainly not asleep. No longer content with records of how many days foreign workers spend in their countries, they increasingly demand documentation of the number of visits, total compensation paid, and type of work performed.
As strict as many of the new record-keeping and tax compliance rules are, there are many exceptions, exemptions and deductions. Those vary by country of visit and the type of work performed by the business traveler. These rules make the administrative task of complying even more daunting.
Globalization and its discontents, including tax complexities, are here to stay. Business travelers and their employers are in a new, labyrinthine tax world. To get out of the labyrinth in the quickest and least expensive way, business travelers and their employers need a map.
Why are tax authorities targeting business travelers?
The shortest possible answer to this question is “because they can.” But why now?
Powerful historical and financial forces are intersecting to create a tension between tax administrators and business travelers. Companies are reacting efficiently to the imperatives of globalization by mobilizing their workforces, and tax authorities are reacting by pursuing those workforces for taxes due.
To demand travel and work records from global companies seems a difficult way to track down revenue. Since business travelers often spend only a few weeks per year in-country, is it worth the tax authorities’ trouble?
Tax authorities believe it is, not only for practical revenue considerations but because they consider it the fairest approach to taxation. This is especially true as border technologies have quickly become highly developed and can trigger the initial alarm bell.
In short, globalization is the culprit, affecting the tax environment in many ways.
Business travel is growing rapidly.
Globalization has greatly increased the number of workers who at any one time are working outside their own countries. One clear indicator is booming air travel.
For example, even as Asia recovers from the global financial crisis, growing at about 5% annually as a region, annual air travel has grown at more than twice that rate.
The disparity may be attributable to large companies’ reaction to the financial crisis: they would rather move their current people around than hire more people in each location.
Business travelers have higher incomes.
Internationally mobile employees of global companies tend to be highly paid. If they could not generate significant income and brand value for their companies when traveling abroad, they would not be traveling.
Some make stratospheric sums: think of hedge fund managers flying around the world. With so many business travelers making so much money, governmental decisions to redefine “taxable income” have paid off handsomely in tax revenue.
Tax authorities’ ideas of good policy are increasingly similar worldwide.
Just as the private sector shares leading practices, so do tax authorities.
A legislative initiative or enforcement technique that works well to raise significant revenue in one nation will surely be tried elsewhere. The Organisation for Economic Co-operation and Development (OECD) supports a more aggressive approach to taxing business travelers.
The Paris-based organization says its mission is to “promote public policies that will improve the economic and social well-being of people around the world.”
Even though its membership is only 34 nations, the OECD does wields worldwide influence on tax and fiscal policy, far more influence than any similar group.There is a competitive, retaliatory side to this globalization of tax administration.
Once one nation is taxing visitors — and major destinations for foreign investment like the US and China are doing so — it is politically difficult for others not to respond similarly.
Tax authorities can be efficient by targeting the largest global companies.
As the cautionary tale of tax woe in China (see sidebar) teaches, tax authorities do not chase after small business owners on their business trips.
Instead, as tax authorities around the world are doing, the Chinese tax administrators made their demand on the officials of a large company so that if they were successful, which they were, it was, the government could collect significant revenue without contacting thousands of people individually.
Governments want to increase tax revenue.
The global financial crisis has left many nations’ public finances in a perilous state. Revenues fell rapidly, unemployment benefits rose and legislatures enacted fiscal stimulus.
All this caused deficits and debt to grow alarmingly. Many nations have responded by raising taxes.
Some have raised indirect taxes such as value-added taxes, and some have raised personal income tax rates on high-income individuals, but almost all have turned to stricter enforcement of the taxes they already have on the books.
We have discussed some legislative changes that put business travelers in the tax spotlight, but in many nations, it has just been a matter of tax administrators’ assertive enforcement.
Travelers from other countries do not vote, they earn significant income, and they are performing services within a foreign nation’s borders.
To many public officials, that is an irrefutable argument for taxing business travelers and their employers.
Countries are using advanced border technology to identify tax compliance obligations.
Governments around the world have put technology to work at their borders, and with some overcrowded exceptions, now they have good records on who is entering and exiting their borders and for what purposes.
Leading countries are now starting to exploit this information for tax purposes, and it will not be long before this becomes a leading practice that tax authorities all around the world are likely to adopt.
The business tax risk of shortterm business travelers
Global companies can move their workforces around the world so nimbly because much of the world’s wealth is now created in services, intellectual property, digital goods, and other sources of income that do not tie their employees to a location in the way that manufacturers’ workers are tied to a factory.
The business travelers of such companies need no permanent establishment (in the physical sense of the word) to do their work. That was the traditional distinction between a taxable and non-taxable foreign company.
In reaction to the new “knowledge economy,” governments are no longer content to apply their business taxes only to those companies with a physical place of business. That is where business travelers enter the picture.
As an extension of the new, stricter approach to taxing the personal incomes of business travelers, tax authorities are also asserting that some activities of travelers can justify their assertion that a PE exists.
In those cases, corporations that had no branch offices or warehouses or any other traditional PE suddenly find themselves facing a demand for corporate income tax filing, as well as other business taxes.
To many corporate executives, this interpretation seems to stretch the nature of what their traveling employees are doing.
Often they are merely visiting customers or looking for new ones. But the OECD and most governments disagree.
To them, governments were always taxing the business activity conducted in factories and offices, the structures themselves merely serving as clear, convenient signals of business activity.
Business travelers and their employers have managed without such physical locations, but governments consider their business activities to be similar and so are determined to tax them.
For example, in Australia and New Zealand, new tax treaties expand the number of ways in which business travelers might trigger a PE. Importantly, business travelers no longer have to “conclude a contract” to trigger a PE; instead, they need only “substantially negotiate” a contract.
China is giving more consideration to the idea that temporary employees stationed in a subsidiary there create a PE for the parent corporation.
In the past, the Chinese tax authorities generally have permitted Chinese entities to host temporary employees (secondments) sent from a foreign parent and reimburse the remuneration expenses to the foreign home entity without creating a permanent establishment (PE) exposure.
More recently, though, the Chinese tax authorities have launched tax inspections of some Chinese entities with such arrangements for the purpose of determining whether they would result in a taxable presence in China.
This comes in advance of a new circular for secondment arrangements and PE assessment that will be shortly issued by China’s State Administration of Taxation.
According to the latest draft of the circular, the dollar-for-dollar reimbursement for a secondment arrangement may still be accepted as not creating a PE in China, provided certain conditions can be met.
The business and tax landscapes that have changed so much over the past five or six years continue to shift. The global financial crisis has acted as a catalyst to more rapid globalization and business transformation, which affects every aspect of the corporation.
Part of that transformative process is for the workforce of global firms to become much more mobile, which means more international business travel. However, tax administrators around the world are increasingly aware of business travelers’ activities and increasingly see the income generated as taxable.
Particularly in view of their governments’ heavy debt load, tax authorities are finding intellectual and public support for this assertive approach, and they are effectively deploying technology to identify new tax obligations.Unsurprisingly, these developments trouble global employers with internationally mobile workforces.
They run a much greater risk of violating tax laws than they did just a few years ago, and some countries’ legal interpretations and enforcement may seem unreasonable to corporate executives.
However, noncompliance and the resulting controversy are not a good option.On the other hand, some global corporations are only superficially aware of the problem. Their human resources departments are not coordinating with their tax departments, and substantial tax liabilities may be accumulating.
Eventually, a hidden problem like that will surface and create significant tax controversy. Some companies will stay with the traditional approach of minimizing PE exposure and tax liabilities through careful monitoring of business activities in each jurisdiction.
Others will choose preemptive compliance, which is more expensive in the short term but perhaps less risky in the long term. Assessing the future of tax enforcement, we see the dispute surrounding business travelers as one of the hottest issues in tax controversy.
As governments’ tracking technologies improve and as they share leading practices, their enforcement becomes more efficient. Tax administrations will move beyond global giants and enforce the same rules on smaller companies.
This trend means that more and more companies need a compliance infrastructure of people, process and technology that combines expertise in human resources and taxation in a coordinated effort to reduce the risk of tax controversy around the world.
This article was originally published in the Ernst & Young Tax Policy and Controversy Briefing which can be accessed using the link below: