Tax Alert - The State Administration of Taxation Addressed Creation of Permanent Establishment due to COVID-19

Executive Summary

Ever since late January 2020, the COVID-19 pandemic has always been a global focus. The economies of all countries have been affected to varying degrees, and some enterprises have altered business location and operation mode. Plenty of multinational enterprises have adopted remote and online work mode or suspended cross-border projects due to immigration restrictions. However there follows disputation on cross-border tax issues.

In April 2020, the Organization for Economic Co-operation and Development (“OECD”) published an analysis entitled OECD Secretarial Analysis of Tax Treaties and the Impact of the COVID-19 crisis, providing analysis and technical guidance on cross-border tax issues caused by COVID-19 pandemic. Following on August 17, 2020, the State Taxation Administration released FAQ of the Application of International Tax Treaties due to COVID-19 on its official website, providing answers to various issues regarding application of international tax treaties. This FAQ covers most concerned determination of permanent establishment (“PE”), actual management organizations and residency issues.

Compared to OECD’s viewpoint, the FAQ provides a more lenient treatment, fitting more with China taxation while adhering to OECD's technical position. The FAQ is based on the Agreement between the Government of the People’s Republic of China and the Government of the Republic Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxed on Income (“DTA between China and Singapore”) and SAT’s relevant interpretation on the DTA between China and Singapore (Guo Shui Fa [2010] No.75, “Circular 75”). Since SAT’s interpretation is applicable to the provisions in the tax treaties signed by China and other countries that are consistent with the contents of DTA between China and Singapore, this FAQ is basically applicable to most tax treaties that China has signed, which provides guidance for the implementation of tax treaties during the epidemic period.

This tax alert aims to elaborate on the detailed contents of SAT’s FAQ and share RSM China’s observation and opinion.

Key Content

Determination of Permanent Establishment

1. Fixed Place PE – Working from home temporarily does not create a PE

OECD believes that it is unlikely that staff working at home in other countries rather than their usual place of work pose a permanent establishment risk in the new location. Since this situation is temporary and special, there is usually no need to establish a permanent place of business. Besides, the employees' home office should not be regarded as the place that the enterprise can control due to the government's restrictions. In line with OECD’s views, SAT holds the view that if the change of the location where employees work is temporary or exceptional due to COVID-19 epidemic, it should not create a PE.

According to circular 75, a PE with a fixed place is usually a business place with substantial existence, which is relatively fixed and has a certain duration in time, and all or part of the business activities are carried out through the business place. The change of work place during the epidemic is usually sudden and temporary, which does not meet the fixed and permanent requirements of the above-mentioned permanent establishment.

It is worth noting that SAT did not further explain the definition of “temporary or exceptional action” and the limitation of “temporary” duration. Based on the global epidemic situation, most enterprises should continue to work at home in the short term. If temporary home office becomes a new mode, the judgment of "temporary or exceptional action " and "temporary" will be particularly important, and even lead to the risk of permanent establishment.

2. Dependent Agent PE – Employees or agents working temporarily from home and concluding contracts in their home for and on behalf of their non-resident employers or principals should not create an agent PE (exceptional action)

In consistency with OECD’s views, individuals may work for overseas enterprises and conclude contracts in the name of employers in their China’s home offices due to temporarily working at home during the epidemic prevention and control period. Usually such activities are exceptional and do not meet the regular requirements, therefore they do not create dependent agent PE.

According to the current regulations in China, if an enterprise of one Contracting State conducts activities in the other party through its agent, and the agent has the right and habitually exercises the authority to conclude contracts in the name of this enterprise, then the enterprise creates a PE in the other Contracting State. When determining the term “habitually”, it is usually judged by the contract nature, business nature and the frequency of the agent’s related activities. The agents formed during the epidemic period are likely to be temporary and exceptional, but not habitual.

It is worth noting that SAT listed two exceptions that:-

1) An individual or agent has been conducting activities and contracts in China on behalf of an overseas enterprise for a long period of time before the outbreak of the COVID-19 epidemic;

2) An individual or agent shifts to conduct activities and contracts in China on behalf of an overseas enterprise on a long term basis after the outbreak of COVID-19 epidemic. However there are no specific standards about “shift” and “long term”, and no clear explanations about “exceptional”. In view of the current global epidemic situation, some enterprises will actively or passively choose to conduct activities in China by individuals on behalf of overseas enterprises on a long-term basis. The transformation time, activity duration and contract amount will be significant judgement.

3. Construction Site PE – The period of complete shutdown caused by the COVID-19 epidemic is allowed to be deducted

According to OECD’s views, when calculating the continuous time of a project, the time of shutdown due to shortage of materials or labor should also be included, which means that the shutdown caused by the COVID-19 epidemic should also be included in the continuous time of the project. This will pose direct impact on the construction site PE.

Now SAT provides a more friendly way to deal with this situation. SAT stated in the answer that, if all constructors and managers from certain construction projects depart from the site due to COVID-19, resulting in a complete shutdown of the construction project, it will not be considered to be “temporary cessation”. This treatment is undoubtedly good news for overseas enterprises carrying out construction projects in China, especially those enterprises whose projects would not reach the time threshold of construction site PE, but the construction period is prolonged due to the epidemic, which can effectively avoid the risk of construction site PE caused by the extension of construction period due to epidemic. In practice, the enterprise should prove that the epidemic has led to the shutdown of the project, and all the management and construction personnel have withdrawn from the site and the project has been completely shut down. 

It is worth noting that there is no specific standard for the determination of the epidemic period, and no clear standard for the applicable period of the policy of shutdown-days deduction. Relevant enterprises should pay attention to the applicable time limit of exemption policy. Besides, SAT’s interpretation only covers three types of PE, which are fixed place PE, dependent agent PE and construction site PE. There is no interpretation on how to determine the duration of a Service PE under the impact of the epidemic. There is no official conclusion on whether the number of days unable to provide services due to retention or isolation under epidemic can be exempted.

Determination of Residency

1. Entity – Temporary change of site of decision-making of senior executives during COVID-19 epidemic shall not trigger a change in the tax residency under a tax treaty

In tax treaties signed between China and most countries, there are provisions on the determination of resident entities. If an entity constitutes a resident entity by the tax laws of both contracting parties, is should be judged that it is only a tax resident of one Contracting Party according to the location of the actual management organization of the enterprise, and the tax treaty shall be applied accordingly.  According to OECD’s views, if the CEO or other senior executives are unable to travel or work in other places temporarily, the actual location of the enterprise management organization and the tax resident status should not be changed when determining tax residency of an entity according to the tax treaty.

In line with OECD’s position, SAT stated in the interpretation that when considering decision site, we should consider the place where it usually makes decisions rather than the location of occasional decisions at a particular time, such as during an epidemic. Under the epidemic prevention, the change of executive decision-making site is temporary, which should not lead to the change of the assessment of the location of the enterprise's actual management organization, nor affect the residency under the tax treaty judged according to the location of the enterprise's actual management organization.

In order to avoid non-resident entities being judged as resident entities due to the epidemic, relevant enterprises should keep information to prove the location where senior executives usually make decisions.

2. Individuals – A temporary relocation of an individual during COVID-19 epidemic shall not change the individual’s tax residency

In most tax treaties, the tie-breaker rules are included. That is, according to the tests with sequence from permanent home, center of vital interests, habitual abode to nationality, it is judged that the individual is only a tax resident of one of the contracting parties. In China's current tax treaties, the above-mentioned permanent home includes any form of residence, but the residence must be permanent rather than temporary stay for some reason. The center of vital interests should refer to the individual's family and social relations, occupation, politics, culture and other activities, place of business, location of property management, etc.

In line with OECD’s views, SAT stated in the interpretation that temporary changes in the residence of an individual during an epidemic usually do not result in a change in the location of an individual’s permanent home or the center of vital interests. Therefore, the residency under the tax treaty will not change.

It is worth noting that if an individual stays in China for more than a certain number of days and is deemed to have China’s individual income tax obligations according to China’s individual income tax law, the individual shall not be exempted from tax obligations based on this interpretation.

Our observation

The SAT’s interpretation is basically consistent with the OECD’s technical position and less restrictive in some explanations. Although there is no official document for this interpretation, the tax treaties signed between China and other countries, as well as official documents such as circular No. 75 still have legal effect, and the specific content of the interpretation does not violate the spirit of the official documents. In practice, the position of the answer can provide a certain reference for implementation, and reduce the tax pressure for enterprises and individuals affected by the epidemic.

The time limitation is still the most important issue according to this interpretation. As the epidemic situation is still variable, the effectiveness and duration of relevant policies are uncertain. In this case, all enterprises and individuals should make preparations in advance and keep relevant information, including entry-exit records, epidemic situation, entry-exit requirements and restrictions of various countries, decision-making of senior executives, shutdown records, etc., so as to provide supporting documents when necessary.

The interpretation involves conditions such as “exceptional”, “temporary” and “impact of epidemic”. Different tax authorities may have different interpretation and judgment criteria. Relevant enterprises and individuals should seek professional advice and assistance when necessary.

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