For companies with operations in more than one location, there’s often a need to move employees between operations, be it for short business trips or for longer term work arrangements. This can, however, create tax risk. There are also transfer pricing tax risks that should be considered.
Transfer pricing (TP) relates to the setting of the price for goods and services that are sold between controlled (or related) legal entities within an enterprise, for example a parent company and its subsidiaries. TP principles govern how all transactions are accounted for, and how profit is distributed, depending on the transaction value created by each entity.
“When drafting a transfer pricing policy, the last thing a person would think about is the people tax risks,” says De Risi. “Why would you, when transfer pricing is all about fairly allocating profits among the various entities within a multinational organisation? Personal tax risks, on the other hand, relate to the tax exposures of, or created by, individuals. However, while a transfer pricing policy is not designed to address or mitigate individual tax risks, international tax managers should not lose sight of the people aspects as part of their holistic approach to managing the overall tax risk of their cross-border operations.”
Potential people-related tax and regulatory risks related to TP
Hewson suggests that the first TP-related tax risk that might come to mind relating to the movement of people is the corporate tax risk of creating a permanent establishment (PE).
In simple terms, a PE is a fixed place of business where a company conducts its operations in a foreign country. Establishment of a PE can expose the company to local tax laws and regulations. Companies need to therefore be cautious of unintentionally establishing PE when moving people between countries.
Beyond this, De Risi says there are also several personal tax considerations linked to PEs that businesses need to be aware of:
- Legal status of employees: ensuring that employees are in possession of a valid work or residence visa is essential. Each country has its own set of possible visa types and procedures that need to be complied with. Failure to comply is not only a risk to the employees themselves, but also to the company – both from a reputational and governance perspective.
- Employment taxes: companies need to abide by the laws of both the country where their employees are working and the country where their head office is located. The compliance requirements may vary significantly from one country to another, leading to increased complexity and potential errors. International companies moving employees across borders face various compliance issues related to employment taxation, from the need to set up a payroll to effect income tax and social security withholding, to the local or head office tax authorities. This can also extend to the need to register for associated levies and to comply with mandatory reporting, placing an enormous administrative burden on companies.
- Personal taxation of employees: independent from an employer’s employment-related obligations, employees themselves need to be aware of the impact of their tax status in the country in which they are, and if and how they will be classified as tax resident. An employee’s tax residency status not only impacts their tax base (source versus worldwide), but also their tax filing obligations.
“In addition to these tax considerations, it is important to determine whether there are any relevant exchange control regulations. For example, if an individual that is a South African resident for exchange control purposes is paid their salary (or a part thereof) outside of the country, it is necessary for the funds to flow back into South Africa in order to comply with the Exchange Control Regulations,” says De Risi.
Potential TP implications of remote working
The advancement of technology has caused a boom in remote working, particularly in the wake of COVID-19. While this has several pros and cons for businesses and employees alike, Hewson suggests that the tax considerations need to be understood too.
“From a corporate perspective, where employees work remotely in another country, it is important to evaluate whether the individuals give rise to tax exposures for the business, such as PEs, or potential recharacterisation of transactions for transfer pricing purposes,” he says.
“For example, if an individual is employed by Company X but is based in Country Y, there is a high likelihood of the individual creating a taxable presence for Company X in Country Y. To address this risk, it may be tempting to employ the individual in Company Y, which is an affiliate and based in Country Y. In this case, the nature of the activity of the individual, together with their roles and responsibilities must also be carefully evaluated. Could they still be seen to be ‘carrying out the business’ of Company X in Country Y? Alternatively, if the individual is very senior and has significant responsibilities and decision-making authority, it is possible that the characterisation of Company X may have been altered through the relocation of the individual, which will have taxation implications for Company X.”
What this means for multinationals
“Well established multinational companies should have structured mobility programmes, policies and procedures in place to manage these risks and ensure compliance. However, with the economic downturn and the advent of new remote working models, it may be time to revisit these programmes to assess it they are tax compliant, cost effective and serving organisations’ talent and people agendas,” says De Risi.
“For companies at their fledgling stage of expansion, it is never too early to consider the people aspect, including how best to structure secondment packages, how to set up payroll, and how to ensure tax compliance in both locations. Early planning is key not only to avoiding future pitfalls, but also to tap into tax efficiencies.”
Hewson agrees, adding that the people tax risks associated with cross-border movements for international companies require careful planning and execution to ensure compliance with local tax laws and to minimise the tax and legal burden. “Working with experienced tax advisors and consultants can help businesses navigate these personal tax considerations and avoid potential pitfalls,” he concludes.