If your employees are working from another country—even temporarily during the pandemic—your organization should evaluate the tax implications of a cross-border work arrangement to protect itself from cross-border tax complications.

The COVID-19 pandemic has significantly increased remote work arrangements. Many employers have found themselves with employees working remotely across an international border. Although initially many countries offered temporary tax relief to employers during the pandemic, the rules aren’t consistent across all countries, and it’s unclear how long the relief will remain in effect. Many countries have varied treatment depending on whether an employee was “trapped” in a country or is working remotely as a matter of convenience.

Below, learn how to navigate the tax implications of cross-border work arrangements.

1. Determine If There’s Risk of Establishing a Taxable Presence

When an employee works across an international border, an employer should consider whether the employee’s activities in that country causes the organization to have a permanent establishment—and therefore taxable presence—in the country where the employee performs their work. Most countries source income to the location where services were performed.

A permanent establishment typically subjects the company to income tax in that country based on the following:

• Types of activities being conducted by the employee
• Profit attributable to that activity
• Income tax treaties
• Additional US tax reporting obligations

Recommendations

• Mitigate exposure to foreign tax systems. Understand the specifics of when a taxable presence is triggered in the country where the employee is working.
• Make sure you understand the employee’s activities. You should also consider the level of authority exercised by the employee on behalf of your organization.
• Evaluate your company’s organizational structure. When a large number of employees work in a particular jurisdiction, determine if an offshore employee holding company could avoid taxable income in a jurisdiction.

2. Understand the Country’s Employee Versus Contractor Distinctions

A common tax question is whether a company has employees, contractors, or consultants. This is a significant distinction because, as noted above, having employees in countries apart from the location of the employer can establish a taxable presence for the employer in that location.

Some countries view contractors as employees, which may inadvertently create a tax presence for the company in those foreign jurisdictions.

Recommendations

• Establish a framework. Obtain a complete understanding of how all cross-border employees are compensated and what duties they perform. A framework looks at job duties for personnel abroad and helps align them with how the activities are viewed locally. Specifically limiting functions for employees or contractors can be the difference between creating a taxable presence for the company or not.
• Learn the definitions. Remember that the definition of an employee, contractor, or consultant in the United States may differ from those in the country where the person is working remotely.
• Manage risk up-front with due diligence. If the United States has a treaty with a country where the organization has employees, income tax issues may be covered. However, treaties don’t necessarily cover local employment law issues, and there’s always the possibility of a new foreign government assuming power and changing the law. To mitigate complications, research local country law and continue to assess these laws periodically because they may change.
• Outsource your administration. To manage global payroll risk, some companies use professional employment organizations (PEOs) or administrative services organizations (ASOs) to handle the daily administration as well as payroll tax and returns for team members working abroad. Outsourcing can reduce risk because employees are contracted with the PEO rather than the company. However, but outsourcing doesn’t necessarily prevent a contracted employee from creating an international tax presence for a company.

3. Consider Withholding Taxes

A withholding tax represents an obligation on behalf of the payer of an item of income to withhold tax from a payment made to a nonresident recipient. After that, the payer is required to remit this amount to the taxing authority on behalf of the nonresident recipient.

Withholding tax is used to ensure a tax payment is collected on specifically identified items of income paid to nonresident recipients. These include payments for management fees and technical services and activities typically performed by employees or contractors.

Most countries have a domestic or standard rate of withholding tax established for payment of income to nonresident recipients. The domestic and standard rates of withholding tax vary by jurisdiction and often may be reduced or eliminated under an applicable income tax treaty between the payer and recipient home countries.

Recommendations

• Evaluate the activities of remote employees. Determine whether the employee is working part-time remotely in a nonresident country and occasionally in the company’s home country.
• Establish procedures to continually evaluate withholding tax risk. Even if your organization has established an arrangement with the employee that mitigates cross-border tax implications for an employee working remotely, your organization’s needs may change, resulting in the employee working part-time from a different location.

4. Determine Transfer Pricing Implications

A growing number of countries have regulations requiring transfer pricing. Tax authorities around the world have intensified their focus on the issue.

Transfer pricing may be implicated in a cross-border remote work arrangement if the employee’s activities benefit more than one company within a controlled group. If the employer implements an offshore employee holding company, transfer pricing is implicated.

Recommendations

• Document the activities of the employee. Be sure to include how these activities impact the entire organization.
• Evaluate the need for intercompany contracts. These may be needed to compensate the company that pays the employee for the benefit provided to other controlled companies in group.
• Apply benchmarking. This is useful to determine the range of prices or profit levels.

To be respected by tax authorities, transactions between related parties may require the following:

• An actual cash payment as opposed to solely an accounting entry
• Payment before the year closes to ensure current deductibility

5. Follow US Reporting Requirements

US companies with employees working abroad should consider US tax reporting obligations arising from the activities performed by its employees outside the United States.

Depending on the US tax classification of an organization’s overseas business activities, various information returns may need to be filed with the organization’s US income tax return. Noncompliance with the information return filing requirements carries at least a $10,000 penalty for each missed filing and may result in the statute of limitations for the organization’s US income tax return remaining open indefinitely.

Form 8858 Requirements

Beginning with tax year 2018, the IRS established new filing requirements for Form 8858, Information Return of US Persons with Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs).

These filing requirements rely on a facts and circumstances analysis of an organization’s cross-border activities to determine whether a Form 8858 should be filed. Depending on the nature of an employee’s activities and level of authority, a remote work arrangement could establish the basis for a Form 8858 filing requirement for the organization.

Recommendations

• Determine the tax classification. If the organization has established a legal entity in the country from which the employee is working, determine the tax classification of the entity from a US tax standpoint.
• Decide if an information return is needed. Based on the tax classification of the legal entity, or lack thereof, evaluate whether a US information return is required to be filed.
• Document relevant fact and circumstances. If a legal entity doesn’t exist and the organization is taking the position that an employee’s activities don’t give rise to an information-return filing obligation, the position should be documented including the relevant facts and circumstances supporting the analysis.

We’re Here to Help

If you have questions about the impacts of your employees working oversees remotely, please contact your Moss Adams professional.

Additional Resources

For regulatory updates, strategies to help cope with subsequent risk, and possible steps to bolster your workforce and organization, please see the following resources:

• COVID-19 Implications resource page
• COVID-19 Implications: A Complete Content Map