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
- 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.
- 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.