Global flexibility and working from home – which jurisdiction has the right to tax?

Being employed by an employer that is tax resident in one jurisdiction, and actually performing the relevant services in another jurisdiction has become increasingly commonplace as employers are more flexible in recognising that a lot of jobs can be performed from an employee’s home. But tax on income in respect of services rendered will have to be paid somewhere, so what are the tax implications of global flexibility?

The first question for consideration is whether an employee’s activities in Jurisdiction A may give rise to a so-called “permanent establishment” (“PE”) of the employer company situated in Jurisdiction B.

Permanent establishment

The term PE is defined in section 1 of South Africa’s Income Tax Act No. 58 of 1962 (“the Act”) as meaning a PE as defined from time to time in Article 5 of the Model Tax Convention on Income and on Capital of the Organisation for Economic Co-operation and Development (“OECD Model Convention”).

Article 5(1) of the OECD Model Convention defines a PE as a fixed place of business through which the business of an enterprise is wholly or partly carried on. In terms of Article 5(2), the term includes, inter alia, (a) a place of management, (b) a branch and (c) an office.

The term Paragraph 12 of the Commentary on Article 5(2) in the Commentaries on the Articles of the Model Tax Convention of the OECD (2005 Condensed version) (“OECD Commentary”) indicates that the list of the examples enumerated in Article 5(2) should, in addition, fulfil the requirements of the general definition of a PE contained in Article 5(1) to constitute a PE.

Therefore, for a place of management or a branch or an office etc to qualify as a PE, it must constitute a fixed place of business through which the business of an enterprise is wholly or partly carried on as defined in Article 5(1) of the OECD Model Convention.

Paragraph 2 of the OECD Commentary on Article 5(1) states that the definition of a PE contains the following requirements: (a) the existence of a “place of business”, i.e. a facility such as premises or, in certain instances, machinery or equipment; (b) this “place of business” must be “fixed”, i.e. it must be established at a distinct place with a certain degree of permanence; and (c) the carrying on of the business of the enterprise through this fixed place of business.

In terms of Article 5(4) of the OECD Model Convention, the PE concept is deemed not to include, inter alia, the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any activity of a preparatory or auxiliary character.

We deal below with each of the three requirements of a PE and the deemed exclusion contained in Article 5(4).

Existence of a “place of business”

As indicated above, the existence of an office as a place of business has been specifically indicated in Article 5(2) as an example of what could be regarded, prima facie, as constituting a PE.

The OECD Commentary on Article 5(1) indicates that it is immaterial whether the premises, facilities or installations covered by the term “place of business” are owned or rented by or otherwise at the disposal of the enterprise. The place of business may be situated in the business facilities of another enterprise. Furthermore, no formal legal right to use that place is required. The mere fact that an enterprise has a certain amount of space at its disposal which is used for business activities is sufficient to constitute a place of business.

“Fixed” place of business 

Paragraph 6 of the OECD Commentary on Article 5(1) indicates that the place of business must not be of a purely temporary nature. The place of business must have a certain degree of permanency. It is then stated that, as a general rule, a PE is usually not considered to exist where a business was carried on in a country through a place of business that was maintained for less than six months.

Paragraph 2 of the OECD Commentary on Article 5(1) provides that the carrying on of a business of the enterprise through a fixed place of business usually means that persons who are, in one way or another, dependent on the enterprise (i.e. personnel) conduct the business of the enterprise in the jurisdiction in which the fixed place is situated, i.e. the business of an enterprise is carried on through its employees or others in an employment type relationship with the company or other representatives. Agents may also create a PE if, inter alia, they are dependent – see below.

Paragraph 7 of the OECD Commentary on Article 5(1) provides that, for a place of business to constitute a PE, the enterprise using it must carry on its business wholly or partly through it. Paragraph 4.6 of the Commentary on Article 5(1) indicates that the words “through which”

in the definition of PE must be given a wide meaning so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose.

According to Vogel in Klaus Vogel on Double Taxation Conventions (Third Edition) (“Vogel”) in paragraph 31 of his explanatory notes on Article 5(1), such business need not contribute directly to the enterprise’s profits, but it must serve the enterprise’s overall purpose. He then goes on to state in paragraphs 32 and 33 that the business need not be an active business and that the business need not have a productive character.

In terms of South African domestic law, the term business” or the phrase “carrying on business” is not defined in the Act. However, the concept of “business” is included in the definition of trade contained in section 1 of the Act and the phrase “carrying on business” is used in section 10(1)(h) of the Act. As there is no definition in the Act of the word “business” or the phrase “carrying on business”, authority in this regard has to be sought from the principles laid down by the Courts.

In the case of ITC 1179 (35 SATC 38), the court said that the word “business” or the phrase “carrying on business” must be given their usual commercial meaning.

Further, in the case of ITC 1529 (54 SATC 252) the Court examined the issue of whether deriving rental income constituted the “carrying on of a business” and the following extracts from cases were cited by the court –

“To constitute a business there must either be a definite intention at the first act to carry on similar acts from time to time if opportunity offers, or the acts must be done not once or twice but successively, with the intention of carrying it on, so long as it is thought desirable”. (Modderfontein Deep Levels v Feinstein 1920 TPD 288.)

“The sensible approach, I think, is to look at the activities concerned as a whole, and then to ask the question: Are these the sort of activities which, in commercial life, would be regarded as “carrying on business”? The principal feature of the activities which might be examined in order to determine this are their nature, their scope and magnitude, their object (whether to make a profit or not), the continuity of the activities concerned, if the acquisition of property is involved, the intention with which the property was acquired. This list of features does not purport to be exhaustive, nor are any one of these features necessarily decisive, nor is it possible to generalise and state which feature should carry most weight in determining the problem. Each case must depend on its own particular circumstances”. (Estate G v COT 26 SATC 168).

Cross-border working from home or other relevant place

The OECD Commentary was recently updated to make provision for the fact that some individuals are able to and choose to carry out all or part of their work for an enterprise situated in a jurisdiction from a place in any other jurisdiction that is not a premise of the enterprise, nor the premises of another enterprise with contractual or other connections to the first-mentioned enterprise (e.g. the individual’s home, the home of a friend, holiday rental, etc).

Such cross-border arrangements present particular issues when determining whether a home or other place described above (hereafter “other relevant place”) is a “fixed place of business” through which the business of an enterprise is carried on in accordance with paragraph 1 of Article 5.

Arrangements where a home or other relevant place is used by an individual to carry out activities related to the business of an enterprise will typically have features that distinguish them from the use of other places by an enterprise. As a result, it may be difficult to establish whether the activities carried at such a place are sufficient to constitute a “fixed place of business through which eh business of that enterprise is carried on”.

According to the definition of PE as set out above, a place of business must be fixed to constitute a PE (see above). This requires that a place of business has a certain degree of permanency.

To constitute a PE under paragraph 1 of Article 5, a home or other relevant place must be a “place of business” of the enterprise. The mere fact that a place is used by an individual (i.e. an employee) to carry out activities related to the business of an enterprise should not lead to the automatic conclusion that that place is a place of business of that enterprise. Whether or not such a place constitutes a place of business of the enterprise will depend on the facts and circumstances of each case. For example, where a home or another relevant place is used on a continuous basis during an extended period of time for carrying on activities relates to the business of an enterprise, this and other facts (see below), may indicate that that place should be considered a place of business of the enterprise.

An individual will typically spend time at a home or other relevant place in a private context and may also undertake activities related to the business of an enterprise at the same home or other relevant place. This presents certain considerations that need to be taken into account in determining whether that home or other relevant place is a place of business of the enterprise. In the specific context of the use by an individual of that individual’s home or other relevant place to carry out activities related to the business of an enterprise, that home or other relevant place would generally not be considered a place of business of the enterprise if the individual worked from that home or relevant place for less than 50% of their total working time for that enterprise over the course of any 12-month period.

If an individual works from a home or other relevant place for at least 50% of their total working time over the course of any 12-month period, then whether the enterprise has a fixed place of business at such a place will be determined by the specific facts and circumstances.

A prominent consideration is whether there is a commercial reason for the activities to be undertaken by that individual in the jurisdiction where the home or other relevant place is located. A commercial reason for the performance of the individual’s activities related to the business of the enterprise in another jurisdiction will be considered to exist where the physical presence of the individual in that jurisdiction will itself facilitate the carrying on of the business of the enterprise, such as where there are people or resources in that jurisdiction to which the enterprise needs access for the performance of its business activities.

Generally, this would be the case if the enterprise (in Jurisdiction B) has a reason to have an individual (e.g. an employee) physically present in another jurisdiction (A) for the conduct of the activities of the enterprise and the use of that home or other relevant place facilitates the conduct of such activities. For example, it might be that the home or other relevant place was not available, then the enterprise would make use of other premises in the other jurisdiction, such as an office rented by the company, for example. A commercial reason will be present where the individual directly engages with customers, suppliers, associated enterprises or other persons on behalf of the enterprise and that engagement is facilitated by the individual being located in that jurisdiction.

Conversely, a commercial reason would not be considered present if that engagement is on an intermittent or incidental basis. For example, short occasional visits to the premises of a customer, or an engagement that is minor in the overall context of the overall business relationship with that customer, would not be sufficient to conclude that there was a commercial reason for the performance of the individual’s activities related to the business of the enterprise in the relevant jurisdiction. Evaluating whether there is a commercial reason will require a consideration of the business of the enterprise and how the specific activities of the individual relate to that business.

A commercial reason requires a link between the individual’s presence at a home or other relevant place in that jurisdiction (A) and the carrying on of the business of the enterprise.

A commercial reason to undertake activities related to the business of the enterprise in the other jurisdiction (A) may exist if, for example, any of the following take place and are facilitated (e.g. because they require physical interaction in that jurisdiction) by an individual working from a home or another relevant place in that other jurisdiction (A):

1. meetings between the individual and customers of the company;
2. cultivation of a new customer base, or identification of business opportunities;
3. identification of new suppliers, managing relationships with suppliers or undertaking, monitoring or managing contractual arrangements with suppliers;
4. the real-time, or near real-time, interaction with customers or suppliers in different time zones (e.g. providing call centre services, or virtual IT support, etc);
5. collaboration with other businesses;
6. performance of services for customers or clients located in that other jurisdiction (A) where such services require the physical presence of employees or other personnel of the enterprise in that other jurisdiction (e.g, training or repair services performed on the premises of the customer); and
7. interaction with employees and other personnel of the enterprise or of associated enterprises.

Where there is no commercial reason for undertaking the activities related to the business of the enterprise from a home or other relevant place located in the another jurisdiction that place would not be a place of business of the enterprise unless other facts and circumstances indicate otherwise.

Conclusion

Therefore, should the activities carried by an individual in a different jurisdiction as that of its employer not be as a result of a “commercial reason” that requires the employer to employ such employee on this basis, the presence of such employee in the relevant other jurisdiction would not “facilitate” the employer’s business operations in such other jurisdiction. It follows that the employee’s activities in these circumstances would not give rise to a PE of the employer in the other jurisdiction.

However, whether or not the activities of an employer may give rise to a PE in another jurisdiction is largely a factual enquiry and each case should be evaluated based on the particular facts and circumstances thereof.