COVID-19: HMRC guidance on Company Residence, Permanent Establishment and related issues regarding the Economic Substance Test
Her Majesty's Revenue and Customs (HMRC) published guidance on 9 April on the implications of COVID-19-related travel restrictions on a company's residence status. Such travel restrictions may force directors or employees to be present in the UK when they would not be here under normal circumstances. This situation raises concerns as to whether a foreign company may become resident for tax purposes in the UK because the central management and control (CMC) of the company might be considered to have moved here.
This note was originally published on 21 April 2020. Its content continues to be relevant as COVID-related travel restrictions still exist around the world, and are likely to do so for some time. As such, references in the note to "this period of lockdown" and "current restrictions" should be read as applying more generally to any such period or set of restrictions. While reading this note, please also bear in mind that, since it was first published in April, HMRC has added wording to its guidance in response to the COVID-19 pandemic for both company residence and permanent establishments respectively, indicating that it believes that its guidance is consistent with that published by the OECD Secretariat on 3 April 2020.
Company Residence - Central management and control
A company is resident in the place where its CMC abides. CMC rests with the persons who decide upon matters of general policy relating to the company’s business. Case law shows us that it is important to identity those people who lead the strategic and tactical decision-making process as opposed to the day to day supervision of a company’s business.
CMC usually rests with the company’s board of directors which typically takes those general policy decisions regarding the conduct of the company’s business. It is normally the place at which the directors hold their meetings that determines where CMC is exercised. Ultimately, it is a question of fact as to where and by whom CMC is exercised. HMRC and the courts will look at the reality of who truly controls the destiny of the company.
In its guidance, HMRC indicated that it does not consider that a company will necessarily become resident in the UK because a few board meetings are held here, or because some decisions are taken in the UK over a short period of time. Instead, HMRC will take a holistic view of the facts and circumstances of each case. This approach is supported by relevant case law (Laerstate BV v HMRC (2009)) in which the First-Tier Tribunal noted that the test of CMC falls to be applied over a significantly long period to give the whole picture so that residence does not fluctuate by reason of isolated acts of control taking place in different jurisdictions.
The new guidance refers to existing guidance that sets out scenarios in which HMRC would not usually seek to argue that a company was resident in the UK. These include examples in which one or more directors of a company are UK resident but the majority of the board is resident outside the UK, and the company holds all meetings outside the UK. In these scenarios, HMRC envisages the UK based director or directors either travelling to the meetings outside the UK or participating from the UK via electronic link. Another example envisages the UK-based members of the board becoming a majority in attendance at a single meeting due to an unforeseen absence of overseas based directors. In a further alternative, the company holds a small minority (no more than one or two) of its meetings in the UK during an accounting period.
While these examples are encouraging, especially in relation to directors in the UK participating in meetings by electronic link, they do not provide a guarantee that HMRC will not seek to argue that companies have become UK resident as a result of the presence of their directors in the UK during the period that COVID-19 lockdown and travel restrictions persist. HMRC's guidance certainly falls short of the statement of the Organisation for Economic Co-operation and Development (OECD) in its analysis of tax treaties and the impact of the COVID-19 crisis, that "A temporary change in location of the chief executive officers and other senior executives is an extraordinary and temporary situation due to the COVID-19 crisis and such change of location should not trigger a change in residency…".
Nevertheless, HMRC does express sympathy for the disruption that is being endured. It also comments that the existing legislation and guidance provides flexibility to deal with changes in business activities necessitated by the response to the COVID-19 pandemic. Therefore, it is reasonable to hope that HMRC will take a sympathetic and flexible approach to this issue. Nonetheless, to strengthen their position as far as possible, companies and individual directors (and shadow directors, where relevant) should take follow the practical steps outlined below. Furthermore, as soon as the current restrictions are lifted so that they are able to safely return to their usual country of residence, directors should do so.
Double Taxation Agreements
HMRC's guidance also points out that, even if CMC is in the UK, this does not necessarily mean the company will be UK resident. If the company is also a resident of a different jurisdiction with which the UK has a Double Taxation Agreement (DTA), under the tie breaker provisions of the relevant DTA, the company may be treated as non-UK resident. The tie-breaker provisions of most UK DTAs either rest on a company's 'place of effective management', or are determined between the competent authorities of each jurisdiction (a competent authority tie-breaker).
The relevant factors differ between the two tests, but will depend broadly, on the company's levels of activity in, and connection with, each country. In reviewing the factors to be taken into account in the two tie-breaker tests, the OECD's paper indicates that, under a competent authority tie-breaker test, this would include where meetings and other activities of senior management are "usually" held or carried out, as well as the location of the company's headquarters. In relation to the test of the company's place of effective management, "all relevant facts and circumstances should be examined to determine the "usual" and "ordinary" place of effective management, and not only those that pertain to an exceptional and temporary period such as the COVID-19 crisis".
In our note considering (among other issues) the question of company residence in light of COVID-19 related travel restrictions, we suggested practical ways to reduce the risk that a company's place of CMC might move to the UK if directors were required to remain here. HMRC's guidance does not alter this advice, and we would suggest that non-UK companies should consider the following steps:
- If possible, continue to ensure that a majority of directors are resident outside the UK. To this end, it may be appropriate to appoint additional non-UK based directors, if that is possible. These should be individuals who have appropriate knowledge or skills to be a director of the relevant company.
- All board meetings should continue to be held outside the UK. Any directors who are in the UK (either permanently or as a result of COVID-19 related travel restrictions) should join the meeting by telephone or video link. Steps should be taken to ensure that the majority of directors at the meeting are outside the UK.
- If possible (and we realise that this may not be realistic for many companies in these difficult times), companies should consider reducing the number of board meetings held during this period of lockdown in favour of additional meetings when directors are able to leave the UK.
- Again, if possible and realistic for the company, significant decisions should be delayed until travel restrictions are lifted, and they can be made outside the UK.
- Because significant decisions may have to be made during this period of lockdown by a particular officer of the company (for example, the CEO), where the relevant individuals are unable to leave the UK, if possible such decisions should be fully discussed and approved in advance by the board outside the UK.
- In order to evidence how and where decisions are made, full minutes should be taken of company business discussed at meetings, and records of decisions taken should note the physical location of all officers involved.
Individual directors (or shadow directors, where relevant) who find themselves unable to travel during the present crisis should keep detailed records of their own position, as follows:
- Keep records of their reasons for being in the UK, and the length of their stay.
- Keep all travel tickets and other records relating to the relevant period.
- Keep any notifications advising them that they could not leave the UK or enter the country to which they wish to travel.
- Consider taking advice with regard to their tax residence status under the UK statutory residence test, and especially as to the number of days an individual in their position may spend in the UK before becoming UK resident for tax purposes.
- Make plans and retain evidence to demonstrate their intention to leave the UK, as soon as this is possible.
It is worth noting that these are sensible steps for companies and directors to consider at any time in which one or more directors are based in the UK and are not restricted to the current crisis.
HMRC has also issued guidance as to whether the presence of individuals in the UK could result in foreign companies establishing a taxable permanent establishment for UK corporation tax purposes. It takes a similar line to its guidance on company residence, i.e. that the existing legislation and guidance in relation to permanent establishments provides sufficient flexibility to deal with changes in business practice resulting from the COVID-19 pandemic.
Broadly, the requirements for a permanent establishment to be created in the UK are either that a business is carried on through a fixed pace of business in the UK, or that an agent acting on behalf of the company has, and habitually exercises, authority to carry out the company's business in the UK. These requirements involve either a degree of permanence or the habitual conclusion of contracts in the UK. Even if the facts indicate that a permanent establishment has been created in the UK, the level of attribution of profits to a UK permanent establishment would depend on the level of activity in the UK and its relative value.
Economic Substance Legislation
Legislation has been introduced in many offshore jurisdictions, including the Channel Islands, Bermuda, the BVI and the Cayman Islands, to ensure that companies that are resident in such jurisdictions and which generate income from certain "relevant activities", have a level of substance in the jurisdiction that correlates with their economic activities. Companies subject to such legislation include finance and leasing businesses, fund management businesses, investment holding companies and others.
'Directed and managed' test
The requirements of this legislation include a 'directed and managed' test. As the name suggests, this obliges companies to hold meetings in the jurisdiction in which they are based. These should be held at an adequate frequency for the volume of decision-making required, a quorum of board directors must be physically present in the relevant jurisdiction, the directors must have the knowledge and expertise to discharge the duties of the board, and where strategic matters or those relating to core income activities of the company are to be discussed, a majority of the directors must be physically present in the relevant jurisdiction. Minutes of meetings, strategic decisions and other records of the company should be kept in the relevant jurisdiction.
COVID-19 guidance and mitigation
The regulatory authorities of many of the affected jurisdictions have issued guidance acknowledging the extraordinary circumstances of the COVID-19 crisis, and confirming that companies will not be determined to have failed the economic substance test because they have to adjust their normal working practices, perhaps by holding board meetings virtually rather than physically in the relevant jurisdiction. However, such guidance also encourages companies to mitigate the effects of restrictions during the crisis where possible (for example, by appointing alternate directors in the relevant jurisdiction if this is feasible) and to keep detailed records of all meetings, the circumstances in which they were held, any decisions made and the reasons for any changes to the company's usual practice, for example with regard to the location of directors. Any mitigating steps taken should also be recorded.
As the economic substance legislation and related COVID-19 guidance may vary between jurisdictions, specific advice should be taken in the relevant jurisdiction.