Taxation of Short-Term Assignments

Considerations Beyond the 183 Day Rule




Feb 11, 2015

Our Client Alert is intended to present relevant domestic and international tax topics which may have implications to your Global Mobility program. This month we highlight several important items for you to remember as you contemplate and plan for international assignments having expected durations of less than 183 days.

To help illustrate both the fundamental and more subtle legal considerations commonly applicable to assignments of less than 183 days duration, let's examine two similar scenarios side-by-side.

 

Two Short-Term Assignments in Ireland

Company A and Company B will each be sending a U.S. employee on assignment to Ireland. Both assignments are expected to last no more than 183 days. Additional facts regarding both assignments are summarized in the table below.

 

 

Company A

Company B

Host Location

Ireland

Ireland

Income Tax Treaty with U.S.

Yes

Yes

Assignment Length

95 Days

170 Days

Payroll Origin

US

US

Employee-Related Costs Charged to Host Location?

No

No

Manager Location

Ireland Entity

US Entity

Job Function

Sales

Communications

Bonus Source

Ireland

US

 

A question we are frequently asked by companies contemplating such assignments is "If we keep the employee in Ireland for less than 183 days, we won't have to pay Ireland income tax, correct?"

Because of the frequency of this question, it is clear that most global mobility specialists and program coordinators today are familiar with the importance of the 183 days limitation in triggering taxation. But similar to most aspects of taxation, there are additional considerations beyond the 183 days limitation that must be simultaneously evaluated to determine if host country income taxation is applicable. So what are some of the other considerations?

The most significant consideration is whether or not the United States has executed an Income Tax Treaty with the host country. If not, then most likely the employee on short-term assignment will be subject to taxation in the host country even though present less than 183 days. However, if the United States has an active income tax treaty with the host country, and assuming the transferring employee is eligible to claim the benefits extended by the income tax treaty, then limiting an employee's work assignment to no more than 183 days potentially becomes relevant in avoiding taxation in the host country location.

In most instances, if the U.S. has an income tax treaty with another country, it will likely contain a provision (frequently known as the Dependent Personal Services Article) that sets forth three key requirements that, if fully satisfied, may be relied upon to avoid taxation in the host country.

The three key requirements are as follows:

  1. The employee does not exceed 183 days of presence in the host country during any 12 month period (can be defined as a calendar year or fiscal year) and,
  2. The employee's compensation is paid by, or on behalf of, an employer who is not a resident of the host country and,
  3. The employee's compensation is not borne by a permanent establishment or a fixed base which the employer has in the host coountry.

While the wording of this frequently-cited treaty Article is similar across income tax treaties, important differences do exist. What may seem to be a small difference in wording may actually create a significant difference in taxation. Therefore, a careful examination of the specific wording must be undertaken to ensure an accurate interpretation of the benefits available under the Dependent Personal Services Article and allocation of taxation rights. Technical explanations, amendments and protocols to a given income tax treaty must also be reviewed to understand the latest treaty procedures and interpretation.

 

Tax Treaty Analysis

In the example we provided above, there is a tax treaty between the U.S. and Ireland and it does contain the "Dependent Personal Services" Article, which is an excellent starting point. But can the potential benefits extended by the income tax treaty be leveraged to eliminate double taxation for both of these assignments?

Applying the Dependent Personal Services requirements to each of the assignment details reveals the following:

 

Treaty Requirement

Company A

Company B

Under 183 days?

Yes

Yes

Compensation is paid from home country?

No - Bonus Paid from IE

Yes

Compensation is not charged back to host country?

Yes

Yes

 

Because all three of the above tests must be met to claim the treaty exemption, we see that the employee from Company A does not qualify for treaty exemption and is required to pay income tax in Ireland even though the assignment is only scheduled to last 95 days. The employee from Company B does appear to qualify for the treaty exemption. And some years ago this would have been the end of the story.

However, in recent years many countries (especially European countries) have begun considering which entity is the "economic employer" of an employee. In general, the "economic employer" is the entity that receives the benefit of the services performed by an employee, which may not be the entity that pays compensation for the services rendered. The OECD (Organization for Economic Co-operation and Development) stated that the substance of an employment arrangement trumps the mere form of an employment arrangement when determining which entity is the employer. Thus, even though it is clear that the receiving entity is not the employee's formal employer, it could still be qualified as the "economic employer".

This term, which is not used by the OECD Model Convention, means that even if the employee is legally employed by the home country (formal employer), the host country entity that is receiving the benefit could be construed to be the (economic) employer and, therefore, the Dependent Personal Services language contained in paragraph 2 of Article 15 would not be applicable to exempt the income from tax in the host country. As the term is not used by the OECD Model Convention, the decision lies with the respective countries if and in what way they apply an "economic employer" approach.

Ireland does apply the economic employer approach in defining the employer for treaty purposes. For purposes of our example, let us assume the communications services provided by the employee of Company B are solely for the purpose of improving and enhancing the Ireland entity. Even though, on the surface, the short term assignment of Company B's employee meets the criteria for treaty exemption, the employee will most likely have an income tax liability in Ireland because Ireland follows the economic employer approach in determining who is considered the employer when applying the treaty exemption.

The list of countries that do rely on the economic employer approach test changes from time to time. Careful examination of all assignment facts and all country specific facts will help both the company and the employee identify all assignment/tax costs.

 

GMT recommends the following actions related to short term assignment planning

  • Check the host country's domestic law to determine when a person will become taxable.
  • If taxable, check if the home and host country have a treaty and then find the latest version of the treaty including technical explanations and protocols.
  • Request a detailed travel schedule for 12 months prior to the assignment from the employee to understand how much time he or she has already spent in the host country for any reason (vacation, holiday, trade shows, business trips, etc.).
  • Read all the provisions of the treaty and commentary carefully.
  • Confirm from your business manager and finance team if the compensation will indeed remain in the home country and will not be charged to the host entity or a client in the host country.
  • Confirm the home country employer does not have a permanent establishment in the host country.
  • Confirm if the host country has adopted the "economic employer" approach.
  • If the "economic employer" approach has been adopted, determine if the host country entity is receiving the benefit of the services provided.
  • Are there any other taxing jurisdictions that you need to consider (state/province/social tax, etc.)?

 

Should you need any immediate assistance regarding the above, please do not hesitate to contact us. We are ready to help!