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By Gary D. Sprague, Esq.
Baker & McKenzie LLP, Palo Alto, CA
As noted in my last commentary, "OECD Proposed Revisions to Article 5 Commentary Clarify Guidance on the Use of Contractors," 41 Tax Mgmt. Int'l J. 36 (1/13/12), the Organisation for Economic Co-Operation and Development (OECD) recently released a discussion draft prepared by a working group subset of Working Party 1, with proposed revisions to and clarifications of the commentary on Article 5 of the OECD Model Tax Convention on Income and on Capital (OECD Model). The discussion draft addressed 25 different permanent establishment (PE) interpretation issues. Some of those issues are centrally important to U.S. multinationals, such as the meaning of "to conclude contracts in the name of the enterprise," the key phrase in Article 5(5) of the OECD Model dealing with dependent agents. Others are perhaps of less consequence (such as Issue 1: "Can a farm be a permanent establishment?"). My last commentary dealt with the additional guidance provided in the proposed commentary regarding conducting business through contractors located in another State. This commentary will highlight proposed clarifications dealing with whether the home office of an employee can constitute a PE of the enterprise for which the person works.
The international business community will welcome the OECD's efforts to bring some guidance to this area. The PE aspects of home offices frequently arise as a question in practice, but there has not been much guidance on the point to date. Enterprises which are seeking to commence business activities in a new jurisdiction frequently find that the first few employees in a jurisdiction can adequately perform their duties without the enterprise needing to incur the expense and complexity of securing office premises in the country. Given the ease of remote communications, and the growing experience of many organizations in managing remote workforces, many enterprises are finding that some functions can be performed quite adequately longer term through employees who do not need to work through actual office premises.
As is frequently the case with OECD Working Party deliberations, the working group started to address the issue by putting on the table case studies which one or more of the delegates regarded as a useful focus for discussion. The four case studies for the most part represented a good framework to tease out the issues, and were as follows:
1. A large multinational insurance company has employees in various countries who sell insurance policies on the local market. These employees are expected to maintain a home office but are not reimbursed for the costs of doing so. The direct supervisors of these employees know the address of the employees but cannot go to their homes without being invited.
2. An engineering company sends one of its employees to work on a number of unrelated building projects in a foreign country. The employee is not present on any construction site for more than three months but lives and works in that country for two years. As part of its usual expatriation package, the company pays the rental costs of the house in which the employee will live. The employee uses part of that home as an office where he works one or two hours each day. The direct supervisor of the employee does not know that he does part of his work from home.
3. An engineering company sends one of its employees to work on a number of unrelated building projects in a foreign country. The employee is not present on any construction site for more than ree months but lives and works in that country for two years. As part of its usual expatriation package, the company pays the rental costs of the house in which the employee will live. The employee uses part of that home as an office where he performs about 50% of his work (the rest is spent on the various construction sites). The company initially intended to rent a separate office for the employee but he convinced his direct supervisor that it was more efficient for him to work from home.
4. A company, resident of one State, has only two employees who are also its shareholders. One employee is a resident of another State who carries on a large part of the activities of the enterprise at her home office, the costs of which are neither paid for nor reimbursed by the company.
Considering these various examples, one might think that the facts which the delegates thought might be relevant would include the following: (1) reimbursement of home office costs by the enterprise; (2) knowledge by managers of the existence of the home office or that the employee works from home; (3) right of managers to enter the home office without the employee's permission; (4) payment by the enterprise of rent for the premises; (5) the percentage of total duties of the employee which are discharged at the home office; and (6) the percentage of total activities of the enterprise which are performed by the individual through the home office.
Despite that promising start, the working group's proposed new OECD Model Article 5 commentary includes a big punt towards an "all facts and circumstances" general rule. That said, there is some useful material that enterprises will find helpful. The working group proposes to add two paragraphs to the commentary, as follows:
4.8 Even though part of the business of an enterprise may be carried on at a location such as an individual's home office, that should not lead to the automatic conclusion that that location is at the disposal of that enterprise simply because that location is at the disposal of an individual (e.g. an employee) who works for the enterprise. Whether or not a home office constitutes a location at the disposal of the enterprise will depend on the facts and circumstances of each case. In many cases, the carrying on of business activities at the home of an individual (e.g., an employee) will be so intermittent or incidental that the home will not be considered to be a location at the disposal of the enterprise (see paragraph 4.2 above). Where, however, a home office is used on a regular and continuous basis for carrying on business activities for an enterprise and it is clear from the facts and circumstances that the enterprise has required the individual to work from home (e.g., by not providing an office to an employee in circumstances where the nature of the employment clearly requires an office), the home office may be considered to be at the disposal of the enterprise.
4.9 A clear example is that of a nonresident consultant who is present for an extended period in a given State where she carries on most of the business activities of her own consulting enterprise from an office set up in her home in that State; in that case, that home office constitutes a location at the disposal of the enterprise. Where, however, a cross-frontier worker performs most of his work from his home situated in one State rather than from the office made available to him in the other State, one should not consider that the home is at the disposal of the enterprise. It should be noted, however, that since the vast majority of employees reside in a State where their employer has at its disposal one or more places of business to which these employees report, the question of whether or not a home office constitutes a location at the disposal of an enterprise will rarely be a practical issue. Also, the activities carried on at a home office will often be merely auxiliary and will therefore fall within the exception of subparagraph e) of paragraph 4.
The most important point in this text, and the most useful for multinational businesses, is that the proposed commentary recognizes that the important question for establishing a basic rule PE under OECD Model Article 5(1) is whether the premises are at the disposal of the enterprise, not merely at the disposal of the employee. The proposed commentary makes the useful point that an individual's home office, which always is at the employee's disposal, is not automatically at the disposal of that person's employer. While the cases described in the proposed commentary text do not expressly address the significance of the various factors noted above, it would seem that the fact that other personnel of the employer enterprise could not enter the employee's home uninvited would be a powerful element demonstrating that the premises are not at the disposal of the employer enterprise. It is a little surprising that the commentary did not more explicitly refer to factors such as the presence or absence of reimbursement of costs of the home office by the enterprise, as the hypotheticals given ran the gamut from the enterprise covering the rent for the entire home, to (apparently) covering just the operating costs of the home office, to not reimbursing anything at all. The commentary thus leaves it unclear whether those facts are relevant parts of the analysis at all. (The example of the stealth home office, where management isn't even aware that the employee works from home, isn't a particularly realistic example, or a useful one to give guidance to multinational enterprises.)
Some of the text of the proposed commentary doesn't advance the ball on determining the threshold as to when the employee's home can be considered to be at the disposal of the enterprise. This would include the point that intermittent or incidental work from home doesn't give rise to a place of business under general rules, the reminder that preparatory or auxiliary activity within the meaning of Article 5(4)(e) doesn't give rise to a PE, and the remarkable sentence in proposed paragraph 4.9 that this issue "rarely" is a practical issue on the basis that most employees live in the same State where their employer has one or more places of business at the employer's disposal. That point certainly is true as an empirical matter, but it is also true that the reason that the business community welcomes guidance on this point is that it is common for employees to be stationed cross-border from places where a place of business already exists.
Proposed paragraph 4.9 gives guidance that one case clearly creates a PE for the enterprise. The guidance on the consultant who "carries on most of the business activities of her own consulting enterprise" seems to apply to an independent consultant who runs the entire business from her home. In this case, there doesn't seem to be much difference between the activities of the employee and the activity of the business as a whole. That result seems appropriate.
For the multinational enterprise facing the case of cross-border employees working from home, however, the proposed guidance is less crisp. Essentially, the enterprise is left with the following statement as to when the enterprise itself could be regarded as having the employee's home office at its disposal: when "it is clear from the facts and circumstances that the enterprise has required the individual to work from home (e.g., by not providing an office to an employee in circumstances where the nature of the employment clearly requires an office)… ."
So when is it clear that the "nature of the employment" clearly requires an office? Perhaps this would be the case if the employee is required to meet with customers or suppliers at the home office. In that case, the enterprise probably has an interest to make sure that the home office premises are suitable for conducting the business of the enterprise. In contrast, where the activities to be performed at home can be done via phone, fax and a good broadband connection, there would seem to be no need for an office of the employer enterprise. Therefore, that set of facts leads to the conclusion that no PE of the employer enterprise exists. This is a reasonable conclusion, and certainly will be a welcome one for many companies seeking to commence business operations in a new jurisdiction.
The possible significance of the facts stated in example 3 that the enterprise "initially intended" to rent an actual office, but determined not to on the basis that the employee convinced his direct supervisor that it was "more efficient" to work from home, is a little mysterious. Surely, an intent that was not acted on cannot create a PE, so the only possible purpose of this example could be to illuminate whether the enterprise has "required" the employee to work from home. In that example, as all parties agreed that he could work from home, there seems to have been no compulsion by the enterprise as to where the person worked. The example doesn't give any insights into when the "nature of the employment clearly requires an office." Even though the enterprise may have once intended to rent an office, it seems that an office was not really required, because the work could be done from home even more efficiently.
In most cases, the employee concerned will be connected with an enterprise that does have an actual office at some other place. In that case, the enterprise perhaps also can rely on the example given in proposed paragraph 4.9, which provides that a worker who chooses to work from his home in one State rather than in an office made available to him in the other State does not render his home office "at the disposal" of the enterprise for which he works. In most cases in practice, the worker doesn't "choose" to work from home instead of showing up for work where he has a nameplate on the door. Rather, in order to perform his functions, he and his managers agree that he can more efficiently attend to his responsibilities by working from the home office. Still, the sense of the proposed commentary is that, as long as the enterprise maintains an actual office at some place, the enterprise has considerable flexibility to allow employees to work from home in other States without creating PEs in those places.
This commentary also will appear in the March 2012 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Katz, Plambeck, and Ring, 908 T.M., U.S. Income Taxation of Foreign Corporations, Cole, Kawano, and Schlaman, 940 T.M., U.S. Income Tax Treaties - Competent Authority Functions and Procedures, and in Tax Practice Series, see ¶7130, Foreign Persons - Effectively Connected Income, and ¶7160, U.S. Income Tax Treaties.
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