COVID-19 has brought border closures and unprecedented disruption to the global business environment for more than 18 months.
Many companies have had to change the way in which they operate, and employees have been forced to work in locations outside their usual place of employment. On July 29 2021, the Inland Revenue Department (IRD) issued guidance examining certain tax issues arising from the COVID-19 pandemic (the IRD guidance). The IRD guidance outlines the IRD’s general views around tax issues relating to tax residence of companies and individuals, permanent establishment, employment income of cross-border employees and transfer pricing (TP).
The IRD’s views and approach in relation to the above tax issues are generally in line with the ‘Updated guidance on tax treaties and the Impact of the COVID-19 pandemic' (the COVID-19 tax treaty guidance) and ‘Guidance on the transfer pricing implications of the COVID-19 pandemic' (the COVID-19 TP guidance) released by the OECD in December 2020 and January 2021, respectively.
It is worth noting, however, the IRD guidance is not legally binding and only represents the IRD’s general views. Each case will be assessed based on its own facts and circumstances. For a detailed discussion of our comments on the IRD guidance and the OECD Secretariat’s analysis of the impact of COVID-19, please refer to KPMG’s Hong Kong Tax Alerts Issue 8, August 2021 and Issue 6, April 2020 respectively.
The IRD guidance should be welcomed by many businesses as it provides a degree of reassurance for taxpayers that may have employees temporarily stranded overseas a result of these restrictions.
Whilst it is good to see the IRD generally following the OECD’s views, the guidance does not cover situations where potential tax liabilities may arise under domestic tax law due to a change in which businesses are being forced to operate or are managed or controlled during the pandemic. This is particularly relevant for cross-border workers who, habitually travel overseas to perform services or conclude contracts on behalf of their employers, are now being forced to work in Hong Kong SAR because of the travel restrictions. This is a situation commonly faced by many businesses during this period and such taxpayers may have treated part of or all of their profits as offshore sourced and non-taxable.
Given Hong Kong SAR’s territorial system of taxation, the territorial concept fundamentally requires taxpayers to determine the location where the profits are derived and profits which have an offshore source are generally not taxed in Hong Kong.
Taxpayers with an offshore profits claim may therefore find themselves in a predicament and risk such profits being challenged and regarded as Hong Kong SAR sourced as a result of their employees performing profit generating activities in Hong Kong SAR during the pandemic. Further clarification from the IRD would be welcomed in this regard.
Nevertheless, the IRD Guidance should provide a degree of reassurance for taxpayers in determining their tax positions during the pandemic – if they can apply a double tax agreement. If a double tax agreement cannot apply, the guidance is only helpful in that it confirms that no concession or relaxation will be accepted by IRD.
Notwithstanding the guidance, employers who have employees that are temporarily dislocated should continue to monitor their circumstances and the government travel rules regulations closely to assess whether if it is really a temporarily dislocation as a result of COVID-19 or a matter of choice.
In particular, consideration should be taken that this guidance given by the IRD only applies to the interpretation of tax treaties and the application of transfer pricing principles. The IRD Guidance does not apply to the interpretation of domestic law nor where the dislocation of the employee is by choice, rather than being imposed by restrictions arising from external factors. Taxpayers should tread with caution and work closely with their tax advisors to carefully assess their tax positions during the pandemic.
Lewis Lu
Partner, KPMG China
John Timpany
Partner, KPMG China
