The COVID-19 pandemic affected many aspects of society’s life, and tax relations were no exception. One of the key issues that bothers individuals faced with a lockdown in some country is determining their tax status.

A situation when an individual’s assets and vital interests are spread throughout different jurisdictions is quite common. You can mainly reside in one state, conduct business and have other sources of income in another one, while having your family in a third place.

In this case, the tax resident status is very important, since tax consequences for an individual in a particular state will depend on it. The first question is how to determine income subject to taxation in the country of residence, and the second is what tax rate applies in the relevant jurisdiction.

Most countries adhere to the so-called “residence and source taxation system,” which is a system allowing a state to impose taxes on all income of its resident regardless of their location, while non-resident income is taxed only in respect of sources within the country.

The OECD Model Tax Convention contains an open list of possible criteria for determining the resident status for an individual or legal entity (citizenship, center of vital interests, place of registration, etc.) and refers to national legislation of states. Therefore, the tax status of an individual shall be determined in accordance with the national law of each country. In the event of any conflict between two jurisdictions regarding the residence of an individual having presence in several states, Double Taxation Avoidance Agreements (hereinafter “DTAA”) help determine the state in which they should pay the tax and its amount.

Some countries use the test of actual time spent in the state as the main criterion for determining the tax status of an individual. For example, to recognize an individual as a Russian resident, they must stay in the country for at least 183 calendar days within 12 consecutive months, regardless of where the center of their vital interests is located. If an individual spends more than six months outside the Russian Federation, on the one hand, they will have to pay tax in Russia only with regard to income received within the country, but on the other hand, the tax rate rises to 30%, which might cause a significant increase in the tax burden.

Moreover, the period during which an individual stays in a state is relevant for determining the residency of a company, if such an individual is a member of its management, and as to a legal entity, national legislation provides the test of “the place of effective management” as a criterion for determining its residency.

Apparently, the COVID-19 pandemic caused a situation when many individuals found themselves in forced isolation, due to which the tax residency of such individuals (and, possibly, the companies they own and operate) can change regardless of their will. This problem is becoming one of the most relevant today and has already been reflected in international practice.

 

OECD recommendations: opinion of the international organization

Some countries have already managed to develop internal acts concerning the impact of the COVID-19 pandemic on determining the residence status of an individual. The OECD also responded by publishing April 3 Recommendations on the COVID-19 crisis consequences for cross-border workers and other people who have to stay in a country different from their usual residence. Therefore, in these explanations, the OECD took the time to examine the impact of the pandemic on both residency of companies and status of individuals.[1]

 

1.  OECD recommendations regarding residency of legal entities

The OECD regards the pandemic as force majeure, which means that staying in another country as part of isolation measures should not lead to double residence and, accordingly, to double taxation of a person.

Section 3 of the Recommendations addresses the issues of determining the residency of companies, in particular, how the principle of “the place of effective management” should apply. There were concerns that the restriction on the movement of senior executives may lead to recognizing “double residency” in respect of the companies they manage.

Such a situation is possible if two states apply different concepts of tax residence in their national laws (for example, when the principle of the place of effective management is provided for by the legislation of the host country and the principle of the place of registration is provided by the national legislation of an individual).

However, according to the OECD, in such cases, most of DTAAs executed in accordance with the OECD Model Tax Convention as amended in 2017 provide for the so-called MAP – mutual agreement procedure of authorized bodies using the residence tie-breaker rules,[2] which eliminate double taxation (see Article 4 Section 3 of the OECD Model Tax Convention). Such rules provide for taking into account all factors and circumstances in the event of a conflict, for example, where a governing or executive body is usually located, after which the authorized bodies of the states jointly agree to resolve the conflict.

• Please note that Section VII.1 of the Russian Tax Code was supplemented by Chapter 20.3, which is devoted to a mutual agreement procedure in accordance with the international tax treaty of the Russian Federation. Moreover, starting 2020, Article 105.18-1 of the Russian Tax Code, which addresses adjustments based on the results of a mutual agreement procedure, has taken effect; however, the details of such a procedure have not yet been regulated, which has already attracted criticism of Russia from the global community.
• Currently, there is only the Draft Order of the Russian Ministry of Finance “On approving the Regulations for performing mutual agreement procedures in accordance with the international tax treaties of the Russian Federation.” This Order is still being finalized and recently has been published with the explanations for review. Unfortunately, some issues in the Order remain unresolved and cause concern among business representatives due to their impracticality. In this regard, for now, we have to rely on general provisions of the Agreements, although many taxpayers might need effective mutual agreement procedures very soon.

As to the agreements executed earlier than 2017, the criterion for the place of effective management is central to them; however, the OECD stresses that in any case this criterion should be understood broadly as a place of usual, permanent managerial decision-making. Therefore, all facts and circumstances should be verified in terms of usual and ordinary management. The forced isolation of a head or an employee of the company itself should result in no change of the legal entity’s residency, which, of course, seems fair.

In this regard, as an example, the OECD noted the guidance issued by the Office of the Revenue Commissioners of Ireland on ignoring an individual staying in Ireland (and, if necessary, in a different jurisdiction) for tax purposes with respect to the company where such an individual is a director. However, it must prove that such staying is precisely the result of travel restrictions due to COVID-19.

 

2. OECD recommendations for residence of individuals

Section 5 of the OECD Recommendation addresses the residence of individuals. In particular, it gives two examples where the resident status of an individual should not be changed, even if such an individual meets the criteria for residence in the country of forced stay:

1. an individual has arrived in a non-residence country for a short period and is forced to stay in it due to the pandemic (hereinafter “Example No.1”). Imagine that an individual might have gone on a long business trip, on vacation or to visit relatives in another country and was “locked in” there due to the pandemic.
2. an employee was forced to leave the country of their “current” residence (at the employer's location) due to the pandemic, having temporarily returned to the country of their previous residence (hereinafter “Example No.2”). Imagine that a foreign citizen had worked in Russia for more than six months, but due to COVID-19, he returned to the country of his citizenship and where he has family.

According to the OECD, for the purpose of taxing an individual’s income, they cannot be a resident of two countries at the same time in terms of the DTAA and OECD Model Tax Convention, and therefore it proposes a consistent hierarchy of criteria for determining the jurisdiction of their residence.

The OECD gives the following procedure for determining residence in the above cases of “lockdown” of individuals due to COVID-19:

• Example No.1: in such a situation, an individual is most likely to have to pass the permanent home test as the availability of residential premises. However, if they have such premises in both countries (for example, they lease one of them out while actually residing in the other), other criteria, such as citizenship or a center of vital interests, might be applied further to determine the country of residence.

• Example No.2: first, in such a situation we should not rule out that (1) an individual might remain a resident of the country of “previous” residence (for example, a foreign worker does not lose their resident status in the country of citizenship, even while staying in Russia) and (2) an individual who returned to the country of “previous” residence re-acquires resident status in accordance with national law.

Despite the fact that in this example the ties of the individual to the place of stay due to COVID-19 are close, the same tie breaker rules are applicable, in particular, the habitual abode test. This criterion is broader than the test for counting days spent in the country, since it includes the frequency, duration and regularity of stay (entry into the territory) in a particular country.

Therefore, in our example about a foreign citizen working for a long time in Russia, the competent authorities will examine the frequency and regularity of their previous visits to the country of their citizenship and their duration. If they worked in Russia, for example, for 5 years holding the position of the company head, and went abroad to see they relatives twice a year and for a short period of time, we believe that there are grounds to presume that they can maintain the status of Russian resident.

 

Residence during the COVID-19 period: national laws

Here are Recommendations of some countries that have already adjusted their national legislation with respect to the issue of residence, or explained the current procedure for determining tax status in more detail.

 

UK

The current sets of rules for determining residence in the United Kingdom is known for being comprehensive and requiring a careful and individual approach, even in quiet non-COVID-19 times.

The HMRC gave a detailed Manual on taking into account the so-called exceptional circumstances for counting days spent in the UK to determine the residence status. The list of such circumstances has no limits and is illustrative (for example, civil unrest, natural disasters, the outbreak of war). However, their main sign is the inability of a person to influence the length of their stay in the country due to such circumstances. Thus, based on the literal meaning, the COVID-19 pandemic may be considered as an exceptional circumstance in the UK, which in certain cases may affect the tax status.

To determine the UK residence, the HMRC divided life situations into two conditional groups:

• cases when exceptional circumstances are taken into account for counting the number of days spent in the country (for example, when an individual has not been a resident for the previous three years, and this year should have spent less than 46 days in the UK);

However, no more than 60 days in total can be deducted from the count of days spent in the UK due to the pandemic.

• cases when exceptional circumstances are not taken into account at all for counting the days spent in the UK (for example, if an individual has a house in the UK and has lived there for a considerable time without accommodation abroad or spending a short period of time there).

 Therefore, forced stay in the UK due to COVID-19 in certain cases might still be taken into account for counting days in order to determine resident status.

However, it is worth noting that the number of days spent is not the only criterion for UK residence. If a person is in the country for less than 183 days (regardless of the pandemic), they also need to pass a series of tests: permanent home in the UK, working mainly in the UK, the so-called “Automatic Overseas Test” (a person is a non-resident if they spend in the UK less than 91 days and work mainly abroad), a test as to family ties with residents of the UK, etc.

Each case is unique and the current situation requires a special approach and taking into account all the circumstances of a person’s stay in the UK due to COVID-19.

 

Australia

Australia has also published Explanations to the situation, when an individual being a non-resident of Australia for tax purposes, has been temporarily staying in Australia for several weeks or months due to the spread of COVID-19. In accordance with these explanations, such an individual does not become a resident of Australia for tax purposes, provided that they usually reside in another country, and also intend to return to their country of permanent residence as soon as possible.

 

Ireland

The above-mentioned Recommendations of Revenue are also interesting because of some other rules. In particular, in cases when an individual is not allowed to leave the state on the scheduled day of departure due to extreme natural events or exceptional actions (none of which could have been reasonably foreseen and prevented), tax authorities will not consider such an individual present in the state for tax residence purposes from the day following the scheduled day of departure. If leaving the state is not allowed due to COVID‑19, the tax office will consider this “force majeure” as excluding the application of the tax residence to an individual.

 

Conclusions 

Currently, states are beginning to regulate some aspects of determining tax residence during the spread of COVID-19. Mostly, countries recognize the pandemic an exceptional circumstance that allows not taking into account the forced presence of an individual on the territory of another state for the purpose of determining their tax residence. The OECD General Recommendations provide that in cases of “forced” residence it is better to rely on the provisions of the existing Double Taxation Avoidance Agreements which contain mechanisms for eliminating double residence, as well as on an analysis of what relations existed prior to COVID-19, how decisions were usually made and where an individual lived during normal conditions.

To date, the Russian Federal Tax Service has given no clarifications on this issue. In our opinion, the state should accept the position of the international community and not take into account the days of forced stay on the territory of the Russian Federation or in another state when calculating the standard 183 days within 12 months. The same applies to Russian citizens who, for any reason, found themselves abroad and whose income in the Russian Federation might be affected by taxation at the rate of 30%. We believe that in any case, taxpayers should check their tax status at the place of their current stay and think over the position as to whether their staying in a particular country is deemed forced and extraordinary.

 

Authors: Head of Tax practice of Capital Legal Services Anastasya Kuzmina and associates Ekaterina Zharova and Tatiana Dolgoarshinnykh.