What effect will the lockdown have on tax residency?
Both the Spanish government and Tax Agency have failed to address this issue. Days spent under lockdown will not count towards tax residency in countries like Germany or France.
AUTHOR: Andreu Bové, Tax Advisor
Bové Montero y Asociados
The lockdown imposed by our governments in response to Covid-19 has generated a significant number of doubts around international taxation matters, such as determining the tax residence of natural and legal persons, or the presence of a permanent establishment (PE).
Although we will focus on the Spanish perspective, these same situations and issues may also arise abroad, wherever Spanish business persons have investments.
In Spain, the tax residence of natural persons is worked out using the following tests: length of stay, centre of economic interests, and family situation. The first test deems a person to be tax resident if their stay in Spain exceeds 183 days in a calendar year. Any temporary or sporadic absences are included for the purposes of calculating the length of stay. The fact that some people will involuntarily spend more than 183 days in Spain due to the restrictions on movement could be decisive in determining their tax residence. As a result, these people would be taxable in Spain on their worldwide income and wealth.
The tax residence of legal persons is determined by the entity’s place of effective management, among other considerations. This will depend on the locations of the people who make key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole. Again, the Covid-19 lockdown will have a direct impact.
If the Spanish Tax Agency were to regard these natural or legal persons as tax resident in Spain, they could become dual resident in Spain and the other country. In this situation, they should consult the double taxation treaty between the two countries, if there is one, in an attempt to resolve the dispute, whether by applying the tie-breaker rules, or via a mutual agreement procedure. In the worst-case scenario, persons affected could find themselves in the unfortunate position of being subject to double taxation.
The enforced lockdown could also mean that some foreign companies unintentionally have a PE in Spain, meaning the profits allocated to this establishment would be taxable in Spain, and they would be required to comply with the corresponding VAT obligations.
A foreign company could have a PE in Spain if the construction, installation, or assembly work it is carrying out in this country exceeds a given number of months (typically 6 or 12). An entity also has a PE in Spain if a person, other than a dependent agent, acts on the company’s behalf and habitually exercises authority to conclude contracts in its name.
That being so, the longer the work lasts, or the more “habitually” the agent exercises this authority, the greater the risk of the foreign company having a PE in Spain and therefore being liable for corporate income tax and VAT.
Another issue affected by the enforced lockdown is the calculation of the exemption provided in article 7.p) of the Spanish Personal Income Tax Act on services performed abroad for non-resident entities. This exemption, capped at 60,000 euros annually, applies to both payments for specific jobs and general pay, although the latter must be proportionally allocated according to the time spent abroad.
To avoid this kind of dispute over residence or PEs, countries such as Germany, France, the Netherlands, Luxembourg, and Belgium have taken appropriate measures. For instance, some of these countries have agreed that days spent under lockdown will not count towards calculations determining the length of stay or tax residence of natural persons.
It is regrettable that neither the Spanish lawmakers nor the Tax Agency has even mentioned these issues, thereby only generating more uncertainty.
Fortunately, the OECD, in its commentaries on the Model Tax Convention, seems to indicate that this type of exceptional circumstance should not be taken into account for these purposes. In addition, a recent OECD recommendation published in light of Covid-19 confirms that these days should not have a negative effect and by extension should not be included for the purposes of determining tax residence or the presence of a PE. Although the OECD commentaries and recommendations are not binding, and should therefore be interpreted with a degree of caution, they do provide context and shed some light on the issue.
We can only hope that the Tax Agency bears in mind the exceptional nature of the present situation and follows the OECD recommendations. This would help to mitigate some of the negative tax effects that the crisis will inevitably leave in its wake. It could also be an opportunity for the Tax Agency to provide greater certainty and continue to improve relations with taxpayers.