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Creation of permanent establishment as a result of the COVID-19 pandemic

The COVID-19 pandemic has led to unprecedented lockdown measures being imposed around the world. These measures have included the closure of borders, restricted movements of people and cancellation of visas. As a result, many employees are required to work from home and, in some cases, away from the country of their employment. A question that arises is whether a permanent establishment (PE) can be created for a company in other countries as a result of some of its employees being forced to work from such other countries because of COVID-19 measures.

A PE is principally created in one of two ways:

  • Where a company has a fixed place of business in another country through which its business is wholly or partly carried on (the so-called “general PE definition”); or
  • If there is a person in the other country and such person acts on behalf of the company and habitually concludes or plays the principal role leading to the conclusion of contracts (the so-called “Dependant Agent PE”).

The above PE concept has been included in section 1 of the South African Income Tax Act and creates South African source income for non-residents to the extent that the income is attributable to a PE as envisaged above. It is noted that, for tax treaty purposes, South Africa does not have such an extended Dependant Agent PE concept, as it limits a Dependant Agent PE to a person with the authority to conclude contracts in a contracting state and who habitually exercises that authority.

According to the 2017 Model Tax Convention on Income and on Capital of the Organisation for Economic Co-operation and Development (OECD MTC) commentary, a general PE will only be found to exist if the following is the case:

  • The existence of a place of business, i.e. a facility such as premises at the disposal of the enterprise;
  • The place of business must be fixed, i.e. it must be established at a distinct place with a certain degree of permanence; and
  • The business must be conducted through that fixed place of business.

In order for a home office to be a place of business at the disposal of an enterprise, it must be used on a continuous basis for business. According to the OECD MTC commentary, the temporary carrying on of a trade at home by an employee does not result in that home being at the disposal of the employer.

The OECD MTC commentary also explains that where an individual performs most of their work at home in one state, e.g. South Africa, rather than from an office made available to them in the other state (where they normally work), that home office is not at the disposal of the enterprise as the enterprise did not require the home to be used for business activities.

Stranded employees working from home due to COVID-19 measures do so under exceptional and temporary circumstances. According to the OEDC, many individuals who stay home to work remotely are typically doing so as a result of government directives and not as a result of an enterprise’s requirements.1 Therefore, home offices that stranded employees are using should not constitute places of business at the disposal of their employers.

Furthermore, as a rule of thumb, a PE is generally not considered to exist in situations where a business is carried on in a country through a place of business that is maintained for less than six months. It follows that a PE will generally only exist if the place of business has a certain “degree of permanence”.2

Based on the above, we do not expect that home offices which stranded employees use will constitute a fixed place of business, as the home office is merely temporary and transitory due to COVID-19 measures. As such, we do not expect that the home offices should create a general PE where it constitutes a deviation from the normal mode of working.

According to the OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis, even if an employee is concluding contracts in the name of his or her employment entity in another country, it is unlikely that the employee will be considered to habitually conclude contracts in such country and therefore create a PE for the employment company. This is because the employee is concluding those contracts subject to government directives/ force majeure and will likely do so for a short period. This would be different if the employees were habitually concluding the contracts on behalf of the enterprise prior or post the COVID-19 pandemic.3

The temporary change in work location of employees, such as working from home or being stranded in a country they do not normally work from due to COVID-19 should, therefore, not create new PEs for businesses, as this is an exceptional and temporary situation.

Possible PE risk
Notwithstanding the above, a PE risk could possibly arise where presence in a foreign country is extended for operational reasons rather than solely as a result of the COVID-19 measures. An example would be where, the COVID-19 measures have been lifted and employees are able to return to their country of normal employment or work from their normal business premises but still chooses to remain in a foreign country.

Another example would be where an employee was already abroad for commercial reasons with COVID-19 measures having the effect of extending that employee’s duration of activities in that country. If, for example, that employee was present in a foreign country for five months before the implementation of COVID-19 measures, it may be difficult to argue that such a presence in-country is merely temporary and, as such, does not give rise to a PE.

It is, however, likely that a PE risk will be created if the COVID-19 measures become permanent and employees continue to work from home for an indefinite period under the “new normal” environment.

The question of whether a PE will be created, due to COVID-19 measures, will depend on the facts of each case as well as the application and the interpretation of the laws of the country in which the employee is stranded.

From a South African perspective, we do not expect the creation of a South African PE by employees forced to work from South Africa solely because of COVID-19 measures. However, a PE risk may exist if the employees are working from South Africa for other reasons and not merely due to COVID-19 measures.

On the basis that the outcome of a PE analysis will be dependent on facts of each case, as well as the laws of the country in which the employees are stranded, it is advisable that companies with stranded employees analyse their specific facts and circumstances to ensure full compliance with the laws.

1 Capital of the Organisation for Economic Co-operation and Development, OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis, April 3 2020, p.2.
2 Paragraph 28 of the OECD MTC commentary.
3 Capital of the Organisation for Economic Co-operation and Development, OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis, April 3 2020, p.3.

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