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The role of the “economic employer” in cross-border assignments
Cross-border assignments of employees are an integral part of the operations of multinationals. However, in practice cross-border assignments regularly lead to uncertainty when it comes to the question in which country the salary is to be taxed. Taxand’s Global Compensation Tax team provides a brief overview of the approaches made by respective tax authorities.
The basic principle of Article 15 of the OECD Model Convention sounds rather simple: if an employee is sent abroad, the right of taxation for the employee’s salary is in principle with the country where the work is actually exercised (Article 15 para. 1). However, according to Article 15 para. 2 of the OECD Model Convention, the right of taxation stays with the country of residence if the employee:
- Has not spent more than 183 days abroad
- The salary is not borne by a permanent establishment of the employer in the country of assignment
- The salary is paid by an employer, or on behalf of an employer, who is not resident in the state of assignment.
In the case of intra-group assignments, the employee will remain formally employed with the sending company, but will exercise his work for the receiving company to which his salary is recharged by the sending company.
In this case it is crucial to determine whether or not the requirements of Article 15 para. 2 of the OECD Model Convention are met, in particular whether or not the salary is paid by an employer, or on behalf of an employer, who is not resident in the state of assignment, in order to arrive at the correct allocation of taxation rights. Whether or not the country of assignment will have a right of taxation will depend on whether the receiving entity can be qualified as an “employer”. Even though it is clear that the receiving entity is not the employee’s formal employer, it could still be qualified as the “economic employer”.
This term, which is not used by the OECD Model Convention, means that even if the employee is legally employed by the home country (formal employer), the host country entity that is receiving the benefit could be construed to be the (economic) employer and, therefore, para. 2 of Article 15 would not be applicable to exempt the income from tax in the host country. As the term is not used by the OECD Model Convention, the decision lies with the respective countries if and in what way they apply an “economic employer” approach.
The OECD commentary refers to both, the formal and the economic approach, but more weight is put on the latter. Under the economic approach, important criteria for assuming an economic employment are:
- The employee is integrated into the business of the host entity.
- The employee is under the control of that entity.
- The activities of the employee form part of the business of the host entity.
- The risks of the activities are borne by this employer.
Many countries do apply an “economic employer” approach, even though the details vary. Some countries like Canada, The Netherlands and the United States put a particular focus on the authority to instruct the individual and the entity that is bearing the risks for the result of the work. In the United States, it is furthermore required to have control of the payment of wages to be qualified as an employer. In The Netherlands, the fact that the salary costs are charged to the Dutch entity is already considered to be sufficient if the other criteria are met. However, no economic employment is assumed in The Netherlands if an employee is seconded for less than 60 days in a 12-months-period.
Some countries basically follow the same approach, but sharpen the rules a bit. Germany also looks at whether the employee is integrated in the organisation of the receiving entity. If the term of the assignment is less than 3 months, it is assumed that there is no integration in the organisation of the receiving entity. However, according to the German view the applicability of Article 15 para. 2 is not only excluded if there is an actual recharge to the German host entity, but also if, from an arm's length perspective, the employee’s salary should have been borne by the host entity. Some cantons in Switzerland follow the same approach and assume that 3 months is the decisive limit. In some parts of the country, the tax authorities do not explicitly express their stance; however there is a tendency to follow this economic employer approach.
Other countries, like Spain or China, assume an economic employment if there is a recharge to the host entity and deny the applicability of Article 15 para. 2 in such a case. The term of the assignment then becomes irrelevant.
Conversely, Finland does not apply an economic employer approach. As a result, in principle only the formal employer is decisive. Even a recharge between group companies does not lead to a different result, so that Article 15 para. 2 may be applied in such cases.
Your Taxand contacts for further queries are:
Gonzalo Fernandez de Lorenzo
T. +34 91 514 52 00
T. +358 9 6153 3589
T. +49 89 23714 17256
Paul van Horsen
T. +31 20 301 66 33
Allison Hearne Hoeinghaus
T. +1 214 438 1037
T. +1 214 438 1028
Despite the fact that the wording of the various double taxation treaties is mostly identical to the wording of Article 15 of the OECD Model Convention, there are huge differences in how the terms of the treaty are interpreted by the tax authorities of the respective countries. Knowing these approaches is key to the fulfilment of all tax obligations in the respective host countries, and should be the basis for planning cross-border assignments.