The tax risks of cross-border employment

taxation 2Author: Shohana Mohan (KPMG)

The issues relating to the international hiring out of labour, personal tax considerations and what to look out for when structuring contractual arrangements.

The world has become increasingly globalised, and cross-border mobilisation is high on the agenda for many countries and companies. Any multi-national company worth its salt has a global mobility policy framework in place, which sets out the parameters for cross-border employment.

These parameters are generally underpinned by hiring-out policies, such as assignment or secondment. Assignments or secondments within the same group of companies are quite useful. It allows for effective skills transfers, and creates a wider inner knowledge of the entire business.

It is natural to initially only consider the human resource related elements of cross-border employment, but it is important to be aware of critical tax related aspects that need attention to ensure compliance.

The basics: What exactly is a secondment principle

Secondment essentially means that an individual is deployed from one related employer to another on a temporary basis. The idea is that the individual goes back to his first employer at the end of the secondment.  This is generally referred to as the “loaning” of an employee.

A secondment agreement generally has three parties, the secondee or employee; the sending entity or the seconder; and the receiver of the services (referred to as the “host”).

The arrangement is set up in such a way that the secondee remains the formal employee of the original employer during the secondment and will, at the end of the secondment, “return” to the seconder.

In this regard, it is important to distinguish between a contract for services (generally where one entity agrees to provide a specific service through the use of its own employees to another entity) or a contract of services where an employer-employee relationship exists.

General tax rules

In terms of the general tax rules, a non-resident who renders services in a country which has a Double Tax Agreement (DTA) in place, should not be liable to pay tax in that country, if the non-resident spends one or more periods of less than 183 days in that country.  In order to qualify for the exemption, the non-resident is required to fulfil the three conditions contained in thedependent personal services article of the treaty

  • the individual must not be present for more than 183 days in the country in which he/she is temporarily rendering the service;
  • the entity at which the services are being rendered cannot be regarded as the individual’s employer; and
  • the individual’s home country employer must not have a permanent establishment in the other country where the services are being rendered, which bears the costs of the individual’s remuneration.

From a South African personal income tax perspective, residents are liable for tax on their worldwide income and capital gains (subject to certain exclusions), while non-residents only have tax liability on their South African sourced income.  This means that, to the extent a non-resident renders services in South Africa and meets the conditions of the DTA [described above], they will not be liable for tax on her income from employment in South Africa.

The abuse of international hiring-out of labour

Unfortunately ‘international hiring-out of labour’ is sometimes abused to avoid paying personal taxes. For example, a local employer may decide to employ foreign labour for one or more periods of less than 183 days. They do this by recruiting individuals through a foreign intermediary (i.e. company), which purports to be the employer and hires out the labour.

This results in the individuals (generally non-tax residents) avoiding paying tax at source in situations where services are rendered in foreign countries that have a DTA in place.

The non-resident fulfils the three conditions contained in the dependent personal services article dealing with income from employment of the relevant DTA and may claim exemption from taxation in the country where he is rendering the services.  Thereby dodging tax in the country that they originate from, and the country that they were seconded to.

The Organisation for Economic Cooperation and Development (OECD) has come up with certain criteria to ascertain who the real employer is. This is to curb abuse in situations where a foreign employee works in another country for less than 183 days and does not have to pay tax in the source country because they are seen as being employed by a foreign employer. Where the nature of the work done by the non-resident indicates an employment relationship with the entity receiving their services, the following criteria is used to determine whether the services are rendered in an employment relationship (contract of services) or whether services are rendered under a contract for the provision of services (contract for services):

  • who has the authority to hire or fire that individual?; and
  • who bears the responsibility for the work produced by the seconded staff? Does the seconding entity bear the risk and responsibility for the results produced by the seconded employees and maintain discipline over the seconded employees’ performance?

If the entity receiving the services is seen to be the non-resident’s employer in terms of the DTA, one of the conditions of the dependent personal services article of the DTA will not be met, and the individual will not be tax-exempt. South Africa will likely have the right to tax the income earned from the work that the foreigner did in South Africa, irrespective of whether he spend 183 days or more in South Africa.

This could result in double taxation and subsequent cash flow issues for the non-resident should he also be held liable for tax in the country where he is considered to be a tax resident.  It is important to note that although South Africa is one of the non-member economies with which the OECD has working relationships, based on certain facts and circumstances, the South African Revenue Services may subscribe to the guidelines issued by the OECD.

In certain circumstances cross-border hiring out may give rise to the creation of a permanent establishment in the country where the employees are sent. This can give rise to international tax consequences, specifically in situations where the sending company provides services through the use of its employees.

Importance of the contractual arrangements

The parties to the contractual agreements are generally a non-resident individual who provides the services, and the home country employer or intermediary who is required to provide a service or labour to the host entity.

The contract of employment is formally concluded between the non-resident and the home country employer or the intermediary.  However, the non-resident is expected to work at the premises of the host entity.  Details of the agreed service deliverables, together with the secondment terms and conditions, are included in a Services and Secondment Agreement.

Given the criteria used to determine who the real employer for tax purposes is, the Services and Secondment Agreement should differ from the how the arrangement between the parties plays out in reality. It is advisable that the Services Agreement between the sending and receiving entities should make reference to the employee selection criteria, supervision, period of the secondment, renewal of the secondment and notice of termination of the secondment.  It should mention that the home country employer will remain responsible for the performance appraisal of the secondee.

It is clear that, although there are business imperatives for mobilising a workforce, this should be considered in light of the personal and corporate income tax considerations in both countries.  Failure to do so will impede successful cross-border employment.

This article first appeared on the January/February 2016 edition on Tax Talk.