Corporate residence in light of Covid-19
- HMRC has issued some guidance to confirm its practice on corporate residence issues, however it does not go as far some territories.
- Non-UK companies may still be at risk of becoming UK tax resident if travel restrictions prevent key decision makers from leaving the UK.
- Other companies may find it difficult to sustain their intended place of tax residence (e.g. for treaty purposes) if directors are unable to travel to meetings.
- Virtual meetings can be a practical solution to travel disruption but are a source of tax risk.
- As Covid-19 disruption may last for some time, companies should consider now what practical steps they can take to manage these risks.
The travel restrictions imposed by many governments as a response to the Covid-19 crisis mean that many people cannot be where they want to be when they want to be. One knock-on consequence facing corporate groups is that their key decision-makers may not be able to be physically located where they were expected to be when they make their decisions or conclude business. While the wonders of modern technology might facilitate decision-making processes by allowing for virtual meetings and remote working, there can be unforeseen consequences for the tax residence of companies especially under tax residence rules, which focus on the location of the strategic management of the company.
This note concentrates on the risk to non-UK incorporated companies of being treated as resident in the UK for tax purposes in circumstances where directors and key decision-makers are located in the UK and unable to travel to board meetings and places of business outside the UK for an extended period. Some other companies may, of course, face the opposite problem; they may wish to be treated as resident in the UK (and not elsewhere) for tax purposes but with directors located in other jurisdictions and unable to travel to meetings or for business in the UK may risk being treated as resident in another jurisdiction for the purposes of its domestic law and/or for the purposes of double tax treaties.
UK corporate residence rules
Under UK domestic law rules, a company is UK tax resident if it is incorporated in the UK or if its central management and control is situated in the UK unless the company is treated as resident in another jurisdiction for the purposes of an applicable double tax treaty.
The central management and control test has developed through case law. It seeks to identify where the key strategic decisions regarding the business of the company are taken. This is essentially a question of fact. But, in the case of a company operating under normal governance procedures, central management and control will usually be located where the board habitually meets to make those decisions. It is not a test that only has regard for the position at an instant in time. It is necessary to have regard to the decision-making procedures of the company over a period.
As we have mentioned, even if it would otherwise meet this test, a company will not be resident in the UK if it is treated as resident in another jurisdiction for the purposes of a double tax treaty with the UK. Prior to the introduction of the multi-lateral instrument (MLI), most UK treaties based on the OECD model contained a “tie-breaker” provision under which a company, which was resident in both the UK and the other contracting state, was regarded as resident in its “place of effective management” for the purposes of the treaty. Now, for many treaties where the counterparty to the UK has signed up to the MLI, the place of effective management tie-breaker is replaced with a process by which treaty residence is determined by mutual agreement between the tax authorities.
The risks of virtual board meetings
Under the current travel restrictions many directors may find themselves unable to travel to physical board meetings in other countries. One practical option – assuming that the company’s constitution allows – may be to hold video or telephone board meetings. However, given the focus of the central management and control test of residence on the physical location of decision-makers when they make strategic decisions, such meetings may affect the residence status of a non-UK incorporated company if directors dial into or otherwise participate in a board meeting when they are physically located in the UK.
The level of risk depends on numerous factors including:
- the composition of the board: If the UK based directors are in a clear minority and their importance to the decision-making process is not disproportionate to the other directors, it may be possible to reach a view that the “centre of gravity” of the governance process has not shifted to the UK;
- the period over which the practice continues: As we have mentioned, the location of central management and control is tested in the context of practice over a period of time. An isolated incident in which directors participate in a board meeting from the UK, when set against a history of regular non-UK meetings, may not disturb the residence status of the company in particular if the matters discussed at the meeting are of a more routine nature;
- the company’s governance history: For similar reasons, whether or not there have been regular instances of directors participating in decision-making processes from the UK in the recent past may affect the ability to take a pragmatic view of a limited period in which directors have to participate from the UK during the period of the crisis; and
- the type and level of decisions being taken by the board during the period: It is key strategic decisions that matter for the purpose of the test. If the matters under discussion are more routine and administrative, once again, it may be possible to be more sanguine over a period in which certain directors participate from the UK. The risks are inevitably greater where key commercial and strategic decisions need to be taken.
It is important to remember that this is a fact-based test. It will be important to consider all the circumstances of the case.
Managing the risk
Given the uncertainty over the period for which the current travel restrictions may be necessary, it might be worth considering ways to mitigate the risk. The suggestions below will not be palatable for all groups, therefore careful consideration will be needed before implementing any change. However, possible strategies could include:
- reconstitute the board by taking UK based members off the board, or adding non-UK based members;
- ensure UK board members do not participate; and
- defer major strategic decisions to later meetings or postpone the board meeting entirely until the full board can attend.
During a period of crisis, none of these options may be ideal. Furthermore, it may simply not be credible for some groups that particular UK-based individuals do not have input in major strategic decisions, which may lead to an inference that key decisions are being taken elsewhere and not through the normal governance procedures.
In such circumstances, and if the hiatus is likely to be prolonged, some groups may need to consider reconfiguring their governance arrangements to permit greater decision making in the UK within UK group companies without prejudicing the residence position of group companies which are not UK resident. This may have a price in terms of transfer pricing for additional services being provided from UK companies, but it may protect the residence status of other group companies and reduce the strain on governance procedures.
The response taken will often be dictated by the nature of the business of the relevant company. It is likely to be simpler for pure holding companies and investment companies to make such changes. Operating companies may face more immediate challenges in the face of Covid-19 and have additional issues to face - such as whether the activities of personnel now in the UK give rise to a taxable presence (a permanent establishments) of non-UK group companies in the UK where those UK based individuals play significant roles in the negotiation and conclusion of commercial agreements.
In the context of the UK’s statutory residence test for individuals, HMRC has issued updated guidance confirming that the Covid-19 crisis will constitute “exceptional circumstances” – allowing some periods of time spent in the UK to be ignored for the purpose of certain aspects of the test. Since first drafting this note, HMRC has now issued guidance confirming its approach to corporate residence and permanent establishments during this time. The guidance states that HMRC is sympathetic to the circumstances, and states that a few board meetings held in the UK or decisions taken in the UK over a short period of time would not necessarily mean that a company becomes resident in the UK. However, HMRC is still likely to look at the facts and circumstances from a holistic perspective.
Other jurisdictions are taking different approaches. The Australian Tax Office, for example, has confirmed that “if the only reason for holding board meetings in Australia or directors attending board meetings from Australia is because of impacts of Covid-19, then we will not apply compliance resources to determine if your central management and control is in Australia.”
Similarly, Jersey has published guidance that it is relaxing its economic substance and residence rules. The guidance states that adjustments to normal operating practices to mitigate the threats from this outbreak will be acceptable, such as holding the meeting virtually to take into account a board member who needs to self-isolate. Luxembourg has also bought in regulations to state that meetings can be held virtually, by remote voting, via proxy, or via videoconference.