International Crackdown: Tax Authorities Look to Employment Structures in Initiating Audits
Authors: Rebecca L. Marks (Boston), Bonnie Puckett (Atlanta)
Published Date: May 26, 2016
In structuring their workforces abroad, taxes are a major driving force for employers—and if recent government initiatives are any indicator, employers should take care when considering the tax implications of their staffing decisions.
On May 24, 2016, several French agencies, led by the French police financial fraud and corruption division and including 5 magistrates from the financial prosecutor’s office, raided the Paris office of a global Internet service provider. The investigators were searching for evidence as part of an investigation into allegations from the French tax office that the company may owe French corporate taxes—with potential penalties of €1.6 billion. France’s position is that although the company’s sales contracts are signed in Ireland, the revenue is taxable in France, in part because some of the company’s sales employees are based in Paris. The French government takes this position despite the fact that the company’s stated business in France relates to advertising, scientific research, and cultural centers, none of which would seem to constitute a taxable presence under a provision in the bilateral tax treaty between France and Ireland exempting from that designation fixed places of business “solely for the purpose of advertising, for the supply of information, for scientific research or for similar activities which have a preparatory or auxiliary character.”
In late 2014, the Chinese government reached a settlement with an unidentified U.S.-based company whose research-and-development employees in China were generating profits that were being channeled to a U.S. parent company as fees. The company agreed to pay $140 million in connection with allegations of tax evasion. The U.S.-China tax treaty, unlike the France-Ireland treaty, allows any employees performing services to constitute a “permanent establishment,” notwithstanding the employees’ authority to conclude contracts or lack thereof.
U. S. government contractors have recently found themselves on the receiving end of large unanticipated tax bills in host countries. As recently as July of 2015, authorities in Afghanistan sought payment of outstanding balances by threatening to reject contractors’ applications to renew business licenses and freeze their local bank accounts. The contractors contested the legitimacy of much of the amounts levied, contending that their employees were covered under bilateral security agreements that exempted them from taxes.
These are just a few high-profile examples of how tax authorities are mobilizing worldwide to track down and get a piece of possible profits being generated within their jurisdictions from foreign companies. The takeaway here is that even if companies take specific measures to avoid qualifying as taxable presences under a tax treaty, doing business in foreign jurisdictions in a way that may suggest that revenue is sourced there may draw government scrutiny. Sales employees based in a foreign jurisdiction, even without contracting authority, could trigger an audit—as could revenue traceable to non-sales employees—and an audit can be onerous regardless of the merits or the result. In light of recent crackdowns worldwide, employers expanding into new jurisdictions or analyzing their risk in connection with current operations abroad may wish to loop in their tax department or advisors, and revisit and/or revise existing and proposed staffing arrangements. Employers that are revising their staffing arrangements, may want to consider taking the following steps:
Review the applicable bilateral tax treaty (if any), specifically the definition of a “permanent establishment.” Remember that a local entity may not protect the parent company if the parent company also appears to be operating directly in the jurisdiction.
Government contractors should determine whether a status of forces agreement or other bilateral treaty applies to their employees.
Evaluate whether staff in the relevant jurisdiction may appear to be revenue-generating.
Review contracts with all staff and compare their contractual duties with the duties actually implemented on the ground; look for job titles, job duties, and provisions limiting the individual’s authority to conclude contracts.
If applicable, consider alternative staffing models and entity structures in light of tax, payroll tax, and employment law concerns.
Rebecca Marks is a member of the International Practice Group, which provides worldwide labor and employment law support in over 100 countries. Her expertise includes crafting practical, business-centric advice on international employment issues for U.S. management of multinational corporations. She supports U.S. human resources internationally and helps educate clients about the differences between US at-will employment law and the employee-centric laws of most of the rest of the world. She...
Bonnie Puckett leads the firm’s Asia-Pacific practice, advising on all types of cross-border and global employment matters within the Asia region and worldwide. Some of her major work includes preparing contracts, handbooks, and corporate policies designed for worldwide as well as country-specific use. Bonnie develops business-practical solutions for employers confronting various international challenges from onboarding, to compensation structure, to performance management, to...