183 Days Or Bust

CHRISTOPHER LYNCH ATII, ATT discusses the 183-day rule.

IT IS NO longer exceptional, with the rapid growth of international trade, for a company to have to send employees abroad, or to bring foreign nationals to the United Kingdom, in order to carry out one-off assignments or longer term secondments. In many cases, these deployments will be straightforward (with employment rights transferring) to other group entities within the overseas territory and the individuals will become tax resident from the moment they arrive in that country.

In other cases, the term of employment is intended to be of such short duration that it is neither economic nor sensible for the full consequences, including payroll tax equalisation agreements, social tax protection applications, overseas tax return filing, and home country double tax relief claims, of a transfer of tax residency status to be applied. This commercial reality is recognised by all modern tax jurisdictions and is provided for both in the model tax treaty drafted by the Organisation for Economic Co-operation and Development and virtually all bi-lateral double tax treaties through the use of what has become known as the 183-day rule.

However, the 183-day rule is not as straightforward as many expatriates (and tax practitioners) would like to think. In practice, ignorance of the conditions that apply to the rules has led to misinterpretation of an individual's tax residency status on numerous occasions. Misinterpretations do not just apply so that a taxpayer is treated as non-resident when, in fact, he is resident; they can also result from over-zealous application of the restrictions, so that a non-resident taxpayer is treated as a resident with the full paraphernalia of equalisation agreements, etc. being applied needlessly.

183-day rule

The following is a full reproduction of Article 15 which contains the 183-day rule, highlighted below in bold, of the Organisation for Economic Co-operation and Development's model tax treaty (which is followed almost verbatim by virtually all major tax treaties):

Interpreting the rule

If a person goes to work in a foreign country for a short time, the rule seeks to ensure that he does not have to be reclassified as a tax resident of that country even if he carries out activities which are remunerated, so long as the three conditions are adhered to.

Condition 1

The individual must spend no more than 183 days (six months) in the foreign country.

This condition is used only to require that the individual was not in the foreign country for 183 days during that country's tax year. However, individuals began to time their visits so that they spent 5.5 months in the country just before the start of the tax year, and then a further 5.5 months after the tax year. In addition, the fact that some jurisdictions, mostly Commonwealth countries, have tax years that are not calendar years also allowed for manipulation of the treaty provisions.

As a result of this perceived tax avoidance, the current condition was introduced so that an individual cannot spend more than 183 days in any 12-month period beginning or ending in a particular tax year. This new version is already incorporated in many tax treaties (including the new United Kingdom/United States treaty).

For the purposes of this rule, the individual simply has to be outside the foreign country in question; it is not a requirement that he returns to his country of origin.

The Organisation for Economic Co-operation and Development lays down very straightforward guidelines for what is and what is not considered to be a day spent in the country in question. The rule set down by these guidelines, known as the days of physical presence method, is generally applicable, although a small number of tax authorities use slightly different tests (in particular cases, local advice should be sought on any aberration from the generally agreed method).

The days of physical presence method is simple because an individual is either present in a country, or he is not. Part of a day, the day of arrival, the day of departure and all other days spent inside the foreign country (whether working days, weekends, public holidays or otherwise) are all counted as days of residence.

In addition, the ability of the person to carry out his duties of employment is irrelevant. So training days, days of sickness, lock-outs, delays in supplies and family bereavements or sickness are, with one exception, included for the purposes of computing the 183 day period. The one exception is where a person's illness prevents him from leaving the country and he would otherwise have qualified for the exemption.

However, days spent in the foreign country in transit in the course of a trip between two points outside that country, such as a stop-over to catch connecting flights or to transfer from air to rail transport, are excluded.

Condition 2

Any remuneration paid for the work carried out, must be paid by, or on behalf of, an employer who is not resident in the foreign country.

The Organisation for Economic Co-operation and Development allows countries to adopt the following alternative condition:

'the remuneration is paid by, or on behalf of, an employer who is a resident of the first-mentioned state, …'.

The effect of this alternative is to restrict the relief still further, so that if the employer is a resident of a third state, i.e. neither the home country nor the foreign country where the work is being carried out, the relief will not be available. Where employing companies from more than two jurisdictions are involved in a transaction, care should be taken to ensure that the treaties for the countries in question are reviewed carefully to ensure that this alternative version of Condition 2 is not in point. The United Kingdom/United States treaty uses the alternative version.

The wording of Condition 2, whichever version is applied, is very specific. The remuneration must be paid by, or on behalf of, an 'employer'. If the salary is paid in the foreign country by a party that is not the employer, the individual is still considered, under Condition 2, to be non-resident (but see Condition 3 below).

It is beside the point that the income is paid by an associated company, subsidiary or related party, unless the money is paid 'on behalf of' the employer. If it is not paid by the employer, then the fact that the payer is linked to the employer by shareholdings or otherwise is irrelevant.

However, it is not necessary for a formal contract of employment or other contract of service to exist between the individual and the company making the payment. The definition of what is an employer for these purposes is more widely drawn.

International legal convention understands the term 'employer' to be the person having rights on the work produced and bearing the relative responsibility and risks. In this context, substance will prevail over form. In other words, each case will be examined to see whether the functions of employer were exercised by the person or company making the payment.

Table 1 lays down the conditions which, in the Organisation for Economic Co-operation and Development's opinion, would indicate that the payer was actually the employer. However, these are not exhaustive, and other tests can be used by local tax authorities.

It follows that, in the absence of such links between the payer and the employee, Condition 2 will be satisfied whatever the nature of the relationship between the home country employer and the foreign country customer.

The United Kingdom Inland Revenue's Double Taxation Relief Manual and Inspector's Manual both at paragraph 1922 include some very useful comments on the term 'on behalf of'. The following is an extract:

'Payments may be made on behalf of a non-resident employer in cases where the payment is physically made by a United Kingdom company [without loss of the 183 day rule relief, so long as] … that non-resident ultimately bears the cost of such remuneration and benefits. Claims should not be admitted where a United Kingdom company pays the remuneration or incurs the cost of benefits and does not receive reimbursement from the overseas employer.'

Condition 3

The third condition for exemption is that the remuneration of the employee must not be borne by a permanent establishment or fixed base which the employer has in the foreign country.

In practice, a subsidiary company is not generally a permanent establishment of its overseas parent company. In the United Kingdom, the Revenue specifically confirms this fact at paragraph 1923 of its Double Taxation Relief Manual. However, care must be taken in this area. In a recently reported decision of the Italian Supreme Court, a non-resident company was considered to have a fixed establishment in Italy. The fixed establishment was another company in the same corporate group as the taxpayer, which pursued a common business strategy and managed the taxpayer's business in Italy. Although this was a VAT case, and must remain questionable in relation to widely understood international tax rules, it demonstrates that each case must be judged on its facts, and that the concept of a fixed establishment is not cemented in legislative rules.

Normally, however, a permanent establishment is simply a part of a home based company which is transplanted into the foreign country. Customers and employees all contract with the overseas company rather than with a separate legal person in the foreign country.

Both the Organisation for Economic Co-operation and Development commentary on Article 15 and the United Kingdom Revenue guidance make clear that the question of whether or not a permanent establishment of the home company bears the cost of the employee's salary or benefits is a tax test. That is, if the costs could be claimed as a deductible expense for tax purposes by the permanent establishment, then the cost is borne in the foreign country.

It is not necessary that the costs are, in fact, claimed, only that an 'entitlement to claim' exists. Thus, if a permanent establishment's accounts show the costs and it decides not to claim them as a deduction in calculating its exposure to corporate income tax, the employee is still considered to be resident in the foreign country.

In most cases, if a permanent establishment exists, the local tax authorities will assume, in the absence of clear evidence to the contrary, that the cost of remuneration of an employee seconded to that establishment, i.e. working in the overseas jurisdiction where the permanent establishment is located, is deductible and therefore that the individual is resident in the foreign country.

However, the Revenue's Double Taxation Relief Manual specifically states at paragraph 1923 that:

'a permanent establishment cannot be said to "bear the remuneration" unless it is charged against its profits without a corresponding credit, for example by way of a management charge'. (Emphasis added.)

In other words, even if a permanent establishment bears the cost, but then recharges the cost to the parent company, the employee's tax status can be protected by the 183-day rule.

Where a subsidiary company, which is not the permanent establishment of the parent, bears the cost of the employee, e.g. as part of the underlying cost of a fixed fee arm's length contract that also includes profit, materials, other (non-employee related) expenses, etc., then the employee will be protected by the 183-day rule under Condition 3. However, care would need to be taken to ensure that the subsidiary could not be considered to be the employer by virtue of any of the tests described under Condition 2.

In fact, technically, even if the only cost being borne by the subsidiary is the salary cost, this would not, of itself, invalidate a claim under Condition 3 so long as the subsidiary is not also a permanent establishment of the parent company (as in the aforementioned Italian case). However, the danger of the subsidiary being classified as the employer, and thus the employee failing Condition 2, is greatly, probably fatally, increased.

Conclusion

It can be seen that considerable care must be taken when attempting to use the 183-day rule for employees seconded to locations overseas. However, the rule is far more flexible than is sometimes supposed, particularly in relation to costs being borne in the foreign country.

The tax, payroll, contracts and human resources departments of the British groups should perhaps consider how best to take advantage of this position, while avoiding the incumbent pitfalls.

Christopher J J Lynch ATII, ATT is European tax manager with the Washington Group of Companies.

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