Overview
For additional guidance, please refer to Steptoe's COVID-19 Resource Center.
The significant health risks of COVID-19 and government responses to the pandemic, including "stay at home" orders and recommendations, have created a variety of tax presence issues for businesses and individuals in the international tax context. On April 21, 2020, following several other measures to reduce taxpayer compliance burdens during the pandemic, Treasury and the IRS provided guidance on several of these issues.
Business Tax Presence
For foreign businesses, questions may arise regarding whether displaced employees normally located in another jurisdiction and currently present in the United States may give rise to a US trade or business (USTB) for their employer or, where a tax treaty applies, a permanent establishment (PE). Although issues presented by mobile employees are not new, the unexpected and potentially prolonged nature of their stays may increase risks.
In the absence of a tax treaty, the USTB standard applies. This standard considers whether the US activities of a foreign enterprise, conducted either directly or through an agent, are "considerable, continuous, and regular." This is generally a lower threshold than the PE standard, and some of the principles potentially providing protection under the PE threshold (discussed below) may not apply.
On April 21, the IRS published "Frequently Asked Questions" (FAQs) addressing certain USTB and PE issues. With respect to USTB, the answers state that a nonresident alien, foreign corporation, or a partnership in which either is a partner may choose an uninterrupted period of up to 60 calendar days, beginning on or after February 1, 2020, and on or before April 1, 2020 (the COVID-19 Emergency Period), during which services or other activities conducted in the United States will not be taken into account in determining whether the nonresident alien or foreign corporation is engaged in a USTB, provided that such activities were performed by one or more individuals temporarily present in the United States and would not have been performed in the United States but for COVID-19 travel disruptions. With respect to PE, the answers state that services or other activities performed by one or more individuals temporarily present in the United States will not be taken into account to determine whether the nonresident or foreign corporation has a PE, provided that the services or other activities of these individuals would not have occurred in the United States but for COVID-19 Emergency Travel Disruptions.
In both situations, this last requirement—that the activities would not have otherwise occurred in the United States—should be noted and documented. In addition, as the FAQs state, protective return filings may be prudent to preserve the ability to claim deductions and other protections in the event that the IRS disagrees with the taxpayer's position.
Several other countries, including Australia, Ireland, and the United Kingdom, have also issued guidance addressing mobile employees (and/or tax residence of individuals, an issue discussed below). In addition, the OECD Secretariat issued an analysis addressing PE issues raised under tax treaties, concluding that "it is unlikely that the COVID-19 situation will create any changes to a PE determination," either as a result of a fixed place of business or a dependent agent regularly concluding contracts. The OECD described several principles mentioned in the commentary to the OECD Model Convention, including that a fixed place of business should only arise where there is a certain degree of permanency and the location is "at the disposal" of an enterprise.
Tax Residency of Individuals
Similar issues arise with respect to individuals and tax residence. A foreign individual will be treated as a resident of the United States with respect to any calendar year if such individual meets the "substantial presence test," i.e., is present in the United States on at least 31 days during the calendar year as well as 183 days during the current year and the two preceding years (counting 1/3 of the days in the preceding year and 1/6 of the days in the second preceding year). Thus, in the absence of an exception, an individual staying in the United States for a prolonged period as a result of the pandemic, such as illness, the need to take care of an ill family member, or fear of being exposed to the virus by traveling, could become a US tax resident under the substantial presence test and, as a result, become subject to US tax on worldwide income.
There is a "medical condition" exception to the substantial presence test that could be relevant to foreign individuals in the United States as a result of illness. Under this exception, an individual is not treated as being present in the United States on any day if such individual "was unable to leave the United States on such day because of a medical condition which arose while such individual was present in the United States" (the "medical condition exception"). However, the regulations interpret the medical condition exception narrowly—the individual must have had an intent to leave the United States and is unable to leave because of a medical condition or problem that arose while the individual is present in the United States. It appears that, under the regulations, the relevant medical condition must be a medical condition of the individual, not a broader health and medical crisis.
On April 21, Treasury and the IRS issued Revenue Procedure 2020-20, which allows an individual to claim a "COVID-19 Medical Condition Travel Exception" for purposes of the substantial presence test. The individual may claim the exception for a 60-day period starting between the dates of February 1 and April 1 and, in that period, will be presumed to have intended to leave the United States and unable to do so (unless the individual has taken steps to become a lawful permanent resident). Unless the individual is otherwise required to file a Form 1040-NR, no filing is required to claim this exception.
The 60-day period provided in the notice should be helpful for many potentially affected taxpayers. However, it remains to be seen how long the pandemic will have a significant impact on travel. Taxpayers may also need to consider other potential exceptions, such as the "closer connection" exception or a tie-breaker provision under a tax treaty. Revenue Procedures 2020-20 states that an eligible individual may claim the COVID-19 Medical Condition Travel Exception in addition to, or instead of, claiming other exceptions from the substantial presence test.
Under the "closer connection" exception, a foreign individual who otherwise satisfies the substantial presence test but was physically present in the United States for less than 183 days in the current year is not treated as a US resident. The individual person must have both a "tax home" in a foreign country and a "closer connection" to such tax home. The closer connection exception must be claimed on a form attached to a Form 1040-NR.
If a foreign individual is physically present in the United States for more than 183 days, but is a citizen or resident of a country with which the United States has an income tax treaty, a treaty "tie-breaker" residency provision may apply to treat the individual as a resident of the other country, at least for purposes of avoiding federal income tax. An individual treated as a resident of another country under a treaty is still treated as a US resident for other purposes, such as determining whether a foreign corporation is classified as a controlled foreign corporation (CFC).
Also on April 21, Treasury and the IRS issued Revenue Procedure 2020-27, which waives certain days of presence requirements under section 911 (the foreign earned income exclusion) for an individual who reasonably expected to meet the eligibility requirements during 2019 or 2020 but is unable to do so because they departed a foreign country as a result of COVID-19.
Potentially impacted business and individuals should consider taking additional measures to support their reliance on the guidance. For example, both the FAQs and Revenue Procedure 2020-20 instruct taxpayers to retain all relevant records and contemporaneous documentation to support reliance on the revenue procedure. In addition, as mentioned above, in certain cases protective filings may be prudent.
