The COVID-19 pandemic caused a shift in the working patterns of employees on an unprecedented scale. The success of remote working has forced or encouraged many to rethink the traditional office working policies. Some employers have noticed an increase in productivity when workers are not faced with a commute into the office, as well as a positive effect on personal wellbeing. While employers may be open to such requests and want to maximize employee wellbeing and retention, they need to be aware of the potential risks associated with such an arrangement.
Complexities of remote work arrangements include:
Depending on the host jurisdiction and the nature of the work activities, an employee may create nexus or a permanent establishment (PE)—a taxable presence for corporate income tax purposes—in the host state or country. For most U.S. states, a business with a single remote employee, even if working only temporarily from another state, will create a physical, taxable presence or nexus for the employer, regardless of whether it has no other connections to the state. The employer could be faced with an income tax return filing obligation in that state or host country and be obligated to source, apportion or attribute, the associated profits accordingly. Remote teleworkers could trigger an additional corporate income tax liability in different states and host countries, including potential double taxation in addition to new compliance obligations. Businesses also may be subject to sales and use taxes, and may need to consider non-tax questions, such as whether the business is required to qualify with the secretary of state in the secondary location.
While a number of U.S. states provided temporary nexus relief measures during the pandemic, exempting businesses whose only connection with the state were remote teleworkers from having nexus and a tax return filing obligation, many of those states are now lifting these temporary relief measures.
Individual Income Tax
Individual income tax obligations may be triggered when employees work from a new location. With the increase in remote work, more taxpayers are choosing to move to states with low or no income tax. However, those who fail to break domicile in the old state and properly establish domicile in the new state may face undesirable state and local tax consequences. For individuals in U.S. states, having dual residency may also pose a risk for long-term remote teleworkers. During the pandemic, it was common for workers to work remotely from vacation or other homes. Since their primary residence remained in their old state, along with other connections, they did not abandon their domicile. However, if they teleworked from the vacation home for more than 183 days (or met other state-specified requirements for determining residency) they may have established “dual residency” in another state. As a result, the individual could be subject to double taxation and/or state withholding on their income. The impact on an individual’s estate and gift tax planning should also be considered.
For internationally mobile employees, income tax treaties reduce the likelihood of double taxation; however, international travel could create an individual income tax liability and filing obligation in a second country. Internationally mobile employees also should consider the impact on their estate and gift tax planning.
Employers will need to ensure that their employees are contributing to the correct social security system based on any bilateral social security agreements or rules in place. When an employee incurs a social security liability in a new country, there may also be an employer liability and additional payroll requirements. Social security rates, including for the employer portion, vary greatly between territories. Even when employees remain liable for contributions in the same location where their employer is based, it may be necessary to obtain an A1 application or Certificate of Coverage to demonstrate continuing liability to the “home” country social security regime in order to be exempt from contributions to the host country. Social security and income tax are two separate tax regimes and operate under their own authorities, rules and regulations. Protection against double taxation under one regime does not automatically grant the same under the other, and generally, host country exemption may be subject to a time limitation.
In jurisdictions where it is determined that an employee has triggered a payroll reporting obligation, employers should be aware of the resulting compliance requirements. In addition to withholding and reporting, the business may need to register in a new state or country, as well as confirm that their payroll system can make withholdings in multiple jurisdictions. Registration and operation of a foreign payroll can be costly and administratively burdensome, and some remote working arrangements may result in dual tax withholding obligations.
The U.S. Supreme Court rejected a New Hampshire challenge to Massachusetts’ practice of taxing people who once worked in that state but started telecommuting from elsewhere during the pandemic. During the pandemic, Massachusetts and New York were two of a handful of states to enforce the Convenience of Employer (COE) rule, which states that if an employee performed core duties out of state for a business located in-state, that employee could be subject to payroll withholding and personal income tax in the nonresident state. Had the case gone forward, it could have provided clarity to similar challenges in other states. The Biden administration urged the court to turn down the case, indicating that federal legislation on the matter is unlikely to progress.
Incentive or equity compensation adds another level of complexity to payroll reporting and tax withholding. When a taxable event such as the vesting of employee stock is triggered, tax withholding and reporting may be necessary for each country, state and/or local jurisdiction in which the employee worked during the time the stock was held. This becomes challenging if there is no system in place to identify and track where employees are working, or the specific rules and regulations in each territory.
Businesses should also consider any treaties or reciprocity agreements that may be in place between jurisdictions to optimize cash-flow positions. Working through the global regulatory process can be an arduous and expensive task without the help of an advisor and the right technology.
Are you allocating costs to the proper locations for cross-border work arrangements? Transfer pricing rules require cross-border services to be charged at an arm’s length price. If someone is now working remotely in a different country, this may require intercompany charges that were not necessary before the relocation. For highly skilled workers with specific expertise, intercompany charges must fully reflect the value they are contributing, and if relevant, include any equity compensation as part of the intercompany charge. Remote workers may also require businesses to revisit their transfer pricing policies, intercompany service agreements and documentation. If tax authorities demand adjustments to your tax and employment positions, it may be difficult to justify pre-pandemic transfer pricing arrangements, so any changes regarding the roles and location of internationally mobile employees should be thoroughly described in the transfer pricing documentation.
Immigration and Employment Law
Prior to establishing a workforce in a new location, employers should consider work permits, minimum wage laws, unemployment taxes, immigration issues, health insurance requirements and duty of care, among many things. There are many critical questions that need to be answered: Does the individual have the legal right to work in the location? Are there any legal/customer restrictions on working in that location? Does the location require a specific employment agreement and/or specific employment benefit? Country-by-country variations in employment law can be significant.
Compensation and Benefits
A hire-from-anywhere approach offers a broader talent pool, but it also raises the question whether compensation should be set or adjusted based on the employee’s physical location versus the original hire or office location. Geographic pay differentials (market pay levels by location) can vary dramatically; balancing internal and external pay equity is complicated when employees with the same job work remotely from locations with extreme pay differences. While this is largely a company decision that should be addressed as part of a compensation strategy, there are also employment law matters (see above) to consider.
Matters are further complicated when an employee is located in a country outside of the office location. Not only may pay levels change but pay delivery systems may be very different. Examples include the country-by-country use of allowances; incentive pay and the types of statutory and non-statutory benefits (especially medical and retirement).
In addition to compensation, wellness and benefit programs may need to be expanded to be effective for a remote workforce and to comply with laws in new locations. According to a survey by Fidelity Investments and the Business Group on Health, almost 70% of companies have converted their well-being programs to virtual services.
Talent management issues also may arise. For instance, do employees have an appropriate workspace that is safe, free of distractions and with adequate physical space? A 2020 NuLab survey reported that almost 20% of people working remotely are doing so in a shared space such as a family/living room, and over 10% are working on a couch. How much expense are employers willing to shoulder for computers, monitors, internet and office furniture? Tracking these resources as well as the expense entails additional administrative complications.
Time zone differences may also impact employee availability and access to the team. Supervision is another concern: Are managers skilled in supervising a remote worker? Are new employees self-sufficient to thrive in a remote working environment? How will potential productivity and performance issues be addressed? The same NuLab survey found that 43% of workers felt they were less productive working from home. Another study by McKinsey indicated that only 22% of the U.S. workforce can work remotely between three and five days a week without impacting productivity.
Aside from the obvious long-lasting health implications brought about by the COVID-19 pandemic, its legacy may center around the shift in attitudes toward remote working and employee mobility. There are already signs that employers will not maintain large and expensive offices and that the practice of flexible remote working arrangements is here to stay. When considering any type of flexible work arrangement, businesses need to decide if the administrative burden is worth the investment. For various reasons, employees are finding a stronger voice when requesting the location and conditions of their employment, while at the same time businesses are feeling pressure to allow more non-traditional work arrangements. Together, these two trends will have a significant impact on ensuring that employers formulate a remote working policy to minimize risk exposure.
Written by Joe Pancamo, Matthew Pascual and Ronii Rizzo. Copyright © 2021 BDO USA, LLP. All rights reserved. www.bdo.com