ECONOMIC EMPLOYER CONCEPT

Technology has rendered time zones and borders irrelevant. Suppliers and
providers of services can work with clients and colleagues across all corners of
the globe, regardless of whether they are in the same jurisdiction or not. Still,
many things can be accomplished only through direct or physical presence. It
follows that even in this age of virtual connectivity, cross-border movement of
persons is still a necessity.
In taxation, international assignments of employees give rise to issues like—
how shall the employee be taxed in his home country and in the host country,
and what are the obligations of the host entity? And will the assignment result
in doing business or the creation of a permanent establishment for the foreign
employer/assignor in the host country? The proper determination of the
characteristics of the assignment will usually give the answers to these
questions. We will discuss more on the tax implications in a subsequent article
in this column.

In the meantime, we focus on the characterization of the assignment,

specifically in relation to the “economic employer” concept. In international
assignment, to avoid the creation of a permanent establishment for the foreign
company, the traditional model is the “secondment” or “formal employment”
concept. A formal employment arrangement is recognized between the assigned
employee and the host company. The employee becomes an employee of the
receiving company.
A global trend has emerged with the adoption of the economic employer
concept veering away from the traditional “formal employer” model. Under this
arrangement, the employee remains employed with his home country and yet
will be economically employed in the host country. Some countries use the
economic employer concept in determining the employer of the assignee. An
economic employer is most commonly interpreted to be the entity controlling
the day-to-day activities of the employee and the one that receives the benefits
of the employee’s work. Other countries look at where the costs of an
assignment are borne. They maintain that if the costs are borne in those
countries, then those countries are expected to retain profits generated from
the assignment and, therefore, economically becomes the employer of the
individual for the period of the assignment.
The OECD Commentary on the Model Tax Convention, however, cautions that
the question of whether the remuneration of the individual is directly charged
by the formal employer to the enterprise to which the services are provided is
only one of the subsidiary factors that are relevant to determine whether
services rendered by the individual may properly be regarded as rendered in an
employment relationship. Relevant domestic laws may ignore the way in which
the services are characterized in the formal contracts. Instead, focus is made
primarily on the nature of the services rendered by the individual and their
integration into the business carried on by the enterprise that acquires the
services. Substance prevails over form, such that the assignee will be
considered an employee of the host entity if the services rendered by the
employee are more integrated to the business activities carried on by the host
entity. Thus, it is also important to determine whether the services rendered by
the individual constitute an integral part of the business of the enterprise to
which the services are provided.
The commentary further provides that an analysis of some factors is necessary
in determining the economic employer. Among these factors are the following:
the party responsible or at risk for the results produced by the employee’s
work, the entity with the authority to instruct the worker, who has control and
responsibility in relation to the employee’s place of work; how the remuneration
is calculated; who provides the tools and materials; and who determines the
number and qualifications of the employees.

In the Philippines, we have not really adopted the economic employer concept
in the area of taxation, such as in the application of the exemption from tax for
short-term employment services based on tax treaty provisions. A look at the
rulings issued by the tax authority, as well as the decisions of the Courts
would show that this economic employer principle had not reached that
sophistication, for the tax authority or the courts to scrutinize the economic
substance of the arrangements between or among the assignor, the assignee
and the host entity.  Philippine taxpayers and tax authorities alike have relied
heavily on the use of bilateral tax treaties in determining the taxation or
exemption from income tax of the income of foreign individual assignees in the
Philippines. But it has not gone enough  to the extent of determining  whether
employer functions are exercised primarily by the employing entity in the home
state or by the host entity.
Some quarters state that Philippine tax authorities are adopting the economic
employer approach based on the principle that when there is a recharge to the
Philippine entity, the host entity is considered to be the economic employer and
the employee cannot claim tax exemption. I respect this view. However, this is
a simple application of the treaty provision which states that if the cost is
borne by a Philippine entity or permanent establishment, the exemption will
not apply. The tax authorities do not tend to scrutinize whether there is
“employer-employee” relationship so the exemption will not be available.
What we have in the Philippines is the four-fold test in determining
employer-employee relationship for labor law purposes. These tests in
determining the existence of employer-employee relationship approximates that
of the tests or factors in determining the economic employer. Thus, an entity
determined to be the employer under Philippine domestic law would easily be
determined to be an economic employer using the factors stated in the OECD
Commentary. Unfortunately, while these four-fold tests had been applied in
labor disputes/issues, that is, in determining the rights and obligations
between an (alleged) employer and an employee, it had not been applied in tax
issues, especially so with respect to international assignments.
There are peculiarities in the characterization of employment in the area of
taxation. The improper application of tax treaty provisions may lead to tax
leaks or abuse. Also, application of general labor rules is not sufficient. Policy
-makers and tax administrators may need to consider this area and craft laws
or rules to address this concern.
****

The author is the managing partner of Du-Baladad and Associates Law Offices
(BDB Law), a member-firm of WTS Global.

Economic employer approach

Do the taxation authorities in the Philippines adopt the economic
employer approach to interpreting Article 15 of the Organisation for
Economic Co-operation and Development (OECD) treaty? If no, are the
taxation authorities in the Philippines considering the adoption of this
interpretation of economic employer in the future?
Yes, the economic employer approach is being adopted by tax authorities such
that when there is a recharge of remuneration cost to the Philippine entity,
then the host entity is considered to be the economic employer and the
employee cannot claim tax exemption, regardless of the duration of their stay
in the Philippines.

The 183-day rule of thumb

Companies have traditionally followed a rule of thumb — often called the “183-
day rule” — that states an employee who is sent to a country on assignment for
no more than 183 days in a calendar year or other 12-month rolling period
doesn’t need to pay income taxes in the host country.

This rule of thumb is derived from three basic rules set forth in Article 15 of
the OECD Model Tax Convention, which is used as the basis for most bilateral
tax treaties. The convention says that host countries have the right to tax
temporary foreign workers on their income. However, the convention describes
three conditions for providing an exemption to paying income tax:

 The employee stays in the host country for no longer than 183 days a
year (defined as a calendar year, a fiscal year or any other 12-month
period)
  The employee is paid by an employer who is not a resident of the host
country
 The remuneration paid to the employee is not borne by a permanent
establishment in the host country

Many companies still follow the 183-day rule of thumb, assuming that if one of
their expat workers stays less than 183 days in a host country, he or she will
not be subject to host-country income tax. That premise, however, has never
been true everywhere, and is even less likely to be accurate today.

A company that sends a short-term expat worker is typically the “formal

employer,” or the employer that has the contract with the worker. Increasingly,
tax authorities in countries around the world are looking beyond this formal
relationship to determine which entity — the company in the home country or
the company in the host country — is the employer “in substance,” also known
as the economic employer. This is often called the “substance-over-form” test,
and it means that even if an expat employee doesn’t exceed the 183-day
threshold (or other time threshold as defined by a treaty or local law), he or she
may still be subject to income tax in the host country.

The economic employer is generally interpreted as being the company that

specializes in the kind of work the employee is engaged in, directly supervises
the employee, has control over the work, bears any risks associated with the
work, and/or profits from the employee’s presence.

The economic employer concept

Many tax treaties and local tax laws follow the OECD commentaries, which
provide scenarios for determining who the economic employer is.

For example, if a parent company containing several groups sends an HR or

marketing executive to a group in a different country to unify strategy, the
work’s purpose is integral to the parent company’s purpose, and the parent
company is considered the economic employer. The same holds true if a
technology company sends workers abroad to train other companies to use its
software.

But if a company in the business of supplying temporary workers sends a

specialized engineer to a foreign company, and the foreign company supervises
the engineer’s work and agrees to indemnify the sending company if he makes
a mistake, it’s a different story.

Who has direct control over this employee and bears the responsibility for his
work? The foreign company does. Who mainly benefits from the work the
employee does? Again, the foreign company does. Is engineering integral to the
business of the company that sent the engineer? No.

The company in the host country of our last example will be considered the
economic employer by tax authorities in an increasing number of countries.

This is of course just one example among countless possible scenarios. A

comprehensive list of factors (beyond the formal contractual relationship) for
determining an economic employer relationship is available in section 8.14 of
Article 15 of the OECD’s commentaries. Below is verbatim copy of those
factors, which are mostly presented as questions that employers should ask
themselves when making a determination.

 who has the authority to instruct the individual regarding the manner in
which the work has to be performed
 who controls and has responsibility for the place at which the work is
performed
 the remuneration of the individual is directly charged by the formal
employer to the enterprise to which the services are provided
 who puts the tools and materials necessary for the work at the
individual’s disposal
 who determines the number and qualifications of the individuals
performing the work
 who has the right to select the individual who will perform the work and
to terminate the contractual arrangements entered into with that
individual for that purpose
 who has the right to impose disciplinary sanctions related to the work of
that individual
 who determines the holidays and work schedule of that individual

NOTE: IN THE PHILIPPINES (We follow the four-fold test for purposes of
determining the Employer-Employee Relationship)

1) Selection and engagement of the employee;

2) Payment of wages;

3) Power of dismissal; and

4) Employer’s power to control the employee’s conduct/manner by which

the task is performed
Steps employers should take to comply

The OECD acknowledges that determining the economic employer is not always
a straightforward decision. The process is in many ways similar to making
determinations about whether a worker is in substance an employee or an
independent contractor in a particular jurisdiction. Often, the answer is not
clear-cut and there is a certain amount of room for interpretation. In most
cases, an employer will want to seek the guidance of an expert familiar with
home- and host-country tax laws and how those laws are being interpreted by
local authorities now.

It’s also important to remember that OECD issues guidelines, not laws.

Countries are not obligated to follow its advice when drafting and interpreting
treaties or local tax laws. But it is certainly true that European nations are
increasingly adopting the economic employer concept, with some interpreting it
more aggressively than others.

Germany is an economic employer country, for example, and Sweden plans to

introduce the concept starting in 2021. In its current version of the planned
law, if the Swedish company benefits from the foreign employee’s work, the
employee must be taxed from the date of arrival — a far cry from the widely
assumed 183-day exemption period.

Clearly, keeping up with international laws and treaties concerning temporary

foreign workers is critical. Multinationals should also make sure short-term
expat assignments are written as contracts to help avoid triggering the host-
country company as the economic employer, especially in countries that are
aggressively enforcing the concept.

In all cases, the employer should make sure it complies with applicable tax
laws (domestic and foreign) and pays foreign income tax when necessary. That
may entail setting up a shadow payroll to pay income tax to host-country
authorities while the expat is being paid through a separate home-country
payroll.