Does Your Remote Employee's Home Office Create A Permanent Establishment?

The Organisation for Economic Co-operation and Development (the OECD) recently published an update to its Model Tax Convention on Income and on Capital (the Model Tax Convention) which includes new, extensive commentary on when an employee's home office in one state may constitute a "permanent establishment" or "PE" of their employer resident in another state. The updated commentary provides a more comprehensive framework for determining the existence of a PE that reflects modern remote-work patterns that have become increasingly common over the past few years.

All employers are well-advised to consider whether the presence of a remote employee (or other controlled individual) in a particular state may give rise to a PE in that state in light of the new framework established by the OECD. This new framework suggests an evaluation of how much time the employee spends working at home (or at some other relevant place such as a cottage, holiday rental or home of a friend or relative)¹ and whether there is a commercial reason for the employee's presence in their home state of residence.

The significance of a PE

All bilateral tax treaties (including those concluded with Canada) are based on the OECD's Model Tax Convention. Under the Model Tax Convention, where an employer, resident in one state, carries on business in another state, the applicable bilaterial tax treaty limits the other state's ability to tax the profits of the employer. Generally, the other state may only tax the relevant business profits attributable to the employer's PE in the other state.

Generally, a PE is a fixed place of business through which the business of an employer is wholly or partly carried on and includes conventional workplaces such as an office, factory or workshop.² Other non-conventional workplaces that are not the premises of the employer, such as an employee's home, can also be a PE if it otherwise constitutes a fixed place of business through which the business of the employer (via the employee) is carried on.

Previously, the Model Tax Convention stated that an employee's home office (in another state) could be a PE (in the other state) if used continuously for business of the employer and if the employer required the employee to work from home (typically inferred from the absence of employer-provided premises) and emphasized that in most cases the issue would "rarely be a practical one." This framework no longer aligns with modern remote-work patterns, as many arrangements now arise from employee preference or by necessity in order to attract and retain global talent.

The new framework

The updated Model Tax Convention includes a two-pronged framework for determining whether an employee's home (in another state) constitutes a PE (in the other state) of their employer. Generally, where these two tests are answered in the affirmative, the employer will be considered to have a PE in the state in which the employee's home is located.

1. The Working Time Test: Does the employee work from home more than 50% of their total working time in any rolling twelve-month period?

An employee's home will generally not be considered a place of business of their employer if the 50% threshold in the Working Time Test is not exceeded. The calculation of working time will depend on the actual conduct of the employee and formal contractual arrangements (to the extent they correspond with the actual conduct of the employee).

2. The Commercial Reason Test: If the 50% threshold in the Working Time Test is exceeded, is there a commercial reason for the activities to be undertaken at the employee's home?

There may be several reasons for using an employee's home to carry out the business activities of their employer. If any of those reasons is a commercial reason, then the Commercial Reason Test will be satisfied.

The Commercial Reason Test will generally be met where the physical presence of the employee in their home state of residence will itself facilitate the carrying on of the business of their employer. This requires a consideration of the business of the employer and how the specific activities of the employee relate to that business. Depending on the circumstances, a commercial reason may exist if any of the following take place and are facilitated by an employee working from home:

• engagement with customers, suppliers, associated enterprises or other persons on behalf of their employer (unless that engagement is on an intermittent or incidental basis);
• cultivation of a new customer base, or identification of business opportunities;
• identification of new suppliers, managing relationships with suppliers, or undertaking, monitoring or managing contractual arrangements with suppliers;
• real-time (or near real-time) interaction with customers or suppliers in different time zones;
• access to business-relevant expertise that is used in the conduct of the activities of their employer;
• collaboration with other businesses;
• performance of services for customers which require the physical presence of the employee or other personnel of the employer; or
• interaction with employees and other personnel of the employer or associated enterprises.

Conversely, no commercial reason will generally be considered to exist when the remote work arrangement serves solely to attract or retain an employee or solely to reduce office-space costs. Where the Commercial Reason Test is not met, the employee's home would not be considered a PE of the employer unless other facts and circumstances indicate otherwise.

For employers with employees working remotely (outside their employer's state), these changes create both clarity and new compliance challenges. The Working Time Test offers a useful early-warning metric, but the Commercial Reason Test requires a deeper evaluation of the substance of the employee's activities and their connection to their employer's business. In this environment, proactive monitoring, clear internal policies and robust documentation will be essential tools for managing PE risk.

Footnotes

1. In this article, a reference to an employee's "home" also includes a reference to these other places. ↩

2. A PE can also be deemed to exist where an employee acting in a state on behalf of a non-resident has, and habitually exercises in that state, an authority to conclude contracts in the name of the non-resident. Some bilateral tax treaties, such as the Convention between Canada and the United States of America with Respect to Taxes on Income and on Capital, can, in certain circumstances, deem a non-resident to have a PE in a State in which the non-resident is rendering services. ↩

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Specific Questions relating to this article should be addressed directly to the author.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.