U.S. Tax Desk Newsletter - September 2021 (part I)

This article will provide you with an update on permanent establishment and residency issues due to Covid-19 in China.

China addresses permanent establishment and residency issues due to Covid-19


The Covid-19 pandemic has significantly impacted the regular operation of multinational enterprises to different extents. One of the notable impacts is the restriction on travelling. Many cross-border workers are unable to perform their duties in their country of employment physically. 

In the wake of these international issues, the Organization for Economic Co-operation and Development (“OECD”) had issued an analysis called “OECD Secretariat Analysis of Tax Treaties and the Impact of the COVID-19 Crisis” (referred to as the “OECD Analysis” in this newsletter) on 3 April 2020.

China’s position on this issue was uncertain, even though it is expected to follow the OECD Analysis. On 14 August 2020, the International Taxation Department of the State Taxation Administration (“STA”) released on its official website of “Frequently Asked Questions” (“FAQ”) concerning the Application of International Tax Treaties due to COVID-19. This FAQ provides China’s interpretation of the permanent establishment (“PE”) and residency issues caused by COVID-19. This interpretation should be analyzed alongside the relevant understanding of the Double Taxation Agreement between China and Singapore in Guo Shui Fa (2010) No. 75 (“Circular 75”) and the recently issued OECD Analysis. In China, the STA’s interpretation of the Double Taxation Agreement between China and Singapore applies to other similar tax agreements signed between China and other countries.

Permanent establishment 

1. Fixed place PE 

Under the FAQ, the STA believes that the change of the location where the employees exercise their employment because of the Covid-19 crisis, such as working from home, is temporary and exceptional. It should not create a PE as the place in which the employee works because of Covid-19; it is not a “fixed place of business through which the business of an enterprise is wholly or partly carried on” as defined. 

For example, Mr. A, an employee of ABC Co in Hong Kong, went to work on a project in China that was supposed to last for two months on a temporary basis and might be working in a hotel room. Because of Covid-19, Mr. A ended up working in the hotel room for more than six months, though he might be working on other activities for ABC Co. The hotel room may not be considered a fixed place of business through which the business of ABC Co is wholly or partly carried on. 

This interpretation is consistent with the OECD Analysis.

2. Dependent agent PE 

Employees or dependent agents working temporarily from home and conducting contracts in their home jurisdictions for and on behalf of their non-resident employers or principals should not create an agent PE of the non-resident employers or principals. This is because the circumstances should be considered temporary. The employee or dependent agent should not be considered as habitually exercising an authority to conclude contracts in the name of the employer or principal. 

This interpretation takes a similar view as the OECD Analysis. 

However, the STA also ruled out two exceptions to this interpretation. They are: 

(i) An individual has been conducting activities in China on behalf of the overseas enterprise for an extended period before the outbreak of Covid-19; or 

(ii) An agent shifts to conduct activities on behalf of an overseas enterprise in China on a long-term basis after the outbreak of Covid-19 and has and habitually exercise such authority to conclude contracts on behalf of the overseas enterprise. 

In other words, the interpretation of not having a dependent agent PE in China only applies to contract-signing activities changed due to COVID-19. The arrangement will not be applicable if the individual employee or the dependent agent has changed to conduct its activities in China because of Covid-19. This may be difficult to substantiate if and when the China Tax Authority questions down the road. 

3. Construction site PE 

In determining the duration of the construction site, the period of complete shutdown (i.e., when all contractors and managers are withdrawn from the site) caused by the Covid-19 pandemic is allowed to be deducted from the length of the duration of the construction site. 

This interpretation is better than the interpretation under the OECD Analysis. 

Under the OECD Analysis, temporary interruption of activities on a construction site due to the Covid-19 pandemic should not be excluded from determining the length of construction as to whether a construction site PE exists. 

China’s interpretation comes from Circular 75. That circular specifies that, when counting the continual period of a construction project, if “operations cease temporarily in midway due to any reason such as equipment or material not being delivered, but the personnel has not been withdrawn completely from the construction site, the continual period will count without interruption and the dates on which the operation cease shall not be deducted from the period.” As stated by the STA, provided that all contractors and managers from certain construction projects depart from the site due to Covid-19, resulting in a complete shutdown of the construction project, it will not be considered to be “temporary cessation”, and that period of the complete shutdown should be deducted from the construction site duration. 

It is noteworthy that, like the OECD Analysis, the FAQ is also silent on determining the duration for a Service PE. For example, suppose an individual of a service provider is stranded in China but is prevented from rendering service in quarantine. In that case, it is not clear if the quarantine period should be excluded from the duration of provision of services under the Service PE provision. 

Determination of residency of an individual and an entity during Covid-19 

1. The residency of an entity 

China’s interpretation is consistent with the OECD Analysis that temporary relocation of the place of management of an entity should not trigger a change in the tax residence of the entity, especially when the tie-breaker rule for dual residency in tax treaty entered by China applies. 

The STA also emphasizes that the relevant facts and circumstances should be considered to determine the “usual” and “ordinary” place where decisions are made, instead of the place pertaining to an exceptional and temporary period such as the COVID-19 crisis should be considered. 

Therefore, there should be sufficient documents to evidence the management’s “usual” and “ordinary” place of decision making before the epidemic. 

2. The residence status of individuals 

Temporary relocation of an individual during the Covid-19 pandemic will unlikely change the individual’s tax residency. The STA’s interpretation is consistent with the OECD Analysis in this regard.

Mazars’ thoughts 

The FAQ issued by the STA provides China’s interpretation of the PE and residency issues due to Covid-19. Most of the views therein are consistent with the technical position presented in the OECD Analysis. The FAQ provides guidance for local tax authorities across China to follow in implementing provisions of international tax treaties during the epidemic. 

 Mazars can assist in filing the relevant forms to claim treaty benefits, advising on what relevant supporting documents should be retained and relying on the FAQ to overcome any inconsistent position taken by local tax authorities.

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