The immediate impact of global business is the cross border movement of employees. When people move across the countries because of employment, more than one State is interested in gaining the tax.
Salary is the payment received by a person who is fixed, regular, and includes non-monetary benefits. Remuneration consists of prerequisites like stock options, rent-free accommodation or automobiles, health or life insurance, and club memberships too.
The general rule of taxation for salary
According to Paragraph 1 of Article 15, the remuneration received by a person is taxable in the State where employment activity is undertaken.
Mr. Randolf is an employee of Global Inc in State A. He works part of the year in State B and another half in State C. As per Article 15(1) both the State B and State C have right to tax the salary received by Mr. Randolf for the period of work exercised in their respective states.
For taxing the salary, the State of the source has to prove that the person receives the salary, wages or other remunerations for the services provided in the State. It is irrespective of when that income is credited, paid, or acquired by the employee in any other means.
For better understanding, let us elaborate on a few scenarios:
|Payments received by the employee/former employee||Tax Treatment as per OECD Model Tax Convention|
|Payment received after termination of the employment||Salary is taxable in the State where the employment activity was exercised.|
|Payment received for unused holidays accrued.||Salary is taxable in the State where the holidays were accrued.|
|Payment received at the end of employment for the unused holidays and sick leaves||Where no adequate records are available: Presume the payments received on the accumulated holidays and sick leaves as a benefit for which the employee was entitled in the past 12 months of employment, and allocate the same on pro-rata basis to the State where the employment was exercised during that period. Where records of employees accrued leaves and place of employment available: Payment on unused holidays and sick leaves will be taxable in the State where the work was exercised When taxes are paid in the State of source for the holiday benefits accrued during the term of employment: The State of residence has to provide relief under the double taxation avoidance agreement for the taxes paid in the State of Source.|
|Payment received for the notice period; an employee is instructed not to work||Taxable as salary, as the remuneration is received by virtue of the employment and therefore constitutes remuneration ‘derived therefrom’ for the purpose of Article 15(1). It will be taxable in the State where it is reasonable to presume that the employee would have worked during the period of notice. It is generally considered to be the State, which was the last location where the employee worked for a substantial period of time before the employee was terminated. Note: the prospective employment location is not taken into consideration.|
|Severance payment (redundancy payment)||Severance payment is also considered to be the salary for Article 15(1). It is presumed to be the remuneration for the last 12 months of employment, allocated on a pro-rata basis to where the employment was exercised during that period.|
|On termination of employment due to violation of the contractual obligations, the employee receives a legal damage||The treatment under tax treaty will be based upon the damage the award seeks to compensate. For instance: |
a) Insufficient notice period: Taxable under Article 15(1);
b) Insufficient severance payment: Taxable under Article 15(1);
c) Discriminatory Treatment: Article 21;
d) Injury to one’s reputation: Article 21;
e) Injury due to work-related sickness: Article 21.
|Payment for an obligation of not working with a competitor of ex-employer||In general: The payment is directly related to employment hence taxable under Article 15(1). It pertains to the performance of activity after the period of employment, hence taxable in the State where the recipient is resident when the payment is received. |
When a component of salary is set aside monthly as provision for non-compete Treatment is similar to the remuneration received during that period.
|Payment on termination, made for life or medical insurance (covering a certain period after the termination of employment)||Taxable as remuneration under Article 15(1) and in the State where the employment was exercised when the obligation to pay benefits arose.|
|Payment of pension||Article 18|
|Payment on termination, for non-work related sickness or where the employer is not obligated to make the payment||It is presumed to be the remuneration for the last 12 months of employment, allocated on a pro-rata basis to where the employment was exercised during that period.|
Exceptions to the general rule of taxation for salary
Following are the exception to the general rule of taxation for salary mentioned under Article 15(1):
Article 15(3): Taxation of the salary of the crew of ship or aircraft in international traffic.
Article 16: Taxation of remuneration of the members of the board
Article 18: Taxation of pensions
Article 19: Remuneration and pensions with respect to Government services
Exemption under Article 15(2)
Paragraph 2 of article 15 is the general exception to Article 15(1). It covers all individuals rendering services except those covered under Article 15(3), Article 16, Article 18, and Article 19.
Let us understand the three conditions provided under Article 15(2).
- Limitation of 183 day period
The first condition states that the time limitation of 183 days should not be exceeded in ANY TWELVE MONTHS commencing or ending the fiscal year concerned.
What is ‘fiscal year concerned’? What is the significance of ‘any twelve months period commencing or ending the fiscal year concerned?’
‘Fiscal year concerned’ is to be understood as the Financial year of the Contracting State, where the resident of the other contracting State has exercised his employment and during which the employment service is rendered.
For instance, the United States of America follows the fiscal year of 1st October – 30th September; the United Kingdom follows 6th April-5th April, and Germany follows the calendar year.
‘Any twelve months period commencing or ending the fiscal year concerned’ is the wordings formulated to plug the tax avoidance measures taken by the enterprises by placing the employees in a tax jurisdiction for 5 ½ months.
Minka, the tax resident of State A and employee of Mindwaves Inc, went to State B on 1st July 2018, for providing consultation services on behalf of her enterprise and returned on 31st January 2019.
State A follows calendar year as the fiscal year
State B follows 1st October to 30th September as the fiscal year.
In which fiscal year, will State B tax Minka under Article 15(1)?
|Fiscal year||No. of days||Explanation|
|1st October 2017 – 30th September 2018||91 days||Taxable. |
Minka stays for more than 183 days in State B, in the 12 months commencing in the fiscal year 1st October 2017 to 30th September 2018.
|1st October 2018 – 30th September 2019||123 days||Taxable. |
Minka stays for more than 183 days in State B, in the 12 months ending in the fiscal year 1st October 2018 to 30th September 2019.
‘Days of physical presence’ method
The period of the 183 days is computed based upon the “days of physical presence” method. The application of this method is simple, methodical, and is commonly used.
The method relies on computing the days when the individual was physically present in the country. Following days are included in the calculation:
- Part of a day
- Day of arrival
- Day of departure
- And all other days spent inside the State of activity such as Sundays, Saturdays, days of holidays, holidays before, during or after the activity, short breaks, training, strikes, lock-out, delays in supply, days of sickness and death or sickness in the family.
When the individual is unable to leave the State due to sickness, then the days are not considered as he would have received the exemption otherwise.
Days spent in traveling outside the country is excluded.
2. Remuneration should be paid by a person who is not the resident of the State of Source.
The condition states that the employer paying the remuneration should not be the resident of the State, where the employment activity is exercised.
In the case of fiscally transparent entities or arrangements, the conditions will apply at the level of the members or partners.
3. Remuneration should not be borne by the Permanent Establishment of the non-resident in the State of Source.
This condition is to prevent the source taxation on short term employment to the extent that the employment income is not allowed as deductible expenses in the State of the source as the employer is neither the resident does not have the Permanent establishment in the State of Source.
The exemption is provided to the employer if the remuneration is not borne by the permanent establishment.
Taxation of remuneration received by the crew aboard a ship or aircraft in international traffic
Paragraph 3 of Article 15, the remuneration received by a person as a member of the regular complement of a ship or aircraft, which operates in international traffic, is taxable only in the State of residence of the employee.