COVID 19 and the unprecedented measures such as travel restrictions and quarantine requirements imposed globally by governments, including Israel, to control the spread of Corona have disrupted travel plans of individuals.

Individuals are not able anymore to freely move between countries, and sometimes have difficulty to leave and return to their home country or “got stuck” in a country, even though they would be out in a different jurisdiction for employment or business purposes under normal circumstances.

This has raised a series of international tax questions on residency of individuals, on residency of corporations, the establishment of permanent establishments and the allocation of taxing rights between jurisdictions.

For example the prolonged stay of a person in Israel might expose that person to the claim that he/she has become a resident of Israel and therefore his/her entire worldwide income is subject to tax in Israel.

1. Impact of COVID 19 on Tax Status of Individuals –  an Israeli Perspective

According to Israeli law, the residency of an individual is determined under the “Center  of Life Test” where for example the place of permanent house of the individual, the place of residence of the family, the place of permanent employment, the economic interests, where he or she is socially active, have to be taken into account and must be examined. The Center of Life test actually also has a subjective component, according to which the intention of a person to live in Israel should be considered. However, recent experience shows that the Israeli tax authorities and the courts give less and less weight to the subjective intent in determining residency.  In addition, to the Center of Life Test there are two rebuttable presumptions, based on the numbers of days spent in Israel during a tax year. Pursuant to these presumptions an individual is deemed to be Israeli resident if he/she was in Israel in a given tax year more than 183 days or in the two preceding years 425 days and at least 30 days during the tax year. These presumptions can be rebutted.

In recent years the Israeli tax authority and partly also the courts attribute more and more importance to the technical count of days spent in Israel in determining residency.

Therefore, individuals remaining in Israel for a prolonged stay due to COVID 19 or a similar crisis, are exposed to the risk that they will be considered Israeli tax residents. The Israeli tax authority (hereinafter: ITA) has not published a position how they will consider the days spent in Israel due to COVID 19. It can be assumed that residency will be determined depending on the facts and circumstances of each individual case.

According to existing rulings by the ITA – not connected to COVID 19  – days spent in Israel for the care of a close family member have been eliminated and not counted in order to determine tax residency. Here it could be argued that legal travel restrictions constitute a similar external constraint so that days spent in Israel due to COVID 19 should be eliminated and not taken into account.  Furthermore, regulations issued under the Income Tax Ordinance clarify that a period of medical hospitalization or a period of sickness in Israel could be disregarded when counting the days stayed in Israel in order to determine the Center of Life.

COVID 19 may not be equated with hospitalization or constitute sickness but the rationale behind the elimination of the period can be used and is relevant to a prolonged stay due to COVID 19 restrictions.

Besides tax implications on the residence status of an individual, a prolonged stay in Israel might also have an impact on the allocation of taxing rights with respect to mixed income of new immigrants.

A new immigrant to Israel (including someone who has returned to Israel after being a foreign resident for at least 10 years, is entitled to an exemption on the income that he produced outside of Israel for a period of ten years from the time of his immigration or return. If the immigrant provides services (whether as an dependent person with salary income or as a self-employed person) and these services are rendered partially in Israel and abroad, the individual  is obligated to report the Israeli part of his service income from that mixed activity. In determining the Israeli part of the income the ITA accepts and prefers – if no other evidence is submitted – the business days approach pursuant to which the Israeli part of income will be calculated based on the number of business days spent by the individual in Israel compared to the overall number of business days in the respective tax year.

In case where  a new immigrant  – for example from the UK –   is forced to stay more days in Israel due to the health crisis, his Israeli part of service income under the business day approach will definitely increase.

It could be argued in this context that the whole period of CORONA should be disregarded and not taken into account, like days of sick leaves.  Another approach could be to follow the approach taken by most European countries such as Germany with its neighboring countries. Pursuant to this approach, “working days” are deemed to be performed in the country where the activity would have been performed without the COVID 19 measures. That would mean, that days, where the new immigrant has been forced to stay and work in Israel due to COVID 19 would be considered days spent abroad, where he would have performed the services without COVID 19 measures. Of course, proper documentation should be provided as to the reason of the prolonged stay.

In this context, it should be mentioned that a prolonged visit by a foreigner in Israel could accidently trigger the start of the 10 year tax benefit period for new immigrants without that the individual has actually decided to move to Israel.

2. Impact of COVID 19 on Tax Status of Individuals – OECD Guidance

The OECD organization has addressed the issue of residence status in April 2020 by releasing guidance addressing how governments should apply standard tax treaty provisions when taxpayers are forced to change their behavior to comply with COVID 19 travel restrictions and quarantines. In para 5 of the OECD Secretariat recommendation it is stated that the tax residence status of an individual is unlikely to be affected by the COVID 19 situation in light of the temporary and extraordinary circumstances that are occurring due to the pandemic. The OECD differentiates between two scenarios. One scenarios is where the individual is forced to stay in a foreign country which the individual has visited while the pandemic broke out (e.g. UK resident comes for a visit to Israel and is forced to stay because of travel restrictions). The other scenario is where the individual had temporarily returned to his former state of residence as the pandemic has started to spread (e.g. an Israeli who relocated to China or the UK returned to Israel because of COVID 19). According to the OECD Organization it is very unlikely that the individual in the first scenario will become a resident in the host country in light of the temporary and extraordinary circumstances.  Even if under the domestic rules of the host country the individual would be deemed resident, the organization assumes that under the “Tie breaker Rules” of the treaty the individual would unlikely change residence status for tax treaty purposes, provided that the individual does not have a permanent home in the host country.  As for the second scenario, the organization points out that the individual’s temporary return to his previous state of residence will probably not affect tax residency, and this would probably be the case also based on the relevant tax treaty but the OECD organization emphasizes that the result is not certain.

3. Impact of COVID 19 on Tax Status of Corporations – an Israeli Perspective

Besides the tax implication on the residence status of an individual, a prolonged stay by an executive or senior officer might have an impact on the tax status of a foreign corporation.  According to Israeli law, a corporation is an Israeli corporation and subject to tax on its worldwide income if it is incorporated in Israel or if it is controlled and managed in Israel. The term “control and management” is not defined in the Income Tax Ordinance. The Israeli courts have ruled that control and management of a corporation is there, where the strategically important decision is made. Now let’s assume that a chief executive officer or other senior executives of a foreign corporation typically flew to another jurisdiction for meetings, but due to the COVID 19 crisis, board meetings may be held via video conference whereby the executive officer or senior officer is present in Israel. It could be viewed that the effective place of management has been transferred to Israel, to the place of residence of one of the members of the management and a corresponding tax liability has been established in Israel.

Such a reclassification of the foreign corporation also bears the risk of double taxation due to double residency. According to the so called “Tie breaker rules” this could be remedied only through a time-consuming mutual agreement procedure between the participating countries. In addition, a transfer of place of effective management to Israel could expose the foreign corporation in the foreign jurisdiction to an “exit tax”, an immediate taxation on the goodwill and any hidden reserves as the full tax liability may end with the change of the place of effective management there.

With these possible far reaching implications “control and management” of a corporation should be determined from a long-term perspective and not from a temporary and exceptional stay of senior officers in Israel.

In order to avoid a reclassification, board meetings of foreign corporations should, if factually and under company law possible, either be postponed, or the individual decision making powers should be temporarily transferred to persons residing outside of Israel, and where documentation demonstrate that these decisions are in fact made and performed  outside of Israel.  These measures will reduce the risk that a transfer or change of place of effective management has taken place.

4. Creation of a Permanent Establishment due to COVID 19 Crisis

In addition to their tax residency determined by the place of incorporation or the place of effective management corporate taxpayers are also taxable where they maintain a permanent establishment. An employee of a foreign corporation who works remotely during an unavoidable stay in Israel could create such a permanent establishment in Israel with corporation’s profits subject to Israeli tax. In connection with a German resident partnership (e.g. GmbH & Co KG) the creation of an Israeli permanent establishment in Israel through the home office of one of the partners, could cause the other partners being liable to limited taxation in Israel and subject to compliance obligations.

However, the existence of a permanent establishment requires a certain durability – permanency – . In this respect it can be assumed that a temporary home office activity caused by COVID 19 will not establish a permanent establishment. However, it is also true that a possible permanent establishment risk exists, depending on the duration of the pandemic and on the fact whether the temporary use of the home-office in Israel will not become permanent. In order to avoid future disputes with the tax authorities it is recommended to collect comprehensive documentation in relation to the reasons and the activities in a respective home office to support arguments against a permanent establishment.

Conclusion

The current crisis and the measures taken by governments such as mandatory quarantines, prohibition of public gathering and travel restrictions to control the spread of the virus has affected the free movement of individuals globally. As a result, individuals “got stuck” in a jurisdiction even though they would be out in a different jurisdiction under normal circumstances. This in return could have an impact on the residence status of the individual himself, on the residence status of the enterprise he is working for and on the allocation of taxing rights between jurisdictions.

The OECD secretariat has issued guidance and recommendations and sees the individual’s tax residency unlikely to be changed in light of the temporary circumstances of the pandemic. Furthermore, the place of effective management of a corporation should not be regarded as being changed by a temporary and exceptional period of time such as the COVID 19 crisis. Finally, the home office of an employee should not be regarded as the creation of a permanent establishment as government directives should be considered as force majeure and not as enterprise requirements. The OECD Secretariat publication, however is a type of guidance and recommendation to countries and not obligatory to the member states. Unfortunately, the Israeli tax authority has not commented on the issue and has not taken a clear stand as how to treat the COVID 19 crisis in relation to the determination of tax residency.

In light of the ongoing health crisis and the continued travel restrictions, individuals, corporations and trusts should be well advised about the various domestic residence laws, plan carefully not to cause a change in residency unintentionally and collect comprehensive documentation in relation to reasons and activities in a respective home office in order to mitigate future disputes with the tax authorities.

Furthermore, this is true, since the world is in the grip of the pandemic for almost a year, and emergency, temporary and transitory circumstances are about to become more and more of a permanent nature.