Be Cautious with Short-Term Business Traveler Foreign Tax Exemption
By Mary Lou Stockton, CPA, and Lynn Carbo, EA
Many businesses ask employees to travel to a foreign country to develop new contacts, suppliers, and customers, or to expand operations. Often, these trips are short-term in nature.
It is often assumed that this short-term travel will not have a tax consequence for the employee or employer. The client may have even heard the term "183 days," and assumed that as long as the employee is not "in country" for more than 183 days, there aren’t any tax implications.
Often, the client is correct, but not always and not necessarily for the right reason. CPAs should be aware of the "red flags" associated with short-term international business travel that may result in unexpected tax liabilities or reporting requirements.
When referring to the 183-day rule, professionals are often referencing dependent services, or the "income from employment" clause of a treaty that is in effect between two countries. Below is an excerpt from the 2001 U.S./U.K. treaty that includes Article 14, Income from Employment:
Under this article, for example, an employee living and working in the United States can go to the United Kingdom, work on a short-term project, and come home without incurring U.K. tax liabilities if he or she meets the above requirements. The tax practitioner, however, must be aware of potential issues, even if it appears that no host country tax will be incurred by virtue of the applicable treaty provision. There may be Permanent Establishment or Economic Employer issues that need to be addressed, as well as reporting and withholding requirements.
There are three areas where an employee might be subject to foreign tax when assigned to an international short-term project.
A CPA needs to be aware if an employee is sent to a country with which the United States does not have a tax treaty. For example, the United States and Brazil do not have a bilateral income tax. Therefore, companies that send employees to Brazil, even for a short-term trip, must look to local Brazilian law to determine whether or not the employee will have to pay Brazilian income tax.
Failing the 183-Day Rule
The second trap for the unwary is the 183-day rule itself. Depending on when the treaty was entered into, the clause may provide that the employee can be present in the country for less than 183 days in any rolling 12-month period, or any tax year. With older treaties, where the rule is 183 days in a tax year, simply look at each tax year of the host country on a stand-alone basis, and count the number of days present in country. Theoretically, someone could make a business trip for up to 364 days, as long as the midpoint of the stay was at the turn of the tax year, and could technically qualify to meet the 183-day rule.
Newer treaties are written to prevent this. Review the excerpt above. This provision makes it much more difficult to spend a short period of time in country without incurring a tax liability in the host country. It means that the employee must continually track their days in and out of the host country to make sure there is no 12-month period beginning or ending in the tax year in which he has been present in the country for more than 183 days. For example, a 364-day trip spanning two tax years would not qualify under the U.S./U.K. treaty due to the requirement to consider “any 12-month period commencing or ending in the taxable year or year of assessment concerned.”
The third trap is the cross charge provision (point c above). A company must understand there cannot be a cross-charged compensation expense for an employee who is going on a short-term international assignment to the host location, unless they are prepared to look to local law with regard to the employee’s tax liability in the host location. Taking a corporate tax deduction for their compensation in the host location, as well as claiming the employee to be exempt from host location taxes, would be considered double-dipping. This issue is particularly relevant in the case of consulting companies, where individuals may be sent to deliver a project, and compensation costs must be matched with related revenue. CPAs should also consider what cross charge may be appropriate for corporate tax reporting purposes.
Finally, it should be mentioned that, for foreign individuals inbound to the United States, the same treaty provisions apply to exempt them from U.S. federal income tax. However, even if the employee is exempt from federal income tax, he or she may still incur state and local income tax. It is important to identify specifically where the inbound foreign individual is physically present and working while in the United States. Federal income tax “reporting” will still likely be required, even if the foreign employee is exempt from U.S. tax by virtue of a treaty.
Proper planning and research is needed when employees go on short-term international assignments. CPAs should review applicable tax treaties between the host location and home country to determine the tax liability, as well as reporting and withholding implications.
Mary Lou Stockton, CPA, is managing director with Global Tax Network Philadelphia LLC in Berwyn. Lynn Carbo, EA, is a senior manager with Global Tax Network Philadelphia. They can be reached at firstname.lastname@example.org and email@example.com, respectively.
LAST UPDATED 8/5/2010