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Ernesto Lacambra

Cases & Lacambra, Barcelona

ernesto.lacambra@caseslacambra.com

 

Covid-19 has transformed the world dramatically. In order to control the global pandemic, governments have been forced to implement restrictive measures, some of them affecting people’s freedom of movement. Restrictions on travel and mandatory quarantine are in order, generating significant uncertainty for many individuals, especially those whose travel patterns have been affected.

These new situations have had and will have an important impact on the field of tax law, particularly on the tax residency of individuals. Almost every country in the world sets out a presence test criterion in its local legislation to determine whether an individual would be deemed to be a tax resident. This criterion is strictly based on a person's physical presence. Generally, the premise is plain and simple: if you remain more than half of the year in a country, the state has the right to impose taxes on you.

What happens if you are being forced to stay away from your home in a country that is not your country of residence? Would your tax residency be affected for 2020?

Unprecedented situations require extraordinary measures. That is precisely what the Organization for Economic Cooperation and Development (OECD) intended to do by publishing its paper ‘Analysis of the tax treaties and the impact of the Covid-19 crisis’ on 3 April 2020. The response by the OECD was quick and sent a clear message to its members: local tax authorities should consider the special circumstances due to the pandemic on the determination of the residence status of an individual. According to the OECD, the implemented measures in certain countries deserved praise and should lead the way for other jurisdictions.

For instance, in Canada, the tax authorities will not solely consider the days of presence in the country if the individual is unable to return to their country of residence as a result of the travel restrictions. The Irish tax administration has confirmed that Covid-19 will be considered as a force majeure circumstance to assess that the individual is not present for tax residence purposes in the country. In the United Kingdom, taxpayers will be able to exclude up to 60 days which will not be taken into account for tax residence purposes if the individuals were prevented from leaving the country. Similar measures have been implemented in Australia for foreigners that usually live overseas, as well as in Germany and Malaysia.

Even if the OECD guidance is not a part of the OECD model or the commentary to it, it seems clear that the OECD must be the organisation to follow when looking for solutions to the new and upcoming challenges. In the current circumstances, mustering a concerted and effective global response to (not only) this problem is essential. But countries are not responding equally to this tax residency issue in the same way that the effects of the Covid-19 are heterogeneous. Ironically, Spain, one of the countries that has and is struggling significantly with Covid-19, has taken completely the opposite direction and has ignored the OECD recommendations.

In an administrative ruling published on 17 June 2020, the General Directorate of Taxes (GDT), an organisation fully dependent on the Spanish tax authorities, confirmed that the days spent in Spain due to Covid-19 restrictions would be considered as days of presence in Spain to count towards the 183-day limit.

It is difficult to understand why the GDT has disregarded the advice of the OECD in this matter, yet not surprising at all. Many local tax authorities are reviewing their response and enacting changes to provide relief to affected taxpayers with a level playing field based on two common circumstances: days spent by individuals exclusively because of the implemented restrictions will not be considered for tax residency purposes as long as:

• the individual is not ‘usually’ a tax resident in the country where they are stuck; and

• they intend to leave the country as soon as this opportunity is available.

Even the date in which the ruling was published is also indicative of the Spanish tax authorities’ approach: 17 June. For instance, for a non-resident who arrived to Spain in January 2020 for professional reasons and was forced to stay in the country due to the pandemic from that date until the end of the state of alarm (22 June 2020), 174 out of the 183 days threshold had elapsed. If such individual was unable to leave the country after the state of alarm finished, they would become a Spanish tax resident by 2 July, only 10 days after the end of the state of the alarm, with no room for flexibility at all.

It must be pointed out that some individuals have not been able to go back home as of the date this article was written. For instance, travel restrictions are still in force for people travelling from Spain to Argentina, Canada, Chile, Paraguay, Perú, Venezuela, and the United States.

It is difficult to understand the position of the Spanish tax authorities, considering that Spain has been hit far more powerfully by Covid-19 than some other countries. To put some light on this statement, by the date this article was written, Spain was one of the countries in Europe with the most confirmed cases of and deaths from Covid-19, with twice the number of cases of Italy or France, despite Spain having a population that's approximately 25 per cent and 30 per cent smaller than Italy and France respectively. Also, Spain has reported the same number of cases as Mexico, though its population is three times less than Mexico's. Covid-19 has demanded a more flexible interpretation on this issue and a tax ruling was the perfect tool to do so. In our opinion, the Spanish Tax Authorities response is belated and unjustified.

Nevertheless, it could be the case that the Spanish tax authorities would opt to hold a less conservative interpretation during the tax audits regarding tax residency in Covid-19 related cases, allowing the taxpayer to prove that they were forced to stay in Spain and left the country as soon as they were able to. Additionally, the ruling concerns a couple of tax residents in Lebanon, which is considered to be a tax haven for Spanish purposes, which could be a decisive factor in the fact that the administration is trying to attract the tax residence to Spain. On the contrary, a lot of unfair situations could arise. It would also be a waste of time and resources, increasing litigation and conflict.

As the OECD recognises in its paper, a residence conflict with the original country of residence jurisdiction will arise in a potential scenario in which the tax residence could be attracted to Spain exclusively for presence reasons, forcing the applicability of the conventions to avoid double taxation. In these scenarios, it is highly probable that the tie-breaker residency rules will ultimately set the tax residence as the original country of residence.

It is impossible to forecast what will happen in the end. Nevertheless, we can think of at least three different reasons to be pessimistic.

First, the content of the tax ruling per se is clear enough. It is unlikely that the administration will not follow the criteria set out in it. Second, recent case law in which the Spanish tax authorities have defended the residency in Spain in recent tax audits is discouraging. And lastly, it is a reality that public debt and deficits will be far greater as a consequence of the Covid-19 pandemic.

Even if the Spanish tax authorities decide to apply such a conservative approach, the Spanish courts are eager to admit the OECD criteria, mainly when substantial justice must prevail over the literal interpretation of law. In addition, whenever a dispute over residence should occur and a double tax treaty is in place between the two countries, we can foresee that even though the Spanish administration could claim the tax residency, it should be possible to resolve the dispute based on other tie-breaking rules besides the permanency in Spain.

We can expect to head towards an undesirable scenario of increased conflict and litigation, especially for the significance of attracting the tax residency to Spain. In these cases, such individuals could be subject to Spanish personal income tax, wealth tax and inheritance and gift tax, among other relevant tax obligations

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