Tax issues arising from cross-border WFH arrangements

Before COVID came, flexible work arrangements, such as work-from-home (WFH), were for the large part unheard of, at least in the Philippines.  However, when lockdowns were implemented, there was no other choice but to embrace WFH to continue business operations.

Lockdowns have now been lifted, but the COVID threat remains, resulting in WFH arrangements becoming accepted as the new normal. In fact, in the EY 2022 Work Reimagined Survey, 40% of respondents from the Philippines indicated that they would like to work remotely more than five days a week (essentially the entire work week), 20% prefer four days a week, 24% three days a week, 12% two days a week, 2% once a week and only 2% want to return full-time to the office. We can also see an increasing number of companies supporting their employees with WFH allowances and subsidies (e.g., internet allowances and equipment subsidies) so that they can set up their workstations and be able to carry out their tasks efficiently and effectively at home.

The WFH arrangement has also expanded to the cross-border workforce. Some foreign companies are now engaging Filipino or foreign nationals in the Philippines without physically moving such talent to foreign/host locations. There are also cases where foreign nationals are hired/assigned to Philippine entities but continue to work outside the country or from their foreign residences. While cross-border WFH may satisfy an employee’s remote working preferences, it may pose some tax issues to both the employer and the employee.

The Philippine Tax Code, with its various amendment in recent years, still considers the situs of taxation for income on services as the place where the personal services are rendered. Thus, compensation for labor or personal services performed within the Philippines regardless of the residence of the payor, or of the place in which the contract of services was made, or the place from which payment was made, is considered Philippine-sourced income. The determination of the tax residency also remains unchanged and so is the scope of taxation, based on the tax residency status of the taxpayer/filer.

To illustrate what these issues are, let us take as an example a Filipino citizen, Juan, who was hired by a Japanese entity, receiving payroll from Japan but living in the Philippines due to a WFH arrangement with the employer. For tax purposes, Juan will remain a resident Filipino citizen and is subject to tax on his worldwide income. His Japan-paid salary is Philippine-sourced income. Thus, even if his salary is paid by his Japanese employer and taxed in Japan, he will not be able to claim Japan-paid taxes as foreign tax credits for his Philippine income tax return because the salary, on which Japan imposes taxes, is not foreign-sourced but Philippine-sourced income. Consequently, there may be double taxation on the same income. Also, as Juan is an employee of the Japanese entity, there is a risk that his presence in the Philippines is creating a permanent establishment (PE) in the Philippines for his employer. If a PE status is created, the Japanese entity may be exposed to corporate taxes (i.e., income tax, VAT or withholding tax) and will be required to fulfill administrative tax compliance here in the Philippines.

Consider another example, this time a foreign national, John, who is on assignment to a Philippine entity, receives his payroll from the Philippine company but stays in his home country while on foreign assignment. Technically, John should not be subject to tax in the Philippines. As a foreign national, he is subject to tax only on his Philippine-sourced income. As he is rendering his services in his home country, the remuneration that he receives for such services is foreign-sourced income, not Philippine-sourced compensation. However, a corporate tax issue arises if the Philippine entity claims John’s salary as an expense in its books. There is a risk that the tax authorities may disallow the tax deduction of such salaries if these were not subjected to Philippine withholding taxes. Furthermore, as an employee of a Philippine entity working in a foreign jurisdiction, there is again a PE risk being created in that foreign jurisdiction. If PE is created, the Philippine entity may be subject to tax and administrative compliance in such foreign jurisdiction.

There are other variations to WFH arrangements (e.g., split payroll, working in third country, among others) that would likely result in the same double taxation, PE creation and tax deduction disallowance risks). Given that cross-border tax on WFH scenarios can be significantly more complex than what most people believe, it is advisable for both companies and their cross-border employees to proactively consult tax professionals who are well-versed in these issues before entering into such arrangements, if possible. For companies that have pre-existing cross-border employees, they should consider conducting a review well ahead of the actual filing of tax returns to ensure that they are not only compliant in both home and host jurisdictions, but that they also understand what options they have to address possible challenges that may arise.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co. Jocelyn M. Magaway is a tax senior director of SGV & Co.