Diana Rjabynina
Kocks & Partners, Brussels
Diana.rjabynina@kockspartners-law.be

Report on a Taxes Committee session at the 2024 IBA Annual Conference in Mexico City

Tuesday 17 September 2024

Session chairs

Alexandra Courela Abreu, Lisbon
Robert Duque-Estrada Brigagao Duque-Estrada, Rio de Janeiro

Panellists

Matthias Bizzarro Baer & Karrer, Lugano
David Saltzman Ropes & Gray, Massachusetts
Simone Schiavini Legance, Milan
Alejandro Torres Von Wobeser & Sierra, Mexico City

Introduction

The mobility of top executives has emerged as an important trend in the aftermath of the pandemic. This panel addressed the primary fiscal challenges associated with cross-border corporate and executive mobility, including issues related to permanent establishments (PE), place of effective management and their consequences – such as exit taxes – in Brazil, Italy, Mexico, Portugal, Switzerland, and the United States. The discussion took a highly practical approach, structured around four concrete examples of how the several challenges are addressed in practice, each highlighting different topics, issues, and risks specific to the tax jurisdictions of the speakers.

Panel discussion

Corporate residency, PE risks and profit attribution

The first example examined a multinational group based in Switzerland with centralised management and local hiring in subsidiaries across the US, Mexico, Portugal, and Italy. The goal was to evaluate the effectiveness of this structure and its implications for permanent establishment risks. Three key questions arose:

1. How is the tax residency of the parent entity determined?
2. Is there a risk of establishing a permanent establishment?
3. If so, how are profits attributed to it?

In Italy and Portugal, corporate tax residency is typically assessed using both the effective management and control test, and the incorporation test. Italy also considers the place of effective management. In contrast, the US relies solely on the incorporation test and Mexico does not have the incorporation test for assigning tax residence for corporations.

PE issues may arise depending on the specific roles and functions of the executives, particularly high-risk positions like CEOs. Domestic laws vary significantly and a detailed treaty analysis is necessary. Previously, a fixed place of business was required to establish a PE, but most countries now adopt a substance-over-form approach – except for Switzerland, where a PE can be created if an executive concludes contracts, reflecting the concept of a dependent agency arrangement. Tax authorities have shifted their focus from preventing double taxation to preventing non-taxation, leading to a more aggressive stance on such structures and home office structures.

Transfer pricing to address PE issues

The second example discussed how transfer pricing can mitigate PE risks. When the founders of a startup (CEO and CTO) move to another country, they create a local company that recharges their management services to the startup, driven by tax consideration or other factors like research and development.

From a Swiss perspective, this arrangement could potentially create a place of effective management or establish a PE, even though the Swiss domestic definition of a PE requires a fixed place of business. The outcome depends on specific factual circumstances, such as how functions are allocated, where day-to-day management occurs, and whether executives travel to the home jurisdiction for management meetings. However, the risk of establishing a PE is reduced when management services are recharged at arm’s length through transfer pricing. Agreements can be made with tax authorities regarding what constitutes a fair recharge, allowing for a (negative) confirmation that no PE has been created. The preferred methods for this are cost-plus and transactional net margin methods (TNMM); profit split is generally less favoured.

In the US, transfer pricing also offers a potential solution, although the absence of formal agreements with tax authorities complicates matters. In Italy, corporate residency issues are often resolved by avoiding executive positions in other countries. If executives are employed by local subsidiaries providing services to the parent entity, cost-plus and profit split methods (especially in the financial sector) are commonly used to establish arm’s-length remuneration based on the functions performed.

Similarly, Mexico focuses on whether effective management occurs within its borders, which can trigger residency issues. By recharging management services at arm’s length, startups can effectively navigate these diverse regulatory environments and minimise their PE risks across various jurisdictions.

Implications of shifting key functions and corporate exit tax

The third example addressed the implications of an executive responsible for managing shareholdings in subsidiaries moving to the jurisdiction of the head office.

In Italy and Switzerland, the relocation may trigger exit tax issues. In contrast, the US does not impose exit taxes on individuals, as this issue is primarily associated with jurisdictions that apply the management and control test. Nor does Brazil apply any exit taxes. In Switzerland, the transfer of functions across the border would trigger exit taxation for profits taxes. No exit taxation would be triggered for withholding tax as permanent establishments of foreign entities are not subject to withholding tax.

The taxable basis for exit tax varies by country. In Italy, it is calculated as the difference between the fair market value of transferred assets, including goodwill, and their tax basis, resulting in a capital gain taxed at 24 per cent. Switzerland applies an exit tax based on hidden reserves, determined by the difference between the fair market value and book value of assets. Withholding tax (where applicable) is assessed on the difference between fair market value and nominal value plus capital contribution reserves. In Mexico, the process is treated as a liquidation, where all assets are valued at fair market value, and profits are taxed accordingly.

Tax migration: procedures, dual residency, and practical considerations

The final example related to a manager relocating from one country to another, raising concerns about migration procedures, dual residency, tie-break rules and practical recommendations, particularly when the destination jurisdiction offers preferential or low tax regimes.

In Mexico, strict formalities govern tax residency changes. Non-compliance, especially when moving to a preferential tax regime, can lead to residency issues. For instance, maintaining property or bank accounts in Mexico may prompt aggressive responses from tax authorities, who can presume tax residency for up to five years.

Switzerland, particularly in some cantons (Switzerland being a federal state) similarly enforces a stringent burden of proof for establishing new tax residency. In particular, a new tax residence and centre of interest must be shown (it is not possible to terminate tax residency in Switzerland without creation of a new tax residency abroad). This can include documentation such as bank statements, utility bills, GPS data and credit card transactions.

Brazil takes a somewhat more lenient approach but can still presume residency for an additional year, particularly when a preferential tax regime is involved, with the burden of proof on the individual. Italy and Portugal have similar systems, where the presumption of continued tax residency applies unless proven otherwise.

The US operates under a different model, imposing worldwide taxation on individuals even after they change residence unless they renounce their citizenship. However, an exception applies to bona fide residents of Puerto Rico and the Virgin Islands, particularly in cases involving cryptocurrency income.

Conclusion

The mobility of top executives across borders poses significant tax challenges, particularly regarding tax residency, permanent establishment and exit taxes. To minimise risks, companies should use strategies like transfer pricing and ensure compliance with local tax regulations. As executive mobility grows, staying informed about varying tax laws is crucial for effective planning and compliance.