There are, of course, an infinite number of things that can prompt a tax investigation or audit – but within that plethora of possibilities, there are international trends of which businesses should be aware. In this blog post, we delve into one of those trends and explore examples of workforce-related tax investigations.
This blog post forms part of a wider series exploring the global enforcement outlook for large businesses, written by lawyers spanning different services, regions and industries. For other blog posts in this series, see here. For an overview of other trends in corporate tax disputes, see our Tax investigations and disputes across borders guide and Tax Matters: Trends in tax disputes podcast.
Where is your workforce located?
Tax authorities are increasingly bringing challenges based on the location of businesses’ staff – with remote working common and expected to persist into the future, this is likely to become an evergreen trend.
Some investigations focus on whether a business has complied with its income tax and social security obligations. For businesses with an internationally mobile workforce, it may not be straightforward to know where workers are located to set up appropriate compliance. The rules are fiddly and treaty protections inconsistently applied, creating risks of double taxation and penalties for the workers and the businesses that employ them.
Other investigations centre on whether businesses have complied with applicable transfer pricing rules. Transfer pricing is a major focus of tax authorities more generally, but in this context should be considered carefully where employees are seconded abroad on a part- or full-time basis. Points to watch are whether the employee’s remuneration is borne by the appropriate group company or establishment and potential impacts on any residual profit split arrangements based on significant people functions.
The location of staff can also affect the taxable presence of the business they work for – for example, by creating a permanent establishment or, in extreme cases, changing its tax residence. Even if businesses have perfect insight into the location of their workforce, responding to enquiries can be challenging, particularly if multiple years – or COVID years – are under investigation. At present, jurisdictions take very different approaches to such issues. Germany has recently issued administrative guidance indicating that staff working from home will seldomly result in a permanent establishment for the business. By contrast, other countries are more inclined to consider an employee’s home to be a permanent establishment if the relevant individual works predominantly from that address. Efforts are afoot to reach international consensus on the principles that should apply in this area, but that will take time and will not help those businesses already facing investigations. The implications of getting this wrong are potentially significant: best case is a compliance headache, worst case is large historic tax bills or emigration charges plus (civil or criminal) penalties.
What is the status of your workers?
Another common aspect of workforce-related tax investigations relates to the status of individual workers for tax purposes. Understanding whether individuals are correctly treated as employed or self-employed may be crucial to identifying the employment tax and VAT consequences for the business, and may also have employment law implications. In extreme cases, these kinds of investigations can threaten entire business models, as some platform operators have found.
There are also anti-avoidance provisions to take into account. In the UK, for example, the off-payroll working rules (commonly referred to as IR35), which may apply in respect of workers who provide services through an intermediary, have contributed to a flurry of tax investigations (and litigation) in this space across a range of sectors where contractor arrangements are commonplace.
How are your senior managers incentivised?
Many businesses are also facing tax investigations into how senior management are incentivised.
Senior staff are often incentivised by management equity programmes (MEPs), under which they have the option to acquire shares of a special class in their employer. Any gains arising are generally subject to the lower capital gains tax rate. Given the connection with the employment relationship (for example, vesting and leaver provisions) and the lack of clear statutory rules for the taxation of MEPs in some jurisdictions, tax authorities regularly challenge this treatment and seek to subject gains to the higher income tax rate instead.
Helpfully, recent case law in Germany has confirmed capital gains treatment for MEPs, providing taxpayers with some hope that these challenges will abate. However, there remains the possibility of investigations questioning the arm’s length nature of the acquisition price and payout gain.
In France, qualified employee share ownership schemes and other non-qualified instruments used to structure MEPs have also come under close scrutiny by the tax and social security authorities. This has resulted in many of the arrangements being recharacterised, with some of the costs (specifically, social security contributions) falling on the employer businesses.
Similar points arise in the UK too. The restricted security and disguised remuneration rules have long caused headaches for businesses. More recently, there has been an increased focus by HMRC on the remuneration arrangements of partnerships, with the mixed member rules and salaried member rules forming the legislative basis for many such challenges. Some of these investigations have already spawned litigation (for example, The Boston Consulting Group UK LLP & Others v HMRC [2024] UKFTT 84, which our colleagues discuss here). More cases on these topics are expected in the months and years ahead.
Are you exposed to the actions of your workforce?
A further aspect of workforce-related tax investigations is the extent to which businesses can find themselves in the spotlight as a result of the actions of their staff.
Businesses have always been exposed to the actions of bad actors. In the UK, corporates have for many years been liable for criminal tax offences if it can be established that an individual representing the ‘directing mind and will’ (typically, a director) had the necessary criminal intention. In practice, that imposed a very high hurdle. To address that, there are now a plethora of offences on the UK’s statute book whereby the criminal acts of workers can result in criminal liability for the business itself, including:
- under the corporate criminal offence of failing to prevent the facilitation of tax evasion (the CCO), if an associated person criminally facilitates a tax evasion offence by any person, unless the entity can establish that it had reasonable procedures in place to prevent the facilitation (see here);
- under the corporate criminal offence of failing to prevent fraud (the FTP), if an associate commits a specified fraud offence (including tax evasion) for the entity’s benefit, unless the entity can establish that it had reasonable procedures in place to prevent the fraud (see here); and
- as a result of the expanded identification principle, if a senior manager of the organisation acting within the actual or apparent scope of their authority commits certain (tax) offences.
Other jurisdictions have similar features in their rules too. For example, in France, entities may be held criminally liable for offences perpetrated on their behalf by their governing bodies and representatives. And, in Spain, an entity may be criminally liable if its legal representatives or employees commit a criminal tax offence for the direct or indirect benefit of the entity in circumstances where the duties of supervision, monitoring and control have been seriously breached. Like the UK’s CCO and FTP, that entity will have a defence if it had reasonable procedures of control in place.
Businesses can also face tax investigations as a result of the good acts of their workers – namely, whistleblowing on poor tax practices. As our colleagues discuss here and here, businesses are well-advised to foster a strong ‘speak-up’ culture, underpinned by robust internal procedures and active promotion by senior management, to ensure staff are empowered to raise any concerns about potential tax misdemeanours at an early stage and via internal channels so that they can be properly investigated and raised with tax authorities on a proactive basis to mitigate potential penalties.
And individual workers are not the only ones who may blow the whistle on businesses’ tax affairs. In France, for example, criminal and civil tax investigations may be triggered by employee representative bodies – and there have been instances of works council filing criminal complaints alleging that businesses have illegally reduced their French corporate income tax bill via inappropriate transfer pricing practices (among other things).
If you would like to discuss any of the points raised in this blog post in further detail, please contact the authors, our tax investigations and disputes team or your usual Freshfields contact.
