In the case of businesses, are there instances where both place of management and place of incorporation tests fail?

QUESTION POSTED BY: Student
PROGRAMME: Postgraduate Diploma in International Taxation
TOPIC: Jurisdiction of Tax Extended (WEEKS 23 & 24)
LECTURER: Renier van Rensburg

FULL QUESTION

ADDITIONAL WRITTEN ANSWER

Yes, there are instances where both the place of management and place of incorporation tests may fail to determine the tax residence of a business. This generally occurs in situations where a business has strong connections to more than one country, and neither of these tests provides a clear answer. Here are a few scenarios where this can happen:

1. Dual Residence

In cases where a business is incorporated in one country but has its place of effective management in another, both countries may claim tax residency. For instance:

A company incorporated in Country A might have its place of effective management in Country B. Both countries may assert tax residency based on their respective rules (incorporation vs. management), leading to a conflict.

Tax treaties typically include tie-breaker rules to resolve such conflicts, often favoring the place of effective management, but in some cases, these rules may be ambiguous or difficult to apply due to overlapping management structures.

2. Ambiguous or Fragmented Management Structure

Some businesses may have a fragmented or decentralized management structure, where key management decisions are made across multiple jurisdictions. In such cases:

It might be difficult to determine a single place of effective management because no one location clearly holds the management’s power or control.

In this scenario, neither the place of incorporation nor the place of effective management test can definitively determine the company’s tax residence, leading to uncertainty.

3. Inconsistent Domestic Laws

Each jurisdiction can apply different interpretations of what constitutes a “place of effective management” or “place of incorporation.” For instance:

Country A may look at where board meetings are held or strategic decisions are made, while Country B could consider where day-to-day operational management occurs.

This inconsistency can lead to situations where neither country’s test adequately determines tax residency, leaving the business in limbo.

4. International Business Structures

Multinational enterprisesWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include... (MNEsWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include...) sometimes use complex international structures, with holding companies, subsidiaries, and regional management centers in different jurisdictions:

The place of incorporation might not reflect where the business is effectively managed, especially for holding companies that exist in jurisdictions for tax purposes.

The place of management might be shared among various regions without a clear central location, which could prevent the application of either test effectively.

5. Digital and Virtual Businesses

Modern, technology-driven businesses that operate virtually across borders may not have a significant physical presence in any jurisdiction:

In these cases, it may be difficult to apply the place of management test since management activities can occur online or in various locations.

Place of incorporation may also fail because the business’s legal entity is disconnected from where it is economically active.

Resolution via Tax Treaties

To resolve such issues, tax treaties between countries often provide a tie-breaker rule based on criteria like the place of effective management, place of incorporation, or mutual agreement between the competent authorities of the two countries. However, when these rules are vague or when the countries don’t agree, disputes can arise.

These situations can lead to double taxationDouble Taxation occurs when the same income or financial transaction is taxed twice, typically in different jurisdictions. It can arise in two primary contexts: economic double taxation, where the same income is taxed twice in the hands of different taxpayers, and juridical double taxation, where the same taxpayer is taxed on the same income in more than one country. Double... or tax uncertainty, requiring businesses to proactively manage their tax riskTax Risk refers to the uncertainty surrounding the potential financial or reputational impact of tax-related decisions and events on a business or individual. This risk arises due to various factors, such as complex tax regulations, inconsistent tax authority interpretations, or evolving international tax laws. Effective tax risk management involves identifying, assessing, and mitigating potential tax-related threats to prevent financial penalties,... through proper structuring, obtaining legal guidance, and, when necessary, seeking relief through Mutual Agreement Procedures (MAPs) or similar dispute resolution mechanisms.