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The Home Office's Permanent Establishment Existence in the era of hybrid work

Jan 19

The Interpretation of 'Home Office' for Examining the Existence of a Permanent Establishment in the Hybrid Work Era: The Gap Between the Israeli Tax Authority's Position and International Trends

 

By

Meori Ampeli, Adv. (CPA) • Anna Tsabari, Adv.


Introduction


The last decade has brought far-reaching changes to global work patterns. Technological developments, alongside social and cultural changes, coupled with the COVID-19 pandemic, have led to a significant increase in the number of employees working remotely (Home Office), sometimes even in other jurisdictions.


These developments pose significant challenges to traditional tax systems, inter alia, due to the blurring of boundaries between countries in the context of determining the place of work, the difficulty in establishing the territorial nexus of business activity, and the question of proper interpretation of the term "permanent establishment" in cases of remote work from home office, which we will focus on in this article.


Permanent Establishment


As is known, "Permanent Establishment" is a central concept in bilateral tax treaties and is primarily designed to resolve disputes between two countries competing for the right to tax the same activity.


The significance of a permanent establishment is that not every business income generated in a particular country (source country) grants taxation rights to that country, and the business activity must exceed a certain threshold or maintain a certain physical presence. If the business activity is insufficient to constitute a "permanent establishment," the source country will have no taxation rights whatsoever, and the exclusive right will be granted to the country of residence.


According to Article 5 of the Model Convention, a "permanent establishment" generally exists in one of two alternatives:

a)     The business activity in the source country is conducted through a fixed place of business at the disposal of the foreign enterprise;

b)    The business activity in the source country is conducted through the activity of a dependent agent.


Article 5(1) of the Model Convention states in this context: 


"For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on."


The Commentary to the Model Convention[i]  indicates that the term "Fixed place of business" must meet the following characteristics:


1.     A physical location where the business is conducted, i.e., a facility such as offices or, in certain cases, a location where machinery or equipment is maintained;

2.     The place of business must be "fixed" both geographically and temporally;

3.     The business, in whole or in part, is conducted through the place of business by factors related to business management.


The Commentary to the Model Convention further states that although no formal legal right to use a particular place is required for the place to be considered a fixed place of business, the mere presence of a company in a particular location does not necessarily indicate that the location is at its disposal. Rather, the company must have effective power to use the location and actually make use of it, as follows:

"Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that location is at the disposal of that enterprise. Whether a location may be considered to be at the disposal of an enterprise in such a way that it may constitute a "place of business through which the business of [that] enterprise is wholly or partly carried on" will depend on that enterprise having the effective power to use that location as well as the extent of the presence of the enterprise at that location and the activities that it performs there.[ii]."


A related sub-question is whether an employee working from home for a foreign corporation establishes a permanent establishment for the foreign corporation in Israel. This question has not yet been addressed in Israeli case law and received its last consideration by the Tax Authority more than a decade ago in Tax Ruling 253/12 titled: "Existence of a Permanent Establishment for a Foreign Company Employing an Individual Working from Israel. In this ruling, the Tax Authority adopted a far-reaching interpretation of the concept of "permanent establishment" created by an employee working from home, as follows:


Tax Ruling 253/12[iii]


Facts:

The ruling dealt with a foreign company providing financial services abroad. The company's clients were located abroad. The foreign company had no clients in Israel and did not engage in any marketing activities concerning entities in Israel. The company entered into an employment agreement with an Israeli resident employee (hereinafter: "the Israeli Employee"), who was hired as an employee in investment management. As part of her role, the Israeli Employee would provide the foreign company with the following services: regular monitoring of risk levels in client portfolios and performing credit analyses and monitoring of portfolios at risk. Besides the Israeli Employee, the foreign company had no other Israeli employees. As agreed, the Israeli Employee would work from her home and be subordinate to her team leader. The scope of her activities and authority would be limited: the Israeli Employee does not perform any marketing and sales services, does not conduct negotiations, and does not recruit new clients. Furthermore, the implementation of her ideas requires approval from her team leader. Additionally, the foreign company bears sole responsibility towards its clients.


The Request:

The foreign company requested approval for the tax treatment of the company's profits derived from the Israeli Employee's activities in Israel.


The Decision:

The tax ruling determined, inter alia, that "the work of A. will create a permanent establishment for the company under Article 5 of the tax treaty between Israel and the USA". Accordingly, the ruling determined that the company must register with the Israeli Tax Authority and report its Israeli-sourced income based on the prescribed formula. As a result, the tax implications are twofold: the employee remains subject to tax on her personal income, while the company incurs Israeli tax liability on profits attributable to the employee's activities in Israel.


We find the decision problematic and subject to several material criticisms[iv]. Similar criticism was later presented in the State Comptroller's Report of 2017, which noted in this context (hereinafter: "the State Comptroller's Report"):

"From the Tax Ruling 253/12, it is unclear why it was determined that despite the Israeli employee's limited scope of work from her home in Israel, without substantial activity towards the foreign company's clients, she would still be considered a 'permanent establishment' of the foreign company in Israel, and why this activity does not fall within the exception existing in Article 5(3)(e) of the OECD Model Convention, which states that activity that is solely preparatory or auxiliary to the activity of the foreign company does not establish a permanent establishment for the foreign company in Israel.


Decision 253/12 apparently contradicts previous tax rulings published by the International Taxation Unit prior to this decision, such as: Tax Ruling 65/06 (a service provider who is not authorized to bind the foreign company and does not engage in sales does not constitute a permanent establishment); Tax Ruling 117/06 (a consultant in distribution service matters performed by Israeli distributors for foreign company products who is not authorized to bind the foreign company does not constitute a permanent establishment), Tax Ruling 118/06 (an Israeli representative engaged in client recruitment and investment sourcing, with limited authority who is not authorized to bind a foreign company does not constitute a permanent establishment); Tax Ruling 36/08 (an information systems expert providing development and installation services who is not authorized to bind the foreign company does not constitute a permanent establishment). It should be noted that in Decision 253/12, the Authority did not indicate that this represented a change in the Authority's policy compared to previous decisions". [v]


It should be noted that the Tax Authority's response to the State Comptroller's Report, as published in the report itself, was as follows:


"In cases where a home office is used on a regular and continuous basis for the corporation's activity, and it is clear from the facts and circumstances that the corporation requested the individual to use this location to carry out the corporation's activity, and when the corporation does not provide the employee with an office in circumstances where employment naturally requires an office, the home office can be considered under the control of the corporation."


Therefore, it appears that according to the Tax Authority's perspective, the facts of the Tax Ruling 253/12 seemingly indicate that the corporation, on one hand, requested the employee to use her home regularly and continuously to perform the corporation's activities (home office), and on the other hand, chose not to provide her with an office, and therefore the employee's home can be considered under the corporation's control. Is that really so?


The Tax Authority has not published any additional reference to the issue since its response to the State Comptroller's Report, including during the COVID-19 period, where this issue received specific attention from the OECD and other countries, as will be detailed below.


In our view, the emerging reality in which Israel desperately needs the return of quality workforce to Israel and the entry of multinational firms and foreign investors, against the background of the wave of departures affecting it in the last two years and the shortage of high-tech workers, requires a re-examination of Tax Ruling 253/12, while developing legal tests adapted to current business reality, similar to tax authorities in other countries, as we will review below. These matters gain additional significance since under Reportable Position No. 13/2016[vi], the Tax Authority applies "permanent establishment" also to the activities of new Israeli residents and veteran returning residents and requires examination of whether their activities from Israel for companies under their control amount to a "permanent establishment" for tax purposes in Israel[vii]. This issue will likely become more pressing in light of the enactment of Amendment 272 to the Ordinance [viii] and the cancellation of the reporting exemption for these populations, which will come into effect from January 1, 2026.


The Model Convention Commentary


The interpretation of the term 'Home Office', which is intrinsically linked to examining the existence of a permanent establishment, is regulated in the Commentary to the OECD Model Convention, which serves as a central model convention on which most tax treaties signed by Israel are based. The Commentary to the Model Convention addresses this term alongside the discussion regarding "fixed place of business", particularly concerning the degree of control the enterprise has over the employee's home in the source country, as detailed below:


"18. Even though part of the business of an enterprise may be carried on at a location such as an individual’s home office, that should not lead to the automatic conclusion that location is at the disposal of that enterprise simply because that location is used by an individual (e.g. an employee) who works for the enterprise. Whether or not a home office constitutes a location at the disposal of the enterprise will depend on the facts and circumstances of each case. In many cases, the carrying on of business activities at the home of an individual (e.g. an employee) will be so intermittent or incidental that the home will not be considered to be a location at the disposal of the enterprise (see paragraph 12 above).

Where, however, a home office is used on a continuous basis for carrying on business activities for an enterprise and it is clear from the facts and circumstances that the enterprise has required the individual to use that location to carry on the enterprise’s business (e.g. by not providing an office to an employee in circumstances where the nature of the employment clearly requires an office), the home office may be considered to be at the disposal of the enterprise." [ix]

 

The mere fact that corporate activities are performed from an employee's residence does not automatically constitute a permanent establishment at the company's disposal. Indeed, work performed from an employee's home typically remains incidental to the company's operations, unless specific circumstances demonstrate that the employee conducts the company's business continuously from home at the company's direction—for instance, when the company refrains from providing alternative office accommodations.

The Commentary to the Model Convention continues with the following example:

19. A clear example is that of a non-resident consultant who is present for an extended period in a given State where she carries on most of the business activities of her own consulting enterprise from an office set up in her home in that State; in that case, that home office constitutes a location at the disposal of the enterprise. Where, however, a cross-frontier worker performs most of his work from his home situated in one State rather than from the office made available to him in the other State, one should not consider that the home is at the disposal of the enterprise because the enterprise did not require that the home be used for its business activities. It should be noted, however, that since the vast majority of employees reside in a State where their employer has at its disposal one or more places of business to which these employees report, the question of whether or not a home office constitutes a location at the disposal of an enterprise will rarely be a practical issue. Also, the activities carried on at a home office will often be merely auxiliary and will therefore fall within the exception of paragraph 4."[x]


Therefore, when an employee primarily works from home despite having access to company-provided office facilities in another jurisdiction, their residence would generally not be considered at the company's disposal, particularly when working from home was not mandated by the employer. Furthermore, the Commentary to the Model Convention emphasizes that most home-based employee activities are typically classified as preparatory or auxiliary in nature, thereby falling within the permanent establishment exceptions outlined in Article 5(4) of the Model Convention.[xi].


Recent jurisprudence demonstrates how these principles have become instrumental in the interpretation of bilateral tax treaties, as illustrated below:


The Agreement Between Belgium and the Netherlands


On December 8, 2023, an agreement was signed between Belgium and the Netherlands providing guidelines regarding the application of "permanent establishment" rules for home office work concerning the provisions of Article 5 of the tax treaty between Belgium and the Netherlands - Agreement between the competent authorities of the Netherlands and Belgium on the interpretation of Article 5 of the Tax Treaty (permanent establishment) for employees working from home (hereinafter: "the Belgium-Netherlands Agreement")[xii]. Although this arrangement specifically applies to the tax treaty between Belgium and the Netherlands, it may provide deeper understanding regarding the appropriate way tax authorities should interpret the concept of "permanent establishment."


The Belgium-Netherlands Agreement distinguishes between three scenarios for determining if and under what circumstances home-based employees (teleworking employees) establish a "permanent establishment" for the foreign employer:


a. Occasional work from home

 According to the Belgium-Netherlands Agreement, the permanence element in the definition of permanent establishment is not met if the employee works only occasionally or sporadically (without a fixed number of weekly or monthly working days) from their home office. In this case, it was determined that working from home lacks sufficient permanence and is only temporary in nature, and therefore does not constitute a "permanent establishment" for the foreign employer.


b. Consistent work from home, with option to work elsewhere

Accordingly, working from home consistently will be considered part of a regular work pattern if the employee works from home a fixed number of days per week or month. However, in cases where the employee uses their home office consistently and regularly but voluntarily and by choice (for example, for convenience), a permanent establishment is unlikely to exist. However, if it was contractually agreed that the employee must (even partially) perform their work from their home office, or if they were de facto forced to work from home (for example, by not providing convenient office access to the employee in circumstances where the nature of employment clearly requires an office), it can be determined that the home office is at the company's disposal and constitutes a permanent establishment.

c. Employer's requirement for regular home work

When employees use their home office continuously for performing business activities of the foreign employer and it is clear from the circumstances that the company requires employees to use this location to conduct business, the home office may be at the company's disposal as a permanent establishment.


Additionally, the Belgium-Netherlands Agreement specifies criteria (non-exhaustive) that may indicate that the home office is at the disposal of the foreign employer:

a)     The employee is obligated, legally or in practice, to work from the home office;

b)    The employee has no practical ability to work in an office or elsewhere;

c)     The employee cannot unilaterally cease using their home office, for example because they cannot properly perform their activities or comply with their employment agreement if not performed in their home office.


The Belgium-Netherlands Agreement sets forth specific criteria for determining when home-based work does not constitute a 'permanent establishment'. According to these guidelines, if an employee's home-based activities for a foreign employer comprise less than 50% of their total working time over a 12-month period, the home office presumptively does not constitute a permanent establishment. Additionally, even where a fixed place of business is deemed to exist under the above criteria, no taxable permanent establishment arises if such location is maintained exclusively for activities of a "preparatory or auxiliary" nature in relation to the foreign company's operations.


German Tax Guidelines Regarding Permanent Establishment from Home Office


On February 5, 2024, the German Federal Ministry of Finance (Bundesministerium der Finanzen) published a decree amending the implementation provisions of the local tax law - the German Fiscal Code (AEAO) - Federal Ministry of Finance - IV D 1 - S 0062/23/10003 001, DOK 2023/1122582 (hereinafter: "the German Amendment")[xiii].


The German Amendment specifically addresses the interpretation of "permanent establishment" definition for local tax law purposes in the case of Home Office in Germany for foreign employers and clarifies that regular employees of companies not based in Germany typically do not lead to the establishment of a permanent establishment.


Additionally, it was determined that a Home Office will generally NOT create a permanent establishment for the employer when:


a.     The employer pays or reimburses the employee for expenses (rent) related to the home office and its equipment;

b.     A lease agreement is signed between the employer as tenant and the employee as landlord for specific areas/rooms in the employee's private home, unless the employer is explicitly authorized to use additional areas/rooms for other purposes, for example to use the space for additional employees or to enter the employee's private home beyond mere work safety inspections; or

c.     The employer does not provide the employee with another workspace.


This interpretative approach reflects the principle that an employee's private residence is generally not considered to be at the employer's disposal. However, the analysis differs substantially when an employee exercises managerial functions from their home office, particularly where substantive management decisions are executed from this location ("management permanent establishment"). In cases where the enterprise lacks other fixed places of business, a private residence may constitute a management permanent establishment if it serves as the actual site of management activities.


The OECD's Approach to Home Office Work in the Context of COVID-19


The home office question gained renewed significance during the COVID-19 crisis of 2020-2021, which presented unprecedented challenges for international taxation.

A primary concern emerged from the combination of suspended international travel and extended lockdown periods. Individuals who found themselves confined in foreign jurisdictions risked inadvertently establishing tax residency there, potentially subjecting their worldwide income to that jurisdiction's taxation. The situation was particularly complex for corporate officers who typically conducted business through international travel. Unable to travel, these executives were compelled to operate from their country of residence. Consequently, an employee's involuntary presence in a particular jurisdiction during the COVID-19 crisis could potentially create a permanent establishment for their foreign employer, triggering reporting requirements and tax obligations for the company.


These issues and other related matters were addressed in two professional publications by the OECD: The first from early April 2020 in the initial stages of COVID-19 (hereinafter: "the First Publication")[xiv]; The second, at the end of January 2021, which serves as an update and expansion of the First Publication, after the OECD and tax authorities in various countries gained practical experience with the end of the first year of the crisis (hereinafter: "the Second Publication" and together with the First Publication - "the Publications")[xv].


The First Publication addressed these concerns by establishing that remote work conducted from a temporary residence necessitated by COVID-19 restrictions would not ordinarily create a permanent establishment, as follows:

"The carrying on of intermittent business activities at the home of an employee does not make that home a place at the disposal of the enterprise."


Moreover, it was determined that the temporary performance of business activities from an individual's interim residence would not, in itself, create a permanent establishment:

"An employee’s or agent’s activity in a State is unlikely to be regarded as habitual if he or she is only working at home in that State for a short period because of force majeure and/or government directives extraordinarily impacting his or her normal routine".


The Second Publication elaborates, drawing on the Commentary to the Model Convention, that a home office constitutes a permanent establishment for a foreign entity only when two conditions are met: the employee uses it continuously as a workplace, and the entity explicitly mandates home-based work. Consequently, the Second Publication concludes that where employees work from home pursuant to government directives or public health measures, such arrangements do not create a permanent establishment for their foreign employer.


 "In Conclusion, individuals teleworking from home (i.e the home office) as a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of the COVID - 19 virus would not create a fix place of business PE for the business/employer".


Similarly, the Second Publication notes that according to the Commentary to the Model Convention, a permanent establishment will only be established if the agent performs their activities for the foreign entity habitually, meaning it is not a temporary activity of that agent in the foreign country. In light of this, the Second Publication's position is:


" the agent’s activity in a jurisdiction should not be regarded as “habitual” if they have exceptionally begun working at home in that jurisdiction as a public health measure imposed or recommended by at least one of the governments of the jurisdictions involved to prevent the spread of the COVID - 19 virus and, therefore would not constitute a dependent agent PE provided the person does not continue those activities after the public health measures cease to apply".


In effect, the evaluation of an agent's activities must extend to the post-COVID-19 restriction period. This necessitates a determination of when—and whether—COVID-19 restrictions were lifted, requiring a concurrent examination of measures in both relevant jurisdictions.


As context, the Second Publication references analogous guidelines issued by several countries, including Australia, Austria, Canada, Germany, Ireland, the United Kingdom, and the United States.

It is worth noting that the Israel Tax Authority has not issued official guidance on this matter, either regarding the general question of home office permanent establishments or their specific treatment during COVID-19.




Conclusion


Remote work (Home Office) has become a significant phenomenon in the global labor market, posing complex challenges in the context of international taxation, particularly regarding the permanent establishment issue. As discussed above, interpreting the term "permanent establishment" in the context of working from home requires adaptation to the changing business reality.


The Commentary to the OECD Model Convention provides a clear interpretative framework, according to which the mere existence of business activity in an employee's home does not automatically create a permanent establishment. The emphasis is placed on the degree of company control over the employee's home and whether working from home is done at the company's request.


Recent developments, as reflected in the Agreement between Belgium and the Netherlands (December 2023) and the German Amendment (February 2024), indicate a trend toward flexibility in interpreting permanent establishment. These countries distinguish between different home working situations and offer clear criteria for examining the existence of a permanent establishment.


The COVID-19 crisis highlighted the need to adapt international tax rules to changing reality. The OECD publications on this matter established that working from home due to COVID-19 constraints does not create a permanent establishment, emphasizing the distinction between temporary emergency situations and permanent business activity.


In the absence of case law or updated guidelines from the Tax Authority, there is a gap between local interpretation (as reflected in Tax Ruling 253/12) and global trends. An adaptation of local interpretation to current business reality is required, while adopting a more flexible approach that considers the unique characteristics of remote work, certainly in light of the effort to make Israel more attractive to international companies and investors and the desire to bring quality workforce back to Israel, to contribute to Israel's economy during its challenging period, and the sooner the better.


For further questions and clarifications, please contact: Meori Ampeli, Adv. (CPA), Dana Heller, Adv., Anna Tsabari, Adv., Shlomi Shalev, Adv., Gershon Pink, Adv., Goni Zussman, Adv., and Itzik Irim, Adv.. You are invited to read additional articles and updates on our firm's website. 

Disclaimer: The information provided in this article does not constitute legal opinion or advice regarding the issues discussed. It is recommended to consult with a tax expert before taking any legal or other actions based on this article.


 


[i] The Commentary to the 2017 OECD Model Tax Convention (Condensed Version) Model tax convention on income and capital, page 117 (hereinafter: "the Commentary to the Model Convention").

[ii]  Id. page. 118.

[vi] Reportable Position No. 13/2016 - "Creation of a permanent establishment (for a foreign resident who is a treaty country resident) or income-generating activity in Israel (for a foreign resident who is not a treaty country resident) by a veteran returning resident or new immigrant": https://www.gov.il/BlobFolder/policy/reportstation16/he/IncomeTax_ReportStation_2016_mas%20hanasa.pdf



[vii] See also in this context Tax Ruling No. 1303/15 - "Taxation of income of a veteran returning resident and attribution of profits to permanent establishment of foreign companies under his ownership - Agreed Tax Ruling": https://www.misim.gov.il/tmmisuyweb/frmShowLinkedAbs.aspx?num=20150036


[viii] The Income Tax Ordinance Amendment Law (No. 272), 5784-2024 dated April 2, 2024 (hereinafter: "Amendment 272"), Official Gazette 3205. See also Government Bills 1726, dated March 6, 2024, p. 694.


[ix] The Commentary to the Model Convention, supra note ii, Commentary on Article 5, para. 18.

[x]  Id. at para. 19.

[xi] The Commentary to the Model Convention, supra note ii, Commentary on Article 5, para. 60-58.

 

[xii] Agreement between the Kingdom of the Netherlands and the Kingdom of Belgium, published in the Netherlands Government Gazette (Staatscourant), No. 33856 (2023), available at https://zoek.officielebekendmakingen.nl/stcrt-2023-33856.html.

[xiii] German Federal Ministry of Finance, Administrative Guidelines on Permanent Establishments (Anwendungserlass zur Abgabenordnung), Feb. 5, 2024, available at https://www.bundesfinanzministerium.de/Content/DE/Downloads/BMF_Schreiben/Weitere_Steuerthemen/Abgabenordnung/AO-Anwendungserlass/2024-02-05-aenderung-des-anwendungserlasses-zur-abgabenordnung-AEAO.pdf.


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