26 August 2011

Tax pitfalls of international labour broking

International labour broking came under the tax spotlight recently in the United Kingdom (UK) where the case of Mr Tomislav Kljun v HMRC TC/2010/04825 was heard in the First-Tier Tribunal. The case has a complicated set of facts but essentially involves Mr Kljun, a Croation resident, who entered into an employment contract with a company in Cyprus. The company in Cyprus then deployed Mr Kljun, for a fee, to a company resident in the United Kingdom, which operates standby vessels in the oil and gas industry on the UK area of the North Sea continental shelf. Mr Kljun's remuneration was paid by the company in Cyprus, which deducted employee's tax in accordance with prevailing tax legislation in the UK. This type of arrangement is generally referred to as the "international hiring out of labour".

Mr Kljun argued that because he was not a resident or ordinarily resident in the UK for the 2007 and 2009 tax years, he was entitled to reclaim employee's tax deducted, placing reliance on Article 15 of the Double Tax Agreement (DTA) between the UK and Yugoslavia (the Yugoslavia Treaty) dealing with Income from Employment. The DTA between the UK and Yugoslavia also covered Croatia of which Mr Kljun was a resident. The refund claims were rejected by HMRC.

The court was required to decide whether there was an entitlement to exemption from UK tax under Article 15 of the Yugoslavia Treaty, which would revolve around the question of which entity was Mr Kljun's 'economic employer' or whether an 'economic employer' was actually present in the current circumstances. If the UK company is found to be his 'economic employer', there would be no exemption from tax in the UK. In his grounds of appeal Mr Kljun contends that he was employed by the company in Cyprus throughout (with which he has an employment contract), he has no other employer and that it was in any event illegal to work for two employers at the same time. Mr Kljun averred that there was no 'economic employer' and more specifically, the UK company, to which he was deployed was not his 'economic employer'.

The court then proceeded to dissect Article 15 of the Yugoslavia Treaty and accepted that the commentaries on the Organisation for Economic Co-operation and Development's (OECD) Model Tax Convention, although not binding, would be of assistance in the current case. Before looking into the mechanics of Article 15 of the Yugoslavia Treaty the court dealt with the concept of 'employer' as used in the aforementioned Treaty, versus the seemingly different concept of a 'person' as used in the Model Tax Convention. HMRC argued that the concept of 'person' was synonymous with that of 'employer', however, the court found the concept of 'person' to be of much wider application. Nonetheless, the court stated that the test remains essentially the same - one needs to determine which entity (person or employer) received the economic benefit of Mr Kljun's work.

Because Mr Kljun's employment was physically exercised in the UK, the court accepted that his remuneration had the capacity to be taxed in the United Kingdom under Article 15(1) of the Yugoslavia Treaty. This was in fact the case and UK tax was deducted at source. However, if all the provisions of Article 15(2)(a-c) of the Yugoslavia Treaty are met, then Mr Kljun's remuneration would be exempt from tax in the UK. Mr Kljun passed the first hurdle under paragraph (a) in that he was not present in the UK for more than 183 days.

The second condition, being Article 15(2)(b) of the Yugoslavia Treaty, is that the remuneration of Mr Kljun must be paid by, or on behalf of, a person for whose benefit the relevant services are rendered and who is not a resident of the UK. The latter part of the test would be satisfied in that the company in Cyprus was not a UK resident, however, the court was not convinced that the company in Cyprus was the person for whose benefit the relevant services were rendered. For reasons set out below the court found the UK company to be Mr Kljun's 'economic employer' for whose benefit the relevant dependent personal services were rendered, thereby precluding him from full tax relief in the United Kingdom.

The Court stated that Mr Kljun's "... connection with a company based in Cyprus is tenuous at best ..." as throughout his employment the company in Cyprus subcontracted most of its functions in connection with Mr Kljun. Further, Mr Kljun's employment contract is governed by English law, the pension provider is based in the UK and meetings / interviews regarding his employment did not take place at the local offices of his contractual employer. The aforementioned factors prompted the Court to suggest that the link with the company in the UK is greater than the link with the company in Cyprus. On further analysis of Mr Kljun's work schedules, holiday provisions, disciplinary procedures, redundancy terms and various other provisions the Court further suggested that, although the United Kingdom company was not his contractual employer, it was effectively acting as his employer in all but name and it was the person which benefitted from his services and bore the responsibility of risks for the results produced by him.

Having regard to the commentaries on the Model Tax Convention, the court stated that, in essence, it means looking at the substance over form and considering whether someone other than Mr Kljun's contractual employer in Cyprus is effectively the employer. In this case the court held that Mr Kljun's 'economic employer' is the UK company as it "... reaps the primary benefit ..." of his employment, resulting in a failed attempt in exempting from tax his remuneration earned in the UK.

Ruaan van Eeden

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