Your payroll manager is off on holiday, so you are pitching in and reviewing the payroll register for approval. It is the end of the day and you have agreed to meet up with a few friends at the pub after work. Then you notice a couple of people have zero net pays. This elicits the inevitable gut reaction of “that cannot be right” and instantly kicks you into detective mode. Ok – Helen is out on leave, check! Jeremy was put on the bench, check! But Sam is sporting a big fat zero. Wait – who is Sam? Sam, Sam, Sam – no bells are ringing, but he certainly has lots of taxable income and still a zero net pay. So you are thinking it is probably right (because how could he get on the payroll without anyone’s approval anyways?) But you feel a little squeamish about just approving the register without further review. So instead, you decide grudgingly to learn more about the situation.
First of all, Sam has not added the banking details, so it appears that there is no intention of actually disbursing funds to him on this payroll. Second, he has elements on the pay register like “Housing”, “Cola”, “Hypo Tax”, and “Tuition”. Also, his wage taxes appear to be at a higher percentage than everyone else.
Slowly your brain starts processing the facts and you come to the conclusion that Sam might actually be an expat! Oh great – this is one of those crazy, complicated compensation structures which is going to create issues on every pay cycle. You are thinking “good bye night at the pub” as you see a long evening stretching out ahead of you full of calculations and analysis.
Although, the zero net pay is starting to make sense. A shadow payroll is a mechanism for companies to calculate taxes at a host location for an expatriate. The company typically pays this tax on behalf of the expatriate in the host location (hence the name shadow payroll). At the home location, the company is withholding a hypothetical tax, commonly referred to as hypo tax. The hypo tax is equivalent to the amount of tax the expatriate would have paid had he stayed in his home country. It also appears the company is on a home based expatriate program, so the employee is receiving all his net pay in his home country.
If this is truly a shadow payroll, then the taxes should be grossed-up. So you check the normal wage tax, which is 34% – but Sam’s wage tax is 51.52%. Typical gross-up calculation would be 51.52% = (0.34/1-0.34). Step one confirmed – the taxable wages are definitely grossed-up!
Now for the pay elements – You go back into the company share drive and look up “Expatriate” and Shazam! There is a tax matrix for the payroll you are reviewing for expatriate shadow tax calculations. The tax matrix has a whole list of items for an expatriate package and its taxability separated by expatriate type with one column for wage taxes and one for social security. Each item has a tax designation as taxable, not taxable or deductible for the calculation of host tax. Eureka! You start adding up the elements on the pay register for wage tax and see that salary + cola + housing – hypo tax + tuition gives you the taxable wages. Then multiply by the 51.52% and you are spot on for the wage tax calculation in the register. You can almost see the foam spilling over the mug.
Last step – you need to find out where Sam is from, since there is no tax calculation for social taxes. You can see from his “Add to payroll file”, that he is from Spain, and there is an E101 on file, therefore no social tax calculation is necessary. You happily press, “approve” on the pay register, grab your coat and head out for the evening fully confident that payroll is in compliance. And Sam’s zero net pay is just perfect.