Business operations tend to get exponentially complicated when you expand overseas. Not only do you have to work within your home country regulations, taxes, and laws, but you have to do the same in the countries in which you do business. As businesses expand into overseas markets, many choose to send their local employees to the overseas market. These expatriated employees – or “expats” for short – complicate matters, because they are usually subject to the laws of both the home country and the work country at the same time. Taxes can be especially complicated because many expats face taxes abroad and at home. There is a real possibility their tax burden can increase depending on their assignment. This is especially true of US expats. Many companies use a process called tax equalization to mitigate the variation in taxes caused by foreign assignments.
Tax equalization tries to remove foreign countries’ tax rates as a consideration in whether an employee accepts an assignment overseas. Without it, employees’ take-home pay could vary greatly depending on the country to which they are assigned. For example, without tax equalization, an employee in Saudi Arabia would pay no local income tax while an employee in France could pay as much as 45 percent in the top income bracket. Even more burdensome, an expat from the United States could face double-taxation by being taxed on the same income in the United States and the foreign country, due to the US’s more onerous rules for expats.
When a company decides to implement tax equalization, the corporation pays the employee’s entire tax liability, both local and international, for the employee. Then, they determine what the employee’s tax burden would have been had the employee worked in the home country. The company deducts that amount, called the hypothetical tax, from the employee’s paycheck. In effect, the employee pays only what he or she would have without the foreign assignment.
While this might seem simple, it can get complicated quickly. In many countries, the tax that an employer pays for an employee is itself taxable income. The employee would have to pay taxes on the taxes that the employer paid. (Employers typically choose to “gross-up” this additional tax burden to eliminate its effects, as well. Grossing-up – the process of paying the taxes on the taxes – can add considerably to the cost of the assignment.) Additionally, other forms of compensation, such as stock options, will complicate how a company chooses to manage tax equalization.
In the end, responsible and effective tax equalization relies on a number of policy choices that can vary from one employer to another. Any employer with more than one or two expats going on assignment each year would be advised to craft fair and transparent tax equalization policy. We recommend the help of an accountant specializing in international employment tax, there are many good ones available. (You can find some on the Worldwide Employee Relocation Council’s web directory.)
Tax equalization does not remove the responsibility of an employee to file tax forms, however. It just means that the employer pays the tax liability. This can be exceedingly complex. So, in addition to obtaining policy help, many companies also hire an international tax firm to prepare tax documents. This measure ensures that everything is paid correctly and on time.
The biggest reason to practice tax equalization is the benefit to your expatriate employees. They know that an expatriate assignment won’t force them to become experts in international taxes. They also know that the tax burden won’t decrease their net income because of the country in which they are assigned. Employees do not necessarily see international relocation as a perk, so mitigating any financial stresses can go a long way toward ensuring a successful assignment.
Additionally, tax equalization protects your company’s reputation. Not only does it help prevent issues around compliance, it also helps to uphold the company’s reputation among employees and potential employees.
With a domestic employee, the employer usually plays no role in managing employee taxes beyond statutory withholdings. Employees essentially manage their own taxes. The individual is held responsible for paying taxes, following tax laws, and ensuring that everything is done correctly. While this type of laissez-faire approach can be applied to employees on foreign assignments, we would not recommend it, for all the reasons discussed above. Alternatively, when a company practices tax equalization, the company takes the responsibility to ensure that every aspect of the tax process is managed compliantly.
For any corporation with expatriates, this can be a daunting challenge. Some of the very largest corporations have in-house departments to focus on expat tax, while many choose to outsource to tax specialty firms. Small and mid-size companies will find managing regulatory compliance impossible to handle on their own.
An increasingly popular option for companies practicing tax equalization is the use of a payroll service with global experience. This can greatly reduce the administrative expenses of expat assignments, as the tax firm is utilized for the initial setup of the assignment and tax equalization only, while the ongoing management of the calculation, disbursement of net pay and payment of taxes is left to the lower cost payroll firm. A seasoned global payroll firm with expat-specific experience and systems can help you through the setup of this orchestrated three party process.
Trusting a consolidated global payroll provider like Celergo can help organizations avoid the common mistakes involved paying international team members. Consolidation reduces the complexity, confusion, and risks typically associated with global payroll processing. We make our clients’ lives easier by managing all aspects of global payroll for them, leveraging over a decade of relevant experience and expertise. Contact us today to learn how we can help you!
**This article is for informational purposes only. It is not intended to constitute legal advice.