Written by: Eva Kolasinski, PMP CSM LSSBB
Head of Operational Excellence at Celergo LLC.
So you are sending some of your local staff overseas for an extended period of time. What will that mean to your current process? Do you know what next steps you need to take? Do you understand what the term expatriate truly means?
Expatriates are generally defined as individuals who are working away from their home country for a period of one to six months on a short-term assignment or from six months to five years on a long-term assignment. They will return to their home country once their assignment is completed. Expatriate assignments may be managed in different ways, home-based, headquarters-based, or host-based.
Expatriates on long-term assignments are often eligible for certain benefits and incur additional deductions. More on those further in this article. These packages are typically structured to ensure that employees have the same standard of living in their new “host” location as they had in their home location. Depending on the combination of locations, these benefits/deductions vary. For example, an expatriate moving from the United States to Canada would have a lower COLA than an expatriate moving from the United States to Japan, since it is more expensive to live in Japan than Canada.
Although an expatriate and a local hire are both employees of the same company, an expatriate is typically not a citizen of the country where he or she is sent to work, known as the host country. A local hire is usually a citizen of that country or has a permit to work locally where he or she is employed.
The expatriate will hold a work visa and often will have additional benefits and deductions to their pay. These additional compensation items often referred to as above base compensation, are utilized to equalize the employee to his or her home country, with the intent that he or she would have a similar lifestyle in the host location as enjoyed at home.
The distinction between an expatriate and a local is important for purposes of benefits and taxation. In many cases, an expatriate will have both home and host country tax liabilities while on an international assignment. We will talk more about expatriate tax liabilities in our second installment of this article, Understanding Expatriate Employees Installment 2: Tax Considerations.
Generally, the distinction between an expatriate and a local hire is clear, but there are cases where the distinction is blurred especially in Europe with the advent of the European Union (EU). In the EU, individuals can move freely among participating nations and accept employment as locals, receiving local pay and benefits. These employees are treated no differently than the local nationals in that country and are typically not considered expatriates.
Most long-term expatriates, who are abroad typically for more than a year and less than five years, are offered an assignment-related compensation package for their time worked abroad. This compensation package is different from an employee working in their home country. This package often is based on the concept of tax equalization, which means that employees should pay no more in taxes at their host location than they would have paid if they stayed in their home country. Companies also apply this concept to living costs, so employees should have the same purchasing power to buy equivalent goods at the host location and not be out of pocket. These two concepts generate above base compensation elements, including the cost of living allowance (COLA), housing allowance, transportation allowance, hypothetical taxes, hardship allowances, housing norms, etc. Not all expatriates will receive the same types or amounts of allowances since above base compensation elements are often based on family size, expatriate policy type, and country combinations. Additionally, companies often pay for benefits in kind, which are company-paid expenses.
Benefits in kind for expatriates are payments made by the company on behalf of the employees, such as for their children’s tuition, housing, host taxes, training, or property management. These benefits may have tax ramifications in the home and host countries. The value of the benefits needs to be added to earnings and are often grossed-up by the employer.
Allowances and norms are additional payments and deductions provided to expatriates to give them purchasing power parity. The theory is that expatriates should be able to buy the same types and amounts of goods in the host country, as they were able to purchase at home. This parity is accomplished through different types of allowances, with the most typical being a cost of living allowance (COLA), which is calculated based upon the cost of a basket of goods in the home country versus buying that same basket of goods in the host country. For example, it is less expensive to buy hamburgers in Cleveland, Ohio than in Tokyo, Japan. COLA takes into account an employee’s income, family size, and home and host location. Other common allowances include housing, transportation, and hardship. Housing allowances are paid in lieu of the company paying the rent on behalf of the employee in the host. The transportation allowance helps offset the increased cost of automobile ownership or commuting expenses in the host location. Hardship allowances are paid for employees who work in difficult locations as an added incentive to take the assignment. In very rare cases, a company will impose a negative COLA, resulting in a reduced income when an employee goes from a higher cost country to a lower cost country.
Companies need to ensure that they balance the costs of assignment by reducing the employees’ compensation with what they would have paid if they were in the home country. For example, norms are deductions withheld from the employees’ pay that are equivalent expense to maintain a house or car in the home country. Therefore, if the company is paying for a housing allowance equivalent to $5,000 in the host country, the company may reduce the employee’s income by $2,000, which is the amount the employee would have paid in rent at home. The same concept applies to cars or transportation. In some cases, companies net the allowances and norms, so the employee gets a reduced allowance. So, in the above example, the expatriate will receive a housing allowance of $3,000. Or if the employee is still maintaining a house in the home country, the company may elect not to charge a housing norm. In other cases, companies as a policy will not charge norms as an incentive for employees to take expatriate assignments.
Below is an example of an expatriate compensation worksheet, also sometimes referred to as a balance sheet, for a U.S. employee who is working abroad for a couple of years. Please note that this is NOT how the employee’s pay stub would appear because the Medicare and Social Security calculations will differ. However, the salary, COLA, car allowance, hypo tax, 401k, and medical should be the same.
Stay tuned for our second installment on expatriates, Understanding Expatriate Employees Installment 2: Tax Considerations. If you would like to learn more about how to ensure your expatriates are paid accurately and timely, please contact a member of our team today. Celergo has the knowledge base to cover your expatriate process!
*This article references “Global Payroll” Chapter 13 of the Payroll Answer Book published by Wolters Kluwer. Chapter 13 is written by Michele Honomichl Founder & Chief Strategy Officer of Celergo LLC.
**This article is for informational purposes only. It is not intended to constitute legal advice.