WHEN companies send their employees on temporary overseas postings, the issue of taxes inevitably arises. Small companies first embarking on such cross-border assignments often deal with these issues on an ad hoc basis.
This 'laissez faire' approach, if managed carefully, can work for low assignee volumes as problems are dealt with individually by negotiations between the employer and the employee. As the company evolves, however, and volumes increase, the laissez faire approach will usually result in inconsistency and a lack of clarity for expatriate employees and the human resources team servicing them.
What are the options for a consistent approach to expatriate taxes?
The principle behind a tax equalisation programme is that the employee should be 'no better or no worse off' as a result of taxes while on a foreign assignment.
Tax protection
Under tax protection, an expatriate employee is protected from higher tax costs but in the event the actual taxes imposed are lower, he retains the benefit. Therefore, an employee who is assigned from Australia to Singapore is likely to have a lower tax liability than he would have had if he remained in Australia. He would therefore pay his own Singapore and Australian tax liability (if any) and retain the tax savings.
Conversely, a Singaporean employee assigned to Australia is likely to suffer a higher tax liability due to the assignment. Under tax protection, he is liable to fund these taxes only to the extent of his hypothetical Singapore tax and the company will be responsible for the excess.
As is illustrated from the above two examples, an arbitrage opportunity exists for the expatriate employee to seek opportunities in lower-tax jurisdictions and avoid those opportunities where he does not personally benefit from tax savings. This can reduce the mobility of employees as they wait for the 'right' opportunity.
The principle behind a tax equalisation programme is that the employee should be 'no better or no worse off' as a result of taxes while on a foreign assignment. In other words, the employer guarantees that the employee's tax burden will be neither greater nor lesser if the employee had remained in the home country. If the tax burden is higher in the host country, the company reimburses the excess. However, if total tax costs are lower, the tax savings will pass to the company, not to the employee.
In the above example, the Australian employee assigned to work in Singapore would be responsible for an amount equal to his Australian hypothetical tax. From this amount, the employer would pay his actual Singapore and Australian tax liabilities (if any) and if there is any surplus, this is retained by the employer.
The treatment of tax is but a part of the overall global mobility policy of an employer. Such policies tend to try to neutralise additional costs and inconveniences relating to an assignment, rather than to fully fund such expenses. Three typical assignment benefits are cost of living allowance (COLA), housing and education. How does the treatment of these items compare to tax equalisation and tax protection methodologies?
Cost differential
COLA is calculated to determine the cost differential between home and host locations. It provides for the payment of the differential percentage applied to a typical 'spendable component' of salary, to top up the amount that an individual would be expected to spend on goods and services in the home location. It does not, however, require an employee to pay back to the employer if the host location is less expensive than his home (that is, a negative COLA). This can therefore be likened to the principles of protection rather than equalisation.
Most companies will provide housing to their expatriate employees. Some will charge a 'housing norm', which represents the amount that a person in his circumstance would typically spend on housing in the home location. Exceptions may apply, for example, where the employee's family remains in the home location or the home is agreed to remain vacant during the assignment.
Other companies choose not to charge a housing norm as this policy forces the employee to either sell or let out his private home, which is seen as too invasive.
Where a housing norm is charged or the expatriate continues to bear his home housing costs, this is clearly comparable to the principles of equalisation. However, where there is no housing norm, the opportunity exists for the expatriate to reduce or fully extinguish his housing costs and therefore derive a financial advantage from the assignment. This result would not be comparable to equalisation or protection, however, as these would still require the employee to bear some cost.
Schooling cost
The result described above could be described as a leakage to the principle of equalisation, as the employer's intention of such a policy, even if not fully enforced, would usually be that the employee retains his home and therefore incurs a 'hypothetical' cost.
Education in the form of international schooling is also typically provided where an expatriate is accompanied by dependent children. Although many policies contain some wording around the company funding the 'additional cost' of such, this often results in full cost reimbursement due to the availability of free public schooling in most home locations.
Accordingly, this item can also be classed as one of equalisation, albeit with a hypothetical cost of or near zero.
It is important to compare not only the expatriate assigned to low vs high-tax jurisdictions but also the expatriate as compared to his colleagues remaining in the home location. These employees will clearly be subject to home-country taxes, and colleagues who are assigned overseas, benefiting from lower taxes while staying on the home country salary, may be viewed as receiving an unfair advantage.
Tax equalisation may therefore be seen as the more equitable tax reimbursement policy. As the expatriate pays the same hypothetical home-country tax regardless of whether he is assigned to a high or low tax jurisdiction, the tax impact of the assignment is fully 'neutralised'. The employee is neither advantaged nor disadvantaged in comparison to his colleagues in the home location or in comparison to expatriates to other locations. The tax element should therefore be completely removed from the potential expatriate's considerations for accepting the assignment.
Under tax equalisation, the expatriate can effectively consider the amount of actual taxes payable to be his employer's concern, and not his own. This removes any temptation on the employee's part to undertake risky tax planning, and enables the employer to implement planning and compliance procedures to manage risk to the employee and the company whilst avoiding unnecessary or double taxation.
As taxes will usually be due on other assignment benefits that are not included in the calculation of hypothetical tax, it is often the case that an expatriate's actual tax liability exceeds his hypothetical tax, even where the tax rates might appear lower in the host location. A tax equalisation scheme also provides clarity and certainty to employees, compared to other tax reimbursement methods, because they know what to expect as the terms are defined in the policy. It also demonstrates the company's commitment and consideration to equity since the intention of the policy is to put all international assignees on a level playing field.
Effective method
Tax equalisation can be a very effective method of addressing the income tax element of compensation for employees on international assignment.
However, it is important for companies to set out the exact terms and conditions of the policy that are:
broad enough to have application to all employees and all countries in which the company is doing business now and in the future; yet
detailed enough that there is clarity and guidance to employees, human resource professionals and tax service providers.
This article was first published in The Business Times on May 6, 2008
