You are an HR professional (or a VP of Tax or a CFO) and you have just been told that your company wants to send an expat (oh horror!) to the UK. “Expat,” you think to yourself – “what now? How can we understand the costs, and what about taxes – isn’t that a really expensive and complicated area?”
Understanding the Basics
Understanding the basics of an expat assignment is critical, especially the tax costs. As many already know, the tax costs can be the most significant line item on the cost projection worksheet. But don’t worry; there are ways to manage it!
If your company does not have an international assignment policy in place, you will have to determine the whole package including housing, COLA, education cost for the kids, and what tax reimbursement philosophy is to be employed. Without a policy, many of these items will be subject to individual negotiations. This can work for a few assignees, but once you expand your program beyond one or two, it’s a good idea to establish a formal policy to help manage costs and reign in the negotiations. While all of the aspects of an expat policy are interesting, my expertise is in the global tax arena, so this posting will concentrate on how to decide the best approach to managing taxes for your expats.
Tax Reimbursement Methods
When an employee goes overseas, there is always an impact on the employee’s taxes – income taxes and social taxes. If left unmanaged, there could be unforeseen consequences, either positive or negative, from the employee’s perspective as well as from the employer’s viewpoint. Expat tax policies address these issues with tax reimbursement methods including tax protection, tax equalization, or the “simplest” of all: laissez-faire (aka “do nothing”).
While laissez-faire keeps the company’s costs down, it usually gets the expat worried about the tax implications of the assignment as any incremental costs will directly hit the assignee’s bottom line.
Tax equalization and tax protection are alternatives which help both employees and employers manage the costs of assignments. If you are not familiar with tax equalization or tax protection, it is easy to get them confused. Here are the basic definitions:
- Tax Protection – Employees are “protected” from any additional taxes that may result from the international assignment but can benefit from any decrease in taxes which may occur when, for example, moving from a high-tax country to a low-tax country or no-tax country. So, the employee may pay less tax, but will never pay more than if at home.
- Tax Equalization – Employees are “equalized” so they pay the same amount of tax – no more, no less – as if they were at home. The company pays any difference and also benefits from any tax reductions. This method is the most equitable for a workforce and the employees can easily understand the tax impact on them: none – the employees pay the same tax as if at home.
Both methods are designed to help the employee, and if the host country tax rates are higher than the home country tax rates, then they technically will result in the same bottom line to the employee and the same cost to the company in the long run. The fine distinction between the two is that with tax protection the company promises the expat that he will be reimbursed for any excess tax costs over his “stay-at-home tax,” i.e. he will pay no more than had he stayed home. Tax equalization says that the employee will pay “neither more nor less” than had he remained in the home location. And, unless they are going to Dubai, the host country will have the right of taxation and will tax the income (yes, even if paid from the home country and even if the work performed is for the benefit of some other location). Because the host country tax system is unfamiliar, it is not always easy to know how much tax will be due in that country.
Tax Equalization vs. Tax Protection
Here you are, with your first expat, and you now wonder: “hmm – tax protect or tax equalize” – how should we decide this?
The answer is usually more complex than meets the eye. When you are in the infancy stage of your expatriate program you usually can afford customization to each expat’s situation. We often see in practice that the first few assignments in an organization are custom built. Tax reimbursement policies are often written once the first few assignments are already underway.
Here are some examples to help illustrate the two approaches.
Tax Protection Example
Let me give you an example where I would clearly recommend tax protection: you are moving a young single line manager from the UK to Spain for 2 years; she will not receive any allowances, only relocation benefits. The tax protection gives her the additional assurance that she is not going to pay more tax than had she remained home, but if she pays less in Spain than what she would have paid in the UK on the same income, then she gets to enjoy the windfall (and spend the extra money on something nice).
Tax Equalization Example
However, on the other end of the extremes, for example, when you are moving a US executive with wife and school age children from the US to Singapore, I would highly recommend tax equalization. You ask: why? Well, it usually will take a bit more financial incentive to get the executive to accept the “risk” (financial and otherwise) of taking such an assignment (so he is doing the company a favor). The assignment costs will increase due to the family’s need for financial assurance, there is a cost of living differential, and housing is a lot more expensive. So, the cost projection worksheet is filling up quickly and the total compensation reportable in both countries becomes staggering. All the numbers will make everyone’s heads spin, but the company really needs this executive to focus on the task at hand. The easiest way calm this person’s financial anxiety is to tax equalize; promise him that he will pay the same amount of tax as if he had stayed home. This will tie his personal bottom line to a tax system he is familiar with and leaves the tax planning and tax risks in the hands of the company (and their trusty tax advisors). This approach also allows the company to pursue expatriate tax planning strategies to help manage the tax costs, therefore reducing the overall cost of the assignment. Such strategies are available in many countries but require expert assistance and a full examination of income, social and corporate tax impacts.
How To Get Started
So, what about this first expat you are told is going to the UK next week (or wait, did they say he had moved already? Or was that just a business trip?)? It is best to break it down into the big components first: immigration, payroll, taxation, relocation etc.
Then consider the needs of the company and the needs of the employee and find out the costs to each party under a couple of scenarios. Once the costs have been established (and you may need assistance with some of the items) then it is time to go back to management to get the costs approved. And don’t forget the tax costs!
Yes, managing expats is a complex and daunting task at first. But if you prepare yourself with good information, helpful advisors, and most importantly gain strong support from your line managers, your company can reap the benefits of international assignees and, at the same time, manage the costs effectively.
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