Avoiding Tax Traps with Short-Term Assignments

Claudia HoweAuthor:
Claudia Howe – Global Mobility Tax, LLP

Has anybody heard about the magic 183 days?  So, if you stay in the host country for less than 183 days, you don’t have to pay tax in that country, right?  … right?  Well, actually the answer is:  sometimes.

Many folks will remember the 183-day rule, but often they do not quite know why or how.  But it sure lulls many international short-term business assignees (and their managers) into a false sense of security that as long as they are in the other country for less than that magic number of days, thinking they will be exempt from that country’s tax.  Let’s step back.

Tax Treaties Help Prevent Double Taxation

Tax treaties come into play when two countries want to tax the same income leading to the dreaded “double taxation.”  As the world has become smaller and more and more people are conducting business in countries other than their home, these folks find themselves in a position where they may be required to pay tax in both countries under the domestic law of each country.  For example, a UK employee goes to the US for a four-month project.  The UK will tax her on her world-wide income by virtue of being a tax resident in the UK.  The US federal government will want to tax her US source income because she has “effectively connected income.”

How Tax Treaties Work

Tax treaties provide that if certain conditions exist, the person is not taxable in the foreign jurisdiction, in this case the US.  Beware, each treaty is worded differently, but in general, the three main treaty conditions for an individual employed in the home country, and claiming exemption from tax in the host country under Article 15, the Dependent Services article, are:

  1. The employee does not exceed 183 days in the host country.
  2. The remuneration is paid by the home country entity (home payroll).
  3. The remuneration is not charged back to an entity in the host country.

As mentioned above, be careful to read the exact wording in each treaty to evaluate exactly what it says – there are variations on the theme.  For example, the 183 days could be in a calendar year, fiscal year, or in a rolling 12 months. The US has concluded numerous treaties and neatly lists them on the IRS website.   The UK also has a list.

The Fourth Requirement (in some countries)

Over the past few years, another hurdle to using the treaty has crystalized itself, also know as the “economic employer” approach.   The term “employed” or “employment” as stated in Article 15 had not previously been defined, until the OECD (Organisation for Economic Co-operation and Development) stated that substance trumped form.  This means that even if the person is legally employed by the home country, the entity that is receiving the benefit of the services, namely the host country entity, could be construed to be the real employer and therefore the Article would not be useable to exempt the income from tax in the host country.  The US has not adopted this approach as of yet, but many of the European countries that follow the OECD model treaty have.

Our friend from the UK on the 4 month assignment remains on UK payroll, spends less than 183 days in the US during any 12 month period (even vacation days not related to the assignment count), and her company does not cross-charge her compensation cost to any US entity.  So, is she off the hook?

State Tax Implications

Not completely.  The treaty in this case will enable our UK friend to be exempt from US federal taxes, but since she is working in the beautiful (and broke) state of California, which does not accept any treaties concluded by the US federal government, she will still be subject to California tax, regardless.

Social Tax Implications

Our friend also has to make sure that her employer has applied for a certificate of coverage under the US/UK totalization agreement to exempt her from US social taxes (more on that another time).

Foreign Tax Credits

Even if the conditions for an exemption from the host country tax are not met, the treaty can still be helpful in avoiding double taxation:  the income may now be taxable in the host country, but under the Relief of Double Taxation article (contained in most treaties), the home country must grant a credit for taxes paid in the host country, up to the amount of tax that would have been paid in the home country on that same income.   This might also apply in cases where no treaties exist.  Keep in mind, though, that in some countries, the practical requirements for claim a foreign tax credit are so complex that for small amounts, it may not even be worth the bother.

Summary

So, what should you, an HR professional, faced with the news of a short-term assignment and, the manager’s famous last words are: “we will make sure it’s less than 183 days,” do?

  1. Check the host country’s domestic law for when a person will become taxable.
  2. If taxable, check if the home and host country have a treaty and then find the latest version of the treaty (not the one you printed 5 years ago and … “it’s gotta be somewhere in this drawer”).
  3. Request a detailed travel schedule for 12 months prior to the assignment from the employee to understand how much time he or she has already spend in the host country for any reason (vacation, holiday, trade shows, business trips, etc.).
  4. Read all the provisions of the treaty carefully.
  5. Find out from the manager and your finance team if the compensation will indeed remain in the home country and will not be charged to the host entity or a client in the host country.
  6. Find out if the host country has adopted the “economic employer” approach.
  7. Are there any other taxing jurisdictions that you need to consider (state/province/social tax, etc.)?
  8. Whew – I am getting tired just writing all these things. . . . .

Unless you have checked all this out, you cannot rely on the famous 183 days.  And don’t forget the reporting and filing requirements for each jurisdiction!  You may want to call your favorite global mobility tax professional to assist with all of the above and to co-develop the options for the assignment step by step so you can articulate the risks and options to that manager and to your management.

More information on Claudia:

4 responses to “Avoiding Tax Traps with Short-Term Assignments

  1. Excellent article, Claudia!

    You’re quite correct that many line and HR execs operate under the belief that if the employee works in a given country less than 183 days, all is well. They rarely know the other issues you so clearly laid out.

    Another point to emphasize is that this discussion is pertinent not only to “Short Term International Assignees” but could also trip up individuals who travel frequently to certain countries – or US states – on business and personal activities.

    In the current environment of ever-increasing and aggressive audit and enforcement of tax compliance, attending carefully to this issue is very important for all of us.

  2. Thanks Claudia. It’s good to be refreshed with the tax facts that you provided, especially in plain English!

  3. Hi Claudia:

    Excellent job! Perfect timing as we roll out our STA policy!

  4. Pingback: Avoiding Burnout in Global Field Service Travel « International HR Forum