Tax equalization for foreign assignments

When sending employees abroad one of the issues that comes up is what the compensation package will look like. This will include topics like costs of living adjustments, housing costs, travel expenses etc.

One of the requirements set by most employees is that they do not want to see a decrease in net income and be worse off. This is actually an important matter because employers tend to think about total employee costs (therefore gross) whereas employees will tend to be focused on net income.

If nothing is agreed or arranged, a gross income  will apply and if the employee is sent to a jurisdiction with a higher tax burden, his or her net income will suffer. In most cases a general consensus will exist that this should not happen and this is often mentioned in the assignment letter under the heading ‘tax equalization’.

What Exactly Is a ‘Tax Equalization’?

In its most basic form, a tax equalization is an agreement between employer and employee that the tax burden on the employee should not change because of the assignment abroad. As most employment contracts state a gross salary, this means that the risks for this change in tax burden is shifted to the employer.

Why Does Tax Equalization Lead to Perceived Complexity?

 While the concept of a tax equalization is simple enough, several aspects will lead to complexity:

• The payments from the employer to the employee tend not to consist merely of regular salary. Other components such as pension payments, travel costs and other reimbursements may not be treated similarly in the host country. A thorough analysis is necessary and possibly a review of the salary package.
• Very often assignments will lead to an employee working in multiple countries. This means that taxes may be due in several jurisdictions and this will inherently increase complexity, especially if the days worked in these countries differ from month to month.
• In case of temporary assignments (which are the most common assignments) social security contributions will often remain due in the country where the employee is assigned from. The host country may not deem these payments to be fully deductible or non-taxable and therefore both complexity and tax burden may increase.
• Relevant data may sometimes become available after the monthly payroll has been processed, which can lead to necessary revisions.

Can the Administrative Burden Be Prevented?

While assignments will always increase complexity for both employer and employee, there are several factors that contribute to the administrative burden.

In general it can be stated that the clearer the policy is, the easier the process will be. Therefore, if the policy is limited to one or two sentences in the assignment letter stating that the assignment should not lead to an increased tax burden, this will often lead to questions and issues later on in the process.

It tends to make sense to define what type of taxes are targeted. If only national taxes are meant, this should be clearly reflected in the policy. Furthermore, wage taxes tend to be pre-levies to income tax. If an employee is entitled to refunds in income taxes because of increased wage taxes, this should be taken into account. Who will be preparing these income tax returns is therefore an important matter.

Having a clear overview of the complete salary package (including all types of reimbursements) and how these components are taxed will prevent surprises later on. Remember that what constitutes taxable wages differs from country to country. Having to gross up unexpected salary components afterwards will be a rather heavy financial burden for the employer and will often lead to an amount of uneasiness with the employee.

Especially in the case of longer assignments, determine how long the tax equalization will apply. Cost of living will differ between countries and very often high taxes in a country also mean that the national provisions are higher. It may not be unreasonable to end the tax equalization after a certain number of years and go back to a regular gross salary where the employee bears the risk for tax increases.

Tax Equalization Policy

In the cases when there is a relatively complex package of salary components and assignments, it is advisable for an employer to set out its tax equalization policy in a more elaborate and often separate document. This has the added benefit of creating a level of equality for the employees. Tax equalization is an often necessary and relevant part of assigning employees abroad. The clearer the policy and taxability of salary components is before the assignment, the less the administrative and financial burden will tend to be. Consult your Crowe Global Mobility specialist for more details.