Globalization, talent shortages, a demand for specific experience in certain locations, and employee ambition are just some of the reasons organizations may find themselves managing payrolls in multiple jurisdictions for some employees. The term “shadow” or “mirror” payroll is one that many people have heard but is not necessarily something everyone fully understands. The operation of the shadow payroll can be challenging for employers and perceived as somewhat cryptic and difficult to understand.
However, today that is going to change. I want to demystify shadow payroll and offer readers a better understanding of this concept, which we expect will continue to grow in necessity in the coming years.
So, let’s start by clarifying some basic concepts.
When is shadow payroll used?
Organizations use it when payroll withholding taxes are due in a location other than where the employee is physically paid. In practice, the employee is paid in one jurisdiction (usually the home location), and a shadow payroll is operated in another jurisdiction (usually the host location).
The shadow payroll functions purely to calculate and pay over the required payroll taxes i.e., no physical pay is delivered via the shadow payroll – it operates in the background to fulfill the employer’s payroll tax obligations in the relevant jurisdiction. In some circumstances, the employer may choose to deliver the salary to the employee in the host location, and in such cases, the home location payroll will become the shadow payroll i.e., operating to fulfill the employer payroll tax obligation but delivering no actual pay to the employee. The critical part is that shadow payroll is the payroll that does not deliver the net pay.
For example, John from the US is assigned to work in France for a year-long secondment. He not only wants to perfect his ratatouille; he also plans to supervise his company’s expansion into the European market. As the arrangement is temporary, John wants to ensure he continues to pay into his US FICA and Medicare programs and his 401(k) plans. He remains an employee of the US company and continues to be paid via the US payroll, but his employer must also operate payroll withholding taxes in France.
In this situation, the US is the home, and France is the host country.
If John is on two payrolls, is he paid his net pay twice?
To ensure that the employee is not paid twice and also to make sure that the records and audit trail is clear, the shadow payroll will need to be netted down to nil – this usually is achieved with an after-tax deduction equivalent to the net pay on the shadow payroll.
If taxes are calculated on both the US and the French payrolls, does John suffer a double deduction?
In the first instance, this is precisely what occurs in many cases (depending on home and host country rules and employee personal circumstances). A double withholding presents a serious cash flow disadvantage when it happens. However, in many cases, employers will have tax equalization or tax protection policies, which include specific rules covering such scenarios. As a result, the employee is protected from the cashflow disadvantage at a minimum, and the employer takes the hit either short term or long term. The topic of tax equalization and tax protection is also complex and we will cover in another blog post.
If I have an employee working in another country, do I always have to implement shadow payroll?
No. A shadow payroll is not always the best or the right option. The specific circumstances must be reviewed each time to make sure that the correct position is taken.
- In some jurisdictions, there may not be a payroll withholding obligation or even a mechanism for foreign employers to operate payroll withholding taxes. If a tax obligation arises for the employee, this must be settled via the employee’s personal tax return.
- Depending on the specific circumstances, the employee may be fully relieved from tax in the host location.
- Again, depending on the specific circumstances, employers may choose to move the employee to “local terms” in the host location. Many factors need to be considered, from the employer’s legal presence in the location to the employee’s personal circumstances, the intended duration of the stay, the social security and pension implications, and the home country tax and payroll rules.
- Sometimes employers may opt to create a professional employer organization (PEO)or employer of record in the host location. This is sometimes used where an employer wishes to move an employee to local terms but is restricted from doing so based on the employer’s presence in the location.
What if there are employees in multiple jurisdictions? What else do I need to consider?
If you have employees working in a country other than the country of the employment or have employees performing duties in multiple jurisdictions, there are several factors that you need to consider, including:
Payroll withholding obligations
Payroll withholding obligations may exist in the various locations. It is essential to consider both domestic rules and double taxation agreements where applicable.
Personal tax implications
Personal tax implications may arise for the employees at all locations where the worker performs duties together with the place of origin. This may mean an employee’s obligation to submit personal tax filing. Again, domestic rules and double taxation agreements must be considered.
Social security compliance
All applicable domestic legislation, EU rules, and bilateral agreements must be reviewed. The general position is that social security is paid in only one location, and there is a correct location once the rules are considered. In other words, while people may have a preference, it is not a choice, and the rules dictate the final answer.
Corporate tax implications
Does the presence of the employee/employees in the location create a corporate tax presence? Has a permanent establishment been made? Domestic rules and double taxation agreements must again be considered.
Which jurisdiction dictates the regulations that the employer must follow?
Classification of employee
Are we dealing with assignees, cross border workers, local hires, or others?
Does the employer have or wish to consider tax protection/tax equalization?
What is the cost and appetite for risk? Sometimes, a lack of clarity in a location may mean that the risk-averse employer may have to invest a lot of time and money in liaising with authorities to get rulings.
What can an employer do?
Each employer needs to assess their specific circumstances- and by this, I mean examine everything from costs to employment law.
They need to determine the requirements of the parties:
- Are they concerned only about compliance, or are they aiming to protect employees from hardship?
- If maintaining a home country connection, why are they doing this? Is it necessary, and does it make sense?
- How big is the scope? How many employees are in these circumstances, and is this likely to grow?
- Is there a requirement to get funds delivered to employees in the jurisdictions?
Employers should also establish options- if any – based on corporate presence or the differing rules in each location. This is not a one size fits all scenario and must be considered on a case by case and country by country basis. A new addition to this list is the short and long-term plans post-COVID-19. What, if any, is the pandemic’s impact, and will it result in working arrangements becoming more long term.
Want to hear more about shadow payroll? Join us Thursday, October 1, for the Spotlight on shadow payroll and the increasingly global workforce of today webinar hosted by Immedis and the GPA.