Employees are often sent to another country to oversee a project or a branch opening. And while the volume of such transfers may have decreased over the past year, it continues to post a challenge from a tax and payroll perspective. There are, after all, several ramifications of such an action that we should be aware of:
- corporate tax issues – tax deductions, permanent establishment
- personal tax implications- tax returns, payroll
- differences in labor law
- social security, and HR considerations.
However, one of the biggest concerns for payroll is to ensure that such employees do not suffer financially and end up taking home less pay because they are now getting taxed in two locations. To prevent this from happening, individuals can rely on double taxation agreements (DTAs).
What are DTAs?
They are official agreements concluded between 2 countries over the administration of taxation when the domestic tax laws of the 2 countries apply simultaneously to a taxpayer. For example, when a taxpayer who is resident in 1 country derives income from sources in the other country or is resident in both countries.
DTAs set a framework from which tax, HR, and payroll professionals can use to answer the most common problems around international double taxation.
International taxation is an extensive topic, this blog focuses on Employment Income and Elimination of Double Taxation only.
Assignment structure
There are different reasons why an employee might move locations, and generally speaking, we will be looking at two different assignment structures: secondment case and service agreement.
Secondment case
In this case, Employee A is employed by Ireland Ltd., who agrees to a secondment agreement with Germany Ltd. Employee A moves to Germany and starts working there. From a company’s point of view, the areas that would need to be considered in the secondment agreement are:
- Provision of labor as the subject of the agreement- the details around the labor agreement
- Who will pay the employee’s salary?
- Who supervises and controls the work of the seconded employee?
- Who is responsible for the risks and takes the benefits of the seconded employee?
- Who deals with tax issues?
- Who pays the secondment fee?
Service agreement
In this situation, Employee A is employed by Ireland Ltd. However, Germany Ltd. needs specific services and contracts with Ireland Ltd for this service. Employee A is assigned the task and moves to Germany until the project is complete.
The areas to be considered in the service agreement are:
- Provision of services as a subject of the agreement- details of the specific need and scope
- The home country has the right to supervise and control the work of Employee A
- What is the service fee? Usually, organizations look to market value prices
- Who deals with tax issues?
Where Double Taxation Agreements fit
Generally speaking, the rule is as follows:
“…salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment, shall be taxable only in that State unless the employment is exercised in the other Contracting State. “
There are exceptions, and they apply only if all 3 conditions are met at the same time:
- the recipient of the income spends less than 183 days in a 12-month period in the other state commencing or ending in the fiscal year,
- the remuneration is paid by, or on behalf of, an employer who is not a resident of the other state, and
- the remuneration is not borne by a permanent establishment in the other state.
For illustration purposes only, here’s are two examples of each and how it could work in practice:
Scenario 1:Employment Income – secondment case
Tax is due here
Employee A spends <100 days in Germany. The salary is received from Ireland Ltd, however, Ireland Ltd does not have a permanent establishment in Germany.
Does the employee have to pay tax on the 100 days?
No. Although the salary payment is made by the legal employer, Ireland Ltd issues an invoice to Germany Ltd. for the salary. The employee has to file a tax return in Germany, and there could be payroll obligations also.
Scenario 2: Employment income- service agreement
Tax is not due because of the DTA relief
Employee A spends <100 days in Germany. The salary received is from Ireland Ltd., however, Ireland Ltd does not have a permanent establishment in Germany
Does the employee have to pay tax on the 100 days?
Yes. Although Ireland Ltd issues an invoice to Germany Ltd, the invoice is not for their salary but the agreed market values process. Here the DTA benefit applies.
Are there any risks with using this method?
- Substance over form prevails
- Elimination of double taxation
What happens if there is no DTA in place?
Check local legislation to see if unilateral relief can be claimed in respect of the foreign taxes paid.
If there is a DTA in place:
- Use the credit method
- Some agreements provide them for the exemption method- foreign income covered by such treaty is exempted from taxation in the respective country.
What are the benefits of using treaties?
Certainty around the correct amount of tax to pay.
Sometimes you can apply for relief in real-time versus through a tax return.
Please remember - The provisions within agreements differ, and it critical to consider the separate agreements every time you have a cross-border case.
What to look for in the DTA:
- Persons covered
- Territory
- Taxes covered
- Residence
- Dependent services
- Rules for determining the elimination of double taxation
