Mobility Programs Managers have always had this strange attraction to tax protection as an alternative to tax equalization as the tax policy of choice for their expatriates.
I suspect that this is due the seeming simplicity of the tax protection principle which is “the expatriate is on their own for tax unless the tax cost to the employee for tax is greater than it would have been at home. In that case, the employer will cover the difference”.
What could be better than that? As the manager responsible for tax I am encouraging my employees to keep their tax costs low and I will only be bothered if the total tax cost exceeds the home country cost. No hypothetical tax or grossup. What’s not to love?
But like any “too good to be true” scheme, once you scratch the surface of tax protection the shine comes right off.
Tax protection evolved in a time where there were true no tax/low tax countries and tax compliance was not nearly as complete as it is today. So who was to know if that reimbursement for rent or tuition should be reported on a tax return if it did not show up in payroll.
What if an employee “forgot” to file a tax return? Lack of attention to tax detail could be forgiven if an expat was ever caught, right?
- “Couldn’t read the tax instructions right”
- “Didn’t know when the tax was due”
- “Thought my employer reported everything on payroll”, etc. etc.
And in the rare instance the strong arm of the local tax man came down on an expat, they were likely long gone from their assignment and on to the next one somewhere else. If tax notices ever caught up with the employee and they actually conceded that tax was owed, guess who paid the bill? The employer!
So the expats spent years potentially not complying or paying their fair share and staying way ahead of the game. But if a single bill came through, the company paid.
In short, the benefit of questionable “tax planning” accrued to the employee. Any risk with blown “planning” accrued to the employer.
Today there is much more complete payroll reporting. It is unlikely that large portions of compensation are not included in tax reporting and is hard to get away without filing returns. Therefore it is more likely that the full share of tax is going collected either through withholdings or with return filings. There are very few no tax/low tax jurisdictions left where total tax costs may be less than stay at home costs.
Therefore, the tax protected expats will constantly be banging on the expatriate program manager’s door and asking for reimbursements of tax costs that exceeded their stay-at-home amounts. The excess costs relate to the taxes payable on things beyond salary like rent, cost of living allowances, tuition, home leave, transportation, etc.
So if you are the manager fielding reimbursement requests, you now have to calculate and negotiate with each expatriate uniquely to determine what their stay at home tax would have been and then calculate what the excess tax is over that amount. I worked with a policy like this in an investment bank. The expats were professional negotiators. Guess who made out!
On the other hand, well-defined tax equalization policies calculate each expat’s contribution to tax (hypothetical tax) and usually provides tax preparation assistance to ensure full compliance with local laws.
The expat does not care if s/he is in a high tax country or a low tax country as the tax cost to him/her is the same. The employer is responsible for actual tax and can integrate planning where it is willing to bear the risk, knowing that if the planning goes south, the employer is responsible to cover the costs. If the planning works, the company retains the benefit.
There are administrative costs associated with tax equalization, but total tax costs can be planned and accounted for. And the policies should be fair to expats and employer’s alike. The winners in tax equalization are not the least compliant or the squeakiest wheels.
Corporate responsibility is achieved and reputational credibility maintained.
When looking at tax protection programs, remember, all that glitters is not gold.
Dave Leboff is the President, US Operations for Immedis. Get in touch if you have questions about expatriate payroll for your own organization by emailing firstname.lastname@example.org.
What is tax equalization? Read Dave’s blog – Expatriate tips #4 – Tax Equalization – An Overview