Understanding the taxation of international and expatriate assignments
Credit: Business World Online
(Second of two parts)
In last week’s article, we discussed how or why taxpayers working on international assignments have to consider the impact of different tax jurisdictions on their individual tax obligations. We also explained how most companies implement a tax equalization (TEQ) arrangement for the employees so that they end up paying more or less the same taxes as if they remained in their home country. This is to ensure that the taxpayers do not face undue financial hardship or receive a financial windfall due to the relocation benefits they may receive.
We also covered hypothetical or “hypo” tax deductions and state taxation (for US expatriates). We will now continue with the other tax areas that have impact on taxation for expatriates.
SOCIAL SECURITY TAX AND TOTALIZATION AGREEMENT
Individuals working outside their home country are generally not subject to social security tax unless they are also performing services for their employer in the home country. If this is the case, they may be subject to both home and foreign (host) social security taxes. In such a case, countries usually enter into “totalization” agreements for a better coordination of their respective social security systems with similar systems in the other countries to exempt foreign assigned employees from double social security taxation.
Typically, the employer must apply for a certificate of coverage from the country where the employee will remain covered. If granted, this certificate is presented to the appropriate officials of the country in which the employee seeks exemption to prove that there is a continuing coverage. Whatever is the final arrangement, bear in mind that social security taxes will likewise be factored in the tax reimbursement scheme or TEQ.
TAXATION IN FOREIGN COUNTRY
If an individual is physically working or deriving income within the borders of another country, income tax will likely be imposed on the individual who may invoke a prevailing tax treaty or double taxation agreement, if applicable. These tax treaties typically include a provision that exempts an individual’s income from taxation provided he or she spends 183 days or less in the foreign country and the compensation is not paid or borne by an employer in the foreign country. For those who fail to meet the requirements under the applicable treaty, a foreign tax credit is available. In the case of the US, its taxing system even provides for a “foreign earned income exclusion” to minimize the impact of double taxation. These two items should be properly accounted for in the tax equalization.
TAX EQUALIZATION SETTLEMENT
At the end of the year, when all the income and deduction amounts are known, the employee’s actual home country tax return will be prepared based on the final income and deduction information provided by both the expat and the employer. Normally, the employer will be responsible for the tax liabilities owed to the tax authorities. As discussed earlier, it is worthy to note that the employer is responsible for the cost of actual home and host country tax liabilities.
Alongside the actual tax returns, the employee’s final hypo tax liability will also be re-calculated based on the employee’s final income and deduction amounts for the year pursuant to the employer’s tax equalization policy. Given this, it is important that the expatriate is aware of the procedures or mechanics involved and the policy itself. If the final hypo tax liability is lower than the estimated tax amounts deducted from paychecks, as discussed earlier, plus any other actual taxes paid by the employee, the company owes the employee the difference and vice versa. The difference is normally settled within a prescribed period of time.
In a perfect world, if the estimated tax deducted periodically from the employee’s paychecks matches or is greater than the final hypo tax liability and income taxes on all the assignment-related allowances and foreign taxes were properly funded by the employer, the employee will not experience too much trouble and will be in a sound financial position as regards settlement at year-end.
COMMON PROBLEMS IN TAX EQUALIZATION PROGRAMS
Aside from the increasing number of global organizations employing tax equalization programs, company policy administrators are faced with the problem of unclaimable settlements or delinquent repayments or even non-payment. A delinquent collection of tax equalization settlements attributed to former and even current employees could be very disappointing to the company.
As a precaution, the company can adopt a policy that requires reimbursement of outstanding balances within a fixed period of time after finalization of the tax equalization process. As an alternative, a company may consider notifying the assignees’ operational or functional heads about the delinquent payment or securing the authorization to offset balances due against future employee entitlements.
Moreover, the company can require periodic adjustments or an “adjust-outright” attitude towards hypothetical tax calculations to address tax rate changes for compensation and personal income variances. An aggressive move also is to make sure the design results in the company owing a final settlement to the assignee and not the other way around. To the company, this is the fundamental goal of the activity or the “name of the game,” so to speak, in equalization settlements.
To the employee, these proactive solutions will improve the TEQ processes and provides the expatriate some assurance of lesser taxes to settle at year-end.
EXPATRIATE’S CHECKLIST WHEN TAKING AN ASSIGNMENT
Given the above points, it is advisable for expatiates to be aware of the TEQ policy put in place by his or her employer in case of international assignments. Following are some pointers:
• Keep in mind that tax equalization is not the law. It is merely a policy usually adopted by the company’s Human Resource division to implement its corporate philosophy on international assignments.
• Study and understand well the tax equalization policy.
• Understand the mechanics of tax equalization and the final settlement processes.
• Understand the information used in the calculations. It is the expatriate’s responsibility to provide timely tax data and advise any changes in personal circumstances that may have tax implications.
If the expatriate has been preparing his tax returns in the past and prior to the international assignment, he or she should not be surprised of the unique processes involved. The expatriate needs to cooperate with his or her new tax preparer.
A tax equalization procedure offers expatriate taxpayers an opportunity to better understand how and when their taxes are prepared. Inasmuch as it is the civic duty of every professional to comply with taxation requirements, a better understanding of how taxes are computed and filed can help individuals better manage their personal finances.