Key Tax Considerations of Sending Employees Overseas

The issue of international assignees was, for a long time, limited to a small number of companies – meaning only those that operated on an international scale. But in recent years, global expansion has shifted into focus for the larger business community. As a result, the challenges and best practices associated with sending employees abroad are worthy of executive-level attention. International assignments come with a host of business implications, and tax is among the priority considerations.

For starters, many professionals mistakenly believe that employee tax exposure can be limited if an international assignee spends fewer than 183 days in a host location. Many tax treaties support this assumption. However, Organization for Economic Cooperation and Development (OECD) principles start with the framework of avoiding double taxation. Furthermore, its Model Tax Convention is designed to provide a uniform basis to settle common problems that arise from double-taxation challenges.

Permanent Establishment Risk

Take, for example, the hypothetical situation of a US company with subsidiaries in Venezuela, China, and Nigeria. The US parent company employs an executive who is not a US person at a subsidiary, and she is compensated through a split US and local payroll. The compensation is then paid to a bank account in a third country. This means the US headquarters is taking a deduction for the executive’s work with no recharge of the cost being made to the associated subsidiary.

In this example, the US employer may have a permanent establishment (PE) risk in accordance with OECD principles. Many tax treaties and domestic tax laws lay out tests to help identify if an employer has a PE risk. A common test is the presence of a foreign-employed executive who often makes decisions for the local business.

Additionally, there is a chance that, in this hypothetical situation, the executive may not be compliant with local tax laws. In the split payroll structure, the locally paid compensation she is receiving has likely been subject to income tax withholdings. Moreover, it is also very likely that she is not reporting the foreign pay to the host country. It should also be noted that, in most countries, the source of employment earning is where the services are performed.

Furthermore, while it’s doubtful that the executive is reporting all sources of income to the host country, there is also a strong possibility that the US parent company should have been withholding taxes on the foreign-paid compensation. Subsequently, the employer could be subject to penalties and interest.

Now, the United States and Venezuela have a tax treaty. OECD principles are not always upheld when taking into account the political climate, but they do provide a starting point for an analysis. A PE risk could be likely, given the nature of the executive’s roles and, therefore, tax issues would need to be addressed.

In China, PE can be created by the secondment of expatriate employees. Since 2009, the Chinese tax authorities started to treat secondment as a PE of the overseas employer. Effective June 2013, the authorities issued Circular 19 to ease the challenges of local tax bureaus misinterpreting bilateral tax treaties.

Assuming the US employer would assess the performance and bear the responsibilities and risks of the work resulting from the executive, Circular 19 would regard the US employer as the real employer of the executive working in China. If the executive spends more than 183 days in the People’s Republic of China in a calendar year, from a Chinese corporate tax perspective, the US employer could be regarded as having a PE and be subject to corporate taxes in China.

From a China individual income tax perspective, if the executive were to stay and work in China full-time, she should report and pay individual income tax on all income, and no time apportionment claim would be allowed. This means no income for days worked outside of China could be allocated to non-China sources.

A very common way to mitigate the PE risk of the US employer in China is for the executive to enter into an employment contract with the Chinese entity. Then, the executive could be regarded as an employee of the Chinese entity, and her salary would be paid accordingly. Under such an arrangement, the Chinese entity would now be the executive’s real employer. The executive could also keep her original employment agreement with the US employer for Social Security contribution purposes.

Lastly, as Nigeria has no tax treaty with the United States, the Nigerian domestic tax legislation requires a closer look. The Nigerian Companies Income Tax Act suggests that corporate tax is assessed on all profits that accrue in, are derived from, are brought into, or are received in Nigeria. Furthermore, a nonresident or foreign company is liable to pay Nigerian corporate tax if they habitually or customarily operate in Nigeria through a dependent agent whom Nigeria authorizes to conduct business or trade on the country’s behalf. Nigerian domestic tax legislations appear to follow OECD rules even though there is no treaty to rely upon.

The split payroll may have been leveraged as a tax-planning strategy by the executive in the aforementioned hypothetical example, which would likely be the result of the employer not proactively implementing a tax-reimbursement policy. By using a secondment agreement, the executive’s costs are recharged to the host location, shifting the employer, for economic purposes, to the host location and thus minimizing the PE risk for the home-country employer. China is the exception.

Understand Tax Policies – Here and Abroad

International moves have significant financial and tax repercussions for employer and employees alike. While every country has different tax policies, the OECD model offers some continuity and may help employers mitigate the risk of costly noncompliance issues.

Understanding the basics of home and foreign countries’ taxes imposed on assignees; corporate tax issues, such as PE risk; and maintaining tax-reimbursement policies may help to ensure that employers are compliant with tax reporting and withholding obligations. By making sure they are compliant, employers can focus on their overall global corporate strategy and work toward success.