“Strategic Tax Reimbursement Policy Alternatives & Best Practices”
Taking the next step in creating a cost-effective framework for global mobility.
• • • • • •
By Paul J. Rubino, CPA - Global Mobility Tax, LLP
The global business environment is such that tax revenue is both a primary decision-point for cross-border employee assignments and the preeminent source of sustaining social and economic programs of citizenries. As countries around the world seek to seize every last tax dollar out of global companies and their seconded employees, companies need to be ever vigilant in ensuring that proper policies are in place to make these global assignments economically viable by keeping tax costs as low as possible. With this undeniable challenge confronting most companies wishing to send their employees abroad, a proper tax reimbursement policy and approach is a must-have for one’s global mobility toolkit.
The current trend in global mobility is for companies to pull back a bit due to rising tax costs around the world. Companies intuitively believe that shorter term assignments like three, six or twelve month assignments create less tax liability for the company and/or its employees. International tax treaties eliminating double-taxation for up to six months and countries with away-from-home tax concessions like the United States for assignments up to one year in a single location, offer significant tax relief for these quick secondments.
But what is the real impact or benefit to the company? Do these short-term assignments create lasting or significant dividends in meeting the company’s long-term global objectives? In my experience, the answer is often times mixed. Some companies get a decent bang-for-the-buck on these short-termers, but a bigger bang could be had with a longer assignment such as for eighteen months, two years or even longer.
The big obstacle: tax costs usually increase significantly after one year abroad. However, this is not always the case as some countries offer tax concessions for longer periods (the UK has Temporary Workplace Allowance for twenty-four months and France has a Favorable Expatriate Tax law for up to five years are just two examples); meaning that it is possible for an assignee in the higher tax rate host country to derive a lower tax cost than the lower tax rate home country once tax concessions are applied. This result is largely dependent on the compensation and benefits package for the foreign assignment.
With proper tax planning and assignment package structuring, companies sending their employees abroad can take advantage of as many tax concessions as may be available to them, lowering the overall assignment tax cost in the home and host countries as much as possible. However, proper tax planning and tax solutions for global assignments should also consider a tax reimbursement policy that the company develops and employs, which aligns its corporate objectives with its global employee candidates in a manner that is both marketplace competitive and financially equitable to both parties. This is where our action-plan for developing a strategic tax reimbursement policy begins.
Step 1: Strategically align Company Objectives with Employee Values
Before trying to develop a Tax Reimbursement Policy that fits a primary company objective of tax cost mitigation, think of how the Policy might impact your company’s ability to attract, retain and promote your company’s best candidates for global assignments. When we speak of being equitable and fair, we mean that in a financial but also competitive way. What are other company’s doing in your industry? What are they doing in the host locations where your assignments would take place? What are the compensation and benefit packages being offered by your competitors to this class of candidates and how are their employees being reimbursed for taxes? A Tax Reimbursement Policy can be a differentiator for a company in attracting these top-shelf employees for these positions as the “expat community” does discuss what kind of package they get, how it is being taxed under a tax reimbursement policy, and what that net bottom line is for each employee. Social media has made that knowledge sharing quite easy.
A sustainable Tax Reimbursement Policy must also be flexible enough to morph, when needed, to the changing global environment. That does not mean Policy exceptions are the rule as Policy administrators need to be ever mindful of setting unwanted precedents for other assignments. Better to modify a section of the Policy on a go-forward basis than to grant an exception that can be referred to later by another employee who will feel disenchanted if not granted the same exception. Policies should be strictly adhered to as much as possible, which is why the newly launched Policy should be developed with great care.
When seeking strategic alignment between company objectives and what’s important to employees, the best gauge is tapping into why these employees joined your fine company in the first place: was it the money, the benefits, the promotion and career opportunities? That will tell you much of what you need to know in terms of where the emphasis of your Policy should be: on increasing one’s bottom line, on taking care of an employee’s non-compensatory considerations, on giving one the opportunity to move expeditiously up the ranks, etc. A smart & strong policy “balances” company objectives with employee values.
Step 2: Consider Tax Impacts of Likely Host Locations
Once the concept of strategic alignment between company and employee have been analyzed and determined, the next step would be to create a Tax Reimbursement Policy that considers the primary destinations for your global mobility population. If your company is primarily rooted in geographical markets such as APAC & EMEA, you would not necessarily develop a policy that includes Mexico & Brazil unless you were planning to expand there. The reason to take this next step is because depending on the host location tax regimes, you can better develop a Tax Reimbursement Policy that anticipates the tax impacts to the company and employee, providing greater balance and fairness to both parties.
For instance, a company sending employees to Dubai where there is no income tax or to Singapore where the tax rate may only be 15% may choose to “share” some of the potential tax savings between the employee and company for an assignment to those locations. This tax reduction sharing may give the company a leg up on the competition if it only “tax protects” employees to these locations rather than “tax equalizes” them (more on both tax reimbursement concepts in a bit). Alternatively, a company may provide “tax equalization” protection to employees relocating to higher tax jurisdictions for a couple of years instead of permanently transferring them to fend for themselves.
A smart tax reimbursement policy will consider the host tax landscape when deciding what tax reimbursement methodology to employ either across all jurisdictions or per jurisdiction. Also be mindful, that just because tax rates are higher or lower does not always equate to the “actual tax” being higher/lower in those locations because of how certain benefits are taxed, tax concessions to expats there, and even how other compensation items such as equity are taxed in that location.
Step 3: Choose a Tax Reimbursement Method that fits Best
The next step in developing the best tax reimbursement policy for your company is to consider alternative tax reimbursement methods that align company objectives with employee values in the context of the global tax implications of each alternative. The most common and widely accepted tax reimbursement methods for foreign assignments are:
- Tax Gross-up
- Tax Protection
- Tax Equalization
Under “Tax Gross-up” method, the company is essentially covering the tax-on-tax effect of paying an employee a taxable benefit that is assignment-related. For instance, paying for an assignee’s education costs in the host location for his/her children would normally be taxable. Under a Tax Gross-up reimbursement policy, you would gross-up that payment for the highest tax rates that payment will attract, so the assignee maintains the “net” benefit.
To illustrate, say the education cost is $10,000 and the employee is on assignment in Singapore from the United States, where the assignee is a U.S. citizen still subject to worldwide taxation. If the Singapore tax rate is 15% on this income and the US tax rate is 35%, you’d want to gross-up at the higher 35% rate as the assignee will effectively pay the higher rate after foreign tax credit offset.
A tax reimbursement policy built on simply grossing-up certain tax payments that are foreign-assignment related is fairly easy to administer and doesn’t result in many entanglements with employees. However, its simplicity doesn’t do much to keep tax costs down for the company as these payments are often grossed-up at higher than necessary rates with little consideration for the impacts of actual tax return preparation results and given its current-year reimbursement timing, it will always result in the highest possible tax cost for a company. We typically see Tax Gross-up reimbursement methods applied when tax protecting taxable benefits for those being permanently transferred or those on a Local-Plus assignment (ie paid as a local hire but with a few tax protected benefits such as host housing).
Under a “Tax Protection” reimbursement method, the entire tax year is considered and compared whereas Tax Gross-up method is on a per-payment basis (note some refer to grossing up a payment for taxes as a way to “tax protect” a payment to provide a “net benefit” and that is true, but we are discussing this concept here as an annual method to reimburse excess tax costs). Furthermore, “Tax Protection” ensures the assignee pays “no more tax than they would have paid” had they remained in their home location rather than worked abroad.
There is a non-explicit benefit here that could inure to the employee on assignment in that if the assignee’s taxes turn out to be lower while on assignment than they would’ve been had they remained in the host location, then the assignee gets to keep the benefit of the tax reduction and not have to pay that back to the company as would be the case under “Tax Equalization” (more on that next). As such, the employee could have a financial gain under Tax Protection but the company’s tax cost will never be lower than the level of the employee as if they remained in the home location.
“Tax Protection” policy is often employed when assignments move to lower tax jurisdictions as compared to the home jurisdiction. Countries like Singapore, Hong Kong, and the UAE (no tax country) are all attractive locations to employ this tax reimbursement methodology as in many cases the assignee may enjoy a lower global tax cost than they would’ve enjoyed in their home country. Providing the employee with some extra incentive to join the company or accept the assignment without any extra tax cost being absorbed by the company is a strategy that many companies in this situation should consider.
Both of the above tax reimbursement methods have their place but the timing and location to employ them is a bit restrictive and can be cost-ineffective to the company. The great balancer of tax reimbursement policy methodologies is, you guessed it, “Tax Equalization”. Under Tax Equalization, the employee neither gains nor loses financially as related to their tax burden. Their tax burden will be the same whether they go on assignment to Singapore, Brazil or the UK. The employee pays the exact same amount of tax on their “hypothetical income” as if they never left home.
Under Tax Equalization, the company pays the employee’s global taxes while recouping the “hypothetical home tax cost” from the employee to help fund their global tax burden. Note the global tax burden can be higher, lower or the same as the employee’s “hypothetical home tax cost”, so the company’s global tax cost will be increased or decreased by employing this methodology. Again, employing this methodology for assignments to lower tax countries inured the tax benefit to the company and not the employee who remains financially “whole or equal”.
“Tax Equalization” is by far the most employed tax reimbursement methodology primarily because it aims to be equitable to the employee; however, it can be costly to a company which employs it without discretion (i.e. sending employees on longer-term assignments in high tax countries without localizing them or choosing a permanent transfer relocation from the outset). Also, it is administratively more complicated and time-consuming in that “hypothetical taxes” need to be calculated for the employee, withheld on a pre-tax basis in most cases from the employee, accounted for correctly by the company, used judiciously by the company to help fund the assignment, and then applied every annual cycle via a final tax equalization calculation after both home and host tax returns are filed.
The final tax reimbursement method sometimes employed by companies with foreign assignees is what we call a “hybrid” method – essentially taking some elements of the above methods and blending together to make the cocktail you want!
An example of this would be to employ a mostly standard Tax Equalization Policy, but to allow the employee to keep some tax benefits resulting from the foreign assignment like not having personal investment income taxed for “Hypothetical State Income Tax” purposes as it normally would under Tax Equalization if the income is not being taxed on the final State income tax return (i.e. if the employee was able to break State tax residency because of the assignment). In this way, the company is again “sharing” some of the tax benefits from the assignment with the employee which may help the company negotiate better assignment packages for its employees without being out of pocket any extra tax cost.
Choosing the best tax reimbursement method for your company’s global mobility program policy is not an easy task as many factors need to be considered, but once a method is chosen, you are now ready to do some fine-tuning.
Step 4: Tax Reimbursement Policy Design
A Tax Reimbursement Policy can take on different methodologies, components, and get as detailed as you want. I’ve seen policies consider areas like recovery of foreign tax credits AFTER separation from employment, estate tax equalization if you die while abroad, and how to tax protect against fluctuating exchange rates associated with equity. For some companies, this may seem the prudent thing to do – cover everything you can think of so there are no questions. Got news – there will always be some out of left field situation that you can’t possibly have thought of so better to not even try. The best course of action here is to keep the policy smart and as short as possible while covering the big ticket items that would most likely affect your company’s mobility population and then negotiate reasonably on the infrequent situations.
At a minimum, a Tax Reimbursement Policy will cover the compensation components that most taxpayers encounter while on a foreign assignment and how to distinguish between those that will be “tax protected” by the company and those that won’t. Here is a list with more detailed descriptions below of common Policy areas we typically develop to provide guidance and certainty to both the assignee and the company:
1. Policy Scope
2. Assignee Responsibilities
3. Tax Services Covered & Process
4. Tax Reimbursement Process & Methodology
5. Hypothetical Taxes Defined & Process (if Tax Equalization Policy)
6. Tax Equalized/Protected Income
7. Non-Tax Equalized/Protected Income
8. Recapture of Foreign Tax Credits
9. Treatment of Terminated, Localized or Part-year Employees
10. Miscellaneous Provisions
1) The Policy Scope sets the tone for the entire Policy. The scope sets out the tax reimbursement methodology to be used (such as tax equalization) and also indicates the types of assignments or assignment durations to which the Policy will apply (for instance, assignments lasting more than 6 months). The Policy scope may also set out objectives or goals to be achieved by applying said Policy and may also note where other policies, such as Relocation or HR policies, intersect with this Policy.
2) Assignee responsibilities under the tax reimbursement policy are important to define, so the parties to this contract understand their requirements and applicable timing. The assignee must understand and agree to abide by all tax laws and tax compliance requirements in the home and host jurisdictions while on assignment. That includes timely submission of tax data to outside tax providers and the timely filing of all tax returns and related documents. Penalties can and should be defined in the Policy for non-compliance or untimely submissions and filings, so that the company is not responsible for delays caused by the assignee. The assignee also must agree to the timely repayment of any tax reimbursement settlements due to the company during the tax equalization process.
3) Tax services to be provided under the Tax Reimbursement Policy is useful to the assignee and HR business partners who need to authorize and administer services under the mobility program. Tax services under a tax equalization policy normally include at a minimum: home/host tax briefings, hypothetical tax calculations, home & host income tax return preparation and final tax equalization calculations. It is important to also note the “scope” of those services provided and subsidized by the company, so the assignee understands that personal income tax planning is usually not covered by this Policy. Designating a particular tax service provider also ensures consistency across all assignments resulting in fewer future requests for policy exceptions. The tax service processes should also be outlined, so the assignee and HR partners understand the timing and flow of process steps. A good tax provider will go over these steps with the assignee during their tax briefings.
4) The tax reimbursement methodology chosen by the company must be clearly explained in the Policy. This is the lifeblood coursing through the veins of the Policy. The methodology establishes whether the assignee will receive Tax Protection, Tax Equalization, a hybrid combination of the two or merely tax gross-ups on certain foreign taxable benefits. For simple tax gross-up practice, full policies are rarely written. Most tax reimbursement policies do embrace the concept of Tax Equalization with perhaps some “tax protectionism” added to cover some aspect of the Policy where the company seeks to “share” some of the tax benefits that may be obtained from the assignment.
The tax reimbursement process encapsulates the “lifecycle” that will be employed from beginning to end each year. This lifecycle is annual by nature and usually begins with the hypothetical tax calculation, its implementation within payroll, any mid-year hypo adjustments, annual tax return preparation in home and host jurisdictions and final tax equalization. The process is detailed within the Policy and explained during tax briefings with the tax service providers.
5) If employing a Tax “Equalization” Policy, hypothetical taxes need to be calculated. The reason is that the hypothetical taxes are a mechanism by which the company can safely extract the tax obligation due from the assignee without having the funds go directly to the government. They are essentially a “salary reduction” in the sense that hypothetical tax withholdings can be paid from assignee to company on a pre-tax basis (allowed in the U.S. and usually allowed in foreign jurisdictions but check each country to be sure), which lowers taxable compensation usually providing some level of global tax reduction. As such, proper implementation of these taxes need to be developed within a company’s payroll system.
The assignee’s hypothetical taxes are usually calculated on the assignee’s “stay-at-home” company income, such as base salary, bonus and equity pay. Typically there will be at least two approaches to hypothetical tax calculations – one on regular recurring pay and the other on irregular supplemental pay. The regular pay is calculated to result in a hypothetical tax “amount” that the company’s payroll team can withhold from the assignee each paycheck. The supplemental pay has a hypothetical tax “rate” applied to that income, so whenever it’s received as taxable compensation, it can have a designated tax rate percentage applied to it for hypothetical withholding purposes.
This hypothetical tax process and the income that is considered hypothetical income for this withholding purpose needs to be defined in the Policy. The Policy should also state the types of taxes that the assignee is obligated to pay while on assignment. For instance, most policies obligate the assignee to pay hypothetical home federal and state income taxes in addition to home social taxes while on assignment. This tax obligation to the assignee can be changed to be a combination of actual and hypothetical tax withholdings as is often the case – like having hypothetical federal and state taxes withheld but also having actual social taxes withheld.
The main reason for having hypothetical taxes withheld instead of actual taxes is because the assignee will receive foreign tax credits on their home tax return for the foreign taxes paid by the company, so the tax reduction on their home tax return may be significantly lower due to these tax credits. As such, the company should better utilize these tax withholdings from the assignee to help fund the assignment instead of having the excess withholdings returned back in the form of a huge tax refund. In the end, final tax equalization will settle all taxes paid by the assignee and those paid by the company, so the assignee is only obligated to pay the taxes they would have paid had they not gone abroad.
6) Tax Equalized or Protected income in a tax reimbursement policy details the types of income that are equalized/protected in the foreign tax jurisdiction. That means if this income is taxed at a higher rate in the foreign/host country, the company will pay the excess tax above home country tax (tax protection) OR if this income is taxed at a higher “or lower” rate in the foreign/host country, the company will make you whole to the level of tax you paid in your home country (tax equalization). The tax reimbursement policy dictates which income is tax protected, tax equalized or not protected at all.
Income that is usually tax protected/equalized includes: base salary, bonus, commissions, equity, and certain levels of personal income. Many policies are gravitating towards casting “limits” on the amount of equity or personal income a company will tax protect/equalize while an employee is on foreign assignment. Best practice for setting these limits includes an equity analysis of the company’s mobility population to determine how much income may be taxed in foreign jurisdictions at today’s value. This can be a difficult task and subject to change based on the company’s stock price and countries where the equity units vest. I am currently seeing companies set personal income levels of around $20k-$30k and equity levels of $100k-$200k that they will tax protect/equalize in today’s marketplace.
7) Non-tax equalized/protected income is commonly an assignee’s personal income (usually above a company set limit), perhaps equity above a company-set limit, and other non-company income like previous employer income or spousal income. Examples of non-tax equalized or protected income include: investment income, capital gains, spousal income, rental income, pension income, previous employer income, sale of properties including primary home, and trust income. The point to understand with this income class is that the assignee and not the company pays global taxes on this income whenever and wherever taxed under the Policy.
8) The recapture of foreign tax credits is essential to any good tax equalization policy. Note that this section would not apply to a tax “protection” policy as the company is reimbursing the assignee for any assignment-related taxes above his home tax level, so foreign tax credits would belong to the assignee under a tax protection policy. However under a tax “equalization” policy, foreign tax credits on tax equalized income as noted above would belong to the company upon final tax equalization settlement. As such, the Policy should include a section as to the ownership of these tax credits and that the company reserves the right to continue tax return preparation services towards the ultimate recovery of these tax credits.
9) Employees terminated or localized while on assignment or those who become new employees and subsequently assignees during the year, have a potential host of other tax matters to reconcile under a good tax reimbursement policy. The common theme amongst all of these situations is that the assignee has only been with the company under this Policy for a portion of the year. As such, allowances and guidelines for part-year Policy implementation needs to be addressed within the Policy. Typically, what happens before or after the assignee is covered by the Policy is their responsibility, not the company.
For instance, foreign tax credits brought “into” the tax equalization settlement by the employee from a previous year belongs to the employee and those foreign tax credits that accrued while the employee was on assignment with the company belongs to the company. These tax credits have a twelve year lifespan in the U.S. until used up (current year, one year back and ten years forward). Therefore it’s important to address how the company wishes to handle these situations within the Policy such as having the employee sign-off prior to assignment that any foreign taxes belonging to the company from the assignment should be paid back either at termination, at a future date meaning continual tax return prep is needed to recover the credits or a percentage of the credits can be settled upon exit from the company.
10) Miscellaneous provisions in a comprehensive tax reimbursement policy will generally include other areas that don’t fit squarely into the nine areas noted above. Examples might include: responsibility for other taxes such as alternative minimum taxes, gift/estate/inheritance taxes, tax reimbursement implications for those dying abroad, estimated tax payments outside of the hypothetical tax withholding process, allocating foreign income exclusions, exchange rate fluctuations, purchasing a home in a foreign country, treatment of passive activity losses and how state hypothetical taxes might be calculated to name a few.
How a company chooses to tax equalize/protect for State taxes is oftentimes an area where companies can “share” some tax benefits with assignees as sometimes a fairly long-term assignment can lead to a “break” in state tax residency cutting off taxation to one’s home State while abroad on most income (California has an eighteen month “bright-line” test that can usually be applied for this purpose). This tax savings could be retained by the company using full tax equalization on all income OR a form of tax protection could be applied whereby the assignee only pays State hypothetical tax on all company home-based income plus any state taxes on non-company income.
Step 5: Tax Reimbursement Policy Launch & Implementation
Once the tax reimbursement policy has been developed and everyone up the food chain has signed off, the last final steps are to properly launch and implement. Every company is different, so I won’t claim to be omniscient in this area. However, I believe successful completion of this final phase requires these three keys:
1) Educate your assignee population, both present and future, on the business reasons for the tax reimbursement policy;
2) Educate your HR team on the Policy process, details, nuances, and implementation;
3) Hire a tax provider firm who can develop, explain, and follow the policy, exactly!
These three “must-haves” are essential to proper launch and survival of the Policy and your sanity. Heck, the tax provider can help you with the first two keys as well and should. Getting proper “buy-in” from your assignee population is vital to success. The reasons why the Policy makes sense financially for all parties, the fairness of the policy, the business objectives that are being met by incorporating this Policy into the core of the company is essential to a healthy launch. That’s why the initial step “strategic alignment” is so crucial. Know your audience – know your employees!
Once the initial launch is successful, the next generation of assignees will have their colleagues’ experiences to draw from making future assignments easier to launch. Trying to launch a new Policy before the first international assignment commences is obviously ideal, but not always reality. Therefore, make sure to have a transition plan in place to cover the existing assignees in a way that’s fair to them. Remember that every exception has the chance to become a precedent so be careful.
Implementing the Policy amongst your HR business partners, payroll administrators and line managers is a requirement for gaining the proper traction you need for the Policy’s sustainability. Everyone needs to know their role and why! Again, a good tax provider should be able to educate your assignees during the initial stages of the assignment process, but should also assist with explaining best practices within an organization’s hierarchy to ensure proper launch, error-free implementation, and Policy sustainability.
The above should be a blueprint for how to go about developing a strong and smart tax reimbursement policy. Don’t however walk this path alone – bring in company stakeholders and outside experts to build the best policy for your company’s business objectives and culture!
About the Author
Paul Rubino, CPA – Global Mobility Tax, LLP
Paul is a Director at GMT - a CPA firm dedicated exclusively to the tax, payroll and HR issues impacted by global mobility. Paul has 30 years tax experience both in the public and private sectors. Paul is based in Florida where he specializes in global tax mitigation for companies & their mobile employees, international payroll delivery & structuring, tax equalization policy design, and global equity planning.
Prior to joining GMT in 2010, Paul spent a number of years in upper management at Big 4 firms as well as a few years in industry and founded his own expatriate tax company. Paul helps lead GMT’s Client Care & Marketing teams and has also written many Client Alerts for the firm related to global tax developments.
Paul was previously published by the International Tax Journal, is a CPA in the States of Florida & New Jersey and is an active member of the FICPA.
Adapted with permission from the International HR Decision Support network, Copyright 2016, The Bureau of National Affairs, inc. (800-372-1033) www.bna.com