The aim of this article is to provide an overview of the tax issues for consideration when an employee is relocating internationally on a temporary basis and to highlight the common pitfalls made by Tax and HR managers.
When an employee is asked by their employer to relocate internationally there are many issues for them to consider. They are being asked to move to a new country, a new office and a new way of life. For many, this opportunity is an exciting one. And rightly so. The opportunity to work internationally offers the chance to build on your career and experience. Most jump at the chance. However there are many issues to consider – for the employee and employer. And tax is usually high at the top of that list.
For the employer it is common that the employee is “assigned” or “seconded” to the host location such that they are viewed as employed by the host location for the duration of the assignment. A discussion of the corporate issues for consideration in this respect are outside the scope of this article but will be considered later in this series (e.g. structuring inter-company recharges, OECD economic employer concept).
Before the employee departs, the HR team will usually prepare a contract which outlines the terms and conditions of the new assignment. There are many issues to consider and logistically it can be complex. Within the company in both home and host countries, input will be required from HR, Payroll, Legal, Tax and Finance. The contract issued will vary depending on the type of relocation that is occurring e.g. whether the move is a permanent or a temporary one. This article will focus on the tax issues for consideration when an employee is relocating on a temporary basis (e.g. for a period of up to 4 years).
A temporary relocation usually takes the form of an assignment from the current employer to the new employer in the host location, the terms of which are outlined in a contract between the employee and employer.
In addition to general employment contract blurb, the terms and conditions generally outline:
how long the assignment is for
the impact on current and future employee entitlements
what relocation and repatriation expenses are covered
who will wear the burden of any increased tax cost in the host location (i.e. the employee or the employer) OR who will benefit from a lower tax rate in the host location
Taxes can vary massively depending on where an assignee is relocating to and it may be to higher or lower tax jurisdiction. It can be difficult to agree the terms and conditions with an employee who is not happy with what the HR department have proposed in the assignment contract. This can delay the employee departing and impact operations. It is also common to see that employees do not fully understand the tax implications of the assignment they are accepting. They accept the assignment and leave for their new role. The issue then comes to a head at a later stage when the tax year has ended and the impact of the assignment is fully understood by the employee. This is far from ideal for all parties and can lead to key employees becoming disgruntled about the process.
Where an employee is going to work overseas for more than a year they will likely break Irish tax residency. This has various implications for both the employee and the employer. They will also likely become tax resident in the host location.
Irish tax residence is determined by reference to the amount of days that an individual spends in Ireland in each tax year (s819 TCA 1997). The tax year is based on the calendar year 1 January to 31 December. An individual is considered Irish tax resident if either of the following tests are satisfied:
The individual is physically present in Ireland for 183 days or more in a tax year; or
The individual is physically present in Ireland in the calendar year concerned and the previous calendar year for a total of 280 days or more.
Therefore, on a continuous basis an individual who spends fewer than 140 days in Ireland in each tax year will be non-resident. A day for residence purposes is counted where an individual is present at any time in a particular day in the state.
Where an employee is working abroad on assignment there are a number of relocation expenses that can be reimbursed without giving rise to an Irish tax liability. These include:
- vouched rent of temporary accommodation (for up to 3 months)
- removal of furniture and effects
- insurance of furniture and effects
- travelling expenses on removal
- storage costs
- temporary subsistence allowance
- auctioneer, solicitor fees and stamp duty arising from moving house
There are various conditions to be satisfied in order for these expenses to qualify as tax-free.
It is best practice to draft and then regularly review a company assignment policy. This does not need to be a complex document but it should be drafted with the assistance of a Tax Adviser or In-house Tax Manager to ensure that all available tax reliefs and exemptions relating to assignments are understood and incorporated into standard assignment packages. It is common that ownership of this document remains with the HR department.
In our experience the following process ensures that temporary assignments are managed properly:
- an assignment policy should be drafted by HR and reviewed by the Tax Department (or external tax adviser). Legal opinion may also be required.
- the policy outlines the relocation benefits offered by the company depending on the length of the assignment (e.g. allowances to cover additional housing costs, education costs for children)
- the policy clearly outlines the company tax policy in relation to assignment base pay and relocation benefits (more on this below)
- a tax departure briefing is offered to all employees before they depart by an external party who reviews the employee’s assignment contract and explains how the assignment will impact their net take-home pay and other non-employment income
- a tax arrival briefing is offered to all employees in the host location on arrival. This provides them with an overview of their tax position in their new home.
In terms of tax costs, the policy will outline whether the company offers:
- Tax equalisation – full or partial
- Tax protection
- Gross packages
Put simply, tax equalisation is: the tax you would have paid had you not gone on assignment.
Say those words to a relocating employee and they will usually smile. Their net-take home pay is guaranteed under a tax equalisation arrangement as the employer wears any additional tax cost in the new location. Equally the employer will benefit from a lower tax rate in the host location.
Tax equalisation won’t make the Finance Manager smile if the employee goes to a higher tax location. The rules in each location vary but generally speaking a gross-up needs to be performed to account for the fact that the employer is covering additional tax for the employee (being the difference in home and host tax rates). It can get expensive. Fast.
Of course there will be a tax saving for the company if the employee relocates to a lower tax jurisdiction. The company pockets the difference.
The mechanics of tax equalisation can vary. A full equalisation usually covers all income (employment and non-employment). A partial equalisation is usually restricted to just employment income. This can mean that the employee needs to pay additional taxes in the host location in relation to personal income. Obviously if they are working in a country with which Ireland has a Double Tax Agreement there will likely be relief from double tax (unilateral credit should be available if there is no DTA). However, they may still have a tax cost in the host country (depending on the type of income and terms of the DTA).
To achieve tax equalisation “hypothetical tax” is withheld from the employee’s salary. Assuming the required conditions have been met this is usually accompanied by a PAYE exclusion order such that the hypothetical tax is then used to fund the host location tax liability at the end of the year. Bear in mind tax years may not align.
Hypothetical tax generally equates approximately to home country income tax. This is the mechanism by which the net pay is guaranteed for a tax-equalised employee.
Year end Tax Equalisation calculation
At at the end of the year a calculation should be performed when the home and host country tax return have been finalised. The calculation essentially tests the net income received by the employee against the assignment contract to ensure the anticipated outcome has been received. If there has been an under or over-withholding of hypothetical tax the calculation will highlight this and the issue can then be rectified.
A shadow payroll is sometimes operated where an employer sends an employee to work abroad and they then run an additional payroll to calculate the tax due under the host withholding tax system. It is referred to as “shadow” because the employee does not receive the “net” amount per the payslip in the host location. Taxes obviously still are due there depending on local rules and are covered by the employer.
The host location payroll needs to consider taxes on base pay, any “tax-on-tax” issues and relocation benefits.
Tax protection is a method which ensures the employee does not suffer additional cost if the tax rate in the host location is higher. If the tax rate there is lower they can keep the benefit. If the hypothetical tax withheld is higher than tax due in the host location the employee is refunded the difference.
A “gross” package usually means the employee wears the tax cost arising in the new location. Their salary is paid gross and local taxes will be withheld as required. They may be compensated with a “tax allowance” which is a component of salary designed to cover additional taxes arising in the host location. They are often then responsible for lodging their tax return in the home and host location and dealing with any additional taxes arising.
It is worth bearing in mind that many key employees have a personal investment portfolio that will be impacted by a change in their tax residency position. They may hold domestic and international investments which need to be reviewed in light of breaking Irish tax residency and assuming tax residency in a new location.
This area is complex and the circumstances of each assignee will be different. This is where a pre-departure meeting with a tax adviser can assist with ensuring the assignee fully understands the implications of their assignment. Both the employer and the employee need to be in a position to quantify the cost of the move. It is worth arranging a tax arrival meeting in the new location also with a local expert.
When an employee is seconded outside Ireland temporarily PRSI should continue for the first 52 weeks. It is possible for the employee to continue contributing to the Irish Social Security system after this period by way of agreement with the Department of Social Protection. This is done by way of application for an A1 certificate (EEA states).
Non-EEA states with a social security convention require that a certificate of coverage be applied for. The domestic legislation of the foreign location should also be considered.
WHEN ASSIGNMENTS ARE NOT STRUCTURED PROPERLY….
There are many issues and risks to manage when sending an employee overseas. If the assignment is not structured properly at both the employee and corporate level it can be a costly and time-consuming exercise for the employer (and potentially the employee).
We list below some of the common pitfalls and ways to avoid them:
- Ensure the tax obligations in the host location are fully understood – these include employment withholding tax obligations and corporate tax obligations. Obtain professional advice.
- When sending employees to work overseas bear in mind that it is possible that ONE employee can create a taxable presence in a new location, particularly if they have the power to conclude contracts on behalf of the company. This gives to many unintended consequences such as the requirement to register for corporate tax in the new location. Passports are stamped on arrival.
- Visas show the employee is working there on business. There is a trail.
- Don’t forget to outline who wears the cost of foreign exchange risk if the employee is paid in their home currency in the host location (or vice versa).
- The importance of a year end tax equalisation or tax allocation calculation should not be underestimated. When done properly it can save time and heartache for all parties.
- Remember that for the employee the move represents personal upheaval. If they are relocating family they are trying to balance the needs of other family members. Tax can become an unnecessary stress.
- Communicate well and properly at all times in relation to tax costs. Employees do not appreciate unexpected costs at year end.
- The process needs to be managed well. Often employers cover the cost of tax return preparation for the employee in the home and host location.
- Work permits and immigration issues need to be considered carefully. Get quality professional advice.
We regularly see that clients can panic slightly when they think about sending an employee abroad. For many employers it is uncharted territory and even within international organisations many Tax Departments (and HR managers) are not familiar with the wide array of issues for consideration. Our top three tips are:
- Get the right advice before the employee leaves
- Quantify up-front the cost for all parties
- Communicate with the employee to ensure they understand it
If you need help managing your employee assignment program get in touch. It’s what we specialise in.
In the next of this series we will cover: Irish tax exemptions to consider when relocating employees.
The material in this article is for general information purposes only and does not constitute legal or taxation advice. Specific legal and taxation advice should be sought before acting. All information and taxation rules are subject to change without notice. No liability whatsoever is accepted by Expats Taxes for any action taken in reliance on the information in this article