Tax related questions and common legal structures for expatriate employees required to to process the payroll of your expatriate workforce.
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Depending on the legal structure, you will need to ask these questions to process the payroll of your expatriate workforce.
When you have employees working abroad, there are a number of important factors to consider.
Whether they’re temporarily on assignment in another country or going to be living permanently outside their home country - there are tax implications for both the business and the individual.
Here are some key tax questions to consider when dealing with expatriate workers, or becoming an expat yourself.
As tax compliance practices differ from country-to-country it’s important to recognise this as only general guidance.
1. What is the legal structure?
First and foremost, an expatriate worker’s ‘legal structure’ needs to be determined. This is a legal – rather than a tax – question, but the legal structure may determine some basic tax compliance obligations.
•Does the employing entity have a subsidiary/branch or any other legal presence in the host country?
•Will there be an intercompany arrangement between the home and host entities?
•Which country’s employment law will apply?
•Is an assignment letter, local employment contract or both required?
•Have immigration-related considerations – such as work permits – been investigated and determined? Does the employer have an assignment policy?
•What international regulations apply between the home and the host country (double tax treaty, social security agreement)?
2. Where is the expatriate worker’s tax residence?
Determining tax residence is a basic requirement, necessary for personal income tax return filing. Tax residence needs to be observed in both the home and in the host country. In cases of dual tax residence, double taxation treaties need to be reviewed to determine ultimate tax residence.
Why is this important? The answer is simple: to avoid facing double taxation and to determine each country’s right to levy tax on specific elements of the employee’s income.
3. What is the social security position?
Social security is very important since it generally covers both short term (eg. sickness, unemployment, maternity) and long term (pension) issues. Some key questions to ask include the following.
•Where does the employee/employer pay social security during the work assignment?
•How can the employee remain subject to their home country’s social security system?
•What about company/private insurances?
•What if the host entity is in the EU (European Union), or outside the EU?
You should generally refer to international social security regulations for these answers.
4. What about payroll/tax compliance?
An expatriate on assignment generally finds themselves obliged to pay taxes in the host country. Potentially, a home country tax liability may also apply (not only in the assignment’s first year but thereafter).
•Should the employee or employer register in the host country for payroll purposes?
•Is there any tax withholding liability by the host entity (where the salary is delivered by the home entity1)?
•What if the salary is paid in separate parts - is shadow payroll required?
•Are there any monthly/quarterly/annual tax return filing liabilities for the host/home employer/employee in the home/host country?
•Can the tax (advance) be paid from a foreign bank account?
•How should I report working days for payroll purposes?
•Is there any joint/family tax return filing possibility in the host country?
•Is there a specific expatriate tax regime?
•In which currency is the personal income tax to be paid? Foreign currency or local? If local, what is the conversion rate to be used?
5. What about other taxes?
It’s not just legal, personal income tax and social security-related questions that arise for expatriate workers; other tax implications may also apply.
These questions generally come up if intercompany arrangements are also made between the home and the host entity. For example, assignment-related costs are charged/invoiced to the host entity by the home entity, or when some assignment-related costs are born by the host entity directly.
•What are the VAT implications of assignment-related cost charges?
•Will the assignee’s activity create a permanent establishment and thus corporate income tax liability in the host country for the home entity?
•Are the assignment-related costs borne by the home entity deductible for corporate income tax purposes?
3 common legal structures for expatriate employees
Both employers and their globally-mobile employees need to understand their legal and tax obligations when working across borders.
Why is this important? Because no two expat work contract situations are the same. It’s essential that both employers and their globally-mobile employees understand their legal and tax obligations. Of course, these obligations differ across the world. You should use this article as a general guide.
1. Expat on assignment
This is probably the most well-known and internationally-used legal structure for an expatriate worker.
‘Assignment’ generally means that a person has citizenship in a country but is living and working in another country. Most expatriates stay in the foreign country for a limited time and then return to their home country. Another characteristic of an assignment is that the person’s activity is connected to the activity of their employer/employment. This is an important point as it has a serious tax impact: in which entities’ interest is the assignee working?
An ’assigned’ or ’posted’ worker is an employee who is sent by their employer to carry out a service in another country for a temporary period. This suggests that the employee will not have a local employment contract with the host (foreign) entity they are assigned to.
In this commonly-used structure, the following legal documents are required:
- employment contract between the employee and the employer (home entity)
- assignment letter between the employee and the employer
- service agreement between the employer and the foreign entity (host entity) where the expatriate is sent to
- certificate of coverage – where applicable – outlining the social security position of the employee.
The assignment letter itself is usually a temporary addendum to the employment contract. It provides specific details that are valid during the assignment period. Any other terms and conditions not mentioned in the assignment letter remain valid as per the employment contract.
The service agreement is between the two companies and details the service that will be performed by the employee, the costs of the services, payment terms and so on. If the assignment is between two related parties, the service fee should be set at fair market value to avoid corporate tax exposures. The proper transfer pricing method should be used to set this service fee correctly, and transfer pricing documentation should be prepared.
2. Dual employment – split payroll
We do see cases when – for various reasons – a local employment contract is created for the expat worker beside the home country employment contract. The reason can range from a local legal requirement, confidentiality, financial etc. but it is generally not tax-driven. The creation of a local employment contract complicates tax compliance as both ’actual home’ and ’actual host country’ payroll is required. In the first, ’assignment’ scenario, a shadow payroll is generally sufficient ie. there is no need for the host entity to file payroll returns. Actual compliance should, of course, be checked in each location.
A local employment contract complicates not only the payroll (personal income tax) but social security compliance as well. It’s even more complicated when there is no international social security agreement between the home and the host country, as dual social security compliance may apply. The local employment contract should be avoided – compliantly – wherever possible.
Here’s an interesting question for legal counselors/employment law specialists to discuss: is it possible to have two employment contracts for the same job/position?
3. Employment without establishment
When the employment without establishment (EWE) structure is used, the home entity does not have any legal presence in the foreign country. Due to whatever business reason, it would like to employ someone locally ie. there is only one employment contract in place. The contract is generally tied to the foreign country’s law rather than the home country’s law. The place of work is also generally in the foreign country’s territory. Since there is no local/host entity under EWE, special registration, compliance and reporting rules apply.
The EWE structure can pose a corporate income tax risk, so careful planning is recommended.