Release date: November 18, 2015
Running time: 08:10 minutes
In this final episode of our “Top global mobility issues facing Tax Directors” series, we discuss the concept of tax equalization and discusses why it is important for companies to assess the potential challenges and costs related to tax equalization treatment for compensation provided to employees in home and host locations.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.
You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Chantal: Hi, this is Chantal McCalla. Welcome to our last podcast in our series discussing the top mobility issues for Tax Directors to think about. Today we are discussing tax equalization costs. We have Candace Doig, a Senior Manager from the PwC Human Resource Services tax group here with us. Candace specializes in international assignments and expatriate tax management at PwC. She has been working exclusively in this field since 1999 and has been with PwC for 14 years.
Candace: Thank you Chantal.
Chantal: Candace, it’s my understanding that some companies implement tax equalization arrangements when an individual goes on a foreign assignment. Can you give us a brief description of what tax equalization means?
Candace: Definitely. The general concept of tax equalization is that the employee’s share of tax will be no more or less than it would have been had they not been working in the foreign country. The employee is held to a hypothetical “stay at home” tax, which is usually based on the home country tax laws.
To clarify, tax equalization essentially puts the tax burden on the corporation. That is, the corporation becomes the one obligated to pay the actual home and host country taxes imposed on the employee. In return, the employee pays a “hypothetical” tax amount, which invariably should equate to his or her “at home” tax obligation.
Chantal: Ok, this sounds pretty straight forward. Now, thinking about our topic, “tax equalization costs”, why is this important for companies to assess?
Candace: Well, historically, this is a cost that does not get evaluated properly, but it does represent a real cost to the company. It is important to be aware of the tax equalization cost before an employee goes on foreign assignment, in order to properly budget the cost vs benefit of the assignment. This can be difficult when dealing with foreign country taxes and different tax laws.
Specifically, if the company is bearing the burden of the tax during the employee’s foreign assignment, it is important to know or estimate how much overall tax cost the company is going to incur for the entire length of the assignment. If the tax equalization costs are not properly analyzed, companies can be in for a surprise when it comes to budget reviews.
Chantal: Candace, it sounds like potentially costs can really sky rocket if they are not managed properly. Is there anything a company can do to mitigate this from happening?
Candace: Yes, there are ways to limit a company’s exposure to tax and additional costs during the length of an assignment.
For an example, an employer should specifically review and analyze exactly what types of income will be subject to tax equalization. Is it all types of income — including non-company income? Or is it only company income? And if so, what company income is included?
What an employer needs to keep in mind with personal income is that not all income is taxed the same way in different countries. For example, what may trigger capital gains tax in one country might be viewed as ordinary income in another country. This could mean that the foreign location’s tax could be much higher. The question here is — who is responsible for absorbing this additional tax burden? If the employer is absorbing the cost, then this could be extremely important to know at the outset of the foreign assignment so that this cost can be properly budgeted for. If the employee is absorbing the cost, then an agreement up front will be required so that he or she knows and understands the taxes they are responsible for in both the home and host countries.
Also, companies may consider policy changes for employees who separate from the company, but decide to remain in the foreign country. Should these employees be able to expose the entity to increased tax gross-up costs on final tax equalization settlements?
To formally address these types of questions and the specific home and host country nuances, we recommend implementing a tax equalization policy to address the different foreign assignment facets or where one already exists, benchmarking the policy against current industry standards to help form a different and more relevant point of view considering the changes in global mobility trends these days.
The tax equalization policy can be developed to mitigate costs by addressing different assignment types and compensation elements. It can also act to level the playing field amongst employees travelling abroad, whether the assignment is short term, long term or a hybrid.
Chantal: Thanks for that detailed response Candace. Can you describe any challenges companies may face while trying to assess their tax equalization costs?
Candace: Yes, what can be challenging is that there are so many different types of compensation structures available today — it’s not just salary and bonus for most companies anymore.
Many companies have variable pay components that are not necessarily a guaranteed payment to the individual — rather, the payments rely on employee performance and potentially also the company stock price. Items like stock based payments are a popular incentive. As a result, these types of payments can be very difficult to budget and account for with respect to how much an assignment will cost the employer. The reason being is that it is difficult to predict employee performance and company stock price before an individual goes on assignment. In addition, what must also be considered is how these items are going to be taxed in the foreign location.
Chantal: I see, so what you are saying is that for accounting and budgeting purposes, a company needs to account for the cost of sending an employee on assignment and this can be very difficult to predict, especially without a tax equalization policy that addresses specific types of income and deductions.
Candace: Yes, that is correct Chantal. The cost of tax equalizing employees can be very expensive, especially if not properly budgeted for.
In order to address some of the unpredictability, companies should develop a base line cost estimate of their tax equalization expense and formalize an accounting policy to deal with the variable pay components. Steps should be taken to avoid large tax equalization and gross-up payments that are not properly budgeted and accounted for within the books and records of the entity.
Chantal: It sounds as though there are a lot of considerations for a company to consider with respect to tax equalization policies when sending employees on foreign assignments.
Candace: Yes, there certainly is Chantal. Formal tax equalization policies, however, are the key to establishing even ground and can help companies properly budget and account for tax equalization expense.
Chantal: Thanks for joining us today, Candace. For any questions pertaining to tax equalization costs, Candace’s contact details are listed on our PwC podcast website atwww.pwc.com/ca/taxtracks.
This concludes our multi-part series on the top global mobility issues facing Tax Directors today.
You can find all episodes in the series on the Tax Tracks website.
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