In the world of long-term temporary assignments, two popular approaches are often used: the Home-Based Tax Equalized (also known as the "Balance Sheet") and the Host Plus (also known as "Local Plus"). Our blog series has covered the basics of each approach, how to select the right assignment approach and finally we focus on tax.
It’s important to know that expatriate assignments are not one-size-fits-all. The budget of the employer, priorities of both the employer and the employee, and the salary affinity between the home and host countries must all be considered when deciding which approach the employer will use. This decision should be based on a variety of factors: assignment length, level of employee, assignment purpose, intended assignment conclusion, and home and host location.
Tax Treatment
The Balance Sheet uses tax equalization. This is where the employer pays all the tax obligations in both home and host locations and withholds a home hypothetical tax contribution from the employee’s paycheck. The hypothetical tax is equivalent to what the average person typically pays on that compensation level and family size in the home location. Social security contributions are typically made in the home country by both the employer and the employee.
For Host Plus, the employee typically pays the host country tax obligation on their compensation. The employer will often pay any additional taxes owed on the gross-up of the benefits. Some policy decisions will need to be made as to who pays any home residual tax obligations, as well as where social security will be paid.
Each approach has its own benefits and challenges, and it is often important to understand which is best for each of your unique scenarios.
We asked Pat Jurgens, our Director of Global Tax, for a more in-depth explanation of the key differences between the home-based tax equalization and host-plus tax methods.
Tax Equalization
The premise of the 'Home-based Tax Equalized' methodology is to maintain the assignee's home-based salary and benefits, provide for over-base expatriate allowances and reimbursements intended to cover the differences in costs between the home and host locations, and to provide for tax support during the assignment in the form of 'tax equalization.' With this home-based approach, the employer's intent is to keep the assignee whole, maintain the assignee's purchasing power, and maintain the same ability to save.
The assignee's share of the tax cost under equalization is referred to as hypothetical tax and is deducted from payroll. This payroll deduction is based on the tax law in the home country, using their stay-at-home salary and bonus compensation. However, hypothetical tax withholding is generally not remitted to the tax authorities in the home country. Instead, the hypothetical tax withheld is used to help offset the tax costs to the company.
In exchange for deducting the hypothetical tax from the assignee's pay, the company agrees to pay actual tax liabilities associated with the international assignment. This will include any tax incurred in the host country and any home country residual tax costs.
Actual tax liabilities during the assignment will vary significantly from a stay-at-home tax, including the following key factors:
- The host tax system may result in a higher tax rate.
- The base salary and bonus are generally taxable in the assignment location, as well as most expatriate allowances and reimbursements.
- The company's contribution toward the tax liability is a tax benefit. This 'tax on tax' is handled through a gross-up calculation, so the calculated tax paid is inclusive of the taxable reimbursement of the employee's tax.
Tax equalization costs are often one of the largest cost elements of a typical home-based tax equalized package.
Host-Plus
The premise of host-based packages is that the employee is responsible for host income tax and host social security on salary and incentives because the employee is on local compensation terms and conditions, and typically is on the local payroll. The employer is responsible for actual tax and social security (primarily host income tax and host social security) on any taxable allowances and reimbursements included in the calculation.
This generally includes a 'gross-up,' as reimbursing employee taxes is also generally considered taxable. The assignee's share of the tax costs under the 'host-plus' methodology is limited to tax and social security due on salary, incentive, and allowances delivered gross, if any. The employer's tax costs will include tax gross-ups on the allowances delivered net and also will include the full amount of the employer's contributions to host country social security on all taxable compensation, including salary and incentive. Under Host-Plus, there is no expectation that the employee's purchasing power is maintained. Additionally, the employee's tax position will be subject to tax law changes in the host country.
In certain circumstances, the employee may also incur tax in their home country. For example, U.S. citizens may incur a residual United States income tax in addition to the host country tax. This residual home tax is net of double tax relief, such as the foreign earned income exclusion and a foreign tax credit. Employers may expect the employee to be responsible for this residual home country tax or assist with reimbursing this home country tax liability.
The best method for a company to use will depend on several factors, such as the tax laws of the home and host countries, the company's budget, and the employee's preferences.
Here are some additional things to consider when choosing between home-based tax equalization and host-plus:
- Tax laws: The tax laws of the home and host countries can have a significant impact on the cost of each method. In some cases, the home-based tax equalization method may be more expensive, while in other cases, the host-based tax gross-up method may be more expensive.
- Company budget: The company's budget will also be a factor. Typically, the home-based tax equalization method may be more expensive, but the host-based tax gross-up method may be more expensive depending on the amount of allowances provided, the country combination, family size, and income level.
- Employee preferences: The employees' preferences should also be considered. Some employees may prefer the certainty of knowing exactly how much tax they will owe, while others may prefer the flexibility of the host-based tax gross-up method. Future plans will also be a factor as to whether the assignee intends to return to their home country.
Ultimately, the best way to choose between home-based tax equalization and host-based tax gross-up is to work with a tax advisor to understand the specific circumstances of the company and the employee.
Pat will be presenting at our Global Tax Chat in December - subscribe to our blog to hear more!
