In the context of Global Mobility, with employees transitioning from one location to another location, there will be potential for cross-border tax issues. Whether this is a temporary assignment or a permanent move, income taxes may be due in both the origin and destination locations and there is the possibility that the same income is taxable to both tax jurisdictions. So double tax relief is essential to minimize the tax costs.
Tax on employment income is generally due in the location of where the employee is working. This is known as taxation based on the source of the income. This may not be the same location where the employee is tax resident. Residency usually means that residents are taxed on worldwide income. This can result in two jurisdictions taxing the same income if there is no double tax relief. Fortunately for Global Mobility programs, there are several ways to take advantage of double tax relief. Understanding these ways to minimize tax costs is essential for the global mobility professional.
Home Country Residency and Ongoing Tax Exposure
Most of the world taxes individuals on a residence basis, meaning an individual that leaves the country on a long-term or permanent basis is no longer taxed on income received outside of that country. Citizenship-based taxation in the U.S. requires individuals to report all their worldwide income, with (partial or complete) double tax relief available through foreign tax credits, foreign earned income exclusion under the U.S. Tax Code section 911, or income tax treaty application.
Under residence-based taxation, an individual may still be considered a resident during a short-term or temporary assignment. Breaking home country tax residency is not always a “bright-line” test, or something that can be declared by filing paperwork. Governments intentionally leave residence open to interpretation of the “facts and circumstances” that are considered, such as owning property, frequent visits, location of immediate family members, center of economic nexus, voting registration, maintaining a driving license, etc.
If an individual is considered a resident of their home country while on a temporary foreign assignment, they will typically be required to report their worldwide income and make use of double tax relief methods.
In subsequent AIRSHARE posts, we will discuss the four ways to claim double tax relief as well as the unique tax considerations for U.S. citizens and permanent residents (green card holders). We also have available for download our ‘Back to Basics’ whitepaper on the topic of U.S. residual taxation and double tax relief.
Double Tax Relief in General (FTC/EWP)
Double tax relief is exactly what it sounds like: a means to minimize your tax exposure to avoid paying full taxes in both home and host locations. Typically, the double tax relief is claimed on the resident tax calculation in the home country. The two mechanisms for home country tax relief are:
Foreign Tax Credits (FTC)
- The home country offers credit for taxes paid to a foreign country. FTC is generally claimed in the home country (where tax residency continues) for certain host taxes paid. Typically, this credit is limited to the amount of the home tax on the income being taxed twice.
- For example, the host tax is assessed at 40% on the income earned during assignment, but the home tax rate is 30%. The FTC would be limited to 30% on the assignment income (the graphic below illustrates this effect on double-taxed income of $100,000).
Exemption with Progression (EWP)
- Common in Europe, this approach to double tax relief considers the progressive tax rate when calculating the home tax for remaining non-assignment income. Typically, this results in a different home tax than using the foreign tax credit method. The graphic below illustrates this effect on total income of $100,000, with income only taxed at home of $70,000 and double-taxed income of $30,000 with host tax rate of 40% and a home tax rate with two tax brackets—20% on the first $70,000 and 30% on income exceeding $30,000. EWP pushes the non-exempt income into a higher tax bracket.
Impact to Global Mobility - The benefits of double tax relief: Low Tax at Host vs High Tax at Host
How much savings can be realized from double tax relief will vary based on the level of income for the employee, and the relative tax systems between the two countries. Generally, we expect there will be partial relief where the home country tax is not completely offset. This will occur for employees coming from a resident country with higher tax rates than in lower tax host countries. The double tax relief is not sufficient to eliminate the home resident tax. For scenarios when the resident country has lower tax rates than in higher tax host countries, often there is no home country residual tax because double tax relief has completely offset the home country tax. Effectively the overall tax cost is based on the tax jurisdiction with the higher tax rates.
Why not join the AIRINC tax team on the next Global Tax Chat.
