How to determine if your Tax Equalization Policy is up to scratch?
Understanding elements to include when designing a Global Tax Equalization Policy
When it comes to a Tax equalization Policy how effective is your companies? What mechanism is in place to confirm all reporting is accurately happening? What does the Tax Equalization policy actually include? When it comes to designing the Tax Equalization Policy, how was it designed?
Many companies often say they have a Tax Equalization Policy in place, however when you dig a bit deeper the only item that is actually in place is a commitment to make sure the assignee pays the same taxes had they of remained at home – hence they are equalized to their net home position.
I have often wondered how companies can make such sweeping statements? What items are they actually Tax Equalizing? How are they calculating the appropriate hypothetical taxes? It can be a mind field as there are a number of considerations to take in to place, designing a solid Tax Equalization Policy becomes almost a work of art rather than a science.
There are countries where molding a Global Tax Equalization Policy can become even more of a challenge. Countries such as the United States of America, have legalities where citizens or permanent residents are taxed on their worldwide income. To build a robust Global Tax Equalization Policy an understanding of the lack of consistency in tax regulations requires careful planning. Key areas to take into consideration are local payroll requirements, permanent establishment risks, uncertainty around the economic employer concept and different minimum day thresholds for taxation and treaty relief.
As an example, for expatriates out of the United States to qualify for taxation or treaty relief the assignee must be out of the US for 330 physical presence days or qualify by Bona Fide Residence. Foreign Earned Income and Housing exclusions can be claimed to help reduce the double taxation bill, this typically works better when the host country has a lower tax rate than the US. Foreign tax credits can be used to claim a credit on US tax due on foreign source income, it typically works better where the tax rate in the Host country is higher than in the US. There can be no double dipping, both methods cannot be used together.
The main principles that should govern the Tax Equalization policy is the need for a flexible approach to make sure it is robust in all jurisdictions. Key elements should be included but should allow for variations depending on country combinations. All taxes should be addressed such as social, municipal, national, provincial and wealth; all income such as employment, investment and spousal; and all eligible deductions such as family size, mortgage interest and filing status.
Often methods of Tax Protection were used in European countries instead of Tax Equalization due to the fact that tax obligations seize in home jurisdictions. The benefits can be significant as the assignees will be no worse off but the assignee can be better off if the host location has a lower tax rate. That being said it is cheaper for companies to maintain. There is no need to gross up the tax and there is no need to advance the tax payments, which can of course have negative impacts to the assignee such a negative windfall.
Creating a robust Tax Equalization Policy process takes planning, there are methods of how to pay the home taxes which includes the grossed up approach or the advanced approach. The whole method relies on a solid tracking mechanism, it relies on the assignee submitting their tax information in a timely method, it relies on potentially offering tax services for a couple of years after the assignment has ended as there maybe foreign tax credit carryovers.
There are three main ways to carry out a Tax Equalization Policy, option one the assignee receives or pays any balance due directly to the tax authority, this method adjusts the balance accordingly in line with the Tax Equalization Policy. Option two, if there is a refund the company pays the assignee however if there is a balance due to the company the assignee does not need to repay anything. Option 3, uses a fixed formula, deducts a housing norm and personal tax items (interest, dividends, capital gains, spousal income and rental income) are not equalized but the assignees responsibility.
To make the Tax Equalization Policy work in the most cost effective method it is critical for COLA and Location premiums to be looked at and adjusted regularly.
Creating a Global Tax Equalization Policy is not for the faint hearted, it requires precision and flexibility as well as an understanding of the varying loopholes. Benchmarking against industry and location norms is critical as well as using appropriate technology to make the tracking, tax collection and cost projections accurate. Overall the key is to make sure compliance is taken into account.
By Nicole Milman