The Effect of Exchange Rates on Expat Salaries

One of the less obvious, but critical issues of structuring an overseas assignment is how an expat worker is paid, and what effect currency exchange rates may have on the actual salary amount. Because of different approaches to paying an expat’s salary, there is no one way to analyze this problem and in many cases, it will depend on the nature and length of the assignment as well as specifics of the employment contract.

Go to the profile of Tim Burgess
Feb 15, 2017
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One of the less obvious, but critical issues of structuring an overseas assignment is how an expat worker is paid, and what effect currency exchange rates may have on the actual salary amount. Because of different approaches to paying an expat’s salary, there is no one way to analyze this problem and in many cases, it will depend on the nature and length of the assignment as well as specifics of the employment contract.

The Key Issues In Assessing Currency Rate Fluctuations for Expat Salaries

Currency exchange rates become an issue for an expat’s salary in two ways:

  1. The final cost to the employer for the assignment
  2. The amount of money the employee receives, relative to both their home currency and the currency of the foreign country where they work and live while on assignment.

Short term and temporary assignments present less of a problem, since extreme currency fluctuations typically occur over a longer time frame. However, for longer term assignments, it is not difficult to imagine scenarios where there could be an imbalance created by exchange rates that benefit either the employer or the employee. The main approaches used are designed to minimize any extreme currency imbalances, or at least define which party bears the risk.

Questions that must be addressed of an expat’s salary by multinational employers include:

  • Whether you should offer contract provisions to adjust salaries if exchange rates vary by more than a certain amount.
  • Do you write these currency buffers into the employment contract and do you account for it when budgeting the position?
  • What happens if the exchange rate moves in the employee’s favor, or if the currency pair is a volatile rate that changes all the time?
  • The answer to these questions may lie in the specific approaches commonly used to manage expat salaries when on assignment.

Comparing the Three Most Common Approaches to Expat Salaries

The three main approaches used are:

  1. Localization
  2. Equalization
  3. Expat Package (for special hardships from the assignment)

Localization

Localization may be the best for the employee, since the expat salary is fixed in the local currency, allowing them to budget for living expenses in the local economy with no unexpected surprises due to fluctuating currency rates. Therefore, the employer would shoulder any changes in exchange rates, either up or down, and the employee would receive a constant salary amount in local currency. This approach places the burden squarely on the employer in terms of budgeting for the position and anticipating changes in exchange rates.

Equalization

With equalization, the expat salary is fixed at a rate based on the home currency, rather than the local, foreign currency. So, if the exchange rate fluctuates such that the worker receives a lower payout in local currency, they will have to adjust their local living expenses and budget, which may seem like an unfair burden of the work assignment. Sophisticated expats might use some form of currency hedge such as forward or futures contracts, but this is out of the normal expertise for the average employee.

Of course, the employee could also benefit from a change in currency rates that strengthens the home currency relative to the host currency, effectively increasing their salary in terms of the local currency. Equalization may require some type of exchange rate buffer in the employment contract to protect the worker against an unforeseen change in currency rates that decreases their take-home pay in the local currency.

Expat Packages

In this scenario, the expat assignee is compensated for any special hardships or costs to the assignment, including housing allowances, education costs or provisions for currency rate fluctuations. This was the normal practice historically since the expat assignment was seen as undesirable or disruptive for the worker. However, overseas assignments have taken on a new attraction as a means toward career advancement. So, the trend is moving away from offering significant compensation for the effort and displacement involved, and that includes generous exchange rate protections.

If localization and equalization are now emerging as the standard practices, it raises the question of how an employer can protect itself and their employee from dramatic changes in currency rates. One answer to this may lie in the method of offering dual or split payrolls to expat employees as a means of spreading out the risk, and minimizing adverse changes in the salary amount.

The Use of Dual or Split Payrolls to Offset Exchange Rate Fluctuations

One solution for guarding against the risk of currency rate fluctuation is to use a shadow or split payroll arrangement. This strategy can allocate a portion of the salary in the home country currency, and the remainder in the host country currency.

Allocating a Split Salary According to Employee Expenses

For example, if the expat has fixed, ongoing expense in their home country such as mortgage payments, pension contributions or health insurance, then those amounts could be paid in the home country currency.

Other expenses related to the assignment, such as rent, food and other living costs could be paid in the local currency to ensure that the employee does not have a monthly shortfall because of exchange rates. Housing allowances could also be paid in the local currency, based on a cost of living index in the host country to ensure fair compensation across specific employee classifications.

Additional Advantages of a Split Payroll

In addition to apportioning exchange rate risk, a dual or split payroll can offer the advantage of fulfilling local payroll requirements such as tax withholding or meeting minimum wage standards. There are accounting complexities to overcome, but in the end an employer can manage the employment contract in a way that controls costs, and assures the employee of a constant salary level. The split payroll can be adjusted for each employee, depending on where they have the majority of their monthly expenses, either at home or overseas.

How to Use a GEO Employer of Record to Manage Exchange Rates for Expats

If a company is using a split or dual payroll to manage exchange rates, this process can be streamlined by using a GEO local employer of record in the host country. The GEO will run the host country portion of the payroll, ensuring full compliance with local tax, withholding and employment requirements. In this way, the issue of exchange rates is mitigated without creating any problems with authorities.

Summary

The complexity of running an expat salary and payroll presents additional challenges when exchange rates are taken into consideration. Because there are related issues of local statutory compliance, income taxation at home and in the host country, and the duration of the employment contract, it may be useful for a company to consider using a payroll solution such as Shield GEO. Shield can help you evaluate the advantages and disadvantages of using localization, equalization or split payrolls to offset the risks of currency rate changes for your company and expat employees.

Shield GEO makes international employment simple. Our customers use Shield GEO to employ and payroll hundreds of workers in over fifty countries. Find out more


Go to the profile of Tim Burgess

Tim Burgess

Director, Shield GEO Services Ltd

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