Taxing situations for expatriates

Taxing situations for expatriates

Sarah Fister Gale

There are so many financial implications associated with sending employees on assignments in foreign countries that it’s a wonder companies send anyone abroad. The cost of sending an employee overseas has been estimated to run three to seven times that person’s salary, annually. In other words, if an employee makes a base salary of $100,000, it can easily cost half a million dollars for that person to take a position overseas–and much of the additional cost is tax related.

Tax equalization, country-to-country tax treaties, income tax, and property tax are among the myriad issues that must be addressed when an employee takes on an expatriate assignment, says Brenda Fender, director of International Initiatives for the Employee Relocation Council in Washington, D.C. “The complexity of tax laws for expatriates is unlimited,” she says. “Taxes can be the largest cost associated with overseas assignments, and there is an endless variety of situations that occur.” The country of origin, the host country, the length of stay, and the present economy are all factors in managing expatriates.

The most frequently heard advice from individuals who have handled the human resources side of an expatriate project is to get outside expertise early on in the process. That doesn’t mean asking your regular tax guy to get involved, Fender says. You need a company with experience handling taxes in the host country and representatives in that country who can meet with your employees to help them handle their financial situation.

You also should have all of the financial aspects worked out before employees and their families get on the plane, warns David Kolb, partner at Global Tax Network, a tax services company based in Denver. “If you wait until they are already abroad to address tax and other financial issues, it’s going to cost you a lot more than it should have.”

The biggest cost–and headache–comes from the additional income tax in the host country. Income tax is comparatively lower in the United States than in most European countries, which means employees are faced with surprising tax burdens in their new assignments. Most companies use the tax equalization law to reduce that burden. Through tax equalization, the employer withholds the amount of money the employees would have paid in U.S. taxes from their paychecks, then pays all of their taxes in the host country.

That typically adds thousands of dollars to the cost of the assignment, says Tim Lenne-man, managing partner at Global Tax Network, but it’s just the beginning of financial complications for expatriates. Beyond taxes, you need to know how other cost-of-living increases will be handled, and who pays for housing and education expenses. You don’t want to just boost the employee’s salary, because it sets expectations for compensation when he returns to the United States, he says, but the employee still needs a package that puts him in a comfortable financial situation.

To manage expectations, living, housing, and school costs are typically added on to the employee’s base salary as allowances, but they still can count as taxable income, so it’s important to make educated choices, Kolb says. When you work with a firm that understands the tax and financial situation in the host country, you can find ways to reduce the burden. In some countries, for example, if the company rather than the employee leases the housing, it’s not taxable income. In Japan, a company can make a donation to a school in exchange for free tuition to eliminate tax implications. “There are a lot of ways to manage costs, and companies are motivated to find them,” Kolb says.

However, it’s a tricky balancing act to find cost-saving measures that don’t backfire, says George Doyle, president of Lexicon Relocation, Inc., a relocation support services company in Jacksonville, Florida. You want the best price but also need to rely on the service. For example, you want your housing locator abroad to find suitable housing for employees at a reasonable price. And you want to be sure that the company delivering your employee’s household goods gets them there on time so the employee’s family doesn’t have to live in a $400-a-night hotel for three weeks. “You need dependable relationships with people who have local knowledge,” Doyle says.

You also want to be sure your employees have the financial guidance they need when they need it, says Lenneman. That means there is someone in their host city who can answer their questions and help them deal with their financial situations, whether it’s leasing a house or filing tax statements. It’s a matter of productivity and satisfaction, he says. If an employee is frustrated or feels abandoned in the host country, she is more likely to give up and come home before the job is over. “The cost of a failed expatriate assignment is huge,” he says.

Small Firm Delivers Big Savings

Name: Ariba Inc.

Location: Sunnyvale, California

Type of organization: Developers of “spend management” software

Number of employees: 820

When Debbie Haynes, global mobility consultant for Ariba, needed an overseas tax accountant, naturally she thought of the Big Five accounting firms, because in her experience, they were the only ones that offered these services. So when her team set up interviews, it was with four of the top five firms–and a representative from a relatively small firm, Global Tax Network, because it was recommended by a coworker. “I met with them as a courtesy,” she says, “but in my mind, I was only considering the Big Five.”

That is until the meetings took place. In the first four meetings, Haynes was given slick presentations by the big firms touting their product offerings. Then David Kolb from Global Tax came in. “He blew our socks off,” she says. And not because he had a flashy multimedia show or fancy brochures. What impressed her was that he sat down and started asking questions about her needs. “It was like he interviewed me,” she says. He asked what their expatriate program needed, how the company felt about the service, how the expatriates felt about the service, and what they thought was missing. “His approach was refreshing;’ she says. “It was a big revelation. I assumed the Big Five were my only options.”

Haynes hired Global Tax in 2000 to manage the 15 expatriates Ariba had in Germany, France, the Netherlands, the United Kingdom, Japan, and Australia. That included taking over the financial situations left by the previous firm. “The first year was a nightmare for him,” Haynes says of Kolb’s work cleaning up unfinished tax business for the program. He reviewed all the foreign and domestic tax returns for every expatriate and discovered that many of them had never been filed and that tax equalization payments hadn’t been made, she says. By the end of the year, however, he had resolved all the problems, and saved Ariba close to $1 million in tax payments and equalization payments alone. “We could not have done this without him,” she says.

Along with the $1 million savings from previous years, Haynes now pays less for expatriate assignments, thanks largely to the one-on-one support she gets from Kolb, which includes individual training on foreign tax laws and how to structure expatriate packages so the company benefits from various tax treaties. “He went over our expatriate policy and told us word for word what makes sense and what we can do differently to save money,” she says. For example, he creates different payment structures based on the length of the assignment, and shows Haynes’s team how to monitor the number of days that expatriates are working in a particular country to establish which country receives which tax dollars. He also helps them create tax-payment policies for non-company income, which her old firm never addressed. “He always tells us how to reap every benefit possible.”

But the real payoff in choosing a tax firm that focuses on customer service is the relationship, Haynes says. She knows that, day or night, if she has a tax problem, she can call Kolb, who is a partner in his firm. “You never get help from someone that high up at the bigger firms,” she says. She also finds that Ariba employees prefer working with the smaller firm because the team is more personal and helpful. “We have a good rapport, which makes everything easier,” and that, she says, is what every tax firm should deliver.

Haynes advises anyone shopping for a foreign tax firm to make sure the service they get is worthy of the fee. “That means access to an expert when you need it, customized plans based on your company’s policies and needs, and detailed invoices that show you what you are paying for,” she says. “If you are not getting that, there are alternatives.”

Cutting Costs by Training Local Talent

Name: CH2M Hill

Location: Denver

Type of organization: Engineering design firm

Number of employees 11,000

Of the more than 1,000 employees that CH2M Hill has working in 20-odd countries, only 4 percent are U.S. expatriates. “It wasn’t always that way,” says John de Leon, vice president of international human resources. “The number of expatriates in proportion to the size of the company has gone down dramatically in the past five years.” For example, in 1998, they had 10 non-Spaniards in their Spain office. Today there are none.

The drop is intentional and it happened for several reasons, he says. “We’ve had re sounding success developing local talent to run our businesses,” which has always been a goal. “Nationals understand the culture and language better than expatriates, and they cost a lot less.”

Expatriate salaries are usually higher than those in the host country, and the extra costs that go along with foreign assignments drive up the pay-package price considerably. That’s not to say de Leon won’t send a U.S. employee abroad. “The first challenge in filling a job is always to find the best person.” If the talent can only be found in the United States, his goal is to find someone who can work well cross-culturally and transfer the skill set to the local workforce.

Once someone has been assigned, there are three major cost categories in addition to the base salary that de Leon has to manage. Taxation is the first and typically most expensive. In most cases, CH2M Hill offers expatriates tax equalization to sweeten the deal. It adds a lot to the cost of the assignment but makes the transition easier, de Leon says. For example, expatriates in Germany may incur twice the income tax they would in the United States, and they are taxed on their housing and cost-of-living allowances as well. Even the tax payment becomes taxable when the company covers it, he says, which adds to the complexity and growing costs. “This financial snowball effect is a great incentive to make sure we really need to fill the position with an expatriate,” he says.

He uses a tax firm that specializes in handling expatriate assignments to manage these issues, and says that the most important thing to look for in a tax services provider is customer service. He finds that shopping around for service providers and building relationships with multiple vendors gives him a sense of comparison and competition. “It’s easy to determine if a tax firm has expertise and access in the host country,” he says. The differentiator, he says, is whether they are accessible and communicate well with your employees, explaining the tax situation in terms they understand. “Foreign taxation is so complicated that the level of communication is critical. You want someone who has an empathetic attitude, who can understand the human side of the tax situation as well as the technical aspects of it,” de Leon says. “When employees have someone like that to help them, they will be more productive and they will see that the company cares about them.”

After taxes, housing and education add the most expense to an expatriate assignment. U.S. employees will expect to replicate their housing situation in the host country, de Leon says. Depending on the country they are going to and the city they left, that can get unrealistic. “If someone has a half-acre wooded lot in Texas, they are not going to find that in Tokyo.”

De Leon relies on strong relationships with destination service providers to manage housing costs while keeping expatriates happy. They greet the newly arrived family and show them housing that meets their requirements and is reasonably priced instead of immediately showing them accommodations that add thousands to the projected housing costs, he says. “Without a good relationship, you are at the mercy of your housing service.”

Finally, when expatriates take their families overseas, they expect to send their kids to private English-speaking schools, he says. The tuition adds $12,000 to $15,000 per child per year of taxable income.

Overall, CH2M Hill spends three times the base pay of its expatriates per year, which is on the low end of average for a US. expatriate assignment. “If you do your homework, you can find important opportunities for savings;’ de Leon says.

Quick Fix Is a Bad Idea

Name: Great Place to Work Institute

Location: San Francisco

Type of organization: Research and management consultancy

Number of employees: 14

Employees naturally expect to be treated well by the company that produces the Great Places to Work lists for 23 countries. So when Amy Lyman, president of the institute, wanted to put together a package for the company’s first expatriate assignment, she struggled with how to make it good–but not too good.

In 2001, the institute already had several affiliates established in foreign countries, but Lyman needed someone with experience to set up the 100 Best Companies in Europe list. Fortunately, the employee who had established the original Best Companies structure for the U.S. lists wanted to move abroad, and her partner had dual citizenship in the U.S. and the United Kingdom. “They both saw relocating as an exciting opportunity for them, not as being uprooted. It made tremendous sense for both of them,” Lyman says.

But Lyman didn’t have the first idea what needed to be done. She admits that she was very naive about the complexities of arranging an expatriate assignment. “My biggest problem was creating a compensation package that would work for anyone we moved overseas, not just something special” for the relocating employee.

Lyman also quickly discovered that the institute’s tax accountant did not have enough expertise in foreign taxation laws to manage the assignment. “As a small company doing this for the first time, we needed someone who could explain everything, from how to compensate for housing and living costs to how to count 401(k) contributions and pay medical benefits in the U.K.”

Finding a service provider that talked to her in plain English about the tax implications was critical to the success of the assignment. “It’s amazing how complex the tax laws are;’ she says. “If we had done this on our own, it would have been a financial disaster.”

Lyman used a firm that specializes in expatriate tax law, which helped her avoid some costly mistakes. For example, she initially wanted to go with an “easy fix;’ raising the expatriate’s salary to accommodate all of her financial needs in the U.K., but quickly learned it was not the right approach. “We found out that it was better to set the salary at what it would be in the U.S. and add living adjustments.” That way, the compensation expectations for the employee’s return were managed, and Lyman can justify the package if other employees want to know why they aren’t receiving the same amount.

Because they got the expertise early on, the assignment was a success, so much so that the expatriate asked to extend her stay an additional two years, Lyman says. “It changes the tax situation, but we trust that our tax person will make it work.”

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