What should today's expatriation administrators look for when it comes to ensuring the implementation an assignment programme that is tax-compliant in the country where it is operated?

Today's administrative requirements are slowly but certainly becoming a nightmare to expatriation administrators. Recent scandals in the business world have forced legislators to implement strict regulations, and to put a significant effort toward enforcing these rules.

International employees by definition have issues in multiple countries

The corporate landscape has changed dramatically in the last few years. It is hard to imagine that once there was a time when there was a general conception that most companies obeyed the law, that a financial administration, once audited, could be relied on, that the proper amounts of money were put in a financial administration, that the public could feel safe in its assumption that financial administrations were correct.

Big business scandals were rare, and most of the time related to individual greed. They did not often lead to the conclusion that something significant was wrong within 'the system'.

Then a pile-up of cases of eminent issues with large companies shook the public and the business community. To many of us, accounting problems arising in companies like Waste Management, Sunbeam, Phar-mor, Enron, Tyco, WorldCom, Global Crossing, and Adelphia are still fresh in our memory. It is not fair to only focus on U.S. companies here; the problems arose in more countries than the United States only as several non-U.S. companies encountered their own issues, as well.

The apparent deficiencies of the 'old' system have lead regulators, as well as the pubic, to believe that it is necessary to draft and enforce new legislation, ensure that cases like the ones mentioned above will be prevented from happening again in the future. This has occurred in many jurisdictions, each in its own way.

As international companies operate in several jurisdictions, the rules of multiple countries generally need to be taken into account. Regulators in many countries have taken action to try to leave no room for fraudulent behaviour. The Sarbanes-Oxley Act, which was signed into law on 30 July 2002, is an example. Sarbanes-Oxley requires executives, boards of directors, and auditors to take responsibility for precise measures to bring about greater corporate accountability and transparency. Notably section 404 of the Act, which seeks to enhance the reliability of internal controls over financial reporting, has received a lot of attention.

As the internal control structure and procedures for financial reporting also regard expat payrolls, it goes without saying that this section also has significant relevance for companies operating an expatriate programme.

However, it is not just legislation aimed at improving corporate governance that is playing a role here. When we look at the broader picture, we see that many governments are focusing much more than before on reviewing legal compliance. This regards tax law, too.

Now, tax authorities are paying more attention to and gaining a better understanding of issues related to having an international workforce. And this must sharpen engagement managers, as well as mobile employees. The increased attention for corporate governance, legislation enforcing corporate governance, and an increasing focus of tax authorities on compliance with tax law causes an increased burden on the shoulders of engagement managers to ensure that a company is fully compliant.

Surviving the jungle of international tax law

The engagement manager is getting more of a crucial role in making sure that the company's expat programme is compliant with all local and international legislation aimed at safeguarding certain corporate governance standards and ensuring compliance with the regular immigration and tax law.

To most engagement managers, this implies a significant burden of work on top of the regular duties. In the past, the first and most important focus was to ensure that the best individual for the job was assigned to a certain location without causing disturbance in the private life and in the business process.

Now, another important burden has come on the shoulders of the programme manager: ensuring global compliance with corporate governance, tax, and immigration law. And practice is teaching us important lessons on how to structure processes to ensure compliance.

Before summarising the most important lessons learned so far, I want to provide an example that illustrates the issue at hand from a tax perspective.

A tale from the practice

The practical problems can be illustrated best by using a hypothetical case. I want to make this example a bit easier than real life generally is. I assume that a company has implemented an assignment policy (and only one policy), and eliminate the practice that we often see, where certain home or host employers grant additional perks to an employee that are not provided for in the normal policy. Our hypothetical multinational company, MNC Inc., offers its assignees the following benefits: base salary; variable bonus pay; one home leave trip per year per family member; and a fixed budget for spouses, where the spouse is granted a lump sum of USD 5,000 to either start an education or to try to find a job in the host location.

To many companies, it turns out to be quite difficult to ensure that the proper amounts of tax and social security contributions are paid into the respective home and host authorities.

When reporting the home-leave ticket properly, the company first needs to be aware of whether an assignee and his family members have used the entitlement to home-leave tickets. Practice teaches that some home-leave tickets never hit accounting records as home-leave trips, but, for example, as business trips. This may have various causes, ranging from an expat who is unaware of the proper procedure, to a business manager who has a business interest in having the cost hit the books of his own business entity rather than a human resource budget. This makes it difficult for programme managers to identify whether an assignee has used his share in tickets, but also for payroll administrators to ensure proper withholdings.

Second, assuming that the company is aware of home-leave taken, and assuming that the home leave ticket has hit the proper cost centre, it needs to verify that when the tickets actually were used that they were reported properly in the payroll administration. Several issues need to be addressed here. In this respect, it is important to find out how the cost hit company records. An assignee can purchase tickets in private and expense them, or have tickets booked via a corporate travel agency. Tax consequences of both options can vary in some jurisdictions.

Also, when cost hit the proper cost centre, the payroll administrator needs to know how the benefit is taxed. Most payroll administrators are far more experienced in local employees than expat employees. Therefore, it may be difficult to them to determine the exact tax consequences of a home leave ticket. A business trip that is a combination of business and pleasure can even add to this uncertainty.

For example, the expat also spends some time in the office. Does the ticket then constitute taxable income? And what about the hotel bill? Should that be picked up by the company, too? Another concern is how to treat the ticket of a partner. In most cases, the partner will treat the home leave as vacation. However, situations may arise in which this is not the case. An example is when the partner joins the employee at a corporate event where the presence of the spouse is expected.

The above questions are relatively easy to answer, as the answer only depends on tax knowledge of one country. However, an additional complication can arise when the individual has (income and/or social security) tax obligations in home and host countries. This especially will be the case with US outbound assignments, and assignments where existing totalisation agreements are used, under which an individual remains covered by his or her home country social security system.

Whenever possible, assignees prefer to remain covered in their home country social security scheme. In most cases, this means that a process needs to be in place where a tax payroll is run in the host location, and a separate payroll for social security purposes is run in the home location. Benefits provided by the host location need to be reported to the home location, as this will influence the amount of social security tax due.

What we often see when a second payroll is involved is that the problem becomes three times the size it was before. Not only do both payroll administrators need to know what the tax treatment is, they also need to ensure that proper communication is in place between both countries to ensure that everyone disposes of the same information at the proper moment in time.

The spouse allowance also can have a significant impact. The tax treatment of this allowance can vary from country to country. In general terms, there are different treatments around the world, depending on how the allowance is qualified. In most cases, it is considered income to the assignee. However, the country where the benefit is taxable may be determined by the moment the payment is made, and the company (home, host, or third country), making the payment. Also, social security can have a significant impact.

So far, we have looked only at dry tax theory. Now, the moment has come to try to quantify the problem. Assume that MNC Inc. is a company with 250 assignees, 200 partners, and 150 children. All are entitled to one home leave ticket per year. The estimated average marginal global tax rate for individuals assigned by this company is 50 percent. The average marginal social security rate is 10 percent. The average home leave ticket cost is USD 1,000, and the assumption is that 30 percent of the cases are incorrectly reported. The penalty for non-reporting can range between 50 and 100 percent of the tax due.

Doing the maths, this brings us to a total of 600 tickets (250 + 200 + 150) with a total value of USD 600,000 (600 X USD 1,000). The total tax liability (income plus social security tax) on these tickets amounts to 60 percent of USD 600,000, or USD 360,000. This amount is before gross-up. After gross-up, the amount is USD 900,000.

Because 30 percent of the cases are not reported properly, a total of USD 270,000 is not reported each year, which is generally increased by a penalty. This ranges between 50 and 100 percent of the tax due. Therefore, in this example, the total exposure can range between USD 405,000 and USD 540,000 for a single compensation item in a single year.

The potential exposures relating to other compensation items, such as base salary, bonus mismatching, spousal programmes, stock option income, non-reported tax liabilities of stealth expats, and the like, will further increase this exposure, as well as the number of past years' authorities included in audits.

Lessons learned

It is becoming increasingly important for international businesses to have proper reporting systems and to have the best control mechanisms possible. Especially when dealing with international employees, there is a fair chance that organisations are not in compliance with the law by both not having the proper controls in place, or by not reporting the correct amounts. This can have a variety of causes, but the major cause is a combination of the facts.

Firstly international employees, by definition, have issues in multiple countries. The fact that multiple individuals within an organisation hold relevant information adds to the exposure, as well as this information often not being shared with the proper person responsible for processing it. Also, the fact that international employees are usually exceptions to the administrators who have to report their income does not make the process less subject to mistakes.

And maybe one of the most important things to think of is that even though at first glance we may not be talking about significant numbers, the total liability for an international population likely can become significant.

Nino Nelissen is director, Executive Mobility Group, Schiphol Airport, the Netherlands, and a member of the MOBILITY Global Editorial Advisory Committee. He can be reached at +31 20571 1831 or e-mail nino.nelissen@executivemobility-group.com.

December 2005

Reprinted with permission of Worldwide ERC®, from the December 2005 issue of MOBILITY.

Subject: Expatriate tax compliance, international tax law and expatriate programmes