No one wants to pay more tax than they have to, which is why most multinationals use a method that benefits expats and the company.

Tax equalisation is a popular year-end settlement method as it ensures potential expats are not put off by the possibility of a job abroad simply because they may have to pay higher rates of tax.

The system ensures that the amount of tax an employee will have to pay will be similar, if not exactly the same, as the level they paid in their home country.
  
According to a recent survey by HR consultancy ORC, 83 percent of companies use tax equilisation for calculating their expats tax bills.

It basically operates by equalising out the rate of tax an employee pays at the end of the financial year between his or her original country of residence and that of the country they now work in, with the company paying any shortfall in taxation. The method is growing in popularity with companies based in Europe, the US and Asia as they attempt to cushion the financial impact of a move abroad for their most talented workers.

Another method is tax protection, which makes the company responsible for excess tax liability and allows the employee to keep the windfall.

While expat employees could be better off financially with tax protection, they often do not know their liability until they reconcile everything at the year's end. Also, tax protection tends to be more costly to run than tax equalisation.

“The tax equalisation system means that the expat should pay no more or no less than the taxes he pays in his home country,” says Joël Lebersborg, a director with the Brussels office of the accounting firm Deloitte & Touche.

“With this system, the employee is not being penalised or benefiting from a move abroad. It differs from tax protection in that the employee could be significantly better off in a new job, but will never be worse off.”

Tax equalisation is known as a balance sheet method in accounting terms. It means that an expat's tax liability is determined by base salary, a cost-of-living differential and a housing differential.

“The factor of uncertainty is taken away by this method,” says Lebersborg. “Any tax liability is covered by the home company and at the end of the year a hypothetical tax is withheld by the company. It means if the system is well managed there should not be any shocks for the company or the individual.”

The system ensures that it is not the tax issue that may persuade an employee to take a new job abroad or not, says Kathleen Billen, attorney-at-law at the Brussels-based law firm Loyens, which specialises in employment issues.

“It means there are no real disadvantages or advantages to a move abroad. If such a system is not in place it could mean that people become unhappy and that is not good for a company off-shoot’s moral.”

However, there are potential downsides to the system because some areas of an expatriate's package are not covered, such as stock options and other forms of bonus.

“Some companies…will only equalise the base salary and not other parts of the total remuneration package,” says Lebersborg.

“In certain parts of the world, stock options, for instance, are taxed on the granting of them, whereas in others they taxed on the exercising of them. This may mean that an employee finds they get away with paying no tax or that they may be taxed twice.”

There are also other issues that must be taken into account when setting up a tax equalisation systems, says Billen.

“It is very important to set it up correctly from the start or things could unravel later on. That means it must be properly audited by experts otherwise the company could end up with a heavy administrative burden.”

Companies should also cover themselves for the likelihood that some employees will leave before the predicted end of their stay abroad. If the business is not properly covered, they may find they cannot claim back any tax refunds from the other country’s tax system.

It is also a system that benefits from economies of scale that come from a large company rather than a small company operating such a balance sheet operation.

“This is definitely more burdensome for smaller businesses as they will tend not to have the expertise in-house and will have to buy this knowledge in,” says Billen.

July 2003