Deloitte reports on an important component of the expatriate compensation package: the application of a tax equalisation system.

The assignment needs to be tax-neutral

A company's reasons for selecting an employee to go on international assignment–whether it be specific expertise,  to manage a business start-up, or to prepare the individual for more challenging responsibilities within the international arena—are likely to be the same reasons given by the company to motivate and convince the employee of the uniqueness of the opportunity. 

However, the chosen employee will need to consider several factors carefully before accepting an international assignment.

Besides personal considerations such as career opportunities, timing, family adjustment, creation of networks and change of cultural environment, the employee will need to take a long, hard look at his or her compensation package.

Tax neutrality

A major component of a typical expatriate compensation package is the application of a tax equalisation mechanism.

Companies have introduced this tax equalisation or tax protection technique to ensure the assignee does not experience changes to their usual net salary due to adverse tax consequences of an international assignment, which would result in them being financially worse off than if they had stayed at 'home'.

The principal of tax equalisation is to ensure that the tax liabilities paid by an assignee will not exceed the taxes the assignee would have paid has they stayed in their home country. The tax impact of the international assignment is therefore tax-neutral for the assignee.

One of the main advantages of the tax equalisation system is that assignees around the world feel their company is treating them equally.  Also, employees are not deterred from accepting an assignment to a country with a higher tax burden than the weight of their current home country tax.

Tax protection

Tax protection means that, tax-wise, the assignee is not worse off on assignment than before, and ensures that the assignee will receive the tax 'windfall' or benefits if the actual costs are lower than they would have been had they stayed in their home country. In other words the assignee's tax liability is limited to the home country hypothetical taxes.

The challenge of private income

But what will the company's position be if confronted with extra taxes resulting from the employee's private or deferred income?

Should the company compensate for higher rates of inheritance taxes in the host country? Or should the company compensate taxes on capital gains in the host country while this income is exempt from taxation in the home country?
 
And how will the company be positioned regarding items with a tax-deductible character in the home country versus the non-deductible character of the same items in the host country?

For example, what happens if an employee who is assigned from Belgium to the United Kingdom decides to sell his principal home in Belgium? As these capital gains are exempt from taxation in Belgium, this decision might constitute an enormous financial burden for the company should these capital gains be taxed under the UK tax system. 

The challenge of equity incentives

Equity incentives are a challenge for both the tax equalisation and tax protection mechanisms.

For stock options, the taxable moment varies in several countries (at grant, vesting and exercise). Therefore it is perfectly possible that an assignee is faced with no taxation on stock options, or with a potential double taxation on the same options.

As both private and deferred income have the characteristic that they are difficult to monitor or to evaluate up front by the company and under certain circumstances even by the assignee, should we then conclude that it is the company's full responsibility to have a solution for all these questions at any given time?

And how will this uncertainty enable a company to control the company's budget?

With international assignments spread all over the world and the fact that there are as many different tax systems as there are countries, companies often do not have a solution for all the situations which may arise.

Tax equalisation policy

To facilitate the search for and the necessity of financial certainty and comfort for both the assignee and the company during the assignment, the development of a tax equalisation policy may be necessary. The ultimate advantage of such a policy depends on the clarity of its content.

The principal goal of a tax equalisation policy should be to provide the employee, as well as the company, with a clear view on the possible extra tax-related costs linked to the international assignment, as well as govern its application.

Capping personal or deferred income, which is taken into account in the equalisation process could be an effective preliminary caution. One step further could even result in the exclusion by the company of all or certain types of personal or deferred income from tax equalisation.

Notwithstanding the various angles of tax equalisation, it is clear that the disadvantages of tax equalisation such as requirement of a policy, possible unforeseen extra tax related costs, administrative burden, are minor compared to the advantages.

The benefits of tax equalisation, such as clarity of the tax liability linked to an international assignment, equal treatment of the assignees, an important factor in the acceptance of an international assignment, all ensure that the application of this system will retain its popularity within the complex world of international mobility.

30 March 2005

Myriam Van Erkel is a manager in the International Assignment Services practice of Deloitte in Belgium.  She can be contacted  by email at myvanerkel@deloitte.com or by telephone at  + 32 2 600 68 58.

Subject: Tax, Tax equalisation