Splitting salaries can provide the perfect tax solution for cross-border workers - but beware of the pension pitfalls, reports Rob Hyde.

To help protect workers from dual taxation, various bilateral tax treaties throughout Europe, such as the 'Double Tax Treaties' between Holland and Belgium or France and Germany, were formed and operated under the principle that 'salary is taxable in the country where taxable activity is being exercised'.

These treaties paved the way for a new system, 'salary splitting' for workers who may live in one country, but work both at home and in another EU country.

Salary is always taxed progressively with the higher the salary, the higher the tax rate, and a split salary therefore divides up money into separate portions, each taxable in a separate country.

Although this may seem like a step backwards because it means mobile workers pay tax in several countries, they actually split their income meaning it falls into a low tax bracket in each country so that mobile workers actually make considerable savings.

According to Joost de Groote, a tax specialist at PriceWaterhouseCoopers in Belgium, salary splitting is an ideal system for workers in frontier zones of the three systems as the geographical positioning of the country means cross-border working is inevitable.

"In Belgium the system is very popular, and an employer who can offer this may therefore be far more successful in recruiting workers."

"In this region of Belgium, near the frontier with France and Holland, many companies and individuals from one country have activities in the other country, and a split salary employment is one of the most effective planning tools to deal with this".

Another advantage comes in the form of a tax refund whereby a worker gets Back a proportion of the amount of tax deducted from his salary.

While Belgium does apply tax to any remuneration earned from work within the country, its' inland revenue will not tax a Gilder or Franc of repayment on salaries earned in Holland or France, as both have signed a double tax treaty with Belgium.

However, the system still has its pitfalls and those unaware will be unable to have their salary split. This means all money earned, regardless where, will be taxed at the full rate within the country of residence unless the worker is able to provide proof of residence in the working state of more than 183 days per year.

If for example a Belgian worker has spent less than this time working in the Netherlands, the remuneration for the work abroad is then taxable in the Netherlands if it is paid by or on behalf of an employer who is resident there.

Alternatively, if the employer has a permanent company in the Netherlands, he can also pay his worker via the Dutch tax system.

But while the split salary system appears to have only benefits for the mobile worker, it does run the risk of creating extra administrative complications for both him and his employer.

Tax specialist for the Belgium-based Loyens and Volkmaars tax lawyers, Tony Leeuwerck says the amount of extra work created for the employer means it could ultimately all backfire on the worker.

Splitting pensions - serious consequence

"Those working in other countries under the split salary system obviously will need to complete a tax return for both home and abroad, but another serious downside is that his pension rights may also be 'split'. If the worker is contributing to a pension plan in every state he works then it may well give rise to problems when he retires".

"A split salary is a perfect solution to reduce the tax cost under certain circumstances. However, the worker really must be able to demonstrate his presence in all countries involved, otherwise the existence of the salary split which will not be recognised in the case of a tax audit".

Another potential danger is that while a worker can enjoy lower tax rates, he may still be subject to several social security rates at a full tax rate.

According to Leeuwerck, the split salary system may therefore seem to be laden with goodies such as low tax rates, but it is also a bureaucratic minefield whereby workers can easily be caught out unaware.

"There are loads of immediate advantages to a split salaries system, as it allows employers to pay employees a substantial net salary without incurring an excessive tax cost, and the employee ends up seeing a substantial increase in his net income.

But such workers really must take care when it comes to social insurance as different countries have different regulations and exceptions are not always made for employees who work in several countries".

"It is possible to make hundreds of variations to the salary split. But while this makes for a flexible system which can be adapted to individual needs, the circumstances of each case must be considered separately to verify whether it is effectively possible and whether, after all necessary deductions are accounted for, real financial advantages can be made".