Is your employee’s income taxable abroad? Here’s what you need to know!

You’ve probably been there: a manager mentions sending an employee abroad for a short-term project, and suddenly you’re faced with a wave of questions. Will the employee’s salary be taxed in the host country? Is the 183-day rule relevant here? What about double taxation? These aren’t just minor details—getting it wrong can have significant financial and compliance implications.

In this blog, we’ll walk you through a straightforward approach to determine if (a part of) an employee’s income is possibly taxable abroad, so you know if you need to take action (calling us for example 😉).

First stop: what’s the situation

Of course, we’ll have to state the obvious; before you can assess the consequences, you first need to get a clear view of the facts and circumstances. Asking the right questions upfront can save a lot of time and confusion later. Here are some key points to consider:

1. Where does the employee live

This question seems simple, but can – in some cases – be complex to answer, especially if an individual has personal ties with multiple countries. In most cases fortunately, it’s straightforward.

2. Where is the employer located

Also straightforward, but very important to consider! Generally, you can determine the employer by looking at the employee’s employment contract.

3. Will there be a recharge of employment costs

If employment costs are being recharged, an employee is usually leased to another party. This can be within the group (international secondments, for instance) or to third parties (temporary agency work, for example).

4. What type of work will the employee perform

The type of work is also important. Depending on the type of work, tax liability based on a permanent establishment (we’ll explain that later) may be triggered. In addition, for some types of work other rules apply, such as in the case of international transport sector. For board members, different rules apply as well.

5. Where will the employee work and how long

Obviously.

Basic principles: in which country is your income taxed?

When it comes to determining if an employee’s income is taxable abroad, it’s essential to start with the basics. Generally, individuals are taxed on their worldwide income in their country of residence. There are also countries that tax individuals based on nationality, but let’s not make this too complex for now. As soon as the employee starts working in another country, it’s possible that the host country will want to tax a portion of that income as well.

So, how do you know which country has the primary right to tax? This is where tax treaties come into play. A tax treaty between two countries will set out the rules for deciding if, and to what extent, income should be taxed in the host country. These treaties help ensure that income is only taxed once and not in both the home and host countries.

In situations where there is no tax treaty, things can get complicated. Without a treaty to rely on, both countries may claim the right to tax the same income. This results in double taxation, where the same income is taxed twice—once in the home country and once in the host country. For both the employee and the employer, this could lead to a higher tax burden and create compliance risks.

Tax treaty rules for employees

When assessing whether an employee’s income is taxable in the host country, there are three primary rules to keep in mind, that we see in most tax treaties:

1. The 183-Day Rule

2. The (Economic) Employer Rule

3. The Permanent Establishment Rule

As tax treaties are the result of negotiations between countries, tax treaties are never the same. So even though you can use these rules as a guideline, you always need to check the tax convention.

These are the basic rules, but note that (international) tax law is never basic. Different rules apply to board members, and employees in the international transportation business (by plane and by boat). In addition, some tax treaties have specific provisions for offshore work. 

The 183-Day Rule

The 183-day rule is one of the most well-known criteria for determining if an employee’s income is taxable in the host country. In simple terms, if an employee spends more than 183 days in the host country within a specific period, the host country may have the right to tax their income earned related to the work performed in the host country. Be aware that each and every day of physical presence in the host country is relevant for the 183-day rule and not only days worked.

However, it’s important to note that the reference period for counting these 183 days can differ depending on the specific tax treaty. Some treaties use the calendar year, others use the tax year, and some apply a rolling 12-month period. Because of this variation, it’s essential to check the relevant treaty to determine which period to apply when assessing the 183-day rule.

Although the 183-day rule is the most well-known criterion, it’s often not applicable in case on intra-company assignments within a group of companies.

The (Economic) Employer Rule

The (Economic) Employer Rule is a key concept that often flies under the radar but can have significant tax implications. Basically, the rule implies that there’s tax liability abroad from day one if an employee (who does not live in the same country as where the employer is located) works in the country where the employer is located.

This rule is not only applicable for formal employers. It also concerns economic employers. The economic employer principle goes beyond the legal employment relationship and looks at who is effectively benefiting from the employee’s work. If the employee is performing tasks that are crucial to the host country entity’s business, or if they are integrated into the local team, the host country may view the host entity as the “economic employer”, even if the formal contract remains with the home entity. Generally, employment costs are being recharged in these circumstances, that’s how you can recognize these structures. 

The Permanent Establishment Rule

The Permanent Establishment (PE) Rule is another factor that can trigger a shift in tax liability for an employee’s income. If the employee is working for a company that has created a permanent establishment (PE) in the host country, the host country has the right to tax the income related to the work performed for that PE as from day one.

A permanent establishment is essentially a fixed place of business through which the company’s activities are wholly or partly carried out in the host country. Most striking example is the opening of an additional shop, but it can take many forms, such as an office, branch, construction site, offshore platform or other business presence. The exact criteria for qualifying as a PE can be quite complex (too complex to discuss here), varying by country and tax treaty.

What’s next? Taking action after determining foreign tax liability

Once it’s clear that an employee is subject to foreign taxation, it’s time to consider the next steps. There are several actions that should be taken, depending on the local tax regulations in the host country:

1. Filing a foreign income tax return
   If the host country has the right to tax part of the employee’s income, they may be required to file a foreign income tax return. This ensures that the correct amount of tax is paid to the local authorities and helps maintain compliance.

2. Setting up a foreign payroll
   In some cases, local legislation may require that the employee’s salary is processed through a local payroll in the host country. This often includes withholding the appropriate amount of income tax and social security contributions based on local rules.

3. Resident income tax return
   Even if the employee is taxed abroad, they still need to report their worldwide income on their resident income tax return in their home country. To prevent double taxation—where the same income is taxed in both the home and host countries—the employee must claim an exemption or credit for the taxes paid abroad.

4. Tax Equalization
   If working abroad leads to a higher tax burden—or in some cases, a lower one—companies often apply a tax equalization policy to ensure fair working conditions for the employee. Under tax equalization, the employee is placed in the same net tax position as if they had stayed in their home country. The company then compensates for any additional foreign taxes or retains any tax savings to maintain consistency and avoid net (dis)advantages.
   
   There are other options as well, such as Tax Protection where the employee is protected against a higher tax burden, but would benefit from a lower tax burden.

These actions obviously have costs, so ideally you would like to have assessed in advance to avoid unpleasant surprises.

Still following?

Figuring out where an employee’s income should be taxed can feel like a (fun) puzzle. We can imagine though that you prefer to focus on the things you do best and leave this stuff to us.

Need help with untangling these rules for your international workforce or implementing a fair international tax policy for your global staff? At Exterus, we help professionals to tackle these tricky questions. Feel free to reach out—we’d be happy to chat about how we can support you and your team!