Tax regimes and social security systems vary significantly from country to country. When an employee is temporarily assigned abroad, this may create tax, payroll and social security implications in both the home country and the host country.
Clear agreements between the employer and employee are therefore essential. These agreements determine how tax advantages, disadvantages, additional costs and potential cash flow issues are allocated during the assignment.
If no specific arrangements are made, the tax consequences of the assignment will generally remain with the employee. In that case, the employee is typically assigned abroad based on a gross salary arrangement.
Choosing the right approach is not only a tax decision. It also affects employee experience, payroll administration, assignment costs and the employer’s overall mobility policy.
Below, we outline three common approaches: a gross salary arrangement, tax equalization and tax protection.
Under a gross salary arrangement, the employee remains responsible for the tax consequences of the temporary assignment. This means that any tax benefit or additional tax burden resulting from the assignment is, in principle, for the employee.
This approach is often the simplest from an employer perspective, but it may create uncertainty for the employee.
Cost-neutral for the employer
No additional settlement between employer and employee is required
The employee may benefit if the combined tax burden in the home country and host country is lower than it would have been if the employee had worked entirely in the home country
The employee may not know in advance what the financial outcome of the assignment will be
The employee may face unexpected tax costs after filing tax returns in both the home country and the host country
The risk of a financial disadvantage may make the employee less willing to accept the assignment
The employee may experience cash flow issues if tax is due in the host country before a refund is received in the home country
Under a tax equalization arrangement, the employee should be in the same net tax position as if they had continued to live and work in the home country. In other words, the employee should not be better off or worse off from a tax perspective because of the assignment.
The employee’s net salary during the assignment is calculated as if the employee were living and working fully in the home country. A hypothetical tax deduction is applied based on that home-country scenario. The employee is then paid the net equivalent of this calculation.
Depending on the assignment package, the employee may also receive additional allowances, such as a cost-of-living allowance, housing support or tax return assistance in the home country and host country.
Any actual tax costs in the home country and host country that are higher or lower than the hypothetical tax position are settled with the employer. The hypothetical tax withheld from the employee can be used to fund tax payments abroad or additional tax due in the home country.
At the end of the tax year, a final settlement is usually prepared. This is known as a tax equalization calculation. The purpose is to compare the hypothetical tax position with the actual taxes paid and to settle the difference.
The tax consequences of additional allowances, as well as any difference between the hypothetical tax and the actual tax due in the relevant countries, are generally borne by the employer.
The employee receives the same net salary and is kept in a tax-neutral position
The employee has more certainty and is protected against unexpected tax costs
Tax advantages and disadvantages may offset each other for the employer across different assignments and countries
This approach supports a consistent and structured international assignment policy
The arrangement may increase costs for the employer
It must be clearly defined what falls within the tax equalization and what does not; only employment income or also personal deductions, and how is the family situation handled? As a result, a tax equalization arrangement can become very complex.
The administrative burden is higher, as tax equalization calculations and settlements must be tracked
Final settlements can be more complex, particularly if the employment relationship ends before the assignment is fully settled
Employees assigned to a low-tax or no-tax jurisdiction may object to not retaining the full tax benefit
A tax protection arrangement is an alternative to tax equalization. Under this approach, the employee is protected against a tax disadvantage but may retain a tax benefit.
This means that the employee pays tax in the home country and, where applicable, in the host country. At the end of the tax year, a tax protection calculation is prepared. This calculation compares the actual tax payable in both countries with the tax that would have been payable if the employee had worked entirely in the home country.
If the actual tax liability is lower than the home-country tax position, the employee retains the benefit and no settlement with the employer is required. If the actual tax liability is higher, the employer compensates the employee for the difference.
The tax consequences of additional allowances, as well as the difference between the hypothetical home-country tax and the actual tax due, are generally borne by the employer only to the extent the employee is in a worse position than they would have been in the home country.
The employee is protected against a tax disadvantage
The employee may retain a tax benefit if the combined tax burden in the home country and host country is lower
This may make an international assignment more attractive to the employee
The employee has more certainty that they will not be worse off from a tax perspective
The arrangement may increase costs for the employer if compensation is required
The administrative burden is higher, as tax protection calculations and final settlements must be prepared
The employee may still face cash flow issues if tax is due in the host country before a refund is received in the home country
The employer has less ability to offset tax advantages and disadvantages across assignments compared to a tax equalization approach
The right salary and tax arrangement will differ for each employer, employee and assignment. What matters most is that the chosen approach is agreed in advance, clearly documented and properly aligned with the applicable tax, payroll and social security rules.
By making these arrangements upfront, employers can reduce uncertainty, avoid unexpected costs and provide employees with greater clarity during an international assignment.
Exterus can help employers assess the most suitable approach, document the relevant agreements and coordinate the related tax, payroll and social security implications.
Would you like to discuss the best approach for a temporary assignment abroad? Please contact us.