Expat Tax Equalisation: How Does It Work?

Tax equalisation is presumably in place to encourage expatriates to work for their employers wherever they may be sent, sure in the knowledge that they are not disadvantaged tax-wise and their tax affairs are taken care of by the company’s appointed tax advisers.

Indeed, it is very common for the employer to enlist the assistance of a firm of tax advisers to oversee the preparation of both home and host country tax affairs, and, crucially, the payment of any local tax and social security which may be due as a result of the assignment to the host country.

A calculation is made of what the home country tax liability would have been on the non-expatriate components of an individual’s remuneration package – in other words, salary, standard benefits in kind, bonuses, stock options etc. No account is taken of cost of living allowances, and other expatriate benefits such as disturbance allowance, school fees, home leave and local accommodation etc.

So an individual seconded from (say) the UK to the United States would have an amount of ‘hypothetical tax’ withheld from their earnings each month in line with what they would have paid on the non-expatriate parts of their salary package if they had remained in the UK.

It follows that the individual therefore suffers no personal tax burden as a result of the expatriate aspects of the assignment such as cost of living allowance, disturbance allowance and accommodation in the host country. The only ‘tax’ that the individual pays is the ‘hypothetical tax’ withheld at source to reflect home country tax and social security liabilities.

Of course, if someone becomes non-resident in their home country, it is unlikely that any great liability to tax would have existed there anyway, however we must remember the aim of tax equalisation is to ensure that the individual is no better or no worse off as a result of the assignment.

So the individual is required to bear the cost in terms of tax and social security that they would have borne on the non-expatriate parts of their salary package, as if they had simply not gone on assignment.

Conversely, it is the employer’s responsibility to bear the cost and discharge any personal tax and social security liabilities resulting in the host country. Therefore, in the example just cited, the employer would be responsible to pay US federal, state and city tax and social security on the individual’s entire salary package as a result of their assignment to the US.

Note that it is the entire remuneration package which is subject to tax in the host country (subject to whatever the local tax laws are), and not just the non-expatriate elements.

The payment of tax on behalf of an individual is, normally seen as a benefit in kind itself which adds to the taxable part of salary. Therefore, an additional liability to tax arises on the amount of tax paid by the employer and so on.

In order to calculate final liability to host country tax to be borne by the employer it is necessary to undertake a process known as ‘grossing up’. We will not explain this in detail, however suffice to say that the company often needs to bear a far greater level of tax to that which the individual would have paid if they had simply stayed at home or been responsible for meeting their own tax obligations in the host country.

Source: The Fry Group, financial advisers to expatriates

See the related articles:

• Expat Tax Equalisation: Paying Too Much?
• Expat Tax Equalisation: But Is It Fair?