For many companies, globalization is no longer a concept but a reality, and doing business in multiple cultures and jurisdictions presents organizations with an infinite range of issues and challenges. In this chapter, we explore some of the challenges, and shares some key strategies concerning international payrolls.

To achieve this we will go through the following steps:

• Why an international payroll?

• The issues

• • Why is it so difficult?

  • What if it doesn't work?

• Calculating the tax liabilities

• • The employer

  • The employee

  • The assignment

  • About compensation

• Making and reporting tax payments and related issues

• What you should do

Related issues

If a company does not have the opportunity to install a payroll function in the host location, then it will need to send money overseas at some stage. The nature of the policy and the agreements entered into with the assignees will detail the exchange rate policy the company has embraced. The actual exchange of funds for transfer into an offshore employee's bank account is the one aspect of international payrolls that continually causes distress, mainly because of the difficulty in predicting the longer-term situations. Over a two-year assignment, the exchange rates between two countries can increase and/or decrease significantly and you as an employer, have no control over them. The question as to how to apply exchange rates to payments to international assignees, when to review those rates and how to determine the fairest approach needs to be agreed upfront in your international assignments policy. Further complexities arise when considering the reporting of payments made. Making payments to an employee in local currency makes it easier to report earnings in that country, however, there is no standard method by which the salary should be converted to an alternative currency. Most international assignees have financial commitments in the home location, as well as requiring funds in the host location for living expenses. Split payrolls, while catering to these two needs, often require hours of manual work to ensure correct recordkeeping in both locations. Critical to the success of your payroll is the setting out of a detailed policy on exchange rates and payroll delivery. It will not help with an explosive exchange rate situation, but it will help with the overall management of the financial side of the assignment and provide a basis for any review of particular circumstances.

Why an international payroll?

The effective management of international and regional payrolls is an essential element of corporate global expansion. Ensuring that the company and its staff in all its locations are compliant with the relevant employment and tax laws is crucial to the company's future. While employment law is of great importance, it is the payroll and the tax side of compliance that often provides the greatest challenges for globalizing companies.

While most companies today recognize the need to implement an international payroll policy and provide assistance to relocating employees, the practicalities of paying employees in multiple jurisdictions is often left up to the payroll group to sort out any way they can.

Large multinationals have the luxury of payroll groups in many of their locations. These companies are lucky. They can simply move the employee from one payroll to the next, paying them in local currency with all the appropriate recording and reporting functions effected. Many companies, however, have a small number of employees in numerous countries, with insufficient funds to maintain a fully-fledged payroll function in each location. This presents these companies with a challenge: how to ensure that all the local requirements of each jurisdiction are met in full and at a manageable cost.

In a perfect world, the management of the payroll would be implemented at the time of the development of a company's international assignment policy. Consider questions such as: Do you have the means to operate an actual or shadow payroll in the host country? Will you have the opportunity to put into place a company payroll function, or will you need to outsource this? What restrictions apply in the locations where you will send employees?

An international payroll must allow the flexibility to meet the requirements of not only the employees, but ensure that both employer and assignees maintain their legal compliance. For example, it is no use insisting that your employees be paid their entire salary payment in the host location, if that country will not allow them to remit their funds to the home location upon assignment cessation. Similarly, in countries which have sophisticated revenue systems - such as the US, which requires employers to withhold and remit taxes from an individual's salary payments - a company must ensure that they have the facility to meet the requirements, including the issuing of employer and employee certificates (such as W-2 forms in the USA) at the appropriate times.

Not only must an international payroll policy be compliant with both the assignees home and host countries income tax legislation but it must also be compliant with the social security tax legislation in both countries.

If a company does not have the facility or understand both these requirements, the potential for lack of compliance can become a serious concern.

The issues

A company would never recommend an employee evade tax payments, yet some companies are unaware that they may not be in compliance with the tax laws of the country to which they send their employees. In many countries it is the company that is responsible for the withholding and payment of employment income and social security taxes, and it is the company that is generally exposing itself to the risk of penalties for non-payment of these taxes on behalf of the employee, and not the other way around.

Would you know what to do to ensure an employee of yours was paid correctly in the US and ensure that all the relevant US taxes, including federal, state and local taxes, were met? Or alternatively, consider Indonesia - do you need to withhold tax from an employee's salary before paying them? What about China - what are the withholding requirements there?

Companies that are sending employees to a number of countries must fully understand the tax withholding requirements in each country. While in one country it may be appropriate to report taxable income at the end of a tax year and either pay the liability when the tax return is submitted or make a payment when a notice is issued by the relevant tax authority, other countries may well require either monthly, or even weekly, payments of income tax by the local entity or a recognized third party, such as an accountancy practice or a recognized payroll service provider.

This can then lead to the situation where both the home (from where the employee is being paid from) and the host country where the services are being performed both require that taxes are paid on a continuous basis. In circumstances such as these the employer must be aware of the home country legislation that will allow an exemption from withholding income taxes. Such countries as the US (filing for W-4) and the UK (a Nil Tax Coding) have within their legislation provision for this situation. However, an employer sending an employee from India to Thailand may well find that there is a requirement for tax to be withheld in both countries.

There are a multitude of reasons why international payrolls are so difficult to administer. Some of the issues include:

• the numerous foreign allowances which are paid to employees;

• negative compensation entries;

• foreign currency restrictions;

• benefits-in-kind;

• payments to third parties;

• multiple sources of payments;

• the method of delivery;

• host country tax obligations;

• multiple employers;

• tax gross-ups;

• exchange rates;

• tax equalization policies;

• accounting for tax reimbursements; and, last but not least,

• the limitations of current payroll systems.

Nevertheless, international payrolls can be managed effectively and efficiently, but they need commitment and planning. Firstly, income and social security taxes need to be calculated, and secondly, taxes need to be paid and accurately reported to the appropriate authorities in accordance with both countries legislation.

What if it does not work?

While every jurisdiction is different, as the world economy globalizes further, we are seeing increasing attention paid to ensuring that appropriate tax payments are being made in all countries.

Furthermore, with the increasing numbers of expatriates and international transfers throughout the world, we are witnessing more open cooperation between the tax authorities and the immigration authorities. In recent years, Indonesia tightened up on the registration of expatriates who reside in Indonesia for more than three months. Although the stated purpose of the registration is to ascertain the numbers of foreigners who live in Indonesia, the register may also be used as a reference for various purposes (such as tax registration).

Problems will arise where an international payroll is not currently administered. The incorrect reporting of taxable income in an employee's home and host country may result in lengthy discussions and correspondence with home and host country tax authorities.

The risk of this happening is dependant on the way in which the international payroll is put together and administered.

It has been seen that large multinationals in the finance and oil industries adopt a worldwide payroll policy for all international employees notwithstanding which country the employee is from or goes to. In these industries it has also been seen that moving from the employee's local payroll to and from the international payroll happens when the employee commences or finishes the assignment. An employee may well expect to remain on that international payroll as their career progresses from one country to another. Where the employer does not have an international payroll or a coordinated payroll reporting system is where the problems arise. This is often seen to be the situation in industries where employees are moved between one country and another at short notice. It is not unusual to see employees working in a country which requires the local entity to pay income tax to remain on his home country payroll and continue to have income tax deducted and paid to the home tax authorities.

Similarly, where an employee is subject to withholding tax in the host country, it has been seen on a number of occasions that the employee returns home without the host country payroll administration being advised of the employee's departure.

In both these situations it is quite possible that both host and home payroll administrators will issue the required tax authority reporting documents which are found to be incorrect to the true situation. As well as there being issues in resolving the reporting problems, there is also the issue of the accounting for any hypothetical tax that may have been used to arrive at the net salary payable and how and when this is made over to the host country entity.

Where a host country (shadow) payroll is operated, there must be regular contact between the home and host country payroll administrators to ensure that any changes, in an employee's compensation is handled correctly. Unless this happens the host country will not be able to correctly administer the local payroll.

Where a local payroll has to be operated for inbound employees an employer must be aware of a number of issues such as the different way of taxing various compensation components, the impact of social security and local taxes such as US state and city taxes.

Technically, potential implications of non-compliance may include the application of penalties to any outstanding tax liabilities or delayed departure from the host location until the relevant taxes and potential penalties had been paid. Should an individual manage to leave the country without payment, it is possible, in some circumstances for that person to be restricted from entering the country in question again, or the employer may find that their company has difficulty doing business again in that particular country. For global companies, these possible restrictions may have a significant effect on their business development.

What you should do

Good international payroll planning advice can help you get it right before you send your employees overseas. Advice from payroll professionals who work with similar professionals in both employer and employee international tax can help to ensure that your company approaches any new venture in another country with the knowledge that you have done everything to ensure that: Your company's set-up and registration in the new country is appropriate to the type of business that will be done there. Know what is required as an employer, and your employees' responsibilities for compliance. If at all possible, companies should meet with their tax advisers several months before they intend to send employees to a particular country. If necessary, this will give time to register the company and obtain advice on the implications for the business and the requirements of employing and paying people in that country Ensure that international employees obtain the most appropriate visas and are made aware of their responsibilities before they arrive at the new location. Some countries require registration with the local authorities, or require individuals to obtain social security numbers or tax file numbers Ensure payroll groups are involved in the planning stages of an international assignment policy, and all planned new business ventures. Although they are the ones who have to make the payments, they are often the last to know of someone who is to be transferred overseas. They will need to ensure that the appropriate procedures are in place to cease payment of taxes in the home location where necessary, and make the relevant payments in the host location If all else fails, companies should not be afraid to ask for help. Surprisingly, some companies sit back and hope that nothing goes wrong. Some have managed this so far. However, the climate is changing and the ability to simply send people overseas and have them pay tax wherever it is easier, or maybe not at all, is fast disappearing. The last thing any employer wants to hear is a distraught business partner on the phone at 2am advising you that one of your international employees is now in jail and they want something done now. Finally, companies do have the alternative to outsource the payroll for their international employees. Specialists in this field can help ensure that you meet your legal and ethical requirements in most locations around the world.

Calculating tax liabilities

Once it has been determined where income tax is to be paid on an ongoing basis, the payroll administrators must become aware of how the components of the remuneration package are taxable in each country. There are four categories of information which will determine where tax is payable. These categories relate to the employee, the assignment, the employer and the wages payable.

The nature of the employer's business or registration in the host location can impact upon the employee's payroll reporting taxable situation in the host location. The employer, whichever entity this might be, will determine the number and type of responsibilities that the employer and employee will need to fulfill. These are often different for the different types of employers such as, resident or non-resident employer, representative office, or subsidiary and so on. Similarly, for example, Thailand requires either the local entity or a nominated third party to operate a local payroll.

In China, for example, it generally does not matter if the employer is resident or non-resident, a monthly tax return and payment of tax liabilities is still required.

In the US, resident US employers are required to withhold FIT (federal income), FICA (social security), Medicare, and FUTA /SUTA (state and federal unemployment) taxes on wages paid to US citizens or resident aliens, regardless of whether the wages were earned in a foreign country or in the US.

The first question to answer is the tax residence of the employee - which country has the legal right to tax the income of the individual. In certain circumstances an individual could be tax resident in more than one country at the same time. Income tax treaties provide tax relief from double taxation and normally determine in which country an individual is resident for tax purposes. Normally, this is determined by the individual's physical presence in a country. In certain circumstances additional criteria may be used to determine tax residence, for example, citizenship held by the employee, the length of the assignment, the physical location of the employee's family and the investments and ties to the home country.

If the employee's personal circumstances can influence the determination of tax residence and therefore tax liability, what influence does the assignment add?

The tax treaty between two locations will determine the parameters, which will apply in relation to the length and period of an international assignment. For example, if an Australian employee is relocated to the US on an assignment of less than 12 months, duplicate living reimbursements are generally not taxable, if structured correctly. Similarly, if structured correctly, Australians assigned to the UK for less than 24 months, may take advantage of a similar tax mitigation strategy in certain circumstances.

Similarly, leaving Japan before January 1 in any one year will negate the requirement to pay inhabitant tax for the previous 12-month period. Furthermore, in certain circumstances and for certain assignments, days spent outside of the host location may be eligible for tax relief in the host location. Where companies operate a tax equalization policy, the company can gain the benefit of these reduced tax liabilities. In other cases, the employee will gain the benefit.

Most assignees receive benefits in three ways: cash, third-party payments and other in-kind benefits.

The cash component often comprises such items as base salary, bonus, cost of living allowance, mobility premium, location allowance, housing and furniture allowance, home leave, motor vehicle allowance, utilities, relocation allowance and so on.

Typical third-party benefits include medical checks and insurance, property management, shipment and storage of household effects, dependent education, cultural training, club memberships, destination services, and tax preparation and payments.

Other benefits-in-kind can include pension plan contributions, benefit plan earnings, motor vehicles and education payments.

Often the way in which a support item is delivered will affect the tax liability for the employee or the employer. In managing international payrolls, it is imperative that the full nature of payments and benefits paid to the employee are recorded to ensure the correct taxable income is reported and the appropriate tax is payable, either by the company or the employee.

For assignees coming into Australia, for example, the cost of living allowance and housing support can be structured in certain circumstances so that a living away from home allowance can be paid and attract a reduced tax liability.

In relation to the employer's tax liability, the most obvious example is Australia's fringe benefits tax (FBT). Generally, assignees taxable in Australia will not pay tax on their home leave trips. As home leave falls under the FBT banner it is generally payable by the employer. The level of tax payable will be determined by whether the home leave is taken via the most direct route from Australia to the home location, which normally attracts a concessional FBT rate.

International payroll management requires full disclosure of all benefits to enable the company to report accurately the payments and benefits paid to the employee, or which are required to be reported on behalf of the employer. It cannot be overemphasized that the local payroll administrators must be fully aware of the compliance obligations concerning the payroll reporting requirements with regard to inbound employees who remain on their home country payroll.

Making and reporting tax payments

Once the jurisdiction of tax liability has been determined, the components of the package have been defined and the various tax treatments revealed (such as employer or employee liability), it is possible to calculate and withholding the appropriate amounts of tax, and make the cash payments.

Standard data recording programs, (Microsoft Excel is sufficient for small numbers of employees) can maintain the recording of payments made to employees, taxes withheld at source and paid over to local authorities, and exchange rate transactions. These details will form the basic data required by most companies. It is similar to a local payroll software package which allows the user to input the payments to be made each pay period and withhold the tax liability, make any deductions required, arrange payments to both the employee and the tax authority and record all details for inclusion in a year-to-date figure, which is then transferred to an annual statement, such as a group certificate.

This type of data recording may be appropriate where there is a small number of expatriates, but for large multinationals it is necessary to have an international payroll reporting system that records all sources of compensation. Such a reporting system must be accessible to both the home and host country payroll personnel who can record all cash component, benefits and third-party payments.

Such a system will then allow both home and host entities to prepare the appropriate documentation that each country's tax authorities require. This will require the employer to report their overall employee taxable income and tax paid as well as provide the employee with their required earnings statement, such as W-2 in the U.S., P60 in the UK and Pay As You Go (PAYG) statement in Australia.

Rodney Moore (rpmoore@kpmg.com.au)

Biography

Rodney Moore KPMG 10 Shelley Street Sydney NSW 2000 Australia Tel: +61 2 9335 8202 Fax: +61 2 9299 7077 Email: rpmoore@kpmg.com.au Rodney Moore is a senior manager in KPMG's international executive services practice in Sydney, specializing in international tax issues for individuals inbound to and outbound from Australia. He has been involved in international executive tax for more than 30 years, firstly in London and then with KPMG in Sydney for the past 22 years.