Spotlight expatriate taxes: The case of ‘accidental expatriates’

The 2011 HSBC expatriates report shows that 71% of expatriates have experienced more complex finances since relocating abroad. In case the expatriation is company-initiated, dealing with this complexity becomes largely the responsibility of the employer.

Shedding some light on the complex matter of expatriates’ tax management, one of my last year’s blog entries gives a primer on the two main tax deduction approaches: tax equalization and tax protection. The notion of tax equalization being predominantly used remains relevant, as the latest expatriate surveys suggest. Indeed, the Cartus Global Mobility Policy and Practices 2012 survey highlights that, with slight variations stemming from the length of an assignment, 71%-73% of organizations adopt a tax equalization policy and only 16%-21% use the tax protection policy. The predominance of the tax equalization approach is also reflected in the Brookfield Global Relocations Trends Survey 2012, for both home- and host-country income tax liabilities.

Although the two main tax management approaches may be well differentiated and seem to cover the main organizational practices, the clarity of the matter vanishes as expatriation assignments become more and more diverse. Now the question might shift from ‘how’ to deduct a tax to ‘where’ the liability is arising. This turns into an especially sensitive topic in case of so-called ‘stateless employees’, individuals who live in one country, work largely in another and yet are extensively involved in business related international travels. In the latest Ernst & Young T Magazine issue, Andrea Chipman is arguing that such a nomadic workforce, although very valuable to companies, generates quite some headache from a Tax & Benefits perspective.

To start with, the E&Y article raises the issue of splitting costs between home and host countries. When tax returns get filed, it takes a lot of reconciliation work, which includes determining the exact amounts of time spent in each location. Naturally, each country has specific rules and tests for applying the concept of tax residency based on the physical presence in the country. This points to the importance of knowing these regulations, as well as sets requirements for detailed recordkeeping of travel and workdays.

Apart from administrational challenges, the same notion of host country tax liability is an issue of its own. In other words, it is not always that easy to determine whether and when a foreign worker’s activities will result in tax liabilities for the individual or the employer.

The term ‘accidental expatriates’ captures well the situations where employees, while based in their home country, engage in a lot of cross-border commuting, which at some point triggers host country liabilities. The problem of potential host country tax violations and/or unexpected liabilities arises because these expatriates are usually not included in the company’s expatriate programs, as they are intended to go on short business trips/assignments only.

Discussing the issues of accidental expatriates, a recent article in the New York Law Journal suggests several reasons for how such host tax violations may occur. First, it may simply be that a manager does not realize the point at which short overseas trips become long enough or accumulate to trigger tax liabilities. Second, costs are a crucial factor because assigning employees to long-term corporate expatriate programs can be significantly more costly than putting them on multiple brief trips for the same work. Thus, reorganizing a specific job in a less costly manner may lead to unintended tax issues. Finally, the NYLJ article suggests that it is also employees’ resistance to long-term assignments, which pushes employers to provide different short-term alternatives.

In addition to employees’ personal tax liabilities arising for accidental expatriates, the E&Y article also draws attention to the corporate tax risks for employers. The author explains that the so-called ‘permanent establishment’, or taxable presence of a company, arises when ‘high-value creating employees frequently travel and work abroad’. Countries’ rules for corporate tax liability depend on the income attributable to foreign employees activities. In more simple terms, above a certain amount of business activities in a host country that country can actually tax a foreign firm’s income.

To address these problems, the tax experts speak about several solutions. As global mobility and HR professionals are often unaware of accidental expatriates, the authors of the NYLJ article propose that educating these professionals is an important component of every compliance program. When managers already possess relevant knowledge, it becomes a matter of auditing and controlling accidental expatriates. For example, such methods can include a company-wide calendar system, a security-card swipe system that registers employees’ exit from and reentry to their home base, or a comprehensive travel management program that uses a single travel vendor and a single company credit card for all travel expense reimbursements. Along similar lines, the E&Y professionals speak about a mobile app called ‘Tracer’ that monitors the movements and whereabouts of employees. Created by Ernst & Young, the app provides a mobile calendar service, which, when activated, records the movements of an employee, thus generating reports that alert when an individual is close to triggering a tax alert in a specific location.