The company remits taxes as they fall due to the tax authority on behalf of the employee, in the home country and the host country.

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1 Tax equalization Tax equalization is a type of tax reimbursement and is the term given to ensuring that an employee is financially no better off, or worse off, by being sent on an international assignment, than if he/she had remained at home. Another way of viewing tax equalization is that the employee is kept whole, meaning that their net pay is protected in terms of having no more and no less net pay due to the personal tax effect of their assignment. Tax protection - another form of tax reimbursement Another form of tax reimbursement which is less commonly used by companies is tax protection. This occurs where the employee is reimbursed by the company if the taxes in the host country are higher than in his/her home country. If the taxes in the host country are lower, the employee is not required to reimburse the company for the savings in tax. Unlike tax equalization which aims to be neutral, tax protection can influence the employee by way of their comparison of the level of taxes imposed in the host country with those imposed in the home country. It makes a difference to their financial wealth, in that his/her net take home pay is higher or lower than what they would have otherwise received at home. The mechanics of tax equalization How it works tax equalization in the usual sense of the term: The company withholds a hypothetical stay at home tax from the employee s gross salary. In countries in which deductions from employment income may be available, such as the United States, the hypothetical tax often is based on a formula that includes a standard allowance for those deductions. The hypothetical tax is collected in the usual fashion that withholding tax (in New Zealand, PAYE) is administered, through the payroll administration system during the year. The tax withheld is an estimate of the tax that would have been payable if the employee had stayed at home and not gone on assignment. The company remits taxes as they fall due to the tax authority on behalf of the employee, in the home country and the host country. At the end of the tax year and upon determination of the actual tax liability, a reconciliation is performed between the hypothetical taxes withheld and the actual taxes, thus quantifying the amount either payable to or receivable from the employee. A sound tax equalization programme will comprise the following elements: 1. A tax equalization policy formulated for, and specific to, the circumstances of the company. This needs to address the various scenarios that a company may find itself in when an employee goes offshore, from which procedures to handle those situations are implemented.

2 2. Incorporation of relevant policies and procedures in to the individual s employment contract which is signed by the employer and employee prior to the employee s departure. The tax equalization provisions added to the employment contract should be reviewed by the company s legal advisors. 3. The policy should include how the collection of tax from the employee will be managed by the company, with measures to minimise the event in which the employee owes the company tax payments. Such measures may include authorising the company to deduct amounts of tax payments due to the company from the employee s salary, and also requiring the employee s tax refunds to be directcredited to the company s bank account upon the assessment of a tax liability by the revenue authority. (This option is limited to countries that permit this practice New Zealand being one such country - but it also throws up additional issues). 4. A pre-assignment consultation with the employee. This should include communication of the employee s responsibilities for adhering to the tax equalization policy and procedures, especially with regards to payments that may fall due to the company. To be sure, it can be a delicate issue for employers and employees alike. Accordingly it should be handled with due care and attention in order to preserve the employment relationship, and minimise the chance of an employment dispute down the track. Some of the issues that need to be addressed in the policy include: The extent to which the company will pay the employee s incremental taxes. This includes such issues as whether the company will pay the tax on his/her personal income, in the event that personal income is taxable to the employee under the tax laws of the host country. Who will prepare the income tax returns for the home and the host countries, and who will pay the return preparation fees. It is usual for independent accountants to prepare the employee s returns in order to protect the privacy of the employee s financial affairs. A formula for the equalization calculation. Provisions to deal with the departure of an employee whilst on assignment. This should include the methodology for allocating the taxes over the respective year of departure, who will be responsible for the preparation of the returns after the employee has departed and collection of taxes from ex-employees. Companies commonly are exposed to a risk of default in payments due from exemployees. This can occur where the employee s tax return results in a refund which is paid directly by the revenue authority to the ex-employee, or where taxes were paid on behalf of the ex-employee and were to be reimbursed to the company but were not.

3 Other things to watch for Things to watch for and to factor in to the employment contract equalization agreement: How does the host country impose taxes? Are there such taxes as capital gains taxes, social security taxes, health taxes or estate taxes? If so, what is the company s policy on reimbursing an employee (or an employee s estate) for the tax cost of these? Does the host country allow individuals to file joint returns (for example, the United States of America permits tax residents who are spouses to file joint returns). This option can add a whole new level of complexity to the tax equalization calculation of individuals on assignment who can elect to use married filing jointly filing status. How other items in foreign tax returns will be treated for tax equalization purposes, such as tax credits and deductions allowable under the respective country s tax laws. Special attention should be paid to the tax treatment of benefits in the host country, and whether the company will reimburse the employee for the tax expense in the event that the benefits are taxable to the employee. Many countries treat tax equalization payments to employees as a taxable benefit to the employee. The tax benefit is grossed up for tax and the equalization policy should address which party is liable for this tax liability. The above list is not exhaustive. However, without crystal ball gazing, these are some of the more common difficulties that have been encountered by employers when applying a tax equalization clause in an employment contract which is silent on the above matters. Equalizing Intra-company transferees versus equalizing a new employee brought on board from offshore In the event that an employee moves from one country to another within the employ of the same company, tax equalization may be easier than that for an individual whose equalization arises out of new employment involving the international relocation by the individual to the country of employment. The situation is far less straight forward because there is no net salary approach to take and therefore no starting point from which incremental taxes can be measured. That is in contrast to the employee transferring between countries within the same company who continues to be paid his/her net salary from their home country, leaving the company to take care of all of the taxes in the home country and the host country. Employees brought into New Zealand With an individual from another country taking up new employment in New Zealand tax equalization it is a matter of comparing the taxes paid in New Zealand (the host country) with the taxes paid on that income in their home country.

4 New Zealand has relatively high income tax rates. Accordingly, the individual taking up employment in New Zealand will be seeking to protect their financial position where their New Zealand employer agrees to tax equalize them. Frequently the tax payable in their home country on their New Zealand income is going to be less than the tax paid in New Zealand on the same income. However, quantifying the foreign tax attributable in the home country to that New Zealand-sourced income in the foreign tax return can be as difficult as it is subjective. A common approach is to apply the marginal income tax rates to the income in both New Zealand and the overseas country to arrive at tax liabilities in both countries. But if the employment contract is silent on the method of calculation, notably in terms of what tax rates are applicable to the income for the purpose of the calculation, it can prove expensive and time-consuming to get both parties to agree on exactly what the incremental taxes in New Zealand were. It can be helpful for the employment agreement to state that the company will have the final say in the amount payable to or by the employee, as a blanket cover for the numerous unforeseen situations that may arise when an employee goes on assignment. Summary Tax equalization is a form of tax reimbursement by a company to an employee. It is often the highest cost to an employer of an employee s international assignment. Tax equalization is complex, with large multi-national corporations operating sophisticated tax equalization software to perform the calculations. Whilst tax equalization measures tax differentials, no governing laws exist. It all hinges on the interpretation of the employment contract. There is more than one way to skin a cat and there can be many more ways to perform a tax equalization calculation. Sound equalization policy and procedures should be an integral part of the overall Human Resources policies and procedures to give certainty to both employer and employee. Employee consent (by way of provisions in the employment contract) is vital for the policy to be effective. This article provides general information which is current at the time of publication. The information contained in this article does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to actions being taken based on the information contained in this newsletter.

5 Gina Wallace is a director of International Assignment Services. She can be contacted on (09) or via ginawallace@expattax.co.nz. References: Yager, J, Managing Expatriate Tax Costs, International Tax Review; June 2005, Vol 16, Issue 6, p37-40 McGladrey, RSM, Expatriate Tax Considerations Someone Will Be Paying More Money In The Future, World Watch February 2007 Goller, D G and Murphy, N, Equalizing Taxes for Employees Working Abroad, Association Management; July 2003, p81 Gale, S F, Taxing Situations for Expatriates, Workforce, June 2003, p AICPA International Taxation Technical Resource Panel, Tax Planning for Expatriates, The Tax Adviser, April 2001, p Yager, J M, Introduction to HR Tax Reimbursement Policies For Canada to U.S. Employee Relations, Swilling, J and Karpenko, E, Uncollectible Tax Equalizations: Protecting Your Company and the Assignee, The Expatriate Administrator, Spring 2005, Volume 1