Few topics may induce a louder groan from global payroll professionals than the mention of shadow payroll. A cursory Google search shows that shadow payroll not only appears to be a complex and confusing issue but it also is often defined in seemingly contradictory ways, only compounding the frustration surrounding this issue.
The simplest explanation of shadow payroll is that it is a method of maintaining international tax compliance while an employee works abroad. Shadow payroll is a process in which a U.S. employee working overseas, for example, receives compensation and benefits in the host country that are shadowed, or mirrored, in the U.S. for calculating, reporting and remitting taxes. The process, as any payroll professional familiar with it would undoubtedly attest, is more complex than that.
Often having little direct effect on an employee, the obligation to maintain a shadow payroll generally rests with the global payroll professional who must calculate, report and remit applicable taxes for more than one jurisdiction. The biggest challenge for payroll professionals arising from operating a shadow payroll is determining what should be calculated, reported and remitted as well as how and when to carry out the calculations, reports and remittances. Payroll departments should be familiar with payroll tax requirements in multiple jurisdictions for that process.
Shadow payroll also requires familiarity with a number of issues and topics with which the average domestically orientated payroll professional may be inexperienced, including home vs. host country shadow payroll, split pay, hypothetical tax and tax equalization vs. tax protection.
Implementing shadow payroll for an employee working overseas may be complex because of many different variables. There also are a few critical challenges, including how employee presence is defined, what is taxable, mandatory local payments and accuracy.
While shadow payroll may be difficult to undertake, the fact is that companies should be aware of the need to operate a shadow payroll to remain compliant, said David Leboff, founder and president of Expaticore, a third-party aggregator of expatriate and host-country payroll services.
Companies “engaged in expatriate programs that are mature in any way operate shadow payrolls because otherwise they're likely not compliant,” Leboff told Bloomberg BNA. “Whether they're doing it or doing it well is another issue.”
When setting up and managing a shadow payroll, it is worth bearing in mind that “you are going to pay for compliance either up front by setting up proper processes or on the back end in penalties and interest,” said Michele Honomichl, executive chairman and chief strategy officer of Celergo Global Payroll.
While calculating certain amounts may imply scientific precision, employers should know that shadow payroll is an art and not a science, both Honomichl and Leboff said.
For more information on shadow payroll, check out the Bloomberg BNA International Payroll Decision Support Network white paper, “The Critical Role of Shadow Payroll.”
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