Shadow payrolls, which are used for calculating the tax obligations of expatriate employees when their home and host countries have authority to tax their wages, must account for differences between the countries regarding taxation of types of payments and variations in exchange rates for applicable currencies, a payroll director said May 19.
Most employers prevent expatriate employees from having to pay more tax than they would have owed had they remained in their home country, so amounts of additional tax that would be due based on payments to expatriate employees for work performed outside their home country often are paid by their employer as an international business cost, said Michele Honomichl, executive chairman and chief strategy officer at Celergo LLC.
Payroll calculations for situations when expatriate employees remain on their home country payroll while working abroad in a host country involve determining the payments to them sourced from their home country, the home country’s taxes on those payments and the host country’s taxes on those payments, Honomichl said at the annual American Payroll Association Congress in Orlando, Fla.
A calculation of host-country taxes for an expatriate paid through home-country payroll is considered a shadow calculation because the currency-converted payment amounts used for calculating host-country taxes are not themselves actual payments to the expatriate and merely are used for calculating host-country taxes based on an applicable exchange rate, Honomichl said.
If an expatriate becomes paid by payroll operations in the host country and in the currency used by the host country, a shadow payroll would be established for the expatriate’s home country using currency conversion to determine applicable amounts upon which home-country taxation would be based, she said.
The variability of exchange rates between currencies in home and host countries causes it to be necessary for employers to adjust shadow payroll calculations to account for exchange-rate changes, Honomichl said. Some employers update their shadow payroll calculations every month to account for exchange-rate changes, although in general, if the comparative value of a host country’s currency to a home country’s currency does not generally change over the course of a year by more than 10 percent, adjustments for exchange-rate changes may be feasible if performed just once or twice a year, she said.
“When currencies of a home country and host country become very close in value, a lot of the time it is necessary to look at expenses that come through and determine if the exchange rate was properly performed” for shadow payroll calculations, Honomichl said.
Employers should recognize that some countries require expatriates working there to be paid in local currency, which may compel them to need to establish shadow payroll calculations for the expatriates’ home country, Honomichl said. While employers should recognize which of their countries of operation have a local-currency payment requirement for expatriates, most countries’ tax agencies tend to accept payments to expatriates in either home-country or host-country currencies if employers retain a reasonable written policy explaining their currency-payment selection and identifying a logistically appropriate frequency of adjusting their international tax calculations to account for exchange-rate changes, she said.
Payments to expatriate employees may be taxable by their home and host country, with regard to some but not necessarily all types of taxes based on wages, if both countries tax wages and do not have a double taxation agreement in effect with each other regarding income taxes, if the terms of a double taxation agreement between them do not apply to the expatriate’s particular employment circumstances or if there is no totalization agreement between them regarding prevention of double taxation for social taxes.
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