Hypotax procedure for international assignments
Whenever several employees of a company are sent abroad, there is a real or perceived difference in treatment.
One concerns the taxation of the salary of the expats.
Different tax balancing models can simplify salary models for employees and at least provide for partial justice.
Ms. Schneider and Mr. Huber both work as engineers in the same company in a comparable position and with identical salary (about 5,000 euros gross per month).
Both workers will be sent abroad for three years: Ms. Schneider to Canada, Mr. Huber to Uganda. At the request of the HR department, the in-house tax consultant has established the tax liability of both employees in the respective sending countries.
When the two engineers learn about it, at least Ms. Schneider’s mood is initially at a low, so much so that she is threatening to withdraw her commitment to the overseas project.
What is the reason for this action?
Due to the different taxation systems and the resulting different tax burden on their income – while Canada is a high-tax country, taxes in Uganda are negligible.
Ms. Schneider’s net salary would be a lot lower than in Germany and that of Mr. Huber would be much higher. Although the latter is pleased about it, he sees that this is at least partially unfair.
So what can the human resources department do to achieve a satisfactory balance for both employees?
Also compensation payments are taxable
Tax compensation models for employee secondments
In fact, different tax balancing models can help to remit workers abroad.
So a common solution used is the assumption of tax burdens. This would be particularly effective in the case of Ms Schneider, who would be exposed to such an increase in her work in Canada. In the process, the engineer would pay all tax payments during the year and, after filing her tax return in Canada, have her employer compile a comparison based on her previous tax burden and her new burden in the host country.
If it turns out that she has paid more taxes than before, her employer pays a once-yearly compensation.
The problem with this:
This compensation payment is a taxable wage, to which – as the name implies – taxes are incurred, which again tear a hole in the salary of Mrs. Schneider.
Now, here too, the employer could create a compensation that would then be taxable again and so it would continue in an infinite loop.
Moreover, Mr Huber would continue to have an advantage over Ms Schneider in this model because, due to the low tax burden in Uganda, he still receives a higher net salary despite Mrs Schneider’s compensation model.
Protect or compensate – that is the question
International tax consultants and secondment specialists therefore often recommend two other tax balancing models that use what is called the hypotax process: the Tax Protection Model and the Tax Equalization Model.
In both methods, a hypotax is determined on the basis of a gross content, ie a hypothetical or notional tax. In the case of the tax protection procedure, the employer would take over that part of the Canadian tax for Ms. Schneider, who exceeds her hypothetical tax burden (hypothetically because Ms. Schneider is no longer taxable in Germany) on actual income.
In short, what Ms. Schneider would pay too much in taxes because of her job is taken over by her employer. Thus, it is not exposed to a higher tax burden than would be the case in the home country (ie in the case of non-posting).
In a sample calculation this would look like this with Mrs. Schneider:
• Actual tax in Canada: 30,000 euros per year
• Hypothetically determined tax (hypotax) in Germany: 20,000 euros.
The sending company bears the difference amounting to 10,000 euros for Ms Schneider. Mrs. Schneider’s previous tax burden is virtually “protected” and nothing changes in terms of net salary. The situation is different in the tax protection model in the case of Mr Huber, who benefits from a tax advantage.
The following example calculation shows:
• Actual tax in Uganda: 10,000 euros
• Hypothetically determined tax (hypotax) in Germany: 20,000 euros.
The sending company reimburses Mr. Huber the difference amounting to 10,000 euros. However, the payment of the difference amounting to 10,000 euros also counts as taxable income, which in turn could lead to financial disadvantages for Mr. Huber. If he insisted on having this monetary disadvantage reimbursed by the employer, it can come here again to an endless loop of tax and additional payments.
Hypotax can not always avoid inequality
Nonetheless, Mr. Huber is better off than Ms. Schneider in this process.
Although this is “protected” by the employer from an additional tax burden, but unlike in their case increases by Mr. Huber’s posting to the low-tax country Uganda its net salary significantly. Thus, no equal treatment of both employees takes place. The HR department could argue in this case that Ms. Schneider has a much higher quality of life in Canada, whereas Mr. Huber in Uganda faces higher risks to life and limb and significant limitations in everyday life.
Tax inequality can be avoided in the tax equalization model. Both Ms. Schneider and Mr. Huber are placed during their assignment abroad as if their income continues to be taxable in Germany. The sending employer bears the additional tax burden on Ms. Schneider amounting to € 10,000 – ie the amount that goes beyond the previously calculated hypothetical tax in the home country.
For Mr. Huber, this model is disadvantageous because it provides that his tax plus of 10,000 euros will not be paid – this tax advantage is due to his employer.
Simplistically, Mr. Huber’s tax advantage balances Ms. Schneider’s disadvantage (“equalization”).
Above all, this model is often used by large, international companies that employ a large number of expats in both high and low tax countries.
Net wage agreement p rotects against currency
and currencycontrol fluctuations
However, neither the tax protection nor the equalization model take into account any currency or tax fluctuations in the respective sending countries.
Therefore, many seconded employees prefer a so-called net salary agreement, which ensures a stable salary. In addition, they no longer have to worry about their tax return on this model, because the employer bears all tax payments in Germany and abroad. For most expats, this variant is the preferred solution. For the company, however, it represents a kind of black box.
Only at the end of the tax year does it know the actual amount of tax to be paid in the sending country. In addition, it is impossible to fix such a salary agreement without tax advisers who know the respective national tax law of a country including any double taxation agreements with Germany – an additional cost factor that must be taken into account.
A hypothetical tax does not apply in this case as the company is obliged to pay the real tax. Their amount is also dependent on the private situation of the expatriate, ie whether this is wealthy, married, divorced, childless or rich. Any additional tax payments must also be borne by the employer. However, if there are tax refunds, these are also due to the sending company and are credited to the employee as a negative salary.
Which tax compensation model companies choose to deploy their employees depends on a number of factors: the number of expats and the posting goals, the global mobility strategy, the incentive systems for expats, the administrative burden and the associated costs all play a major role Role.
Regardless of which variant companies choose, they should fix the chosen model in writing in the Posting of Workers Directive and Contract and communicate it transparently.
A contribution with kind permission of the BDAE group
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