Tax equalization is a policy employers can implement to shield employees from the complications of tax management when working abroad, short- or long-term. It keeps these workers’ take-home wages the same even if working in a new environment with drastically different tax policies—a boon to seamless management of a remote international workforce.
We will explore what tax equalization is, its processes and calculations, benefits for all parties, challenges, and considerations, and how to determine its suitability for your company.
How Does Tax Equalization Work?
Tax equalization allows companies to ensure that employees’ tax burdens are neutralized, keeping their financial responsibilities consistent across borders. They maintain the same tax liability during an international assignment as they would in their home country. Employers handle additional tax expenses, if there are any, and retain windfalls from lower tax rates, thus affecting the overall compensation.
The way this works is typically through a “hypothetical tax” (hypotax) rate. The employer will pay the employee’s taxes in both their home country and the assignment country. Then, they will charge the employee (or reduce their salary) commensurate with an estimate of what their salary would have been, minus taxes, if they had always been posted in their home country. Assignees can maintain financial stability knowing their income remains consistent with that from their home country.
In this system, the employer assumes all responsibility for managing tax obligations, including filing and withholding, for the employee engaged in international work. This ensures employees don’t suffer any financial consequences for completing work abroad and smooth operations for employers.
Tax Equalization vs. Tax Protection
Another approach to neutralizing tax burdens for global workers is tax protection. It has the same ultimate ends as tax equalization, but it employs different means to achieve them.
Unlike tax equalization, tax protection requires the employee to manage upfront payments for both home and host country taxes. This includes filing tax returns for both jurisdictions, ensuring accurate calculations to assess any tax liability. Annual assessments help determine whether the amount paid is greater than it would have been if the employee were not remote for the duration. And, in cases where it is, then the company typically compensates the worker for the difference.
The trade-offs between these two methods have to do with ease of management for the party responsible. Tax protection is easier for employers and harder for employees in the short term, with the potential for negative consequences from friction in the long term. In contrast, equalization is almost always harder for the employer and easier for the employee.
Benefits of Tax Equalization for Expats and Employers
It may seem like tax equalization is much more beneficial for employees than it is for their employers, and there is some truth to this in the immediate term. Companies bear the burden of managing global taxes so that their workers don’t have to, thereby preventing the need for employees to navigate different tax environments. Employees can find comfort in knowing their income and hypothetical tax projections align with expectations.
However, there are also clear benefits for the employer. Companies that implement tax equalization policies may have an easier time recruiting and retaining talent, especially globally. And they can streamline their compliance with global tax laws by frontloading complicated logistical hurdles rather than allowing them to build up steadily over time.
These benefits are maximized when using an optimal global payroll solution like Omnipresent to develop, implement, and manage your tax equalization, protection, or similar arrangement.
Challenges and Considerations in Tax Equalization
One of the biggest hurdles to effective tax management for global workers, including tax equalization, is the risk of double taxation. Equalization can be an approach to avoiding double taxation in its own right, but it might also require a sophisticated double taxation agreement (DTA) to ensure that employees are being taxed fairly.
Another consideration is whether a particular approach to equalization is legally sound in a given country. In Germany, the Hamburg High Labor Court has found that agreements based on fictitiously calculated wages (i.e., a hypotax) may violate collective bargaining protections enshrined in the Tarifvertragsgesetz (TVG). Other methods like tax protection may be preferable, or employers may decide to forego any strategy of equalization or protection.This is why it's essential to understand the region’s specific legal environment before finalizing any assignment agreements.
One way to prevent or mitigate these and other challenges is to work with a qualified Employer of Record (EOR) in the target countries in which employees are based.
Does Your Company Need a Tax Equalization Policy?
When assessing the need for a tax equalization policy, balance the income benefits for employees against the company's tax preparation workload. Consider all locations where employees reside, including state and country, to forecast future tax scenarios accurately.
If you do decide to implement such a policy, make sure to remain compliant with payroll and tax laws applicable in the countries in which you are operating. If these include areas in which certain elements of tax equalization may not work smoothly (e.g., hypotax in Germany), then consult with an EOR or compliance specialist who operates across these particular countries.
Final Thoughts on Tax Equalization for Expats
Ultimately, tax equalization is a policy that companies can implement to help their global employees acclimate to living and working in a different country seamlessly. It takes the complexity out of taxes so they can focus on all of the benefits that come with being a digital nomad. It can also help companies attract and retain the best global talent to work for them.
Omnipresent is an EOR provider that helps companies manage global workforces seamlessly and efficiently. We’ll help you develop and maintain a tax equalization policy for your workers.
Get in touch today to learn more about how Omnipresent can help.
