Protection vs. Equalization vs. Localization
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Subject: Protection vs. Equalization vs. Localization
Once an international assignment exceeds a year OR it is know that the international assignment will exceed a year, everything paid to, for, or on behalf of the expatriate is taxable compensation to the expatriate. Further, since taxation in both home and host countries is the norm, inflation of the overall tax liability is unavoidable. Therefore, tax preparation assistance as a benefit for expatriate employees is almost imperative. Companies may opt to address taxation issues by adopting a localization, tax protection, or tax equalization approach.
- LOCALIZATION is the least common approach. Under the localization approach, the expatriate employee is responsible for his or her own tax liabilities. Localization may result in significant tax burden on the employee. Additionally, most company’s feel the expatriate will turn to the company for financial support in meeting these tax liabilities should this approach be utilized. Therefore, this approach is seldom utilized.
- Under tax PROTECTION, the expatriate employee is responsible for paying actual home and host country taxes. A hypothetical (or stay at home) tax is determined and compared to the actual worldwide taxes that the expatriate employee paid. If the actual worldwide taxes exceed the hypothetical taxes, the employer reimburses the excess to the expatriate employee. If actual worldwide taxes are less than the hypothetical taxes, the employer receives NO reimbursement from the employee. This is the most generous approach since the employer reimburses the expatriate employee for amounts in excess of the hypothetical tax. However, there is a timing issue with this approach. Normally, all home and host country taxes are paid up front. Then after the returns are completed, or later, credits and double taxation issues are worked out and refunds are returned from the tax authorities. Therefore, an expatriate could pay 30% taxes to the home country and another 30% taxes to the host country and be forced to live off of the remaining 40% of gross salary … or call upon the company for financial support.
- When tax EQUALIZATION (or no gain or loss) approach is utilized, the employer bears the responsibility for paying the expatriate’s actual home and host country tax burden. In exchange, the expatriate pays a hypothetical (i.e. ‘as if’ or ’stay at home’) tax to the employer as determined under the company’s equalization policy. The amount is recalculated annually along with the preparation of the home country tax return. The result may generate a refund to or an additional payment from the expatriate. The benefits to this approach are numerous but the major benefits include:
- The expatriate bears an approximately similar tax liability; thereby, leaving the issue of taxation out of the equation of accepting the assignment.
- Hypothetical withholding, when retained by the company like in the equalization approach, is considered a form of deferred compensation and therefore not taxable in most of the countries today.
Basically, localization was the first approach used when companies began sending assignees abroad (i.e. an assignee goes to a foreign country and with the governments sophisticated tax treaties, etc. the assignee should not be unduly burdened by taxes.) Then after realizing there is no dollar for dollar benefit, the timing issues, and the expatriates complaints of dealing with double taxation, companies began an effort to entice employees to accept international assignments by using the protection approach. After losing money with the protection approach and expending extreme efforts on researching the best tax effects, equalization was developed. Today, the majority of sophisticated expatriate companies utilize the equalization approach.
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