Non-residents
296. Tax equalisation vs tax protection
June 1996

 

 

Introduction

Following the re-admission of South Africa into the international trading community, more and more South African companies are setting up overseas operations. Frequently South African employees are assigned overseas to manage and run these operations. The international geographic mobility of employees raises new issues for, inter alia, human resources departments responsible for formulating expatriate remuneration packages. One of the first questions asked by an expatriate, especially if being assigned to a high tax jurisdiction, such as Japan is "Who will pay the host country taxes?", as the employee will most likely be taxed on his employment income in the host country. The term "host country" refers to the assignment location; the "home country" is where the employer is based. There are three main schools of thought regarding host country taxes. They are:

"Laissez-faire" simply implies that the expatriate must sort out his own host country tax affairs with no involvement from the employer.

 

Tax equalisation and tax protection are more complex. The employer takes a more active role in the expatriate’s host country tax affairs. Tax equalisation tends to be more common among United States employers whereas United Kingdom employers lean towards tax protection.

 

Tax equalisation

The concept of tax equalisation is that the expatriate should be neither better nor worse off from a tax point of view by accepting an overseas assignment. He will continue to be subject to the same level of tax as if he had remained at home. The tax impact of the assignment is therefore neutralised for the expatriate.

 

The mechanism to ensure that the expatriate employee continues to bear the same level of tax involves the deduction of so called "hypothetical" home country tax. For the purposes of "hypo" tax deduction, the employer ignores items specifically paid because the expatriate is on overseas assignment e.g. a cost of living allowance. This hypo tax is used by the employer settle the applicable host and home country taxes. In addition the employer will pay any taxes due over and above the hypo tax. If the home and host country taxes are less than the hypo tax then the employer enjoys the benefit.

 

The advantages of tax equalisation include the following:

 

A major disadvantage is that administration of a tax equalisation policy tends to be time consuming and consequently expensive.

 

Tax protection

Tax protection is similar to equalisation to the extent that the expatriate should pay no more tax than if he had remained at home. If the tax in the host country is higher the excess is met by the employer.

The difference arises when the employee is assigned to a low tax jurisdiction, e.g. Hong Kong, as the tax benefit is enjoyed by the employee and not the employer. If hypo tax is deducted, the difference between the (low) host country tax and the (higher) home country tax is refunded to the employee.

Tax protection tends to be more popular when the employer has a small number of expatriates and/or if an incentive is required to encourage an expatriate to take up an assignment.

The advantages of tax protection include the fact that it is less time consuming and easier to administer than tax equalisation. As stated previously, it can be used as an inducement for an employee to accept an overseas assignment. The disadvantages include the following:

 

Example:

A South African national is assigned to Hong Kong.

 

 

Equalisation rand

Protection

Salary

300 000

300 000

Cost of living allowance

220 000

220 000

Total remuneration

520 000

520 000

 

 

 

Hypothetical tax (onR300 000)

*121 540

54 375

Hong Kong tax payable

54 375

54 375

Cost to employer

452 835

520 000

Employee net salary and allowances

398 460

465 625

 

*Cost of living allowance ignored for hypo tax as this income only arises as a result of the overseas assignment.

 

M R Ahern, Deloitte & Touche

General tax principles - international assignments