Global Mobility: The Basics of a Shadow Payroll

In today’s global economy, companies must consider mobility when it comes to processing international payroll. Multinational companies that have employees operating in multiple countries, on both short- and long-term assignments, face multiple payroll challenges, especially when it comes to processing taxation.

As an example, if an employee from the U.K. is on a long-term assignment in the Netherlands, then that employee may be liable for tax and social insurance in both locations. In situations like this, companies use a shadow payroll; a process to assist with the reporting and tax withholding obligations in a host country for an employee who is remaining on his or her home country’s payroll system while on assignment in the host country.

Defining a Home vs. Host Country

A fundamental aspect of shadow payroll is understanding the difference between the employee’s home country and host country. The home country is the country in which the net pay is paid to the employee. Likewise, the host country is the country in which the employee receives no payment. It is important to note here, however, that the home country is not automatically the country from which the employee originates.

For example, if you’re a Swedish-based company but have an employee from the U.K., who is on an assignment in the Netherlands for more than 183 days, then that employee’s home country will likely be the Netherlands since that’s where the net pay is paid, and their host country would be Sweden.

How do you know if you need a shadow payroll?

Determining whether you need a shadow payroll lies in answering two important initial questions:

1. Do you have employees moving from country to country?
2. Is the employee’s assignment a short-term or long-term?

If the assignment requires the employee to work in another country for more than 183 days, then it is considered long-term and a shadow payroll is required.

Best Practice: Find out if you’re capturing dual tax

Assessing Tax Treaties, Hypo Tax, and Net of Foreign Tax Scheme

Once you determine if a shadow payroll is required, you need to do a quick assessment of the tax requirements of the countries involved. Many countries have tax treaties in place to allow for the reduction of taxes, avoid or mitigate double taxation of the same income, eliminate tax evasion, and encourage cross-border trade efficiency.

However, when an employee is a taxpayer in one country, but works in another, he/she may be subject to different taxation or double taxation even when the tax treaties between countries are considered. “Tax equalization” is the offsetting of any such difference so that working abroad is “tax neutral” for the employee.

The basic principle behind a “tax equalization policy” is that the employee will not suffer a financial hardship or experience a financial windfall as a result of the tax implications of an international assignment. The employee should be in a tax neutral position during the assignment.

To assist in the reduction of liability many countries offer a ‘Net of Foreign Tax Scheme’ whereby the company can apply to have the host country tax removed as well as any social or pension requirements.

Best Practice: If there is no Net of Foreign Tax Scheme in place, the company should pay the host country taxes so the employee avoids a hardship.

If you are not following these best practices you will need to utilize hypo take – taken from hypothetical – to report on the host countries taxes on the home payroll, but bear in mind, due to the cut-off calendars, this may be a payroll cycle behind the host country payroll.

The iiPay Difference

If you process global payroll, then understanding shadow payroll is a must. But, it’s one thing to understand it and quite another to process it. The iiPay solution is designed to create efficiencies in the payroll process, account for multiple payroll assignments and give the user unparalleled visibility to both locations. Contact us today to learn more: https://www.iipay.com/contact-us/