The Oversea Employee
The tax problems associated with sending employees overseas once existed only for a small number of businesses; namely, those companies which could afford to send their employees to distant shores. However, in recent years, the practice of sending employees abroad has proven to be increasingly practical. As a result, the importance of executives carefully studying the challenges involved with sending employees out of the country has never been greater. There are many business implications involved with international work assignments, taxes being one of the most important.
Many employers believe that tax exposure problems can be reduced or eliminated altogether if the employee spends less than 183 days in the host location. Although many tax treaties support this assumption, it is inaccurate. The Organization for Economic Cooperation and Development (OECD) has released a list of principles which state that the primary goal should be to avoid double taxation. The Model Tax Convention sponsored by OECD was designed to develop a common platform on which to solve problems that arise from double taxation causes.
Reducing Tax Exposure Problems
Here is a hypothetical problem. A company based in the U.S. owns stations in the nations of Nigeria, Venezuela and China. This company employs a person who is not a U.S. citizen at one of the subsidiaries. The worker receives monetary compensation through a split U.S. and local payroll. The worker’s income is paid into a bank account in a third country. By this process, the American headquarters is taking a deduction for the employee’s work without recharge of the cost made to the associate subsidiary.
In the above example, the American-based company could have a permanent establishment risk, according to OECD principles. Multiple tax treaties and domestic tax laws have tests to help an employer determine if he or she has a permanent establishment risk. The most common indicator of a risk is the presence of a foreign-employed individual who makes executive decisions for the local business.
In the hypothetical story, there is also the chance that the employee is not exercising compliance with the local tax laws. Using the split payroll structure, any locally-paid compensation is typically subject to partial withholding for income tax purposes. The employee will most likely not report foreign pay earning to the U.S. company.
In addition, the American company should most likely be withholding taxes on the foreign-earned pay as well American pay. Failure to do so can result in harsh penalties.
Working in Venezuela
The United States and Venezuela already have a tax treaty. While the principles of the OECD are generally not taken into account with regard to political climate, they do provide an easy starting point. Given the work environment, a permanent establishment risk is possible. As a result, tax issues will need to be resolved.
Working in China
In the case of a China-based subsidiary, a permanent establishment risk is easily created by the secondment of expatriate employees. As of 2009, Chinese authorities began treating secondment as a personal establishment risk on the part of the overseas employer. In June 2013, authorities released Circular 19 to help reduce conflict between local tax bureaus.
Based on the assumption that the American employer will bear all risks and responsibilities associated with outsourcing employees, Circular 19 regards the U.S. employer as the actual employer of the individual working out of the United States. If, however, the employee is stationed in China for more than 183 days of a calendar year, the U.S. employer will be regarded as having a permanent establishment risk and will be obligated to pay Chinese corporate taxes.
If the U.S.-employed individual were to work full time in China, he or she would be required to report all income to the Chinese officials. No time-apportionment claim would be allowed. An easy way for the US to solve the permanent establishment risk problem is for the U.S.-employed worker to enter into a contract with the Chinese entity. In this way, the worker would be considered a Chinese employee and taxes would be handled accordingly. For Social Security purposes, the employee would also keep his or her original contract with the United States.
Working in Nigeria
Because Nigeria has no tax treaty with the United States, tax issues must be handled differently than for Venezuela or China. The Nigerian Companies Income Tax Act states that corporate tax must be assessed on any profits that enter the country of Nigeria. In addition, foreign companies are required to pay corporate tax if they habitually operate in Nigeria through another agent. In short, Nigeria’s tax structure closely follows the guidelines of the OECD, even though there is no written treaty on which to base facts or arguments.
Avoiding Costly Non-compliance Fees
Relocating employees to another country can have significant impact on both the employer and the employee. While every country’s tax system operates differently, the OECD offers some continuity and has helped several employees avoid being hit with costly non-compliance fees. By ensuring compliance with the tax system of the country being outsourced to, employers can ensure that they are doing their best to make the world a better place.
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Until next time!