India has started making its presence felt in the international trade community. More and more Indian companies are setting up overseas operations and similarly more and more overseas companies are setting up their operations in India. 

Thus we see Indians assigned overseas to manage and run these operations and foreigners coming to India to manage and run operations in India. One of the first things which come to the mind of the person being sent outside the country is the tax impact on the salary of the individual. Expatriate does not want to bear the additional tax burden for being sent to a high tax jurisdiction and thus comes the question as to who will pay the increased tax on the salary.

Following two approaches are commonly used by the companies:

• tax equalisation and
• tax protection

Following paragraphs briefly explain about the two approaches which can be used to protect the interests of the employee. In the following paragraphs, the country of which the individual is a resident is called as a ‘home country’ and the country to which he is send is called as the ‘host country’.

Hypo tax is used widely for executives who are sent to work overseas to ensure that the tax situation does not become a factor in an executive’s decision to accept an international assignment. The expatriate pays no more and no less tax than counter part in home country. 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” or “stay-at-home” tax.

Hypo tax is calculated on the remuneration the assignee would have earned if the assignee continued to live and work in the home location Hypothetical tax will normally be withheld from the assignee’s normal pay and is retained by the employer as a “tax reserve”.

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 to 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 host country taxes are less than the hypo tax then the employer enjoys the benefit.

In simple words, from the salary of an employee hypo tax will be deducted and the employer will bear the tax burden in the host country.

Under an equalization policy, any tax savings will go to the employer but, similarly, any additional tax liability will be borne by the employer.

The advantages of tax equalisation include the following:

• Tax savings are enjoyed by the employer thus reducing overall assignment costs;
• Employee geographic mobility is improved.
• Tax compliance in the host country

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

Some employers may implement a tax protection policy instead of tax equalization policy. 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 author is a member of the Institute. The views expressed herein are his personal views and do no necessarily represent the views of the Regional Council