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How to… calculate hypotax

Keeping track of legislation is just part of the puzzle.  Rebecca Darling, Head of Production, explains some of the issues around getting tax wrong and how you can address this.

When an employee goes on assignment they will most likely become subject to a new tax regime in the host country and the base on which tax is calculated is often increased by assignment-related payments and benefits. Home country tax liabilities may also continue. Ignore this and positions in high-tax locations may be hard to fill while low tax jurisdictions are oversubscribed. To promote mobility and ensure equity between assignees globally, 80% of companies using a home-based approach to assignment pay employ a tax equalisation policy, according to ECA’s latest Expatriate Salary Management Survey. This allows for employees on assignment to effectively pay the same amount of tax they would have paid had they remained at home. This ‘stay at home’ tax figure is known as hypothetical tax (or hypotax).
As hypotax is, by definition, hypothetical, its method of calculation is not enshrined in tax law and must instead be determined by company policy. A balance is needed between accurately estimating home country taxes whilst standardising procedures to facilitate administration and promote employee equity. Containing costs will also play a role. As each organisation’s expatriate demography, corporate strategy and budget is different from the next, each will strike a different balance.
Generally, the starting point is the notional home salary. Added to this are any additional allowances and benefits-in-kind normally received in the home country. A few companies (usually US-based due to the nature of the domestic tax system) go further and include personal income or even spousal income.
Guaranteed bonuses should be included; some companies will also include non-guaranteed bonuses to ensure that sufficient tax is withheld in the event of such a payment, rather than having to reclaim it from the assignee upon reconciliation.
As the principle of hypotax is to maintain home country tax levels, benefits specifically relating to the assignment (e.g. cost of living allowances, host country housing etc.) should not be included.

The gross figure is then netted down for home country tax and social security contributions. This is the hypotax that the employee will pay on assignment. One way to net down is to use an individual’s actual tax figure, perhaps taken from the home country payroll or precisely calculated according to their individual circumstances.
This case-by-case approach may work well for a company with a few assignees, but could prove time-consuming and costly where there is a large expatriate workforce. It also raises equity issues. Personal factors (deductions for mortgage interest, alimony etc.) are not considered when determining home country salaries, so how can their inclusion in the host country salary be justified?
Using a standardised methodology avoids employees on equal home salaries receiving widely different assignment salaries. It can also help curtail discussions with assignees about what should and shouldn’t be included in the calculations. Most companies therefore net down using a set of standard assumptions for all their assignees, although actual family size is usually taken into account. Some countries provide financial relief for families as cash allowances through social security rather than the tax system, so family allowance benefits can be included in hypotax calculations where entitlement ceases on assignment.
In addition to the standard assumptions applicable to all individuals, companies may wish to incorporate certain non-standard reliefs or benefits into hypotax if most of their expatriate workforce receives them.
Pension contributions often attract tax relief and some companies providing occupational plans include this relief in hypotax. However, they could be penalising individuals with private pension arrangements, as their tax relief is ignored unless the employer takes these personal factors into account.

ECA subscribers can access their Tax calculators and reports at MyECA. One-off calculations or data can be purchased under Tax services in ECA’s online shop. For further in-depth analysis of tax and social security developments, download our free Global Perspectives ‘Tax & Social Security’ white paper available from the Insights section of the website.

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