Peter Ashby, Client Service Director at leading financial advisory firm, Grant Thornton, guides us through the tax considerations of dismissing employees while on assignment.
Cost cutting and economic gloom are nothing new, at least not to those who have been around for an economic cycle or two. There’s little doubt that we are in an economic downturn and whether it’s a recession or not, employers will be reviewing costs. We all know international assignees cost significantly more than ordinary employees so expatriate costs will be under the microscope.
- Terminating an expatriate’s contract becomes more complicated because there will be two jurisdictions to think about, which means:
- two sets of tax law,
- two sets of social security law,
- two sets of employment law, and
- some unexpected expenses.
- Let’s look at these in more detail.
Two sets of tax law
Tax law is complicated enough if you are taxed in just one country. But terminating an assignee and bringing them home brings in two regimes. If you terminate an employee on assignment the termination payment could be taxed both in the home and host countries. Exemptions for tax on terminations in one country are worthless if the other country then taxes the payment.
The main problem is that a termination payment is usually a conglomerate of a number of components, such as:
- Pay for the period terminated
- Accrued holiday pay
- Bonus entitlement
- Pay in Lieu of Notice (PILON)
- Contractual termination payments
- Compensation for loss of office
- Restrictive covenant payments
These components are taxed in different ways making the operation of withholding taxes on such payments a tricky problem, especially when encountered for the first time.
There are very many tax treaties around the world to ensure you cannot pay tax in two countries at the same time on the same income. However, there is not a treaty between all countries and even where there is, the wording of the treaty varies from country to country so that you can never be sure of the treaty position without researching it.
One unfortunate thing is that although there are treaties to prevent ‘double’ taxation, if a termination payment is taxable in one regime but tax free in another, there is no double taxation to prevent. This means that very often you can end up with the worst of both worlds since the country that is taxing you does not, in many cases, have to apply a treaty exemption if you are not paying tax in the other jurisdiction. It is rare to find both the country of residence and the country of source exempting termination payments.
Planning usually takes the form of deciding when and where to terminate an international assignee’s contract. Do you bring them home and then terminate the contract, or terminate and then bring them home? By weighing up domestic legislation and the treaty, you can often save a substantial amount of tax by terminating in the right country.
Two sets of social security law
As we all know, tax and social security (Federal Insurance Contribution Act (FICA) tax, National Insurance Contributions (NIC) etc) are not aligned in many countries. In fact, many countries have no social security at all, while others collect most of their fiscal take from employees through social security rather than tax. There is less scope for double social security costs. However, since the rates of social security vary enormously from nil to over 50% combined rate for employer and employee, it is well worth planning to minimise this cost.
An employee will often remain subject to home social security for the whole assignment if he remains employed by the home employer whilst working in another country. In this case, social security will only be levied once.
Nevertheless, many companies have arranged their global workforce so that they do not pay social security whilst working on assignment. These employees need to plan the contract termination very carefully as termination payments can often be substantial.
Careful planning is essential to ensure that this cost is minimised. Certainly, with very large payments, some preplanning can save significant amounts.
Two sets of employment law
Employment rights come from two sources: from an employment contract and from statutory rights created by the country in which you work. The latter can vary from virtually non-existent to outright draconian. It is worth bearing in mind that merely by working in many countries, even for an employer based outside that country, an employee can acquire statutory rights which will over-ride a contractual right.
Therefore, to terminate someone’s contract abroad it is also necessary to consider the statutory employment rights they will have in that country. This could give rise to rights for compensation in the event of a termination that are far greater than at home. It could leave the employee with aright to sue in the other country. Countries where there are few statutory rights, like the USA, may even have a litigious predisposition. This means that if you terminate an assignee in that country, you could be sued there.
Worse still is that in some countries the law provides for the employee to be given financial assistance if his contract is terminated, as well as legal assistance to ensure his rights have been properly respected.
In addition, the process of terminating an employment contract is fraught with danger in many countries. Many European countries make it very difficult to summarily dismiss employees without a valid reason. Failure to take the right steps at the right time may mean the employee can raise a valid grievance and be entitled to compensation for wrongful dismissal.
While sending an employee home after terminating their employment is relatively straightforward these days, expatriates may have been provided with benefits that the employer will have to deal with: a second hand car, computer or mobile phone for example. Along with the relocation of people and property back to the home country, there may be school fees to pay for the rest of the school year as well as property leases and the attendant utility contracts to terminate.
Once the assignee is back home, you may still have to provide accommodation if they have let their house and cannot regain occupation because the house was let for the intended assignment period.
Terminating any contract of employment is fraught with emotional cost and this is likely to be even greater when it concerns an international assignee. This, together with the extra expense, including the tax and social security costs, of a failed assignment, means there will be a far greater impact to take into account, overall, when terminating the contract of an employee working overseas.
Get some good advice from an employment lawyer and an expatriate tax expert. It may be very good value for money.