Global commerce has led to increase in mobility of technology and people across the world. When an employee based out of one’s country (home country) is deputed to another country (host country),two major concerns that the employee faces are the risk of income being taxed in both the countries and the tax rate of the host country being higher than tax rate of the home country.
While the first concern is normally taken care by Double Taxation Avoidance Agreements entered between various countries,the concept of tax equalisation takes care of the other concern.
Tax equalisation is a concept,where an employee seconded to a foreign country for his employment pays no more or no less tax than what he would have paid on the same level of compensation in the home country had s/ he continued his/ her employment back home. The additional tax liability arising due to higher tax rate or the benefits arising due to lower tax rate in the host country are borne by the employer. This method has gained popularity as the employee neither suffers incremental tax on income nor realises any financial windfall from tax consequences of the international assignments.
Tax equalisation is a different concept from tax protection. Though,under both the concepts,the employee is not required to pay the incremental tax in the host country,if the employee is tax protected,then the benefit of lower tax rate in host country is usually enjoyed by the employee as against the employer if s/he is tax equalised.
Now the question arises as to how this concept of tax equalisation works. To understand the mechanics of tax equalisation,it is important to understand two concepts of hypothetical tax and tax perquisite.
Hypothetical tax is the tax which the employee would have paid on the same level of income in the home country. This would also be the amount of tax that the employer would consider for the purpose of withholding the tax from the compensation paid to the employee. However,it may be noted that this tax is not the actual tax payable by the employee in the host country,hence the name hypothetical tax.
The employer normally withholds hypothetical tax from the salary of seconded employee. However,the actual tax liability of the employee in the host country would be discharged by the employer. The difference between actual tax and the hypothetical tax is termed as tax perquisite. As per the extant Indian laws,tax perquisite is considered as an income taxable in India. Accordingly,the amount of tax perquisite is grossed up and included in the amount of salary chargeable to tax.
The process of tax equalisation has numerous advantages,some of them being
* Tax savings are enjoyed by the employer;
* Taxes of the seconded employee are handled by experts,thus ensuring proper compliances of tax laws
However,one of the major disadvantages is that the administration of tax equalisation policy tends to be time consuming and an expensive process. Besides,if the tax rate of the host country is high,the additional tax is borne by the employer thus increasing the overall cost of the international assignment.
In spite of this disadvantage,tax equalisation is a welcome concept in the international assignments as it assures the seconded employees that they do not shell out more tax than what they are required to in their home country thus promoting mobility of talent globally. However,a careful planning of tax equalisation policy is required to ensure a win-win situation for both employers and employees.
Author is with Tax & Regulatory Services Division,PwC India