Improvements in technology have made it easier than ever for companies to account for employees operating in overseas locations. The reduction in technological barriers has also made it possible for businesses to take advantage of a telecommuting workforce, located in both their Home country and overseas. The convergence of the two trends has resulted in an increasing number of companies discovering that they must now address the tax and payroll compliance issues that result from employees operating outside of their Home country.
At the same time, the countries hosting overseas employees have begun to take advantage of recent improvements in enforcement technology to better track the bank accounts, income, and assets of overseas employees operating within their borders. This has allowed the Host countries to do a better job of tracking down both the employees operating there and their employers to ensure they are complying with the requisite tax and payroll reporting requirements.
Even if the overseas employee transfer does not result in any additional tax liability in the Host country, the employer or employee may still need to report assets, income, or bank accounts to the Host country or risk the financial costs associated with noncompliance, such as interest and penalties. For example, US residents who are temporarily employed in Canada may be exempt from Canadian income tax due to the income tax treaty, however the employer will still have Canadian income tax withholding obligations unless a waiver is obtained in advance from the Canadian tax authorities.
Income Tax Treaties May Not Provide Protection
Some companies fall prey to the fallacy that, if their Home country has an income tax treaty with the Host country, their overseas employees are not subject to taxation in the Host country if they are there for fewer than 183 days. Although most income tax treaties include the 183-day rule, it is only one of several requirements for determining whether an employee qualifies for treaty exemption. Many income tax treaties will also require that both of the following conditions also be met to qualify for an income tax exemption in the Host country:
- The compensation is not paid by, or on behalf of, an employer who is a resident of the Host country and;
- The compensation expense (including all benefits, e.g., hotel, meals) is borne by the Home entity and is not borne by a permanent establishment (PE) in the Host country.
It is important to note that the meaning of the above two conditions can vary by treaty. For example, some countries will use a legal definition of the word “employer” while others may look at it from an “economic” perspective (i.e., which company is bearing the responsibility and risk for the employee’s work). As well, although a PE can be a fixed place, such as a building, a PE can also result from the length of a project or due to the specific activities being performed by the employee (e.g., the employee is concluding or heavily involved with negotiating contracts on behalf of the Home country employer in the Host location). For these reasons, it is critical to understand how the treaty will be applied for the specific Home and Host country combination and scenario, regardless of the assignment duration.
Employers must also understand that income tax treaties only apply to income taxes and not social taxes, which are separate taxes that are often covered by different laws and agreements. Therefore, even if an employee is exempt from income tax in the Host country under an income tax treaty, social tax may still be due.
US Citizens and Lawful Permanent Residents (Green Card Holders) Face Additional US Reportings
US citizens and green card holders working overseas are required to submit annual federal income tax returns even if they are not physically working or living in the US. This filing requirement remains, even if the US employee is able to utilize exclusions and credits in their US tax returns to eliminate their US tax liabilities.
US taxpayers may face two additional federal reporting obligations. The first is the Foreign Account Tax Compliance Act (FATCA), which requires the disclosure of foreign assets above a specified level for their filing status and their residence. In addition, a Report of Foreign Bank and Financial Accounts (FBAR) may also be required when a US taxpayer has foreign financial accounts totaling more than US $10,000 at any time during a calendar year.
Although neither the FATCA nor the FBAR forms are difficult to fill out and submit, some US residents operating overseas fail to do so because they are not aware of their filing obligations. In some cases, a resident who fails to properly submit a required FATCA or FBAR form can become compliant by paying a fine, but residents found to be noncompliant have faced fines topping $1 million. Because of the possible legal penalties that may result from failing to file the requisite FBAR or FATCA form, it is best to contact an attorney if you are delinquent with these filings and may have unreported income relating to the accounts.
Technology Making It Harder to Claim Ignorance
The improved ability of employers to track their employees has made it more difficult for employers to claim they are unable to comply with tax and payroll reporting requirements for their overseas employees. The result has been that employers are facing increased financial, legal, and reputational risks for failing to comply than they did in the past. Additionally, many Host countries have been looking to increase their revenue, and they are aware of the fact they are hosting foreign employees who are currently noncompliant. This will likely result in increased enforcement efforts in the future.
More and more companies are asking if an organization’s global employees are tax compliant too late in the game. Beginning the process of finding a mobility tax partner as soon as possible can save an organization operational nightmares and financial burdens. A partner who specializes in mobility tax services for companies can assist in the development of long-term, short-term, and non-traditional assignment tax planning and compensation structuring.
The information provided above is for general guidance only and should not be utilized in lieu of obtaining professional tax and/or legal advice.