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Law Office of Joseph C. Grasmick --Business Immigration--
Representing Canadian Businesses and Professionals for over 15 years

HR Tax Reimbursement Policies-for Canada to U.S.A. Employee Relocations

Introduction to this Web Page

Introduction to HR Tax Reimbursement Policies For Canada to U.S. Employee Relations:

1. The Tax Reimbursement Policy
2. What Policy is Best for Your Company
3. Tax Planning Reduces Assignment Costs
4. Conclusion
5. About the Author

Other Tax Topics on This Site:

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Introduction to this Web Page

The Law Office of Joseph C. Grasmick is prepared to help HR managers get U.S. immigration permits for Canadian employees. This Web site focuses on immigration. Nevertheless there are a few other employment issues that relate very directly to the immigration issues. One of these very important issues is The Tax Reimbursement Policy

Tax reimbursement may be the most significant assignment cost that a company incurs when transferring an employee from Canada to the U.S. It is therefore critical for employers to fully understand the implications of a tax reimbursement policy and how to manage the policy in order to minimize costs.

For this reason, we share our Web site with James Yager of KPMG Peat Marwick Thorne in Toronto, to further service our immigration clients. James is a Principal with the International Executive Tax Services group of KPMG Toronto.

This article first appeared in CERC News, July/August 1995 No.76. CERC (The Canadian Employee Relocation Council) is the premier Canadian organization concerned with employee relocation. Membership information is available from CERC headquarters, Voice: 416.489.2555, Fax: 416.489.2850.

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Introduction to HR Tax Reimbursement Policies For Canada to U.S. Employee Relations



KPMG Peat Marwick Thorne
Director, International Executive Tax Services Group
Suite 3300, Commerce Court West
PO Box 31
Toronto, Ontario M5L 1B2 CANADA
Voice: 416.777.8214
FAX: 416.777.8818

Imagine asking an employee to take a foreign assignment where his/her tax liability will be cut in half after a relocation to the foreign country. The employee's decision will likely be influenced by this potential tax windfall. Now assume it is two years later and you are asking the same employee to move back to Canada where he/she will incur a significantly greater tax liability than what was incurred during the foreign assignment. It is likely that the employee will also be influenced by this decrease in net compensation. In both cases, the employee will incur a significant change to net compensation due to the foreign assignment. This change to cash flow may not only influence the decision to accept a foreign assignment, but may also influence job satisfaction. To mitigate the impact of taxes on a foreign assignment, many companies have adopted a tax reimbursement policy.

Many multinational companies have an international compensation policy designed to ensure that employees on international assignments receive total compensation, housing, living standards and other benefits which are comparable to that which they would have if living in their home country. The intent is to keep the employee "whole", regardless of assignment location. The procedure of keeping an employee whole is known as the "balance sheet" approach.

By employing the balance sheet, the assignment costs to an employer can vary significantly, depending upon the location of an assignment. For example, an employee who is transferred from Toronto to Tokyo will be subject to increased housing expenses. To keep the employee whole, the employer would have to reimburse the employee for these additional costs. The assignment costs are magnified by income tax reimbursements. Most industrialized countries consider employer provided foreign assignment benefits to be income to that employee, which would be subject to the local country's income tax. Furthermore, tax reimbursements provided by the employer to pay for the additional income taxes incurred on assignment benefits are also considered taxable compensation. The "tax on tax" impact can be a major expense to an employer. A simple formula can be used to estimate the tax reimbursement required to reimburse an employee for the additional tax costs arising from company provided benefits:

Tax reimbursement equals:

Taxable benefit
1- Marginal Tax Rate
Taxable Benefit

For example, the tax reimbursement required to reimburse an employee residing in Japan in the 65% marginal tax bracket to a company provided taxable benefit of $10,000 would be $18,571. Therefore, the employer would have to give the employee a cash benefit of $28,571 in order to provide a cost of living benefit of $10,000 plus a tax disbursement of 18,571.

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1. The Tax Reimbursement Policy

Tax reimbursement policy is designed to ensure that an employee will not suffer combined taxes on income (host country taxes, social security taxes and home country taxes) in excess of that which would have been paid if the employee were living back in the home country. The most common methods utilized to accomplish this objective are either:

  1. tax protection, or
  2. tax equalization.

Tax Protection

Tax protection plans are designed to reimburse an employee to the extent that the employee's combined total income and social security taxes exceed the amount that he/she would have paid if he/she remained in the home country. If combined actual taxes are lower because of the foreign assignment, then the employee realizes a benefit from the foreign assignment, since he/she is entitled to keep the tax benefit.

Generally, a company will compute a hypothetical tax for the employee. The hypothetical tax is typically the home country tax that the employee would incur if employed in the home country at the same compensation level, but without the foreign assignment benefits. If the actual tax incurred by the employee exceeds the hypothetical tax, the employee would claim a refund from the employer for the difference between the actual tax and the hypothetical tax. If the actual tax incurred by the employee does not exceed the hypothetical tax, the employee would not file for tax reimbursement from the employer, but would just pay the actual taxes incurred.

Tax Equalization

Tax equalization plans are designed to provide an employee with neither a tax benefit nor tax detriment from the foreign assignment. If combined actual taxes are higher because of the foreign assignment, the employer would reimburse the employee for the additional costs incurred. However, if combined actual taxes are lower because of the foreign assignment, then the employee must reimburse the employer for the difference. Regardless of the tax jurisdiction where the employee works, the employee will be subject to the same level of taxes, net of reimbursement (or payment) from the employer.

Under a tax equalization policy, a company will typically withhold a hypothetical tax from each payroll payment to the employee. The hypothetical withholding is based on the projected tax the employee would have incurred on compensation in the home country, assuming no foreign assignment benefits. After the end of the tax year and after preparation of all the relevant tax returns, a reconciliation would be prepared based on actual income received during the year. The reconciliation would determine whether the employee is due a refund of hypothetical taxes, or whether he/she must reimburse the company for underpayment of hypothetical taxes.

  • Ease of relocation--If an employee is subject to tax protection he/she may be able to obtain a windfall by being relocated to a low tax country. As discussed earlier, he/she may hesitate accepting a new assignment in a high tax country where the windfall would no longer be available. Under tax equalization, the employee would have the same net tax liability, regardless of the location of the assignment.
  • Compliance-- When tax protection is utilized, an employee would have an incentive to under report income, since lower taxes may accrue to his/her benefit. If an employee under reports income, the employee and employer may be faced with legal issues and an embarrassing situation in host country, if discovered by the tax authorities. Under tax equalization, the employee would be subject to the same level of tax regardless of the level of compliance. Tax equalization would, therefore, promote full compliance, since the employee incurs no additional tax costs to comply and avoids the potential problems of non compliance.
  • Expense to employer-- tax protection is a one way street. If the total tax liability of the foreign assignment is less than the hypothetical tax, the employee keeps the benefit. However, if the total tax liability is greater, the employer incurs the additional costs. Under tax equalization, the employer keeps the tax benefit of having employees in low tax countries, which helps to offset the tax costs of having employees in high tax countries. Generally, tax protection will be more expensive if the employer has many international executives in low tax jurisdictions. Otherwise, the cost of tax protection generally will not be significantly greater than the tax equalization. Since Canada is a high tax jurisdiction, an employer will likely have significantly lower expenses with a tax equalization plan, if the hypothetical tax is based on Canadian taxes. There could be many instances where the taxes in the host country are lower than the hypothetical Canadian taxes.

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2. What Policy is Best for Your Company

Not all reimbursement policies are created equally. When designing, modifying, or implementing a tax reimbursement policy it is important to align the human resource policies with the overall corporate strategies. What may be an optimal policy for an investment bank may not be workable for a mining company.

Once the human resource policies are determined, the tax reimbursement policy should be appropriately aligned. For example, the employer should determine whether it is appropriate to apply the balance sheet approach to their tax reimbursement policy. The balance sheet approach should minimize employee financial concerns regarding the relocation. However, the balance sheet approach may be expensive and does not help an employee become assimilated to a foreign environment. Rather by keeping an employee "whole" it recognizes differences based on nationality.

In its purest form, the balance sheet would favour a comprehensive tax equalization policy. Deviations from the balance sheet include tax protection (as discussed above), and tax gross-up (which reimburses the tax and the "tax on tax" on specific taxable benefits).

Some companies apply an "ad hoc" tax reimbursement policy where each individual is treated separately. This may be workable for a company with a handful of international employees, but would be inappropriate for a company with hundreds of international assignments.

Other companies use the "Laissez-Faire" method. This method generally implies that the employee is on his/her own with respect to taxes. This policy (or lack of policy) would promote assimilation to the foreign environment but may create unexpected surprises to the employee at tax time. Such surprises may impact job performance.

Once the general policy is determined, it is important to put it in writing and communicate the policy to all employees covered. As with any type of personnel policy, it is important to be specific regarding the provisions. For example, a tax equalization policy that merely states, "The employee will incur neither greater nor lesser taxes due to the foreign assignment" may leave many issues open for interpretation and may result in misunderstandings.

Some of the issues that should be covered in a tax reimbursement policy include the following:

Covered taxes

Most policies cover all income taxes including federal, provincial and other local taxes based on income. Many policies also cover social security taxes.

Penalties and interest are another type of "indirect" tax. Although, many policies provide that tax penalties and interest will be reimbursed by the company, they typically also provide that such charges will be born by the employee if the reason for the charges is due to the fault of the employee. This type of provision should promote timely compliance with the tax laws.

Death taxes are another type of tax to consider. Many countries impose an estate tax based on the value of assets situated within that country upon the death of the owner. The United States has an estate tax that ranges from 18% on a taxable estate of less than US10,000 to 55% on a taxable estate in excess of US$3,000,000. For example, if an employee, who is neither a U.S. citizen nor domiciliary, owns a house in the U.S. worth US$400,000 with a US$200,000 mortgage, he/she could incur a U.S. estate tax of US $41,800. Should the employee be considered a U.S. domiciliary (an individual with an intent to reside indefinitely in the U.S.), the tax could be imposed on the employee's global estate.

Few policies address the reimbursement of death taxes. This may lead to unexpected surprises upon an untimely death of a relocated employee.

Income and Deductions Subject to Tax Reimbursement

Some policies reimburse an employee for the additional taxes incurred on all of the employee's net income including non-company income and deductions. Other companies only reimburse the employee for the additional taxes arising on company compensation.

The policy should address whether investment income is subject to tax reimbursement. This may create a significant issue if the employee is the heir of a family fortune with investment income that far exceeds his/her compensation. Some companies put a cap on the amount of investment income subject to reimbursement to avoid these type of issues.

Similarly, the policy should address whether the employee will be allowed RRSP deductions. If the employee is no longer a resident in Canada, an RRSP contribution may not be allowed, or the contribution may provide no tax benefit. To alleviate this problem, some companies allow a hypothetical RRSP deduction if the employee contributes the funds to a specially designed savings account.

Home Sale/Rental

Converting a principal residence to rental property may result in a taxable transaction in Canada when the property is eventually sold. If sold when the employee is resident in a foreign jurisdiction, additional foreign taxes may be incurred. This tax may not have resulted if the employee has always occupied property as a principal resident. Since the tax liability could be significant, it maybe appropriate to specify whether the policy would reimburse such taxes.

Repatriations and Terminations

The policy should provide the method for reimbursing an employee after the end of an assignment. Some employee benefits, such as tax reimbursements, to relocation allowances may continue for a period of time after the end of an assignment. This may result in additional taxes in subsequent tax years. Many companies provide their repatriated employees with a "tax gross up" in the year the assignment ends. The tax gross up reimburses the employee for the additional taxes on the foreign assignment benefits plus it reimburses for the "tax on tax". The tax gross-up is designed as a final settlement in order to avoid the tax reimbursement policy continuing for years after the assignment ends.

Tax Refunds

Tax reimbursement policies should provide that tax refunds related to reimbursed taxes should be refunded to the company as soon as received. In some cases an opportunity may arise which results in a refund of taxes paid in prior years. It may be appropriate for the company to keep track of potential refund opportunities and follow up with the employee.

Many companies withhold sufficient hypothetical taxes during the year to assure that at year end the company will owe the employee a refund of hypothetical taxes. This will avoid the employer having to chase the employee for underwithheld hypothetical taxes

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3. Tax Planning Reduces Assignment Costs

Many strategies are available to reduce the tax liability of the relocated employee. If the employee is covered by a tax reimbursement policy, it is likely that the tax savings will accrue to the benefit to the benefit of the employer. For this reason, it is desirable for the employer to require their relocated employees to participate in pre-departure tax counseling sessions so that the employee is aware of tax planning opportunities and can play an active role in reducing tax costs.

The employer should monitor the preparation of tax returns to assure that the employees are in compliance with the tax law and that tax strategies are being appropriately implemented. Many companies engage the services of tax professionals to fulfil this need.

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4. Conclusion

There is no perfect universal tax reimbursement policy. Each company must evaluate the options available to align the goals of the policy with the overall corporate strategies. However, once the optional policy is determined, the company should take appropriate steps to draft a written policy and properly communicate the provisions to the transferred employees. It is important that the employees are kept aware of the provisions of the policy in order to avoid misunderstandings, and to obtain their assistance in minimizing their taxes. A properly drafted and implemented tax reimbursement policy can promote a successful relocation while saving assignment costs.

©1995 Canadian Employee Relocation Council

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5. About the Author

James Yager is a Principal with the International Executive Tax Services group of KPMG Peat Marwick Thorne in Toronto. His clients consist primarily of corporations who have employees on international assignments.

Prior to relocating to Toronto in June 1993, he worked in New York, Hong Kong and Miami where he served U.S. based clients expanding internationally and foreign based clients from Canada, Europe, Asia and Latin America expanding into the U.S.

Having been an expatriate for over eight years, he is "intimately" aware of the cross border tax issues faced by both employees and employers.

Mr. Yager has been actively involved with the Canadian Employee Relocation Council and the National Foreign Trade Council. He recently testified before the U.S. House Ways and Means Committee for increased tax benefits for Americans working Abroad. He is also the treasurer of the American Club in Toronto.

Mr. Yager is a U.S. Certified Public Accountant and Canadian Chartered Accountant. He has received a B.A. in economics from Cornell College, an M.B.A. from The University of Iowa and an M.S. in Taxation from Florida International University.

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