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Five Ways to Structure Contracts and Payroll for International Employees

When a multinational assigns an employee to work abroad, there are several ways to structure both the contractual and global payroll arrangements for international employees.  No single method is optimal in every situation, and will depend on the company’s presence and commitment to the host country, as well as the existing employee relationship, preferences and benefits. 

According to one study by EY, fully half of companies simply rely on their historical practice and what has worked in the past, and as the study points out:  “if little has changed in the way of business strategy, size, geographic scope, acquisitions or mergers over the past several decades, then this may be a perfectly appropriate response. In reality, however, relatively few organizations can make that claim.” 

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Cost continues to be one of the largest hurdles for implementing any new global payroll and contract methods for international employees.

There are various payroll methods for international employees, and whether a company uses in house resources, outsources or uses a hybrid, there will always be consequences for employees and human resource departments. 

Factors to consider in selecting an option include:

·      Creation of permanent establishment

·      Compliance with unusual local payroll and contract requirements

·      Visas and Work Permits

Home Country Payroll

The most straightforward method in terms of human resource management is to have the employee under contract and on the home country’s payroll, just as with other home country employees.  Although the employee is actively working in the host country, their employment is managed without any changes.  Over a third of international assignments use the home country method, perhaps due to its simplicity and ease of initiating the assignment. In practice the home country payroll is fraught with risk for any purpose other than short term business travel.

Advantages:  A home country contract and payroll allows for seamless management, since there are no host country requirements.  The employee will feel a greater sense of continuity and will not risk losing any benefits or pension contributions in the home country.

Disadvantages:  Despite the home country employment relationship, there are often social security and other payroll compliance requirements in the host country that will be triggered depending on such factors as the work performed and the length of stay. Similarly length of stay is crucial in determining the individuals potential personal tax liability in the host country. In some countries there may be tax treaties that apply to offset the withholding requirements. The employees’ immigration status (e.g. a sponsored work permit) may also trigger a requirement for a host country payroll.  In addition, the employee’s presence and work activity in the host country could trigger unintended ‘permanent establishment’ for the company for corporate tax liability purposes.

Split or Shadow Payroll Between Home Country and Host Country

In this approach, the contractual and employment relationship continues in the home country, but a second payroll will also run in the host country.  Compensation could be allocated in a split payroll to benefit the employee or employer.  All taxation and withholding are made based on the host country’s statutory requirements, but there is a continuity of benefits and standing in the home country.  Split or shadow payrolls are used by nearly 30% of multinationals for their expat assignees.

Advantages:  Employers can use a split or shadow payroll to maintain continuity with the employee whilst also ensuring compliance in home and host country. It may also allow employers to provide a more cost effective remuneration package for an employee. Maintaining an element of payroll in the home country can also be an advantage with tax deferral, pension contributions, fluctuations in currency exchange rates, and financial security in unstable host economies.

Disadvantages:  There may be a need for two employment contracts due to local requirements, and the employee’s activity may trigger ‘permanent establishment’.  The employee will be active in two tax jurisdictions which may complicate their personal tax. The home country human resources department must locate a local payroll partner to take care of the taxation and withholding for the host country portion of compensation.

Local Payroll in Host Country

This is the simplest solution, where all international employee contractual and payroll relationships are transferred to the host country, where it is managed for full local compliance.  In essence, a new employment agreement is initiated, and the home country relationship is terminated permanently.

Advantages:  This provides the greatest grounds for compliance with host country regluations. Full local payroll also is less complex to run than a shadow or split payroll because the payroll is restricted to the host country only.

Disadvantages:  This method may be undesirable to some expat employees who may lose benefits related to their home employment like security of pension or social contributions. If the home employment is terminated employees may also lose any accruals related to their tenure such as seniority.  It can expose the employer to foreign exchange fluctuations on the full balance of employee compensation.

Local Payroll with Home Country Payroll in Hibernation

While this method appears similar to a full local payroll approach, the home country employment relationship is placed in ‘hibernation’, rather than being terminated.  The brief suspension of the home country contract and payroll may be a practical approach for temporary assignments where repatriation is expected. For example the employee can be given “leave without pay” in the home country whilst they are employed in the host country.

Advantages:  The advantage for the employee is an implicit guarantee of continuing employment while on assignment abroad, including benefits and employment status.  Full local payroll also is less complex to run than a shadow or split payroll because the payroll is restricted to the host country only.

Disadvantages:  In some cases, the employee may have contractual rights in both countries, which can complicate attempts at termination.

Dual Employment in Home and Host Country

In dual employment, the employee has a contract in both the home and host country.  The dual employment approach can offer the greatest flexibility by using split payroll methods for both taxation and pension contribution reasons.  While this can give rise to management complexity for human resources, it probably offers the most options for preserving and enhancing employee benefits and any tax advantages between the home and host country.

Advantages:  Ensures that local employee contract laws are adhered to, while preserving the original employment agreement in the home country.

Disadvantages:  Dual employment can add complexity to payroll, tax and withholding requirements, and could give rise to legal rights in both countries for the employee.

Summary

There is no one formula that works for determining how to contract and payroll international employees, and the five primary methods each offer advantages and disadvantages.  It is significant to note that a full 64% of multinationals use either home country or split payrolls for their expat employees. 

Studies are showing that organizations are starting to experiment with global payroll arrangements and host country policies could provide organizations with a more cost-effective solution compared to the home country policy option.

Use of a Global Employment Organization for outsourcing the employment relationship could make the other options such as local or dual employment more attractive to a human resources department. Shield GEO is able to support clients in all of the described methods within the scope of our Global Employment Solutions.

Get in touch to find out more about how an Employer of Record solution can help your company

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