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Risks of Non-compliance with Tax Laws for Multinational Companies and Employees

Tax compliance may be one of the more problematic areas for companies expanding into foreign markets. Depending on the extent of business activity and how an assignment is structured, there are potential risks of non-compliance for the worker, home country company and local corporate entity. Host country rules will be applied for statutory withholding of employee taxes and social security amounts, as well as employer contributions and corporate taxes.

Governments take an exacting approach towards the enforcement of tax laws given the ongoing need for revenue. Foreign companies and their expat workers are not exempt from this scrutiny. The rules and applicable tax treaties should be researched prior to initiating an overseas assignment, in order to avoid the more common instances of non-compliance. The risks of non-compliance are greatest when a company fails to establish a legal local entity and attempts to run remote payroll, or simply pays the worker in the home country while on assignment.

Individual Worker Tax Compliance

An employee or independent contractor working in a foreign country can be subject to the same personal income taxation as citizens of the country. The worker may also be liable for their portion of required social security and other statutory contributions. There are several ways that individual workers in a foreign country might be non-compliant for taxation:

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Status as a Tax Resident But Not Paying Taxes Due

Most countries have established criteria for tax residency, usually based on the number of days spent in the country in a 12-month period, or the tax year. This article details the tax residency rules in the US.

If a tax treaty that grants an exemption is absent, workers on assignment may find themselves subject to personal taxation in the host country as well as at home. China uses a more complex formula to determine tax residency.

Being Paid In the Home Country Instead of in the Host Country

When an employee on assignment continues to be paid in their home country, there is a risk that their employment could also result in tax and social security liability in the host country.  In general, an employee that engages in revenue creating activity should have a work permit sponsored by a local entity, which will also run payroll and make withholdings. Without this, the employee or employer may be accountable for unmet tax and social security payments.

Worker is Paid as a Contractor When They Are Actually an Employee

If a worker is assigned as an independent contractor, but is later reclassified as an employee, they may be subject to accrued past due tax and social security contributions.  If they are unable to make the payments, then the employer could be liable for the employee share.

Improper or Incorrect Tax or Social Security Payments

Inaccurate withholding or payment of taxes and social security can make the employee liable for any deficient amounts, even if the mistakes or miscalculations were not their fault.

Failure to Register Correctly

Tax and statutory withholding are administered through a proper payroll with a legally registered local entity.  Failure to register with tax authorities by the employee could result in non-compliance with local tax laws.  In China, a foreign employee must register with both local and national tax authorities, depending on the source and amount of local income.  In contrast, in the UAE there are no tax or social security withholding or registration requirements for expat workers, simplifying the payroll process.

Company Tax Compliance

There are distinct risks for companies or the local corporate entity that may be non-compliant with tax regulations due to having workers in a foreign country.  In many cases, the company could be found liable for both the employee and employer portions of unpaid statutory contributions, as well as unpaid taxes.

Permanent Establishment Created But No Tax Payments

If a company’s employees are engaged in revenue creating activity, then the company may be liable for corporate tax payments due to creation of ‘permanent establishment.’  Tax treaties can affect permanent establishment criteria and how the tax is levied against foreign companies in each country.

Incorrect Payment of Corporate Tax or Employers Share of Statutory  Contributions

Miscalculations in corporate tax or statutory contributions for employees, can result in non-compliance for the company.  For example, in China the tax rate on corporate income is 25%, and there are complex formulas for determining the correct taxable income.

Withholding of income tax and employee share of statutory contributions is the responsibility of the company and their local entity.  Amounts must be calculated accurately and submitted by specific due dates.  However, some countries such as the UAE do not require tax or social security withholding for foreign nationals.

Paying Employees in the Home Country When They Have Become Tax Resident in the Host Country

Where a company elects not to establish a local entity, and runs payroll in the home country, the employee may still meet the criteria as a tax resident.  In that case, the company may be non-compliant if they fail to run a local payroll and deduct host country taxes and social security from the employee’s pay.

Penalties for Non-compliance

In general, non-compliance with tax laws may bring a range of consequences for both the company and employee, depending on local rules and policies toward enforcement.

Company Penalties

A company can expect to pay back taxes or past due contributions, as well as fines and penalties for non-payment.  Non-compliance can also affect their business reputation and invite ongoing scrutiny by the host country authorities. If a company has a local corporate entity, they are equally accountable for complying with tax and statutory withholding, especially if they are running a local payroll and are aware of the host country requirements.  In the US, failure to withhold taxes on employees can result in penalties equal to 100% of the original amount owed.

Employee Penalties

Employees may also be subject to past due tax bills and withholding, but in some countries if they cannot pay the owed amounts the employer will be liable. In addition, employees with tax law violations could have their visa status affected, and may encounter future immigration problems.  In China, penalties for non-payment can amount to 5 times the unpaid tax, and expat employees must complete a ‘deregistration’ process prior to departure from the country.

Summary

Tax compliance should be a priority for multinational companies operating in foreign countries. Home country requirements and tax treaties further complicate this area, and underscore the need for thorough research and legal advice from tax experts.  In most cases, use of a GEO solution such as Shield GEO can eliminate most instances of non-compliance, since the GEO establishes the local employer of record and ensures tax compliance for both employees and the company.  This is an attractive and cost-effective solution given the potential for fines, penalties and interruption of business activity in the event of a tax violation.

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

The information in this article is subject to changes in local legislation.

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