India Based Expatriates, Split Salary Taxation

Categories: US Tax Savings

Posted on Thursday, April 16, 2009 by paul

No Comments

The Supreme Court has recently passed a judgement in the case of Eli Lilly (and various others), finally putting to rest a long debated issue on whether or not Indian tax deduction is required to be done in a case, where an individual is working in India, but, the payroll of the individual is situated outside India (whether wholly or partly).

The facts of the Eli Lilly case were that certain expatriate assignees were deputed to India by Eli Lilly to its Indian JV and during the period of the Indian assignment, these expatriate assignees received salary in India as well as outside India. The Indian salary component was paid by the Indian JV into an Indian bank account whereas; the foreign salary component was paid by Eli Lilly into a foreign bank account. This was a typical split salary structure that was adopted by various companies for temporary cross-border employee movements.

The Indian JV was deducting tax at source on the payments made by it to the expatriate assignees. However, no tax was being deducted at source on the foreign salary either by the Indian JV or Eli Lilly. Similar structure was also adopted by other companies.

The issue in contention of course was whether or not Indian tax deduction is also required to be done on the foreign salary portion. In its judgement, the Supreme Court held that the Indian entities were required to deduct tax at source even on the foreign salary portion (i.e. in addition to the tax being deducted on the Indian salary portion).

However, it is interesting to note some of the observations of the Supreme Court in issuing the judgement.

The Supreme Court observed that Section 192 read with Section 5 and Section 9(1)(ii) of the Income-tax Act (Act) is broad enough to require an employer to withhold tax in India even on the salary that is paid to an expatriate assignee by the foreign entity to a foreign bank account.

Section 192 essentially lays down the provisions where, an employer is required to deduct tax at source on salary payments made to employees. It provides that where any person makes a payment to an individual that is liable to tax under the Act as ‘salaries’, tax is required to be deducted at source by the payer before such payment is made.

Section 5 and Section 9(1)(ii) are charging sections, laying down deeming principles of taxability of salary income in India. Read together, they essentially provide that salary received by an individual for services rendered in India is taxable in India under accrual (deemed or otherwise) principles.

Both the Income-tax Department and the India entities agreed that as far as the employees were concerned, the foreign portion of the salary was taxable in India. However, the Indian entities’ contentions were that tax deduction on the foreign portion was not required to be undertaken as Section 192 is a machinery provision and it only applies to the amount of income actually paid by them. Therefore, since the foreign portion is not being paid by them, they did not need to deduct taxes at source on that portion.

The Supreme Court held that provisions relating to collection and recovery as well as chargeability and liability are interlinked and not independent of each other. The deeming provisions of Section 9(1)(ii) read with Section 192 constitute an integrated code and so long as the salary was chargeable to tax in India, the Indian employer was required to deduct tax on the same.

The Indian entities also contended that the tax deduction provisions cannot have extra-territorial operation and cannot therefore apply to salary payments made to the expatriate assignees by a foreign entity to a foreign bank account. Extra-territorial operation concept essentially arises out of the fact that is based on Section 1 of the Act, the provisions of the Act extend only within India and therefore, cannot apply to an entity situated outside India.

The Supreme Court opined in this context that if the payment of foreign salary by the foreign parent has a territorial nexus with the expatriate’s services rendered in India then the provisions of the Act would apply to such payments. Whether the overseas payments have a territorial nexus to India would depend on the facts of each case. The connection can be based on the residence of the person or business connection or even the situation of the income-generating asset within the territory of the taxing state.

In the present case, since the foreign salary portion relate to and have been paid in connection the expatriate assignees’ rendering services in India, there was definitely a territorial nexus to India.

Further, the Supreme Court also highlighted that Article 245(2) of the India Constitution provides that no law made by the Parliament shall be deemed to be invalid on the ground that it would have extraterritorial jurisdiction and therefore, this contention of the Indian entities is not valid.

The issue of extra-territorial application has been looked at by the Supreme Court even in the past. In the case of Electronics Corporation of India Ltd, the Supreme Court has observed that the general principle flowing from Sovereign States is that laws made by one State can have no operation in another State. However, the Supreme Court had also observed that parliamentary statute having extra-territorial application cannot be ruled out of the contemplation and that operation of the law can extend to persons, things and acts outside the territory of India although, it is important that there should be a nexus with something in India for the law to be constitutionally valid.

Therefore, from the above, it becomes apparent that one cannot take the extra-territorial operation argument merely because the source of income or the payment transaction takes place outside India. What is important is whether there is a territorial nexus or connection to India and also what the relevant provisions of the Act are related to that nexus or connection or transaction.

Another important observation of the Supreme Court was that if the expatriate employees had themselves deposited advance or self-assessment tax, the Indian entities could not be proceeded

against for payment of tax. The Supreme Court also observed that for payment of interest for default in deduction of taxes, the date on which the expatriate employees have themselves deposited taxes would be considered as the date of payment of taxes (even though the Indian entities had not deducted and deposited the tax liability).

In conclusion, the Supreme Court decision now gives clarity to the companies who were under bonafide belief that they were under no tax deduction obligations where the payroll was situated outside India (whether wholly or partly). This would clearly bring delight to the Tax Authorities as the Revenue treasury would swell with employers deducting taxes at source (which is a more definite source of collection of taxes than payment of advance or self-assessment tax by the expatriate employees themselves).

For employers, the decision would mean that they would now have to consider the following administrative aspects while planning assignments -

• Foreign companies that have no establishments in India would now have to register with the Indian income tax department, obtain a TAN (or tax collection and tax deduction account number) and file returns like all resident companies.

• Indian companies who have deputees from their foreign sister concerns would now have to deduct tax at source on the global salary paid to the expatriate assignees during the period of deputation/assignment.

• The Indian companies will have to collect tax on that portion of salary that is paid abroad on a monthly basis and add it to the tax that is being deducted on salaries paid in India for services rendered here. The two components will have to be clubbed to deposit the deducted tax on a monthly basis.

• The employer obligations with respect to filing quarterly returns and issuance of Tax Deduction at Source Certificates would need to be done reporting the global salary and the related Taxes Deducted at Source.

India Based Expatriates, Split Salary Taxation

Categories: US Tax Savings

Posted on Thursday, April 16, 2009 by paul

No Comments

The Supreme Court has recently passed a judgement in the case of Eli Lilly (and various others), finally putting to rest a long debated issue on whether or not Indian tax deduction is required to be done in a case, where an individual is working in India, but, the payroll of the individual is situated outside India (whether wholly or partly).

The facts of the Eli Lilly case were that certain expatriate assignees were deputed to India by Eli Lilly to its Indian JV and during the period of the Indian assignment, these expatriate assignees received salary in India as well as outside India. The Indian salary component was paid by the Indian JV into an Indian bank account whereas; the foreign salary component was paid by Eli Lilly into a foreign bank account. This was a typical split salary structure that was adopted by various companies for temporary cross-border employee movements.

The Indian JV was deducting tax at source on the payments made by it to the expatriate assignees. However, no tax was being deducted at source on the foreign salary either by the Indian JV or Eli Lilly. Similar structure was also adopted by other companies.

The issue in contention of course was whether or not Indian tax deduction is also required to be done on the foreign salary portion. In its judgement, the Supreme Court held that the Indian entities were required to deduct tax at source even on the foreign salary portion (i.e. in addition to the tax being deducted on the Indian salary portion).

However, it is interesting to note some of the observations of the Supreme Court in issuing the judgement.

The Supreme Court observed that Section 192 read with Section 5 and Section 9(1)(ii) of the Income-tax Act (Act) is broad enough to require an employer to withhold tax in India even on the salary that is paid to an expatriate assignee by the foreign entity to a foreign bank account.

Section 192 essentially lays down the provisions where, an employer is required to deduct tax at source on salary payments made to employees. It provides that where any person makes a payment to an individual that is liable to tax under the Act as ‘salaries’, tax is required to be deducted at source by the payer before such payment is made.

Section 5 and Section 9(1)(ii) are charging sections, laying down deeming principles of taxability of salary income in India. Read together, they essentially provide that salary received by an individual for services rendered in India is taxable in India under accrual (deemed or otherwise) principles.

Both the Income-tax Department and the India entities agreed that as far as the employees were concerned, the foreign portion of the salary was taxable in India. However, the Indian entities’ contentions were that tax deduction on the foreign portion was not required to be undertaken as Section 192 is a machinery provision and it only applies to the amount of income actually paid by them. Therefore, since the foreign portion is not being paid by them, they did not need to deduct taxes at source on that portion.

The Supreme Court held that provisions relating to collection and recovery as well as chargeability and liability are interlinked and not independent of each other. The deeming provisions of Section 9(1)(ii) read with Section 192 constitute an integrated code and so long as the salary was chargeable to tax in India, the Indian employer was required to deduct tax on the same.

The Indian entities also contended that the tax deduction provisions cannot have extra-territorial operation and cannot therefore apply to salary payments made to the expatriate assignees by a foreign entity to a foreign bank account. Extra-territorial operation concept essentially arises out of the fact that is based on Section 1 of the Act, the provisions of the Act extend only within India and therefore, cannot apply to an entity situated outside India.

The Supreme Court opined in this context that if the payment of foreign salary by the foreign parent has a territorial nexus with the expatriate’s services rendered in India then the provisions of the Act would apply to such payments. Whether the overseas payments have a territorial nexus to India would depend on the facts of each case. The connection can be based on the residence of the person or business connection or even the situation of the income-generating asset within the territory of the taxing state.

In the present case, since the foreign salary portion relate to and have been paid in connection the expatriate assignees’ rendering services in India, there was definitely a territorial nexus to India.

Further, the Supreme Court also highlighted that Article 245(2) of the India Constitution provides that no law made by the Parliament shall be deemed to be invalid on the ground that it would have extraterritorial jurisdiction and therefore, this contention of the Indian entities is not valid.

The issue of extra-territorial application has been looked at by the Supreme Court even in the past. In the case of Electronics Corporation of India Ltd, the Supreme Court has observed that the general principle flowing from Sovereign States is that laws made by one State can have no operation in another State. However, the Supreme Court had also observed that parliamentary statute having extra-territorial application cannot be ruled out of the contemplation and that operation of the law can extend to persons, things and acts outside the territory of India although, it is important that there should be a nexus with something in India for the law to be constitutionally valid.

Therefore, from the above, it becomes apparent that one cannot take the extra-territorial operation argument merely because the source of income or the payment transaction takes place outside India. What is important is whether there is a territorial nexus or connection to India and also what the relevant provisions of the Act are related to that nexus or connection or transaction.

Another important observation of the Supreme Court was that if the expatriate employees had themselves deposited advance or self-assessment tax, the Indian entities could not be proceeded against for payment of tax. The Supreme Court also observed that for payment of interest for default in deduction of taxes, the date on which the expatriate employees have themselves deposited taxes would be considered as the date of payment of taxes (even though the Indian entities had not deducted and deposited the tax liability).

In conclusion, the Supreme Court decision now gives clarity to the companies who were under bonafide belief that they were under no tax deduction obligations where the payroll was situated outside India (whether wholly or partly). This would clearly bring delight to the Tax Authorities as the Revenue treasury would swell with employers deducting taxes at source (which is a more definite source of collection of taxes than payment of advance or self-assessment tax by the expatriate employees themselves).

For employers, the decision would mean that they would now have to consider the following administrative aspects while planning assignments -

• Foreign companies that have no establishments in India would now have to register with the Indian income tax department, obtain a TAN (or tax collection and tax deduction account number) and file returns like all resident companies.

• Indian companies who have deputees from their foreign sister concerns would now have to deduct tax at source on the global salary paid to the expatriate assignees during the period of deputation/assignment.

• The Indian companies will have to collect tax on that portion of salary that is paid abroad on a monthly basis and add it to the tax that is being deducted on salaries paid in India for services rendered here. The two components will have to be clubbed to deposit the deducted tax on a monthly basis.

• The employer obligations with respect to filing quarterly returns and issuance of Tax Deduction at Source Certificates would need to be done reporting the global salary and the related Taxes Deducted at Source.

Income Tax for Indian Residents Working Abroad

Indians from time immemorial have been a very enterprising and adventures tribe. They have always tried to find opportunities to seek employment suiting to their skill sets in far off lands.

It is well known to us that one of our major foreign exchange earnings are the income remittances from abroad. In fact this forms a very large part of our foreign exchange reserves.

Indian Workers Abroad and their annual remittances

In fact As per a Global Consultancy namely M/s. Manpower Borderless Workforce, India has emerged as the third most popular country for sourcing foreign talent in the Manpower Borderless Workforce Survey, and there are totally 2.2 Million Indians working in various countries of the world, and their total remittances to India is USD 28 Billion Per Annum. An astounding Amount really!

Now let us see how the Indian Income Tax Laws treats the remittances from these Indians who are working abroad.

An individual is taxed based on his residential status in India. The residential status, in turn, is determined based on the physical stay of an individual in the relevant financial year (tax year) as well as

preceding ten tax years. This is particularly relevant in respect of Indians working overseas or having income outside India.

Residential Status

Broadly, and individual could be a resident or a non-resident in a particular tax year. Once an individual’s residential status is determined to be a resident, it is further examined whether he is an ordinary resident or not an ordinary resident in India.

Physical Stay is the Basic test

An individual is said to be a resident in India if he fulfils any of the following two conditions. First, if he is present in India for a period of 182 days or more in that tax year OR second, if he is present in India for a period of 60 days or more during the relevant tax year and at least 365 days or more during the four preceding tax years. In case an individual does not satisfy any of the above two basic conditions, then he is said to be a non-resident.

Non Resident (NRI)

In the case of a citizen of India, who leaves India in any tax year for the purposes of employment outside India, the above said period of 60 days is substituted by 182 days. This is particularly beneficial for individuals going and working overseas in a particular tax year. Similarly, in the case of a citizen of India or a person of Indian origin who being outside India, comes on a visit to India in any tax year, the above said period of 60 days is substituted by 182 days. This is helpful for non-resident Indians who visit India for family or other purposes.

Resident But Not Ordinary Resident (RNOR)

In the case of an individual who is a resident, it is to be further determined whether he is an ordinary resident or not an ordinary resident. A person is said to be not ordinary resident if he satisfies any of the following additional conditions. First, if he has been a non-resident in India in nine out of the 10 previous years preceding the relevant tax year OR second, if he has been in India for 729 days or less in the seven tax years preceding the relevant tax year. If none of the above two conditions are satisfied, then a person is said to be an ordinary resident.

Provisions Under Indian Income Tax

In case an individual is a non-resident, then only income received / deemed to be received or accrued / deemed to be accrued in India is taxable in India. Thus, broadly speaking, his overseas income would not be taxable in India, provided it is first received outside India.

Income Tax Clearance Certificate

An expatriate before leaving the territory of India is required to obtain a tax clearance certificate from the person’s respective Income Tax Circle Officer stating that he does not have any outstanding tax liability. Such a certificate is necessary in case the continuous presence in India exceeds 120 days. An application is to be made in a prescribed form to the Income Tax Authority having jurisdiction for assessment of the expatriate to grant a tax clearance certificate. This is to be exchanged for final tax clearance certificate from the foreign section of the Income Tax Department. Tax Clearance certificate is valid for a period of 1 month from the date of issue and is necessary to get a confirmed booking from an airline or travel agency and may be required to be produced before the customs authorities at the airport. This is of utmost importance for the purpose of Income Tax, and one is likely to forget this aspect while taking up a job abroad, as she /he will be fully occupied with various aspects connected to the job, living abroad, health care, accommodation and many other such aspects.

DTAA

India has agreed into DTAA or Double Taxation Avoidance Agreements with 65 Countries of the world. The list of all the countries with which India has DTAA is provided in the Separate Chart at the end of this article. It is also important to examine the conditions laid out under the respective Double Taxation Avoidance Agreements (DTAAs), also known as treaties, which India has entered into with these 65 countries to finally determine the taxability or otherwise for any particular source of income. Generally, the DTAAs provide for taxability of income in one country. Else, if the income is subject to tax in both the countries, then credit could be claimed for tax paid in the other country, subject to the prescribed conditions.

Relevant Sections

Indian Income Tax Laws for Indians working Abroad – All incidences of Indians working abroad under various capacities across the world are comprehensively covered under these sections (Sec. [10(5B)], [Sec. 10(6) (ii)], [Sec, 10(6) (vi)], [Sec. 10(6) (viii)], [Sec. 10(6) (xi)], [Sec. 10(8), 10(8A), 10(8B) and 10(9)].

List of Countries with which India has DTAA

Australia Czechoslovakia Israel Malta Philippines SwedenUnited States

Austria Czech Republic Italy Mauritius Poland Switzerland Uzbekistan

Bangladesh Denmark Japan Mongolia Portugal Syria Vietnam

Belarus Egypt Jordan Morocco Qatar Tanzania Zambia

Belgium Finland Kazakhstan Namibia Romania Thailand Non treaty countries

Brazil France Kenya Nepal Russian Federation Trinidad and Tobago

Bulgaria Germany Korea Netherlands Singapore Turkey

Canada Greece Kyrgyzstan New Zealand South Africa Turkmenistan

China Hungary Libya NorwaySpain United Arab Emirates

Cyprus Indonesia Malaysia Oman Sri Lanka United Kingdom

Tax planning for expatriates.

· Non resident employees are taxable only on remuneration (including the value of perquisites) for services rendered in India, wherever paid. Any other income is taxable only if it is received in India or arises or is deemed to arise in India.

· Remuneration from an employer is not taxable if the expatriate's sty in India does not exceed 90 days (183 days under treaties during the year if certain conditions are fulfilled.

· Timing of arrival and departure maybe planned to take advantage of the 90 / 183 - day rules.

· Expatriate technicians (including nonresident Indians) satisfying specified conditions are not liable to pay further tax on remuneration for four years if the employer bears the tax.

· Tax clearance is necessary before any expatriate; departure if the stay in India is continuous for more than 120 days.

· In most other respects, expatriates are taxed on the same basis as Indians.

Territoriality and residence

The extent of Indian tax liability depends on the residential status of the individual. For tax purposes, an individual may be resident, nonresident or not ordinarily resident.

Residents are on worldwide income. Nonresidents are taxed only on income that is received in India or arises or is deemed to arise in India. A person not ordinarily resident is taxed like a nonresident but is also liable to tax on income accruing abroad if it is from a business controlled in or a profession set up in India.

Residence rules

An individual is treated as resident in a year if present in India (I) for 182 days during the year or (2) for 60 days during the year and 365 days during the preceding four years. Individuals fulfilling neither of these conditions are nonresidents. (The rules are slightly more liberal for Indian citizens residing abroad or leaving India for employment abroad.)

A resident who was not present in India for 730 days during the preceding seven years or who was nonresident in nine out of ten preceding yeas I treated as not ordinarily resident. In effect, a newcomer to India remains not ordinarily resident

Alternative approaches to expatriate compensation

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25 Nov 2010

ECA’s Lee Quane and Barry Rodin take a look at alternatives to the home-based international pay method, why they are being used and some of the issues that can arise.

Recent ECA policy surveys have highlighted the continued high demand for talented mobile staff as well as greater use of intra-regional assignments. This has contributed to increasingly cosmopolitan assignee workforces at different stages of their careers, originating from countries with varying living standards. These factors, along with the growing variety of business reasons for international assignments and diversity of assignment types, mean that there are now a greater number of variables and issues for international employers to manage.

Consequently, although the home-based expatriate compensation approach remains dominant (52% of companies surveyed in ECA’s latest Expatriate Salary Management Survey applied this method to all assignments), a growing proportion of employers are using different pay methodologies as part of their mobility policies to support the many different assignment objectives and mobility requirements.

Variations to pay policy may be subtle. For example, companies might use the home-based approach but withdraw or reduce certain allowances (notably the expatriate allowance) when the assignment is seen as less business critical or is part of an employee’s career development. In other cases the difference is more profound, with companies using a home-based approach for some expatriate employees, for example, and a host-based approach for others.

A growing proportion of employers are using different pay methodologies to support the many different assignment objectives and mobility requirements

To explore this more fully, ECA’s Alternative compensation and benefits approaches for international assignments survey was undertaken earlier this year to identify when, why and how four specific alternative compensation approaches (defined below) are applied by organisations employing foreign nationals in China, Hong Kong Singapore and UAE; locations where there has been increasing interest in these approaches.

Although there are a number of ways that a company can compensate expatriate staff instead of through the build-up approach, the survey focused on the following four main approaches:

Local national plus: Local national salary, plus benefits typically provided for foreign assignees/expatriates.

Local national: Local national salary, plus benefits typically provided for local nationals.

Expatriate market rate: Both salary and benefits are based on an established expatriate market-rate.

Third country salary structure: Salary structure is based on a third country (ie neither the employee’s home nor host location; eg a headquarters country or an offshore territory).

Of these, the local national plus approach is the most commonly applied alternative method in Hong Kong (used by 53% of surveyed employers adopting alternative pay approaches) and Singapore (56%). Salary levels for nationals of these locations deliver a relatively high buying power, especially compared

with most other Asian countries. Adding benefits typically given to expatriates generally results in attractive packages for most expatriate nationalities.

In the UAE and China, the expatriate market rate method is the most commonly applied alternative method, used by 57% and 49% respectively of employers adopting alternative pay approaches.

What about the 'plus'?

Regardless of the benchmark chosen to determine the expatriate’s cash compensation, it is common to grant benefits to assignees above and beyond those provided to the local labour market. This can vary considerably. According to the survey, 84% of companies provide allowances for children’s education in China compared to 51% in Hong Kong, for example, and while 98% of companies in Singapore who use the local national plus approach provide assistance for housing costs, this falls to 89% in Hong Kong. Since Hong Kong is amongst the locations in the region with the highest local market salary levels, it is understandable that companies there don’t feel the need to be as generous regarding benefits provision as elsewhere.

The benefits typically granted to international assignees but not to their local peers are housing, children’s education, relocation assistance and home leave. The provision of such add-ons can give rise to debates regarding inequity, especially for multinationals managing assignees in many countries. For example, our experience shows that expatriates employed in Europe and North America on a permanent basis will generally have their compensation and benefits based on the local market. Providing additional benefits to expatriate staff would be inequitable and, in some locations, illegal. However, it may well be that these same multinationals will take a different approach in the locations explored in the survey and this may well be easy to justify: foreigners in Singapore, for example, do not have access to cost-effective housing like their local peers do. Similarly, schools in some locations will charge higher fees to the children of foreigners so extra financial assistance would be necessary for expatriate staff. Data from ECA’s latest Benefits Survey shows that school fees for international students in Singapore can be 80% higher than what locals are charged.

The area of pensions and social security is particularly challenging. When expatriates are employed on local contracts in any of the countries surveyed, they are often ineligible to remain in their home country social security schemes. This has a major impact on retirement provision…

Pensions and social security

The area of pensions and social security is particularly challenging. When expatriates are employed on local contracts in any of the countries surveyed, they are often ineligible to remain in their home country social security schemes. This has a major impact on retirement provision and this may not be solved locally since local schemes may not be available or may be subject to residence restrictions. For example, fewer than 25% of companies compensating expatriates using a local plus compensation approach in Singapore or an expatriate market rate approach in China enrol these staff in a local social security scheme partly due to residency restrictions. If no private pension is possible this can be the most difficult problem to overcome. Solutions we have seen used in cases like these include enrolment in an offshore personal pension, trying to enrol the employee in a local pension scheme or simply providing cash in lieu of pension provisions.

A cheap option?

While companies may be attracted to adopting any of these four alternative compensation structures in order to save on costs, they may not always make the savings they expect. The gap between local and expatriate salaries in these locations tends to get narrower from middle managerial positions up. Therefore, using a salary structure which is based on local benchmarks may produce a salary similar to that if the standard home-based approach had been used. Furthermore, the value of benefits is likely to be the same for expatriates compensated using the home-based approach as those compensated on any of the alternative options. Add to this the fact that the home-based approach normally applies to assignments of a period of three years, whereas a host-based approach is more likely to apply to a longer term, or even permanent move, then these compensation options may not save companies money in the long-term particularly if they have no transition strategy in terms of fully localising an employee.

Looking for equity

This would suggest that companies are using these approaches for reasons other than as a cost-saving tool. In the four locations surveyed, a growing number of companies are employing expatriates on a long term or permanent basis. Ideally in such scenarios companies should endeavour to base the compensation and benefits provided to foreign staff on the same benchmark as that used for local nationals – for equity if for no other reason. However, in cases where such packages are unattractive or impossible to deliver (e.g. low salary levels in the location of employment or the inability of expatriates to participate in host country social security and pension schemes) companies will need to consider other salary benchmarks.

Companies are increasingly drawing from talent bases globally to fill local skills gaps. Even in China, with the largest population in the world, a combination of underdeveloped skill levels and a declining working

population means that one way in which companies are trying to overcome the war for talent at managerial level and above is to move skilled people in from overseas on a long-term basis. Providing the same compensation to every nationality of expatriate (as opposed to the home-based approach) can help to establish equity amongst the expatriate employees.

Are these alternatives for you?

Certainly, for companies employing expatriates on a permanent or one-way basis, removing the link to compensation levels in the employee's home location makes sense. Employing an expatriate on a permanent basis on a home-based compensation approach can be expensive and administratively burdensome – annual revisions need to be made to cost of living allowances and the salary delivered in more than one location, for example. If a company is sending junior staff on assignment in order to give them international experience – and this is increasingly the case – they may well feel that one of these alternative approaches is an appropriate compensation method. Other reasons for adopting these methods include the growth in the hiring of foreign nationals who are already in the location of operations and more assignments to locations where the local salary may be attractive enough to encourage mobility among certain nationalities. Furthermore, if the company's aim is to achieve equity amongst its expatriate staff in any of these locations, these alternative methods would make sense.

One thing to be aware of is that these are locally determined policies and as such it is difficult to have a uniform policy globally. The fact that when not using the home-based approach companies benchmark assignee salaries against the local market in Hong Kong, but against the expatriate market rate in China, for example, shows that any alternative compensation and benefits policy has to be designed to reflect a number of factors. These include where you wish to use this policy, why you are employing expatriates in these locations, where you are drawing them from and for how long you wish them to remain in their locations of employment. For assistance with any of this, don’t hesitate to contact us.

Alternative approaches to expatriate compensation

Share on facebook Share on twitter Share on email Share on print More Sharing Services More Sharing Services136

25 Nov 2010

ECA’s Lee Quane and Barry Rodin take a look at alternatives to the home-based international pay method, why they are being used and some of the issues that can arise.

Recent ECA policy surveys have highlighted the continued high demand for talented mobile staff as well as greater use of intra-regional assignments. This has contributed to increasingly cosmopolitan assignee workforces at different stages of their careers, originating from countries with varying living standards. These factors, along with the growing variety of business reasons for international assignments and diversity of assignment types, mean that there are now a greater number of variables and issues for international employers to manage.

Consequently, although the home-based expatriate compensation approach remains dominant (52% of companies surveyed in ECA’s latest Expatriate Salary Management Survey applied this method to all assignments), a growing proportion of employers are using different pay methodologies as part of their mobility policies to support the many different assignment objectives and mobility requirements.

Variations to pay policy may be subtle. For example, companies might use the home-based approach but withdraw or reduce certain allowances (notably the expatriate allowance) when the assignment is seen as less business critical or is part of an employee’s career development. In other cases the difference is more profound, with companies using a home-based approach for some expatriate employees, for example, and a host-based approach for others.

A growing proportion of employers are using different pay methodologies to support the many different assignment objectives and mobility requirements

To explore this more fully, ECA’s Alternative compensation and benefits approaches for international assignments survey was undertaken earlier this year to identify when, why and how four specific alternative compensation approaches (defined below) are applied by organisations employing foreign nationals in China, Hong Kong Singapore and UAE; locations where there has been increasing interest in these approaches.

Although there are a number of ways that a company can compensate expatriate staff instead of through the build-up approach, the survey focused on the following four main approaches:

Local national plus: Local national salary, plus benefits typically provided for foreign assignees/expatriates.

Local national: Local national salary, plus benefits typically provided for local nationals.

Expatriate market rate: Both salary and benefits are based on an established expatriate market-rate.

Third country salary structure: Salary structure is based on a third country (ie neither the employee’s home nor host location; eg a headquarters country or an offshore territory).

Of these, the local national plus approach is the most commonly applied alternative method in Hong Kong (used by 53% of surveyed employers adopting alternative pay approaches) and Singapore (56%). Salary levels for nationals of these locations deliver a relatively high buying power, especially compared with most other Asian countries. Adding benefits typically given to expatriates generally results in attractive packages for most expatriate nationalities.

In the UAE and China, the expatriate market rate method is the most commonly applied alternative method, used by 57% and 49% respectively of employers adopting alternative pay approaches.

What about the 'plus'?

Regardless of the benchmark chosen to determine the expatriate’s cash compensation, it is common to grant benefits to assignees above and beyond those provided to the local labour market. This can vary considerably. According to the survey, 84% of companies provide allowances for children’s education in China compared to 51% in Hong Kong, for example, and while 98% of companies in Singapore who use the local national plus approach provide assistance for housing costs, this falls to 89% in Hong Kong. Since Hong Kong is amongst the locations in the region with the highest local market salary levels, it is understandable that companies there don’t feel the need to be as generous regarding benefits provision as elsewhere.

The benefits typically granted to international assignees but not to their local peers are housing, children’s education, relocation assistance and home leave. The provision of such add-ons can give rise to debates regarding inequity, especially for multinationals managing assignees in many countries. For example, our experience shows that expatriates employed in Europe and North America on a permanent basis will generally have their compensation and benefits based on the local market. Providing additional benefits to expatriate staff would be inequitable and, in some locations, illegal.

However, it may well be that these same multinationals will take a different approach in the locations explored in the survey and this may well be easy to justify: foreigners in Singapore, for example, do not have access to cost-effective housing like their local peers do. Similarly, schools in some locations will charge higher fees to the children of foreigners so extra financial assistance would be necessary for expatriate staff. Data from ECA’s latest Benefits Survey shows that school fees for international students in Singapore can be 80% higher than what locals are charged.

The area of pensions and social security is particularly challenging. When expatriates are employed on local contracts in any of the countries surveyed, they are often ineligible to remain in their home country social security schemes. This has a major impact on retirement provision…

Pensions and social security

The area of pensions and social security is particularly challenging. When expatriates are employed on local contracts in any of the countries surveyed, they are often ineligible to remain in their home country social security schemes. This has a major impact on retirement provision and this may not be solved locally since local schemes may not be available or may be subject to residence restrictions. For example, fewer than 25% of companies compensating expatriates using a local plus compensation approach in Singapore or an expatriate market rate approach in China enrol these staff in a local social security scheme partly due to residency restrictions. If no private pension is possible this can be the most difficult problem to overcome. Solutions we have seen used in cases like these include enrolment in an offshore personal pension, trying to enrol the employee in a local pension scheme or simply providing cash in lieu of pension provisions.

A cheap option?

While companies may be attracted to adopting any of these four alternative compensation structures in order to save on costs, they may not always make the savings they expect. The gap between local and expatriate salaries in these locations tends to get narrower from middle managerial positions up. Therefore, using a salary structure which is based on local benchmarks may produce a salary similar to that if the standard home-based approach had been used. Furthermore, the value of benefits is likely to be the same for expatriates compensated using the home-based approach as those compensated on any of the alternative options. Add to this the fact that the home-based approach normally applies to assignments of a period of three years, whereas a host-based approach is more likely to apply to a longer term, or even permanent move, then these compensation options may not save companies money in the long-term particularly if they have no transition strategy in terms of fully localising an employee.

Looking for equity

This would suggest that companies are using these approaches for reasons other than as a cost-saving tool. In the four locations surveyed, a growing number of companies are employing expatriates on a long term or permanent basis. Ideally in such scenarios companies should endeavour to base the compensation and benefits provided to foreign staff on the same benchmark as that used for local nationals – for equity if for no other reason. However, in cases where such packages are unattractive or impossible to deliver (e.g. low salary levels in the location of employment or the inability of expatriates to participate in host country social security and pension schemes) companies will need to consider other salary benchmarks.

Companies are increasingly drawing from talent bases globally to fill local skills gaps. Even in China, with the largest population in the world, a combination of underdeveloped skill levels and a declining working population means that one way in which companies are trying to overcome the war for talent at managerial level and above is to move skilled people in from overseas on a long-term basis. Providing the same compensation to every nationality of expatriate (as opposed to the home-based approach) can help to establish equity amongst the expatriate employees.

Are these alternatives for you?

Certainly, for companies employing expatriates on a permanent or one-way basis, removing the link to compensation levels in the employee's home location makes sense. Employing an expatriate on a permanent basis on a home-based compensation approach can be expensive and administratively burdensome – annual revisions need to be made to cost of living allowances and the salary delivered in more than one location, for example. If a company is sending junior staff on assignment in order to give them international experience – and this is increasingly the case – they may well feel that one of these alternative approaches is an appropriate compensation method. Other reasons for adopting these methods include the growth in the hiring of foreign nationals who are already in the location of operations and more assignments to locations where the local salary may be attractive enough to encourage mobility among certain nationalities. Furthermore, if the company's aim is to achieve equity amongst its expatriate staff in any of these locations, these alternative methods would make sense.

One thing to be aware of is that these are locally determined policies and as such it is difficult to have a uniform policy globally. The fact that when not using the home-based approach companies benchmark assignee salaries against the local market in Hong Kong, but against the expatriate market rate in China, for example, shows that any alternative compensation and benefits policy has to be designed to reflect a number of factors. These include where you wish to use this policy, why you are employing expatriates

in these locations, where you are drawing them from and for how long you wish them to remain in their locations of employment. For assistance with any of this, don’t hesitate to contact us.

See also