The international expansion of business is inevitable. It used to be that this was reserved for only international oil companies (IOCs), which span the entire oil and gas value chain. This, however, is no longer the case. More and more, middle-market companies are able to sell their products and services internationally. These middle-market firms often start selling into the various markets from their respective countries and eventually end up sending their personnel to those markets to continue to penetrate and grow the business.
Thus, the globalization of business creates more opportunity for companies to go from dipping their toes in market to establish a presence through either a branch or establishing a subsidiary. Ultimately, they send the best and brightest to plant these flags and bring in more business.
These international assignments come with a host of business implications, and taxes is among the top priorities. They may send one or two individuals with their respective families or they may send a team of people depending on the size of their budget.
If you are one of these middle-market companies, you probably want to know in advance how to compensate these people while making sure you and them remain compliant with both home-country and host-country laws. The global mobility of the workforce brings a litany of tax, immigration and accounting issues that must be run to ground to avoid unpleasant surprises, such as missed filings and related penalties and interest and, worst of all, an unhappy employee.
U.S. Payroll Tax Obligations
Generally, a U.S. employer generally must withhold U.S. income taxes plus Social Security and Medicare (i.e. FICA) taxes from wages paid to an employee. Also, the employer must pay FICA and unemployment (FUTA) taxes on such wages. The employer must deposit these taxes timely and, in most cases, file quarterly employment tax returns reporting the wages, income tax and FICA taxes paid and file an annual FUTA return. Additionally, the employer must file and pay for state unemployment taxes. The employer also must provide to the employee and file with the Social Security Administration and the Internal Revenue Service (“IRS”) a Form W-2, Wage and Tax Statement showing the wages paid and taxes withheld from the employee. To do all of this, an employer must obtain an employer identification number or an EIN.
For an international employee, these U.S. tax obligations raise many questions and, depending on how your business is structured, the answer to those questions may differ every time. Thus, it’s important to establish the facts and circumstances while also having a good understanding about what international assignment entails.
For example, a foreign company may be unwilling to obtain a U.S. employer identification number simply to payroll their employee working in the U.S. If the foreign company already has a subsidiary in the U.S., it may be able to utilize the U.S. subsidiary EIN for these purposes.
Typical Scenarios Driving the International Assignment Complexities
In comparison to a well-established multinational accustomed to the exchange of personnel from across the world through an expansive network of affiliates, a growing middle-market company often finds that this process to be a growing pain. Nevertheless, like the large multinational, the middle-market company must comply equally and must involve the various departments or teams in the company, which may include the following:
Executive (CEO and Business Development): Decision to penetrate a foreign market or serve a foreign customer is made.
Legal (Corporate Counsel): Input is needed to understand the contracting with customers.
Finance, Accounting, & Tax (CFO, Accounts Payable, & Tax Director): Create the expansion budget, understand financial reporting implications, and comply with U.S. and local country corporate and payroll tax reporting and withholding requirements, involves tax experts to manage tax risks associated with going global.
Human Resources (HR director, Payroll, Employment and Immigration Attorney): Find and recruits candidates, formulates compensation package and terms and conditions, coordinates with payroll for tax reporting, obtains work permits and visas, tries to gain an understanding of global workforce requirements and establishes related policies and procedures.
Insurance (Risk Management Function): Provides customer with security in terms of being able to deliver products and services.
The typical scenario is a chain reaction that involves internal and external advisors who can provide the guidance for a successful project or simply one without surprises. Also, it is possible that the responsibilities described above often rest in a few number of people that represent entire management of a middle-market firm.
Finance, Accounting, Tax & Human Resources – Collaborate Throughout the Entire Process
It might seem that there must be one single best way to structure the international assignment to help meet the company’s goals. But there is not. Different expat assignments need to be structured in different ways depending on the business circumstances. For example, you may be sending someone to a jurisdiction where you have an up-and-running affiliate but your next expat may be going to a place where you have no on-the-ground infrastructure. As you can see, this can turn into a complicated planning scenario in an instant. Whether you are a U.S. business sending a U.S. citizen to work abroad or a foreign business sending a non-U.S. citizen to work on U.S. soil, the time and effort must be invested to prevent incorrect taxation for the business and the employee, payroll reporting, and noncompliance, which all translate into higher costs to the company in addition to the compensation package negotiated with the employee.
U.S. Employees Working in a Foreign Country
A U.S. citizen or resident alien (green card holder) is subject to worldwide taxation regardless of where the individual earns the income. Thus, if he or she relocates to a foreign country you and they will need to understand the U.S. withholding and reporting requirements. For example, both the company and the employee will need to understand if the foreign earned income exclusion will apply so that U.S. withholding is reduced. Furthermore, taxation in the U.S. and the foreign country may also depend on whether there is a tax treaty between the countries. Often times, the tax treaties may provide additional wiggle room to work with as the operation in defined.
What about social security? As discussed above, U.S. or foreign employers are still responsible to comply with relevant social security systems unless they can avail themselves from a totalization agreement. Thus, the preplanning process will require this consideration as well as understanding what documentation needs to be in place in order to receive benefits under either a double tax treaty or totalization agreements.
Foreign Employees Working in U.S. Soil
It’s not rare for a foreign company that already has a U.S. subsidiary to assign someone to assist the U.S. operations in some form or fashion without truly first addressing how the employees will be taxed. As mentioned above, these requirements still apply to those foreign workers in the U.S. with some few exceptions.
A foreign employer generally must withhold income taxes unless the employee is a non-resident alien who is present in the U.S. only for a short time (90 days or less) during the tax year and earns only a small amount ($3,000 or less), or unless there is evidence that a tax treaty provides some protection.
To make matters more complicated, the audit risk for the foreign employer grows significantly when the employees already in the U.S. try to file in the U.S. to report their wages. This creates a matching issue with the IRS because there is no evidence of a form w-2 (wage reporting statement) properly issued by a U.S. employer.
Payroll Processing and Related Mechanisms to Ensure Tax Compliance
Again, both the employer and the employee must understand specifically how the payroll reporting will take place in each relevant jurisdiction to remain compliant. For example, if an international assignee is paid by a foreign country payroll and is subject to U.S. taxation, the foreign employer may need to use a “shadow” payroll to make sure that the U.S. tax withholding and reporting requirements are met. If there is a U.S. subsidiary in place, the foreign parent and the U.S. subsidiary must determine who will pay the employee as part of this consideration.
Permanent Establishment Risk (Economic Nexus that may Result in Unexpected Taxation)
Another important question is whether you are deemed to be doing business in the country as a result of the activity your employee is engaged in in the foreign country. If so, the employee may have just caused you to have to register your business and file and pay income taxes plus other local taxes such as VAT (which exists in almost all non-U.S. jurisdictions). This concept of permanent establishment risk alone is worthy of executive-level attention and is beyond just how to pay the employee. Again, a treaty may provide protection if there is one between the jurisdictions at play.
In the eagerness to operate “freely” and cross-border throughout multiple jurisdictions, companies and their employees often find the world is filled with countries looking to protect their tax base in addition to ensuring that local immigration and labor laws among other are complied with. International business continues to grow nonetheless.