Corporate relocation is already a complicated process, and it’s even more challenging when you need to send employees out of the country (as if the HR department didn’t have enough red tape already!).
One area that trips up even the most seasoned HR professionals is shadow payroll. Understanding this is crucial to a smooth relocation because it will ensure that the company stays on the right side of the tax law in both the home and host country. Continue below to learn more.
What is Shadow Payroll?
Shadow payroll provides a way for expats and international workers to retain their same benefits, insurance, and investments while relocating temporarily to a different country. It assists with reporting of tax withholdings in a host country while the employee remains on the payroll of their home country. The term “shadow” is used because the employee’s payroll will shadow what is being reported in their home country, even though they’re not receiving any pay from the host country.
The purpose of this is so that employers can remain in compliance with payroll tax laws of the host country without having to strip away any benefits, retirement, or investments from the employee. All necessary tax documents and forms for the host country will get completed as they should but the employee will never actually receive any payment from that country.
When You Need Shadow Payroll
If you’re not sure whether or not you need a shadow payroll system, here are a few questions and scenarios to help you make a determination:
- Does your organization ever send employees out of the country on assignment?
- When the employee goes on assignment, is it long-term or short-term?
Trips less than 6 months – If you send employees on business trips that last less than six months, a tax treaty is usually sufficient enough for that employee to remain on their home country’s payroll. The host country should not require payroll and tax obligations and the employee will remain on their home country’s social security program as well.
6 months to one year – Once the trip exceeds six months, a tax treaty will no longer be enough to cover the obligations, and the host country will expect that employee to be put on a payroll in that country. A portion of their income is now taxable in the host country and a social security treaty is usually required for them to remain on the home country’s program. For business trips lasting longer than six months, shadow payroll is required.
Longer than 183 days – Once a trip extends beyond 183 days it is considered a long-term assignment and the employee will be responsible for many tax obligations and will have to pay taxes on their whole income in the host country. Shadow payroll at this time is mandatory.
When You Don’t Need Shadow Payroll
You won’t need to set up shadow payroll for an employee that is traveling out of the country for less than six months. They can remain on the home country payroll and will not have to face any tax obligations in their host country.
How to Handle Shadow Payroll (3 steps)
You understand what shadow payroll is and why it’s important, here’s how you set up a global payroll system that will work no matter where you send your employees.
Ensure the employee is on the home payroll – The first thing you need to do is make sure that everything is good at home. If the employee is traveling to Canada from the U.S. for a year, you’ll be responsible for U.S. and Canadian tax requirements.
Process U.S. payroll normally – No matter where the employee is working, since they’re traveling from the U.S. as their home country, they will still be responsible for all tax obligations in the United States as will the employer. Nothing changes here.
Add the employee to the host country payroll as a joiner – To avoid double taxation, the employee needs to be added to the Canadian payroll as a joiner with the application of foreign net tax scheme. This will then allow the employer to remove the host country tax, social, and pension payments.
Tips for Setting up Shadow Payroll
Here are a few tips to ensure that all of this is done properly and both the employer and employee experience a smooth employee relocation.
- Maintain strong communication with the host country
- Identify all pieces of compensation data including 401k payouts, money market accounts, and insurance flex spending accounts
- Review documents and information carefully for accuracy
Examples of Shadow Payroll
This could be difficult to understand so here is an example of a situation that would merit shadow payroll.
Let’s say you have an employee that will be working on a long-term assignment in Canada traveling from the United States. The U.S. taxes employees on a worldwide basis which means that the employer needs to remain in compliance with United States tax laws and Canadian laws.
To keep everything organized and in compliance, the employer must set up a shadow payroll for Canada just as they would if the person was actually employed there. Then they’ll be able to figure out the expat payroll tax requirements and ensure that everything is satisfied. That employee will receive wages from the United States payroll system and all tax requirements will be handled but there are also state and provincial obligations as well. The individual steps and requirements are case-to-case.
One concern that a lot of employees have is being double taxed because their wages are taxable in two countries. While in some cases this is necessary to satisfy the local and provincial obligations in the host country, many countries have reciprocal tax agreements and credits to help expats keep more of their wages.
Final Thoughts
Relocating employees is a challenge for HR departments and in our 16+ years of working with businesses like yours, we’ve seen a lot of situations where misinformed HR managers got their company and themselves into trouble with tax requirements and foreign laws. Read up, inform yourself, and make sure you know all the laws in the host country.
If you’d like to get a second opinion on your situation, we specialize in helping human resource departments develop the procedures and policies necessary to systematize the relocation process. We make it simple so you don’t have to. Contact us here to learn more!