The internationalization of business seems an inescapable fact of life. As a result, the Canadian payroll professional is faced with a wide range of practical and conceptual issues in the successful management of outbound expatriate employees.
Compared to domestic payrolls, there are differences in the reporting and treatment of compensation, resident versus non-resident employees, application of credits specific to foreign assignments, and the impact of the assignment on participation in retirement and benefit plans.
Balance sheet compensation
There is no set policy that is perfect for all situations. However, most companies use a “balance sheet” methodology as a basic design of a compensation package to ensure an expatriate employee is no worse off than domestic counterparts from a compensation and tax standpoint. The cost of balance sheet compensation to the employer is high and can generally run anywhere from two to three times the employee’s base salary.
In coming up with a balance sheet for an employee, compensation will include various payments (allowances) in addition to base salary. These payments are designed to fairly reimburse the employee for additional costs that the employee will incur as a result of taking a foreign assignment.
Allowances often paid to overseas employees either directly on an expatriate’s payroll or reimbursed via an expense report include:
•overseas premium;
•cost-of-living or goods and service differential;
•housing allowance;
•education allowance;
•home leave for one or two non-business trips back to Canada;
•tax preparation service fees;
•moving expense reimbursement;
•incidental allowance; and
•rental maintenance allowance.
Equalization and protection
•Tax equalization. A tax equalization allowance reimburses the individual for the additional income taxes incurred as a result of the foreign assignment. The intent of a tax equalization policy is to equate an expatriate’s total out-of-pocket income tax cost to approximately the same amount that the expatriate would pay if he were working in the home location. Tax equalization results in the employee not incurring a tax advantage or disadvantage as a result of foreign assignment.
•Tax protection. Under a tax protection policy, a company reimburses an expatriate who pays higher taxes in the host country than in the home country. Generally, reimbursements are calculated only on employment income. If the host country tax is lower than the home country tax, under tax protection, generally the company will allow the expatriate a windfall.
Canadian resident versus non-resident expatriates
The impact of error in the determination of residency at the onset of an assignment could result in a high cost to the employer and/or employee. For the payroll professional, it could result in a significant administrative issue in retroactive correction to past payroll records.
A resident of Canada is subject to Canadian tax on worldwide income. Therefore, if an individual is a resident of Canada, but employed abroad, the individual is subject to Canadian income tax on the employment income earned abroad. Likewise any investment income earned abroad is also generally subject to Canadian tax when an individual earns it. The concept of worldwide taxation applies regardless of whether or not the funds are returned to Canada.
A non-resident of Canada is generally only subject to Canadian income tax on three types of income:employment income earned in Canada, business income earned in Canada and capital gains from the disposition of taxable Canadian property.
The advantages of becoming a non-resident include:
•An individual, if relocating to a country that has lower tax rates, would generally be able to reduce the overall tax burden on worldwide income, including employment income. That is because those items of income would not be subject to the Canadian marginal tax rates, but to the lower tax rates in the host country.
•In the year of departure from Canada, the effective rate of Canadian tax on the individual’s Canadian tax return would generally be lower than it would be in a full year of living in Canada. This is because the Canadian tax structure uses progressive tax rates. When an individual leaves Canada part way through the year, the individual generally has proportionately less income taxed at the higher rates and proportionately more income taxed at the lower rates, which has the effect of reducing the average rate of tax in both the year of departure and the year of return.
•Generally, any appreciation in value of investment assets (other than Canadian real estate, shares of private Canadian companies, and other taxable Canadian property) that accrues while the individual is a non-resident will escape Canadian taxation.
The disadvantages of becoming a non-resident include:
•A non-resident of Canada does not “build” room in the employee’s registered retirement savings plan (RRSP) while on an overseas assignment. For an individual who is not a member of a company pension plan, this can cause concern, as the individual may have up to $13,500 in RRSP room that is not accumulating while the individual is non-resident. As a result, the individual would lose the ability to accumulate long-term tax deferred dollars within an RRSP.
•The effect of departure tax rules may pose a significant cost to the departing expatriate. There are rules in the Income Tax Act that require an individual to dispose of all property other than: Canadian real property, capital property used in a business carried on in Canada by the individual, pension plan interests, property owned by the individual before he came to Canada that was still owned when he left Canada and the period of Canadian residence was for less than 60 months, and stock option rights. All other property is subject to the deemed disposition rules and must be reported as having been disposed of on the tax return for the year of departure.
The Income Tax Act does not specifically define residency. Over the years, the task of ascertaining residency has fallen on the tax courts. They have identified a number of factors that must be considered in determining an individual’s residency status, including:
•permanence and purpose of stay abroad;
•resident ties elsewhere; and
•residency ties (including family and property) within Canada;
In addition, modern tax treaties that Canada signs with other countries contain treaty tiebreaker rules. The general presumption under a treaty is that if an individual is a resident of two countries under the laws of each country, the individual’s residency is decided under a set of tiebreaker rules which would decide residency in favour of one country or the other.
Although it is up to the expatriate to inform the Canada Customs and Revenue Agency (CCRA) of residence status, payroll professionals may be interested in knowing how an individual is to inform the CCRA of residency status, in case an employee makes such inquiries of the payroll department.
There are generally two ways to notify the department of one’s non-residence status. The first is to simply disclose in the tax return for the year of departure the fact that the individual has ceased to be resident of Canada.
Alternatively, an individual may apply for the CCRA’s determination of residency status. This is done by completing form NR73, Determination of Residency Status (Leaving Canada) and filing it with the CCRA.
Canada/Quebec Pension Plan (C/QPP)
An employer can continue an employee’s coverage under the CPP providing certain conditions are met. An expat employee can also continue CPP coverage via a social security agreement that Canada has with another country. For countries with existing social security agreements, where continued coverage is available, an individual’s time spent working outside of Canada will count for years as “creditable” periods towards CPP eligibility.
However, if CPP contributions are not made while the individual is outside of Canada, the earnings will not be pensionable and will not increase the individual’s CPP benefit entitlement.
How an individual will be affected by a foreign assignment with respect to CPP benefits varies greatly from employee to employee, depending on what stage of a career an employee is at.
Quebec residents, who contribute to the QPP are subject to reciprocal agreements between Quebec and the country to which the employee is being sent. The agreements are generally similar to the Canadian ones and have the same goal, which is to eliminate double taxation and to ensure the employee that the number of service years in a foreign country will be part of the complete pension amount.
Where an individual cannot participate in the C/QPP while abroad, there are two possible alternatives. The employer can enroll the employee in the host country’s social security program if eligible. Or, the employer can take no action at the onset of the assignment. Once the assignment is over and the employee returns to Canada, the employer needs to make certain calculations. If it is determined that the expatriate assignment had no impact on the total benefit, no action would be required. If the assignment had a negative impact on the total benefit, the company can provide a make-up payment equivalent to the net present value of the lost benefits the person would have received. An actuarial firm can perform this type of calculation if required.
Income tax
Normally, any person paying salary or wages to an individual is required to withhold income tax and remit it to the CCRA. However, where salary is paid to a non-resident of Canada, the payer is not required to withhold any income tax if both of the following conditions are met:
•the payment relates to services the individual performed outside of Canada; and
•where the non-resident used to be a resident of Canada, and the salary is paid by a Canadian resident company, the salary is subject to a foreign income tax, or is paid in connection with selling property, negotiating contracts or rendering services for the employer in the ordinary course of business carried on by the employer.
Typically, the portion of a particular payment that relates to services performed outside of Canada would be determined by prorating the payment using a ratio of the employee’s total workdays outside of Canada during the relevant time period over the employee’s total workdays in the period. For bonuses and other incentive compensation, the relevant period is typically the period of time for which the payment is calculated (e.g., the previous fiscal year of the employer).
Workers’ compensation
Workers’ compensation assessments or premiums that normally apply to a Canadian employer’s gross payroll will not generally apply to the salary and wages paid to expatriates after they have ceased to be residents of Canada and started working in a foreign location. However, it is advisable for employers to check with their provincial/territorial workers’ compensation body to ensure that they no longer have to include an employee’s salary and wages in their assessable or insurable payroll.
Health-related deductions
Manitoba, Newfoundland, Ontario and Quebec each require employers to pay a payroll-related levy to help fund their provincial health-care systems. In general, the levies apply to total annual payroll paid to employees who report for work at the employer’s place of business in the province, as well as to employees who are not required to report to the employer’s business establishment in the province, but who are paid from or through the employer’s place of business in the province. As a result, if an employer subject to a provincial health-related levy continues to pay salary and wages to an expatriate employee, the employer will have to include the salary and wages when calculating the total amount of payroll subject to the levy.
A Quebec employer that posts an employee to a country that has signed a social security agreement with Quebec, under which reciprocal health insurance coverage is provided, must make a contribution to Quebec’s Health Services Fund.
In Alberta and British Columbia, provincial residents are required to pay premiums for coverage under their public health-care plans. To be eligible for coverage, individuals must meet specific requirements., including being physically present in the province for a minimum period of time during the year. Although it is the individual’s responsibility to contact the provincial health authority to determine eligibility, an expatriate employee’s eligibility could have an impact on payroll deductions. In companies in Alberta and B.C. that have established group plans, the employer is responsible for deducting and remitting the employees’ monthly health-care premiums to the provincial health authority.
Payments outside of payroll
If an employee is a resident of Canada or is a non-resident of Canada working in Canada, the Canadian tax treatment of certain elements of an expatriate’s compensation package must be determined for purposes of assessing whether or not the particular items of compensation constitute “income” for tax purposes. The common types of payments made to expatriate employees include:
•moving expense reimbursements;
•home loss reimbursements;
•housing loan interest reimbursements;
•cost-of-living allowances; and
•tax reimbursements
There is potential relief for these taxable benefits under the Income Tax Act’s special work site allowance provisions.
Tax credits
Provided certain conditions are met, the Overseas Employment Tax Credit (OETC) is available to reduce the Canadian tax liability of individuals who have performed duties in a foreign country. Under the OETC rules, an individual on foreign assignment can earn up to $80,000 (Canadian) and remain resident of Canada, free of any Canadian tax liability if he meets CCRA conditions.
In general, an individual resident in Canada is taxed on both Canadian source and foreign source income. To mitigate the occurrence of double taxation, Canadian tax legislation provides relief via the foreign tax credit mechanism. In general terms, a reduction in combined federal and provincial income tax can be claimed equal to the lesser of: the foreign tax paid, and the Canadian tax otherwise payable on the foreign income.
When a Quebec employee works outside of Canada for a period of at least 30 consecutive days, he is eligible for a deduction in his taxable benefit calculation, called the Foreign Employment Deduction. The calculation of a foreign tax credit available against the Quebec tax paid is similar to the federal, but the credit is reduced by the amount taken in the Canadian return. In Quebec, a taxpayer cannot take the foreign employment deduction and the foreign tax credit on the same income. Generally, it is more beneficial to take the deduction than the credit because the deduction usually exempts all the income.
This article was excerpted from the Complete Payroll Manager by Carswell. For subscription information contact 1-800-387-5164. The authors hold positions with PriceWaterhouseCoopers. Kathy Marasco is senior manager, international assignment solutions, Calgary; Laurie Paré, is partner, international assignment solutions, Calgary; Gaétan Bélanger is senior associate, international assignment solutions, Montreal.
Compared to domestic payrolls, there are differences in the reporting and treatment of compensation, resident versus non-resident employees, application of credits specific to foreign assignments, and the impact of the assignment on participation in retirement and benefit plans.
Balance sheet compensation
There is no set policy that is perfect for all situations. However, most companies use a “balance sheet” methodology as a basic design of a compensation package to ensure an expatriate employee is no worse off than domestic counterparts from a compensation and tax standpoint. The cost of balance sheet compensation to the employer is high and can generally run anywhere from two to three times the employee’s base salary.
In coming up with a balance sheet for an employee, compensation will include various payments (allowances) in addition to base salary. These payments are designed to fairly reimburse the employee for additional costs that the employee will incur as a result of taking a foreign assignment.
Allowances often paid to overseas employees either directly on an expatriate’s payroll or reimbursed via an expense report include:
•overseas premium;
•cost-of-living or goods and service differential;
•housing allowance;
•education allowance;
•home leave for one or two non-business trips back to Canada;
•tax preparation service fees;
•moving expense reimbursement;
•incidental allowance; and
•rental maintenance allowance.
Equalization and protection
•Tax equalization. A tax equalization allowance reimburses the individual for the additional income taxes incurred as a result of the foreign assignment. The intent of a tax equalization policy is to equate an expatriate’s total out-of-pocket income tax cost to approximately the same amount that the expatriate would pay if he were working in the home location. Tax equalization results in the employee not incurring a tax advantage or disadvantage as a result of foreign assignment.
•Tax protection. Under a tax protection policy, a company reimburses an expatriate who pays higher taxes in the host country than in the home country. Generally, reimbursements are calculated only on employment income. If the host country tax is lower than the home country tax, under tax protection, generally the company will allow the expatriate a windfall.
Canadian resident versus non-resident expatriates
The impact of error in the determination of residency at the onset of an assignment could result in a high cost to the employer and/or employee. For the payroll professional, it could result in a significant administrative issue in retroactive correction to past payroll records.
A resident of Canada is subject to Canadian tax on worldwide income. Therefore, if an individual is a resident of Canada, but employed abroad, the individual is subject to Canadian income tax on the employment income earned abroad. Likewise any investment income earned abroad is also generally subject to Canadian tax when an individual earns it. The concept of worldwide taxation applies regardless of whether or not the funds are returned to Canada.
A non-resident of Canada is generally only subject to Canadian income tax on three types of income:employment income earned in Canada, business income earned in Canada and capital gains from the disposition of taxable Canadian property.
The advantages of becoming a non-resident include:
•An individual, if relocating to a country that has lower tax rates, would generally be able to reduce the overall tax burden on worldwide income, including employment income. That is because those items of income would not be subject to the Canadian marginal tax rates, but to the lower tax rates in the host country.
•In the year of departure from Canada, the effective rate of Canadian tax on the individual’s Canadian tax return would generally be lower than it would be in a full year of living in Canada. This is because the Canadian tax structure uses progressive tax rates. When an individual leaves Canada part way through the year, the individual generally has proportionately less income taxed at the higher rates and proportionately more income taxed at the lower rates, which has the effect of reducing the average rate of tax in both the year of departure and the year of return.
•Generally, any appreciation in value of investment assets (other than Canadian real estate, shares of private Canadian companies, and other taxable Canadian property) that accrues while the individual is a non-resident will escape Canadian taxation.
The disadvantages of becoming a non-resident include:
•A non-resident of Canada does not “build” room in the employee’s registered retirement savings plan (RRSP) while on an overseas assignment. For an individual who is not a member of a company pension plan, this can cause concern, as the individual may have up to $13,500 in RRSP room that is not accumulating while the individual is non-resident. As a result, the individual would lose the ability to accumulate long-term tax deferred dollars within an RRSP.
•The effect of departure tax rules may pose a significant cost to the departing expatriate. There are rules in the Income Tax Act that require an individual to dispose of all property other than: Canadian real property, capital property used in a business carried on in Canada by the individual, pension plan interests, property owned by the individual before he came to Canada that was still owned when he left Canada and the period of Canadian residence was for less than 60 months, and stock option rights. All other property is subject to the deemed disposition rules and must be reported as having been disposed of on the tax return for the year of departure.
The Income Tax Act does not specifically define residency. Over the years, the task of ascertaining residency has fallen on the tax courts. They have identified a number of factors that must be considered in determining an individual’s residency status, including:
•permanence and purpose of stay abroad;
•resident ties elsewhere; and
•residency ties (including family and property) within Canada;
In addition, modern tax treaties that Canada signs with other countries contain treaty tiebreaker rules. The general presumption under a treaty is that if an individual is a resident of two countries under the laws of each country, the individual’s residency is decided under a set of tiebreaker rules which would decide residency in favour of one country or the other.
Although it is up to the expatriate to inform the Canada Customs and Revenue Agency (CCRA) of residence status, payroll professionals may be interested in knowing how an individual is to inform the CCRA of residency status, in case an employee makes such inquiries of the payroll department.
There are generally two ways to notify the department of one’s non-residence status. The first is to simply disclose in the tax return for the year of departure the fact that the individual has ceased to be resident of Canada.
Alternatively, an individual may apply for the CCRA’s determination of residency status. This is done by completing form NR73, Determination of Residency Status (Leaving Canada) and filing it with the CCRA.
Canada/Quebec Pension Plan (C/QPP)
An employer can continue an employee’s coverage under the CPP providing certain conditions are met. An expat employee can also continue CPP coverage via a social security agreement that Canada has with another country. For countries with existing social security agreements, where continued coverage is available, an individual’s time spent working outside of Canada will count for years as “creditable” periods towards CPP eligibility.
However, if CPP contributions are not made while the individual is outside of Canada, the earnings will not be pensionable and will not increase the individual’s CPP benefit entitlement.
How an individual will be affected by a foreign assignment with respect to CPP benefits varies greatly from employee to employee, depending on what stage of a career an employee is at.
Quebec residents, who contribute to the QPP are subject to reciprocal agreements between Quebec and the country to which the employee is being sent. The agreements are generally similar to the Canadian ones and have the same goal, which is to eliminate double taxation and to ensure the employee that the number of service years in a foreign country will be part of the complete pension amount.
Where an individual cannot participate in the C/QPP while abroad, there are two possible alternatives. The employer can enroll the employee in the host country’s social security program if eligible. Or, the employer can take no action at the onset of the assignment. Once the assignment is over and the employee returns to Canada, the employer needs to make certain calculations. If it is determined that the expatriate assignment had no impact on the total benefit, no action would be required. If the assignment had a negative impact on the total benefit, the company can provide a make-up payment equivalent to the net present value of the lost benefits the person would have received. An actuarial firm can perform this type of calculation if required.
Income tax
Normally, any person paying salary or wages to an individual is required to withhold income tax and remit it to the CCRA. However, where salary is paid to a non-resident of Canada, the payer is not required to withhold any income tax if both of the following conditions are met:
•the payment relates to services the individual performed outside of Canada; and
•where the non-resident used to be a resident of Canada, and the salary is paid by a Canadian resident company, the salary is subject to a foreign income tax, or is paid in connection with selling property, negotiating contracts or rendering services for the employer in the ordinary course of business carried on by the employer.
Typically, the portion of a particular payment that relates to services performed outside of Canada would be determined by prorating the payment using a ratio of the employee’s total workdays outside of Canada during the relevant time period over the employee’s total workdays in the period. For bonuses and other incentive compensation, the relevant period is typically the period of time for which the payment is calculated (e.g., the previous fiscal year of the employer).
Workers’ compensation
Workers’ compensation assessments or premiums that normally apply to a Canadian employer’s gross payroll will not generally apply to the salary and wages paid to expatriates after they have ceased to be residents of Canada and started working in a foreign location. However, it is advisable for employers to check with their provincial/territorial workers’ compensation body to ensure that they no longer have to include an employee’s salary and wages in their assessable or insurable payroll.
Health-related deductions
Manitoba, Newfoundland, Ontario and Quebec each require employers to pay a payroll-related levy to help fund their provincial health-care systems. In general, the levies apply to total annual payroll paid to employees who report for work at the employer’s place of business in the province, as well as to employees who are not required to report to the employer’s business establishment in the province, but who are paid from or through the employer’s place of business in the province. As a result, if an employer subject to a provincial health-related levy continues to pay salary and wages to an expatriate employee, the employer will have to include the salary and wages when calculating the total amount of payroll subject to the levy.
A Quebec employer that posts an employee to a country that has signed a social security agreement with Quebec, under which reciprocal health insurance coverage is provided, must make a contribution to Quebec’s Health Services Fund.
In Alberta and British Columbia, provincial residents are required to pay premiums for coverage under their public health-care plans. To be eligible for coverage, individuals must meet specific requirements., including being physically present in the province for a minimum period of time during the year. Although it is the individual’s responsibility to contact the provincial health authority to determine eligibility, an expatriate employee’s eligibility could have an impact on payroll deductions. In companies in Alberta and B.C. that have established group plans, the employer is responsible for deducting and remitting the employees’ monthly health-care premiums to the provincial health authority.
Payments outside of payroll
If an employee is a resident of Canada or is a non-resident of Canada working in Canada, the Canadian tax treatment of certain elements of an expatriate’s compensation package must be determined for purposes of assessing whether or not the particular items of compensation constitute “income” for tax purposes. The common types of payments made to expatriate employees include:
•moving expense reimbursements;
•home loss reimbursements;
•housing loan interest reimbursements;
•cost-of-living allowances; and
•tax reimbursements
There is potential relief for these taxable benefits under the Income Tax Act’s special work site allowance provisions.
Tax credits
Provided certain conditions are met, the Overseas Employment Tax Credit (OETC) is available to reduce the Canadian tax liability of individuals who have performed duties in a foreign country. Under the OETC rules, an individual on foreign assignment can earn up to $80,000 (Canadian) and remain resident of Canada, free of any Canadian tax liability if he meets CCRA conditions.
In general, an individual resident in Canada is taxed on both Canadian source and foreign source income. To mitigate the occurrence of double taxation, Canadian tax legislation provides relief via the foreign tax credit mechanism. In general terms, a reduction in combined federal and provincial income tax can be claimed equal to the lesser of: the foreign tax paid, and the Canadian tax otherwise payable on the foreign income.
When a Quebec employee works outside of Canada for a period of at least 30 consecutive days, he is eligible for a deduction in his taxable benefit calculation, called the Foreign Employment Deduction. The calculation of a foreign tax credit available against the Quebec tax paid is similar to the federal, but the credit is reduced by the amount taken in the Canadian return. In Quebec, a taxpayer cannot take the foreign employment deduction and the foreign tax credit on the same income. Generally, it is more beneficial to take the deduction than the credit because the deduction usually exempts all the income.
This article was excerpted from the Complete Payroll Manager by Carswell. For subscription information contact 1-800-387-5164. The authors hold positions with PriceWaterhouseCoopers. Kathy Marasco is senior manager, international assignment solutions, Calgary; Laurie Paré, is partner, international assignment solutions, Calgary; Gaétan Bélanger is senior associate, international assignment solutions, Montreal.
