If the term “shadow payroll” invokes thoughts of something peculiar happening behind the scenes with international compensation, you’re not alone in your thinking. Even seasoned relocation professionals sometimes need a refresher of the concept to remember its importance in today’s changing world of global mobility.
Shadow Payroll and How It Works
Some employers may have dual payroll withholding responsibilities in both their home country and a foreign jurisdiction. If so, they will often run what is known as a “shadow payroll’ in respect to an employee’s taxable income. The payroll in the host country will “shadow” what is being reported in the home country.
To put it another way, the employer needs to run parallel payroll processes – one at home that continues paying the employee on assignment and another “shadow payroll” in the host country that tracks the employee’s payroll for host country tax filing obligations.
For example, if a company has an employee on a long-term assignment from the U.S. (home) to Canada (host), the company will report 100 percent of the assignee’s wages in the U.S. and Canada for compliance with both countries’ payroll rules. Since the U.S. taxes income on a worldwide basis, the employee and company must stay compliant in the U.S. while taking into consideration any Canadian tax requirements.
To accomplish this, the employer will set up a “shadow” payroll in Canada for the U.S. employee, as if he or she were being compensated in Canada, to calculate payroll tax requirements for the wages earned in Canada. At the same time, the company’s U.S. entity should “shadow” report any payments/benefits paid outside of the U.S. for W-2 reporting purposes to facilitate the global compliance reporting process.
Every country has different compliance laws for payroll and some countries require all compensation benefits to be reported and taxed in the host country if an employee is living/working there for a specific assignment period, regardless of where they are paid. For example, there are host payment requirements in Brazil and Russia where a country-specific salary must be paid locally.
Typically, as in the above U.S. to Canada assignment example, the employee will continue to be paid his or her salary solely from the U.S. payroll system and all U.S. payroll tax requirements will continue to be satisfied. Other assignment benefits, such as housing and taxes, might be paid by the employer’s host country entity.
Why Understanding This is Important
Global compensation rules around the globe are already very complex and confusing, but in our rapidly changing world, laws seem to be in a constant state of evolution. Yet, being uninformed or unaware of a law may not escape a company’s or employee’s liability.
Making errors with payroll/tax compliance can lead to avoidable fines, unnecessary headaches for company employees, and potential detainment from leaving a country.
Countries are also linking tax departments with immigration processes to ensure compliance. As we see greater numbers of employees on assignment, we are also seeing stricter payroll requirements being enforced around the world. Host nations are becoming increasingly more demanding regarding who must join their local payrolls.
Further, the risk of non-compliance can be greater should companies not keep a tight rein over the tax issues relating to their mobile workforce.
Shadow Payroll’s Most Effective Applications
Shadow payrolls are most effective when:
- Discussions take place with one’s global mobility and tax partners when an international assignment or travel is pending or in the planning stage
- Effective and clear communications take place regularly between employer home and host country entities
- The organization’s entities understand the importance of compliance and develop a standard approach to be taken when assignments or extended business visits arise
- Compensation data is captured and, where appropriate, shared with the home/host payroll and one’s tax team to facilitate wage reporting and tax withholding requirements in the appropriate country
- The organization knows what information is critical to track as the answers might activate a requirement to be part of local payroll: What’s the assignee’s exact job? Who’s paying for the assignment? What is the length of assignment? Is the assignee staying at a leased residence or at a hotel?
- Employee assignment/business travel developments are tracked so companies can be alert for changes to plans. For example, projects can fall behind schedule or get extended to the point a long business trip turns into a much longer assignment, etc.
- Employers have reliable resources ready to advise them as needed
NEI Experts Support Shadow Payrolls
NEI’s experts are just a call or email away. Our many years’ experience helping global clients with shadow payroll can provide additional support or training to ensure your global compensation program and compliance needs are satisfied.
To discuss further, please contact your NEI representative or Janine Jarecki, CPA, NEI Controller - Expense Administration at firstname.lastname@example.org.