Tax Equalisation and Hypo tax in International Assignments

CA Aditya Mohan

Globalization has transformed the commercial system in the present world and in the transformation introduced new concepts, ‘Tax Equalisation’ being one of them. When an employee based out of one country (‘home country’) is deputed to another country (‘host country’), two foremost concerns that the employee bumps into are the risk of his income being taxed in both the countries and the tax rate in the host country being higher than tax rate in the home country. While the former concern is normally taken care by Double Taxation Avoidance Treaties entered into between various countries, the tax model equalisation takes care of the later.

The concept is gaining popularity since it works on the phrase “No one wants to pay more tax than they have to”. It denotes neutralisation of tax impact of the International assignment on the employee i.e. when an employee travels from home country to the host country. Considering a situation, where an employee is seconded/assigned from India to US for a two years assignment. As per the terms of the assignment, he is tax equalised. In other words, he would be liable to income tax in India for the financial year as if he is employed in India and the tax cost relating to his assignment in US would be taken care by the employer company. Presently, many companies use tax equalisation mechanism for calculating their expats tax bills.

The concept works on the principle that an employee should be no better off or no worse off as a result of being assigned abroad. This policy finds its place in the assignment contract to encourage employees to work for their employers when sent abroad with the knowledge that they are not disadvantaged tax-wise and their tax affairs in the Host country are taken care of by the employer’s appointed tax advisers. This situation is also referred to as Employee under Hypo Tax Regime. Hypo tax is a tax as mentioned above, calculated based on assumption that had the employee remained in his home country, what would be his tax liability.

How this concept is followed numerically:

Now, looking on to the above case, the employee would bear hypo tax cost of Rs. 150 and employer would bear the assignment related tax cost of Rs. 50. Now, let’s see how the concept is followed practically: Rs. 200 shall be paid by the employer in home and host country to the tax Authorities. And employer recovers Rs.150 from the employee which will go into former’s pocket.

Nevertheless, this does not imply that a company gets to pocket the tax savings by assigning/seconding an employee. Tax Equalisation is a favourable position to the employee where the host country tax rates are higher than the tax rates in the home country. The situation is unfavourable in the case where the employees are seconded to the countries like UAE where no individual taxation exists or Singapore where tax rates are less than India tax rates, since there would be no or nominal International assignment related cost to be borne by the employer and the whole cost in the form of hypo tax shall be recovered from the employee. However, the employee may choose to bear the actual tax cost rather than being tax equalised in case of secondment to countries like these.

Applying the concept, corporate image is protected as it facilitates and ensures expatriate tax compliance in both the countries. The factor of uncertainty is taken away by Tax Equalisation.

At the end needless to say, if the system is well managed there should not be any shocks to the company or to the individual, along with meeting 100 percent compliance of the tax provisions.