Taxable Income - Tax equalisation

The concept of tax equalisation is that the expatriate should be neither better nor worse off from a tax point of view by accepting an overseas assignment. He will continue to be subject to the same level of tax as if he had remained at home. The tax impact of the assignment is therefore neutralised for the expatriate.

The mechanism to ensure that the expatriate employee continues to bear the same level of tax involves the deduction of so called "hypothetical" home country tax. For the purposes of "hypo" tax deduction, the employer ignores items specifically paid because the expatriate is on overseas assignment e.g. a cost of living allowance. This hypo tax is used by the employer settle the applicable host and home country taxes. In addition the employer will pay any taxes due over and above the hypo tax. If the home and host country taxes are less than the hypo tax then the employer enjoys the benefit.

The advantages of tax equalisation include the following:

• tax savings are enjoyed by the employer thus reducing overall assignment costs;
• corporate image is protected as tax equalisation facilitates and ensures expatriate tax compliance;
• employee geographic mobility is improved.

Note: A major disadvantage is that administration of a tax equalisation policy tends to be time consuming and consequently expensive. Compensation earned by an individual, the receipt of which is postponed until a later date, usually upon termination of employment or retirement. Typically, the deferred amounts are invested on the recipient's behalf and may be supplemented by contributions by the company. If the compensation arrangement meets certain requirements, an individual may not pay income taxes on the compensation until he or she receives a distribution of some or all of the deferred amounts.