Sending Employees Across Borders
2004 Year-End Tax Review for International Assignment Program Managers with Canadian Companies
The world of the international assignment program (“IAP”) manager with Canadian multi-national companies is even more complex than ever. New tax laws in Canada and abroad, privacy legislation in effect, new international business in exotic places, mergers and restructurings etc. are all combining to make life very challenging for the Canadian HR professional. At the same time, there are expectations to hire, motivate and retain key expatriate employees and save money in the process.
As we approach the year-end and 2004 assignment tax reporting, now is an opportune time for Canadian HR professionals to review all aspects of their assignment programs to ensure that they are on track. A number of the following comments are based on our own observations in our assignment tax practice.
Whether your company IAP has one assignee or one hundred, whether they are inbound or outbound to or from Canada, many of the following comments will apply.
Categorize your Assignees
Your assignment employee population may include :
- long-term assignees outside Canada for some years,
- rotational employees on month-in, month-out rotations,
- short-term assignees, away for up to one year,
- business-trippers, and
- inbound assignees, of various types
Assignees in each of the groups have their own distinct income tax profiles. Too often, Canadian companies aggregate some or all of the above without appreciation for the unique tax reporting that each group requires. Ensure that you understand these differences. For example, long-term assignees often require the preparation of T4 supplementaries which are specially prepared to report only Canadian Pension Plan contributions, even though the employee may have been employed outside Canada. Also, inbound employees on very short-term assignments in Canada may be exempt from Canadian tax, but still require specialized reporting. To recognize the unique needs of each grouping, companies need clear, consistent international assignment policies. Often assignment policy documents do not exist, or are found in a desk drawer, are never published and are still circulating for comments years later. Legislation in the US is now requiring that companies have full and complete policy documentation in all areas of their business. In Canada, we can expect similar legislation in the near future.
There is a growing North American trend towards the independent, formal audit of company policies and procedures. Companies without detailed assignment policies can expect to face penalties. Time to dust off and improve your IAP policies and procedures. A one-size-fits-all IAP no longer works.
Assignee Tax is Not Our Problem :
Understanding at least the basic tax issues faced by each category of assigned employees is critical to ensuring the accuracy of year-end payroll reporting and avoiding common errors. Tax laws in Canada, and in many foreign countries, impose dual inter-connected responsibilities :
- On the employer company , to ensure that it withholds, remits and reports assignee tax properly; and
- On the assigned employee , to ensure that an annual tax return is submitted on a timely, accurate and complete basis, and that taxes are paid.
You cannot have one without the other. Companies which abandon their oversight role are inviting a visit from the tax auditors. Such visits are easily triggered by inaccurate T-slip reporting , incorrect levels of tax withholding, disgruntled employees and many other reasons.
Assignment Tax Policy (“ATP”)? What is That?
In April each year, as we prepare our Canadian tax returns, we are reminded of the amount of tax we pay. Assigned employees are no different. However, the tax returns of expatriate assignees are complicated by foreign taxes, tax credits for working outside Canada, social security taxes, foreign exchange conversions etc. The CRA closely scrutinizes such returns and the assignee can experience ongoing unfavorable adjustments. Due to the increasing complexity of the tax laws, many companies are re-discovering the productivity gains that can result from the introduction of a formal ATP. Recent studies have demonstrated that formal ATP’s can help to minimize assignee frustration with the tax filing process and can reduce overall compensation costs if properly planned.
No single direct area of assignee HR management gives rise to more frustrated employees, floods of e-mails, harassed program managers and expensive tax penalties and interest, than the whole issue of tax.
A simple tax reporting appendix to the assignment agreement, outlining both the employer’s and assignee’s tax responsibilities, often goes a long way toward stemming the flow of tax-related questions, and relieving the HR manager of the undesirable task of attempting to interpret complex tax laws.
Overseas Employment Tax Credit (“OETC”) :
This tax credit was introduced in 1984 and was originally intended as an indirect subsidy toward the compensation costs of Canadian companies doing business outside Canada. The OETC is claimed in the income tax returns of eligible employees following the preparation and notarization by the employer of Form T626-Overseas Employment Tax Credit. The tax credit results in a significant saving of Canadian income tax to the assignee. In some cases, the amount of tax actually saved is dependent on many factors such as the level of income, the impact of alternative minimum tax, the days worked outside Canada and whether the employer’s tax policy requires that some or all of the recovery be returned to the employer. IAP Managers should:
- Carefully review the eligibility of each assignee to ensure that the assignee meets the ‘assignee conditions’ such as days worked outside Canada vs. in Canada, nature of the work undertaken etc.
- Re-visit the conditions that the employer must meet for assignees to be eligible for the credit. Where the multi-national has a complex corporate structure, eligibility may not be readily apparent.
- Maintain extensive documentary evidence to support the opinion that the employee is eligible for the tax credit. The CRA attempts to audit as many OETC tax credit claims as possible and this evidence will be invaluable should it be required during an audit.
- Making an application for a reduction in 2005 assignee tax withholdings. First-time applications must be carefully prepared and supported by sufficient documentary evidence that will withstand the experienced scrutiny of the international audit section in the Calgary District Tax Office. If in doubt, seek professional help.
There are many very subtle terms and conditions that must be met by both the employer and the assignee before the assignee is eligible for this credit. These conditions are extensive and in some cases, complex. The OETC is a minefield into which many employers have wandered blindly.
Where the Canadian employer corporation is itself owned by a US or other foreign corporation, the CRA will take an initially skeptical approach to any requests for reductions in assignee tax withholdings where the assignee may be claiming the OETC. This skepticism has arisen because of a number of cases where Canadian corporations have planned for their employees to claim the OETC, but the profits from those foreign ventures were reported and taxed outside Canada. The original intent of the OETC rules was that the loss of tax revenue to Canada through the allowance of OETC claims would be compensated by tax revenue recovered from Canadian companies on the profits of their international ventures. There is a growing trend toward the use of inter-entity or technical service agreements which define the terms and conditions of assignee transfers from one multi-national group company in Canada to a foreign company in the same corporate group. These agreements are often beneficial in minimizing risk and ensuring that OETC claims are defensible.
In order for an assigned employee to be able to claim the OETC, the employer must undertake one or more of several ‘specified activities’. The CRA are currently reviewing the nature of specified activities in an obvious attempt to deny the OETC wherever possible. Based on conversations with CRA officers, some oilfield and gas maintenance activities may not be classified as specified activities. Also, in some cases, the maintenance of previously-installed equipment may not be a specified activity. IAP managers should seek professional advice if they have any concerns about the nature of their company’s activities.
Proposed ‘Secondment’ Rules
On December 20, 2002 the Federal Department of Finance announced new rules that impact multi-nationals who second assignees to foreign-based corporations. Where Canadian resident assignees are ‘seconded’ to a wholly foreign-owned corporation, then the OETC may not be available to those assignees.
Foreign Tax Voodoo
A growing number of foreign countries are introducing laws to apply income and other related taxes to assignees. In 2002, Yemen finally introduced an income tax on the income of assignees that was back-dated to January 1, 2000. This new law resulted in retroactive adjustments to the tax returns of Canadians working there. In July 2004, Saudi Arabia introduced legislation to tax certain categories of assignees to that country. Many Canadian companies commence business in foreign countries with little understanding of the extent of host country taxation and of how foreign tax will impact the assignee’s Canadian tax returns. IAP managers should:
- continually monitor the tax laws of the host country;
- if necessary, appoint a local agent to handle assignee tax reporting;
- set a time schedule for the reporting to the Canadian head office of foreign taxes paid;
- ensure that the evidence of foreign tax paid is clear and unambiguous;
- understand the impact of foreign taxes paid, if any, on the assignee’s Canadian T4 supplementary and include gross-ups for foreign taxes paid by the employer where applicable; and
- ensure that the Canadian tax service provider receives a copy of the foreign tax return/evidence of payment of tax.
Assignee Tax Audits
Many Canadian employers have experienced the disruption to normal business, ill feeling and expense created by an audit of assignee income tax returns. On occasion, negative adjustments are proposed by faceless bureaucrats at the International Tax Services Office in Ottawa. The productivity of assignees can be dramatically impacted as they attempt to resolve issues, often from afar. In some cases, assignees have felt abandoned by their employers. IAP managers must make hard choices about the level of support the employer is willing to provide. Generally, a well-planned defensive strategy including an assignee communications program goes a long way toward diffusing the level of tension and restoring assignee productivity.
Social Security Taxes
In 2000, a small Calgary-based oil company opened an office in a North African country and sent four employees to conduct exploration activities. The company chose to ignore warnings about host country social security taxes and these taxes were not paid. In 2002, the company was visited by a social security tax auditor who then presented an invoice to the company for some $ USD 400,000.00 for overdue tax plus interest and penalties. Local legal counsel was hired at great expense to advise whether the tax was due. An obscure clause in the local hydrocarbon regulations was discovered which exempted the company from the tax, provided the employees had home country coverage. Our firm prepared T4 supplementaries for the period, retroactive CPP contributions were made, coverage in Canada was obtained and provided to the local auditor, and the issue was resolved.
Due to a lack of detailed planning by the company, significant costs were incurred to rectify a situation that should never have arisen. There are substantial tax planning opportunities for Canadian companies who in some cases can avoid high host country social security tax. Any Canadian company sending employees, particularly to the US, should consider this issue carefully.
US Tax Identification Numbers
The US Department of Homeland Security has ordered that procedures be dramatically tightened in any US government department that authenticates the identity of individuals. At CompassTax, we have noticed that the process for obtaining tax identification numbers from the Internal Revenue Service has become more rigorous. Recently, we have noticed changes in procedures and new documentary evidence requirements when applying for Employer Identification Numbers (“EIN’s”) and Individual Taxpayer Identification Number s (“ITIN’s”) for our clients. IAP managers will no doubt receive comments from assignees about these new extensive procedures and complaints in cases where the applications were not completed accurately and delays arose in obtaining identification numbers.
As globalization and new international business opportunities arise for Canadian multi-nationals, IAP managers are being challenged as they balance the often conflicting objectives of containing costs, meeting assignee and international assignment needs and offering quality programs and services with limited resources. In a world of increasingly complex tax laws, Canadian HR professionals will be better equipped to navigate the minefield of assignee taxation by following these recommendations, as they strive to attract, deploy, motivate and retain skilled global workers who can take their company to new heights.
By Peter J. Simpson, CA and Cindy Jay, CA Manager, Expatriate Tax Services Group at CompassTAX ™ in Calgary, Alberta.
CompassTax™ assists Canadian companies and their expatriate employees with taxation issues that arise as a result of global assignments. CompassTax works with Canadian companies to design and implement assignment tax programs, provides pre-departure tax counselling and tax return preparation services for assigned employees.
CompassGuides™ publishes its Compass Navigator™ suite of assignment manuals, administrator guides and checklists that enable Canadian companies and their assigned employees to meet the challenges of global assignments.
CompassGuides also produces its Compass Voyager™ suite of pre-departure planning guides, tax organisers and checklists to help employees plan their departure from Canada.
CompassPoints is not intended as a substitute for competent professional advice. Assignment Tax Program planning must be tailored to the circumstances of the program. CompassPoints is not intended to be a definitive analysis of the law but rather a guide to matters that should be considered.