The issues that come with cross-border employment
EY’s Seb Purbrick explains the issues to consider when an employee is seconded to the US, as international assignments can bring unwelcome complexity in terms of tax. Specifically this article focuses on the tax issues when an employee moves to work in the USA.
On the face of it alleviating double taxation would appear to be a straightforward issue. Domestic law and international treaties provide a simple and clear mechanism for relief from double taxation and many a tax adviser has assured a client they will not suffer double taxation because of the existence of a treaty.
However, in the context of international assignments, all is not always as it might seem and real complexity exists not just in the consistency (or lack of it) of approach, but also in the logistics of tax administration needed to execute a timely foreign tax credit (FTC) claim.
In this article I will consider cross-border assignments, focusing on employees going from the UK to work in the US on a short-term basis.
Issues to consider
There are a range of issues that should be considered when seeking to prevent double taxation with a proposed cross-border assignment:
- personal tax residence and the resulting income of tax on earnings and investment income;
- payroll obligations of the employer in the home and host country (potential dual payroll reporting);
- the treatment of expenses and benefits made available to the employee to reimburse the costs of relocating abroad and ongoing incremental costs of living;
- how any deferred remuneration (ie, bonuses or share plans) is treated and the impact of cross-border social security;
- the not insignificant tax administration required; and
- the anticipated length of the assignment.
UK and US residence
The last point – length of the assignment – can create particular challenges when an individual is assigned abroad from the UK for a period that is insufficient to enable them to break UK tax residence.
If we consider the Statutory Residence Test (SRT), under the Full Time Work Abroad (FTWA) condition contained within the automatic overseas test an individual will be able to break UK residence where they show they are working full-time (on average 35 hours per week) in an overseas employment for the duration of the UK tax year.
The individual must not be present in the UK on visits for more 90 days and cannot perform more than 30 UK workdays during the tax year. This is generally thought of as working abroad from 6 April in year one to 5 April in the following year. Though note that, strictly applying the test within Sch 45, Finance Act 2013, it is possible to be working outside the UK for a shorter period as the test allows a break from work (not attributable to annual leave, parental leave or sick leave) of not more than 30 days.
If we take the example of Mr B, he takes an assignment from the UK to the US for period of one year, relocating on 1 July. Under this arrangement the individual is not able to break UK residence under the FTWA test or other parts of the SRT (not leaving the UK to live abroad for a sufficient length of time). Depending on other circumstances Mr B is likely to continue to be subject to UK income and capital gains tax on a worldwide basis (assuming he is UK domiciled), meaning all earnings received in respect of duties carried out in the US remain subject to UK income tax.
However, the earnings will also be subject to US income tax, as the length of the assignment will likely disable the application of paragraph 2, Article 14 of the US-UK Income Tax Treaty (with the individual spending more than 183 days in the US in any 12-month period).
Mr B therefore has dual tax obligations in the US and UK and will need to claim double tax credits, the administration of which can become very complex.
One area of complexity the employer will need to consider is the PAYE implications of this arrangement. Where individuals are seconded from the UK home employer to the US host, and UK residence is not broken, the employer will continue to have a PAYE obligation to withhold income tax on the earnings (by contrast a relocation to an employment in the host country might give a different answer).
There will also be a US payroll and W-2 (the US equivalent of a P60) requirement, meaning payroll reporting is necessary in both jurisdictions. How the employer approaches this can have significant personal implications for the employee. In the absence of what is known as an Appendix 5 agreement, there is a real time double tax issue, as UK PAYE and US withholding are both required. The employee is unlikely to be able, or willing, to fund taxes in both countries.
This can draw the employer into settling the US liability on behalf of the employee and seeking reimbursement from the employee once personal tax returns have been filed in the UK and US. This will create timing issues as to when refunds are received, and gross-ups maybe required. This can also be unsatisfactory where an employee leaves the employment before the FTC is claimed.
An Appendix 5 arrangement is an agreement with HMRC that the employer can relax PAYE income tax withholding on the basis that foreign taxes are due in a foreign jurisdiction; this allows the PAYE amount to be reduced with reference to the expected FTC. There is clearly an advantage of claiming the credit through payroll.
Typically the final FTC will then be calculated by filing the UK and US personal tax returns with adjustments to the final claim as required. The employer will be able to replace the amount of PAYE relaxed with a deduction equivalent to the FTC, which would be equal to the amount of US tax being withheld by the employer through the US payroll.
Expenses and benefits
The story does not end there, however. The US and the UK have different rules with regard to expenses and benefits. For example, the UK currently treats a secondment of up to two years as an extended business trip, allowing relief for travel and subsistence, housing, etc.
The US away from home rules only allow relief for up to one year. The US has no concept of a P11D and primarily takes a market value approach to determining the taxable benefit value. These differences, and there are many more, create reporting and accounting issues for even the most diligent employer.
Deferred remuneration is another area of significant and increasing complexity: the approach to sourcing and grant to vest periods for bonus, share or incentive payments can be challenging.
The US tends to apply a grant to vest/payment period to determine taxable income with reference to where the duties are performed, and although the UK approach can be aligned with this, HMRC audits in this area can easily become entrenched in discussions as to the reasoning and purpose of the award plan when determining which period deferred earnings are for. Adding to the complexity, the US-UK double tax treaty also allows a sourcing based on grant to exercise for stock options.
Any mismatch in treatment for any of the above-mentioned earnings will have double tax issues to resolve and a possibly temporary financial burden upon the employer and/or the employee.
To briefly touch on the impact of non-earned income, if Mr B is considered US resident under the Substantial Presence Tax (which is very possible in year one, with a 1 July departure date), any income/gains received from investments will be taxed in the UK and US with reference to domestic tax law.
The relevant articles of the US–UK Income Tax Treaty would need to be applied to alleviate double taxation with the first consideration being in which country the individual should be treated as resident for treaty purposes under Article 4. Complications arise when the treaty is not applied uniformly by the US and UK authorities. The treaty also does not override the significant reporting of foreign financial assets under the US FATCA provisions.
Employers and employees therefore need to be well appraised of the different tax issues arising out of short-term assignments. Compliance and administration are likely to weigh heavy for both parties.
About the author
Seb Purbrick is a senior manager in the People Advisory Services group at EY