The shadow payroll : the key elements to remember
The expression “shadow payroll” is generally used when a company sends employees on an assignment abroad for a significant period of time. For example, the posting of employees to France is a common practice, the formalities of which are summarized in this article, as well as here. Therefore, it is necessary to understand the importance of shadow payroll so as to limit tax and social risks. This article aims to demystify the concept of shadow payroll, and to provide an understanding of what this concept involves for companies.
What is shadow payroll ?
The shadow payroll is a process helping expatriates to declare their taxes and social contributions in the host country. This is a method of complying with international tax regulations. In other words, citizens working abroad must abide by the fiscal and social provisions of both the host country and the home country.
Throughout the assignment, the expatriate remains registered in the workforce and payroll of his home country. Thus, it is the home country that will establish the payslips and wire the salaries to the expatriates. The latter will therefore not receive any salary from the host country. The latter will simply take notice of what is declared in the home country to “duplicate” the payroll and determine the contributions applicable in the host country. Note, however, that the shadow payroll may also apply to the home country. In this last case, the employer pays the employee using the payroll established in the host country.
As a result, shadow payroll is a complex process requiring in-depth expertise.
When should we use shadow payroll ?
The company must first consider the following questions :
- Does the company have employees assigned to missions abroad ?
- Are the assignments short or long ?
Here are some examples to better understand when shadow payroll is required :
- Business trips and short-term assignments (less than 6 months). In most cases, a tax treaty will apply for trips of less than 6 months. In this case, the employee remains on the payroll system of the home country. There is no payroll requirement in the host country, and the employee remains affiliated with his home social security system. Thus, the shadow payroll is not necessary.
- Long-term assignments (more than 183 days abroad). The tax treaty will not apply because the duration of the assignment is greater than 6 months. The host country usually requires the employee to be registered with local social authorities. Part or all of the employee’s income may be subject to tax in the host country. The employee generally remains affiliated with the home payroll and social security system. As a result, the shadow payroll is necessary.
In summary, the shadow payroll is generally applicable if the transferred employee works in a foreign country for more than 183 days, or according to the employee’s visa or work permit. These general provisions may however vary according to bilateral tax treaties.
How to set up the shadow payroll ?
Setting up shadow payroll requires in-depth knowledge of tax obligations in various countries. It is also crucial to draft the payslips on a timely basis. Here are some best practices for shadow payroll :
- Collection of all payroll parameters in the home country such as base salary, bonuses, pension contributions and other benefits.
- Conversion of these elements into a “fictitious payroll” applicable to the host country.
- Calculation of gross and net salary, taking into account the tax obligations of the host country.
- “Neutralization” of amounts calculated according to the regulations of the home country and the host country. This will prevent double payments of salaries and contributions in the 2 countries.
After setting up the shadow payroll, the payroll department must regularly ensure that the payroll parameters are up to date. It is therefore important to verify at least once a year the current fiscal and social provisions in the host country and in the home country.
What are the challenges for multinational companies ?
Shadow payroll calculations are complex due to the availability and accuracy of data, and the different laws between countries. The biggest challenges with shadow payroll are :
- To determine what needs to be calculated, reported and paid
- To determine how and when to perform these calculations, declarations and payments
Another problem is that many HR systems are not designed to track in real time changes in employees’ assignments. This can lead to incorrect tax and social contributions calculations.
In general, during the assignment, the expatriate receives his salary from his home country, although the costs may be re-invoiced to the host country. In addition, the host entity may finance other expenses, such as taxes, housing, and tuition fees for dependents.
Above all, the most important thing about shadow payroll is getting it right the first time. Here are some guidelines to help you to fulfill this task :
- Establish effective communication between the home entity and the host entity
- Check the integrity and completeness of payroll data
- Update payroll parameters monthly
- Regularly perform payroll accruals and consistency checks
- Examine the fiscal and HR provisions annually
- Automate payroll wherever possible, to reduce the risk of errors and to save time and money
Shadow payroll is a common practice for established multinationals. But this process is more complex for companies starting to expand overseas. Compliance with reporting requirements can quickly turn into a headache for payroll managers. The shadow payroll is often seen as an administrative procedure unrelated to a company’s international mobility program. However, it is not the case. Therefore, it is necessary to have a sound understanding of the shadow payroll. This will avoid increasing tax and social risks both in the home country and in the host country.