What is Tax Equalization?

Tax  Equalization is an agreement whereby the Company offers the Expatriates a certain tax protection that is intended to maintain the same tax burden as if they had not moved from their country of origin.

This is a complex matter. One of the most important topics as an Expat is to understand your tax implications. In short, there are two basic tax policies around this topic:
  • Gross Compensation: In this scheme, any compensation paid by the company is defined in gross terms (i.e. before taxes), being the Expat the risk taker of lower or higher taxes to be paid during the assignment.
  • Tax Equalization: in this case, the company offers the expatriate a certain tax protection that is intended to maintain the same tax burden (in relation to their employment with the company) as if they had not moved from their country of origin. The advantage of this alternative is that it allows the company and the Expat to negotiate neglecting the tax differences between countries.
I will use a Spanish Expat as an example to try to explain the difference between these two approaches:
  • Fixed Gross Salary in Spain: 100 pesetas
  • Tax rate in Spain : 50%
  • Net Fixed Salary in Spain: 50 pesetas

Let's start with the gross compensation approach, and imagine that the conditions of expatriates are defined as an additional gross amount equivalent to 100% of their fixed gross salary, i.e. an additional 100 pesetas. Sounds good!. Let's see what the situation would be in two different countries.

First, let us take Sweden, one of the countries with the highest taxes in the world:
  • Fixed Gross Salary Total : 200 pesetas (100 + 100)
  • Tax rate in Sweden : 50 %
  • Fixed Net Salary in Sweden: 100 pesetas = 200 * (1-50 %)
On the other extreme, your find for instance Singapore, where the income tax is zero:
  • Fixed Gross Salary Total : 200 pesetas ( 100 + 100 )
  • Tax rate in Singapore: 0 %
  • Net Fixed Salary in Singapore: 200 pesetas
The difference in net pay received by country varies between 100 and 200 pesetas!. Before judging whether an expatriation package is attractive or not, it is wise to find out what your taxation will be.

Consequently, gross compensation policies have the following effects:
  • If the policy does not take into account the difference in taxes between the countries of destination, lower tax destinations are encouraged while high tax countries are discouraged.
  • Expats need to understand the taxation in the country of destination to estimate, in net terms, the conditions of their transfer
  • Changes in the tax systems are absorbed by the expatriate, and have no effect on the company.
In the case of tax equalization, the employee has a tax protection. In this context:

  • The policy is neutral with respect to the taxation in the different countries
  • Expats feel protected and tend to worry less about their taxes in the country of destination.
  • Changes in the tax laws are absorbed by the company
There are many mid-way alternatives that contain both gross and equalized concepts as only some elements maybe equalized such as bonus, fixed compensation, housing or school, etc.

In short, taxes are a delicate issue in any expatriation. You do not need to become a tax expert , but it is very interesting to look for professional advice in case of doubt on this complex matter.

I have prepared a presentation that tries to explain this  complex concept in simple terms. You can find it in Slideshare