In a Tax Corner article on October 25, it was explained that tax and payroll withholding may be triggered in a country by a non-resident employee performing duties there. Additionally the article indicated that, at the same time, such an employee would also normally be taxed via payroll in the country in which they are resident and employed.
What should you do if you have employees in this position? In this week's essential read, GPA tax expert Lee McIntyre-Hamilton provides some answers drawing on the UK position (though the principles apply across most countries).
Example scenario
By way of example, let’s take a UK resident employee who is employed by a UK Company and who works in Germany a few months each year for the German company’s subsidiary. Let’s assume that the duties don’t qualify for exemption under the UK/German double tax treaty and are therefore subject to income tax in Germany.
In this case, the individual would be subject to PAYE and NIC in the UK (as normal). However, subject to certain tests, the authorities in Germany may also require withholding on the same income. Oh no, double tax!
Yes, unfortunately, the employee would suffer withholding in the UK and Germany on the same income. In practical terms, this situation would require a shadow payroll in Germany to operate withholding in Germany on income paid via the UK payroll.
There may be some respite in respect of NIC/social security since, depending on the circumstances, the employee should be eligible to pay NIC in the UK and may be exempt from social security in Germany. Further details on this can be found here.
Help via the double tax treaty
Fortunately, under the double tax treaty between the UK and Germany, HMRC would allow a credit against the employee’s UK tax liability for the tax paid in Germany on the same income. This would be claimed by the employee filing a UK tax return. Once the credit has been claimed via the UK tax return, a refund of PAYE should be generated.
All good? Not quite.
Problems with double tax…
Whilst having a mechanism for mitigating double tax is very useful, there are still two key potential problems in this case:
i. The credit claimed for the tax paid in Germany can’t exceed the UK tax that is due on the same income. By way of a simple example, if £450 of tax is paid in Germany on £1,000 of doubly taxed income and this same income is subject to tax of £400 in the UK, then only £400 of the £450 paid in Germany can be claimed in the UK. This means that the employee is still out of pocket by £50 in this case. In principle, this issue will arise in all situations where the non-UK tax is higher than the UK tax on the double tax income.
ii. Cash flow may also be an issue. Where withholding is required in Germany (in addition to PAYE in the UK), then the employee would be left with a very small net salary. They would need to wait until the UK tax year end to claim a credit and receive a refund of PAYE in respect of the doubly taxed income. For most employees, this would be a tough ask!
What can employers do?
Most employers recognise that it would be wrong to allow employees to be adversely impacted by non-UK tax that results from working overseas. There are a couple of key things that can be done in this scenario:
* Appendix 5 agreement This is a very useful agreement for payroll. Following agreement with HMRC, this agreement (known as an “Appendix 5 Agreement”) enables the UK employer to offset the non-UK tax withheld via payroll against UK PAYE. This can significantly reduce or completely eradicate any cash flow issues because the non-UK tax is, in effect, offset against PAYE in real-time. The employee would simply receive their normal net pay in the UK and would not see the effect of the non-UK withholding (since the non-UK withholding paid across by the employer will immediately be offset against PAYE). Of course, if the non-UK tax is more than the UK tax on the same income, there may still be some excess tax to pay overall. Detailed HMRC guidance on the relevant conditions and application process can be found at Guidance overview: PAYE guidance on Appendix 5: net of foreign tax relief - GOV.UK (www.gov.uk)
* Employer-paid tax In order to mitigate the effects of any excess tax required overseas (i.e. where the non-UK tax rate is higher than the UK) or where there is no Appendix 5 agreement, employers may wish to settle the non-UK tax on the employee’s behalf. Where a credit is due in the UK and this is claimed via the employee’s tax return, then any subsequent refund of PAYE may then be repaid to the employer. In such cases, it will be important to set up an appropriate contractual loan agreement for the amounts loaned in respect of overseas tax. Where the loan balance is over £10,000, there may be UK tax to pay on the deemed interest rate (applied at the UK official rate of interest). Further details can be found at Expenses and benefits: loans provided to employees - GOV.UK (www.gov.uk). Also, the overseas tax position should also be reviewed in this regard. Where the tax loan is not repaid to the employer this would be deemed additional income in the UK (and would also likely be treated as additional income overseas).
Additional considerations
* Where there is no double tax treaty between the UK and the overseas country, the UK does accept what is known as “unilateral foreign tax credit” claims, subject to certain conditions. Further details in this regard can be found at INTM151060 - International Manual - HMRC internal manual - GOV.UK (www.gov.uk)
* HMRC will not allow any foreign tax credit claims in respect of tax in the overseas territory that was not actually required. This may apply, for example, where non-UK tax withholding is operated when, in fact, an exemption would have been possible under a double tax treaty or where deductions may have reduced the tax liability overseas. Therefore, care should be taken to review the non-UK tax to ensure that there are no available exemptions or deductions.
In conclusion, whilst on the surface, dealing with double tax via payroll can appear straightforward, it can be tricky to manage in practice and particular attention should be paid to the specific rules.
For example, according to HMRC’s latest guidance, an Appendix 5 agreement would not be accepted where the employer is settling the tax on behalf of the employee (i.e. there must be a payroll overseas operating withholding on a contemporaneous basis). However, used properly, these mechanisms can be very useful to employer and their doubly taxed employees alike.
The information in this article is a broad summary for the purpose of furthering understanding, is not advice and should not be relied upon to take any particular course of action.
Author: Lee McIntyre-Hamilton
Lee has over 23 years of experience in international mobility, expatriate tax and employment tax. He works with a diverse range of international organisations, from small owner-managed businesses to large multi-national corporations and non-profit organisations. Lee delivers coordinated, joined-up global mobility tax, international social security and payroll advice across many territories globally. He is a published writer on international tax matters, notably the Tiley & Collinson UK Tax Guide.
Contact Lee: lee@globalpayrollassociation.com
In a Tax Corner article on October 25, it was explained that tax and payroll withholding may be triggered in a country by a non-resident employee performing duties there. Additionally the article indicated that, at the same time, such an employee would also normally be taxed via payroll in the country in which they are resident and employed.
What should you do if you have employees in this position? In this week's essential read, GPA tax expert Lee McIntyre-Hamilton provides some answers drawing on the UK position (though the principles apply across most countries).
Example scenario
By way of example, let’s take a UK resident employee who is employed by a UK Company and who works in Germany a few months each year for the German company’s subsidiary. Let’s assume that the duties don’t qualify for exemption under the UK/German double tax treaty and are therefore subject to income tax in Germany.
In this case, the individual would be subject to PAYE and NIC in the UK (as normal). However, subject to certain tests, the authorities in Germany may also require withholding on the same income. Oh no, double tax!
Yes, unfortunately, the employee would suffer withholding in the UK and Germany on the same income. In practical terms, this situation would require a shadow payroll in Germany to operate withholding in Germany on income paid via the UK payroll.
There may be some respite in respect of NIC/social security since, depending on the circumstances, the employee should be eligible to pay NIC in the UK and may be exempt from social security in Germany. Further details on this can be found here.
Help via the double tax treaty
Fortunately, under the double tax treaty between the UK and Germany, HMRC would allow a credit against the employee’s UK tax liability for the tax paid in Germany on the same income. This would be claimed by the employee filing a UK tax return. Once the credit has been claimed via the UK tax return, a refund of PAYE should be generated.
All good? Not quite.
Problems with double tax…
Whilst having a mechanism for mitigating double tax is very useful, there are still two key potential problems in this case:
i. The credit claimed for the tax paid in Germany can’t exceed the UK tax that is due on the same income. By way of a simple example, if £450 of tax is paid in Germany on £1,000 of doubly taxed income and this same income is subject to tax of £400 in the UK, then only £400 of the £450 paid in Germany can be claimed in the UK. This means that the employee is still out of pocket by £50 in this case. In principle, this issue will arise in all situations where the non-UK tax is higher than the UK tax on the double tax income.
ii. Cash flow may also be an issue. Where withholding is required in Germany (in addition to PAYE in the UK), then the employee would be left with a very small net salary. They would need to wait until the UK tax year end to claim a credit and receive a refund of PAYE in respect of the doubly taxed income. For most employees, this would be a tough ask!
What can employers do?
Most employers recognise that it would be wrong to allow employees to be adversely impacted by non-UK tax that results from working overseas. There are a couple of key things that can be done in this scenario:
* Appendix 5 agreement This is a very useful agreement for payroll. Following agreement with HMRC, this agreement (known as an “Appendix 5 Agreement”) enables the UK employer to offset the non-UK tax withheld via payroll against UK PAYE. This can significantly reduce or completely eradicate any cash flow issues because the non-UK tax is, in effect, offset against PAYE in real-time. The employee would simply receive their normal net pay in the UK and would not see the effect of the non-UK withholding (since the non-UK withholding paid across by the employer will immediately be offset against PAYE). Of course, if the non-UK tax is more than the UK tax on the same income, there may still be some excess tax to pay overall. Detailed HMRC guidance on the relevant conditions and application process can be found at Guidance overview: PAYE guidance on Appendix 5: net of foreign tax relief - GOV.UK (www.gov.uk)
* Employer-paid tax In order to mitigate the effects of any excess tax required overseas (i.e. where the non-UK tax rate is higher than the UK) or where there is no Appendix 5 agreement, employers may wish to settle the non-UK tax on the employee’s behalf. Where a credit is due in the UK and this is claimed via the employee’s tax return, then any subsequent refund of PAYE may then be repaid to the employer. In such cases, it will be important to set up an appropriate contractual loan agreement for the amounts loaned in respect of overseas tax. Where the loan balance is over £10,000, there may be UK tax to pay on the deemed interest rate (applied at the UK official rate of interest). Further details can be found at Expenses and benefits: loans provided to employees - GOV.UK (www.gov.uk). Also, the overseas tax position should also be reviewed in this regard. Where the tax loan is not repaid to the employer this would be deemed additional income in the UK (and would also likely be treated as additional income overseas).
Additional considerations
* Where there is no double tax treaty between the UK and the overseas country, the UK does accept what is known as “unilateral foreign tax credit” claims, subject to certain conditions. Further details in this regard can be found at INTM151060 - International Manual - HMRC internal manual - GOV.UK (www.gov.uk)
* HMRC will not allow any foreign tax credit claims in respect of tax in the overseas territory that was not actually required. This may apply, for example, where non-UK tax withholding is operated when, in fact, an exemption would have been possible under a double tax treaty or where deductions may have reduced the tax liability overseas. Therefore, care should be taken to review the non-UK tax to ensure that there are no available exemptions or deductions.
In conclusion, whilst on the surface, dealing with double tax via payroll can appear straightforward, it can be tricky to manage in practice and particular attention should be paid to the specific rules.
For example, according to HMRC’s latest guidance, an Appendix 5 agreement would not be accepted where the employer is settling the tax on behalf of the employee (i.e. there must be a payroll overseas operating withholding on a contemporaneous basis). However, used properly, these mechanisms can be very useful to employer and their doubly taxed employees alike.
The information in this article is a broad summary for the purpose of furthering understanding, is not advice and should not be relied upon to take any particular course of action.
Author: Lee McIntyre-Hamilton
Lee has over 23 years of experience in international mobility, expatriate tax and employment tax. He works with a diverse range of international organisations, from small owner-managed businesses to large multi-national corporations and non-profit organisations. Lee delivers coordinated, joined-up global mobility tax, international social security and payroll advice across many territories globally. He is a published writer on international tax matters, notably the Tiley & Collinson UK Tax Guide.
Contact Lee: lee@globalpayrollassociation.com