United States: Multinational reorganizations can bring about a host of employee mobility issues - consider employment frameworks early

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1 from Global Mobility United States: Multinational reorganizations can bring about a host of employee mobility issues - consider employment frameworks early October 16, 2014 In brief Many cross-border, corporate re-organizations and US mergers with foreign entities have caught the attention of the media and governments. These transactions are often driven by shareholder and management s desire to streamline business operations, reduce costs, and combine operations with other businesses. In order to execute a new business strategy, senior executives or other employees typically need to cross borders and change their physical work location. The result is a host of mobility tax and other issues that need to be analyzed early in the planning stages so as to avoid later disruptions and unexpected costs. The shifting of executives and employees across borders could involve a formal relocation of the person s home, but it could also be accomplished through more frequent business travel. Regardless of the practicalities, this geographic shifting of talent can generate US and foreign tax and reporting obligations. And a key step is to determine the employment arrangement for individuals involved to manage tax compliance obligations. These obligations include, for example, the withholding of individual payroll taxes, remitting corporate-level income tax that may result from the assignee s activity, or other enterprise-level taxes. Adopting an integrated approach to employment structures as part of the reorganization or merger planning could potentially yield cost reductions and greater efficiency for the combined enterprise. A host of other considerations should also be thought about by Tax, HR, Legal, and other departments well before executives or employees are crossing borders so as to evaluate the impact on costs and budgets and identify preparatory actions. As an example, if the relocating employees are compensated with equity in their employer, should these awards be modified in any way or adjusted to preserve intrinsic value prior to the reorganization? Should mobility policies be altered to accommodate these unique cross-border employees? How will the inter-company charging of employee-related costs need to change?

2 In detail What employment framework should be used to support the relocations? Ensuring tax compliance is a core driver When senior executives and employees cross borders to work, establishing the appropriate employment structure is critically important to ensure that tax and other compliance obligations are met. Many types of foreign taxation can be triggered including foreign corporate income tax, value-added taxes, and individual taxes levied on both the employer and the employee. The employment structure or framework should delineate which entities are benefiting from the employee s services and which entity will be obligated to withhold and deposit the applicable foreign taxes triggered by the employee s presence in that country. For example, if the cross-border employee s shift in work location triggers a foreign individual income and/or social security tax, the employer may likely have an obligation to withhold such tax under foreign law. Which entity is the employer for this purpose and does the organization want that entity to be registered in that country due to any collateral tax consequences (i.e., additional entity tax filings)? If the entity is not properly registered, what does the registration process entail and how long does it take? Corporate income tax liabilities in the host country must also be considered. The activities of the employee (e.g., having and using authority to sign contracts on behalf of a company) or simply their physical presence in the country for a specific length of time may trigger a risk that the employing entity has a permanent establishment (PE) there. The existence of a PE gives a country a right to tax the profits of that enterprise, creating not only corporate-level tax liabilities including income and value-added type tax, but also the additional burden of filing tax returns. If PE risk is not correctly managed, it can result in not only unexpected tax liabilities and penalties but also possible reputational damage for the entity and increased scrutiny by local tax authorities. Non-tax factors must also be balanced Non-tax factors can also weigh heavily when determining the proper employment structure. This includes how various benefits will be provided to the employee, such as wealth accumulation vehicles. For example, will US employees relocated abroad be able to enjoy the benefits of participating in a US tax qualified plan such as a 401(k) plan that allows employees to make pre-tax contributions? This benefit may not be an available feature in a foreign retirement plan. Whether the assignee can continue to participate in such plan will depend upon not only the employment structure of the assignment, but also the terms of the specific plan. Other issues like immigration rules, foreign labor laws, and industry specific issues should also be considered before the business decides what employment structure is appropriate and efficient for an assignee. The four general types of employment structures Typically, multinational corporations use one of the following frameworks (or a combination thereof) when assignees are asked to work abroad: Secondment In this framework, the employee is seconded or loaned to a host country employer (the economic employer) to work for the benefit of such employer. Companies often take the position that secondees remain common law employees and stay on the home country employer s payroll for compensation and other benefit purposes. The home country employer charges these expenses back to the host country employer to the extent they relate to the services performed. When the assignee is finished working in the host country, he/she returns back to the home country. In this situation, the risk that the home country entity attracts a PE in the host country jurisdiction may be reduced, depending upon the jurisdiction. This assumes that the secondment involves proper and consistent documentation, including the intercompany services agreement relating to the assignee s supply of services, and the employee is working for the benefit of the host employer. Local hire or transfer Under this structure, the employee terminates employment with the home country employer and is hired on a local contract by the host country employer. The employee is no longer on the home country employer payroll and all related home country employer benefits are terminated. The employee is paid locally as a domestic individual from the host country, and is enrolled in the host country pension scheme, social security and other benefits. 2 pwc

3 In this situation, the distinction between economic and commonlaw employer is not necessary. This employment framework arguably provides the greatest protection for the home country entity attracting a PE with respect to such assignee. Dual employment In a dual employment situation, the employee is simultaneously employed by both the host and home country employers under different contracts and with different terms and conditions. The employee reports to both entities and has separate responsibilities regarding both entities. Each employer pays separate compensation and other benefits to the employee. This structure is typically used for more senior-level employees. Many foreign jurisdictions are skeptical about how companies use this framework and inquire about the surrounding details. Global employment company (GEC) A GEC is typically a wholly owned subsidiary resident in a country that has a robust income tax treaty network. Employees relocating abroad are terminated by the home country employer and are hired by the GEC. Companies typically take the position that the GEC becomes the common-law employer and pays the compensation and benefits of the employee. The GEC generally recharges all compensation and benefits expenses related to the employee to the host country (economic) employer, which could be a foreign branch of the GEC or potentially another wholly owned entity that is a taxpayer in the host jurisdiction. GECs can also facilitate globally aligned systems relating to performance evaluations, pay, and benefits. GECs can protect the original home country employer from attracting a PE, but only if the relationship is substantive and the GEC is implemented and managed properly. A centralized management function, among other factors, is very important to demonstrate that the GEC employment arrangement has substance so that tax authorities will not simply look through the GEC as an employer. Other factors include where decisionmaking occurs, where board meetings occur, and whether control of the GEC occurs in the same jurisdiction as the GEC s resident jurisdiction. Weighing the various priorities Choosing the most efficient employment structure for assignees working abroad mandates a weighing of factors that are most important. The overriding business objectives usually drive the decision e.g., concerns over PE risk; the desires of senior executives regarding their benefit choices; or simply the quickest way to get the employees where they need to go. In fact, the ability to rapidly deploy assignees abroad has quickly become a business necessity, particularly where a reorganization or merger creates a critical need for executives and other employees to immediately collaborate and become integrated. Regardless of what structure is chosen or the reasons for the decision, proper documentation and substance is essential in order to sustain the expected results. Beware of undetected employees crossing borders Instead of permanently relocating abroad, employees and executives may prefer to reside in their home country and travel to other jurisdictions to conduct business. These travelers may unknowingly cause adverse tax consequences for themselves and the enterprise. This is especially true for non-treaty partner countries or where a branch structure exists and where there is no favorable time threshold for incurring tax both at the corporate and individual levels. Newly reorganized companies must be particularly wary of frequent business travelers as executives are eager to manage the new enterprise and may not be aware that their travels potentially present tax problems for themselves and the enterprise. The company may consider establishing a monitoring program by leveraging technology so as to document and understand travel patterns and exposures. Some companies may wish to pre-clear all business trips where the risks are high to certain countries to minimize exposure. Employment frameworks may also be needed for these types of employees crossing borders depending upon the foreign tax and immigration requirements that arise. Companies may also consider the possibility of cooperative compliance agreements with certain foreign tax authorities with respect to frequent business travelers. These arrangements can eliminate individual tax filings relating to frequent business travelers as long as employers pay the proper amount of tax owed through the employer s payroll withholding system. While there are risks, significant cost savings and greater certainty with respect to tax compliance are two of the many benefits that can be achieved. 3 pwc

4 Will employee equity-based compensation arrangements be affected? Challenging issues can arise when mobile employees are compensated with both equity and cash, typically pursuant to several executive compensation plans within the organization. For executives or employees receiving an equity compensation award while also crossing borders, the question arises how such grants will be taxed in the host jurisdiction. Other jurisdictions may not respect the tax treatment under US law and instead tax them differently and at a different point in time. Obligations to remit foreign tax on equity grants may be levied on both the company and the executive/employee. And companies may have withholding obligations in various jurisdictions with respect to the same equity grant, in some cases even after the employee has returned to the home country. In a reorganization or merger situation, an important question is how the transaction affects the value of equity compensation awards already granted to executives or employees. Once the reorganization or merger occurs, there may be a need to resize and adjust outstanding equity awards to preserve intrinsic value that was present before the reorganization or merger depending upon the particular transaction. Postreorganization adjustments and changes to plans here and abroad further complicate the tax analysis of these grants. For example, in some cases a corporate transaction may result in the acceleration of vesting of outstanding stock awards or the grant of new stock awards with intrinsic value. To avoid individual taxation, a local tax ruling may be required that explains the economics of the transaction. Absent a ruling, employees may be forced to pay tax prior to a liquidity event. Also, in some countries (such as France or the UK) which allow for favorable taxation of gains on stock awards, any adjustment or modification may eliminate such preferential tax treatment. Due diligence should be completed for each country to avoid surprises and preserve award value. How should costs be allocated? Various costs are associated with executives and employees crossing borders to work. Cash and equity compensation can be a significant part. And other employer-provided benefits and the associated gross-up of benefits (aimed at making the individual whole from a cost perspective) can also be large amounts, potentially more than double the employee s regular salary. Retirement, healthcare, and other benefit costs are also in the mix. All of these costs must be properly accounted for on the organizations books and records. Re-charging of costs and determining which entity within the group of companies ultimately bears these costs may not be significant from a financial statement perspective, but this issue can be very important when analyzing what and how much tax must be remitted. For example, if these costs are born by an entity with a PE in a particular jurisdiction, this fact could cause the individual to become subject to the country s personal income tax depending on the facts. Moreover, if and how costs are recharged may affect their tax deductibility. Companies will need to review their inter-company agreements with an eye toward maximizing their cash tax benefits. This will likely involve an in-depth review of cost sharing agreements for employee compensation and benefits. Will individual tax reporting for employees need to change? Depending upon the specific merger or reorganization, assignees may need to perform additional information reporting to the tax authorities. An example is where US citizens are compensated with foreign parent company stock rather than stock in a US company. These employees, both domestic and internationally mobile, will likely have new reporting requirements on IRS Form 8938, Statement of Specified Foreign Financial Assets. Individuals must report specified foreign financial assets (SFFAs) if the person meets certain requirements and their interests in SFFAs exceed certain thresholds. SFFAs include stock in a foreign entity (among other foreign assets) or options to acquire stock in a foreign entity and thus such grants would likely be reportable. Additional reporting requirements may also arise as a result of individuals participating in foreign pension and deferred compensation as well as potential FBAR (Report of Foreign Bank and Financial Accounts on Form FinCEN 114) reporting where the individual has signature authority over company bank accounts located overseas. Foreign executives or employees that are temporarily working in the United States could also trigger these IRS reporting requirements. Those individuals treated as US residents under either the green card test or the substantial presence tests would need to report if the thresholds are met. This is the case even if they file Form 1040NR by electing to be taxed as a resident of a foreign country under an income tax treaty s residence tiebreaker provision. Failure to comply with these reporting obligations could subject the executive to a $10,000 penalty. And a failure to comply that lasts more than 90 days after the date of an IRS notice of such failure will be 4 pwc

5 subject to an additional penalty not to exceed $50,000. What is the impact on global mobility policies? Mobility policies that govern the global movement of employees will likely need to be revisited if a reorganization or merger takes place. Decisions will need to be made as to how to integrate policies and programs to achieve consistency if desired. Organizations will likely want harmonized policies that do not result in disparate treatment of employees. For example, do both the target and acquiring companies provide tax equalization and income tax return preparation benefits as well as other overseas assignment related benefits to their assignees? Do both companies provide assignee choice provisions in their policies enabling greater flexibility for assignees? Even before the reorganization or merger takes place, companies should consider the impact of the policies at that time on costs associated with the transaction. If senior executives are expected to cross border to implement the transaction, what are the tax impacts and how will they be treated under existing policies? Do any extraordinary costs or issues arise such that policies should be adjusted prior to the executive s departure? For example, if foreign executives will be temporarily working in the United States, will the company be responsible for the cost of the US 3.8 % net investment income tax on personal investment income? What new tax obligations may arise with respect to Board members? Cross-border reorganizations and mergers can alter which directors serve on the Board of Directors of a specific company. US citizens can become directors on the Board of a foreign-based company and vice versa. Not only may this result in cross-border travel and the need for potential relocation, but companies making payments to such Board members must consider whether they need to withhold taxes on payments to them for services. Moreover, such directors may be compensated with cash or equity-type compensation, causing even more complexity when determining what US federal, state, local, or foreign tax withholding may be appropriate and when it must be remitted. The takeaway A business engaging in a cross-border reorganization or merger must align employees with its new strategy and the geographic dynamics of its new organizational structure. The resulting shifts in executive and employee work locations can occur at all stages of the transaction, whether such shifts are in the form of formal relocations or increased cross-border business travel. Executives and employees may need to cross borders even while negotiations are occurring and before legal transactions take place as well as after the transaction is effectuated. Shifting talent can also be an integral part of the posttransaction integration and transition period, and such work location changes often become a permanent part of the workforce make-up. The plethora of tax and other issues noted above requires additional analysis and decision-making. Significant benefits can come from early planning. Early means as part of the planning stage for the reorganization/merger, not a week or so before the individual is expected to leave. Affected departments should be part of the process, including not only HR but the Tax and Legal departments as well. Failure to think about these issues upfront can result in a potential delay of getting people to their needed work location in a compliant manner, unexpected tax costs and penalties, and burdens on the executive and employees who should instead by focused on the job at hand. This upfront planning could also result in an opportunity to achieve additional cost and resource savings. Reorganizations can be an excellent time to review existing processes, particularly as they compare to the target enterprise. One example: Are the employment structures used by both organizations efficient and costeffective? If the reorganization or merger involves the combination of businesses, perhaps a GEC could serve to integrate the businesses with a common procedure and structure for cross-border assignments, streamlining administration and compliance obligations while also achieving PE protection for the employing company in certain circumstances. Centralizing resources in this way could yield cost reductions, efficiency, and other intangible benefits. 5 pwc

6 Let s talk For more information, please contact your regular International Assignment Services (IAS) engagement team or the following professionals: International Assignment Services Peter Clarke Global Mobility Services Global Leader peter.clarke@us.pwc.com Clarissa Cole clarissa.cole@us.pwc.com Al Giardina alfred.giardina@us.pwc.com Derek Nash derek.m.nash@us.pwc.com SOLICITATION This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwC does do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see for further details. 6 pwc