International Payroll And Double Taxation: How To Navigate

In today’s interconnected world, many individuals and employers operate across international borders and this can lead to complex tax implications, especially in relation to payroll.  One significant challenge which consistently arises is the issue of double taxation as well as the financial and compliance burdens this can bring.  This blog introduces some key aspects and options to mitigate the impact.

What is the meaning of ‘Double Taxation’?

Double taxation typically refers to a situation where an individual’s earnings are taxed by more than one jurisdiction.  This regularly occurs in international scenarios where an individual works and earns income in one country but is resident and subject to taxation on that same income in another country (their ‘home’ country).  It can lead to complex tax issues and potentially higher tax liabilities for an individual.

Whilst all countries have their own domestic rules setting out when taxes apply and any potential exemptions, in the vast majority of cases, there will be a compliance requirement when operating internationally.  As such, most UK-resident employers who assign employees to work overseas will have a foreign wage tax-withholding obligation and the need to run an international payroll alongside their UK payroll.

Double Taxation Agreements

Many countries have agreements with each other, often known as tax treaties or bilateral tax agreements, which contain various rules and criteria that set out which jurisdiction has the primary right to tax certain categories of income.  Such agreements help prevent double taxation through provisions which typically allow for a reduction or elimination of tax.

A major advantage of double taxation agreements is that they help promote international trade and activity by providing certainty and clarity concerning the tax obligations for individuals operating across international borders.

Navigating double tax treaties can be challenging and a thorough understanding of the provisions and how they apply to specific situations is required.  It would therefore be recommended that when international opportunities arise, taxpayers should seek advice from tax professionals familiar with international tax regulations to ensure operations are structured in a tax-efficient manner.

Foreign Tax Credits

When individuals earn income in a foreign country, they are typically subject to taxation in that country.  To avoid double taxation, the taxpayer can claim a foreign tax credit in their home country for taxes paid to the foreign country.  This credit works by offsetting or reducing the domestic tax liability.

There are often limits on the amount of credit which can be claimed (typically you can claim the lower of the amount of foreign tax paid, or allowed by a Double Taxation Agreement, or the amount of UK tax chargeable on the income), and rules governing the use of foreign tax credits as well as requirements for documenting foreign taxes paid (such as the need to obtain tax receipts or statements)

WHAT OPTIONS ARE AVAILABLE TO CLAIM FOREIGN TAX CREDIT RELIEF?

When a double tax situation arises, employers and employees are keen to understand potential options available to minimise the impact.  The following are a couple of commonly used options:

NET OF FOREIGN TAX CREDIT (‘NOTC’)

To avoid having to deduct both UK PAYE and foreign wage tax from employee salaries, many employers seek permission from HMRC to operate an ‘Appendix 5’ Net of Tax Credit scheme.

A NOTC arrangement requires the employer to seek prior approval from HMRC before being operated, as well as compatible UK payroll software.  No approval is required from the employee to operate the scheme in the payroll.  This arrangement applies to employers who are required to deduct foreign tax, in addition to UK PAYE, from the salaries of employees who are sent to work abroad, and it aims to give provisional relief for double taxation on the same payment of earnings at source.

The NOTC arrangement is not statutory, instead being an administrative concession to save employers, employees and HMRC time and costs by dealing with the issue of double taxation through payroll.  It is important to note that whilst the employer operates the scheme through payroll, the claim for double taxation relief is still a personal matter for each employee.

Appendix 5

When operating Appendix 5, it is a matter of deducting the value of foreign tax that the employee is liable to pay from their UK PAYE liability, although calculations are required to ensure that excess amounts are not deducted / too much credit claimed under the scheme.  All other UK PAYE and National Insurance requirements must still be carried out by the employer as normal.

At the end of the UK tax year, or earlier if an employee is a leaver, an annual statement detailing foreign earnings, foreign tax and the foreign tax offset through the UK payroll is required to be issued to each employee to accompany their P60 / P45.  An equivalent statement must also be submitted to HMRC to ensure all records are kept up to date.

The NOTC scheme is a highly effective and useful tool.  Whilst there is ongoing administration required to ensure the scheme works smoothly, there are several advantages of operating such an arrangement:

• Double tax relief is claimed in real time, with immediate impact and improved cash flow
• No impact on employee net pay (if full credit is available)
• HMRC approved scheme
• Both UK and foreign tax burdens are met by the employee without risk of any taxable benefits (assuming full credit is available)
• There is no requirement under the Appendix 5 arrangement for UK tax returns to be submitted by employees, thereby keeping taxpayers out of self-assessment (albeit a tax return could still be required due to other personal circumstances)

Income tax returns

An alternative approach is to claim foreign tax credit relief entirely through a UK tax return.  Considerations under such an approach include:

• Cash flow impact during the year as tax is due overseas as well as UK PAYE at the same time
• Tax returns can only be completed following the end of the UK tax year, resulting in delays to receive the relief
• Co-operation required by the employee to complete a tax return and risk of employees having left the Company before the tax return is completed (i.e. Company has less control over the position)
• Decision to be made as to whether a) the Company settles the foreign tax during the year and only looks to recover it from the employee following completion of the tax return or b) if the employee is to suffer both taxes and receive a reduced net pay. If the Company settles the foreign tax without recovery from the employee, this gives rise to a benefit which will attract additional tax and National Insurance liabilities

In conclusion, international payroll and double taxation can pose significant challenges for individuals and employers operating globally however with careful planning, the use of tax treaties / foreign tax credits and seeking expert guidance, it is possible to navigate such challenges efficiently whilst optimising the tax position.  Implementing appropriate strategies and policies within your organisation can help mitigate the impact of double taxation and allow you to focus on global operations with confidence.

If you require any support in relation to the areas outlined above, including applying for and managing a Net of Tax Credit scheme, please do not hesitate to contact Craig Burnett, or your usual AAB contact.