Consider the Virtues of Home-Based versus Host-Based Assignment Approaches

by Lauri Morrison, KPMG LLP, Short Hills and Achim Mossmann, KPMG LLP, New York City (KPMG LLP in the United States is a KPMG International member firm)

When determining the structure of an international assignment, organizations headquartered in continental Europe frequently use a host-based assignment philosophy while U.S.-based organizations generally follow a home-based assignment philosophy. In an ever-changing global landscape where corporate mergers, acquisitions, or reorganizations happen on almost a daily basis, many U.S.-based companies now find themselves subsidiary to a European-based parent. As organizations headquartered in Europe move to standardize policies and procedures, they challenge their U.S. subsidiaries to implement a host-based approach for their U.S.-outbound assignments.

This article aims to explore the basis for the differences between the home- and host-based assignment principles and to determine whether there are likely to be any barriers or challenges to U.S.-based organizations adopting the host-based assignment principles of their European-headquartered organizations.

Host-Based Assignment Philosophy

The host-based assignment model is typically used for international assignments that benefit the host organization. In general, this means that assignees, while on assignment, are treated similarly to employees of the host organization. However, in recognition of the temporary nature of the assignment, assignees will generally continue participation in home country company retirement plans and statutory social security plans and will not participate in the corresponding host country plans.

The home country employment relationship (or employment contract) is changed from "active" to "dormant," and an active employment relationship with the host company is established. The concept of a dormant employment relationship generally allows for continued participation in the home organizations retirement plans and in the home country social security system. The assignment compensation is often determined by using a "net-to-net" calculation. This calculation generally takes into consideration home and host country taxes, cost-of-living (including exchange rates), housing costs, and a savings rate. Typically, assignees are paid via host company payroll and the assignees are responsible for the tax liability on all compensation elements. Taxes on assignment allowances are generally borne by the host company, as is the overall cost for the assignment.

This approach is very common for European-headquartered companies¹ (see graph below) and is often adopted because it is easy to administer, does not require a charge-back process, and reduces the risk of any permanent establishment (PE) exposure. In addition, the host-based assignment approach may foster the integration of the assignees into the host country system as they are treated like host company employees. This approach is also easy to administer because, among other reasons, most countries do not require their citizens/permanent residents to file home country tax returns if they break residency in their country of citizenship and/or residency.

Source: KPMG IES 2007 Global Assignment Polices and Practices Survey

Home-Based Assignment Philosophy

As stated above, U.S.-based organizations generally apply home-based assignment principles for their international assignments. The U.S. employment relationship with the home company remains in place, but without any active duties applied to the assignee. The assignment compensation is typically determined by using the balance sheet approach by which the U.S. base and incentive compensation continue to be paid on the U.S. payroll and the assignee typically receives cost of living and housing allowance via the host country payroll.

The assignee, while on assignment is generally tax equalized. Under the tax equalization concept, the assignee pays no more and no less tax than he or she would have paid if he or she had remained in the United States. The U.S. company pays all additional home and host country taxes. All assignment-related costs are charged to the receiving unit.

In summary, this approach is typically used by U.S.-based companies² (see graph below), and is partially influenced by the U.S. personal tax regime whereby all citizens/permanent residents continue to have U.S. tax filing obligations and liability to pay U.S. taxes even when they reside outside the United States for extended periods.

Source: KPMG IES 2007 Global Assignment Polices and Practices Survey

Discussion of Issues

Employment Relationship, Letter of Understanding, and Secondment Agreement³

It is common practice to send a U.S.-based employee to work for an overseas affiliate and have him or her remain an employee of the U.S. entity. Typically, this arrangement is supported by a "secondment agreement" and a "letter of understanding." The secondment agreement is an agreement between the home and the host country entities that details the terms and conditions of the temporary transfer of an employee to the host country entity. Secondment is the temporary "loaning" of an employee to another entity for a fixed, specified period of time (e.g., three years). During the assignment period, the employee provides services to the host company; however, ultimate dominion and control of the employee (e.g., the right to terminate employment or award pay increases) are retained by the home country entity.

The letter of understanding expressly details the components of the employee's compensation package (including base salary, bonuses, differentials, allowances, and reimbursements), assignment dates, the assignee's continuing affiliation with the home location including retention of home country benefits, performance evaluation, and payroll structure, and which entity retains dominion and control over the employee being seconded.

Participation in Home Country Company and Statutory Benefit Plans

Employees from the United States on an international assignment can only participate in their home-company retirement plans and in the U.S. social security system if they are employed by a U.S. employer. The home-based approach allows an assignee to continue participation in U.S. company retirement benefits as well as the U.S. social security system. Since a U.S.-employment relationship is typically not based on an employment contract, but rather on the concept of "employment at will," a "dormant" employment relationship is not recognized and cannot be used to continue participation in U.S. retirement and social security plans.

Employees assigned abroad are generally in favor of secondment arrangements since these allow individuals to remain in their home country social security systems and continue participation in home country benefit and retirement plans.

U.S. Payroll Reporting and Withholding Requirements

U.S. payroll reporting and withholding is required for a U.S. citizen or permanent resident with a U.S. employment relationship, and in many other cases as well. A U.S. payroll is necessary to fulfill the U.S. reporting and withholding requirements. In addition, and important to note, a U.S. payroll is required in order to contribute to the U.S. social security system — unlike many other countries, the U.S. social security system does not allow for voluntary contributions. Further, most U.S.-based retirement plans rely on a U.S. payroll engine to drive benefit calculations.

In many cases, an employee remains on the home country payroll, with some or all compensation costs (e.g. , base pay, foreign allowances, benefits, tax payment advances) being charged to the host country entity. However, host country tax laws may require taxation and employer reporting of any compensation payments.

Conclusion

The rising trend in cross-border commercial activity, and in particular, mergers and acquisitions involving European companies purchasing or merging with U.S. companies and vice versa, has repercussions for international assignment programs in both companies that are party to the transaction. At the very heart of the matter, from an international assignment perspective, are the principles and philosophies that underpin the international assignment program. The move from a host-based to a home-based approach — or from home-based to host-based — can be a huge undertaking. But in the interest of streamlining two (or more) programs and consistent treatment of assignees across the board, one philosophy — or approach — generally should prevail and apply.

It is our experience that the home-based assignment philosophy most typically applies in cases where U.S. employees are sent on an international assignment. There are four main reasons for this:

• It allows for continued participation in company-provided retirement plans
• It allows for continued participation in the U.S. social security system
• It allows for ongoing payroll reporting and withholding requirements to be met for U.S. citizen/permanent resident assignees of a U.S. employer
• It supports the unique concept of world-wide taxation of U.S. citizens and permanent residents.

This is not to say that U.S. organizations cannot move from a home- to a host-based assignment philosophy. However, care must be exercised that the above issues are addressed so as to help foster tax compliance (at both the employer and employee levels) and maintain the competitiveness of the policy according to company needs.

Footnotes:

1 KPMG's Global Assignment Policies and Practices Survey showed in January 2007 that 22 percent of European-headquartered organizations provide compensation based on a host-country approach compared to only 4 percent of U.S.-headquartered organizations. KPMG LLP's IES practice hosts and publishes the Global Assignment Policies and Practices (GAPP) Survey. (This Web-based survey, the first of its kind in the field of international assignment management, is based on data provided by more than 300 companies. The survey continues to serve as a valuable barometer for the world's leading multinational companies and allows participants to benchmark their program and policies. For your copy of the survey, please contact your local IES professional. Also, please feel free to register and then participate in the survey at http://www.kpmglink.com. After completing at least 70 percent of the questions, you can receive instant results. You can log on and view the data whenever you want, as the survey is live and continuous.)

2 KPMG's Global Assignment Policies and Practices survey showed in January 2007 that 71 percent of U.S.-headquartered organizations provide compensation based on a home-country approach. The corresponding figure is 42 percent for European-headquartered organizations.

3 For an in-depth discussion of this topic, see R.S. Jones and J. Seymour, "Letters of Assignment and Inter-Entity Agreements: An Important Relationship," in KPMG LLP's The Expatriate Administrator 2003-03, Autumn 2003, http://www.us.kpmg.com/microsite/tax/ies/tea/fall2003/index.html.

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