To Deduct or Not To Deduct the Negative Cost of Living Adjustment? That Is the Question

by Laurie Jones, KPMG LLP, Dallas
(KPMG LLP in the United States is a KPMG International member firm)

Many international assignment program managers are used to explaining and often defending the cost of living adjustment (COLA). They can spend a significant amount of time justifying how this complex calculation can protect an assignee's purchasing power and why it should fluctuate (up or down) in response to goods and services prices, exchange rates, and inflation. Despite the explanations and rationale, many assignees still think of the COLA as an "uplift" or incentive, making it a challenge to convince them that it should ever go down.

But, what happens when there isn't any COLA to begin with — when it is actually less expensive to purchase goods and services in the host country versus at home?

Clearly, when the COLA is positive, a payment is made to the assignee. But, on the flip side, when the COLA is negative, should you really be deducting it from your assignees' compensation?

In this article, we'll explore the concept of negative COLA and identify the key discussion points around its implementation.

Background

Multinational organizations will generally provide a COLA to its assignees, with the goal of protecting the employee's purchasing power while overseas. As such, the COLA works as an "equalizer." It is flexible and is intended to move up or down to achieve the protection goal in the face of currency exchange rate fluctuations and other economic factors. To calculate COLA, a cost comparison is usually conducted by a third-party data provider (e.g., ORC, ECA, or AIRINC) and the results indicate what adjustments are needed so that the assignee neither gains nor loses purchasing power while on assignment.

Perceptions and Application of COLA: an Illustration

Who is affected by negative COLA anyway — aren't goods and services always more expensive for an assignee? Let's take a look at the following illustration.

Molly is an assignee on a long-term assignment from the United States to India. We'll assume that her employer follows a home-country, balance sheet approach which is founded on the principle that the assignee neither loses nor gains from a financial perspective due to accepting the international assignment.

Based on COLA data from a third-party data provider, the home index is 100 and the host index is 75. In this example, the statistical data shows that Molly would spend 25 percent less to purchase goods and services in India as compared with a similar "basket" of goods and services in the United States. Basically, the amount of money Molly spends on goods and services in India is much less than what she would have normally spent back at home.

Depending on Molly's salary and family size, this could equate to a few hundred dollars in "negative COLA" per month. The negative COLA represents "cost savings" that theoretically (and oftentimes practically) accumulate to the benefit of the assignee and may produce a windfall or gain if not deducted from the assignee's compensation.

If COLA Is Negative, Will You Actually Deduct It from the Paycheck?

Survey Highlights

The trend among most multinational organizations is not to deduct a negative COLA from the assignee's compensation, consistent with 78 percent of the respondents to KPMG's Global Assignment Policies and Practice Survey.¹ Of all respondents, slightly more than half (52 percent) actually inform the assignee of the windfall generated by not deducting the negative COLA. Conversely, just 18 percent responded that they actually deduct a negative COLA, sometimes by netting the deduction against another positive allowance.

This begs the question, why wouldn't the organization deduct the negative COLA? After all, is the employee supposed to not "gain" from taking the assignment?

According to the balance sheet principle, it would seem that when the COLA is lower at the host location than at the home location, the organization should deduct the amount from the assignee's compensation.

However, organizations informally report that the concept of a COLA is already complex enough and rarely understood as an equalizer. It seems hard enough to convince an assignee that an existing COLA amount should go down. If the amount is negative from the start, how will international assignment program managers convince the assignees that deducting the amount from their compensation is the "right thing" to do?

From a practical standpoint, some HR professionals have taken the position that it may be administratively too difficult to justify the deduction of COLA from an assignee's compensation. In light of anticipated assignee morale issues and potential disagreements over the validity of the third party calculations, the ancillary costs of the deduction may outweigh the benefits.

To Deduct or Not To Deduct? That Is the Question

Yes, Deduct It — We Believe in the Balance Sheet Approach

The primary reason that organizations will deduct negative COLA from the assignee's compensation is this action supports the balance sheet approach. These organizations recognize that deducting the negative COLA mitigates the assignee's windfall that otherwise is generated.

Deducting the negative COLA supports consistency with the balance sheet approach towards assignment compensation and:

• Keeps the assignee's purchasing power comparable to what he or she would experience at home
• Maintains parity with assignees whether in higher or lower cost-of-living locations
• Neutralizes the perception that the COLA is an uplift, allowance, or bonus payment — it is paid when the costs are higher, and deducted when the costs are lower.

No Deduction — It's Difficult To Justify a Negative COLA "Deduction" and Not Worth the Hassle

The reasons why organizations will not subtract the negative differential from the employee's compensation may vary, but often include:

• Assignee morale — deducting is seen as unfair or unjust
• Complex calculation to defend — based on theoretical spending patterns determined by the third party
• Administration — requires constant review of pricing and exchange rates (although this issue also applies to positive COLA adjustments)
• Payroll — challenge to implement negative amounts correctly via payroll.

Summary

The COLA is an often maligned (particularly when adjusted downwards), misunderstood, and occasionally misapplied aspect of assignee compensation. Many assignees perceive it as an entitlement as a result of taking the international assignment and see it as an uplift and/or incentive. When dealing with negative COLA, things can become tricky for the international assignment program manager.

Although some assignees might think it beneficial to retain the windfall should the organization decide not to apply a negative COLA, consider these points²:

• Assignees will enjoy a savings advantage not available to individuals in positive COLA or higher-cost countries
• Assignees are likely to feel the financial impact of repatriation or a subsequent assignment to a high-cost location all the more, as the ability to save or use windfall monies as additional spendable income disappears
• Assignees would receive a smaller increase than expected when transitioning to a higher-cost location, because the organization never deducted the negative COLA amount from their compensation in the first place, and
• Assignees' purchasing power — not total pay — is supposed to be protected.

Footnotes:

1 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 "Maintain Employee Purchasing Power in Lower-Cost Locations," Lois N. Camiolo, ORC, July 2005.

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