The accepted wisdom in terms of crafting a compensation approach for international assignees is that tax equalization is the right thing to do. Having said that, tax equalization is not a "fits-all-sizes" policy for every organization or every situation. Survey results tend to show, however, that many organizations prefer tax equalization as a tax reimbursement approach. Results from KPMG LLP's (KPMG) Web-based International Human Resources survey (www.kpmgvirtualihr.com) on International Assignment Programs and Policies show that tax equalization is both the most common and competitive practice, regardless of industry or assignee population. According to the survey, 70 percent of the participants tax equalize their assignees and only 11 percent tax protect. In spite of this fact, it may not always be clear to organizations why tax equalization may be a better policy for them.

This article will highlight the process of adapting tax equalization through the experience of one company's (we will call it XYZ Co.) recent change in policy to tax equalization.

Before beginning, it is necessary to define the two tax reimbursement approaches:

• Tax Protection: An assignee pays no more than he or she would have paid had he or she stayed at home (but if the actual burden is less, the assignee retains the windfall).
• Tax Equalization: An assignee pays no more or no less than he or she would have paid had he or she stayed at home. (The windfall, if any, goes to the employer.)

The Decision to Switch

Why should an organization care if the assignee ultimately benefits by enjoying a low (or perhaps non-existent) tax burden while on assignment? Why shouldn't the employee be able to keep such benefits anyway? Those two questions are at the heart of the tax reimbursement issue. At the end of a process that considered these questions and the answers thereto, XYZ Co. made its decision to change its tax reimbursement policy.

XYZ Co. realized, principally, that while the two approaches—tax protection and tax equalization—are designed to alleviate potentially excessive tax burdens, they are really compensation philosophies, and not merely tax strategies. From a compensation perspective, XYZ Co. determined that there are two main reasons why tax equalization was a better choice than tax protection for the company, and both have to do with equity. A third reason involves mobility.

Compensation Equity
The first reason tax equalization may be preferred to tax protection is equity among assignees. XYZ Co. had assignees in low and high tax jurisdictions, and was experiencing inequity among assignees. For example, consider two assignees from the United States holding the same position, with equivalent base salaries in two different locations overseas and both are tax protected. One assignee is in a low tax jurisdiction (e.g., Hong Kong), the other in a high tax jurisdiction (e.g., Germany). All other factors being equal, when an assignee pays less tax in the lower tax jurisdiction, he or she has more disposable income compared to his or her counterpart in the high tax jurisdiction. Therefore, the assignee in the low tax jurisdiction is receiving a benefit that the assignee in the high tax jurisdiction is not, and essentially making more money than his or her peers in the other jurisdiction.

The second reason favoring tax equalization is the equity that a tax protection policy negatively affects. This is the financial equity between assignees and home country peers. If, in part, the intent of the international assignment is for the assignee to return to the home country, then it is important that the assignee's compensation remain in line with that of his or her home country peers. Assignees will more than likely need additional allowances to help with living costs in the host location, but ideally the assignee should still receive base income that is comparable to his or her home country peers' incomes. In addition, this will make it easier to incorporate the assignee back into the home country pay scale upon repatriation. A tax equalization program helps ensure that all of the compensation elements in the international assignment program are kept the same as if he or she had stayed at home; making not only taxes, but also allowances, a neutral factor and not a compensation incentive.

Assignee Mobility
A third, and no less important consideration is mobility. In certain locations, assignees are reluctant to return from their assignments, or to move to a new assignment in a higher tax location, since, if given the choice, living in a low tax country with assignee allowances was seen to be far more lucrative then what he or she would be enjoying from a financial perspective as compared with other (high tax) locations. This can significantly frustrate international human resources managers and inhibit the selection of assignees and moving them around the world.

Transition

In starting the transition from a tax protection policy to a tax equalization policy, XYZ Co. asked KPMG to provide cost projections for its current international assignee population to calculate the impact of the switch for each assignee's package. To make this process as efficient as possible, KPMG ran sample "generic" projections for specific countries to illustrate the disparity between high tax and low tax countries instead of running calculations for every location where XYZ Co. had assignees. The results illustrated that assignees in low tax areas were receiving more net compensation than in other locations. Later in the process, more specific calculations were prepared comparing the tax equalization and tax protection regimes for assignees in the low tax countries using current compensation and tax rates, thus quantifying the windfall assignees in the low tax countries were receiving. The calculations illustrated that upon change to a tax equalization policy, assignees in these low tax countries would no longer receive a tax windfall ranging from a few hundred U.S. dollars to as high as USD 50,000—further confirmation of the inequity arising from the tax protection policy.

Exploring Transitioning Alternatives
Any change in policy that affects assignees' income will create controversy. Therefore, it is imperative that before communicating any type of change, the company's leadership agrees on how the new policy will affect the existing assignee population. During XYZ Co.'s transition to tax equalization, discussions were held on the following three alternatives for transitioning the existing population:

• Grand-fathering assignees so that those already on assignment would remain on the old policy through the end of their assignment; assignees who had their assignments extended and all new assignees would be covered by the new tax equalization policy.
• Transfer all assignees on a specified day (as of January 1) to the new policy with no compensation (on the basis that tax protection had been an unintended benefit for some period of time).
• Transfer all assignees on a specified day (January 1) to the new policy, providing compensation (a "mitigation allowance") for the loss of tax benefit.

A mitigation allowance can come in many forms. For example, organizations can "buy-out" the assignee, by providing an allowance that would be equal to the amount the assignee would have lost over the remaining period of his or her assignment. However, not all mitigation allowances represent the total amount of compensation the assignee would have received. Often a percentage is reached after evaluating the specific assignee situations.

Putting Transition into Effect
After examining XYZ Co.'s international assignment situation and the company's business needs, it was agreed that Option 3 (the provision of a mitigation allowance) was preferable because many of the assignees needed to stay in the host location for at least one to two more years, and many had expressed that loss of the tax windfall would be viewed negatively.

XYZ Co. decided that a mitigation allowance equal to the lost tax benefit would be paid, two-thirds during the first year of the new policy, and then one-third of the benefit in the second year. This amount was incorporated into the assignees' salaries and paid gross. It was grossed-up locally if necessary, and for U.S. assignees any U.S. tax was reimbursed.

In addition, a few assignees (those with a short amount of time remaining on assignment) were permitted to elect out of equalization.

Communication
Only when these decisions are made should an organization begin to communicate the changes. When drafting communications, it is important to realize that while the main information to be delivered may be the same for everyone, there are three different audiences that require different variations of this information:

• Assignees who need to know the new policy, but who also will want to know how it will affect their financial situation, why the change was made, and any additional actions required by the assignee.
• Administrators of the program who need to know all the same information the assignee will need, but also how it affects their role as administrators. Is there additional paper work involved? Are there different forms required to be filled out by the assignee or administrator? Are there any other changes in procedures?
• Management (e.g., senior executives or office managing partners, etc.) who will need to know the same as all of the above, but probably not all of the minute details that the administrator needs.

Most high-level managers should also be told why the change was made and how the new policy affects the organization's bottom-line as compared to the old.

In addition to drafting the content of communications, the mode in which the communications are delivered is also extremely important. Options include e-mail, an organization's intranet, a printed manual, a group presentation, or face-to-face meetings with each assignee (or any combination of these). KPMG worked with XYZ Co. to draft multiple communications to the assignees, the administrators, and management that were delivered via e-mail and via a presentation by local management. Frequently asked questions (FAQs) were composed and distributed to all parties affected by the policy change; the FAQs were designed to answer the most anticipated questions.

The initial communication on change came from the headquarters office, the hub for XYZ Co.'s international assignment program. Subsequently, headquarters prepared communications for the administrators in other offices to be discussed with assignees in that particular office. In addition, presentations by the home office Human Resources (HR), local representatives, and KPMG (as XYZ Co.'s tax providers), were scheduled in various locations to discuss how the new tax equalization program would affect individual tax filings and each assignee's new responsibilities for both their home and host country tax returns. (In the end, due to time constraints, home office HR personnel were not able to participate in these meetings.)

Hindsight

After all the communications were done and the effective change date passed, KPMG debriefed XYZ Co. on how the process went.

One of the issues that came up was the need for more time. The initial discussions in XYZ Co. regarding a policy change began in early 2001, giving the company approximately eight months to implement the policy by the end of the year. However, the drafting of the policy and communications, and approvals needed from senior levels and overseas offices, took more time than XYZ Co. had planned. Therefore, with hindsight, it became clear that at least three more months should have been factored into the amount of time company decision makers had planned.

Another issue concerned the communications. Even though the headquarters office prepared detailed communications and spent an enormous amount of time explaining the "ins" and "outs" of the policy change to the company's global administrators and leadership, the transition would have gone more smoothly if representatives from the headquarters office had been able to directly participate in the meetings with the assignees. The company's local representatives could not handle the follow-up questions as effectively as administrators in the headquarters office. In addition, assignees, knowing the personnel in the headquarters office, would call them directly. Therefore, the headquarters office administrators spent more time discussing the same answers with each individual assignee that called or e-mailed, when one meeting in each location with headquarters office HR representatives participating probably could have answered and put to rest many, if not all, of the questions.

Conclusion

XYZ Co. concluded that tax equalization was a wise choice given its company's assignee situation and business goals. However, tax equalization may not be feasible or desirable for every organization or for every situation. Before making any changes to a company's tax reimbursement policy, it is important to look at and thoroughly analyze the equity and mobility issues as they relate to the particular organization. A decision to change should be made based on a thorough analysis of these issues, and not whether or not the change will be easy to do. The planning process can be arduous, and there is no substitute for preparation. Timelines should be established, and adhered to, but also build in time for the unforeseen (but inevitable) hold-ups. And communicate...communicate...communicate.

All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.