If you’ve heard this term before but didn’t actually know what it meant, this is the article for you! Or maybe you have a vague idea about what shadow payroll means but aren’t up to speed on the particulars -- we’ve got the answers to your questions.
Working in global mobility often means being an expert in many categories (Immigration! Payroll! Real estate! Moving!), which also means that there’s a lot to know. We’re here to help.
So, what does the phrase “shadow payroll” mean?
It’s a term used to report compensation data that is actually paid from another country. If you have an employee on assignment in a foreign country, their wages may need to be reported in both the home and host countries via a shadow payroll.
It’s important to note that just because compensation is not paid from one location does not mean that the income is not taxable in that country. Different countries have different payroll compliance laws mandating specific wage reporting requirements to ensure taxes are being paid in a timely manner in that particular jurisdiction. Some countries require that all compensation benefits (regardless of where paid from) be reported and taxed in that country if an employee is living/working there for a specific assignment period.
During an assignment, an employee’s base salary typically continues to be paid from an assignee’s home country, even though the costs may eventually be charged back to the host work country. Other assignment-related allowances such as housing, taxes and dependent education costs are often paid from the host entity.
Can you give me an example?
If an employee goes on a three-year assignment from the U.S. (home country) to Germany (host country), the employer needs to report 100% of the employee’s wages in the U.S. as well as in Germany to be in compliance with both countries’ payroll rules. In order to facilitate the global compliance reporting process:
- The U.S. entity needs to “shadow” report any payments/benefits that are paid outside of the U.S. for W-2 reporting purposes (such as host housing, German taxes and education paid in Germany)….AND
- The German entity needs to “shadow” report all wages/benefits deemed taxable as income being paid outside of Germany (such as base salary and 401k benefits paid in the U.S.)
While this may seem like wages are being over-reported and/or double-taxed, foreign tax credits and tax treaties between countries ensure that income is taxed in the appropriate jurisdiction and double-taxation is avoided. Although 100% of wages are reported, taxes may not be withheld and/or assessed on all wage amounts.
How do I do this without messing it up?
The key success factors in global compliance when it comes to shadow payroll are:
- Strong communications between the home and host countries
- Identifying raw compensation data (i.e. costs or data needed to compute a benefit for country-specific reporting)
- Timely collection and sharing of compensation data between home and host countries to facilitate wage reporting and tax withholding requirements in the appropriate country
- Reconciling total compensation data exchanged each period
- Reviewing for reasonableness and accuracy (to resolve discrepancies)
If this seems like an overwhelming task that is outside of your comfort zone, it’s always a good idea to have some help on your team. Lexicon’s Global Compensation team specializes in this area and can provide support to ensure your global compliance needs are being met – get in touch to learn more about how we can take the burden off your shoulders.