How to run a shadow payroll for employees on international assignments

For Giuseppe Brancato, an Italian railway engineer working for a German company who is stationed in Latvia, pay is a multi-country affair. His income is taxed in Latvia, where his employer pays payroll taxes, while his pension is split between an American and an Italian retirement account that his employer pays into.

He doesn’t pay into the German or Italian state social security system, but he still has to declare his income in Italy. He also has to be careful how much money he sends to his wife, a marketing manager who lives with their son in Milan, to avoid triggering tax audits and other onerous checks.  

“No one in the company explains this to you,” Brancato says of the complications surrounding cross-border money transfers. “It’s something you learn by yourself, or by speaking to other people.” Before Latvia, he spent six years overseeing construction of a state-of-the-art metro system in Qatar.

In both cases, his employer handled any payroll requirements in his host country while managing his benefits from a home country. These mirror payroll systems — also called “shadow payroll” — are increasingly common as the global workforce becomes more mobile, according to the Global Payroll Association (GPA). Traditionally, many short-term business assignments have been payroll exempt, but today, more and more countries are adopting immediate payroll requirements.

What is shadow payroll?

Shadow payroll describes a situation where an employee’s international assignment gives rise to a local payroll tax obligation in the host country in addition to payroll requirements in the home country. Specifically, it occurs when the host location has a payroll tax withholding obligation that is triggered by the employee performing employment duties in the host location.

The employee is typically paid in the home location, where social security and pension contributions are usually maintained, while a shadow payroll is simultaneously operated in the host location to calculate and pay the withholding taxes owed.  

The employee is usually aware of the shadow payroll, but shouldn’t be affected in practical terms. The shadow payroll happens in the background — hence the term “shadow” — with the net pay arriving in the home country as usual (unless certain benefits related to the assignment must be paid locally).

But not every assignment abroad results in a shadow payroll. Sometimes employees who transfer overseas become fully local hires; they are hired on new contracts in the assignment country, move onto the assignment country’s social security system, and are physically paid in the new location.

Other times, an employee on a short assignment is exempt from tax in the host country, so long as the employer successfully applies for an upfront dispensation. Finally, some jurisdictions don’t have any provisions for employers to register and pay withholding taxes. In that case, the employee’s tax position still needs to be addressed, either through year-end tax returns or moving the employee to local terms.

Home and host country needs

Running an effective shadow payroll requires careful planning around four separate pillars: home country requirements; host country requirements; both countries’ relocation, travel and subsistence rules; and year-end obligations.

Each employee has a specific situation and different benefit needs and residency requirements, says Chris Acostandei, Director GlobalView Product at ADP. 

“That’s the most challenging part: the compliance piece,” he says. Payroll suppliers such as ADP offer the tools to be compliant, but the decisions on how and what to report is part of accounting audit guidance. “Those instructions are submitted to us from the clients who are working with their accounting partners,” Acostandei adds.

The first question from the home country perspective is the employee’s expected residence status. From there, the employer must determine any withholding tax obligations and exemptions, and understand the employee’s social security position.  

“It helps if they feel like the company is taking care of them.”

Chris Acostandei, GlobalView Product Director, ADP

On the host country side, the employer must consider any employer and employee registrations, and determine whether there is a payroll withholding requirement, which would trigger a shadow payroll.

Then, the employer must ask whether the correct credits and deductions are being claimed, identify any available expat relief (along with deadlines), determine whether a re-gross calculation will be required, understand if social security will be applied and if the appropriate retention certificates are in place, and determine how you will manage the payroll tax filings and payments.

Even when the employee stays on their home country’s social security system, documentation and reporting are still typically required in the host country. There are also time limits on some social security arrangements.

Extensions and year-end obligations

Next, the employer must look at tax exemptions and review periodically if the assignment is extended. What is the payroll treatment for other assignment-related allowances, including per diems? Are they paid net or gross? Keeping up to date with legislative changes in the host country is also key to compliance.

Finally, the employer must consider year-end payroll tax reconciliations, payroll tax filings in both countries, employee tax filings in both countries, tax equalizations year-end calculations, and the settlement of final tax positions.

To ensure best practices, employers should have a very clear policy and procedures in place for employees on international assignments, ADP’s Acostandei says. 

“Cross-functional collaboration is very important — between HR, finance, tax and legal to make it a smooth process for these associates,” he says. “The company also needs to consider data management—so that data is accurate—and do regular reviews.”

Throughout the shadow payroll framework, the employer should identify a process owner and determine the processes and procedures required, according to the Global Payroll Association. It must understand each country’s audit and control process, and ensure it has the proper record-keeping in place to retain the necessary payroll records for regulatory reporting and compliance audits.    

Benefits of shadow payroll

Despite the complications, shadow payroll can be a major asset to companies. Global mobility, or movement of workers from one country to another, is often a key component of a company’s talent strategy. It allows the company to engage the right talent where it’s needed and to provide employees with more opportunities. 

A smooth shadow payroll benefits both the employer and the employee, since it helps companies remain compliant, mitigate risk and retain talent. Employees, meanwhile, can keep contributing to retirement or health care plans in their home countries.

“It helps employees concentrate on the work rather than worry about how they deal with their taxes,” Acostandei says. Employees might be excited to go to another country, but if it costs more for them, they won’t do it. Living abroad is still complicated, but “It helps if they feel like the company is taking care of them,” he adds.  

Brancato, the Italian railway engineer, acknowledges that his salary is higher because he works abroad. But for him, the greatest benefits of his international assignments are not financial. He has worked on some of the world’s most advanced infrastructure projects, building a modern metro from scratch in the desert and connecting hundreds of miles of the Baltic region with high-speed rail.

“The benefit for the local populations and for the growth of these regions is incredible,” he says. “That’s the main reason I love my job.”

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