Plan for extra business costs when expanding

By Kevyn Nightingale | October 24, 2014 | Last updated on October 24, 2014
3 min read

There can be many benefits for an American company to have an employee presence in Canada, but it’s not without its complications. Chief among those: dealing with two tax codes.

The U.S. has measures to mitigate double taxation, but total tax can still be higher than it would be if all your employees continued to work stateside.

Most advanced nations, including Canada, have higher personal taxes than the U.S. This can make your employees reticent to accept foreign assignments. But there’s a way to soften the blow and make that time north more appealing — tax equalization or tax protection:

  • Equalization: Pay is adjusted up or down so your employee’s after-tax income is no different than it would have been had she continued working in the U.S.
  • Protection: Same as equalization, except there’s no downward adjustment. This would only be an issue if tax in the foreign country is lower than the tax in the home country.

Equalization calculation

The equalization calculation is often complex because it’s hard to determine the hypothetical tax that your employee would have paid at home. Once hypothetical tax determined, it’s compared to actual tax; then you pay the employee the difference.

But that payment is taxable — always for U.S. purposes and often for foreign purposes. So that amount also has to be equalized.

Equalization policy

You need to decide what income to equalize. Employment income is standard, but what if your employee has other sources, such as interest, dividend, rental, capital gains, etc.?

What if your employee stops contributing to the U.S. retirement plan, or starts contributing to a foreign plan? The foreign plan may not be tax efficient for an American. What if there’s no foreign company plan, but available individual plans? What if your employee’s spouse also moves? Should the spouse’s income be equalized?

With so many questions to be answered, mistakes can be expensive.

Learning the hard way

Here’s a typical scenario of a U.S. company expanding into Canada without planning ahead.

A mid-level or senior employee is moved, but no one considers the tax issue until Canadian withholding starts. It’s much higher than U.S. withholding, so the employee asks firm for help. The employer typically says something like, “Don’t worry, we’ll make it the same as it would be if you were still in the U.S.”

The employer then learns the cost of equalization is considerably greater than anticipated. There’s the equalization cost itself, and the cost of doing the calculation. Sometimes the calculation must be done in advance, not just after returns are finished. That doubles the cost.

The problem is not the absolute cost level — it’s expensive to move people around the world — instead, unanticipated costs can be problematic. It’s better for you to know your costs in advance than to enter into a venture you thought was going to be profitable, only to find out otherwise.

Kevyn Nightingale