Whats the Latest in Global Compensation

For many years, expatriate policies were standard across all industries. The average expat for a U.S.-based global company was a U.S. national, executive-level employee. Today, the typical expat could be any age, experience level or nationality. International assignments have become a standard career path for many employees. As a result of these changes, companies continue to review their expat programs for applicability in the current market.

Morristown, New Jersey-based Price Waterhouse LLP, a professional services firm that offers international assignment planning and support services to global companies, recently completed its fifth annual “Survey of Expatriate Compensation and Tax Policies.” Conducted in 1990, 1992, 1994, 1995 and 1996, Price Waterhouse has experienced an outstanding response level each year. In 1996, 2,500 surveys were mailed and more than 370 organizations participated, many of them Fortune 500 companies. The majority of respondents are HR professionals with responsibility for their companies’ expat programs. Since participation guarantees respondents access to the results, the high response rate illustrates HR’s continued need for information.

The survey changed significantly in 1992, and the methodology has remained fairly consistent in the four surveys since that time. This article announces the 1996 results and identifies areas of policy change with an emphasis on the differences between 1992 and 1996. Data was extracted to reflect only the practices for U.S. expatriates.

A growing number of compensation policies support multiple relocations.
More than 50 percent of the responding companies pay their expats a home-country-based or modified home-country-based compensation package, and this percentage is growing. The home-country-based approach assumes that the employee will continue to maintain a home-country salary with allowances and deductions to provide a standard of living comparable to that which he or she would’ve maintained in the home country. The reasoning for this approach continues to be the need to have a mobile workforce. A home-country-based plan minimizes the financial impact of moving from one location to another.

Other approaches listed in the table “Comparing Compensation Systems Used Most Often” could result in a mobility problem—providing financial incentive either to remain on assignment (when headquarters compensation is higher than home country) or to remain in one location rather than move to another (when the local package in the current location is higher than in the proposed location).

Corporate culture, assignment locations, and repatriation successes and failures all play a role in determining the success of any one of these approaches. Many companies that use the local-market package encounter few, if any, problems from expatriates, while other companies have switched to different compensation systems because of retention and mobility issues.

Fewer companies are paying incentive premiums.
As illustrated in the table “Comparing Incentive Premiums”, the survey uncovered two trends relating to premiums: 1) a rising number of companies putting a stop to incentive premiums altogether; and 2) among those that do pay them, a sizable decline in the number of companies that pay premiums each pay period. Also, there has been a slight increase in the number of companies paying premiums as lump sums. Typically, employees received incentive premiums each pay period that were equal to 15 percent of salary and were paid tax-free. For many employees, this premium created financial shock at the time of repatriation because it would become a part of daily spending, leading to a higher standard of living than the employee would have when he or she returned home.

This suggests that it would make more sense to pay a premium before the start of the assignment and upon completion so the employee doesn’t use it for daily living expenses. In addition, the employee would be receiving the money when it’s needed.

Those companies that have chosen to eliminate this premium have tried to focus more on career planning so financial gain doesn’t become the primary reason for accepting assignments.

Goods and services differentials are more company-specific.
Typically, most companies have used standard goods-and-services differentials so that when expats from different companies compared their packages, the numbers would be similar. Over the past several years there has been significant change in this area as more and more companies are working with their differential consultants to develop more company-specific data.

In 1992, 24 percent of 350 respondents customized their cost-of-living data. In 1996, this percentage increased significantly to 43 percent. More than 55 percent of the companies that customized the data to eliminate duplicate benefits have adjusted allowances to account for providing company cars.

In addition, more than 55 percent of these companies have used an index which represents a more efficient level of purchasing. This way the expat’s purchasing pattern remains the same—such as assuming the same level of consumption of chicken—but the outlet priced or the brand chosen results in a lower cost for the same quality of good. When employees first arrive in a new location, they spend much more on goods because they shop at the most obvious central outlets. In a short time, however, they usually find less-expensive outlets or brands and adjust their spending accordingly.

Housing norms ensure that expats share housing costs.
Although it appears there are problems with renting home-country housing while on international assignment, most U.S. expatriates continue to choose this option due to the financial benefits they gain. In keeping with the home-country pay system, most companies that responded to the survey charge the expat for a portion of the host-country housing costs. This charge typically is called a housing norm and is developed by consulting firms from statistical data reflecting what would’ve been spent on housing in the home country.

Approximately 27 percent of survey participants provide free housing at the assignment location. In these cases, should employees choose to rent their home-country housing while on assignment, they may receive a significant windfall.

As mentioned earlier, a growing number (34.7 percent) of the respondents don’t provide an incentive premium. For many of these companies, the rationale is that free housing is the incentive premium since the employee is able to keep the windfall resulting from the rental income. This relationship between charging a housing norm and offering an incentive premium illustrates the importance of reviewing expatriate packages on an overall basis rather than item by item.

There are two popular choices for tax-balancing policies.
As a result of using the home-country compensation system, most multinational companies reimburse their expatriates for the excess home- and host-country tax on base salary and other company income resulting from the assignment. The two most popular forms of tax balancing are tax equalization and tax protection.

With either approach, the HR professional begins by calculating a hypothetical tax. A hypothetical tax represents the tax that would’ve been due had the employee not received assignment-related allowances or reimbursements—or, in other words, what the employee would’ve paid had he or she remained in the United States.

Tax equalization holds the employee responsible for the hypothetical tax regardless of the actual tax due. This keeps employees balanced to the compensation system that they’re paid under. For example, if an expat receives a U.K.-based package, he or she would be tax-equalized to the United Kingdom. This approach is designed to minimize any losses or gains resulting from the assignment.

Under a tax protection program, the hypothetical tax would be compared to the actual total taxes due. The company would reimburse the employee for the difference if the actual tax was greater than the hypothetical tax. If the actual tax is less than the hypothetical tax, then the employee would be allowed to keep the excess.

The tax-reimbursement method for personal or non-company income (interest on savings accounts, dividends and so on) is most often tax equalization (56 percent) or laissez faire (27 percent). Under a laissez-faire system the expat is responsible for his or her own taxes in the home and host countries. This area of expatriate policy also has had little change over the past few years.

Itemized deductions are used to calculate hypothetical taxes.
Although most company policies state that employees will pay “no more and no less” tax than had they stayed at home, in 1996, fewer than half (47.5 percent) of the respondents used actual deductions in the calculation of the hypothetical tax. Even fewer companies used actual deductions in 1992 (40.5 percent). Although quickly fading in popularity, currently a majority of the companies use a fixed deduction rate of approximately 14.2 percent. Using a fixed rate allows, in many cases, the employee to have the benefit of deductions they aren’t spending.

For example, if an employee sells his or her home, he or she no longer has a mortgage-interest deduction. This would result in a higher tax. Although the employee may believe that the company should protect this loss, it’s important to note that the employee no longer has a mortgage cost. As a result, although the tax may increase by $2,000 as a result of the loss of the deduction, the employee no longer must spend $6,000 for mortgage payments. This means the employee receives a $4,000 windfall.

As mentioned earlier, any single element of the program must be evaluated in the context of the entire program. Hypothetical deductions again illustrate this idea. Although the preceding analysis regarding the $4,000 benefit to expats technically is correct when evaluated by itself, it’s missing an important point. There may no longer be a home-country housing cost, but the expat will have a host-country housing cost in the form of a housing norm. Even so, some percentage is a windfall.

Determining whether a windfall exists lies in the difference between pre-assignment housing costs and the housing norm. If, for example, the home-country-housing cost is $15,000 per year and the housing norm is $11,000, the employee will realize a $4,000 benefit in the housing area. If the hypothetical itemized deductions are removed and the hypothetical tax is $3,000 higher than the employee’s pre-assignment tax cost, then the employee is ahead by $1,000 overall ($4,000 gain in housing less $3,000 loss in taxes).

Expats may receive a second windfall depending on which elements of compensation are taken into consideration. For example, if the hypothetical deduction rate is applied to company income and an employee exercises significant stock options, then the resulting hypothetical itemized deduction could be greatly overstated. In fact, applying the percentage to total company income assumes that every dollar of company income produces a corresponding tax deduction. In reality, this may not be the case.

In 1992, 52.1 percent of respondents charged the employee a hypothetical state tax. In 1996, this percent increased to 63.1 percent—a major movement in expatriate policy. As the level of state tax rates continues to rise and companies continue to identify areas of policy that are providing windfalls, this percentage will increase.

Trends help you support policy changes.
A final telling statistic is the percentage of respondents who believe the number of expatriates will continue to grow: 67 percent in 1996 vs. 48.5 percent in 1992. Along the same lines, 1996 data show that only 7.7 percent believe the expat population will decline in size in the future. Compare this to 23.7 percent in 1992.

As always, a word of warning for any company relying on survey data. For companies just beginning to expand internationally, the data should be used with caution. The information represents what companies are doing at a point in time. It doesn’t allow a user to determine what companies would be doing if they had the opportunity. As any allowance provided to an employee becomes a part of his or her spending pattern, it’s much easier to increase allowances if you begin conservatively than to reduce a package if you start too high. Most new expatriate programs have attempted to minimize any hidden windfalls that were available in older programs.

Global HR professionals are continuing to take a hard look at their expat programs, reevaluating policies and processes in search of possible areas of cost reduction while maintaining a package that’s competitive and equitable for the employee. HR professionals can use survey information like the statistics in this article to justify policy changes by identifying market trends that will ease management concerns regarding competitiveness. The trend toward package reduction will continue; however, the movement in this direction is slow. Changing anyone’s compensation is a sensitive issue, and HR should continue to focus on trends to support any change in policy.

Global Workforce, Vol. 2, No. 3, pp. 17-21.