Accounting for Tax
Equalization Costs
March 29, 2012
Webinar Format:
Webinar Format:
• We will proceed with the webinar in its entirety, before p
y,
responding to any questions
• Questions should be submitted via the link in the Microsoft Li M ti
Live Meeting under Q&A
d Q&A
• Trouble logging in or dialing in: cdaas@gtn.com
Webinar Format:
Webinar Format:
Your Presenters
Your Presenters
Mary Lou Stockton
Mary Lou is the Managing Director of the Philadelphia office. She has over 15 years experience providing expatriate tax services with Ernst & Young in Philadelphia. Her clients have included a large pharmaceutical manufacturer a large global
pharmaceutical manufacturer, a large global software consulting company, and many smaller companies that were just starting up their overseas activities. She has also worked in the corporate tax environment, having been Director of Tax with a national US retailer. Mary Lou received her undergraduate degree from Bryn Mawr College, and her Masters of Science in Business Administration from Temple University.
Your Presenters
Your Presenters
Brett Sipes
Brett is a Director in the Global Tax Network (“GTN”) office in Minneapolis, MN and has over 14 years of combined experience at GTN, in the Global Mobility practice at Ernst & Young, and the International Executive Services practice at KPMG Brett overseas
Executive Services practice at KPMG. Brett overseas the delivery of GTN’s compliance and advisory services to his clients, and specializes in managing complex and unique assignments. In addition to his client duties, Brett also has a lead role in GTN’s strategic technology initiatives. Brett received his undergraduate degree in accounting from Northwestern College in St. Paul, MN.
Disclaimer
Circular 230: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in our communication (including any attachments) was not h
d i
i di
i i (i l di
h
)
intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalty or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Our advice in our communication is limited to the conclusions specifically set forth herein and is based on the completeness and accuracy of the facts and assumptions as stated. Our advice may consider tax authorities that are subject to change, retroactively and/or prospectively. Such changes could affect the validity of our advice. Our advice will not be updated for subsequent h
ld ff t th
lidit f
d i O
d i
ill t b
d t df
b
t
changes or modifications to applicable law and regulations, or to the judicial and administrative interpretations thereof.
Agenda
A.
B.
C.
D.
What is tax equalization?
q
Why does a tax equalization policy create accounting issues?
Other potential accrual issues for assignments
Comparison of the 3 common methods of accounting for tax equalization costs.
E Analysis of the “full accrual” method of accounting for tax E.
Analysis of the “full accrual” method of accounting for tax
equalization costs.
What is Tax Equalization?
What is Tax Equalization?
• Company policy to minimize tax impact to an assignee related p yp y
p
g
to going on an assignment.
• Results in company paying individual tax liabilities on behalf of an assignee.
Why Does Tax Equalization Create Accounting Issues??
• Timing of tax payments can vary and can often occur long g
p y
y
g
after assignment is completed.
• If tax accruals are not implemented, there can be unpleasant b d ti
budgeting surprises when tax payments are paid long after i
h t
t
id l
ft
the assignment is over.
Other Issues Not Covered
Other Issues Not Covered
• Accrual for:
•
•
•
•
•
Base salary and normal compensation components
Assignment allowances
Deferred compensation (i e bonus)
Deferred compensation (i.e., bonus).
Equity awards
Tax equalization costs on equity awards
• Compensation Reporting
Comparison of the 3 Common Methods of Accounting for Tax Equalization Costs
i f
li i
Method
Description
Cash method. Tax payments are recorded as an expense when paid.
Partial accrual method. Hypothetical tax and/or tax payments withholding is recorded in a reserve account.
Full accrual method.
Expense accruals are made based on the tax cost projection and all tax payments are reconciled through the tax accrual account.
Example
• The Widget Company sends Gary Smith on a one year g
p y
y
y
assignment from the US to Belgium. • Gary remains on U.S. payroll and is tax equalized.
• Widget Co withholds hypothetical tax during assignment period.
• Widget Co pays Belgium tax liability on behalf of assignee.
Widget Co pays Belgium tax liability on behalf of assignee
• Tax liability is paid two years after the assignment (i.e., in 2014)
Basic Fact Pattern – Projected Costs
Basic Fact Pattern Projected Costs
Projection At Outset of Assignment
Amount
Projected Actual Belgium Taxes to be funded by Widget Co:
funded by Widget
$100,000
Projected Hypothetical Tax Liability to be funded by Gary:
(40,000)
P j t d N t T C t t Wid t C
Projected Net Tax Cost to Widget Co:
$60 000
$60,000
Basic Fact Pattern – Final Actual Costs
Basic Fact Pattern Final Actual Costs
Final Actual Costs
Hypothetical Withholding
Amount
Year Paid
($40,000)
2012
Actual Tax Payment
110,000
2014
Final Actual Net Tax Costs:
$70,000
Sample Journal Entries: Cash Method
Sample Journal Entries: Cash Method
Year:
Description
Account
2012
Hypo Tax Withholding Collected
Cash
Dr.
40,000
Salary Expense
Salary Expense
2014
Cr.
40 000
40,000
Belgian Tax Payment
Salary Expense
Cash
110,000
110,000
Sample Journal Entries: Partial Accruall
Year:
Description
i i
Account
2012
Hypo Tax Withholding Collected
Cash
Dr.
40,000
Expatriate Tax Accrual (Liability)
2014
C
Cr.
40,000
Belgian Tax Payment
Expatriate Tax Accrual (Liability)
Expatriate Tax Accrual (Liability)
40 000
40,000
Salary Expense
70,000
Cash
110,000
Sample Journal Entries: Full Accrual
Sample Journal Entries: Full Accrual
Year:
Description
Account
2012
Hypo Tax Withholding Collected
Cash
Dr.
40,000
Expatriate Tax Accrual (Liability)
2012
40,000
Record Accrual for Projection
Salary Expense
60,000
Expatriate Tax Accrual (Liability)
2014
Cr.
60,000
Belgian Tax Payment
Expatriate Tax Accrual (Liability)
Salary Expense
Cash
100,000
10,000
110,000
Summary Comparison of Accounting Methods
h d
Net Amount of Tax Costs to the P&L Recorded by Year
Accounting Method
Cash Method:
Partial Accrual Method:
Full Accrual Method:
2012
2013
2014
Total
(40,000)
0
110,000
70,000
0
0
70,000
70,000
60,000
0
10,000
70,000
Analysis of Full Accrual Method for Accounting for Tax Equalization Costs
f
l
Advantages
• Can help to reduce “surprise” expenses for tax payments th t
that are made after d ft
assignment is completed.
• Can minimize need to project when tax payments will occur, h t
t ill
unless there is a need to analyze cash‐flow issues.
– .
Disadvantages
• Can result in additional time to prepare the calculations and reconcile accounts.
d
il
t
• Can result in additional administrative work to track all tax payments.
ll t
t
Implementing Full Accrual Method: Tax Calculations/Analysis Required
l l
/
l
d
1. Cost projection at beginning of assignment
2. Estimated tax calculation at end of each tax year/calendar year
3. Reconciliation of amounts in tax accrual at end of each tax year/calendar year
year/calendar year.
4. Reconciliation of amounts in tax accrual after annual returns/tax equalization completed.
5. Updating tax cost projection each year throughout assignment.
Implementing Full Accrual Method: Challenges for Tracking Tax Payments
h ll
f
k
• Gross‐ups on assignment allowances can easily be buried
• Host country tax payments often recorded as an adjustment to wages, not as an actual payment of cash. Consider intra‐company chargeback issues
chargeback issues.
• Depending on policy of company, payments to company may not be recorded as reduction to wages, so tying accrual to timing of compensation adjustments may not work.
ti
dj t
t
t
k
Implementing Full Accrual Method: Tracking Tax Payments
k
Host C
H
Country
Taxes
Hypo Tax
Withholding
Taxes paid
By
3rd Party
Gross-ups
Tax Accrual
Account
Tax
Equalizations
Est. Tax
Payments
Refunds signed
To Company
Employer
Social
Taxes
Tax Accrual (Balance Sheet Liability) Account – Typical Impact
l
Debit to the Accrual Account
Home or Host tax Payment paid by company (or third party)
Credit to the Accrual Account
Initial Tax Cost based on projection
Estimated tax payments made by the Hypothetical tax withholding
company Employer social taxes
Home or host tax refunds signed over to company by employee
Tax equalization payment made by company to employee
Tax equalization payment made by employee to company
Tax grossups funded by the company
Productivity Tip
Productivity Tip
The Process Should be Unique to Your Organization
• Agree on the terminology
• Start the process when it makes sense –
ideally at the beginning of the assignment • Identify the owner of the process up‐front
Id tif th
f th
f t
• Remember it takes time to get everyone on board – HR, Tax, Finance.
• Continual refinement and process i
improvement
t
Terminology
• These are terms of art These are terms of art ‐ agree on what they mean!
agree on what they mean!
Hypo tax
Grossup
Tax Equalization
q
Tax Accrual
TEQ
True Up
Stay at home Tax
Home Tax
Theoretical Tax
Foreign Host Tax
Foreign Host Tax
Tax Reimbursement
Tax Cost
Next Steps
1. Determine what process my company is using.
2. If full accrual, work with tax service provider to confirm process working appropriately.
ki
i t l
3. If not using full accrual, then:
a.
b.
Get approval from appropriate levels at company to move to full pp
pp p
p y
accrual process.
Work with tax service provider on transition plan. Can be very challenging to correct for current assignees, so consider changing on g g
g
,
g g
go‐forward basis.
Resources
• Today’s presentation/slides will be posted on our website.
• GTN’s December Newsletter on Topic here:
http://www.gtn.com/newsletter_2011_12.php
• GTN’s “Tax Accrual Process Guide” with case study, journal
entries, sample T-Accounts, and other helpful information available
upon request.
• Contact Mary Lou or Brett, or your GTN contact, for additional
assistance.
Thank You!
Questions?
Polling Question
Polling Question
Your company accounts for the international tax costs of the p y
assignment:
A. On the cash method. Tax payments are recorded as an expense when paid.
paid
B. On the partial accrual method. Hypothetical tax withholding is recorded in a reserve account. Tax payments are recorded when paid.
C On the full accrual method. Expense accruals are made based on the tax C.
On the full accrual method Expense accruals are made based on the tax
cost projection and all tax payments are reconciled through the tax accrual account
D Unsure or some combination of the above.
D.
Unsure or some combination of the above
Contact Details
Mary Lou Stockton
Managing Director
Global Tax Network PA, LLC
Global Tax Network PA, LLC
45 Darby Road, Suite E4
Paoli, PA 19301
Phone: (484) 885‐2419
Email: mstockton@GTN.com
Web: www.GTN.com
Brett Sipes
Director
,
Global Tax Network MN, LLC
750 Boone Ave. N., Suite 102
Minneapolis, MN 55427
Phone: (763) 390‐4919
Email:l bsipes@GTN.com
b
Web: www.GTN.com
30