Shadow Payroll- Everything you need to know
“Shadow payroll” is a catchy term you have probably heard about but may not fully understand. If you’re considering sending an employee to work abroad or perhaps recruiting a wide range of new remote workers based in their home countries around the world, then understanding the implications of shadow payrolls could be very important in terms of managing overall global payroll risk.
In this article, we will examine in detail the concept of shadow payrolls and give you a high-level understanding of what they are and why they are used. We will provide an example of how to process shadow payroll and explain the challenges and benefits for multinational organizations.
What exactly is Shadow Payroll?
Shadow payroll is a mechanism established to assist with an ex-pat employee’s host-country reporting and tax withholding obligations while the employee is on assignment in the host country. During this time, the employee remains on a home-country payroll. The payroll in the host country will “shadow” what is being reported in the home country, but the employee will not receive any compensation from the host country. A shadow payroll can also be established in the home country where an employee is paid through a host-country payroll.
To understand shadow payroll more clearly, let’s look at a likely scenario:
Here, it is vital to understand the difference between an employee’s home country and host country. Basically, the home country is where the staff members receive net pay, and the host country is the one in which they receive no payment. However, the home country may not be the same as the one they employee is originally from.
For example, if a company is based in the UK but has placed an employee from Sweden on assignment in the Netherlands for more than 183 days, their home country will likely be the Netherlands as that is where they receive their net pay. The host country for the employee in this instance would be the UK.
How to determine if you need a Shadow Payroll?
It is best to consider the below questions when deciding whether or not you need to run a shadow payroll in your organization:
Here are a couple of examples to better understand What could trigger in need for shadow payroll:
- Short business trips (less than 6 months) – in most cases, a tax treaty will apply for assignments that are less than 6 months. In this case, the employee remains on home payroll. There is no host country payroll requirement, and the employee remains on home country social security program. No shadow payroll is needed here.
- Short- term assignment (from 6 months to 1 year) – The tax treaty will not apply as the period is longer than 6 months. Host country usually requires that the employee be put on payroll. Some or all of the employee’s income may be subject to tax in the host country. The employee remains on home country payroll and if social security treaty applies, the employee usually remains on home country program. Shadow payroll is needed here.
- Long- term assignment (more than 183 days) – If the assignment requires employees to work in another country for more than 183 days, it is considered a long-term assignment and a shadow payroll will be required.
How to process Shadow Payroll?
Now that we already know what shadow payroll is and when you require it, let’s see how to process it within your global payroll system.
Challenges for multinational organizations
Shadow payroll calculations are often very complex because of data availability, accuracy, inconsistent policies, and lack of local payroll expertise. There are several challenges with accurately calculating shadow payroll. Probably the biggest challenges that arise from administering a shadow payroll are:
- Figuring out what should be calculated, reported, and remitted.
- How such calculations need to be done?
- When to carry out such calculations, reports, and remittances?
Typically, during the international assignment, the employee gets paid his/her base salary from the home country, even though the costs may eventually be charged back to the host country. Other assignment-related allowances such as taxes, housing, and education costs for dependents are often paid from the host entity.
Another headache is that many existing HR, HCM or global payroll systems are not designed to cope with the pace at which multinational organizations around the world are scaling and internationalizing. Companies acquire other companies or decide to expand into new regions- they quickly locate new people there, often doing so without consulting the human resources or global payroll department to understand best practices for this global mobility activity. Some also forget the need for local expertise in a foreign country- a local country payroll provider needs to be engaged as they have the expertise to fully understand the local country employment laws, income tax nuances and compliance obligations.
Reporting difficulties are also an issue as the software was not designed to account for multi country reporting at employee level or payment element level. It is therefore difficult for global payroll head office professionals to state with certainty that an employee based overseas has fully complied with local law and has been taxed correctly.
For this reason, global employers need to ensure that they have innovative technology in place to handle the complexities of international and shadow payroll. Ideally, their global payroll needs to be deployed in a cloud platform using technology that integrates with the human resource HCM system. This will ensure greater visibility and control when it comes to paying employees accurately in different locations.
Here are some other best practices to calculating shadow payrolls:
Multinational organizations should also look to automate their entire global payroll function – removing the likelihood of human error, reducing pressure on internal resources, ensuring compliance in real-time, and saving money. Automation and integration technology can be the solution to a complex multi-vendor landscape and several other challenges that multinational organizations face when it comes to payroll management on a global level.
Using Payslip, we can manage all our payrolls across nine in-country vendors on one platform. When the global Covid-19 pandemic arose, it was not an issue from a payroll perspective, and critically getting everyone paid. The Payslip platform enabled continuity for our international payroll service including the fast and seamless implementation of the Payslip Employment Self Service during this time.
Payroll Manager, LogMeIn
With business and employee growth rates of above 50%, we rely on our vendors to deliver on time, every time. Payslip’s workflow automation, enables Phorest to manage our payroll provider process – data driven, real time and transparent. Payslip saves us time so we can focus on our business growth.
International Payroll Manager, Phorest