Skip to content

UKG Inc., a leading provider of HR, payroll, and workforce management solutions announces entering into a definitive agreement to acquire Immedis. Read More

Hypotax Explained – What it is and How it Works

Christine Kelly
Christine Kelly

Chief Operating Officer

Jun 30, 2020 2 mins

Hypotax is short for hypothetical tax and a term that you’re likely to comes across when employees work on international assignment – i.e. where an employee is sent on secondment to another tax jurisdiction for a defined period of time. Hypotax arises when employees are tax equalized. 

What is tax equalization? 

Tax equalization is an employer policy which ensures that an individual moving from one location (home country) to another location (host country) for a defined period of time is no better or worse off than if they had remained in their home location. A tax equalized employee should be provided with a copy of the employer’s policy and an assignment letter stating that they are tax equalized and explaining the terms prior to the commencement of their international assignment.  

Tax equalization policies vary – it’s not a one size fits all 

In general, under tax equalization the employer determines the net compensation the employee would receive if they did not go on assignment and ensures that the employee receives this amount whilst overseas. Any assignment related benefits will be in addition to the stay at home amount. In these circumstances the employee continues to be physically paid on the home country payroll and host country payroll is done in the background having no impact on the employee. It is run purely for the calculation, payment and filing of taxes and is often referred to as shadow or mirror payroll.    

How it all works 

At the start of the assignment a hypothetical tax calculation is done to calculate the amount of tax that the assignee would pay on their base compensation. Calculations will be redone from time to time throughout the year, for example if there is a salary increase, a bonus or any legislative updates. The employee pays the hypothetical tax throughout the year which is deducted from the home country payroll. 

Hypothetical tax is an estimate and year–end reconciliation via payroll is required. The personal tax return is based on the final actual position. Hypothetical taxes are not paid to the government, these are deducted by the employer who then uses these funds to pay the actual home and host taxes. The amount deducted will not necessarily reconcile to what is paid to the government. 

The company makes all actual tax payments due throughout the year.  These payments are made through payroll and balancing amounts might be paid with the tax return. Sometimes one or both locations will permit a reduction in payroll taxes throughout the year to recognize the obligation in the other location. Double taxation agreements will be considered both during the year and at year end. 

At the end of each year, a calculation is performed to compare the total tax that the assignee has paid in hypothetical versus the hypothetical tax that would be due based on their actual compensation received during the year. This calculation reconciles the estimate performed at the start of the year with what would be due based on actual circumstances. This is called the Tax Equalization Calculation. 

The main point of tax equalization is to ensure that the employee is no worse off and no better off as a result of the secondment. The company sometimes gains if the employee goes to low tax jurisdiction and may suffer additional charges if the assignee goes to a high tax jurisdiction. Hypothetical tax is the method used by employers to determine the level of withholding to be applied to international assignees throughout the year in order to facilitate tax equalization. 

The Immedis team are always happy to share their knowledge so if you have any questions or need support with your next global payroll project, CONTACT US today.