Concept of tax equalisation and Hypo taxes
A taxpayer is habituated to the tax rates and tax structure of his home country. However, tax structure varies is different countries. In such a scenario, if an employee is deputed to another Country for work purposes his income would definitely impacted due to tax rates. For example if the average tax rate of home country is 30 per cent and the Host Country does not tax personal income, his income to the tune of 30 per cent is higher than, his home country and would be eager to be deputed to the Host Country. On the contrary, if the tax rates are higher than that of the Home Country, the employee would be demotivated to be deputed to such location.
Given the above situation, the employer and employee enter into an agreement called tax equalisation. As per the said agreement, the employer would continue to deduct taxes as per the tax structure of the Home country and any other additional taxes in the Host Country would be borne by the employer. Hence, the tax equalisation removes taxation as condition/ criteria in the decision making process for the international assignee.
It is pertinent to note that tax equalisation is not governed by any tax laws and is as per the convenience of employer and employee.
Hypothetical Tax (Hypo Tax) vs Actual tax
In case of deputation assignments, the salary structure includes salary drawn by the employee in the home country and other deputation perquisites. The employer as stated above would deduct taxes at tax rate applicable to the employee as per his home country tax rate. This tax is called Hypo tax. Since this is not the actual tax the same need be paid to the Government treasury. However, the tax in the host country on the aggregate income needs to be remitted to the Government of the host country. In case the actual tax is higher than the hypo tax the same would be borne by the employer and in case the actual tax his lower than the hypo tax the benefit would be availed by the employer. In India, tax liability of employee borne by employer and is treated as employee’s income and hence this calls for grossing up while calculating host country tax liability.