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How does it work?
With the Balance Sheet approach the employee retains their home county salary while on assignment. The company then administers a series of allowances and programs to protect the salary. At a high-level, salary is distributed into four main categories:
1. Income Taxes
Through a process called tax equalization the employee’s contribution to income tax remains at home country rates. The employee contributes a hypothetical tax to the company approximately equal to the amount of income taxes the employee would have paid had they remained in the home country. The result, the employee nets approximately the same as they would have at home. In turn, the company pays the actual income taxes in the host and home locations on company source income and allowances.
2. Goods and Services
The company pays the employee a Cost-of-Living Allowance (COLA) when host location goods and services (G&S) costs are higher compared to the home location. The COLA is calculated by an external provider who compares the cost of a large market basket of items in both the host and home countries. In addition to protecting the employee against excess G&S costs the COLA can also protect against exchange rate and inflation changes. Best practice companies update the COLA 2-4 times a year to reflect changing economic conditions.
Due to the temporary nature of an expatriate assignment, the company covers the cost of rental accommodation in the host location. In turn some companies require the employee to contribute to these costs at their home country rates through the deduction of a housing norm from the employee’s salary. While the housing norm deduction aligns to the balance sheet philosophy, increasingly companies are discontinuing the practice as not all employees are able to cease actual home country housing expenses. Paying these actual costs plus a housing norm would be akin to paying for housing twice.
With tax equalization, COLA and housing support, the company covers the employee’s additional host location costs and the employee simply contributes to costs at home country rates. The result, the employee can save at the same rate as they did prior to the assignment. This is the definition of economic neutrality and the reason the Balance Sheet approach is so commonly used.