In conjunction with retaining the expatriate in the home country salary structure, most companies pay the employee a set of allowances designed to deal with addi- tional costs that the employee could incur. The most significant of these costs is in relation to goods and services (food, clothing, recreation, etc.), housing, personal
or a goods-and-services allowance, usually based on information from external consultants. There are numerous ways of comparing such costs, which need to be monitored regularly to reflect the impact of the exchange rate between the two locations. Typically the external consultant provides an index that compares costs in the two locations, where 100 indicates that costs are the same in the two loca- tions. The allowance is usually doled at each pay period. The purpose of the allowance may be viewed in two slightly different ways. It may be seen as a pro- tection against higher costs, or it may be seen as part of an attempt to ensure that the employee neither gains nor loses in living standards from accepting the assign- ment other than from changes in direct pay. The latter philosophy may be termed acost equalization approach. The distinction is not just a semantic issue. A com- pany that sees the payment in protection termswill not take any action when the employee moves to a country with lower costs; a company adopting the equaliza- tion approach may do so. Those who adopt the equalization approach argue that to do so avoids employees’ receiving arbitrary variations in real living standards based on the location to which they are sent. Thus an employee sent to a much lower cost country will receive an additional windfall unrelated to the amount of money needed in the location; another employee sent to a higher-cost location is protected but does not enjoy any such windfall. If costs suddenly rise in the low- cost location, the employee may perceive a decline in living standards when, in reality, there has merely been a reduction in the windfall gain. Because of this, some companies that do not reduce the employee’s pay in lower-costs locations choose to show the employee the windfall gain to avoid complaints if costs rise.
It should be emphasized that the above approach should be used in conjunc- tion with retention in the home salary structure. If the employee is placed in the host structure, a comparison back to home costs is inappropriate because the local salary may reflect local living costs. If a higher (or lower) salary exactly reflects living-cost differences, no allowance would be needed. Unfortunately, the salary levels of two countries rarely precisely reflect differential living costs, hence one of the problems of a host pay approach: most commonly the cost differences are partially reflected and so a payment of a goods-and-services allowance in addition to host salary would still be overly generous.
Where a company uses a headquarters approach, the cost comparison should still be made but between the headquarters country and the assignment location.
The result will be that the salary reflects the headquarters living costs, not the actual home location of the employee. It also ensures that expatriates of different nationalities receive the same pay, which is often the underlying objective of those using a headquarters approach.
Housing
Housing is affected by two considerations. Most companies prefer their expatriates to rent rather than purchase housing in the assignment location. This is felt to be
EXPATRIATECOMPENSATIONPRACTICES 631
administratively simpler, to protect against possible losses if the host housing mar- ket falls, and to provide greater flexibility in disposing of the home on return.
Second, consideration needs to be paid to the employee’s house in the home country.
The most common approach is that the company encourages the employee to retain the home if the expectation is that the employee will return to the same location.
In this case, the company usually provides assistance in renting out and managing the property. In the assignment location the company will assist the employee in finding a home and will pay the rental cost either directly to the landlord or as an allowance to the employee. Some companies pay an allowance equal to the actual rent of the property; others pay a defined amount but leave the employee to select the property and to keep any amount by which the housing allowance falls below the actual rent or to pay out of their own pocket any amount by which the rent exceeds the allowance. Whatever approach is adopted, companies need to decide how much they are willing to pay for the employee’s housing. Many companies use external consultants to set housing allowance levels, which often vary by family size and by job level.
Most U.S. companies take a “housing deduction” to reflect the savings that the employee is realizing in home housing costs. European companies are less likely to take this deduction, largely because they do not assume that the employee will rent out the home property while on assignment. Once again, the philosophy of most companies is to equalize costs for the employee, and whether this is done by requiring a home deduction or not depends on the circumstances of the employee. Some companies will allow the policy to vary depending on individual circumstances; others choose a policy that reflects the majority of their expatriate population.
The payment of host housing costs is a policy that most companies adopt regardless of whether they use home, host, or headquarters pay as a base. Again, in one sense this undermines the logic of host pay systems because it represents a clear distinction between expatriates and local nationals. However, it is a prag- matic reflection of the need to help employees find and pay for housing when on limited-term assignments.
Personal Taxation
In the area of taxes, the equalization philosophy is firmly entrenched. Most com- panies use an external accounting firm to prepare expatriate tax returns. This is particularly important for U.S. citizens and U.S. permanent residents as they are
year. Despite this, the principle of tax equalization is usually followed for other nationalities although practice is more varied than for Americans.
For the employee, the normal approach is that the company will pay all per- sonal taxes that arise from employment income; increasingly companies also pay all or a portion of the liability related to nonemployment income. In return, the employee pays the company through regular payroll deductions, an amount usually termed a “hypothetical tax deduction,” equivalent to what would have been paid in taxes at home.
Education
An international assignment is disruptive for expatriates with children. Where the language of the assignment country is different from the home country, most expa- triates want to send their children to a school in the assignment location that pro- vides teaching in the home country language. Even if the language is the same, if the curriculum does not match that of the home country, it may disrupt the child’s ability to progress through the home curriculum. This is especially true for chil- dren in secondary education.
Such international schools are usually private and therefore charge tuition and fees, and companies will generally meet at least the direct tuition costs and often other additional costs. For U.S. expatriates, this usually means the “American”
schools that exist in many cities around the world; similar schools exist for French, Japanese, and British children, although in smaller numbers. If no school is avail- able in the assignment location, most companies will pay for boarding schools in the home country or in a third location. The cost impact for companies is therefore quite high if they send expatriates with children on assignment. This has led some companies to seek to persuade expatriates to send children to local schools if the language of the assignment and home countries are the same. This is sometimes acceptable for younger children, but differences in the curricula and in university entrance requirements make this difficult for older children.
As with housing, most companies pay for education, regardless of the salary base for expatriates.