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back to index backGLOBALtalk August,  2006


New Kids on the Block: Tax Implications for Expatriates in the East European EU

The induction of eight Eastern European countries into the European Union (EU) in 2004 has opened a Pandora’s box of tax issues. Fritz discusses the changing tax landscape across Eastern Europe and gives tips for best working out tax and social security issues for intra-EU expatriate employees.

Eight East European states entered the European Union (EU) on May 1, 2004: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia. In response to these additions to the EU, many foreign companies have founded affiliated or subsidiary companies, permanent establishments, or representative offices in these states. These business activities have called for numerous foreign assignments to Eastern Europe.

An expatriate who lives and works in one of the East European member states must cope with the legal and administrative procedures adapted to EU law or in the process of adapting—particularly with regard to taxes. Expatriates are predominantly concerned with two types of taxes: individual income tax and social security taxes.

Individual Income Tax

Either a double taxation agreement or national law regulates whether and where expatriates are subject to individual income tax.

Double taxation agreements. All of the eight East European member states of the EU have concluded double taxation agreements with many other states. An expatriate should, therefore, check whether a double taxation agreement applies between his or her host East European state and his or her home country. If a double taxation agreement applies, its regulations usually override national tax law.

Most double taxation agreements regulate that income from employment is taxed by the state where the employment is exercised. Thus, the East European state of activity, not the home country, has the right of taxation.

But there is an exception to that rule called the 183 days rule.” Most double taxation agreements state that income from employment is only taxable in the expatriate’s home country if the expatriate is present in the state of activity for a period or periods not exceeding in the aggregate 183 days in the fiscal year concerned, the remuneration is paid by or on behalf of an employer who is not a resident of the state of activity, and the remuneration is not borne by a permanent establishment the employer has in the state of activity.

In most cases, the 183 days rule does not apply and the expatriate’s remuneration is taxable in the East European state of activity. Depending on the agreement, double taxation is then avoided either by the exemption method” or the credit method.”

If the exemption method applies, the home country exempts the remuneration from its income tax that is taxed in the state of activity. Usually, it is an exemption with progression, meaning the home country, in calculating the amount of tax on the remaining income of the expatriate, applies the applicable tax rate if the remuneration has not been exempted.

If the credit method applies, tax paid in the state of activity on the remuneration is deducted from income tax in the home country. Usually the deduction cannot exceed that part of the home country’s income tax that is attributable to the remuneration.

No double taxation agreement. If no double taxation agreement applies between the expatriate’s state of activity and his or her home country, the tax laws of both countries are applicable.

The national tax law of most countries—including the eight East European member states—determines that, though inland-source income is entirely taxed, tax credits regarding foreign-source income are allowed. There are two credit methods: one method allows a credit for foreign tax paid on foreign-source income to the extent of inland tax payable on the same income; the second method allows a deduction of foreign tax paid on foreign-source income from the taxable income. One or both of these methods are usually applicable in the expatriate’s home country and his or her state of activity.

Double taxation thus can be avoided by the mutual use of foreign tax credits: a foreign tax credit in the expatriate’s home country regarding income from employment earned abroad, and a foreign tax credit in the state of activity regarding further income from sources in the home country.

Social Security Taxes

Either Regulation (EEC) No. 1408/71, a bilateral social security agreement, or national law regulates whether expatriates are subject to social insurance contribution.

Regulation (EEC) No. 1408/71. This regulation applies to expatriates who are nationals of one of the EU member states or nationals of Iceland, Liechtenstein, Norway, or Switzerland. It covers all classes of social insurance.

Regulation (EEC) No. 1408/71 states that a person employed in the territory of one member state is subject to the social security legislation of that state even if that person or his or her employer resides in another member state. Thus, European expatriates are normally subject to social insurance contributions in the states where they work, not in their home countries.

But there are exceptions to this territorial principle” when an employee is assigned abroad for a limited period. An expatriate employed in one member state that is sent by his employer to perform work in another member state for a period that does not exceed 12 months will continue to be subject to the social security legislation of his or her home country.

If, owing to unforeseeable circumstances, the duration of the work exceeds 12 months, the legislation of the home country can continue to apply for a further period of 12 months. But the request for extension must be supplied before the end of the initial 12-month period.

Apart from those exceptions, an application for an agreement of exemption” between the social security authorities of both countries can be filed if the anticipated duration of the assignment to another member state exceeds 12 months or the expatriate does not work for his home employer but for a company in the assignment country.

Such an agreement of exemption usually is concluded for a period of up to five years if the expatriate retains certain contractual bonds to an employer in his home country, a time limitation on his foreign assignment is discernible, and there is a legitimate expectation the expatriate will continue to be subject to the social security legislation of his home country.

As long as an expatriate continues to be subject to the social security legislation in his or her home country on the basis of these exceptions or agreements, he or she will be exempt from social security contribution in the assignment country. If not, the above mentioned territorial principle commits the expatriate and his or her employer to pay social insurance contributions in the assignment country.

Special rules apply when an expatriate is employed in two or more member states. He or she is subject to the social security legislation of the home country if he or she pursues an activity in that country or if he or she is attached to several employers from different member states. The expatriate is subject to the social security legislation of the member state where his or her employer resides if he or she does not reside in one of the member states where he or she is pursuing an activity.

It should be mentioned that Regulation (EEC) No. 1408/71 is still fairly new in the East European member states of the EU, so their social security authorities are still dealing with some comprehension and implementation problems.

Bilateral social security agreements. Expatriates who are not nationals of one of the EU member states, or nationals of Iceland, Liechtenstein, Norway, or Switzerland, should check whether their home countries have concluded bilateral social security agreements with their East European states of activity. Like Regulation (EEC) No. 1408/71, bilateral social security agreements avoid double insurance, but to a lesser extent.

Many bilateral social security agreements do not cover all classes of social insurance. They may, for instance, cover pension insurance and unemployment insurance, but not health insurance and work accident insurance. Most bilateral social security agreements follow the territorial principle, so expatriates usually are subject to social security contributions in the states where they work. As to the classes of social insurance not covered by a bilateral social security agreement, an expatriate may face double insurance in the country where he or she works as well as the home country.

But there are also exceptions in cases of temporary foreign assignments—the admitted time limit for the assignment may be different. Like Regulation (EEC) No. 1408/71, most bilateral social security agreements allow agreements of exemption for a period of several years.

No social security agreement. If no social insurance agreement exists between the expatriate’s home country and his or her East European state of activity, the social security laws of both countries are applicable.

The social security law of most countries—including the eight East European member states of the EU—determines that an employee who works in that country is subject to its social security legislation even if the employee or his or her employer resides in another state. But usually an expatriate is liable for social insurance contribution in his home country if he or she is assigned to another country by the home employer. Thus, double liability to social insurance contribution is due in both countries.

Source: Mobility magazineGAI


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