Companies have long accepted the high cost of expatriate assignments as the price of doing business in the global arena. But there’s a way companies can minimize this cost, although they seldom use it or don’t use it effectively. When expatriate assignments start to linger or change in purpose, HR can “localize” expatriates and reap substantial savings without compromising the assignment or hindering the assignee. The localization process migrates employees away from their U.S. expatriate packages and into the host country economy, usually by eliminating some of the expats’ allowances immediately and phasing out others.
He stresses that it’s important for HR to “plan upfront and think through possibilities” so the process can go smoothly for both the company and the employee.
It can be well worth the effort: Expatriate assignments cost an average of $1 million over a three-year period, and converting an expat package to a local one can save the company hundreds of thousands of dollars. HR professionals say the money saved more than compensates for headaches that may arise during the transition.
With an understanding of what’s involved with localizing expatriates, HR can keep employees satisfied while adding to the company’s bottom line.
Know When to Localize
Robertson says companies that consider localization upfront have better success during the transition period. “In assignment letters, companies spell out the provisions for localization,” he says. “When they send someone out to develop a business, for instance, they tell the employee upfront ‘if the business flourishes, we’d like you to run it and we’ll localize you.’” In addition to having a goal set for the company, it allows expatriates to go into assignments with clear expectations.
Mary Rowe, director of Motorola’s global assignment center in Schaumburg, Ill., says her company has three categories of expatriate assignments, which simplifies the decision on when to localize. “Our international transferees understand from the start that the job is located in another country, and they will be treated as a local hire with host-location salary structure.” Rowe says the company is increasingly using this category.
“Less frequently, we have ‘wind-downs,’ where an employee has been on an assignment for five to six years, and we approach him or her to be a local hire. Because the person is used to expat benefits, we wind down these benefits over a period of time.”
Rowe says a third scenario occurs when an expat has been on assignment for a shorter period of time, but the company sees that the position itself has moved to the host country and is no longer an expat assignment. “We treat this situation as though the position had been a local hire from the beginning and immediately convert benefits,” she says. “We will ask the employee to convert to local status. We do offer to bring the employee back [if they choose not to localize], but we don’t offer repatriation—there is no job back home.”
Sometimes you can’t plan for localization, and the question arises as the assignment evolves or when HR reviews the length of existing expat assignments. A typical cutoff point has been three to five years, but that timeframe is shrinking.
ON Semiconductor in Phoenix reviews assignments after 12 to 18 months because “expat assignments are so costly,” says Jennifer LaCroix, the company’s HR director. “We look at the original purpose of the global assignment and the length of time the employee has been on one,” she says.
The company immediately rules out two assignment types when deciding whether to localize: “We don’t typically localize for a technology transfer, when employees are sent for a year or two,” LaCroix explains. “And some assignments are development-related.”
Sometimes an employee who doesn’t want the assignment to end drives the decision to localize. “The employee may have a good opportunity in the host country that the U.S. [office] can’t match, or maybe the person has married or has family in the area,” explains Maurizio Cascapera, manager of international human resources at Nestlé U.S.A. Inc. in Glendale, Calif. “Maybe they’ve just fallen in love with the country.”
In some cases, though, localization isn’t a good option. Environments can be so unattractive that employees will walk away from the assignment rather than be localized. “A guideline for HR might be to look at places where independent data providers like ORC, Runzheimer International, ECA International, etc., include a hardship allowance—these locations are not good candidates for localization,” says Ken Wade, Deloitte & Touche’s international assignment services tax practice leader in Chicago.
Whatever spurs the decision to localize, HR has a lot of critical information to communicate. Employees will want to know how the change affects them, and they may be overwhelmed by some of the information. The good news is, most experts believe that long-term expats aren’t particularly surprised when the discussion comes up about localizing. Still, HR needs to be prepared for questions.
Pension and retirement issues are of primary concern to expats facing a conversion. “Cross-border integration and transfer of pension benefits is very difficult,” says Robertson. In addition, employees on multiple assignments may not legally be able to accrue retirement credits in their home countries, or their company plan may not allow it. “A bunch of pieces don’t add up to a whole pension because pensions usually have a heavier accrual at the end,” he adds.
In a case like this, companies can set up integrated umbrella plans, Robertson explains. The employee’s patchwork of pension plans will make up a certain percentage of his retirement, and the company provides the difference through an unqualified plan.
“At Motorola, vesting is based on years of service,” Rowe says. “Perhaps an employee hasn’t been in the United States long enough to vest but spent 10 years in the United Kingdom. Motorola looks at those years in the United Kingdom.”
Nestlé also has a global approach to vesting. “If an affiliate is owned 80 percent or more by Nestlé, the employee continues to vest,” says Cascapera. “Of course they can’t contribute to a 401(k) when they’re not on a U.S. payroll.”
Neil Krupp, national practice leader at Deloitte & Touche’s international human resource consulting practice in Chicago, says companies should consider these alternatives:
- Shadow a 401(k) plan by creating a plan that does the same thing. Sometimes this is a book entry rather than a formal plan. The company matches the tax advantage of the 401(k) with increased wages or similar measures.
- Retain employees on their home country plan, if plan language permits.
- Establish an offshore plan. Some parts of the world have fewer restrictions on plan design; companies can register a formal retirement plan in places such as Bermuda, the Canary Islands or the Jersey Isles, and enroll employees there.
- Attach employees to an offshore or global employment company (O/GEC). Again, there may be fewer restrictions on what you can do for employees. Additionally, you can provide for coverage of many nationalities within the employment company.
Krupp recalls a client company that used an O/GEC to accommodate retirement planning for 100-plus expatriates representing 22 home countries. “The employees had sequential international assignments and could no longer be covered under their respective home company plans.” He adds: “Companies can use a similar approach to provide health care-related benefits.”
Salary, taxes and perks
Other typical concerns HR must address include changes in salary, phasing out of allowances and adjusting to taxes in the new home country.
“As a local, the employee will be paid the going rate for a local performing that task, which may result in a cut or a raise,” says Cascapera. If it’s a pay cut, “we do try to ease the blow of the change by transitioning the employee over a period of three years.”
Cascapera’s company eliminates home leave perks 12 months after the localization process begins. Payment of tuition for the employee’s children is retained at 100 percent for three years, but any other allowances are reduced to 75 percent the first year, 50 percent the second year and 25 percent the third year. He adds that these continued allowances are billed back to the foreign affiliate, as is any cost the U.S. office incurs in helping the employee sell a home.
“Housing can be a sticking issue because expats will almost always pay more—the market figures out that they don’t have a lot of choices, and they seldom get the same prices as locals,” says Robertson. “They’re also unlikely to have been owners [in the host country]. Now they’re looking at buying a house and getting money out of one country and into another.”
Companies typically pay employee taxes as part of their equalization allowances for expats, and continue to do so for a few years after localization. But if they can taper off or stop entirely two or three years after localization, then that’s money saved in the long run.
In addition to continuing the tax equalization support for a few years after localization, HR should help employees understand their new tax situation and perhaps steer them toward a tax adviser once support is cut off.
Wade believes that tax preparation assistance should continue until at least a year after all allowances are gone. “A person who prepares his own return in the United States may fill out a 1040 [form] and Schedules A and B [forms],” says Wade. “When that person goes overseas, the tax return can jump to 25 to 50 pages.” And in some countries, income tax payments must be made a couple of years after the fact, he adds.
“U.S. citizens and green card holders still have to file a return in the United States,” Wade continues, “and that gets complicated, too. Employees need help with tax preparation or they will almost certainly pay too much.”
Krupp adds that individual tax misfiling, intentional or otherwise, can be disastrous for companies. “A company may get into trouble if employees don’t file tax returns correctly,” he says. “Typically, work permits and visas are sponsored by the company—which is responsible for the employees’ behavior.”
Krupp recounts an incident in Germany in which a company had localized about 17 employees. “The company left it up to employees to file taxes, and about half of them didn’t report all their income as required under German law.
“German tax authorities found out about the situation,” says Krupp. “Not only did the employees have to make up their back due taxes plus penalties, the company was ‘excused’ from doing business in Germany at all.”
Even when companies have standard policies about localization, they should still allow room for tweaking to fit the situation. “We may have to maintain some benefits, like a second medical plan,” LaCroix explains. “Sometimes, local care may not be adequate or of high quality. Even in places where care is good, cultural differences and language barriers—in a medical circumstance—may require a second medical plan.”
Most issues can be worked out if communication is good and the expat has positive reasons to accept the localization. “Sometimes it has to be a ‘local-plus’ situation,” says Rowe. “The employee isn’t on an expat package but has a little more than the locals.”
Because of this, localization doesn’t save the company the cost of the entire expat package. “Sometimes a local salary will be higher,” Krupp adds. “But depending on the location and how rich the [expat] package was to begin with, employers can typically expect to save 25 percent to 45 percent of the additional costs associated with expats.”
Localizing does have its drawbacks for companies, including the loss of managerial control over the employee, according to Krupp. “The parent company may lose its ability—or it becomes more difficult—to further deploy that employee on another assignment should such an opportunity develop.”
LaCroix points out that what makes an assignment successful is often a sponsor in the home country who is “looking to utilize the expat’s knowledge when he comes back. You lose that when you localize the employee.”
But HR professionals note that the organization doesn’t lose intellectual capital in the “big picture” sense because that person is still working for the company.
Don’t Trip Over Legal Concerns
During localization, HR wears many hats—and some of them may be unfamiliar. For instance, employers will need to arrange for permanent residence status for localized employees. “We rely heavily on our host country affiliate, or we will lean on immigration law firms to help us understand all the ins and outs,” says Cascapera.
That’s an approach most companies take. “Don’t scrimp on getting outside experts involved,” says LaCroix. “This is not a do-it-yourself project, even if it’s only for two or three people.”
Employment law issues become even more of a concern once the employee becomes localized. “Employees will fall under the employment law and jurisdiction of the host country,” explains Krupp. “You will lose the U.S. employment-at-will prerogative.”
Krupp notes that most European countries have strong pro-employee laws. In France, for instance, even an employee who quits is entitled to a termination payment, says Wade. “The company should question beforehand ‘What are we getting into?’ both in terms of employment law and financial exposure.”
Despite all the caveats and obstacles, savings that come from localizing expatriates outweigh the drawbacks, say HR professionals. “The cost of a U.S. expat assignment is usually three or four times the employee’s salary. When we localize, we can bring that down to one-and-a-half or two times the salary, depending on the location,” LaCroix says.
Besides cost containment, localizing has other advantages for companies. “Localizing gives more equity among peers in the host country,” says Rowe. Also, a localized expat brings the business expertise and cultural viewpoint of his or her native country to the new permanent location, which can help the company achieve its diversity goals.
“Companies are making the decision to localize sooner, and they’re implementing the process sooner in the assignment life cycle,” adds Krupp. “This is driven by a desire for cost containment, plus better planning by companies and a desire to realize a return on investment on the expat.”