Shadow Payroll: What Is It and How to Get Started

From acquiring talent to maintaining global compliance, there are many things to consider when expanding into a new market. Many organizations choose to send an employee abroad to the country they wish to expand into to test the market, to create a more seamless working relationship with local and international offices or to build relationships across markets. In doing this, the organization will have to keep the employee on their payroll while also meeting legal obligations in the host country.

Investing in a shadow payroll can assist in this. We are taking a closer look at what shadow payroll is and how it can benefit your organization.

• What Is Shadow Payroll?
• How Does Shadow Payroll Benefit Global Organizations?
• How Shadow Payroll Works in Practice
• How to Get Started With Shadow Payroll

What Is Shadow Payroll?

Shadow payroll assists with an ex-pat employee’s host country taxes while the employee is on assignment in the host country. By using a shadow payroll, the employee remains on their home country’s payroll. 

This means the payroll in the host country will ‘shadow’ what is being reported in the employee’s home country. However, they will not receive any compensation from the host country. 

How Does Shadow Payroll Benefit Global Organizations?

When sending an employee to work abroad, an organization faces several challenges, such as payroll and tax in the host country. You can do a few things to ensure your business remains compliant, such as creating a legal entity in the host country.

Unfortunately, creating a legal entity in the host country can take months to do - and it will also incur financial obligations. On the other hand, there is the option of a shadow payroll which is easier and more cost-effective to implement.

A shadow payroll benefits organizations by protecting them from paying fines and penalties associated with non-compliance while an employee lives abroad.

How Shadow Payroll Works in Practice

If you are a US-based organization hoping to expand internationally, you may decide to send an existing employee on a three-year assignment to a country, such as the UK, for a variety of reasons. Your employee will remain on a US payroll during their time in the country. 

Although it seems simple enough to send an employee abroad for a certain amount of time, this brings various obligations. Your employee’s length of stay and their job while staying in the UK will likely require income and social taxes paid to UK authorities, both on your employee’s behalf and on your company’s obligations under local law.

As a result, you may have to establish a legal entity to make these payments. This is dependent on the nature of the activities your employee will do, where they will do it and whether you expect to hire more employees in the UK. Even in situations where a legal entity is not necessarily required, your organization must register a local payroll. 

You may find your employee’s assignment requires your company to set up a UK legal entity and remit taxes to UK authorities. It is important to remember that since US citizens are taxed on their worldwide income, your employee will also be taxed by US authorities on money they earn while working in the UK.

Fortunately, the US and UK have a tax treaty and a social security agreement. The social security agreement means your employee will not have to pay UK social security. However, the tax treaty will not protect your employee from UK income taxes unless the assignment lasts under six months.

This is where a shadow payroll comes in. Establishing a shadow payroll in this situation will allow the employer to remain compliant with host-country income tax obligations while also paying the employee at the same time on a US payroll and fulfilling US tax and social requirements. 

How to Get Started With Shadow Payroll

Here are five steps to follow to get started with shadow payroll and enroll it within the global payroll system. In the example above, the employee’s home country is the US and will work in the UK. Here is how the company would implement shadow payroll:

1. Confirm the employee’s home country and add them as a joiner to the home country payroll.

2. Process the US payroll with variable pay elements as standard.

3. Prepare the US payroll reports required for internal staff or payroll providers who process global payroll in the host country.

4. Add the US employee onto the UK payroll as a new starter.

5. Implement tax equalization and hypothetical tax.

Hypothetical tax is required if there is no foreign tax scheme. This means any tax difference will be offset so working abroad is neutral for the employee and they can pay taxes as if they are still living in their home country.

To learn more about expanding internationally and the services available to help organizations do so seamlessly, we have written a page filled with everything you need to know. It outlines how a Global Employer of Record (EOR). can help you with the process.

Whether it is a national or international expansion you are pursuing, a Global EOR supports businesses through HR outsourcing and maintaining growth momentum. You can learn more about what a Global EOR is and how they can help you using the button below.