Four types of allowances are often included in an expatriate’s compensation package: hardship allowances, housing allowances, cost-of-living allowances, and education allowances. A hardship allowance is paid when the expatriate is being sent to a difficult location, usually defined as one where such basic amenities as health care, schools, and retail stores are grossly deficient by the standards of the expatriate’s home country. A housing allowance is normally given to ensure that the expatriate can afford the same quality of housing in the foreign country as at home. In locations where housing is expensive (e.g., London, Tokyo), this allowance can be substantial—as much as 10 to 30 percent of the expatriate’s total compensation package. A cost-of-living allowance ensures that the expatriate will enjoy the same standard of living in the foreign posting as at home. An education allowance ensures that an expatriate’s children receive adequate schooling (by home-country standards). Host-country public schools are sometimes not suitable for an expatriate’s children, in which case they must attend a private school.
Unless a host country has a reciprocal tax treaty with the expatriate’s home country, the expatriate may have to pay income tax to both the home- and host-country governments. When a reciprocal tax treaty is not in force, the firm typically pays the expatriate’s income tax in the host country. In addition, firms normally make up the difference when a higher income tax rate in a host country reduces an expatriate’s take-home pay.
Many firms also ensure that their expatriates receive the same level of medical and pension benefits abroad that they received at home. This can be costly for the firm, because many benefits that are tax deductible for the firm in the home country (e.g., medical and pension benefits) may not be deductible out of the country.
• QUICK STUDY
1. When and why might an international business adopt a compensation structure for managers based on consistent global standards?
2. What is the function of the balance sheet approach to expatriate pay?