Nevena van Kuyk
Ernst & Young Bulgaria EOOD
During recent years – and especially after Bulgaria’s accession to the European Union – more and more companies have started investing in Bulgaria. Expanding into a new location and developing business ties lends an urgency to companies’ drive to recruit talented employees. To meet business objectives, highly qualified personnel are increasingly being assigned from within the multinational company to apply their expertise and knowledge to the new Bulgarian business entity for a certain period of time.
Cross-border mobility can be of various types. Even though long-term assignments (from one year up to five years) are still not uncommon, there is a trend towards shorter-term assignees (for up to two years), project assignees, business travellers and commuters (employees who work in another country during the week and join their families on weekends). As employers, companies face different challenges when they move staff across international borders. These include immigration permits, payroll and tax withholding obligations in the host country, personal income tax return filings, pension build up, social security, double taxation provisions and various disadvantages of tax residence status of employees. Business travellers and short-term assignees to Bulgaria who usually remain tax residents of their home country may also incur income tax liability in Bulgaria. This article provides some food for thought and indications of possible income tax liability faced by a company’s assignee who (partly) works in Bulgaria.
Formal versus economic employer
When employees work in another country while remaining tax residents of their home country, tax treaties usually determine where and how their income earned abroad will be taxed. Most tax treaties are based on the old Office of Economic Co-operation and Development (OECD) model treaty. In accordance with the old model, most tax treaties make remuneration derived by a tax resident of one country with respect to employment carried out in another taxable only in the country where the employment is carried out (general rule). The old OECD model, however, provides an exception to this general rule. The exception that the income can only be taxed in the country of residence and not the country visited applies if the following three conditions are met:
1. The employee is present in the country of work for a period not exceeding 183 days in a calendar year; and
2. The salary is paid by or on behalf of an employer who is not a resident of the country of work; and
3. The salary is not borne by a permanent establishment or fixed base which the employer has in the country of work.
It can be concluded that if one of the above conditions is not met, the country of work and not the country of residence will have the right to tax the employment income of the expatriate. The above concept of taxation of employment income is often referred to as the 183 days rule. This rule exempts an employee from paying tax in multiple jurisdictions if the employee performs working activities in foreign countries for just a short period of time and meets all the conditions. Provided the expatriate is present in the other country for less than six months in a calendar year (a tax year or a 12-month period), whetherthe country of work has the right to tax his employment income depends primarily on the answer to the following question:
Which company is considered the employer during the period of the assignment?
Tax treaties are based on the so-called formal employer concept but are giving way in more and more countries to the concept of the so-called economic employer. A formal employer is the entity with which an employee has an employment contract, ie, there is a formal legal relationship. The formal employer is usually the company in the home country which sends the employee abroad, pays his salary during his assignment and cross charges the costs to the host entity. The economic employer, by contrast, is the company under whose instructions and for whose risk the employee works on a daily basis and derives benefits from his work. This is in general the interpretation which the OECD commentary offers as a basis for the OECD conform tax treaties. It means that substance over form should prevail as a concept (ie, not the formalisation of the employment relationship through a legal contract but the actual factors indicating where the nature of the employment relationship should be leading).
To understand the treaty implications in practical terms, let’s look at an example. An employee of a Hungarian company is assigned for two years to another entity of the same concern in the Netherlands. His salary will be paid by the Hungarian company and salary costs will be cross-charged to the Dutch entity since the work to be performed during the assignment will benefit the Dutch entity. Hungarian law adopts the formal employer concept while according to Dutch case law as from December 2006, the economic employer (ie, the entity to which salary costs are being cross charged and for which risk and benefit the employee works) is adopted. Having a formal employer in his home country (in Hungary) and an economic employer in the host country (in the Netherlands), the Hungarian employee may face the threat of double taxation. Should he remain a tax resident of Hungary for the assignment period, Hungary will not give relief from double taxation on the income which will be taxable in the Netherlands since there is an employer there. The employee will be taxed in any case from day one in the country of assignment.
The Bulgarian situation
Looking into the situation in Bulgaria, until recently, working in Bulgaria was regulated under its most common form, ie, the legal employment contract concluded between an employer and an employee. Therefore, answering the question about the company which is considered the employer was not a complicated task. As of January 1 2008, in Bulgarian income tax law the legal employer definition has been broadened by introducing the economic concept of employer. An employer is considered any resident or non-resident entity carrying out activity through a permanent establishment or a fixed base in Bulgaria as well as any representative office, which hires individuals under an employment relationship or is a party to a cross border secondment arrangement.
The wider employer definition affects Bulgarian companies which have foreign secondees working in Bulgaria who control the working activities of the secondees and bear the costs of their assignment. These companies as employers have an obligation to process monthly payroll and salary tax withholding on the employment remuneration of the secondees in Bulgaria as they do that for their local employees. Having an employer in Bulgaria, an assignee will be taxed in Bulgaria on his employment income, naturally only for the part related to Bulgarian working days.
Under the provisions of the applicable tax treaty, should the assignee remain a tax resident of his home country while working in Bulgaria for a Bulgarian employer, it is likely that his home country should give relief for double taxation for the part of the salary which is allocated for taxation to Bulgaria. However, a personal tax return filing obligation occurs in general for the individual and a monthly tax withholding and transfer of taxes to the Bulgarian Revenue Agency is compulsory for the resident company. In addition to it, a tax return has to be filed in the home country as well, ie, the employee himself will have the added administrative burden of being under two tax systems.
Meeting the challenges
As Bulgaria adopts the economic concept of employer as a host country while in the home country the formal employer concept has been adopted, both employees and employers will be confronted with a more complex situation. Companies often think that no tax liability is involved for their employees in Bulgaria as they will be here only for a very short assignment period. Even for very short-term projects, having a company considered an employer in Bulgaria will create payroll process and monthly tax withholding obligation.
Additionally, the remuneration of the secondees is often paid partly by the sending entity and partly by the Bulgarian one whereby certain compensation elements are paid by the foreign entity directly to the foreign employee’s account. While all remuneration elements that are taxable under Bulgarian tax law regardless the country of payment should be clearly identified and have to be processed through the monthly Bulgarian payroll. It is, therefore, very important to allocate correctly and in a timely fashion the foreign remuneration package to determine the Bulgarian gross income.
Furthermore, companies with global mobility programmes often use the so called tax equalisation agreement as a basis for the secondment structure. This structure implies that the employees assigned to Bulgaria receive a gross remuneration package with a guarantee from the company that they will not pay more taxes in Bulgaria during the period of secondment in comparison to the taxes which they should have paid if remained their home country. The company then bears the cost of the excess of taxes in Bulgaria. Tax equalisation agreements are not covered by Bulgarian income tax law, which refers to a gross amount of employment income as a taxation basis. How to convert a net amount of guaranteed foreign salary to Bulgarian standards and tax it on a monthly basis? In principle, this should be done in a similar way as in the annual tax returns before the change in law.
However, to process a correct payroll on a monthly basis and ensure compliance with the provisions of the law implies prompt information regarding the exact number of working days and salary components of the secondee in Bulgaria and co-ordinated good communication between the Bulgarian entity, the foreign entity and the tax services provider.
Since there are still grey areas as from the very recent introduction of the economic concept of employer in Bulgarian tax law, it is advisable that companies review their global mobility programmes, analyse the personal income tax exposure and be aware of their obligations in Bulgaria provided they are considered an economic employer for their expatriates.
