I don´t understand what a tax advance is.  Can you help?

Tax advances are a complicated topic. First, we´re going to presume that your company has a written tax equalization policy.  Second, we´re presuming that your company is interested in tax planning.  A key tax planning technique is to postpone, for as long as possible, the reporting of income.  Tax advances help to do just that.

When a company utilizes tax equalization, the international assignee agrees to pay an annual "stay-at-home" (hypothetical) tax based on the items of compensation that he would receive if he was living and working in his home country.  In exchange, the company pays - on behalf of the assignee - any actual worldwide taxes incurred by the assignee.  These company tax payments may be considered tax advances provided:

• the proper documentation is in place, and
• for financial statement purposes, the advances are treated as loans to the assignees.

Proper documentation would include a signed loan agreement between the assignee and the company.  The signed loan document and proper financial statement accounting will allow the tax advances to be treated as bona fide loans.  As a result, the tax advance is not treated as current year income to the assignee.

How are tax advances cleared?

Tax advances are settled through the final tax equalization settlement in the year following the year of payment.  As a part of the annual tax equalization, the advance is reclassified as tax reimbursement compensation and is reported in the assignee´s income.  The result of this accounting is that you have "pushed" the income from the tax reimbursements into a future year.  This tax planning technique is known as the "one-year rollover". 

Since this tax planning technique only works in some countries, be sure to discuss the one-year rollover methodology with your tax service provider.  (See our May 2004 newsletter for a discussion on the "one-year rollover".) 

To summarize, for tax advances to be effective, you must be in compliance with the documentation and financial statement requirements and the technique has to be recognized in the countries in which you operate