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A topic that continues to gain industry interest is the localization of international assignees in the host country. According to Bosson and Wilkes, this practice continues to grow in use as HR managers, under pressure to trim the costs of global mobility programs, increasingly are turning to localization.

Employers are using localization today more than ever based on perceived cost savings as compared to traditional international assignments. The term “localization” in today’s global environment has developed many variations to its once straightforward and purest form, which is the process of transitioning an expatriate remuneration package (compensation, medical benefits, retirement/pension plans, and taxes) into one provided to a locally hired employee in a similar position.

The fundamental decision to use localization depends on whether the employee will return to the home country. The answer not only affects participation in benefit plans, but also affects important personal financial decisions such as retirement and estate planning, as well as whether to purchase a home in the host location. Localization is a viable option when the understanding is that there is no intention for the employee to return to their home country.

Why Do Employers Localize?

The primary reason most employers move to localization is cost savings. If managed correctly, localizations can reduce costs, although the exact savings (25 to 50 percent) vary greatly depending on location and extent of localization. However, there are other reasons why employers consider localization initially, for example, what began as a temporary assignment may have become a permanent position, or the temporary assignment may have concluded and the assignee has moved into a new role that is really a host-location position.

Localization is not always driven by the employer, as an employee also may request to be localized in the host country. It may be that the job opportunity that the employee wants is in the host country and cannot be matched in the home country or it is time for the employee to repatriate, but there is not an appropriate position in the home country, or the assignee (for personal reasons) simply wishes to remain beyond the terms of the international assignment contract.

Localization Is Easy, Right?

When localizing an employee, there are many complex issues that employers and employees must consider seriously and proactively address as part of the local agreement. Following are a few of the most critical components to consider.

Base salary. The preferred approach is for employers to transition the employee to local salary levels. It is not recommended that the employer simply convert the home country base salary using an exchange rate; rather, total compensation should be compensable to the position the employee will be holding in the host country.

Employment law/immigration. Given that localization is a permanent move, it will be necessary to start a legal permanent residency/citizenship process. Consult with qualified attorneys in both the home and host countries. In some situations, even though the employee is employed in the host location, they still may be entitled to severance payments from the home country organization. There is a possibility the employee will not be able to secure permanent residence in the host country for any number of reasons. Consult legal counsel.

Income taxes. While the employee now will be subject to the host country tax system, he or she may have continuing liability for the home country income taxation. This is a complex issue, and does require research and consideration prior to acceptance of localization. Employers must clearly state what, if any, tax support will be provided so the employee is fully aware of the tax compliance obligation inherent with the localization. Employers should be aware that federal governments do hold corporations to a higher standard of liability for tax filing and payment than the employee. There have been situations where the employer left it to the employees to file tax returns but the employees failed to report some or all of the income as required by the home country (Germany, Brazil). The taxing authorities of Germany and Brazil discovered the failure to report, and the respective governments not only forced the employees to make up their back taxes due plus penalties, but the employer was forbidden from doing business in both Germany and Brazil. The government maintains the position that it was the employer that stationed the employee abroad and is, therefore, responsible for assuring that all tax liabilities are paid in full. Consult with your tax firm.

Pension/retirement benefits. This is the real “800-pound gorilla” in the room that represents formidable challenges to evaluate and resolve for both the employer and employee. Each country has its own rules and regulations as to how long an employee has to work to qualify (be vested) for benefits, and each country calculates the retirement/ pension benefits differently, which makes the integration and transfer of pension benefits extremely difficult—impossible in many circumstances. Multiple “bits and pieces” of pension plans will not equate to a home country peer’s “whole pension,” as there is a heavier accrual in the last years in the calculation itself. In most countries, employees rarely can remain in their retirement (401(k)) or social insurance plans as voluntary contributions are not accepted (only exception might be if they were self-employed) and frequently the employee loses his or her rights to disability benefits. Some of the questions that must be answered include:

1. After the localization, will the employee be able to continue contributing to a qualified pension or savings plan such as a 401(k) plan?
2. If the employee is still entitled to participate in such plans, will future contributions be calculated on the basis of a host country salary?
3. If the employee is prevented by plan rules from participating in those retirement plans and must withdraw his or her funds, who will pay the likely tax penalty? If the employee retains funds in home country qualified plans, the income generated by those funds, though not normally taxable at home, probably are considered taxable in the host country. Who is liable for such taxes?
4. How will the employee’s years of service in the home country count toward retirement benefits in the host country?
5. The employee will retire with split participation in both home and host country social security/pension systems. Will that cause the employee to be subject to a reduction in benefits?
6. How can the employee know what his or her final social security/ retirement/pension income will be?
7. Who will help the employee apply for benefits under a totalization agreement (if one exists)?

Solutions for the Biggest Challenges?

It is a challenge for employers to establish and administer pension programs in multiple countries. Many multinational companies are seeking a global approach to employee mobility and use global employment companies to address these needs.

Establish an offshore global employment organization (GEO), an employee leasing organization, to which your “global nomads” are attached. The organization may be “for profit” or operate “at cost” to the parent, which is a corporate business decision. A GEO permits all global employees who are subject to work assignments in multiple or sequential global locations to be placed on a global pay scale that is compensatory to the position’s responsibilities regardless of the location of assignment, have a formal retirement plan that is registered for multiple nationalities, and provides equitable employment law protections.

If the size of the employer’s global employee population would not justify the cost of establishing a GEO, and the primary challenge is the resolution of the pension/retirement plan issues, then consider a shadow 401(k)-type plan that can be established in an offshore plan. There are several countries that have fewer plan design restrictions and favorable tax regimes to support such schemes.

Challenges With Implementation

While localization offers some clear-cut benefits to employers and employees, localization is not for everyone. Generally speaking, localization will be much more difficult when it involves employees from an advanced industrial nation going to one of the lesser developed countries. Many countries have low standards of living, less sophisticated social security, retirement savings, and pension systems, and less reliable currencies. All of those factors can spell trouble for the long-term planning crucial to localization.

Further, the transition from expatriate to localized employee is most effective when the employee knows up front that the assignment-related benefits will cease and the employee, if he or she wants to remain in the host country, will be localized (i.e., after three to five years on assignment). For clarification, it is recommended the potential for localization be stated in the expatriate policy and letter of assignment.

Localization represents a real alternative to traditional temporary assignments. At the same time, the significant differences between locations around the globe mean that there are challenges to localization that sometimes cannot be surmounted. Certainly, localization programs and policies are in effect and are effective at a number of employers around the globe, but determining if and how they apply in any organization requires consideration of a large number of factors.

Ideal Scenarios for Localization

When attempting to structure the localization agreement of an employee from a highly developed country to a developing country, there are case-by-case modifications that are necessary because of extreme differences in the base pay structures of the home country versus the host country; cost-of-living differentials; and cultural or quality of life differences that made localization an extremely difficult employment status to “sell.” Such “modifications” make the costs savings and intangible benefits of localizations a debatable issue. It becomes apparent rather quickly to multinational corporations that there were certain criteria that make localization a more acceptable option to offer their assignees:

• limited promotional opportunities or the employee has “outgrown” the internal progression structure in the home country;
• significant promotional opportunities in the host country;
• employee’s skills and competencies are in higher demand in the host country;
• salary structure/pay scale of the host country is higher;
• employee benefits and employment laws are more favorable in the host country;
• employee (and/or their family) has personal reasons to want to remain in or transfer to the host country; and
• employee has requested the localization.

There are different approaches to implementing local status. The most common is a straight localization, ceasing all assignment-related benefits effective immediately (housing allowance, cost-of-living allowance, home leave, and the like) on the effective date of localization.

Transitioning from an expatriate-based lifestyle to a local-based lifestyle may take time, hence the reason many employers respond by providing transitional assistance. Transitional assistance may mean employers continue to pay some premiums/allowances for a specified period of time (e.g., one, two, three years) or to provide the allowance on an annual declining scale basis during that time (e.g., 75 percent, 50 percent, 25 percent). This approach is commonly known as a “local-plus” package, which provides allowances less than the full expatriate package, but more than local pay and benefits.

Some assignment-related allow­ances would be phased out over a pre-determined duration of time. For example, many employers will continue to pay a reduced housing allowance for a specified period of (transitional) time after the effective date of localization and phase out education assistance and home leave. In locations where assignees receive a cost-of-living differential, common practice is to stop this allowance immediately. Other assignment incentives such as mobility/foreign service premiums and hardship allowances normally cease with the effective date of conversion to local status.

A less common approach is the lump-sum method that is rarely used because of the tax treatment of lump-sum payments for those employees with both home country and host country income tax exposure. Stated simply, a lump-sum payment is fully exposed to income taxation in both the home and host countries and may not generate as much benefit to the employee as employer-paid (or directly reimbursed) household goods shipment, immigration expenses, and education costs.

Policy? Absolutely!

It is important that employers have a clearly defined localization policy/ agreement that must be communicated and re-communicated to the employee and business manager in the beginning of the discussion to localize. Employers may want two policies; one to address expatriate conversions and another for international transferees who were never on an assignment.

Localization is not the cost-saving solution that so many have made it out to be. The appeal of near-term reductions in assignment program costs can lead to shortsighted decisions that can come back to haunt the employer, the employee, or both.

It is in the employer’s and the employee’s best interest to make sure that all involved understand that localization is not to be entered into lightly. Employee and employer must make some tough decisions and confront the questions of whether the long-term goal is localization or eventual return to the home country, and whether it ultimately will result in cost savings. But, in the long run, the result is better for both the employee and the employer when the right decision is made in the beginning.

Proceed with caution to ensure localizations are managed based on educated decisions by all parties involved.

Yvonne Bosson, GMS, is founder and president of Bosson Consulting, Dallas, Texas. She can be reached at +1 214 499 0237 or e-mail bosson@ybosson.com.

Deborah Wilkes is director, global consulting services, Lexicon Relocation, Jacksonville, Florida. She can be reached at +1 904 390 7195 or e-mail dwilkes@lexiconrelocation.com.