The Decision To Go Local: Some of the Practical Issues To Consider When Localizing Foreign Nationals in the United States

by Ed Kennedy, KPMG LLP, Atlanta
(KPMG LLP in the United States is a KPMG International member firm)

Although it is not a new phenomenon, a growing number of companies are warming to the concept, and the practice, of localizing employees on assignments to the United States. When a company decides that there are compelling reasons for moving an assignee from an "expatriate package" to a "local package," the challenges can be complex and sensitive. The company's international assignment program administrators, in such cases, are faced with the many issues arising from moving an assignee from his or her expatriate package to a local compensation package. When this happens, the administrators should reach out and work with a variety of individuals and groups, both inside the organization and outside, to develop an approach that will be effective, sensitive, and advantageous for the assignee, as well as for the company.

This article sheds light on some of the more common issues encountered when localizing an employee and offers practical approaches to these issues.

What Is Localization?

"Localization" has many different meanings, and companies may even have different localization packages depending upon specific factors. For purposes of this article "localization" is defined as follows:

The conversion of an international assignment remuneration package to one that is essentially identical to normal full-time employees at the location in question: this encompasses base compensation, incentive payments, equity plan participation, perquisites, retirement benefits, and social security plans.

Why Consider Localizing?

The impetus for deciding to localize an international assignee may stem from business or personal considerations. Below are highlighted some of the more common considerations related to localizing:

Business Considerations

• A need for the employee on assignment to remain in a particular position indefinitely. This often occurs after an assignee has been at a particular location for a certain period of time and local management decides that this person is a good long-term "fit" for the position. (This rarely occurs at the beginning of the assignment.)
• A transfer of all or part of a business unit to a particular location. At the time the business unit is relocated, management may decide that some of the employees currently working for this unit should be retained at the new location. The issue for these employees is when should the localization occur.
• The recognition of potential cost savings to the company by placing the assignee on a local program—it could be more tax-efficient and, therefore, not as costly to the employer. The costs can be particularly lower with respect to social security and retirement plans.

Personal Considerations

• The assignment is in a location the assignee finds attractive due to factors such as climate, culture, and social policies, etc.
• The assignee may not have any particular ties to the "home" location—it may have been merely another international assignment or the assignee may have been away from the original home location for such a long period of time that ties to the home country have been lost, or, at least, are not so strong.
• The assignee marries a local individual and wishes to remain in the U.S.

When To Consider Assignees for Localization

The time for localizing an assignee depends upon many factors: a company's business goals and strategies, costs, immigration, resource needs, personal reasons, etc. Once the decision is made to localize, the company should go ahead and localize as soon as practicable, rather than waiting for the end of the employee's assignment.

Often the decision to localize is made after the employee has been in the U.S. for five years. The "five-year rule" generally correlates to the length of time an assignee can remain in home country social security plans when transferring from a country that has a "totalization agreement" with the U.S. (which allows for participation in home country social insurance plans for up to five years).

For consistency's sake, many companies take the same approach for assignees transferring from countries with no totalization agreements. This approach also recognizes that after five years, international assignees may typically fully assimilate into the local culture and environment and do not need special allowances to compensate them for the differences between the home and host locations.

When business or personal reasons drive the localization, employers should use those reasons as catalysts for localizing an employee. For example, when a company moves the business unit to the assignee's host location, i.e., the United States, localization should begin as soon as the move is completed.

Barriers to Localization

While localization can provide benefits to both the employer and the employee, administrators should be aware of possible barriers to localization and develop an action plan to address these barriers before the assignee is presented with a localization offer.

These barriers generally can relate to compensation and benefit concerns and concerns related to conflicting company and personal goals.

Compensation and Benefit Concerns

Oftentimes, an assignee is justifiably concerned about a transfer from the home country compensation and benefits plans to the new—and probably unfamiliar—U.S. plans. The home country plans may be perceived as more generous than these plans, or may provide different benefits or levels of benefits.

• Pensions – Employees working in some countries may have a significant part of their pension benefit funded through state plans. In addition, these plans are often defined benefit plans, with the result that employees have a reasonable certainty of the amount of benefits to be ultimately received. This is to be contrasted with the United States, where it is possible that a larger portion of the employee retirement funding is provided through defined contribution plans. As a result, there is a perceived greater unknown benefit potential or detriment with U.S. qualified plan participation than with the more traditional defined benefit plans with which they may be more familiar.
• Expatriate allowances – International assignees receive assignment-related allowances such as home leave, housing, and education allowances. Assignees may be unwilling to part with these allowances before the end of their assignment period.
• Health and welfare benefits – The employee may be entitled to certain health and life insurance, disability benefits, maternity benefits, survivor's benefits, unemployment benefits, and other similar benefits. For these benefits, the barriers we mentioned may be more related to educating the assignee regarding the benefits and common practices in the United States, or whichever the host country, keeping in mind that they have been on special expatriate insurance plans while on assignment in the United States.
• Employment-related benefits – The employee may enjoy, through company benefits plans such things as maternity or paternity leave, partner benefits, and other benefits. This also can include payments such as termination indemnities, which are payments made to employees upon termination of employment. Such payments are not uncommon, and can be substantial in countries such as Brazil and Venezuela.
• Conflicting company and individual goals – While the company may view the employee as the right person for the job, the employee may instead want to repatriate after the assignment ends rather than stay on, let alone be localized. Conversely, the assignee may want to remain in the host country, but the company may not have a position available.
• Immigration issues – While the company and the individual are in agreement that the United States host location is the right permanent location, approvals for an indefinite stay and right to work may not have been granted by the U.S. immigration authorities.

Moving Past the Barriers

The first step in moving past the barriers is to evaluate whether business and personal needs are in harmony. If both parties cannot come to an agreement that localizing is in their mutual interest, then localization should not be considered and, instead, both parties should come to an agreement as to what the employee's future employment options will be (repatriation at end of assignment, termination upon end of assignment, transfer to another location, etc.). Nonetheless, if the parties are in agreement as to the localization, then the employee and employer should agree on the specific issues to be resolved during this process.

Some of the key issues to consider are discussed below.

Salary Issues

The most pressing issue for the employee may be the new localized compensation package. An individual who has been on an international assignment compensation package will likely wonder how the local U.S. compensation package will compare to the current package.

Similarly, compensation administrators will be concerned about the internal equity implications of localizing a person who may currently be receiving an overall package in excess of what a similarly situated local employee would receive.

Rather than merely converting the employee's home country salary into local currency and using this as the new base salary, a best practice for many companies is to determine the appropriate local salary using a salary survey from the company's compensation consultant. Such independent salary information may be used as the baseline for determining the new base salary. This baseline amount can serve as the starting point for the new salary negotiations.

Expatriate Allowances

International assignees often receive over-base allowances to compensate them for items such as home leave, children's education, taxes, and housing. Part of the localization process involves educating the assignee to the fact that these allowances are generally not appropriate for local employees, and indeed, would not be expected by the assignee upon repatriation to the home country. Many companies find it difficult—and indeed sensitive—to remove all the allowances immediately upon localization. Therefore, they may phase out allowances over a period of time; alternatively, the assignee may receive a lump sum to compensate for the loss of his or her allowance.

Cost of Living Comparisons

Understanding the actual cost of living in the home country and the United States is important in any discussion with the assignee about his or her "new" salary. An assignee localizing from a higher cost location to a lower cost location may not receive a significant increase in compensation as a result of the localization and may even see a lower overall compensation package.

Important in addressing this issue is to be able to show the employee a comparison of the cost of living in both locations to establish the impact that a lower compensation level would have on the assignee's overall standard of living. Administrators and localizing employees alike should be cognizant that the current host location living costs and accommodations may not be representative of such costs for similarly-situated local employees.

Tax Implications

Understanding the tax implications of localization is also important. Assignees are often subject to some form of tax equalization while on assignment; consequently, they may continue to understand the home country taxing system, but have little or no knowledge of the U.S. system. Becoming a local employee with local tax obligations confronts that individual with an unfamiliar situation. Managing this process by explaining to the assignee what tax obligations to expect (both income and social taxes) can go a long way towards removing concerns and apprehensions (often based on misunderstandings) about being localized. It can be a good idea for the current tax services provider to discuss the tax implications of localization with the assignee. An individualized tax calculation showing the assignee the anticipated U.S. tax obligation after localization and comparing this to the assignee's current tax obligation or net after-tax pay should be considered.

Benefits Issues

Perhaps the most vexing matter is addressing the disparities in benefits between the U.S. and the assignee's home country. For benefits other than pension and social security (discussed below), the company's human resources (HR) professionals must both identify and develop an appropriate action plan for each benefit that the assignee is currently receiving. Properly analyzing the benefits involves identifying each benefit the employee currently receives, comparing this to the corresponding host country benefit, identifying gaps in the benefits provided, and working with the company's benefits consultants to determine if an alternate approach can be developed. Below we highlight several issues that need special attention in the case of localization in the United States.

• Many countries provide greater health insurance benefits than the U.S. The assignee may also be aware of the many reports in circulation suggesting a lack of health benefits coverage for many U.S. workers and the significant (uninsured) medical costs certain workers have incurred. It is important that HR addresses these issues and explains to the assignee the actual facts about the health plans covering the assignee. HR should assist the assignee with estimating the actual annual cost of participating in these plans under common fact patterns.
• Individuals need at least 10 years (40 quarters) of coverage to qualify for social security benefits, including Medicare. Assignees transferring to the U.S. from countries with which the U.S. has an agreement for totalization of benefits are allowed to count quarters of participation in their home country plans for purposes of calculating their retirement benefits; but this does not extend to Medicare benefits (health insurance provided to individuals over retirement age). Special care should be taken in the case of employees who have less than 10 years of service. In such cases, it may be necessary to obtain special health insurance coverage for these employees.
• Other benefits that may require analysis include maternity/paternity benefits, life and disability insurance, and spouse/family benefits, among others.

Pension and Social Security Concerns

When an employee's career is spent working in multiple jurisdictions, pension and social security concerns take on heightened importance. The assignee may experience a situation whereby he or she is participating in a home country plan that provides benefits equal to or greater than the pension and social security benefits provided by the United States. In such situations, it is best to review the benefits provided by the existing plans and compare these to the benefits under the host country plans to determine the actual benefit/detriment to the assignee as a result of localization.

This is an important exercise; in evaluating the potential benefit/detriment, it is possible that an actual change in benefits may not be as detrimental as imagined, because the comparison the assignee initially makes does not factor all the pension and social benefits provided by the host country. For example, a recent comparative study was performed by KPMG LLP in the U.S. of the estimated retirement benefits for employees arising under a company's U.S. qualified plans (which included both a 401(k) plan and cash balance plan) and U.S. social security benefits, to current home country retirement benefits (social security and complementary pension plans). The study concluded that the assignees would actually receive significantly greater retirement benefits under the U.S. plans than under the home country plans.

Immigration and Labor Law Issues

Individuals localizing in the United States need to have valid work permits. This may mean obtaining permanent residence status. HR professionals and/or immigration law experts (in house or engaged by the employer) should review the assignee's current work authorization documentation and determine what steps are necessary to obtain long-term resident status. The immigration/work permit/residency issues should be addressed early in the localization process to ensure that the assignee is an appropriate localization candidate and will be compliant with U.S. (and home country) laws.

Other Concerns

In addition to the above matters, other assignee concerns about localization can arise.

Given that the employee may have certain estate, trust, and other personal financial plans in place in the home country, will his or her localization to the U.S. have any impact? Some foreign executives residing in the U.S. find that the personal financial planning ideas they implemented in their home countries are not effective, or even tax-disadvantaged, in the United States. Estate planning, trusts, and savings and investment vehicles all need to be carefully reviewed to avoid expensive tax issues.

One common concern is that a newly localized assignee may lack the U.S. credit history necessary to borrow funds to purchase a house or automobile. The company may find it appropriate to work with its local bank to assist the employee, where appropriate, with these issues until he or she can establish a credit history in the new home country.

Another concern may be qualifying for in-state tuition at an educational institution for the employee's children if the employee, prior to being localized, was able to file tax returns claiming state non-residency status. Depending upon the specific fact pattern, an assignee may not qualify as resident for in-state tuition purposes. If this is the case, HR should determine whether the tuition differential should be considered in the localization process.

Communications

Communication between the company and the assignee is crucial during the entire international assignment cycle, and especially if this includes a change in terms and status (i.e., localization). It is vital that the assignee understand what is happening and the steps the company is taking to mitigate the impact of localization and to smooth the transition for the assignee and his or her family. It is recommended that HR prepare an individualized document summarizing the assignee's current compensation and benefits package and compare this to the proposed package, identifying areas where localization will be advantageous to the assignee, as well as areas where the localization may be detrimental to the assignee.

Conclusion

Successful localization in the United States is a process that involves working with the assignee to address the many personal concerns that arise throughout this process, while bearing in mind the company's strategic goals and interests. It should involve internal and external individuals, groups, and organizations that can provide specialized knowledge to assist the assignee (and the international assignment program administrator) in understanding the implications of the localization in all its aspects. Throughout the process, communication is so crucial to helping the employee clearly understand each change. The communication should be both in person and documented in writing to reduce misunderstandings and to help ensure that the localization takes place smoothly and successfully.