What Are the Characteristics of the Balance Sheet Approach?

Expatriate assignments present distinct challenges for both employees and companies, extending beyond the professional realm into personal financial well-being. Ensuring that an employee’s financial standing remains consistent across international borders is a complex undertaking. The balance sheet approach has emerged as a widely adopted method to navigate these complexities, providing a structured framework for compensating employees on global assignments. It aims to maintain financial neutrality for expatriates.

Foundational Principles of the Balance Sheet Approach

The core objective of the balance sheet approach is to achieve “equalization,” ensuring that an expatriate’s purchasing power and standard of living are maintained at a level comparable to what they would have experienced in their home country. This means the employee should neither gain nor lose financially as a direct result of their international assignment. A fundamental aspect of this method is the use of “hypothetical” amounts, which are theoretical figures representing what the expatriate would have paid for certain expenses had they remained in their home country. These hypothetical amounts, such as hypothetical home country taxes or housing costs, serve as benchmarks in the compensation calculation. They are not actual deductions from the expatriate’s salary but rather conceptual figures used to determine the necessary allowances and adjustments. The balance sheet approach aims to guarantee the assignee the same net income and disposable income as if they had remained home-based, with their original base salary and taxable domestic income.

Key Compensation Categories

The balance sheet approach meticulously addresses specific categories of an expatriate’s compensation to ensure the equalization principle is applied across their financial life. The goal is to provide an equivalent purchasing power in the host location to the one the employee had at home.

Goods and Services

This category covers everyday living expenses. Adjustments are often made using cost-of-living indices, which compare the prices of a defined market basket of goods and services between the home and host locations. For instance, if the cost of groceries, transportation, and recreation is higher abroad, a cost-of-living allowance (COLA) is provided to offset this difference. This allowance ensures the expatriate’s home purchasing power is protected for their daily needs.

Housing

Housing costs can vary significantly between countries, and the balance sheet approach accounts for these differences. It addresses the costs associated with rental accommodation in the host location, ensuring the expatriate does not pay more than they would have in their home country. This might involve a housing allowance or direct payment of rent by the company, subtracting a “housing norm” or hypothetical home country housing expense that the employee would typically incur.

Income Taxes

The approach aims to neutralize the impact of differing tax rates and regulations between countries. This is achieved through a process called tax equalization, where the employee contributes a “hypothetical tax” amount, representing what they would have paid in home country taxes. The employer then covers the actual income taxes in both the home and host locations, making certain the employee’s tax liability remains financially neutral. Hypothetical taxes are withheld from the employee’s gross salary but are not remitted to the home country’s tax authorities; instead, the employer uses these funds to manage the actual tax obligations.

Savings and Investments

Maintaining an expatriate’s ability to save and invest is another characteristic addressed by this approach, ensuring their long-term financial goals are not adversely affected by their assignment. The balance sheet model protects the employee’s capacity to build wealth and accumulate savings as if they had remained in their home country. This ensures that the portion of their income typically allocated to savings and investments remains intact, regardless of the host country’s economic environment.

The “Build-Up” and “Build-Down” Mechanism

The “Build-Down” Mechanism

The practical application of the balance sheet approach involves a conceptual “build-up” and “build-down” mechanism to arrive at the total expatriate compensation package. This process starts with the expatriate’s “home country hypothetical” salary, which represents their expected income and expenses had they not taken the assignment. This hypothetical salary serves as the baseline for all subsequent calculations. The “build-down” aspect involves hypothetically deducting home country expenses from this hypothetical salary. These deductions typically include hypothetical home country taxes, housing costs, and goods and services expenses. These are not actual withholdings but rather theoretical subtractions to determine the “spendable income” and “reserve” that the expatriate would have had at home. The remaining amount after these hypothetical deductions represents the portion of their home salary available for discretionary spending and savings.

The “Build-Up” Mechanism

Conversely, the “build-up” phase involves adding assignment-related allowances and premiums to ensure financial neutrality in the host country. This includes mobility premiums, which incentivize the international move, and allowances for host country housing, goods and services differentials (COLA), and education for dependents. Tax equalization payments are also added to cover any actual tax liabilities exceeding the hypothetical home country tax. This comprehensive “build-up” ensures the expatriate’s final compensation package allows them to maintain their home country standard of living and financial capacity in their new international location.