Hypo Tax (Tax Equalization)

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Many corporations have developed the policy of "Hypo Tax" or "Tax Equalization" in order to protect their expatriate employees from the financial impact of transferring to countries with different tax rates from those in the home country.

The principle is that in order to make the change in country "tax neutral" for an expat, the company will deduct from the employee's paycheck the equivalent that the employee would have paid in his or her home country, and in turn pay all the taxes due in Italy. Since Italy has a higher income tax burden than many countries, such as the USA, UK, Germany, France, etc.. it is generally an advantageous benefit.

If you are an expatriate sent over by your company, then they will surely have an accounting or tax advisory firm that will take care of this ?the ones I have worked with were quite professional about asking for all the necessary information and preparing your returns. If things go well, you need not even care what you pay in tax in Italy ?that's your company's problem. Your problem is ensuring that your "Hypo" tax is properly calculated, and that all applicable deductions permissible by your home country legislation have been considered. Because that is what will affect what gets taken out of your pocket at the end of the day.

But there are some things that you need to know, such as what to do if sometime down the line the fisco decides that there was some mistake in your return: make sure you keep declared records, and agree with your personnel department ahead of time (when switching to a local contract, leaving the company, or moving to the next assignment) that if something comes up, they will pay for the necessary tax advisors to clear things up ?it happened to me, and fortunately my company came through. One other consideration is that in the framework of preparing your home country Hypo Tax, the guys will also inform the fisco of any financial activities that you have OUTSIDE of Italy ?and the fisco will tend to remember these in the future if you ever switch to a local contract. One last aspect: the hidden tax liability in Italy if you decide at some point to switch from an expat contract to a local contract. For more detail on that, please go on to the next page.

There is one potentially seriouse problem that I did encounter relative to my company's Hypo tax policy when I switched from an expat contract to a local contract in Italy. But the problem would be similar if you go back to your country of origin or on to your next expatriate assignment.

The issue is this: When your company pays the balance of your taxes due for the prior year, the Italian Fisco considers this as additional income that needs to be taxed. So each year, your "declared" income will be steadily growing, even if your salary remains the same. Since your company will always pay the balance of your income tax in the following year, when you leave Italy or switch to a local contract, you will have accumulated an additional tax liability which again will be paid by your company in the year after. Which again creates another tax liability ?and this becomes a never-ending and ever-growing cycle! See simplified example for a three year expat assignment in Italy:

For simplicity, suppose a flat tax rate of 35%

Year 1

Year 2

Year 3

"Real" Taxable Gross Earned Income after deductions

100.000

100.000

100.000

"Artificial" income due to the fact that your company pays the balance of your taxes due in the year after

11.667

13.028

Total Taxable Income as considered by the Fisco

100.000

111.667

113.028

Tax paid to the Fisco on your behalf by company during the year (assume 2/3rds)

23.333

26.055

26.373

Balance on tax due paid in following year (considered income!!) (assume (1/3rd)

11.667

13.028

13.187

Total Tax due

35.000

39.083

39.559

The way out of this mess is a bit complicated, and not very familiar to many Fisco staff ?so make sure that, even if you can do the calculations yourself, that it be prepared by a commercialista or tax advisory firm that can then defend this in front of the fisco. The basic solution is to calculate an "infinite" series of future theoretical tax payments (F.T.T.) exclusively on the "artificial income" (A.I.) for each year in the future, going to infinity, assuming that 100% of the tax is paid in the year after. Over time ?usually within 20-40 years, this will tend towards zero, so you can propose to the Fisco to pay the sum of all future tax payments up front and get this thing over with. Going back to the example above, the calculation would be:

Year

A.I.

F.T.T. @ 35%

3

13.027,76

4.559,72

4

4.559,72

1.595,90

5

1.595,90

558,57

6

558,57

195,50

7

195,50

68,42

8

68,42

23,95

9

23,95

8,38

10

8,38

2,93

11

2,93

1,03

12

1,03

0,36

13

0,36

0,13

14

0,13

0,04

15

0,04

0,02

16

0,02

0,01

17

0,01

0,00

18

0,00

0,00

19

0,00

0,00

20

0,00

0,00

Total

20.042,71

7.014,95

Here, you (actually, have the commercialista do it) tell the fisco that your total future artificial income on this would have been 20.042,71 Euros, and that your company would be willing to pay up front the total future tax deriving from it, equivalent to 7.014,95 Euros. The fisco will be happy because they will get the money up front immediately, and both sides will be rid of an annoying work burden to calculate this on a yearly basis.

Please go to the next page to see what types of deductibles are permitted. Please note that this is not intended as a comprehensive list ?consult your commercialista!

 

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