What is shadow payroll?

Shadow payroll is a specialised payroll process that multinational companies use to handle tax obligations when employees work in a different country from where they’re officially employed and paid. You run a separate tax calculation in the working country to stay compliant with local laws, while your employee continues getting paid normally from home. No double payments, just double tax compliance. It’s called “shadow” payroll because it runs alongside your regular payroll system but serves a completely different purpose: ensuring you meet foreign tax requirements without actually paying the employee twice.

Here’s how it works in simple terms: your employee continues receiving their normal salary from your home country payroll, but you also create a second payroll calculation in the country where they’re working. This second calculation figures out what taxes you owe to that foreign government. The key difference is that whilst your regular payroll pays the employee, the shadow payroll pays nothing to the employee. It’s purely for tax compliance purposes.

Think of it like filing taxes in two countries at once. Your employee gets paid once (through your normal payroll), but you calculate and pay taxes in both their home country and the country where they’re working.

Today’s business landscape sees unprecedented levels of international employee mobility. Companies are sending more employees abroad for:

• Market expansion initiatives
• Technical expertise transfer
• Leadership development programmes
• Project-based assignments
• Remote work arrangements

As governments worldwide crack down on tax avoidance, they’re increasingly scrutinising foreign workers within their borders. Tax authorities want their fair share of revenue from economic activity happening in their jurisdiction, regardless of where the employee is technically employed or paid.

This creates a complex compliance challenge: how do you keep employees on familiar home country payroll whilst satisfying foreign tax authorities’ requirements?

An employee typically becomes subject to local tax obligations when they spend more than 183 days (approximately 6 months) working in a foreign country within a 12-month period. Most countries follow some version of the “183-day rule” for determining tax liability, but this rule is more nuanced than many businesses realise.

Important variations:

• Some countries count calendar days, others count working days
• The 12-month period might be a calendar year, tax year, or rolling 12 months
• Partial days (arrival/departure) may or may not count
• Some countries have shorter thresholds (as low as 90 days)

When employees are sent abroad for more than 6 months, shadow payroll is almost always required. These assignments typically involve:

• Market research and development projects
• Setting up new offices or operations
• Technical implementations or system rollouts
• Executive leadership roles in foreign subsidiaries

Even shorter assignments often trigger shadow payroll requirements because:

• Tax treaties may not apply beyond 6 months
• Host countries require payroll registration
• Social security obligations may arise
• Income becomes subject to local taxation

Employees who regularly commute between countries for work may need shadow payroll, especially when:

• No special tax agreements exist between the countries
• The employee spends significant time in the host country
• Cost-charging arrangements trigger economic employer rules

The rise of remote work has created new shadow payroll scenarios:

• Employees working from foreign countries whilst employed elsewhere
• “Workations” that extend beyond typical business trips
• Flexible work arrangements spanning multiple countries

Short-term specialists moving between projects in different countries often require shadow payroll for each location where they exceed local thresholds.

Most tax treaties provide exemptions for short-term business travel, though you must verify:

• The specific treaty terms between the relevant countries
• That the employee maintains tax residency in the home country
• That costs aren’t recharged to a host country entity
• That no permanent establishment is created

Some jurisdictions, like Switzerland in certain circumstances, don’t require employers to withhold taxes, allowing employees to handle obligations through personal tax returns.

When using an Employer of Record service, the EOR handles all local employment and compliance responsibilities, eliminating the need for shadow payroll entirely. This can be particularly attractive for organisations that want to focus on their core business rather than managing complex international payroll compliance.

Tax liability assessment

• Determine the employee’s current tax residency status
• Analyse host country tax requirements and thresholds
• Review applicable tax treaties and social security agreements
• Assess permanent establishment risks for the company

Assignment structure design

• Define assignment duration and scope
• Establish cost-charging arrangements between entities
• Design tax equalisation or tax protection policies
• Set up communication protocols between home and host teams

Host country registration

• Register with local tax authorities as required
• Obtain necessary payroll tax identification numbers
• Set up local bank accounts for tax remittances
• Ensure compliance with employment law requirements

System configuration

• Establish shadow payroll calculation systems
• Configure tax rates, social security contributions, and local allowances
• Set up currency conversion mechanisms
• Create reporting templates for local authorities

• Data collection: Gather all compensation data from home payroll, including:
  • Base salary and overtime
  • Bonuses and incentive payments
  • Benefits and allowances
  • Assignment-specific payments (housing, education, etc.)
• Currency conversion: Convert all payments to local currency using appropriate exchange rates
• Tax calculation: Apply local tax rules to determine:
  • Income tax obligations
  • Social security contributions
  • Other statutory deductions
• Net-to-zero processing: Ensure the employee receives no net payment through shadow payroll
• Reporting and remittance: Submit required filings and pay taxes to local authorities

• Hypothetical tax calculations: Calculate what the employee would have paid in home country taxes, creating a baseline for equalisation.
• True-up processes: Regularly reconcile home and host country tax obligations to ensure employees aren’t advantaged or disadvantaged by the assignment.
• Year-end reconciliation: Conduct comprehensive reviews to identify any over- or under-payments requiring adjustment.

• Tax equalisation: Under this policy, employees pay exactly what they would have paid in home country taxes, regardless of host country rates. The employer absorbs any additional tax burden or benefits from any tax savings.
• Tax protection: Employees are protected from paying more tax than they would at home, but they keep any tax savings from lower host country rates.
• Laissez-faire: Employees bear the full cost of assignment-related tax implications, both positive and negative.

Social security obligations don’t always follow income tax rules:

Totalisation agreements: Many countries have agreements preventing double social security taxation. Employees may:

• Continue home country social security contributions
• Be exempt from the host country’s social security
• Receive certificates of coverage for treaty protection

No agreement scenarios: Without treaties, employees might face double social security obligations, significantly increasing assignment costs.

Shadow payroll activities can sometimes create permanent establishment (PE) exposure for the home country company, triggering:

• Corporate tax obligations in the host country
• Additional reporting and compliance requirements
• Potential restructuring of assignment arrangements

• Challenge: Collecting accurate, timely compensation data from multiple sources
• Solution: Implement integrated HRIS systems with automated data feeds and establish clear data collection protocols with defined responsibilities and deadlines.
• Challenge: Currency fluctuation impacts calculations
• Solution: Use consistent exchange rate policies (e.g., average monthly rates) and build currency risk into assignment budgets.

• Challenge: Keeping up with changing tax laws across multiple countries
• Solution: Partner with local tax advisors in each jurisdiction and subscribe to regulatory update services.
• Challenge: Meeting different reporting deadlines and formats
• Solution: Create compliance calendars for each country and use standardised reporting templates adapted for local requirements.

• Challenge: Managing multiple payroll systems and ensuring synchronisation
• Solution: Invest in global payroll platforms or partner with providers offering integrated shadow payroll services.
• Challenge: Coordinating between home and host country teams
• Solution: Establish regular communication schedules, shared documentation systems, and clear escalation procedures.

• Challenge: Unexpected assignment cost increases due to tax gross-ups
• Solution: Model different tax scenarios during assignment planning and build contingency budgets for tax equalisation.
• Challenge: Administrative costs of running multiple payroll systems
• Solution: Evaluate the total cost of ownership, including internal resources, and consider outsourcing to specialised providers.

Many organisations find that the complexity, cost, and compliance risks of shadow payroll outweigh the benefits, especially when:

• Speed to market is critical for business operations
• Administrative burden of dual payroll systems becomes overwhelming
• Compliance expertise in multiple jurisdictions is lacking internally
• Cost predictability is more important than maintaining a home country employment contract

Shadow payroll is a complex compliance solution that serves an important purpose: ensuring multinational companies meet tax obligations when employees work internationally whilst remaining on home country payroll. However, the reality is that shadow payroll requires:

• Substantial internal expertise in international tax law
• Dedicated resources for setup and ongoing management
• Robust technology infrastructure and processes
• Constant monitoring of changing regulations across multiple jurisdictions
• Significant investment in compliance systems and local advisers

Whilst shadow payroll can be effective for large enterprises with dedicated global mobility teams, many organisations find that the complexity, cost, and risk factors make it impractical for their needs.

Rather than wrestling with the complexities of shadow payroll, many companies are discovering that an Employer of Record (EOR) provides a more straightforward path to compliant international employment.

What is an EOR? An EOR is a third-party organisation that becomes the legal employer of your international workers whilst you maintain day-to-day management control. This arrangement eliminates the need for shadow payroll entirely.

How Boundless makes it simple: At Boundless, we specialise in compliance-focused international employment solutions. When you work with us as your EOR:

• No shadow payroll complexity: We handle all local employment and tax obligations directly
• Full compliance assurance: Our expertise covers employment law, tax requirements, and regulatory changes across multiple jurisdictions
• Predictable costs: Clear, transparent pricing without hidden compliance expenses
• Rapid deployment: Get your international team operational quickly without lengthy setup processes
• Risk mitigation: We assume legal responsibility for employment compliance, reducing your exposure

While shadow payroll has its place for specific scenarios, an EOR solution often provides a more efficient, compliant, and cost-effective approach to international employment. Instead of managing complex dual-payroll systems, you can focus on your core business whilst we ensure your global team remains fully compliant with local regulations.