Evidence suggests that international payroll processing is already a strategic focus for multi-nationals: In a 2020 Deloitte survey of international enterprises, 88 percent reported that they had a global payroll strategy, or intended to put one in place.
1. Payroll processing is an essential business function for any enterprise with employees. It primarily involves managing payments to employees, making any deductions from their gross pay and remitting employment and payroll taxes to authorities. Payroll does not usually process independent contractor pay
2. International payroll processing presents challenges to both operational efficiency and compliance
3. Useful payroll strategies for international businesses may include automation, regional processing hubs, process optimization, outsourcing and global PEO solutions.
Here we explain what payroll processing is, set out some key challenges for international payroll processing, and offer five payroll strategies.
For an in-depth look at paying employees working globally check out How to Pay Remote Employees Working Around the World.
What is Payroll Processing?
A company’s ‘payroll’ is the list of everyone who is on that company’s ‘list’ of employees. ‘Payroll processing’ is the function within a business that deals with the payments to employees. The payroll processing unit of a business deals with:
- Administering accurate timesheets, or for salaried employees, accurate salary information
- Making necessary deductions such as required pension or student loan contributions
- Withholding employee income and payroll tax
- Remitting income and payroll tax and deductions to the authorities at the necessary intervals
- Organizing direct deposits/automatic payments or dispersing checks for employee payment and recording those amounts for employees in pay stubs (also known as ‘payslips’)
- Garnishing wages in accordance with court orders relating to child support, alimony/maintenance debts and other matters.
International payroll processing is payroll processing across international borders (including ‘shadow’ payroll).This brings distinct operational and compliance challenges compared to processing payroll domestically. We consider these challenges below.
Does International Payroll Processing Cover Contractors or Freelancers?
It is becoming increasingly common for businesses to draw on independent contractors or freelancers for their workforce. In many cases, this provides flexibility and cost savings that cannot be rivaled by traditional employment.
In a colloquial sense, independent contractors are on the list of individuals paid by the enterprise so we might be inclined to say that they are ‘on the payroll’. This is a mistake, however. It is important for compliance, legal, and operational reasons that an enterprise treats its employees and independent contractors distinctly. The reason is that businesses only withhold taxes, and make necessary contributions on behalf of employees.
Independent contractors are required to file their own taxes and make necessary contributions themselves. This means that contractors need to be dealt with separately on an operational level to ensure that taxes and contributions aren’t mistakenly withheld.
In addition to the operational risks, there is a serious compliance risk if payments to contractors are processed alongside payroll processing: This is the risk that tax authorities and other regulators might perceive it as employee misclassification.
Incorrectly classifying a worker as an independent contractor can result in significant back-taxes, penalties, and payment of missed contributions.
In order to properly distinguish payments to employees and payments to independent contractors, many large enterprises assign the tasks to distinct business units (e.g., vendor management, rather than payroll) to ensure that separate procedures are followed. However, it is possible for both employees and contractors to be paid by the same business unit, as long as the payroll policy and procedures make it clear how the two are to be distinguished.
How to Process Payroll
How is payroll processing actually carried out in reality? While processes differ, depending on the country (or where within a country, depending on state or territory), the general process is as follows:
- Step One: Define payroll policies and procedures
- A rigorous and compliant payroll function requires payroll administrators to follow duly authorised policies. Ideally, a standalone ‘payroll policy’ is developed to apply across the organization. A payroll policy covers such matters as the payment schedule, acceptable payment methods, deductions, benefits, how to deal with overtime and undertime, and the sign-off process.
- For companies operating internationally and carrying out payroll themselves, it is important to have a separate policy, or distinct procedures for employees in different countries.
- Step Two: Register with the appropriate authorities
- In most countries, employers need to register with the tax authorities before making payments to employees. In the United States, this means registering with the Internal Revenue Service (IRS) for an Employer Identification Number. In the United Kingdom, this means registering with HM Revenue & Customs (HMRC) for PAYE (‘Pay as you Earn’). Keep in mind that this registration must be carried out in every country that an international business operates in.
- Step Three: Ensure all necessary information is available
- In order to process payroll, an accurate set of employee information must be available. Much of this can be gathered at the time of, or shortly after, hiring. In addition, employers must ensure that accurate information relating to all benefits, deductions, garnishments and tax withholding are available.
- Ideally, all information should be maintained in a comprehensive database compliant with applicable data protection rules and regulations.
- Read more about this at What is Payroll Data and How Is It Useful?
- Step Four: Process payroll
- Generally speaking, calculating payroll begins with gross pay. Then, from that amount, all taxes, health insurance contributions, pension contributions, workers’ compensation levies, other deductions and any applicable garnishments are applied.
- This process should be carried out periodically: either weekly, bi-weekly, monthly, or semi-monthly, as required by the payment schedule.
- Step Five: Remit withheld amounts at required intervals
- Withheld income and payroll taxes must be remitted to the tax authorities at required intervals. Similarly, all essential contributions must be remitted to the relevant bodies (such as pension funds) as required.
- Step Six: Maintain compliant payroll and payroll records
- All payroll information must be maintained accurately and in accordance with applicable laws (such as data protection and tax laws).
- It is worth noting that a failure to file payroll tax returns, or filing inaccurate returns, is taken very seriously by tax authorities and in some cases may constitute tax fraud.
Why Does Payroll Processing Matter?
Payroll processing is probably not your core business. However, it’s something that your organization needs to get right. The same goes for international payroll processing. In New Zealand, a poorly implemented payroll solution nearly un-seated a Government (for more on implementation processes check out The Complete Guide to Global Payroll Implementation).
In 2012, the New Zealand Government introduced a payroll solution from Australia called ‘Novopay’. It was an unmitigated disaster. Thousands of teachers went unpaid, with 90% of schools affected. This ended up costing the government $45 million to rectify. It also resulted in the resignation of several senior bureaucrats, as well as a seriously bruised reputation for the sitting National Party Government.
While introducing any new payroll process carries an element of risk, you cannot afford to continue with outdated, overly complicated payroll processing systems.
Below we look at some of the key challenges that are faced by international payroll processing and set out several payroll strategies for responding to those challenges.
The Operational Challenge for International Payroll ProcessingSome of the challenges of operating an international payroll include:
- Legacy in-house payroll functions
- For some companies, payroll is processed in-house. This isn’t done for any strategic reason, rather, it’s simply the way things have ‘always been done’. Whilst this may have made sense in the company’s early days, often little thought has been given to outsourcing or superior payroll strategies. This becomes even more problematic when operating across international borders with different laws and payroll customs.
- Managing remittance and payment methods
- In some countries, employees still have the right to demand payment by check. Businesses need to consider which payment mechanisms they will permit in different countries, within the bounds of the law. Having multiple payroll processing methods can be time-consuming, costly, and lead to an increased rate of error. To read about some of the international rules that apply to processing payments internationally read What is Global Compliance and Why Does It Matter?
- Prompt error correction
- Some degree of error in payroll processing is inevitable. However, significant time can be sucked up for organizations that do not have a process in place for detecting these errors and promptly correcting them. This problem is multiplied when dealing with payments across multiple jurisdictions.
- Accounting for employee leave and absences
- This is a general sticking point for payroll processing systems. Systems need some way of automatically accounting for the effect of employee leave and absence on employee payroll. As many company systems still require employees or their managers to manually account for these absences, there is significant room for human error.
- Integrated software systems
- Payroll errors regularly occur where there is a disconnect between human resources (HR) software platforms and payroll processing platforms. Not all organizations have integrated these systems, particularly across international boundaries.
- International variations
- With employees spread over several different countries, international enterprises need to manage the tension between payroll differences in each country, and the importance of implementing enterprise-wide policies.
The Compliance Challenge for International Payroll Processing
Being responsible for payroll across several international locations means ensuring that complex payroll requirements comply with each location. Some matters that need to be taken into account include:
- Correct calculation of payroll and income withholding tax
- Employers have a responsibility to ensure that the correct amount of tax is withheld and sent to the tax authorities in each jurisdiction they operate in. A related tax concern is whether the presence of employees in a country will create a ‘permanent establishment’, and leave the company liable to pay corporate income in that location
- Withholding/deducting employee benefits and contributions
- This means ensuring the correct amounts for employee benefits such as health insurance, workers’ compensation and pension contributions are paid. This presents a challenge as required deductions differ considerably in different countries (for example health insurance contributions are not mandatory everywhere). Relatedly, employers need to ensure that 13th month pay is provided in every country where that is legally required
- Data protection
- Payroll information contains employee personal data which is protected under a range of data protection laws including the General Data Protection Regulation (GDPR) for employees in the European Union, the California Consumer Privacy Act for employees based in California, the LGPD in Brazil, and the China Civil Code for employees based in China (this came into effect 1 January 2021).
- Payroll processing must have systems in place to protect this information from unauthorized processing or disclosure
Five International Payroll Strategies
Given the challenges involved, what can an international enterprise do to improve its payroll processing? Payroll strategies to improve operational efficiency and compliance include:
- Automating as many aspects of payroll as possible has a range of benefits. It increases the accuracy of payroll data, makes it easier to comply with international data protection laws (such as the GDPR), and enables a range of reports and data analytics that may be useful to organizations (e.g., up-to-date analysis of overtime and predictions of future use).
- Set up regional payroll processing hubs
- If an enterprise has several locations in Asia, for example, they might process payroll in just one location. This strikes a balance between fully ‘localized’ payroll processing, and reducing the possible costs of duplicating payroll processes.
- Establish quality improvement processes and optimize payroll
- While some degree of error is inevitable, international enterprises need systems in place to monitor their payroll processing on a range of payroll performance metrics to identify areas for improvement. For example, possible measures include the number of payroll errors as a percentage of total payments and the number of days needed for error correction. Payroll should be marked in a rolling schedule for review and internal audit.
- Payroll frequency is another area that can be optimized to increase the efficiency of payroll. While fortnightly payment is common in the United States, monthly payment is common in various countries in Europe and Asia. Where appropriate in a certain country, there are significant cost savings to be made by reducing the frequency of payroll.
- Outsource payroll
- According to one recent survey, over 40% of US companies outsource their payroll. This is hardly surprising, as providing payroll services in-house can be costly and inefficient. Payroll specialists know how to process payroll quickly and cost-effectively, freeing up your time to focus on revenue-generating aspects of your business.
- You could contract payroll processing to a third party as a form of business process outsourcing (BPO). This company would be responsible for ensuring that payroll is processed in accordance with applicable laws and any internal policies. These obligations are set out in a contract for service.
- Engage a global PEO
- Through this option, a Global Professional Employer Organization (‘PEO’) becomes the legal employer of the workforce in a particular country. Your company (the ‘client company’) still retains day-to-day control of the workforce, but the PEO takes on all employer obligations, including payroll. The key difference between using a global PEO and outsourcing is that a global PEO takes on the legal and compliance obligations of an employer, whereas in outsourcing they do not.
Frequently asked questions
Human resource management (‘HR’) is the section of the business that deals with staff/personnel-specific issues: Specifically, their hiring, administration and training.
From the employee’s perspective, payroll processing could be the most important part of employee administration: Payroll processing is the function within the organization that transforms the individual’s total or ‘gross’ pay into their ‘net’ pay (the amount they actually take home)
The steps to processing payroll are:
- Develop payroll strategy, policies and procedures. For example, consider whether it is worth outsourcing payroll
- Ensure that the business has all necessary tax and regulator registrations (for example, payroll registration in Australia, and an Employer Identification Number (EIN) in the United States);
- Gather necessary information from employees (such as the information necessary for a W-2 form in the United States);
- Process payroll on a regular schedule
Remit necessary amounts to tax department and other regulated entities
- Ensure ongoing compliance with the payroll process.
Global payroll (also called ‘international payroll’) means the payroll function of a company with multiple international locations.
Global payroll can be managed by the company itself through setting up individual subsidiaries or companies in each country in which it operates. Or, it can be contracted out to a third party payroll firm or global PEO firm that takes care of this function for client companies.
It can be. No matter what the size of the business, setting up a compliant payroll function that will keep employees satisfied can be complicated and expensive. For example, ensuring that each employee has the correct income tax, payroll tax, social security and pension contributions, workers’ compensation levies etc deducted is no easy matter.
It is for this reason that many companies see the benefit in outsourcing the payroll function to a third party.
There are several options.
International employees can be paid through a subsidiary of a global enterprise specifically set up in a given country. Or, they can be paid through a global PEO solution.
Another possibility is a ‘shadow payroll’ set-up where an individual gets paid in their home country, but a system is set up to ensure full payroll compliance in the country they are currently living in.
Ensuring international payroll processing is integrated across different countries, as well as sensitive to local differences, is a major challenge for international businesses. That challenge partly arises from operational processing issues: managing various payment methods, promptly correcting errors, dealing with employee leave and absences, integrating software systems, and managing local variation. But it is also a result of potential compliance risks, including tax and employee benefit liabilities and data protection.
A range of payroll strategies exist to help deal with these payroll processing challenges. Horizons can help with a fully outsourced payroll processing solution or global PEO solution.
Get in touch today to work out which solution is best for your enterprise.