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Taxation peculiarities of employment of foreign nationals

This Article was published in Apskaitos, audito ir mokesčių aktualijos (No. 45) on 6 December 2016. The author of the following text is auditor Daiva Žumbakienė who was asked to share her opinion on law and tax.

 

An employment of a foreign national, a resident of other country in Lithuania, ten years ago was a rare case, but nowadays it became commonness. Migration of employees between EU countries and transition of employees from third countries turns to be ordinary case, especially when cheap workforce from countries like Belarus and Ukraine are expanding Lithuania.

It is an open secret that favourable geographical position motivates foreign nationals to establish appropriate legal entities in Lithuania (UAB), Latvia (SIA) or Estonia (OU). Thus accountants and Managements of foreign entities face issues like:

·         How taxes should be paid under employment agreement if Managing Director (MD) lives in Estonia and visits Lithuania only couple times a year?

·         Under what type of employment agreement foreign MD should be employed?

·         Do social security contributions from the salary of foreign MD have to be paid in both Lithuania and Estonia?

·         How to account expenses of business trips (per diem) when foreign MD travels to Lithuania for work?

·         Are the conditions equal for foreign MD from EU and foreign MD from Belarus?

·         If employees are third country nationals, additional issues concerning Migration Office should be kept in mind.

In this article I will try to examine problems presented above.

 

Labour Law

Under what type of employment contract foreign MD should be employed: permanent contract or other?

It is a common mistake to assume that employing foreign MD, who is often the only shareholder, for one hour a day under permanent contract is fair from the standpoint of the law. Unfortunately, it is not.

First of all, it is not logical when you realize that MD fails to board a plane and fly forth and back only for one working hour a day and it is almost impossible to do so through the whole year.

Second, foreign MD has to travel for work to different countries. Hence if he has a meeting in USA and accountant marks in a payroll sheet that he was working in Lithuanian at that time, the record is only on paper.

The employment of foreign MD under permanent contract is a discrepancy between what is written and the real life.

Teleworking contract might fit the reality more. It is important that under the teleworking contract the precise address of foreign MD workplace has to be indicated. Putting the Estonian address - the address of residence of foreign MD – might correspond to the facts more.

Nowadays technologies allows to monitor and control entity and (or) group of entities from anywhere of the world. Teleworking contract means that a workplace of foreign MD is in Estonia and not Lithuania. Hence in the payroll sheet the real fact will be recorded, not the fictitious one.

 

Business trips

After employment contract with foreign MD is brought into force, the question of business trips are to be solved. At this moment it becomes clear that often labour law is an integral part of tax accounting and vice versus.

If a person has concluded a permanent contract for one hour a day, the accounting of business trips might become a bane of accountant’s life. Logically the expenses of foreign MD business trips’ cannot be treated as standard expenses of the entity. In this case incurred expenses of business trip have to be imposed with 15 percent tax tariff, i.e. as non-allowable deductions.

Completely opposite situation appears when foreign MD is employed under teleworking contract. In this case the expenses of travels from Estonia to Lithuania should be treated as allowable deductions. Daily allowances have to be paid according to Ministry of Finances of Estonia. Accountant should consistently check whether the rules have not changed.

Employment under teleworking contract and payment of Estonian daily allowances enables expenses to be treated as allowable deductions. All this information (regarding teleworking contract and daily allowances) is provided in Commentary on Law on Personal Income Tax. However, it is a common practice in our country to emphasize minor aspects, while essential ones are suppressed or spoken in whispers.

 

Personal Income Tax (PIT)

Paying salary for foreign MD who is the resident of other than Lithuanian EU country and who is employed under the employment contract raises a question whether PIT should be deducted or should not. Most often accountants say: “I will deduct 15 percent as PIT from the first euro cent and that’s it”. Unfortunately, accountants often trip up about PIT deduction. Tax-exempt amount of income (TEA) (additional TEA) is applied only for Lithuanian residents, thus TEA must not be applied for foreigners. Is it true that 15 percent of PIT should be withheld from the total salary of foreign MD? It depends on the circumstances. Here the complexion begins.

 

Double taxation conventions

Under the treaty for the avoidance of double taxation between Lithuania and corresponding EU country, income received for the work in Lithuania is subject to tax of the Republic of Lithuania. Income for the work performed in other country than Lithuania must not be subject to tax of the Republic of Lithuania; the priority is given to the other country, in this case - Estonia.

Hence the accountant has to calculate in two ways:

1.      When foreign MD comes to Lithuania, income for these days should be subject to 15 percent PIT of the Republic of Lithuania;

2.      When foreign MD leaves Lithuania, income for the period when he is working in a place of residence must not be subject to 15 percent PIT of the Republic of Lithuania.

Accordingly, there will be two different types of declaration in the general PIT declaration:

1.      For the work in Lithuania, as usual to us, FR0572 has to be filled, indicating the part of the salary for the work in Lithuania and PIT deducted;

2.      The salary paid for the work in foreign country has to be provided in Appendix U of Declaration FR0573.

It should be noted that foreign MD has to be included in a box Number of Employees (Declaration FR0572) even though he was not working in Lithuania that month.

 

Social security contributions

According to the directive related to SoDra (State Social Insurance Board under the Ministry of Social Security and Labour), resident of the EU has to pay social security contributions only in one country.

Taking into account the fact that Lithuania has the highest social security contributions, the question arises: “What contributions should be applied to foreigners?” SoDra’s contributions are treated in several ways:

·         In terms of expenses, 39.98 or 41.98 percent from the salary is a lot, especially when the salary paid to the foreign MD is quite solid. Is entity capable of paying so many taxes in Lithuania? Maybe it is worth in case like this to pay foreign MD less and pay social insurance contributions in Estonia?

·         The quality of health care is really high in Lithuania and that is the reason why most foreign MDs agree to pay SoDra’s contributions either from the whole minimum wage or from the half of it. Lithuanian doctors are appreciated in Europe, especially in Scandinavia. Thus, the elderly foreign MDs prefer to pay social insurance contributions in Lithuania, while the younger ones counts whether it is worth it;

·         Regarding pensions, foreign businessmen often considers whether it is worth to pay social security contributions of 39.98 percent from 1000 euros in Lithuania and, respectively, social security contributions from salary received in Estonia. Maybe it is better to prefer one country and, let us say, to pay social security contributions from 2000 euros only in Estonia? Every businessman compares the profitability of the choice and the attractiveness of social security systems. How many years one needs to work in Lithuania to receive a minimum pension? What is the size of it?

 

Form A1

Resident of the EU, after he or she files a request to social security institution of an appropriate country, can get Form A1. The essence of this Statement is described in the following example:

·         Let us say that Estonian resident (spending more than 183 days a year in Estonia), living and working in Estonia, is paying all of social security contributions in Estonia;

·         After submitting Statement A1 to SoDra, income received for the work in Lithuania will not be subject to income tax of the Republic of Lithuania, i.e. it is not obligatory.

Hence, if foreign MD provides SoDra with Statement A1 and his or her income is not subject to income tax of the Republic of Lithuania, there is no difference for the entity under what kind of contract foreign MD is employed.

If foreign MD does not visit Lithuania for an appropriate month, social security contributions for that month will not be deducted.

 

Example

Under the teleworking contract gross salary for the foreign MD is 1000 euros. All month MD was working in Estonia and not a day in Lithuania. The salary to be paid is 1000 euro. Thus gross salary is 1000 euros and net salary is 1000 euros as well.

 

Receiving Statement A1 might take a while. In most cases entity employs foreign MD and pays contributions to SoDra. After Statement A1 is summited to SoDra, overpaid amounts are refunded.

 

Legal differences between PIT and social security contributions

PIT deductions are strictly regulated under double taxation conventions.

Regarding social security contributions, the situation is completely opposite. A person decides himself whether to pay contributions in one or both counties. SoDra does not forbid paying social security contributions in more than one country. 

 

Regarding natural person’s side

We have reviewed questions concerning entity’s profitability in terms of taxes.

Foreign natural person often raises a question: “How should I pay taxes in my homeland and how should social security contributions to SoDra be paid?”

The question above can be applied not only to businessmen, but to IT specialists, doctors and others, working under employment contracts in Lithuania, but for foreign entities (the ones that have no permanent establishments in Lithuania).

When the gross and net salary is the same – 1000 euro, who is paying taxes – employer or employee?

 

PIT

After natural person files annual return in Lithuania, he or she must before 1 May of the calendar year pay income tax deducted from the income received from foreign legal person. In this case resident of Lithuania will be applied with TEA (additional TEA).

 

Social security contributions

How social security contributions should be paid if income is received by a resident of Lithuania, who is working in Lithuania under any kind of employment contract for foreign entity which is not registered in Lithuania? According to the answer received from SoDra, foreign entity has to register in SoDra in order to get an insurer code. In this case obligation to pay all social contributions and to file all requests arises.

 

Pension

According to SoDra, non-resident of Lithuania has to work at least 15 years in order to get minimum pension.

Rules of PIT and social insurance contributions are applied equally for residents of EU and non EU (Ukraine, Belarus, etc.). Contributions to SoDra would be lower, i.e. 9 percent tariff would not be applied, if a person has visa of D category. For ones having not only Category D visa but also temporary residence permit standard SoDra contributions is applied.

 

 

Law and tax are closely related. Without knowing or going deep into separate aspects one can mistake. As the trade between different countries is increasing, specific nuances of double taxation conventions will become relevant and more important. 

 

Auditor Daiva Žumbakienė

Director of UAB Raimda auditas 

 

The member of ACCA and member of LAAA Board (Lithuanian Association of Accountants and Auditors)