Expatriate International Cost of Living

Organisations spend insufficient time creating a well designed expatriate remuneration strategy and policy. This is dangerous given that the highest employee turnover is at the beginning and end of international assignments, indicating a lack of integration of expatriate pay philosophy with the broader organisational pay philosophy.

The remuneration of expatriates often tends to be a rushed last minute decision due to urgent operational requirements. The resulting implications often only arise after the expatriate arrives in the host country, and when the assignment comes to an end. For example, the post assignment position back in the home country pays less than the expatriate earned on assignment.

Inconsistent treatment of expatriates quickly leads to unhappy expatriates. Once an organisation has more than 1 or 2 expatriates in the field it becomes vital to have a defendable expatriate pay philosophy in place. This philosophy should clearly convey the organisation’s remuneration principles regarding expatriate assignments. An expatriate assignment pay philosophy is intended to provide guidance in the consistent and equitable treatment of all expatriates and forms the basis of the organisation’s expatriate pay policy.

Most large global organisations have over time established a clear policy for remunerating expatriates. This is often a legacy policy, where past practice has become policy. However expatriate pay is a complex area of remuneration with complex issues such as volatile exchange rates, weak and strong currencies, constantly changing differences in cost of living between countries, different tax regimes, as well as the reality that there are attractive and not so attractive countries to work and live in. This is an area where a clear philosophy and an aligned practical policy are required to ensure attraction, fairness, equity, motivation and retention.

Firstly let’s deal with what makes an employee an expatriate. In my view an expatriate is a person working in a foreign country, where they are not permanently resident, on an assignment of typically not more than 3-5 years but is a citizen from another country. There are as many different expatriate pay practices as there are organisations employing expatriates. However we can identify at least four broad approaches to expatriate pay that has emerged as the dominant philosophies underlying expatriate pay.

Salary Build-Up (SBU)

The Salary Build-Up approach uses the current market related home salary as the base for calculating the expatriate package. Home in this case is the country where the employee permanently resides or is a citizen. The purpose of the build-up approach is to maintain internal equity between countries and to equalise the impact of differences between country tax rates. This ensures that expatriates neither lose nor gain as a result of tax treatment in the host country.

The Salary Build-Up approach typically involves deducting hypothetical tax in the home country, and builds on top of the home salary with an international premium (to compensate for hardship experienced), cost living index and the exchange rate to calculate a total net (i.e. after tax) assignment package.

The net assignment package is then “grossed up” in the host country for local tax and other statutory and non-statutory deductions to ensure the net pay assignment package is paid to the expatriate.

Salary Purchasing Power Parity (SPPP)

The Salary Purchasing Power Parity approach uses the principle of putting all expatriates within the organisation on an equal footing regardless of nationality and geographical location. The purpose of the SPPP approach is to ensure parity in the level of the purchasing power of the salary of expatriates doing the same job at the same level in different parts of the world, taking hardship, cost of living, and exchange rate differences into account.

This approach is typically used by global organisations that have a large number of expatriates, who move from one international assignment to another and compete globally for skills. Organisations using the SPPP approach typically establish a single global pay scale which is often by default that of the global headquarters country. The expatriate’s salary is calculated by adding calculated additional amounts for the hardship, cost of living, and exchange rate differential between the global headquarters (home) and the host country.

The assignment package is then taxed in the host country and other statutory and non-statutory deductions made to arrive at the net pay assignment package paid to the expatriate.

Cost of Living Allowance (COLA)

The Cost of Living Allowance approach uses the principle of retaining the expatriate’s home salary and paying an additional separate allowance, primarily for cost of living, but also for hardship based on the differences between the home location and the host location. The purpose of the COLA is to ensure parity in the level of the purchasing power of expatriates doing the same job at the same level in different parts of the world, taking hardship, cost of living, and exchange rate differences into account by paying a cost of allowance to compensate for the differences. At the end of the assignment the COLA falls away.

This approach is typically used by global international organisations that have a large number of expatriates, who move from one international assignment to another and compete globally for skills. Organisations using the COLA approach typically have country level pay scales. The expatriate’s COLA is calculated by adding calculated additional amounts for the hardship, cost of living, and exchange rate differential between the home country and the host country.

The assignment package is then taxed in the host country and other statutory and non-statutory deductions made to arrive at the net pay assignment package paid to the expatriate.

Local Market (LM)

The Local Market approach uses the principle of applying the local (i.e. host country) expatriate market pay rates. In many organisations the policy is to use the better of the Build-Up or the Local Market approaches, to ensure that the assignment package is equitable and competitive in the host market.

Due to the need for market data, the Local Market approach is typically only used where a strong local and / or expatriate market exists in the host country, and reliable salary surveys exist that accurately report the level of market salary for different positions. For example, take an organisation sending an expatriate from an economically poor, relatively low salary market country, to a city such as New York. It is likely that having used the home base salary as the basis of the calculation, that the resulting total assignment package will be significantly lower than the New York Salary Market. This would occur even after adding an international premium (to compensate for hardship experienced), and a cost living amount (to compensate for the higher cost of living in New York) as well as applying the exchange rate. The reason is that the market level of home base salary in an economically poor country is so much lower than the equivalent market salary in New York.

The Local Market approach is typically used in high economic growth and high cost of living countries where demand for skills is high and there are a large number of expatriates comprising many nationalities such as the United Arab Emirates, Hong Kong or Singapore.

In conclusion it is important to ask questions about your current expatriate pay philosophy. Does your current expatriate pay philosophy drive the desired behaviour? Is the current policy and practice aligned to organisational objectives? Does the current policy work for or against the organisation achieving its global objectives?

We recommend a regular review of organisational expatriate pay philosophy in light of what the organisation seeks to achieve and where it operates geographically, whilst ensuring integration with the other pay related strategies of the organisation.