As small and medium-sized enterprises (SMEs) grow in size and scale, the complexity of their payroll process changes. When it comes to international expansion, organizing payroll can become even more challenging due to the vastly different compliance requirements within each market as well as the individual cultural and legal nuances.
For U.S.-based companies, the European market can be particularly complex. Although the 28 member countries of the European Union (EU) are unified in some ways, when it comes to interpreting payroll, they can vary greatly, from how they implement EU directives to government disclosure requirements. Non-EU states such as those in Eastern Europe, Switzerland, and Scandinavia can present unique difficulties of their own, ranging from a lack of electronic reporting to complex national and municipal tax systems.
In a function such as payroll, which relies heavily on process, it’s easy to forget about the importance of observing cultural sensitivity and the related complexities. But in order to have a successful global impact, it’s important that cultural sensitivities are not just observed but fully embraced.
This article looks at six specific major differences and challenges that SMEs from the United States can face when managing payroll in Europe:
1. Reporting Frequency and Requirements
Each country in Europe has specific requirements regarding what type of information must be reported and when. In some nations, employers are obliged to keep up-to-date figures and report information to external authorities monthly. In other countries, government reporting is much less of a burden and only required annually.
In 2012, reporting in the United Kingdom was revamped and real-time reporting, known as Real Time Information (RTI), was implemented. It was the single biggest overhaul of the British Pay As You Earn (PAYE) system since its introduction in 1944. Essentially, all U.K. employers must now notify Her Majesty’s Revenue & Customs (HMRC) of their PAYE liability at the same time, or before, they make payments to employees. The process is not as complicated as in some countries because employers are required to report the information to only one source, HMRC, and this is done via the Government Gateway (a centralised online reporting system). Under RTI, reports must be submitted to the government each time the business completes a pay run; failure to comply results in fines. Where an employer provides additional benefits, such as private medical insurance, these may generate additional complexities for payroll. In the Republic of Ireland, benefits are taxed notionally through the payroll, whereas in the U.K. they are reported after the end of the tax year on a special form.
In some countries, the tax authorities are proactive. For example, Finnish tax authorities send individuals a pre-filled tax return in the spring of each year. If there is nothing to correct, once checked it can simply be filed for personal records. However, if corrections are required, these must be returned and a new return will be issued in the autumn.
For the majority of U.S. jurisdictions, quarterly and annual reporting is the norm, while electronic reporting is usually required, which is not the case in all of Europe. There are also differences with Europe in terms of recordkeeping. In the U.K. and the Republic of Ireland, companies must keep accounting records for six years. As payroll records are, generally speaking, accounting records, U.K. companies need to keep these for the same amount of time.
2. Employee Rights and Benefits: Annual Leave Entitlements
Employee entitlements, including annual leave and paid public holidays, vary by country and region. The approach some EU countries take to entitlements is unique. The influence of unionisation and European Works Councils also must be taken into account, particularly as in some countries they can shape everything from company pay rates to holiday entitlements and even the way office furniture is arranged.
European statutory holiday entitlements contrast with the United States—the average leave and public holiday entitlement across the EU is 34 days, making it a potentially difficult landscape for a payroll manager to navigate. Members of the EU have a legal obligation to offer four weeks’ paid holiday as a minimum as part of the Working Time Directive (WTD).
French citizens have 30 days of annual leave. But employees who wish to work for more than 35 hours a week receive up to 22 days extra, which is called the RTT (Reduction du Temps). Companies must closely track any extra hours logged by employees and factor them into their payroll considerations. Any additional hours after the RTT period are compensated with remuneration and almost never by additional leave.
Outside of the EU, Norwegian employees are not entitled to holiday pay during the first year of employment, although they are still entitled to leave. The holiday pay, Feriepenger, is based on the income of the previous year and can include extra work-related remuneration such as bonuses. Technically, this is supposed to be paid at the time the leave is taken, but to ease the administrative burden on payroll, most companies will process it in June and replace the salary for that month with the holiday pay.
Such complexity can result in a need for higher headcounts when managing payroll in certain countries, which entails extra cost. A recent survey by the RES Forum in the United States showed that only 31% of company respondents had a clear understanding of differing tax rates for expatriate employees and the best ways to manage exemptions.
Some European nations also require public holidays to be paid, ranging from up to 14 days in Malta, to 12 in Russia, to just two in Norway. This compares against an average of 7.6 for U.S. workers, whose holiday leave is determined by their employers. Differing public holidays can impact processing, as payroll may have to go out a day early in some instances.
3. Data Security
A significant area in which the United States and Europe differ culturally is over the use of data. The principle of collecting and exchanging data freely is the norm in the United States, which can make managing payroll easier. Federal legislation surrounding the protection of personal information doesn’t exist in the same way it does in Europe.
In Europe, data protection legislation is rigorous, and non-EU companies operating in the region can face strict compliance requirements.
Safe Harbour rules previously allowed companies in the EU to transfer personal and sensitive data to the United States. However, after an Austrian citizen’s lawsuit against Facebook, the European Court of Justice decided in October 2015 that Safe Harbour rules did not provide sufficient security in relation to the usage of the transferred personal data from EU citizens.
On 2 February 2016, the European Commission and the United States agreed on a potential solution for transatlantic data flows: the EU-U.S. Privacy Shield. It was subsequently adopted and put into effect by the European Commission on 12 July 2016 and imposes stronger obligations on U.S. companies to protect Europeans’ personal data. It also limits U.S. government access to this personal information.
U.S.-based companies of all sizes with access to the data of European citizens are requested to voluntarily self-certify on an annual basis, that they adhere to the Privacy Shield requirements. At this early stage it is difficult to gauge how effective—and secure—the new agreement will be, but many keen eyes will be assessing its performance over the coming months.
4. Compliance: Income Tax Systems
A variety of tax regimes exist across Europe—similar to the United States, where there are also variances among states. However, the lack of uniformity can potentially complicate the process for SMEs wishing to move into the European marketplace, as it’s not possible to take one model and replicate it across the continent.
In the United States, the tax system is progressive at the federal level; the rate paid varies and depends on how much employees earn. While there is a standard federal income tax, different states levy additional income taxes at different levels, using varied systems. In Europe, there is no common system in existence either. Some countries operate a progressive system of tax and others use a flat rate, which can make calculations easier.
Some European countries have a dual tax system, two different income tax deductions within one country characterised by a national and a municipal tax. Sweden has a dual taxation system that is progressive at the national level while a flat rate is applied at the municipal level. Countries operating such a system include Croatia and Denmark, where a church tax is also levied.
Ireland has two progressive forms of tax—PAYE and the Universal Social Charge (USC). These apply at different rates for different levels of income, increasing the complexity of a gross-to-net calculation.
Specific tax relief also may be available to certain groups of employees. For example, in the Netherlands, expatriate employees with skills that are in short supply in the country can apply for what is known as a 30% ruling. This means the Dutch wage tax would only be applied to 70% of the individual’s income.
Trade unions or Works Councils are common with many employers in Europe, and the rights of employees to join them are protected. In the U.K. alone, an estimated 6.5 million people are members of a trade union. Other forms of workers’ representation include collective bargaining agreements, with which payroll departments must ensure compliance. These help to define legislative standards, minimum wages, overtime calculations, and leave entitlements. Strong Works Councils exist in Germany, Poland, Austria, France, Belgium, Luxembourg, and the Netherlands. Their main tasks are to represent other employees, monitor compliance with legislation, and hold discussions with management on transactional issues.
6. Day-to-Day Payroll Management
The frequency of payment runs and the required tasks, such as creating payslips, can make European payroll difficult to calculate. Many European countries lack professional bodies such as the United States’ American Payroll Association (APA), so getting guidance can be tricky. Multinational employers with no local payroll experience tend to seek advice from sources such as employment tax specialists.
In Europe, the norm is to run monthly payroll. However, there are discrepancies within industries—including agriculture and hospitality—where a biweekly payroll may be considered standard. The requirement for extra payment runs forces payroll managers to have to make gross-to-net calculations more frequently.
Payslips are a legal requirement, and certain information is mandatory in the same way it is in the United States—usually including details of an employee’s gross pay, net pay, amount of and purpose for any deductions, and the method of payment. While required information varies among countries, meeting legal obligations is compulsory for every business.
Some payslips are more complex and may require the use of an official language, for one. The French payslip can stretch to 40 lines of text, listing numerous fields such as social welfare registration, healthcare, unemployment and retirement insurance, family benefits, housing benefits, transportation tax, and pension contributions. This compares to an average of just 14 lines in the United States.
Every jurisdiction requires different information in order to calculate correct net pay, and in this way Europe is no different than the U.S.’s 50 states. A successful approach to a global payroll will take each of the parameters discussed in this article into consideration.