Shadow Payroll vs. Regular Payroll: What's the Difference?

Shadow Payroll vs. Regular Payroll: What's the Difference?

When an employee is assigned internationally, they are required to pay taxes in the host country. Shadow payroll is a mechanism to ensure that expats comply with tax laws in their host country, while still receiving their salary from their home country. In this blog, we will explain what shadow payroll is and how it differs from regular payroll.

What is shadow payroll?

Shadow payroll is not an actual payroll that pays salaries, but a parallel system that reports income and calculates tax and social security obligations in the host country. The employee usually receives his or her salary in the home country, but has to pay taxes in the host country. That is why a shadow payroll is needed.

Key Differences Between Shadow Payroll & Regular Payroll

Feature	Normal payroll	Shadow payroll
Goal	Paying salaries to employees in the same country	Ensuring tax compliance on international assignments
For whom?	Local workers and residents	Expats, international employees and cross-border workers
Payroll processing	Complete payroll processing and payment	No actual payment, only tax calculation and reporting
Taxes	Tax is withheld and paid in the same country	Tax is calculated and reported in the host country, even if the salary is paid elsewhere
Social security contributions	According to local labor laws	May require contributions in host country depending on treaties
Payroll management	Managed in the country of employment	Coordinated between home and host country payroll teams

Example of shadow payroll in practice

A US employee is sent to Spain for 12 months. His salary is still paid through the US payroll. However, under Spanish tax law, the employer must report and pay local taxes for the work performed in Spain. A shadow payroll is set up in Spain to calculate and remit local taxes, social security contributions, and other legal obligations—without actually paying the salary.

How to implement shadow payroll for international assignments?

Setting up a shadow payroll requires close collaboration between home and host country payroll teams to ensure tax compliance and avoid double taxation. Here is a step-by-step guide:

Step-by-step implementation of a shadow payroll

1️⃣ Determine which employees need shadow payroll

Is the employee an expat, cross-border worker or on a long-term assignment?
Does the assignment last longer than 6 months? (Often the threshold for tax liability)

2️⃣ Research the host country's tax and compliance regulations

Study income tax laws, social security rules and reporting requirements.
Check bilateral tax treaties to avoid double taxation.

3️⃣ Align home and host country payroll systems

The home country payroll continues to make salary payments.
The shadow payroll is set up to report income and pay local taxes.
Ensure that there is no double withholding of taxes.

4️⃣ Calculate and report taxes correctly

The host country payroll simulates tax calculations based on the home country salary.
The employer pays local income tax and social security contributions.
The employee may be required to file taxes in both countries.

5️⃣ Manage tax equalization and reconciliation

Apply a tax equalization policy so that the employee does not pay more or less tax than in the home country.
Perform a year-end reconciliation to correct any overpaid or underpaid taxes.

6️⃣ Ensure compliance and documentation

Maintain detailed payroll records for audit purposes.
Work with local tax advisors to ensure accurate filing.
Perform regular payroll audits to prevent errors.

7️⃣ Automate and optimize global payroll

Use global payroll software (such as ADP, Workday, SAP, CloudPay).
Automate tax calculations and filing to minimize errors.
Integrate payroll with HR and financial systems for accuracy.

Key Challenges & Solutions

Challenge	Solution
Complex tax rules per country	Work with local tax advisors to stay up to date.
Risk of double taxation	Take advantage of tax treaties and exemptions where possible.
Currency fluctuations	Set a standardized exchange rate policy for payroll calculations.
Differences in payroll reporting	Ensure strong coordination between home and host country payroll teams.
Social security compliance	Check whether there are social security treaties between countries to determine contribution obligations.

Conclusion

Shadow payroll is essential for international employers to ensure expatriates comply with tax and social security regulations in their host country. By setting up a well-structured and automated process, companies can ensure tax compliance, avoid double taxation and maintain a smooth global payroll operation.

Would you like to stay informed about everything related to social-legal legislation or payroll? Contact Rovoco!