Is the Sky the Limit? The Risks Of Shadow Payrolls For Aviation Professionals

Many airlines manage their global staff through a shadow payroll system. But does this store up tax turbulence?

Eliot Anthony | 14 January 2025

It never should have happened. 

A UK contractor was sent by his UK company to provide aircraft maintenance services at a German airport for a German company. While working there, he was given access to a personal locker where he could store his personal belongings. It didn’t take long for the German tax authorities to pull him before a court. The judges ruled that his locker had created a Permanent Establishment (PE). That meant tax liabilities in Germany. 

As ridiculous as it sounds, it’s part of a long line of similar decisions made by the German Federal Tax Court (BFH). This slightly farcical case presses the need for non-resident companies to reassess their compliance risks when sending staff overseas. Even seemingly negligible offences can trigger tax obligations that many companies are not prepared to take on.  

The aviation industry is particularly vulnerable. In many respects, it’s a perfect microcosm of the global economy, being by its very nature a global industry where companies operate over continents. Many employees are obliged by the terms of their contract to cross borders multiple times a year. Every time this happens, a tax liability can potentially be triggered. 

Setting up shadow payrolls for employees is one way of getting around this situation. A shadow payroll simply involves paying employees their home wage but paying the host country tax, all via the same home country payroll. They’re used widely across the board. 

To the layman, they’re a have-your-cake-and-eat-it mechanism. Employees can receive their usual wages while employers escape the pain of double taxation. But don’t let that lull you into a false sense of security. As the recent case of the not-so-personal locker makes clear, compliance risks always remain. 

Is it Even Worth It?

Before we get into that, ask yourself: is setting up a shadow payroll even worth the hassle? In a cost-benefit analysis, the reward might not outweigh the expense. This is because it’s up to the employer, in most cases, to pay the overseas taxman, and some taxmen demand more than others. Ireland has famously low taxes when compared to the average Scandinavian country, for example.

Let’s imagine that you’re operating in a country with a high tax burden compared to your own, but your proposed seconded worker won’t carry out a high-value-added job. In this scenario, you’d probably consider a different strategy. 

Companies must also shoulder the burden of currency fluctuations, as leaving it to employees will dent company morale. In these volatile times, a single statement by a senior politician can weaken a currency’s value within an hour. 

Exchange rate calculations can result in employers and employees both losing out. This necessitates careful and regular monitoring and adjustment of payroll calculations. ideally with efficient, automated software. I make this latter point for a reason. Whenever I speak with aviation professionals, I’m struck by how bogged down they are with legacy systems totally unsuited to the demands of modern air travel. In the worst cases, this can spill over into crises. Southwest Airline’s 2022 scheduling snafu, largely the result of inadequate digital infrastructure, is a case in point. 

They Do Things Differently

Now, to business. Once you send an employee overseas, you expose yourself to a whole new set of laws. Don’t let the illusion of a streamlined, safe global order fool you. Despite OECD-wide rules and double taxation treaties, you’re not 100% safe. Because, to butcher an old saying, in foreign countries, “they do things differently”. This seems obvious, but you’ll be surprised by how many people I’ve spoken to who didn’t take these things into account — to their detriment. 

The devil’s in the detail. And companies find this out, one way or another. Take Brazil, where there are hundreds of payroll regulatory changes every year alone. Here you can run a shadow payroll, but all workers — even foreign workers — must receive money in local currencies, whereas in the UK, foreign workers can receive money in their home currency. Failure to comply with Brazilian law, even for a misdemeanour as innocent as that, will be dealt with harshly—Brazil has one of the highest tax penalties in the world. So, tread carefully wherever you are. 

Overpaying taxes, often through miscalculations, is a common consequence of poorly run shadow payrolls. This is one to watch out for because it may take you a long time to recover the money from the host country’s coffers. It takes up to four months for HMRC to return tax refunds — but up to 10 months in Romania. That’s not to mention some African countries, which lack individual annual filing and whose governments make it almost impossible to receive tax rebates. 

When in Rome

Start from the host country in your calculations, and work your way back home. Different countries demand different things from foreign workers. If you expect to send a worker to the EU — and pay them below the wage of an EU worker under a shadow payroll — you will be non-compliant under the Posted Workers Directive. At least, potentially. Even within the EU, countries apply these rules differently. You can pay them as per your home country’s arrangement in Ireland, Switzerland and Finland, but not in Italy or Germany.

Thoughtfully digging into regulatory nuances, even with supranational bodies like the EU, is more than a useful exercise. It could make or break your Global Mobility strategy. 

You can also forget the 183-day rule; it isn’t as widely applied as you might think. Most countries, it’s true, acquire taxation rights after 6 months. But others, like Switzerland, can claim taxation rights after 90 days. The U.S doesn’t only claims taxation rights on all citizens wherever they are in the world (discouraging American employees from taking overseas assignments). It also taxes foreign residents in a complex formula involving the number of days an individual has spent on US soil in the last three years (with the thankful exemption for crew members of foreign vessels).

But a week is a long time in politics, and this situation might change. LaHood’s 2025 tax bill is set to end the citizen-based taxation of American companies — so watch out. 

Read Double Taxation Treaties Carefully

I admit, it won’t make for an exciting afternoon. But you must read the knotty legalese of any relevant double taxation treaty (DTT). You’re obviously on safer ground if the home country has a DTT with the host. The UK, for example, doesn’t have a DTT with Paraguay, and Germany doesn’t have one with either Brazil or Hong Kong. 

Situations change too, and you’ll always be at the mercy of grand geopolitical forces. Germany’s DTT expired with the UAE in December 2021. The same thing can and will happen again, and the fallout could be catastrophic if you don’t get ahead of it.

While it’s true that Germany, like many countries, offers some limited protection to countries it hasn’t signed DTTs with (e.g., it doesn’t allow foreign tax credits to be carried forward or back), you’ll still end up paying more than if a DTT was in place. Global Mobility professionals must keep their eyes peeled.

Then there’s the nitty-gritty detail of the DTT itself. Most DTTs allocate taxing rights based on the residency of the employee, whether they’ve stayed more than 6 months and the location of where they perform their duties. But this spells out a bureaucratic nightmare for aviation emloyees.

OECD countries have got around this issue by allocating taxation rights for crew members according to the company’s Place of Effective Management (POEM). This is, in short, the country where the aeroplane’s operator is located. This is true in the vast majority of DTTs; you’ll find it in Article 15 (3). 

How to Treat Contract Workers

Things get more complex when you stir contracted workers into the mix. More freelancers and contractors are working for airlines than ever before. Of course there are: airlines rely on them to fill chronic industry-wide labour shortages. 

Now, a freelancer can be simply taxed based on their country of residence. But what about a contractor working on behalf of a company with a POEM different to that of the airline which owns the aircraft? I’m sorry to say that there are no clear-cut answers. We’re in legally murky water now. 

For one, you can’t be sure that a contracted employee supplied via an intermediary is not, in fact, working for you. A 2023 employment tribunal in the UK ruled that a contracted pilot flying a Ryanair plane, and supplied via an intermediary company, was working for Ryanair. As such, the pilot could claim holiday pay from the company. 

The next year, a Danish court made the opposite ruling: a contracted pilot flying for a now bankrupt airline — and supplied to them via an intermediary — was not working for them, but for the intermediary. I repeat: in foreign countries “they do things differently”. 

All things being equal

Back to the shadow payroll. If you’ve seriously considered the risks as outlined, you must think about how you will run the payroll. Companies can, and do, benefit enormously from sending employees overseas to low-tax countries like the UAE. Their employees receive wages as normal, but the company reaps the reward of not having to pay their taxes.

This is called a ‘Tax Equalised’ scheme, which ensures that high-tax economies won’t negatively impact employees. The company, in effect, promises to keep or pay the difference. 

This is where shadow payroll becomes a useful arm of HR. The industry is experiencing serious struggles right now. Plenty of aviation companies are finding it difficult to source or retain employees. But say you promised your employee that they could keep all the money saved from an overseas assignment under a ‘Tax Equalised’ scheme. Then you can be sure that morale will turn bright and cheery. 

Get the Right Advice

Shadow payrolls are an indispensable part of managing a globally mobile workforce. But they come with sizable baggage, and it’s only through forensic analysis of the host country’s laws and regulations that Global Mobility professionals can make the most out of them. Even then, perfectly compliant companies can get caught out by regulatory changes and fall prey to the subjective rulings of activist judges. My advice is simply to talk to the professionals through a free consultation on the best aviation compliance strategy for your specific needs.