Compliance: Converting International Contractors to Employees

Bret Silverberg
by Bret Silverberg

Employee Contracts

You’ve hired a new team member overseas as a contractor. Maybe you’ve hired more than one. Your risk officer or CEO has asked you to reduce the employment risk exposure and create compliance into the next year. You realize this is a big ask. Where do you start? What should you bear in mind as you attempt to migrate the contractor to employee status? If you are feeling a little lost, you are not alone. When it comes to converting international contractors to employees, here’s what you need to know:

Clearly state the organization’s goal. Most contractors understand that the company that employs them is taking a risk. This risk varies by country, but in essence, hiring a person as a contractor is illegal, if they’re functioning as a full-time employee. You may want to communicate to the contractor that your company wants to be able to offer a more extensive set of benefits, for example, and is required by the board to comply with local employment laws and best practices. Therefore, a conversion is necessary. Lay out the vision and steps in an uncomplicated way. What will happen, by when? What can the “new” employee expect once he or she is on board?

Understand the individual situation. Get a general idea of each employee’s individual situation. Why did he or she agree to work as a contractor in the first place? What benefit did he or she envision? In many countries, employees enjoy many more benefits, mandatory and otherwise, than contractors so it’s prudent to understand the contractor’s motivation for having accepted this structure in the first place. On the other hand, your colleague may not be paying taxes, which is convenient for the employee but high-risk for the company, because it’s the company’s obligation to make sure taxes are withheld and reported. More importantly, get an idea of the employee’s and thereby your, tax risk. Has the contractor been paying taxes? What documentation has he or she kept? Understanding the situation can help you tailor your negotiation.

Negotiate reasonable terms and be prepared to walk away.
Contractors are often happy with the decision to switch to employee status because they receive some increase in benefits, even if that increase is through the payment of employer social security and other mandated benefits.
The bigger and more complex problem comes in setting an appropriate employee salary compared to the contractor fee. Contractors in transition tend to negotiate heavily for increased salaries because they may not have withheld taxes while they were contractors. For those who did, self-employed taxes could result in a lower income tax bill. In any event, their net pay typically ends up lower as an employee than as a contractor – a situation that you’ll need to address with a fair amount of finesse. Striking a balance between too much and not enough is a delicate dance.

The best way to deal with the contractor to employee transition is having a detailed negotiation which includes:

• Some small estimate of self-employed taxes
• Additional benefits received as an employee
• A general net to gross estimate to arrive at a new salary

There is typically a tendency to overcompensate because you don’t want to lose the valuable skills of an individual who has proven his or her worth. Therefore, you will be tempted to agree to a final salary that is significantly more than the amount paid to a typical employee. If your company is considering growing its operations in a particular country, this inflated salary can create challenging precedents for future hires. Plus, the extra employee salary and payroll tax cost may outweigh the apparent savings of those early days of hiring this individual as a contractor. Showcasing the value of the benefits you’ll be contributing on the new employee’s behalf will help smooth the negotiations and keep over-inflated compensation in check.

If you’ve made what you consider a fair market offer, made concessions to meet the contractor’s individual need and he or she is still unhappy with the new terms, you may have to walk away. Doing this can get tricky. You will need to do everything you can to ensure that you part ways on good terms. In many countries, a negotiation that turns sour can open you up to a reclassification assessment by local authorities if the contractor decides to turn “whistleblower”.

Still feeling nervous about contractor conversion or just have a few questions? Globalization Partners is here to help. We can guide you through employment contract and negotiation best practices in 150 countries. Our Global Employer of Record platform and Global PEO services allow you to onboard your new employee in days instead of weeks to a payroll instantly compliant with local employment and tax laws. Less stress. Full compliance.

Fill out our contact us form and we’ll get back to you promptly. 

Bret Silverberg

Bret Silverberg

Director, Content Strategy, Globalization Partners

Bret Silverberg joined Globalization Partners in April 2017. He has 10 years experience working in content marketing and publishing.