By Globalization Partners
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Building a global team is one of the most exciting phases in the growth of a company. However, it also involves considerable research. You need to answer a key question: Should I hire an employee or a contractor?
To stay on the right side of the law, reduce risk, avoid fines, and maintain compliance on an international scale, it’s important to make sure you are classifying your workers properly – as either employees or contractors – based on the labor laws of the country where they are located.
Contractor or employee? How to make the right determination
Though every country is different, the following guidelines provide a general overview of the legal description of a contractor:
- You do not exercise supervision, direction, or control over these workers. While you may give instruction on the deliverables and specification for the project, you do not direct their daily work or set their schedules.
- They are free to provide services to other companies without your consent. They may or may not work for other companies – it is irrelevant to your engagement with them.
- They do not work for you full-time on an indefinite basis.
- The workers are paid a fixed price for the completion of certain tasks or projects and do not participate in any benefits programs.
When is a contractor considered an employee? International tax and HR advisors generally use the following parameters:
Does the individual:
- Work full time for one company?
- Take management direction from that company?
- Have no other clients?
- Receive some employee benefits? (i.e., vacation days, stock options, car allowances, private health insurance, etc.)
If you answered yes to one or more of these questions about the hire you are hoping to make, there could be complications down the road. This is particularly true if the relationship with the contractor does not end on a positive note.
International worker classification
- Perform work on a finite basis. There is a clear end in sight to their projects.
- Payment is made on a project basis.
- Responsible for paying any applicable employment taxes.
- Do not partake in any benefits programs the company offers.
- Source their own resources to complete their work.
- Set their own daily working hours.
- The work performed is for one specific project, not for integral business operations.
- Responsible for their own work expenses.
- Can be terminated at any point, though some countries require notice periods.
- Employees work on an indefinite basis for the company.
- Payment is made in the form of a salary.
- Employers are responsible for their portion of employer taxes and social charges.
- Employees participate in benefits program offerings, such as vacation days or car leasing.
- Employees rely on the resources of the employer to complete their work.
- Employees work within the working hours defined by their employer.
- The work they perform is a part of everyday business operations.
- Employees are reimbursed by their employer for work-related expenses.
- Employees are due severance pay and a notice period prior to termination —varies widely by country.
The main reason companies hire contractors is because of the flexibility – they can quickly gain the expertise of a highly-skilled professional without going through the process of establishing themselves as a legal employer in a new country. They also operate more independently and could save the company money long term.
On the other hand, the main reason companies hire employees is because they are looking for professionals who will fully commit to their business long term. Typically, full-time employees are going to be more invested in the success of the company, and they can help build out operations in a new country, hiring others and growing high-performing teams.
Both employees and contractors can play key roles for fast-growing international companies, but it’s critical to make sure you classify them properly. If someone “should” be an employee according to local labor law, but the individual is classified as a contractor, that is where companies can run into problems.
Worker misclassification: how it happens
The story of worker misclassification almost always begins the same way: a first sales hire in Brazil, a fantastic programmer in Poland, a QC overseer of the third-party manufacturer in China.
Imagine this: Your company has decided that this year’s business strategy will involve at least one international venture. This means you and your HR team will be responsible for facilitating the perfect hire once the decision has been made.
You begin to research what you will need to set up payroll for your international hire. After perusing countless websites with conflicting information, you begin to panic. You wonder how you will make this hire when you don’t have an entity registered in‐country.
With the pressure mounting, many HR professionals in companies small and large default to hiring the candidate as a contractor or consultant — “Let’s just get the person on board and see.”
If the individual is open to it, then this appears to solve several immediate problems. You also avoid spending time and money setting up business entities in countries where you aren’t sure you’ll hire more than one person or keep them on the team long term. It seems like a simple solution where everyone wins. Problem solved.
But is it? It all depends on worker classification labor laws in the country where your contractor is based. If the individual meets the legal definition of an employee but is functioning as a contractor, you may only be exchanging one problem for another.
Worker misclassification risks
You may be tempted to dismiss the small risk of discovery and reclassification by the local authorities. But the chance of discovery is not necessarily the most significant risk. After all, how many authorities have time to investigate more than a small percentage of contractors? However, it’s worth bearing in mind that some countries have the means to be more vigilant than others.
For instance, in Brazil, incoming payments made from a corporation to an individual are automatically flagged for the tax authorities’ investigation. That is not to say that every payment will be investigated, but some are, and the means to track them are in place.
More granularly, outgoing payments from the Brazilian client to its international supplier are also tracked. If a match is discovered, the Brazilian client can be fined for working with a company that is hiring someone illegally. In the age of austerity measures and limited funds, local authorities are getting more sophisticated than ever about identifying tax opportunities.In the age of austerity measures and limited funds, local authorities are getting more sophisticated than ever about identifying tax opportunities. Click To Tweet
Setting aside the risk of discovery by the tax authorities, the greater risk is what could happen should you part ways with a disgruntled contractor.
Suppose you decide to terminate your engagement with a contractor, and the negotiation does not go well. In that case, the more significant threat can be that the contractor decides to inform the authorities. The threat of action is often sufficient to elicit a significant payout to the contractor, which can run into the hundreds of thousands of dollars.
If such a case does go to the authorities, and they deem that the individual has the attributes of an employee, here are some of the consequences you can expect:
• It is the employer’s responsibility to withhold and report income taxes in an employment relationship. Also, the employer is required to pay employer payroll taxes. If a tax assessment is made and your contractor is reclassified as an employee, the employee’s fees are typically treated as net income.
Employee income tax and the payroll tax are assessed on top of that. The assessments can go back several years, including interest and penalties. Considering income tax rates of around 30 percent, and payroll taxes going from around 10 to 20 percent in Asia and up to 40 percent in some European countries, plus interest and penalties, the total assessment can be a substantial amount, with figures north of US$250,000 not uncommon.
• If you treat your contractor as an employee, legal documents that state the contrary will not have any validation. In just about every other jurisdiction, some form of notice period exists in labor law. So, if the contractor claims employee status, the individual could also claim unfair dismissal.
• Worker misclassification can trigger potential corporate tax issues. Once the tax authorities realize the company has improperly hired in‐country, they may then assess that the company’s activities have triggered Permanent Establishment or nexus and that they should have been following corporate law and paying local corporate taxes all along. Local tax authorities will document the legislation covering this in many jurisdictions. Reclassification is the proverbial blood in the water.
The issue around classifying your workers is one of managing risk. How risk-tolerant is your company as plans are being made to hire contractors? Is it an early-stage startup, where the business case for having boots on the ground in a particular country is strong, and the decision is made to kick the can of contractor management down the road? Or do you work for a public company with a policy that prohibits hiring contractors entirely? Does the reward outweigh the risk, or is it the other way around? These are the questions you’ll need to answer as you consider your international hiring strategy.
Transitioning contractors to employees
As companies mature, there often comes the point where they decide that they must bring their contractor risk under control and hire these individuals as employees. 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.
A full-time employment relationship also provides a level of job security that can increase engagement. There are greater protections in place for employees when companies make a commitment to hiring them full-time.
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 will 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 involves a detailed negotiation, including:
- 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 workers who have proven their 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.
What are your options?
Hiring international workers doesn’t have to be complicated, thanks to the Employer of Record (EOR).
An EOR helps companies get to market faster by offering a legal alternative to hiring directly. Your company can bypass entity setup, registration, and payroll tax deductions, plus the time and costs required to execute all of the above.An EOR helps companies get to market faster by offering a legal alternative to hiring directly. Click To Tweet
With compliant international entities already in place, an EOR takes care of payroll and meeting mandatory labor requirements. At the same time, your company manages and directs the individual on a day-to-day basis.
The employee receives local statutory benefits, is covered by all mandatory labor laws, and your company reduces its exposure to employment risk. Above all, an EOR reduces the exposure to worker misclassification risk and allows you to make a legal hire quickly.
If your company has decided that a contractor is better fitted for your needs, Globalization Partners can help you conduct a worker classification assessment and hire international contractors compliantly. In the future, as your company grows and the relationships with your contractors evolve, you can easily convert them to full-time employees, if required.
Through Globalization Partners, you can start and grow your international presence, with the added benefit of being able to hire both employees for your long-term growth and international contractors for short-term projects.
Hire anyone, anywhere – quickly and easily
Globalization Partners helps you scale your company in new regions without the burden of entity setup. You identify who you wish to hire, and we take on the risk and responsibility as the legal employer.
Not sure whether you want to hire a contractor or an employee? We take you through a step-by-step assessment to guide you towards the compliant choice – the one that makes the most sense for your growing company. Contact us today to learn more.