Companies that need to hire full-time employees overseas often default to hiring the employees as “contractors,” because the company in many instances does not have a legal entity in that country that can act as employer of record. Without that employing entity, the company cannot register as an employer, make payroll tax payments or provide benefits. Therefore, the only way to pay the individual is to hire as an independent contractor. What is the risk of this?
There are cases where hiring an individual on a contractual basis MAY be acceptable when the following conditions are met:
Defined as individuals who are:
- Hired on a short term basis (project-based), for less than 6 months, or
- Hired, but they also have a portfolio of their own clients, and your company is just one of those clients.
Unfortunately, most contractors don’t actually fit into either of these categories, and the company takes on significant risks and liabilities by incorrectly categorizing global employees as contractors and wiring gross pay to them once per month. When is a contractor actually an employee? International tax and HR advisors generally use the following conditions to assess whether a contractor is actually an employee:
Typically defined as individuals who:
- 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.)
“See no evil, Hear no evil” – What are the risks?
We understand the temptation to close your eyes and not look too carefully at whether a contractor is actually an employee, but it is also good to know: What are the risks of hiring international employees as contractors and not complying with international tax and HR laws?
1. The employee may be avoiding paying and reporting the correct income. However, it is the employer that is responsible for withholding and reporting income taxes, not the employee. There are multiple cases of million-dollar lawsuits where employees sued employers for their personal income tax liabilities for “not withholding income taxes” – and the employees often win, claiming that they were an employee and shifting their personal income tax burden away from the employee and onto the company. Regardless of what the contract says, if the employee should be defined as an employee, the employer is responsible for reporting the individual’s income in-country.
2. If there is any issue with the employee/contractor in the future, such as a termination, the contractor can claim that s/he was in fact an employee, and back-claim all the usual statutory rights of an employee (e.g. employment protection and benefits). Most companies end up back-paying all these benefits, plus interest and penalties. In many countries, these benefits are considerably more expensive than the client would have expected based on similar situations in the United States. Employees in Europe, Canada and Latin America especially are far more likely to back-claim benefits than US employees, because there are complex and significant labor protections that favor the employee.
3. By hiring contractors, companies avoid registering in-country, and following the corporate laws required of all companies doing business in that country. When discovered, this can trigger issues with the local (corporate) tax authorities, because once the tax authorities realize the company has hired illegally in-country, they then assess that the company should have also been following corporate law and paying local income taxes. The legislation covering this is well documented by local tax authorities in many jurisdictions.
4. Hiring employees as contractors creates a precedent that later causes headaches as the company grows. Getting contractors to convert to employee status is very expensive because the employees tend to negotiate heavily for increased salaries. They typically feel justified doing so because they may not have had taxes withheld while being paid as a contractor, and their net pay as an employee is often a lot less than as a contractor….and the client company is in an illegal situation, which puts the employee at a negotiating advantage.
5. A company is legally required to follow employment law and corporate law in the country in which they hire people. Hiring full-time employees as contractors breaks both labor laws and corporate tax laws.
Now what? How to Hire Globally and Be Compliant
If you have determined that the person you are planning to hire (or have already hired) fits the qualification of an international employee, Globalization Partners offers a streamlined solution that helps hire employees globally in a legally compliant way.
Through our Global Employee Leasing Platform™, Globalization Partners puts your employee on OUR locally compliant payroll in the country of hire, and leases their services back to you via a contract of services in the USA. The employees like our platform because all of their HR rights are easily and quickly met and social security payments made, which often provide more substantial benefits than in the US. The clients are happy because our platform transforms global HR, legal and payroll matters into the payment of a simple monthly invoice, and they can leave the compliance matters to us.
Our platform can be used as a long-term permanent solution or as an intermediary one, depending on whether the client ultimately prefers to set up their own legal entities in certain countries.
Not sure if your upcoming hire is an employee or contractor, and need assistance assessing?