By Globalization PartnersJanuary 2015
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As companies scale and expand internationally, the debate around whether to hire an employee or an independent contractor arises. Since there are many laws, tests, and definitions of what contractors and employees are, it can be difficult to get it straight. However, it is extremely important to accurately classify workers to avoid legal consequences that could be prejudicial for the company.
Worker classification can be complex, so understanding the differences between independent contractors and employees can help your company stay compliant.
Contractors are defined as workers who:
- Operate independently on a contract or project basis.
- Are not part of the employer payroll.
- Manage their own entity.
- Pay their own taxes.
- Work for multiple companies or clients.
Employees are typically defined as workers who:
- Work full time for one company.
- Take management direction from that company.
- Are part of the employer payroll.
- Receive mandatory employment benefits.
There are as many advantages to hiring an independent contractor as there are to hiring a full-time employee, but the question here is which hiring option best meets the needs of your company.
To determine when to hire a contractor and when to hire an employee, consider these factors.
When to hire an employee
To determine when your company should hire a full-time employee, it is important to consider:
- How the position fits your business model
- If the role is a long-term need
- If the work is essential to the company
For example, professionals with finance and marketing expertise are essential to any business and are long-term needs, while consultants often serve short-term project goals. Companies must also keep in mind that if the position requires close supervision and timely reporting, employees are a better fit.
Deciding is not as easy as it sounds and should not be taken lightly. It is important to analyze all of the benefits and downsides of hiring both types of workers to not only choose the right fit for your company, but to classify the workers correctly and avoid penalties.
Benefits of hiring employees:
- Full-time employees are generally more loyal. Having a sense of job security and benefits derives from personal stability and, therefore, leads to greater loyalty.
- Hiring employees may be more costly upfront, but they become an integral component of the company’s profitability and success.
- Employees are more likely to be committed to the company’s vision and are more integrated in the organizational culture.
They develop company-related skills that improve their performance and contribute to the company’s growth.
Disadvantages of hiring employees:
- Full-time employees are entitled to employment benefits, which translates to increased expenses.
- Employers are obligated to pay salaries, regardless of their profits and revenue.
- Employers withhold taxes and are responsible for all the employee-related legal paperwork.
- Employees require specific company training.
When to hire a contractor
The decision to hire a contractor should be made after the following determinations:
- The work is not part of the company’s core business
- The role is for a short-term or seasonal project
- The work does not require close supervision
Most companies choose to hire an independent contractor because costs like taxes, benefits, and administration are significantly lower, but there are other advantages and downsides, as well.
Benefits of hiring contractors:
- Independent contractors provide the flexibility of hiring when needed and for specific projects or tasks. Once the project ends, the contract does as well, and companies can avoid the inconveniences of laying off and firing.
- Contractors have specialized skills, they are fully trained to perform a task, and they have the tools to develop a project. This means training is not required and productivity is immediate.
- Since contractors are independent entities, there is less propensity for lawsuits and legal actions.
Disadvantages of hiring contractors:
- Employers have little control over contractors. Since they are independent workers, they manage their own time and procedures.
- Contractors are less committed to one company — their loyalty is limited to a project or task, and in most cases, ends with their deadline.
- Employers may not own copyrights unless there is a written agreement on intellectual property rights.
Worker misclassification risks
It is crucial to look carefully at all the aspects of worker classification. Incorrectly categorizing employees as contractors and failing to comply with international tax and HR laws could lead to significant risks and liabilities. Here are a few possible problematic scenarios that proper worker classification will help you avoid.
If there is any issue with contractors in the future, such as a termination, contractors can claim they were in fact employees, 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 more expensive than the client would have expected based on similar situations in the United States. Employees in Europe, Canada, and Latin America are far more likely to back-claim benefits than U.S. employees, because there are complex and significant labor protections that favor the employee.
2. Local law and income taxes
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.
3. Scaling and growth
Misclassification can lead to growth pains.: Hiring employees as contractors creates a precedent that later causes headaches. Getting contractors to convert to employee status is expensive because the contractors 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 contractor at a negotiating advantage.
Hire contractors or employees and remain compliant
There is no right or wrong hire — it all depends on what your company’s priorities and needs are and what works better for your business strategy. However, it is essential that, regardless of the type of worker you decide to hire, you remain compliant with the law.
As an Employer of Record, Globalization Partners helps you hire employees and contractors in over 185 countries. Our solution allows you to hire, onboard, and manage staff legally and compliantly.