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If your company is in the process of opening a new branch in another country or looking to expand its market reach internationally, you may want to hire local people in addition to or instead of sending existing employees to the new country. One of the choices you need to make is whether to hire the people who will work in your international offices as employees or contractors. There are notable tax differences between independent contractors versus employees, as well as other critical differences.
To avoid legal challenges and to ensure your global growth goes as smoothly as possible, learn more about the difference between an employee and a contractor and how to classify them both.
International employee and contractor differences
When your company decides to work with an individual, you must determine whether you and your new hire will have an employee-employer relationship or a company-contractor relationship. It’s often less expensive for companies to work with contractors versus full-time employees, which makes the idea of classifying workers as contractors appealing.
However, there are often financial consequences if your company misclassifies a worker. In the U.S., the Internal Revenue Service (IRS) and the Department of Labor (DOL) have rules regarding who can be classified as a contractor versus an employee. Although the exact distinctions between the two and the rules regarding classification can vary from country to country, generally speaking, the following can help you determine if the person your company wants to hire falls under the category of contractor or employee:
- Autonomy: A critical question in determining whether you’re hiring employees or contractors is how independent they are. Often, international contractors provide services to multiple companies at a time. They usually have several clients and don’t spend all of their working hours devoted to a single business. Contractors typically set up their own schedules and are focused on the profits and wellbeing of their own company rather than the profits and wellbeing of your company.
- Control: Another distinction between contractors and employees is the amount of control a company has over workers’ actions. In the U.S., the IRS defines workers as employees when the company they work for has behavioral control over what they do. If your company tells workers where to work, when to do their work, and how to do it, they are most likely employees. Contractors will have more control over the process of doing the work.
- Supplies: Often, when a company hires independent contractors, these workers provide their own supplies and equipment. Any expenses the contractors incur, such as travel costs or material purchases, are their responsibility. On the other hand, companies usually purchase equipment, such as laptops or mobile devices, for employees to use. When employees no longer work for the company, they typically need to return the equipment.
- Benefits: The benefits a company offers workers also influence the type of relationship they have. Often, employees receive benefits, such as health insurance coverage and retirement plans, from employers. Independent contractors typically need to provide their own health coverage and retirement plans.
- Payment process: How a company pays workers often differs based on whether they are contractors or employees. Employees get paid by payroll, and the company often has to withhold taxes. The exact amount and types of tax withheld vary from country to country. Contractors typically invoice a company. They are responsible for ensuring that they pay their own taxes. The company won’t withhold taxes for them.
Why hire an international independent contractor vs. a temporary employee?
Another notable difference between independent contractors and employees is the length of the relationship between the company and the worker. Due to the financial and time cost of hiring employees, many companies hope that their employees will remain at their organization for as long as possible. When a company needs someone to perform a task or complete a project on a more limited basis, it often works with contractors.
There’s also the option of hiring temporary employees. For example, when a business is first making inroads into a new country, it can make sense to have a temporary team on hand to assist with the transition or to bring workers in the new location up to speed on the company’s culture and policies.
In that instance, you might find yourself trying to decide whether your company should hire a contractor, such as an independent business consultant, or a temporary employee. The benefits of working with a contractor include lower expenses and less administrative effort on the part of your company since contractors are responsible for their own taxes and other costs. When the relationship is over, it’s easier to part ways.
If you hire employees, even temporary employees, the relationship is more durable and your company has a bigger commitment to the employees. It can be more challenging to end relationships at the end of the project.
Why hire an international employee vs. a subcontractor?
Working with a contractor makes sense in certain contexts, such as when you need a person for a single project or on a limited basis. However, when your company plans to operate in a country long term, it makes more sense to hire international employees rather than rely on contractors.
Usually, one factor determining whether it’s more appropriate to hire employees is the relationship the workers will have with your company. If you need people to perform essential tasks, such as managing the customer service team or handling your company’s ledgers and financial records, you need to hire employees.
Hiring employees instead of contractors also makes sense if your company wants to establish a presence in a country. When you bring on local employees, you benefit from their knowledge of the country and its culture. Since they work for your company and enjoy the benefits of employment, such as paid time off, a steady salary, and health coverage, you can count on them to be loyal to your company.
Hiring employees instead of contractors also allows your company to avoid misclassification penalties. Sometimes, companies decide to work with independent contractors because they think doing so will save them money or cut down on paperwork. But if a government agency or labor department reviews the relationship your company has with a contractor and determines that it is closer to that of employee-employer rather than contractor-client, it can fine your company or issue other types of penalties.
How countries define contractors vs. employees
In the U.S., there are three main things to consider when determining whether to hire an employee or contractor: the relationship, financial control, and behavioral control. Other countries also have rules that determine how to classify employees and contractors. When your company is planning on opening for business in a new country, you want to know the rules in that country and understand how the rules affect your company.
Often, the differences between contractors and employees and the criteria used to determine an individual’s classification are similar from country to country. For example, Australia considers people to be contractors when they run their own business, use their own tools and supplies, and negotiate their own fees. Employees in Australia work for someone else. The employer pays the employee’s wages and controls how, where, and when the employee works.
Contractors in Canada have control over how, where, and when they work. The company the contractor works with doesn’t have to withhold taxes or pay employment insurance (EI). Contractors in Canada have more autonomy than employees but also assume more risk should they lose work.
The exact definitions and rules for contractors vary slightly across the European Union, but as a general rule, contractors work independently and don’t have their taxes withheld by companies.
Risks of misclassifying international independent contractors
Hiring independent contractors can seem like the less expensive and simpler option than hiring employees — rather than familiarizing your company with the labor and tax laws of a country, you assign those responsibilities to the contractors you hire.
However, it’s critical that you only classify and treat workers as contractors if they meet all the criteria for being considered a contractor. Companies that misclassify workers can face penalties and a considerable amount of legal headaches.
For example, if you decide to hire contractors in a new country, but the nature of your business relationship is closer to that of employee-employer, the contractors can report your company. If the court in the new country agrees with the contractors, you’ll need to reclassify them as employees. Your company will be responsible for withholding taxes, paying benefits, and following all the other employee rules in the country. You might also have to pay back taxes and benefits, which can be quite costly.
Payroll and tax considerations for independent contractors
Your company’s tax and payroll obligations can vary based on the location of the independent contractor. For example, if your company is based in the U.S. and hires contractors based in the U.S., you’ll likely need to issue Form 1099 to the contractors at the end of the tax year. Form 1099 lists the amount you’ve paid the contractors during the past year.
You don’t need to issue 1099s to contractors who live outside the U.S., even if they work for your company. The exception is if the contractor doing the work is a U.S. citizen. If you work with contractors who live abroad but are citizens of the U.S., they still need to pay U.S. income taxes and should receive a Form 1099 from your company.
Regardless of where the independent contractors are located or what their citizenship status is, your company won’t have to withhold Social Security, Medicare, or income tax from the payments you make to them. Contractors are responsible for paying their taxes on their own.
Work permit considerations for international contractors and employees
If your company decides to hire contractors or employees who already live and work in the country you are moving into, you most likely won’t have to worry about securing work permits or arranging for visas for them. It’s a different story if you plan on sending contractors or employees from your home country over to work in the new location. In that case, they will need to have the appropriate permits and visas before they can work in the country.
The rules are different for contractors and employees. Your company can sponsor employees and arrange for their permits, but you can’t sponsor independent contractors. If you decide to hire contractors, your best option is to hire people who already have the appropriate documentation and status for the country you are hiring in.
Get international help from Globalization Partners
Once you’ve determined whether your company should hire a contractor or employee, leverage Globalization Partners’ AI-driven Global Growth Platform™ to hire anyone, anywhere. Our technology streamlines the hiring and management process for all of your contractors and employees — delivering in minutes what used to take months.
THIS INFORMATION IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL OR TAX ADVICE. You should always consult with and rely on your own legal and/or tax advisor(s). Globalization Partners does not provide legal or tax advice and the information is not tailored to the specific situations of your company or your workforce. Globalization Partners makes no representations or warranties concerning the accuracy, completeness or timeliness of this information. Globalization Partners shall have no liability arising out of, or in connection with, the information, including any loss caused by use of, or reliance on, the information.