The story almost always begins the same way. A first sales hire in Brazil. An amazing programmer in Poland. A QC overseer of the third party manufacturer in China. Your company has decided that this year’s business strategy will involve at least one venture overseas. This means you and your US based HR team will be responsible for facilitating the perfect hire once the decision has been made.
The pressure is on. An exceptional candidate has been identified and is anticipating an offer. Everyone is excited. You begin to research what you’ll need to make payroll. After perusing countless websites with conflicting information, you begin to panic. You wonder how you’re going to make this hire when you don’t have an entity registered in-country to act as the employer of record. The panic deepens. Losing this hire would mean delaying access to a much needed market opportunity or worse yet, losing the candidate to another company, maybe even a competitor.
With the pressure mounting, you, like 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. Your company can make an immediate offer to secure good talent instead of waiting several months to register an entity; you can pay the employee regularly through a simple wire transfer, and your company is able to “fly under the radar” in that particular country for a market test. You also avoid maintaining a string of dormant entities that were set up to hire just one person who subsequently left. It seems like a simple solution where everyone wins. Problem solved. But is it?
Before you start down the road to hiring a contractor, it’s worth reviewing what the potential risks might be. And the first one occurs before the individual is hired.
By far the biggest deterrent to candidates accepting a contractor role is that in many countries, an individual receives significant employee benefits through basic payroll taxes, even without any supplementary insurance. For instance, Japan provides such excellent public healthcare that any additional health insurance is neither expected nor offered. Australian social security includes a 9.5% contribution to “superannuation,” which is a strong government pension plan. In addition, local labor laws in most countries will provide the individual with a range of statutory rights, including minimum vacation, public holidays and statutory notice periods.
Typically, the best candidates are leaving a role as an employee and don’t want to surrender the security and benefits they currently enjoy. Even if you are certain the candidate you’ve found is the right fit and he or she is willing to work as a contractor until other arrangements are made, there are “gotchas” that can spring up to create a complex set of problems that become difficult to solve.
Contractor or Employee?
As they do in US, other countries have guidelines about what constitutes a true contractor and what is really an employee in disguise. Though the guidelines may be similar, the penalties may be much more severe if an overseas tax authority decides a contractor should be reclassified as an employee.
As a rough guideline, contractors are defined as individuals who are:
- Hired on a short term basis (project-based), for less than 6 months, or
- Hired, but also have a portfolio of their own clients, and your company is just one of those clients.
Unfortunately, most contractors don’t fit neatly into either of these categories, and your company takes on significant risks and liabilities by incorrectly categorizing what the tax authorities would likely deem global employees and wiring them gross pay once per month.
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.
You may be tempted to dismiss the small risk of discovery and reclassification by the authorities. 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 investigation by the tax authorities. That’s not to say that every payment will be investigated but some of them are, and the means to track them is in place.
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 common consequences you can expect:
- In an employment relationship, it is the employer’s responsibility to withhold and report income taxes, not the employee’s. In addition, the employer is required to pay employer payroll taxes. If a tax assessment is made, and your contractor is reclassified as an employee, the fees paid to the employee are therefore typically treated as net income. Employee income tax and payroll tax is assessed on top of that. The assessments can go back several years, including interest and penalties.
- Even if you attempt to mitigate this risk by putting a clause in the contractor agreement which clearly states that the contractor is responsible for his or her own tax and has not entered into an employment relationship with your company, if you treated the contractor like an employee in day to day practice, then that will determine employee status. What you have written in the agreement won’t matter.
- By hiring contractors, companies avoid registering in-country and following the corporate laws required of all companies doing business there. When discovered, this can trigger potential corporate tax issues. Once the tax authorities realize the company has hired illegally in-country, they may then assess that the company’s activities have triggered Permanent Establishment.
Though hiring a contractor in the United States is not outside the norm for many organizations and industries, most other countries around the world have far stricter mandates. It’s important to understand the long term risk of making a contractor hire and the impact it will have on your employee and your organization.
Do you have questions about hiring contractors overseas? Have you employed a contractor you’d like to convert to an employee? Globalization Partners can help. Our unique blend of PEO services and Global Employer of Record Platform allow us to help you avoid falling into the contractor trap.
Our team of experts can help you with your contractor dilemma in 150+ countries around the world.