As your company explores international growth opportunities, you may decide to hire independent contractors. When you do, you will need independent contractor agreements to formalize those relationships and get the most value from them.
How can you create the right agreements for your contractors? In this comprehensive guide, we’ll explore how to write an independent contractor agreement and include the proper elements for a successful partnership.
What is an independent contractor agreement?
An independent contractor agreement is defined as a legally binding document signed between a company and an independent contractor. It outlines the work to be performed and the terms under which the contractor will perform it. Essentially, it helps both the company and the contractor see eye to eye about the details of their relationship.
Contractor agreements are important because they define the company-contractor relationship and lay out the expectations for the job. They give the company and the contractor specific details about how long the project should take and how payments will work. They also specify what benefits, if any, the contractor will receive and how the two parties will handle disputes.
Independent contractor agreements can also relieve the company from liability if the relationship proves to be a poor fit.
Contractor agreements can be lengthy and complicated. They may contain complex legal phraseology and critical details about the working relationship. Fortunately, independent contractor agreements are relatively straightforward to write once you know what elements they require.
When is an independent contractor agreement necessary? Some countries have labor laws that specifically require written contractor agreements for contractors. In other countries, informal verbal agreements are sufficient. However, we recommend always putting strong, written independent contractor agreements in place for clarity and peace of mind.
Who qualifies as an independent contractor?
Let’s discuss in more detail how you can distinguish between contractors and employees. That way, you can be confident about which class of workers you should hire.
The criteria for differentiating between international independent contractors and employees may differ from country to country. In Australia, the fundamental distinction between employees and contractors comes down to whether they work for themselves or your company. Meanwhile, Canada tends to weigh several factors equally in its determinations.
However, the essential difference between the two groups generally comes down to a few primary factors.
1. Payroll taxes
When you hire employees, you add them to your company’s payroll. You issue their paychecks on a regular schedule through your payroll department. When you do, you withhold payroll taxes from their wages, so they receive a net pay that is less than their overall gross pay.
The taxes withheld from employee paychecks generally go to social security programs. These programs fund benefits like healthcare, retirement pensions, or disability pensions. Your company usually contributes a small percentage of its employees’ wages to the same programs.
On the other hand, when you work with contractors, you do not add them to your payroll. You do not withhold payroll taxes or pay into social security programs on your contractors’ behalf.
When contractors’ projects are complete, or on whatever schedule their contracts specify, you pay them the entire gross amounts they have earned. Contractors are responsible for accounting for their own social security contributions with their income taxes each year.
When you hire employees, the law usually requires you to offer certain benefits. The specifics of those benefits vary by country. For instance, if your country has a strong state healthcare program, you may not have a legal obligation to offer your employees health insurance. Nevertheless, you must generally provide some form of benefits. They often include health insurance and paid holidays, vacation days, sick leave, and maternity or paternity leave.
Contractors do not receive these benefits. They must go without health insurance or purchase their own, and if they take time off between projects, they do not receive pay.
To make up for the benefits they lose, contractors can often command higher pay than employees in the same industry.
3. Degree of autonomy
One of the most fundamental differences between employees and contractors hinges on their relationships with the company.
Generally, employees work for a company, and the company has a significant degree of control over the work they do and how they do it. Companies generally expect them to work specific, regular schedules and perform the tasks their managers assign to them. Employees also receive supervision, direction, and training from managers.
On the other hand, contractors work for themselves rather than for your company. They exercise a significant degree of control and autonomy over their work.
Contractors choose the projects they wish to take on, often by submitting bids for them. If they have supervisors, those people are generally members of the contracting team rather than managers within the company. They can usually choose when and how they work, as long as they meet the deadlines and any other requirements their contracts specify.
Why does worker classification matter?
Getting your worker classification correct is important because misclassifying employees as contractors can have significant financial consequences for your company.
If courts determine your company has improperly classified employees as contractors, you can owe legal penalties. You will become liable for the accumulated payroll taxes you should have paid to the government. Additionally, you often become liable for years of back pay in the form of the benefits your contractors should have received.
Your company could end up owing thousands, even millions of dollars. The consequences are especially large if the misclassification has gone on for years, or if you have many misclassified workers. Your reputation as a dependable, ethical business would likely also suffer. Fortunately, by being diligent in your research and classifications, you can keep your company compliant with the law.
Why do companies need written contractor agreements?
Companies need written agreements for contractors for a few different reasons. They define the relationship clearly for the company and the contractors. They also provide useful information for tax authorities, such as the Internal Revenue Service (IRS) in the U.S., the Canada Revenue Agency (CRA) in Canada, or the Tax Administration Service (SAT) in Mexico, among others.
Here are a few of the specific benefits of written independent contractor agreements:
- Establish worker status: Writing a formal independent contractor agreement helps you enhance clarity in your business partnership. For instance, one of the main advantages of independent contractor agreements is that they distinguish your contractors clearly from your employees. This distinction clarifies what you do and do not owe your contractors and helps everyone understand the terms of the relationship. A formal contractor agreement also communicates the contractor’s tax status to agencies like the IRS or the SAT.
- Avoid misunderstanding: Providing that clarity enables you to avoid costly misunderstandings. For example, many employees receive benefits from the companies they work for, but most contractors do not. Having strong independent contractor agreements can prevent contractors from retroactively claiming they should have received certain employee benefits.
- Show commitment: In many ways, a contractor agreement is also a gesture of good faith. By signing it, your company and your contractor show your mutual investment in a good working relationship and a quality finished project.
What’s included in a basic independent contractor agreement?
Every independent contractor agreement is different. From contract job to contract job, your company will likely have different needs and requirements. One job might allow for contractors to take their time on the project, perfecting every detail, while another might need exacting work done on a tight deadline.
Still, each contractor agreement needs the same essential elements to be strong, comprehensive, and protective. Let’s take a closer look at what a standard independent contractor agreement contains.
1. Business relationship
A basic independent contractor agreement clarifies the working relationship. It specifies the worker is a contractor and not an employee. It also elaborates on what the contractor should expect to receive from the company.
This section should also outline the pay the contractor will receive for the completed work. If your company is operating in a country other than your home country, be sure to specify the compensation amount in the local currency.
It’s also important to state the company’s and contractor’s tax obligations. Companies should be upfront about the fact that they will withhold no taxes from the contractors’ earnings, so contractors will be responsible for their own social security contributions.
2. Scope of work
A strong independent contractor agreement specifies the nature of the work the contractor will perform. It should include the specific tasks required, the timeline for the project, and the compensation the contractor will receive in return.
The deliverables you ask for from your contractors are often specific and clear. For instance, the contractor agreement might specify the construction of several buildings in an office complex or the production of three advertisements promoting a new healthcare initiative.
However, with more creative work, you may not have a concrete end target in mind — developing one will be part of the contractor’s job. In that case, be sure to describe your objectives as clearly as possible so the contractor understands your expectations.
A strong written contractor agreement should specify what benefits, if any, a contractor receives. Most commonly, it stipulates that the contractor will receive no benefits. The agreement should explain clearly that the contractor will not receive health insurance or paid time off.
A section on benefits is critical for preventing misunderstandings. By stating plainly that your company provides no contractor benefits, you give your contractors clarity. They cannot say in the future they thought they were entitled to benefits when the contract explicitly states otherwise.
The section of a contractor agreement on liability, also known as the indemnification clause, is essential for your company’s legal protection. It clarifies who will bear responsibility in the case of on-the-job injuries or legal challenges that arise from your contractor’s work.
The indemnification clause also often specifies who is responsible for the expenses associated with the work, such as paying any licensing fees.
Your company should use this section to outline the contractor’s liability for fees, expenses, and any legal judgments incurred. Specify that by signing the agreement, the contractor agrees to indemnify your company for all claims and losses that result from the contractor’s work or actions.
In many cases, your company will also want to use this section to ask your contractors to provide proof of liability insurance. Requiring liability insurance is a smart policy, especially for highly physical jobs like construction. This insurance helps cover the expenses if contractors become injured while working or if their work results in legal issues for your company.
5. Intellectual property
Many contractor agreements contain a section about who owns the intellectual property the contractor produces for the company. If your company wishes to retain the intellectual property rights, stating this fact clearly in the contractor agreement can prevent disputes about legal ownership in the future.
The laws about intellectual property rights differ from country to country. For this reason, stating your company policies clearly in contract agreements is essential for your protection as your company grows internationally.
Many independent contractor agreements contain a confidentiality clause. These clauses specify that contractors cannot share, use, or discuss with others the confidential information they have access to while working for your company.
Be sure to specify what your company considers confidential information. It might be patents, trade secrets, confidential financial data, or client lists, for instance. Providing this clarity helps your contractors know what they can and cannot divulge to others.
7. Noncompete clause
Similarly, many contractor agreements contain noncompete clauses. These clauses are relatively common in some industries, such as business services, wholesale trade, finance, and real estate, and less so in others.
Noncompete clauses usually require that contractors not work for any of your direct competitors for a specified time after completing their contracts. They also sometimes prohibit contractors from setting up their own businesses within that same timeframe. In this way, they reduce your direct competition and protect your company’s interests.
8. Termination requirements
Your independent contractor agreements should specify when you can terminate the agreement, when the contractors can terminate the agreement, and what compensation they will receive in either case.
For example, you might specify that either your company or the contractor can terminate the agreement at any time, for any reason, with 48 hours’ notice. You might also specify that you can terminate the agreement if the contractor fails to adhere to the timeline or produces substandard work.
9. Dispute settlement
Including a section about dispute settlement is critical because it provides clarity around how you will handle disagreements. In this section, when your company is operating in another country, you should be sure to specify which country’s laws will apply to dispute resolution. You should also explain whether you will resolve conflicts yourselves or use third-party mediation services.
Even though you hope never to use your dispute settlement clauses, they give you and your contractors valuable peace of mind. They illustrate your good-faith intentions to resolve any issues fairly and transparently.
How to negotiate an independent contractor agreement with a potential hire
When you’ve chosen a contractor you’d like to hire, you’ll need to agree on and sign an independent contractor agreement with that person. Here are a few tips and tricks for ironing out the finer details:
- Ask for input: Many contractors have years of experience in their field. They may be comfortable letting you know what compensation and terms will work for them. Especially with more seasoned contractors, you can often match their typical rates and requirements in your contract terms.
- Base compensation on employee salaries: In some cases, you’ll pay your contractors significantly more than you would pay your employees. However, sometimes, especially for longer-term contracts, contractor rates are very close to employee rates. In that case, figure out what you would pay an employee over the same period, and then use that figure as the basis for negotiations.
- Consider unique circumstances: Certain scenarios sometimes necessitate higher pay for your contractors. For example, if your company is hiring for short-term contracts, you may need to offer higher pay rates, since those positions can be harder to fill. Of course, if the contractors have particularly specialized or hard-to-find skills, you may need to offer a higher pay rate as well.
- Comply with the law: Remember that different countries have different rules governing classifying, hiring, and paying contractors. You’ll need to research the regulations in your area and abide by them.
Tax obligations when you’re hiring independent contractors
Your company usually should not have payroll tax obligations to your contractors. You will not contribute anything to social security on their behalf. You pay your independent contractors their gross earned amounts, and they become responsible for their taxes from that point.
However, certain countries have exceptions to this rule, so you may have some tax reporting obligations to the country where you are operating. To cut down on worker misclassification, for example, the UK has implemented “anti-avoidance” taxes. By law, companies must pay taxes on their contractors if the contractors perform relatively similar work to that of employees.
Be sure to check with local experts to determine what, if any, your tax obligations will be.
How to mitigate risk with independent contractor agreements
When you’re drafting independent contractor agreements, you need to ensure they mitigate potential legal and financial risks to your company.
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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.