Here's one great way to lower your international expansion risks

There are, of course, risks that come with expanding across borders. These may include rising interest rates, inflation, geopolitical conflicts, supply chain disruptions and more. Perhaps now more than ever, multinational organisations are looking for ways to minimise these risks while still pursuing the benefits of international expansion.

Some multinationals are exploring alternatives to what might be called traditional international expansion, which involves establishing a legal entity in the target country, setting up a local payroll, and hiring and paying employees directly. 

This article summarises one low-risk, flexible alternative option to traditional international expansion. It also outlines some important considerations when taking this route that are sometimes overlooked or downplayed by service providers.

Expansion options

Companies must evaluate their options carefully before expanding internationally so they can pick the optimal solution based on target-country rules, short- and long-term corporate strategies, and other factors. It’s important to keep in mind that each country has its own unique rules related to tax and labour, and has its own legal entity options. This section is intended to provide high-level information on common options, including benefits and risks, and is not exhaustive.

Hiring independent contractors

Hiring independent contractors when expanding across borders has advantages, such as cost savings and access to local knowledge and connections. Hiring contractors, however, is extremely risky. Organisations may violate local labour laws by misclassifying workers as contractors rather than employees under local law. Hiring independent contractors should only be done in extremely limited circumstances and is generally not an appropriate expansion option given compliance risks.

Registering as a non-resident employer

In some situations, a company may be able to register in a country as a non-resident employer (NRE). The primary advantages of this approach are the cost savings and the short time it takes relative to establishing a traditional legal entity. NREs, however, provide limited flexibility in terms of the number of local employees and the kinds of activities allowed. An NRE is generally used to hire one or two employees for two years or less.

Using an employer of record

An employer of record, or EOR provider, is a business with an established local legal entity in a given country. When an expanding organisation uses an EOR, the EOR hires the local workers, pays them in local currency, provides benefits, and remits income and social security taxes to local authorities. Meanwhile, the expanding company (that is, the EOR provider’s client) oversees and manages the workers. It’s critical to note that an EOR solution doesn't require the expanding organisation to set up a legal entity and payroll in the target country.

EORs are not intended to be a permanent employment solution. Depending on local rules, the nature of activities, the number of employees engaged and other factors, an organisation may trigger a permanent establishment and related obligations.

Establishing a local legal entity

Establishing a legal entity in the expansion country is the most formal option for conducting business activities in a new market and provides the greatest flexibility. Expanding internationally through a legal entity provides a business with full market access, and the ability to engage in the greatest number of activities and hire any number of employees, among other advantages. This is generally the best option for long-term business commitments.

Testing a new market — and lowering risk — with an EOR

The above summary of expansion options should make clear that establishing a local legal entity is generally the most compliant and flexible means of expanding into a new country. But setting up a legal entity in a new market represents a significant commitment, and it can be expensive and time-consuming to establish and (if necessary) wind down.

An EOR, by contrast, provides a company with a relatively low-risk, quick means of expanding across borders and, if necessary, exiting the market. In times of acute global economic or geopolitical turmoil, or when a company is not convinced that expanding into a new market will prove beneficial, an EOR can be particularly appealing. An EOR allows an organisation to assess market viability, workforce potential and customer demand while minimising costs, legal and administrative complexities, and compliance risks.

Many EOR providers also operate in several countries, which means that companies can test markets in various jurisdictions simultaneously. This can help them compare results that may determine the course of their future operations.

When to switch from an EOR to a legal entity

It's essential to keep in mind that an EOR solution is not designed to be permanent, nor does it allow a company to engage in a full range of business activities in a country. Critically, an EOR solution tends to limit an organisation’s growth in the target country. Depending on local tax laws, enforcement trends and other factors, if a company employs too many workers over time under an EOR, it risks creating a taxable presence, or permanent establishment (PE). So, it’s important for businesses using an EOR to monitor their local headcount and activities.

When PE risks increase, a company will need to consider establishing its own local legal entity and transitioning the EOR workers to a payroll associated with the new entity. Or the company may simply dissolve the relationship with the EOR and exit the market.

Triggering a permanent establishment is a complex, sometimes ambiguous area, so a company in this position will want to work with a third-party expert familiar with local tax and labour laws to understand the risks and benefits of staying with an EOR. Generally speaking, a company should use an EOR for two years or less before establishing its own legal entity or exiting the market. 

PE risks are sometimes underplayed or not mentioned by EOR providers themselves. So, it’s important to either engage an EOR provider that can also establish legal entities, bank accounts and payrolls in the expansion country or to hire a third-party advisor who will provide an accurate assessment of when to make the switch from the EOR to the company’s own legal entity.

Establishing a legal entity can take up to six months in some countries, so organisations should prepare well in advance. Although creating a legal entity can be expensive and time-consuming, it becomes more cost-effective than using an EOR once a company reaches a certain size in a market. Furthermore, it allows organisations to expand without worrying about their tax status. 

It’s also important to understand that while an EOR offers a quick, low-risk way to start operations in a new location, it may not be appropriate for every expansion situation. Depending on the expansion country, corporate strategies, the number of employees to be engaged, planned activities, and other factors, it may be best to establish a legal entity from the outset.

If you decide to exit the market

As mentioned, one of the benefits of using an EOR provider to enter a new market is that it is relatively quick and cheap to dissolve the relationship and exit the market if your plans change or if your activities have not provided the anticipated benefits. By contrast, winding down a legal entity can be expensive and typically takes about six months.

If an organisation using an EOR decides to exit the market for whatever reason, it should notify local workers and the EOR provider as far in advance as possible. There may be contractual and/or compliance obligations related to employee notification and the provision of benefits. In some cases, there may be tax or other obligations if the engagement is terminated before the end of a calendar year. 

In closing, it’s worth mentioning that an EOR can be a good option for organisations that are winding down a legal entity in a jurisdiction but still want to retain a foothold in the market. Just as an EOR can provide a relatively low-risk way to enter a market for the first time, it can reduce the risks that come with completely exiting a market by allowing the organisation to maintain its local relationships, serve local customers and retain valued employees.