Any company considering expanding into a new market must understand the target country’s labour laws well in advance of hiring local contractors to avoid penalties and make accurate budget projections.
Despite sometimes-significant differences, most countries’ labour laws are underpinned by similar principles. To start with, they tend to protect the worker over the employer. This is true in one particularly critical area of employment law — that of worker classification, or what constitutes a benefits-eligible employee as opposed to an independent contractor. This article explains why hiring independent contractors in another country can be a risky expansion strategy, and what you need to consider before you hire contractors abroad.
Three ways to hire workers when expanding internationally
The focus of this article is on hiring independent contractors, but businesses expanding across borders should understand contractors in the context of other employment relationships. As mentioned, each country has its own employment laws. That said, there are typically three ways to hire local employees when expanding into a new country. (This post does not address sending expatriate employees abroad.) You can hire a worker as:
- An independent contractor.
- A benefits-eligible employee through an employer-of-record (EOR) service.
- A benefits-eligible employee through a local legal entity you establish.
From the expanding company’s perspective, these options tend to proceed from the riskiest, quickest to establish and cheapest (hiring an independent contractor) to the most compliant, longest to establish and most expensive (hiring an employee through your own legal entity).
Many businesses considering international expansion — especially those that intend to test the waters of the target market before fully committing — are naturally drawn to hiring local workers as independent contractors, because that option is quick and (in the short term) cheap. In certain limited situations, hiring an independent contractor can be a sound option. But in most scenarios, hiring a worker as an independent contractor carries significant financial and reputational risks.
The basics of independent contractor classification
Countries have worker-classification laws for two primary reasons: to protect workers from being denied rightful employment benefits under local laws and to protect local tax bases from missing out on social security, income and other employment-related taxes. Companies should keep these factors in mind when hiring abroad. A company that misclassifies local workers as independent contractors rather than employees, and is later found to have done so by local authorities, runs the risk of incurring significant penalties. It may also damage its reputation with the local talent pool and with local consumers.
When hiring a contractor in another country, local law may dictate that you enter into a written contract (typically in the language of the home country) that specifies the relationship between the worker and the employer. While this kind of written agreement documenting the independent nature of the relationship may be a necessary step, a contract on its own does not determine employment status. Authorities will examine the true nature of the working relationship when making determinations about whether a worker is an independent contractor or a benefits-eligible employee under local law.
Given the wide variety of working relationships, it’s not surprising that worker classification is a grey area of employment law. Moreover, each jurisdiction has its own evolving ways of making these determinations. Organisations expanding into a new country must therefore not only understand worker-classification laws, but also local enforcement trends. Typically, this means hiring a local advisor with knowledge of these laws and trends.
While each country has unique laws determining employment status, companies expanding internationally should understand the basic principles of worker classification. The factors listed below in this section will lead authorities in most countries to classify a worker as an employee, not as an independent contractor. You should consider these factors before hiring an independent contractor. If one or more of the factors applies to the worker you intend to hire, you almost certainly should not hire them as an independent contractor.
- Someone besides the worker allocates tasks to be done and specifies periods in which to do them.
- A high percentage of the worker’s income comes from one employer.
- The worker is not part of a separate organisation of three or more people and does not have a distinct separate identity (such as business cards).
- The worker works a set number of hours as specified by a contract.
- The worker can be moved from task to task.
- The worker is paid a fixed amount per month.
- The worker is provided with equipment or tools of trade.
The risks of non-compliance
If your company hires an independent contractor when expanding into a new country, and local authorities later determine that contractor was a de facto employee, you could face severe consequences. You could owe the worker back pay and face penalties for not withholding and remitting income and/or social security taxes. You may also need to provide for missed pension pay and other compensation.
Keep in mind that the longer the independent contractor relationship lasts, the greater risk you run and the greater incentive the worker has for coming forward to local authorities. After all, their social security benefits are at stake. No matter how trusted the contractor, they may come to believe they should have been paid as a benefits-eligible employee for the length of their working relationship. If, as is common, local authorities rule in their favour, penalties can run into the equivalent of hundreds of thousands of US dollars.
There are other risks associated with hiring contractors abroad, including the risks of triggering a permanent establishment, or taxable presence, which can lead to penalties for failure to establish a local legal entity and pay corporate taxes.
If you do hire independent contractors across borders
Given the stakes involved, any company considering hiring independent contractors in another country should perform due diligence on the labour laws of the target country, how local authorities tend to make employee-classification determinations and the authorities’ general enforcement practices. Most companies will want to hire an experienced third-party advisor with knowledge of local laws and practices to understand their options and lower their risks.
It’s good practice to have a contract in place in the local language as well as in the home-country language, though typically the contract written in the target country’s language will prevail. The contract should clearly state the independent nature of the working relationship, though remember that local authorities will ultimately make determinations based on the actual nature of the relationship, not on the contract language. Keep in mind that an independent contractor is free to work for other agents, uses their own equipment and sets their own hours, among other things.
Some countries require a contractor to obtain an exemption-from-tax certificate from the local tax authority documenting the worker’s status as an independent contractor in their line of work. Generally speaking, independent contractors (not the agents that hire them) must make applicable tax payments and filings to local authorities. That said, you may be required to report your payments to local authorities, and in all cases you should track your contractor payments.
This article is an updated and expanded version of a previously published post.
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