The options will vary by country, and each carries its own benefits, limitations and risks. As your situation changes, you may need to move from one method of employment — such as using an international employer of record, or EOR — to another, such as establishing a subsidiary and related payroll.
We interviewed three experts with decades of combined experience helping companies expand and hire across borders. They address the basics of how to hire, along with some of the benefits and limitations of hiring workers as contractors, as employees through an EOR, as employees through a legal entity and more. They also provide some real-life cross-border hiring scenarios, tell us what clients routinely get wrong and provide some general hiring advice to help your organisation lower risk.
Charlotte Hultman is Vistra’s global sector head for corporates. For nearly two decades she has helped companies overcome the challenges of expanding into new jurisdictions. Saul Howerton is Vistra’s vice president, advisory. His expertise spans a broad range of technical areas, from HR and global mobility to international tax and entity establishment. Tom Lickess is Vistra’s global head of international tax advisory. His focus is on tax operational compliance and efficiency throughout the business lifecycle.
What are the common ways of hiring workers when expanding into a new country?
Charlotte: There are several ways to hire workers when expanding across borders. These will vary by country and depend in part on the activities of the expanding company. Generally speaking, though, there are five ways to hire.
The first is to establish a legal entity and hire employees through that company.
The second is to set up a branch office, which is similar in some ways to establishing a legal entity such as a subsidiary, but as the name suggests is really an extension of your home-based entity and does not provide the same limitations on liability.
The third option is through a non-resident payroll, which is to register your foreign entity in the new country and hire workers through your headquarters.
The fourth option is through an employer of record, or EOR. This involves hiring workers through a third party who is already established in the country and can make payrolls and provide benefits while the expanding company actually directs and controls the workers.
Finally, you can hire workers as independent contractors.
How does the expanding company know what hiring route to choose?
Charlotte: That will depend on a number of factors. The first consideration is usually timing, or how quickly you need to get your workers on the ground, whether to capitalise on a hot market, assist with an important client or for other reasons.
You’ll also have to consider your short- and long-term goals. For example: Would you like to test the market before fully committing? If so, you may not want to set up a legal entity, at least in the short term. Setting up a legal entity has many benefits, but it can be time-consuming and expensive.
Other factors include the legislative, regulatory, cultural and other realities of the target country. For example: How long does it take to set up a bank account and legal entity, or register a branch and obtain the relevant approvals and licenses? You’ll also want to consider the ease of doing business in the target country and what’s involved in winding down operations if things don’t work out.
Can you give an example of a real-life scenario involving these kinds of choices?
Charlotte: We recently helped a US software company looking to rapidly expand into Asian markets. They settled on several locations, including China and the Philippines. In both countries, they opted to go with our international EOR solution to onboard the new workers.
Not only was this quicker than setting up legal entities, using the EOR option fit their strategy in each country. In the Philippines, the client is testing the market before committing to a greater presence there, so they are using the EOR solution indefinitely. In China, on the other hand, we’re actually in the process of setting up a local legal entity for the client. When that’s established, we’ll transfer the local employees from the EOR payroll to the client’s payroll through the legal entity.
So in the case of the Philippines, the client was using the employer of record as a longer-term solution, whereas in China it was purely an interim solution while the legal entity was being established?
Charlotte: That’s right, and those are two common uses of an employer of record. In each case, the client considered the regulations of the target countries and their goals, and weighed the risks and benefits to make informed decisions. They didn’t seriously consider hiring independent contractors in either case, because the risks were too high. Tom can really speak to that.
What are some of the risks of hiring workers as independent contractors when expanding internationally?
Tom: On the face of it, hiring workers as independent contractors can seem like a good short-term solution, but as Charlotte points out there are significant risks. Unfortunately, it’s not uncommon for clients and prospects to come to us after they’ve hired workers as contractors when they should have hired them as benefits-eligible employees.
Why is that important?
Tom: It’s a matter of misclassifying workers under local laws, which can result in significant financial penalties and reputational damage. A company that misclassifies a worker as an independent contractor may be required to remit employee taxes and social security contributions, and that’s on top of the gross amounts already paid to the worker. This may not sound like a lot, but over time it can add up to the equivalent of hundreds of thousands of US dollars, and the company may have to pay additional penalties. And that’s just for one misclassified worker.
Is this a new risk?
Tom: It’s not new, but with widespread tax base erosion, employer classification is increasingly an area of focus for authorities around the world. Certain jurisdictions have implemented specific tax anti-avoidance provisions to tackle what they see as a growing abuse of contractor misclassification. In the UK, for example, there are now IR35, or off-payroll working rules in place that require companies to determine if any employed contractors should be properly classified as employees. If there’s a mistake, the company may be liable for historic employee taxes and social contributions, along with penalties and interest.
Are there ramifications beyond employee taxes and penalties?
Tom: Yes, there are also corporate tax risks, particularly if you don’t have a local legal entity. If you engage a contractor in another country and he or she should have been classified as an employee, then the activities may give rise to a corporate tax nexus, commonly called a permanent establishment. In other words, if the worker has been carrying out business-like activities, even acting in an agency capacity, you may be liable for corporate income tax on those activities.
Could you give some problem scenarios in the area of independent contractor classification?
Saul: It’s pretty common for clients to hire contractors in a new country for a short-term assignment, say up to a year. Once in place, however, that kind of engagement may turn into a long-term solution. The client may even bring on additional contractors, since hiring this way is easy and they’ve become comfortable with it.
Unfortunately, clients in this situation can eventually find themselves with several long-term contractors, for which no employer social security or tax remittances have been made and annual leave has not been tracked. As Tom mentioned, this can result in the client becoming liable for back payments, penalties and severance.
How do clients usually come to find they’ve misclassified contractors?
Saul: In some cases, local authorities will conduct an audit and determine if one or more contractors were in fact de facto employees.
Keep in mind that many contractors come forward themselves to report these misclassifications to authorities. This may come from the working relationship ending poorly or because the contractor simply believes they’ve been denied benefits that were rightfully theirs.
Also, I’ve seen numerous cases where long-term contractors have used their status as leverage against the client when a contract comes to an end. These contractors may cite the client’s non-compliance with statutory employer obligations, as well as unused leave accruals, which are often not tracked. In some cases, these contractors are able to use that leverage to negotiate favourable notice periods or early contract-termination pay-outs.
It’s clear that hiring independent contractors abroad carries risks. What are some scenarios where a client might want to consider using an international employer of record, or EOR, instead?
Charlotte: Using an EOR can be an excellent way to make the shift from paying existing workers as contractors to paying them as employees, for whatever reason. Tom mentioned the UK’s IR35 rule, which has raised the stakes of hiring contractors there. The UK’s Supreme Court also ruled this year that certain Uber drivers should be classified as benefits-eligible workers rather than contractors, further highlighting this risk area.
These and similar developments in other jurisdictions have led many multinationals to review their existing contractors in light of local worker-classification rules. In some cases, they are transferring their contractors to an EOR solution so they can pay the workers as employees and lower many of the contractor-related risks we’ve discussed.
You talked earlier about a client using an EOR to hire employees in China and the Philippines. What are some other scenarios where using an employer of record might be appropriate when expanding?
Charlotte: In addition to those earlier scenarios of testing a new market or using an EOR as a bridge solution while a legal entity is being established, many of our clients use an EOR when acquiring another company or part of a company in another country. An EOR is a particularly useful solution when buying part of a company, or engaging in a so-called carve-out deal in which the buyer has no legal entity in the target country. In such cases, the buyer may need a quick, temporary payroll solution for the transferred employees.
This is similar to our China example — using an EOR as a stopgap solution while a legal entity is being established.
Saul: An EOR can also give you time to obtain work visas and fulfil other obligations. These can take longer than the length of service under a transaction services agreement, or TSA, in a carve-out deal. So, an EOR model can be a great way to initiate local support for employees, while the entity and operations are being established.
Charlotte: One other scenario is using an EOR when reducing your footprint in a country. In some cases, your main activities will come to an end or you may need to reduce your workforce and liquidate your legal entity for any number of reasons. If you still need to keep some talent in the country, you can in some cases transition employees to an EOR. As Tom mentioned, though, you need to be careful not to trigger any local corporate tax nexus rules.
Saul: We recently helped a client in that situation. They needed to reduce their footprint in China, and were shifting the majority of their manufacturing from that country to Southeast Asia. This in turn reduced their need to employ Hong Kong-based employees. In the end, they went from five Hong Kong employees to one. They de-registered their Hong Kong entity and set up their remaining employee with an EOR. This reduced their costs, and they were still able to meet their compliance obligations in Hong Kong.
Before limiting or reducing your footprint, keep in mind that you should carefully review all your options, including not only employer of record but also representative office and non-resident payroll. Always keep an eye on permanent establishment triggers and your situation. And bear in mind that every country’s laws and regulations are subject to change, so that what was the optimal solution at the time you reduced your footprint may not be the optimal option a year later.
That’s true too of your own activities in-country, which like laws are subject to change. You may find that you need to expand again, and with growth comes increased tax and other obligations, and maybe even a need to re-establish a legal entity.
Are there situations where an EOR is not the right solution?
Tom: As Saul mentioned, when using an employer of record arrangement in another country, you should review your activities in light of local and international tax permanent establishment laws. If the employees are carrying out business or business-like activities in the country, no matter how few employees there are, you may trigger a permanent establishment and related obligations. The longer you use an employer of record, the greater your risk of triggering a permanent establishment.
In some countries, there may be clear limitations on how long you can use an EOR. In Germany, for example, a company may use an EOR for a maximum of 18 months before it must hire the workers through its own local legal entity.
So, an EOR can be an excellent solution, but as we’ve discussed it’s often a short-term or stopgap measure.
Can EORs be used in any country?
Saul: In addition to Germany’s legislation, we do see limitations in some other countries. This year in Mexico, for example, the government published amendments to federal laws on the outsourcing of personnel, which is hiring employees through a third party — effectively an employer of record. In Mexico, these arrangements have traditionally been used to reduce certain employee costs, including those related to social security. The situation in Mexico is complicated, but it’s an example of how tax and other authorities continue to look to ways to protect their tax bases and workers.
The bottom line is that if you’re thinking of engaging an employer of record or similar limited-footprint option such as a non-resident payroll, you have to keep abreast of local laws and enforcement trends, and be prepared to switch to another option quickly if circumstances dictate. Often this means establishing a legal entity such as a subsidiary.
Is there anything in this area that clients and prospects routinely get wrong?
Saul. I often see companies that fail to develop a long-term strategy and growth plans when expanding into a country. Ideally, they should consider the number and type of activities they intend to have there, and when they’ll establish them. The answers will dictate the best employment options. I also encourage clients to consider where they think they’ll be at six, 12 and 18 months before deciding on an option. This helps prevent duplicate efforts and unnecessary expenses.
If you plan on moving from one employee to six after six months, for example, it probably makes sense to consider establishing a subsidiary from the start, rather than switching after such a short time. It can be time-consuming and expensive to change your employment approach once you’ve established a way of doing business.
And as we’ve discussed, this applies to contractors as well. You really need to consider the risks of hiring contractors in light of your own long-terms strategies and local laws and practices.
Tom. This is a related point, but to lower risk I agree that companies must routinely review their strategies, the current regulatory landscape in the host country and their corporate situation.
It’s also important to emphasise that each country’s laws are unique. Don’t assume that the permanent establishment rules of one country apply globally. Country-specific tax regulations and enforcement are nuanced, and companies disregard that fact at their peril.
Is there a general rule of thumb when it comes to hiring workers in another country, or one piece of advice you'd like to end on?
Charlotte. We didn’t need a pandemic to tell us that situations frequently change, and change quickly, for multinational organisations. But recent events have highlighted just how important it is for businesses to be nimble in the face of change. You need to be able to quickly adapt to new situations, and if necessary change how you employ workers — whether that’s moving from an employer of record to a subsidiary or making another similar change as you move through the corporate lifecycle.
Saul. It’s fundamental and can’t be repeated too often: Companies need to understand the legislative landscapes of all their countries of operation, including their statutory compliance obligations and local employment laws. It’s also crucial to understand not just mandatory benefits, but also best-practice local offerings, such as enriched medical coverage, car leases and so on. This comprehensive view will ensure compliance, but also position you as an attractive employer that can recruit and retain top talent. That can sometimes get lost when making the important decision of how to hire and pay workers across borders.
Tom. I’d echo both points. Companies need to be flexible and keep abreast of changing regulations to lower risk. You need a service provider that can act as your EOR or transition you to a subsidiary or other employment option as your situation changes, no matter what countries you’re in. You also need a provider to give you information and authoritative advice that enables you to make informed-decisions without over-engineering.
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The contents of this article are intended for informational purposes only. The article should not be relied on as legal or other professional advice. Neither Vistra Group Holding S.A. nor any of its group companies, subsidiaries or affiliates accept responsibility for any loss occasioned by actions taken or refrained from as a result of reading or otherwise consuming this article. For details, read our Legal and Regulatory notice at: http://www.vistra.com/notices . Copyright © 2022 by Vistra Group Holdings SA. All Rights Reserved.
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