Switching from an EOR to a legal entity? Here’s what actually happens

There are benefits and risks to all cross-border hiring solutions, whether you pay independent contractors, use an employer of record, register a local payroll or employ under a registered entity. Each organisation’s situation is unique, and choosing the optimal solution isn’t always clear-cut.

Employers of record, or EORs, are increasingly popular in part because they provide an easy way to pay employees in a new country without fully committing to the jurisdiction. The EOR pays and provides benefits to the employees through its own local legal entity on behalf of the client, while the client manages the workers from the home country.

Depending on the circumstances, an organisation that engages an EOR typically must make a big decision 12 to 18 months after the start of the engagement. It must either wind down the activities in the jurisdiction (terminating the relationship with the workers and the EOR) or establish its own legal entity and transition the workers to a new local payroll.

The subject of when to switch from an employer of record to a legal entity is important and should be fully understood by any organisation using or considering an EOR provider. The risks of using an EOR for too long rise the longer you remain in the country, the more activities you engage in, and the more employees you have, among other factors. After you meet certain thresholds — which typically aren’t explicitly stated in local regulations — local authorities will expect your organisation to establish its own legal entity, in part so they can collect corporate and indirect taxes.

The risks of using an EOR solution for too long are perhaps not as widely known as they should be, even for organisations with long experience in international expansion and operations. (Check out the ebook “Hiring across borders with an employer of record” for details.) What’s just as important — and perhaps even less well-known — is what actually happens when switching from an EOR provider to a legal entity.

This article provides a summary of some of the most important steps when making the switch. It should be emphasised that the number and types of legal entities vary by country. To lower your risk, you’ll almost certainly want to hire a third-party tax and HR expert that understands local hiring options, and local regulations and enforcement practices. An experienced provider should be able to provide information and guidance related to each of the steps listed below.

Establishing your own local presence

• Choose a legal entity.
  • Common entity types include subsidiary or branch registration.
  • There may also be an option to move to a non-resident payroll or representative office registration (subject to corporate tax nexus considerations).
• Establish a local bank account.
  • Establishing a local bank account is often a requirement for establishing a local entity.
  • The time it takes to register a bank account will vary by jurisdiction and other factors, but the process often takes a month or longer — in any case, longer than many organisations anticipate.
• Establish your chosen legal entity.
  • Obtain a local corporate tax identification number.
  • Register a local payroll.
    • Register with local tax and social security authorities.
    • Understand local payroll requirements, including:
      • Tax and social withholding rates and how to remit payments.
      • Any local quirks, such as Christmas (13th month) bonuses.
      • Any headcount thresholds that may determine certain employer obligations, such as health and safety obligations or the need to establish a works council.

Fulfilling employer obligations

• Review the terms of the EOR contract, and understand local employee-transfer obligations, to understand employee-transfer deadlines.
• Draft and enter into employment contracts related to the new legal entity.
  • When transitioning employees from an EOR, local law and/or best practice may stipulate that new contract terms and entitlements are the same or better than the prior contract (in this case, the contract with the existing EOR provider).
  • Contracts must be in the local language or dual language.
  • Contracts should be legally vetted by an expert familiar with local employment law before delivering to employees to ensure that the employer is protected.
• Draft and issue notifications.
  • Before the transition, notify the EOR workers of the planned change in employer, providing ample time for the workers to consult with you about the coming changes.
• Understand and arrange to provide statutory benefits.
  • Employer obligations are country-specific, and there are often state-level obligations as well.
  • Providing local benefits can be expensive, and you may not have the same benefits purchasing power as your previous EOR provider; work with a third-party expert to understand your options and budgeting considerations.
  • The most common statutory benefits are:
    • Paid time off
      • Holidays
      • Annual leave
      • Other leave
    • Pensions
    • Insurances
      • Employer’s liability
      • Social security
      • Life insurance
• Understand and arrange to provide locally appropriate supplementary (that is, non-statutory) benefits.
  • Transferred employees should have the same or better supplementary benefits than they had with the EOR provider, which may be a challenge due to the EOR provider’s ability to pool resources.
  • To be a competitive local employer, supplementary benefits should be provided based on country and region within the country, as well as industry and job role; determining what is customary and competitive in the local market will usually require third-party assistance.
  • The most common supplementary benefits are:
    • Supplemental medical, vision and dental
    • Health and wellness programs
    • Long-term disability and income protection
    • Share-based compensation, such as employee stock ownership plans, restricted stock units or incentive stock options
• Understand and follow local rules related to data protection and personal information.
  • Many countries require employee consent before obtaining and retaining many types of personal information.
  • Background checks may need to exclude obtaining banking information or criminal record data.
  • Transferring personal data across borders typically carries additional restrictions and may require registrations.
• Draft and issue local HR policies.
  • Policies for each country of operation must account for local regulations and customs; that is, the new legal entity cannot rely solely on organisation-wide HR policies.
  • Local policies commonly address remote work, expatriate employees, incentives for high-performing employees, promoting organisational values, and more.
• Obtain a work permit sponsorship (if applicable).
  • Typically, an organization with a legal presence must obtain work permits and visas for non-local nationals.
  • Few EOR providers sponsor foreign nationals, so this may not be a factor. In the rare case where a non-local national is being transferred from the EOR to the new legal entity, you should note that:
    • Not all countries allow an employee’s work visa to be transferred from one employer to another.
    • Employers in this situation must obtain a new visa sponsored by the new entity; this may require minimum operational periods and/or a local bank account.
• Review existing salaries (optional).
  • Consider undertaking a compensation benchmarking exercise to ensure retention of transitioning employees and attract new employees under the entity.
  • Do not plan to reduce compensation, as this may be unacceptable under local regulations and is generally considered bad practice.

Fulfilling corporate and indirect tax obligations 

• Understand corporate tax requirements and register with local corporate tax authorities.
  • In some cases, a financial report will need to be filed when registering.
  • All filings must be completed in local GAAP and may need to be done using a specific accounting platform.
  • Understand and take advantage of local tax incentives, such as research and development credits.
• Document intra-group financing
  • Failure to comply with intra-group financing rules can lead to interest-deduction denials, tax leakage and reviews by tax authorities.
• Perform a transfer pricing assessment.
  • Determine transfer pricing arrangements and benchmarked pricing to ensure arm’s-length transactions and undertakings.
  • Prepare compliant transfer pricing documentation, including intercompany agreements.
• Understand local indirect tax (VAT/GST) requirements and register with local indirect tax authorities.
  • Requirements will vary based on the country, your business activities (for example, business-to-business or business-to-consumer), location of service and other factors.
  • In some cases, such as in the EU, an existing registration in another state may suffice.
  • You will likely need to hire a third-party tax agent to meet VAT/GST obligations and take full advantage of indirect tax recovery.