Key Takeaways
1. Make managing contractors part of your people capability/HR strategy
2. Benchmark contractor payments
3. Indirect tax compliance
4. Income tax compliance
5. Craft independent contractor agreements
6. Consider the optimal payment method
7. Regularly review contracting arrangements
8. Consider contractor management outsourcing
Managing contractors is not the same as managing employees. Businesses need to have processes in place to ensure that independent contractors and freelancers are managed effectively, in full compliance with tax, labor and commercial laws.
Here we offer 8 key tips for managing contractors.
Hire contractors globally with Horizons EOR services.
What Is the Meaning of ‘Contractor’?
An independent contractor is a professional that engages with a company to provide services according to the terms of a contract. They may work ‘in house’, or they may be a remote contractor. They are usually distinguished from employees, according to a set of ‘common law rules‘ based on the degree of control that the company exercises over the individual. In short, the higher the degree of control from the company, the more likely they are to be an employee rather than an independent contractor.
To read more about the connection between independent contractors and employees see What Is a Contingent Workforce?
Independent contractors need to be distinguished from ‘contractors’ in the building or construction industry. In that sense of the term, a ‘contractor’ is someone who enters into a contract for the overall management of a building/construction project: This includes labor and materials. The key difference between this and independent contracting is that independent contractors only enter into a contract for services — it is not bulk contracting covering products as well as services.
Throughout this article, we use ‘contractor’ as a shorthand for ‘independent contractor’.
What Is the Purpose of Managing Contractors?
The purpose of managing independent contractors is to ensure that:
(a) their performance matches contractual expectations
(b) the interests of the client business are protected at all times
(c) the contractor is paid in full compliance with applicable laws and regulations.
We consider each of these in turn:
- Contractual performance
- Managing contractual performance begins with the contract for services (otherwise known as an independent contractor agreement). This sets out in broad terms how the relationship will proceed and how the deliverables of the contract will be provided.
- But it can’t end there. Managing contractors successfully means having mechanisms in place to ensure that performance continues to meet expectations over time.
- Protection of clients’ interests
- Businesses need to ensure that, where contractors have access to company assets and intellectual property, those interests are protected. Managing contractors means, one way or another, ensuring that the right mechanisms are in place to mitigate this risk.
- Compliance
- Businesses need to ensure that there is no ’employee misclassification’. This phenomenon, sometimes known as ‘sham contracting‘, means that professionals are being treated as contractors for tax and social security purposes, but they should be treated as regular employees.
- It is also important that businesses ensure they are compliant with income and indirect tax (e.g., VAT or GST) obligations when managing contractors (more on this below).
When managing contractors, we recommend the following 8 actions to ensure that you are working towards these three goals.
8 Tips for Managing Contractors
Where managing contractors, we recommend the following steps:
- 1. Make managing contractors part of your people capability/HR strategy
- Sometimes, managing independent contractors is the job of the human resources (HR) department, in other cases there is a separate vendor management unit. Whichever the case, it is essential that the business is strategic about which individuals might be classified as independent contractors and which as employees. This is the best way of mitigating the risk of employee misclassification and being penalized by the tax authorities.
- 2. Benchmark contractor payments
- In the case of employees, a specialist recruitment agency will probably have the best up-to-date information on employee wages, salaries and benefits in that location. This will often be true for contractors or freelancers in that area as well. As a general guide, it may well be worth checking out the prices (including those of local contractors or freelancers) on freelancer marketplaces such as Upwork, Fiverr, Guru or Toptal.
- 3. Indirect tax compliance
- In many countries, indirect tax (such as Value-Added Tax (VAT), Goods and Services Tax (GST), or Sales tax) must be added to payments to contractors, but not to employees. While it is the responsibility of the contractor/freelancer to charge these amounts, it is up to the business in question to ensure that it is registered for indirect tax and all receipts and payments are reconciled at intervals as required by law (e.g., monthly or quarterly).
- Read more about how independent contractor taxes work in our expert guide.
- 4. Income tax compliance
- By definition, companies are not generally required to withhold employee income tax to remit to the tax authorities. Nor are they generally required to withhold payroll taxes. Generally speaking, the contractor themselves is required to account for income taxes (and sometimes payroll taxes).
- However, in some countries, there are steps that a company needs to take if it is not withholding those amounts. For example, in the US, companies are required to file Form 1099-NEC for US independent contractors who are paid more than $600 in a year (for this reason, in the US, independent contractors are often known as ‘1099 employees‘). For foreign contractors to US companies, the business needs to hold valid W-8 BEN forms submitted by those contractors, or otherwise withhold 30 percent of the payment. You can read more about IRS requirements for foreign contractors here.
- 5. Establish an independent contractor agreement
- The contract entered into between a client and a contractor is sometimes called a ‘contract for services’ to distinguish it from the ‘contract of service’ that is entered into between an employer and an employee.
- This independent contractor agreement should clearly specify the tasks to be performed by the contractor, responsibility for taxes and compliance, contractor payment schedule and payment methods, warranties and indemnifications, dispute resolution mechanisms, confidentiality/data protection/non-disclosure and intellectual property rights.
- Note, that the contract needs to be carefully reviewed to ensure that it doesn’t exert a degree of control over the contractor to risk employee misclassification.
- 6. Consider the optimal payment method
- Contractors may themselves have preferences about payment method. That aside, businesses also need to consider the cost of. the chosen payment method that would best square with their internal processes and invoice management. Traditional payment methods include ACH/SWIFT transfers, wire transfer, credit card or check (the latter especially in the US). However, third party online payment services are often more cost-effective: These include Payoneer, Paypal, Transferwise, WeChat Pay or AliPay.
- Read more at How to Pay Independent Contractors.
- 7. Regularly review contracting arrangements
- It is important to have a process in place for regularly reviewing the work of contractors, just as you would the work of regular employees. This ensures that contractors are providing deliverables as expected, and that any potential problems can be ironed out.
- At the same time, it is important to review whether the relationship is still legally compliant. In ongoing relationships, it is possible for a contracting arrangement to become more akin to employment. In these cases, the possibility of employee misclassification arises.
- In this situation, you might consider How to Convert Contractors to Employees.
- 8. Consider contractor management outsourcing
- Managing contractors efficiently means sourcing the right professionals for the job, ensuring that invoicing is tax-compliant, managing timely payment and making sure that contracts for services are fit-for-purpose. In some cases, as discussed above, it is also essential to maintain and/or submit tax documentation as directed by the tax authorities (such as the W-8 BEN in the USA).
- To ensure contractor management is legally compliant, especially when operating internationally, it is worth considering whether contractor management outsourcing would be worthwhile for your company. For more information see our expert guide How to Increase Revenue through Contractor Management Outsourcing (CMO)
Managing Contractors Effectively with a Contractor Management Firm
Businesses often hire contractors as a seemingly quick and effective option for hiring professionals, both overseas and locally. However, businesses inexperienced in managing contractors — especially across international borders — are likely to come unstuck without effective support.
Horizons provides comprehensive contractor management services to ensure that both your contractors, and employees, are managed efficiently and in full compliance with the law. Get in touch today for more information.
Frequently Asked Questions
Managing contractors effectively means integrating contractor hire and payment into your workforce strategy, establishing the right compliance and legal mechanisms, and implementing efficient payment methods.
A contractor’s work program needs to be identified at a high-level in the independent contractor agreement, through regular agreement on milestones, and in invoicing and payment processes.
