A crucial question for any international expansion is whether to use international contractors or employees. Here we set out the advantages and disadvantages of using international contractors to fuel your global growth, and contrast this with hiring employees.
Please note that this constitutes general information. The precise rules relating to when a contractor or an employee may be engaged, differ according to the laws of different countries. You should seek out professional legal and compliance advice before deciding which option is right for you.
What is the difference between a contractor and an employee?
Contracts are the key tool for a business to protect its rights. For example, when purchasing goods internationally, there will be a contract in place for the sale of goods, specifying price, a description of the goods sold, and other matters.
Contracts are used for services, as well as goods. For example, if your business needs some task performed by an electrician or a plumber, you enter into a contract for their service. As these contractors are at an ‘arm’s length’ from the company, we often call them ‘independent contractors’.
A crucial question for international human resource management is: Should I structure my global human resources as international contractors or employees. Here we look at the advantages and disadvantages of each option.
What are the advantages of engaging international contractors?
Engaging international contractors may appear to have a lot of benefits as an international staffing option. Potential advantages include:
- Flexibility. In theory, the relationship between your business (the client) and the contractor is governed by general contract law. This means that a range of general laws will apply (for example, laws dealing with misleading conduct, illegal contracts, contractual mistakes and undue influence). However, otherwise, the nature of the relationship is left up to the parties. If you wish to make a contractor your agent, for example, you might do so, with relative ease;
- Cost. Contractors usually do not have the full set of entitlements as an employee. For example, by using employees you may not be required to pay health insurance contributions, accident insurance, parental and sick leave. In addition, the minimum wage may not apply to your services;
- Ease of compliance. As there are far fewer legal and regulatory rules that apply to independent contractors as opposed to employees, it may be easier to ensure that you comply with the laws in that country.
Note, as set out below, there are considerable risks with using international contractors, which means you should engage professional advice before doing so.
What are the disadvantages of using contractors?
Despite their potential advantages, there are also some possible disadvantages of using contractors:
- Legal and compliance uncertainty. In many cases, the existence of a contract and its terms, is not settled by what is written on a piece of paper (there are some exceptions where contracts must be in writing). Instead, this is determined by the nature of the relationship itself. This means, there is a risk that your contract would be interpreted by a Court as an employment relationship, no matter what you may have intended. This could make you liable for employee benefits, minimum wage entitlements as well as court-imposed penalties;
- Tax. In general, taxes will be payable by the contractor rather than the client. But this may not be the case with all taxes. In addition, there may also be due diligence obligations on the company to ensure that the contractor is meeting tax obligations. Note also, that using international contractors does not avoid permanent establishment risk. There is a risk that the presence of the contractor in that country becomes a ‘dependent agent permanent establishment’ and makes you liable for corporate income tax there;
- Enforceability. It is likely that there will be a range of clauses in the contract aiming to protect your organization, its assets, and processes. This might include, for example, clauses preventing the misuse of company intellectual property, or clauses prohibiting a contractor from working with the competition. You should specify in the contract the country where any disputes are to be settled. On a practical level, however, it can be exceedingly difficult to enforce a contract in another country (and potentially not worth the financial expense in doing so).
Pros and cons of engaging employees
There are a range of advantages that come from engaging employees, rather than independent contractors:
- Compliance certainty. The terms of an employment relationship are more clearly regulated by the law, so it is more straightforward to understand with an employment agreement in place, exactly what is required of each party;
- Tax certainty. Employment makes it clear which taxes are owed and by whom;
- Enforceability. As long as the employment contract is compliant with the laws of the country in question, there should be no problem with enforcing the terms of that contract.
Challenges for engaging employees in a new country include:
- The complexity of compliance and tax obligations. The compliance and tax obligations of employers are usually significant. It can be difficult to understand the consequences of being an employer without long experience of how things work in that country;
- Once you have tallied up the costs of employee benefits, it may appear too expensive to enter into that country and operate as an employer.
Where does a PEO fit in?
Once you have decided that it makes sense to engage employees in the new country, there are several business models that could be used to facilitate this. You could set up a local legal entity (such as a subsidiary of your head office operation) which will act as the legal employer in that country. The other possibility is to engage a global Professional Employer Organization (‘PEO’) on the ground in that country. The global PEO can act as the ‘employer of record’ for your employees in that country.
The employees still work on and for your business, but the global PEO takes on key payroll, human resources, and compliance obligations.
Engaging a global PEO can swiftly deal with the employer challenges in entering a new country:
- As specialists, they understand and are responsible for tax and compliance obligations for those employees;
- While it varies on a case by case basis, they can be a significantly cheaper option than employing through a local legal entity of the global enterprise, or even engaging independent contractors.
Using international contractors can appear to offer a mix of flexibility and price that is hard to beat for your international workforce. However, there are substantial compliance and reputational risks in doing so. Using a global PEO on the ground to employ your workforce directly, is a good way of ensuring full compliance at excellent value.