When you take your business into a new foreign market, one of the first things you need to do is put boots on the ground.
While incorporating and outsourcing are two popular options that have many advantages depending on your needs, using contractors is another option that many companies use.
There are benefits to doing so, but there are also risks that many companies may not be aware of. So, make sure you have a strong understanding of contracting labour laws before deciding to go in that direction.
Am I able to use foreign independent contractors?
As a result of the complexities related to directly engaging employees in a foreign country, many organizations will utilize independent contractors. While in some cases this is a feasible option, organizations need to be very careful here not to misclassify the worker.
A major risk of using foreign independent contractors is that you could be unintentionally creating an employment scenario for the contractor, which opens you up to the roles and responsibilities of being an employer in that country.
It’s quite surprising to learn how many organizations unknowingly put themselves at risk with contractors.
Contractor definitions and legislation can be grey in some countries, but common factors to consider when thinking about using a contractor are: degree of control, exclusivity of work, and compensation.
Are you directing their daily tasks and activities? Are you enforcing company policies on this individual?
Contractors are typically given a goal or an overall task, and the paying party is unable to manage the contractor’s daily activities or the means they use to achieve that goal.
If the contractor is reporting to a manager who directs their daily tasks, schedules, or requires them to wear a uniform, for example, they could be interpreted as an employee.
Is the contractor working for your organization exclusively? A contractor by definition will be offering their services to the public and working for multiple organizations throughout the year.
How are you paying this contractor? If you are paying a regular salary or hourly wage, this too could be interpreted as employment.
Many organizations use independent contractors as a means to avoid paying costly employer tax burdens, like social security, statutory bonuses, vacation time, retirement plans, and other social programs.
What can go wrong?
Organizations often use contractors because they don’t know of any other options, or even to avoid paying the social costs in that country.
Many countries are beginning to catch on to the fact that their governments are not getting paid for business being conducted in-country, and are auditing foreign businesses.
Because a bank account cannot be established in-country by an unregistered foreign business, many will pay their contractors with direct, recurring wire transfers.
This is a big red flag that can catch the local government’s attention, and they could eventually begin to ask questions about the purpose of the transfers.
One of the more common causes for a government audit is a dispute between a contractor and the paying party, where the contractor ends up claiming that they were an employee based on the terms of the engagement.
When this happens, the paying party could have to back pay all social contributions for the length of the engagement, as well as a possible fine. In extreme cases, the organization could even be barred from operating in that country, or even jailed for tax evasion.
Another common cause is if the contractor fails to file their taxes after the end of the contract. It is the responsibility of the contractor to pay their taxes as a self-employed person, typically through their own entity.
However in many countries, such as China, the liability falls back on the paying party if the taxes are not claimed. How do you ensure that your contractors are paying their taxes?
Failure to adhere to country specific HR laws and payroll processes could result in hefty fines that could be detrimental to an expansion operation, or a non-profit with limited funding.
An organization’s reputation could also be on the line if there are penalties levied against them, which could have long term effects.
Statutory HR and payroll compliance is different in every country, and these types of issues compound in complexity when you are working in multiple foreign countries.
Just like in your home country, your new country’s labor laws change on a regular basis. Staying on top of these requirements and changes could eat up a lot of an organization’s resources.
What’s the best way to incorporate contractors into my international HR practices?
Contractors could make sense for short term projects, such as construction or any job that doesn’t require the contracting entity to manage the day to day activities.
Establishing the level of commitment and resources available for your foreign trade endeavour, and conducting thorough research, is the best way to decide whether becoming a direct employer or contracting out is the best option for your company’s international hiring needs.
Does your business use independent contractors in its international HR strategy? Share some of your tips on working with independent contractors.
Cody – your observations are valid and we have observed many of the problems you refer to.
Our experience is that the major cause of the problem are inexperienced North American managers who are ignorant of the local regulations, and who simply try to do it the same way they always have.
As you pointed out, it exposes the firm to significant risk. In some cases we have seen senior executive jailed when serious accidents occur with “contractors” not covered by social security. In another example, several “contractors” who ware denied benefits made a valid claim made against the firm. They collected full salary for 4 years, and all due to an inexperienced manager.
Incorporated service contractors like builders, construction firms, engineering consulting groups, drilling etc are simple to work with. They are able to sign a contract, execute the project in an independent manner, and issue a legal invoice.
However, when we find that when North American managers attempt to hire individuals as “contractors” simply to avoid hiring employees, then it invariably ends up being non compliant.
If the foreign firm has a local division, then it is relatively simple to either hire staff directly, or pay a labour management firm to do it on your behalf. Even in super difficult countries there is always a simple way (local firms found all the legal shortcuts – just copy them).
If the foreign firm does not have a local office, then their only option is to find a local labour management provider to supply the labour and ensure all taxes are paid. In many countries, we have found that local accounting offices can offer this service, and will provide an auditable set of books at the same time (double value).
A more common but related problem we run into is one where head office management or technical staff go to the offshore division and work there without
any visas. A current example of how to do everything wrong is Minera IRL in Peru, where the COO was caught working in country. Instead of resolving the issue he decided to flee, and now cannot re-enter the country under any circumstances. Under the Peru / Canada FTA he can still be persecuted for tax evasion (not very smart for a COO).
This case raises another interesting question: if the COO signed contracts, or notarized documents while in Peru, unless he has a Business Visa, those contracts and agreements and not valid. We have found many cases where large purchase contracts and joint venture agreements were not valid for this reason.
Overall, as Trade and Management Consultants, our greatest challenge is overcoming the ignorance (and often arrogance) of managers, and in all cases if we
find that the firm is playing loose with the rules on one issue, it is guaranteed to be offside on pretty much all of them.
Note: Minera IRL is a public company, and all reports and information are therefore
public. They started out doing everything right, but now have been doing an incredible job of getting it all wrong.
Makes for a very interesting trade case study (or soap opera).
Excellent value add to the original topic Brent! And you have made some very interesting case studies in your comment yourself. Thank you very much for your thoughts.
Cody and Brent;
You both make excellent points. I have worked for small and medium size firms that find onerous to establish a subsidiary in a foreign country to hire one or two sales managers to maintain and grow the business there.
In such cases, the sure bet is to find the talent, then hire and manage through a labour management firm. Such firms will hire the individual(s) directly, pay wages, social security contributions, retain and submit income taxes, issue tax forms to the employee(s) and bill you the cost plus a fee for the service.
This limits your liability, eliminates your risk, brings transparency to your operations and provides peace of mind.
Thanks Alberto, we appreciate you adding your advice!