Surprise: Your "Contractors" May Be De Facto Employees
Part two of a two-part series. Part one is available here.
Can a company avoid complicated employment laws by hiring contractors?
Last time, we shared the story of Company X, a tech startup that found itself on the hook for significant tax liability when it hired a sales rep in the U.K. without setting up a legal entity. Even though the company had just one employee on the ground to begin exploring the market, permanent establishment (PE) was created as a result of revenue-generating activities.
Unfortunately, Company X’s issues with international operations did not end with the question of PE. To simplify hiring and avoid international employment concerns, the company opted to hire the Sales Rep/Consultant as a contractor. And soon, Company X had multiple contractors working as sales reps and software developers on the ground in several countries beyond the U.K., including Germany, Belgium and the Netherlands.
If he walks and talks like an employee, he is an employee
Employment law internationally is pretty straightforward on contractors—it doesn’t really matter whether or not a company decides to label its workers as contractors. If they behave like and are treated as employees would be, they become de facto employees. Which means they are protected by country employment law, are entitled to statutory benefits and should have taxes withheld from their paychecks.
To better understand this, keep in mind that a true contractor…
- Is free to work for other companies
- Does not have company business cards
- Can be substituted
- Uses his or her own equipment
- Is not usually granted stock options
Everyone else is an employee.
Company X found itself in some hot water when it thought it was bringing on contractors, but really was hiring employees. Some of the issues they faced included:
- In Germany, the company had a small group of software developers working on new products. However, the country’s strict intellectual property rules left them in a lurch when it was discovered that the developers retained the rights to their inventions, not the company.
- Contracts in Belgium included stock options for workers as an incentive to sign. But, as no one thoroughly investigated the consequences of this benefit in country, the employees were upset to find they suddenly owed money to the government, as tax is due on options at issuance.
- Netherlands staff of Company X included sales reps that created PE—and the need for an entity. Since a proper entity was not setup in country, year-end came with no taxes being taken out of employee paychecks, creating major complications for both the company and its staff.
Be sure your “contractor” isn’t really an employee
Though it may seem like the simpler solution, staffing your international operations with contractors may end up causing you more problems than going through the formal entity setup and employee hire process. As evidenced by Company X’s story, the consequences are many and can be quite painful.