Considerations When Employing Workers in a Country Where the Company Currently Has No Employees

Quick Hits

• Employers interested in engaging individuals to work in a country where they currently have no employees may want to consider whether to employ them directly, engage them as contractors, or engage them via an employer of record (EOR).
• Each of the options has pros and cons, such as employment protection, payroll and corporate taxation issues, immigration issues, and employment-related benefits.
• EOR arrangements are legally questionable in some countries, and unlawful in others, including Spain.

There are generally three options for an organization looking to engage someone in a country where it does not currently employ people:

1. Employ directly
2. Engage as a contractor
3. Engage via an employer of record (EOR) / third-party entity

There are pros and cons for each approach, which are presented below in the context of a checklist of factors to consider when taking on someone in a new country.

Setting Up a Local Entity

It is a common misconception that an organization must have a local entity in order to employ someone directly. While that is true in some countries, in the majority of countries, it is not a requirement and an overseas entity can employ someone directly. Nevertheless, there can be advantages to having such an entity, including tax advantages, a greater credibility with customers and business partners, and better risk management. On the downside, there can be a number of filings and other regulatory requirements when setting up a local entity.

An entity is not required to engage someone as a contractor or to contract with an EOR—indeed, the main reason for using an EOR is to avoid setting up a local entity.

Immigration

An employer has an obligation to ensure that its employees have a right to work in the country in question—with potentially serious penalties in the event of a breach. The obligation usually requires the employer to inspect a passport or other identity document to check that it is from a country approved for work. Where an individual does not have permission to work, obtaining a work permit can be extremely difficult or impossible, and, in most cases, very time consuming. Such issues need to be identified at the outset to ensure an appointment is viable. Note that most countries do not require a work permit for U.S. citizens visiting a country simply to attend a conference or meetings, and they may turn a blind eye to someone working on such minor things as emails while abroad or on vacation. However, when these visits last longer than two or three weeks, enforcement action becomes a risk. Immigration risks do not usually arise when engaging someone as a contractor or using an EOR (as the obligation lies with the contractor or EOR).

Employment Protection

Employees will usually qualify for local statutory employment protection, which typically covers matters such as leave entitlements, minimum wage, statutory notice, severance pay, and dismissal protection. These employment rights cannot generally be avoided by trying to assert that U.S. law applies to the contract, if the employee is based abroad, unless it is a temporary arrangement and the employment relationship remains more closely connected to the United States than the other country.

A contractor will not generally qualify for employment protection rights unless found to be a misclassified employee. When engaged by an EOR, the individual will usually have employment rights but against the EOR, though, the EOR will almost certainly have a clause in its terms of business allowing it to pass on associated costs and risks.

Payroll Taxes

An employer will usually have to run payroll and withhold income tax and social security. However, there are many vendors that will provide this service. This will not be necessary if someone is engaged as a contractor or via an EOR (which will have its own payroll service).

Corporate Taxation

It is possible that activities carried out by an employee may be classified as a “permanent establishment” and trigger an obligation to pay corporation taxes on the revenue generated for the company. This is less of a risk—but still not insignificant—with a contractor or EOR arrangement, and consultation with tax advisors is a sensible option to consider.

Pension Plans and Health Insurance

Many countries mandate that employers provide pension plans, healthcare, or other benefits for employees. These can usually be provided via vendors. There is generally no requirement in relation to contractors. EORs are set up to provide these benefits, which is a key attraction of their services. However, they will pass on the cost, plus a mark-up.

Employer’s Liability and Other Insurance

It is a legal requirement in many countries to obtain employer’s liability insurance, and employers may want to confirm whether any additional mandatory insurance is required. This is generally not a requirement when using a contractor or EOR.

Registrations

There may be requirements for employers to register with a local labor authority, tax office, or other regulator. In some countries (including in particular European countries), there is also a requirement to register with the local data protection authority. Registrations will not generally be relevant when using a contractor or EOR, but employers may nevertheless want to consider these on a case-by-case basis, as the requirements may still apply depending on the situation and the activities that will be carried out.

Bank Accounts

An employer will normally need a bank account in the country. This will not be necessary when using an EOR or contractor.

Legality of EOR Arrangements

EOR arrangements have boomed in recent years, in part fueled by the increasing prevalence of remote working. Despite this, their legality is at least questionable in many countries, and they are clearly unlawful in some (such as Spain). There are a lot of “gray areas,” and EORs operate in these areas of legal uncertainty. To the extent that there is risk, it is often the EOR rather than its client company that is most at risk of fines and costs arising from an adverse finding. A company that uses an EOR may be at risk of a finding that it is, in fact, the employer (or a dual employer); in reality, though, it is already bearing employment costs indirectly via indemnity to the EOR, so it will likely have already planned and budgeted for these costs.

Control

Engaging someone as an employee provides the highest level of control over that person’s activities. By contrast, a consultant is self-employed and (in theory, at least) has more control over when and how he or she performs services. In an EOR arrangement, it is the EOR as the employer that has primary control over the worker—and responsibility for dealing with issues such as discipline and terminations. Experience has shown that EORs may sometimes take less care when dealing with such matters properly, as they know their terms of business generally mean they can pass on costs to the client—even when a botched handling of a termination leads to increased litigation costs and damages.

Using an EOR also significantly limits the ability to impose nonsolicitation agreements, restrictive covenants, and other business protection clauses. This is because such clauses are usually upheld only when for the benefit of the employer. Protection clauses written to benefit the ultimate client company rather than the EOR are unlikely to be upheld by a court.

Misclassified Contractors

Contractors sometimes bring legal claims asserting that they are, in reality, misclassified employees and therefore entitled to employment law protections. In particular, claims can arise at the time of termination aimed at securing severance pay or dismissal protection. The tax authorities can also instigate challenges. Courts adopt a number of tests to determine whether a contractor is, in fact, a misclassified employee, and those tests are remarkably similar around the world. Genuine contractors will have control over their work and will be in business in their own right, submitting invoices for their services. They will usually be paid based on results or a daily rate, rather than an hourly wage. The more an individual is integrated into a business (such as being given a company email address and portrayed to the outside world as an employee), the higher the risk of a misclassification finding.

Conclusion

The best approach to take will depend on which of the factors above are more important, as well as on the particular country’s laws. Another key issue is the duration of the arrangement, with direct employment more likely to be suitable when it is permanent rather than temporary. As applicable local laws can vary significantly by country, a careful, well-tailored approach will likely be best.

Ogletree Deakins’ Cross-Border Practice Group and Global Reorganizations Practice Group regularly provide legal updates in response to developments in the law. Further information can be found on the Cross-Border and Global Reorganizations blogs.

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