Independent Contractor or Employee: Are Independent Contractors the Best Solution for Multinational Organizations?

by Ogletree, Deakins, Nash, Smoak & Stewart, P.C.
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Almost every organization expanding overseas needs a vehicle to explore the market before making the business decision to establish a legal entity, yet few legal vehicles are available for this preliminary measure. Most often, multinational organizations meet this need by entering into independent-contractor arrangements with individuals. While a useful vehicle from a business standpoint, in order to avoid exposing the company to liability, the independent-contractor arrangement requires onerous criteria to be met. Otherwise, an independent-contractor arrangement may expose the organization to liability to the foreign country’s revenue authority, payroll tax liability to the foreign country’s social entitlement programs, and liability to the individual engaged as a contractor under applicable labor and employment laws.  

In this four-part series of blog posts we will provide a checklist of considerations applicable to global entities, drafting tips for strong independent-contractor agreements and ancillary documents, and a short survey of particular considerations and requirements in several major and secondary market countries where independent-contractor vehicles are frequently used. 

International Legal Implications of an Independent-Contractor Relationship

Before embarking on the independent-contractor path, companies should consider the potential ramifications: What laws might apply? What problems might the arrangement cause? And what happens if the worst happens? 

1.      Misclassification—Contractor Is Deemed Employee

The primary adverse consequence of using an independent-contractor arrangement improperly, is that the contractor will be deemed an employee. The worker is generally referred to as having been “misclassified,” or having a “sham” contract. If a contract is found to be a sham, the individual in question generally will be considered an employee under the applicable country’s laws.  Therefore, the worker will be deemed to be entitled to country-specific mandatory benefits and payment entitlements on termination (such as notice of termination and severance pay). 

Moreover, the misclassified worker will also be entitled to the local country’s applicable protections from termination of the relationship.  In other words, a company could be ordered to “reinstate” an independent consultant as its employee, and/or he or she may be awarded all statutory rights and benefits applicable to employees, retroactive to the beginning of the relationship. For that same time period, the company could also be liable for any payroll withholding taxes or social entitlement contributions such as health insurance, social insurance, dismissal indemnities, and workers’ compensation insurance—plus interest. Companies that were required to provide these benefits and did not may be compelled to do so, which could include registration and administrative requirements. Some jurisdictions also have specific penalties for employee-misclassification, including criminal penalties.

Typically, misclassification claims arise when an independent contractor becomes disgruntled after the relationship terminates and files a lawsuit against the company or reports the company to labor and/or tax authorities.  Notably, for multinational organizations, when a misclassified employee acting as an independent contractor provides services for multiple company affiliates in multiple countries, he or she might be deemed an employee of any—or all—of them, bringing multiple countries’ employment law protections into play. 

2.      Specialized Protections for Non-employee Workers

Even when the contractor arrangement is properly entered into, companies must adhere to protections available to nonemployees under the particular country’s laws. Some countries define “employee” more broadly—or define another category of “worker”—for purposes of certain statutes. In other jurisdictions, companies have the duty to their contractors to comply with workplace health and safety laws. Contractors have rights to organize in some countries as well. A company may even have to provide certain benefits to contractors that are similar to employment benefits, such as social insurance. The lesson here is that even a genuine choice of independent-contractor status might not get the company true relief from employment-type obligations.

3.      Taxation of Profits and Other Tax Consequences

Where the company has no subsidiary in a foreign country, its independent contractors could be considered the company’s “permanent establishment” in that country—which, in essence, means that the company will have to pay taxes on profits attributable to its business conducted in that country. Many countries have bilateral tax treaties with one another that protect against double taxation, which would allow foreign-country taxation to be limited to the amount exceeding tax in the home country. Even so, applicable corporate tax is determined by local tax authorities, requiring the company to file a tax return in the country where the independent contractor works, disclosing financial information. In countries without bilateral tax treaties, a foreign tax credit is often available, although typically subject to a cap. If the contractor has the authority to conclude contracts on behalf of the company, this both increases the risk of a “permanent establishment” and may increase the amount of taxable profits.

Of course, independent-contractor status has income-tax consequences for the contractor as well. Contractors are usually responsible for their own income taxes and are allowed to deduct expenses. Expatriate contractors may be subject to double taxation on their income in their home and host countries, depending on the bilateral tax treaty at issue as well as the local country’s laws. Moreover in some countries (such as India), companies are required to make certain withholdings from service payments to contractors.

4.      Mobility, Diligence, Permits, and Other Issues

There are several relevant considerations for companies embarking on independent-contractor arrangements in foreign jurisdictions, in addition to the above:

  • If the independent contractor in question is not a native to the country where the services will be performed, and/or if he or she travels across borders to perform services in multiple jurisdictions, immigration considerations must be taken into account. Most countries’ immigration laws require work permits, and these are difficult to obtain absent an employment agreement. Contractors who circumvent immigration requirements inappropriately by using business-visitor visas may be subject to deportation. In addition, the company might be subject to penalties if a contractor violates immigration laws, which include criminal penalties in some jurisdictions. Where the company itself has no local presence, the authorities might even target a company’s client, for whom the contractor provided services as a representative of the company.
  • Many jurisdictions require a company to seek and obtain a license to conduct business by filing a commercial registration. Where a specialized license is at issue for a particular industry, this may not be available without a local legal entity and/or where the company is utilizing independent contractors.  
  • Public companies must be mindful of U.S. securities law implications as well.  Knowingly misclassifying employees might cause problems for required compliance certifications. Additionally, in connection with acquisitions or divestitures, a significant number of potentially misclassified contractors could raise a material issue in the corporate due diligence process.

In the next issue of our four-part Independent Contractor series we will present a questionnaire on issues to consider before engaging independent contractors for multinational organizations.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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