Running a business internationally or in your home country requires exceptional talent. In the current talent marketplace this is very hard to achieve, with more funding in start-ups than ever before the race to find exceptional employees is most definitely underway.
And it looks like there is no sign of it stopping anytime soon.
This poses a conundrum, should you hire remote workers? If you run a tech or SaaS business this is actually a blessing because it means that you don't have to rent office space, or pay for lunches etc. But it also means having an international workforce.
This complicates the payroll situation because you're paying people in different currencies and different time zones. Each geographical location has their own local tax laws which, despite your company being based in the UK or the US or Europe they still apply to you. If your employee is based in Germany you still have to adhere to their tax laws, not just your own.
Payments to foreign contractors for services can get pretty confusing if this is your first time hiring remote workers.
There are a lot of factors when it comes to paying foreign contractors, such as tax compliance, legal compliance and minimizing operational costs. Making sure that your employees get paid, on-time, every time is really important. As we just mentioned, the race for talent is crazy right now. Losing a valued employee over a missed wage payment or a tax mix up is just not worth it.
Here are a few considerations when paying foreign contractors:
- How you define contractors accurately requires in-depth knowledge of the tax and employment laws in the country that your business is based. But it also requires you to know the tax laws in the country where the employee is based.
- We must know how the worker is classified and that comes under the jurisdiction of the local government where the employee lives. Some governments will consider that person to be an independent contractor, some governments treat them as an employee. So it's important to know what classification your worker falls under.
- In general terms, if a person is with a single employer for a prolonged period of time, with no end date, and if the company is paying benefits and holiday pay etc, this is not legally compliant, as the worker is acting as a pseudo-employee.
- If the employee works for multiple companies simultaneously and has control over their working status, or works for a single company for a short time they’re usually deemed as a freelancer/contractor. When this happens the contractor is considered self-employed and responsible for their own income tax obligations.
The penalty for misclassifying employees can be pretty steep. Tax penalties can accumulate rapidly. If the company is inside the United States of America and treats an international worker like a contractor, but the IRS treats them as an employee, you can get into serious trouble.
We've seen this recently in the news with giant companies like Uber. In some parts of the world Uber drivers are considered contractors, and therefore Uber is not legally liable for their tax obligations. In some countries Uber has been deemed as a full-time employer, since the driver isn't working for anyone else.
The most common tax penalties issued by foreign governments when it comes to worker misclassification is Back Tax Withholding on wages. Also, any unpaid benefits and overtime pay, since overtime is usually paid at a different rate to standard time.
It's also worth mentioning that classification lawsuits are generally not initiated by local governments.
With millions of people to keep tabs on, the issue usually arises from the worker themselves. The contractor will report their employer for something trivial like not paying them for vacations, when they believe they should be entitled to vacation pay. This will then trigger a series of events with the relevant tax office and a whole slew of infractions will be uncovered.
In the United States of America for instance, companies that hire independent contractors or freelancers will require the freelancer to complete a 1099 to comply with Federal tax laws. This lets the IRS know that worker is a contractor, not an employee.
If the firm is US-based but then paying international contractors, the IRS requires the company to have the contractor file FORM W8-BEN, which ostensibly tells the IRS that the contractor is a foreign entity and not liable for US tax.
It's a very smart idea for businesses to have contracts set out with the contractor beforehand. Having proof in black and white is a good way to cover your back should any of these issues arise later on.
The Permanent Establishment Risk Clause
There’s a clause in many countries called a “permanent establishment risk” clause. It arises if a globalized company fails to declare its own standing in a particular foreign country.
For instance you may designate your contractors as contractors because you're based in the UK with an office in the US. But, if the IRS decides that your business is US-based now because you have a permanent presence, they can designate your contractors as permanent employees.
If local tax agencies can legitimately claim that businesses are operating within their country's borders on a continual permanent basis, it can easily classify that business as permanently established. This “permanent establishment risk” clause makes the company liable for local corporate tax and designating its contractors as full-time employees not contractors.
Permanent Establishment Risk is then ostensibly a compliance risk. Every single global company needs to understand its business designation in certain foreign markets, and the tax laws within those markets. Otherwise you run the risk of being classified as a permanent establishment.
Again this depends on which country you're operating in.
For instance the United States of America has very strict taxation rules.
The IRS, which is the Federal branch of the government that handles taxation, charges tax on every single employee and corporation in the entire United States of America. However, individual States have their own tax liabilities. For instance, the state of Washington doesn't have an income tax so you just pay Federal tax.
Somewhere like the United Arab Emirates where there is no personal income tax and no corporation tax (this is due to change in 2023), the liability would be reduced.
In these two separate cases, misclassification could have very different outcomes. You could be facing a bill for millions of Dollars from the IRS, or a simple slap on the wrist and a letter of intent to get your affairs in order from the United Arab Emirates.
Let’s take a closer look at how countries designate contractors and employees:
United States Of America
Form 1099 is the basic form you must fill out if you earn non-employment income, like bank account interest or stock dividends. Section 7 of this form was used to declare freelance/contractor work until 2020 when Form 1099-NEC was introduced.
Form 1099-NEC is considered contractor non-employment compensation. If you're based in the United States of America and have contractors that are based there and they meet the following four criteria, you must report any payments.
1: You made a payment to someone who is not your employee.
2: You made that payment in the course of your trade or business, this also includes non-profit agencies and government entities.
3: The payment was made to an individual, a partnership or a corporation.
4: You made a payment of at least $600 during the financial year.
Form 1099-NEC is brand new for 2020, usually you would report this income on Form 1099-MISC but with the onset of the pandemic and the increase in international workers the IRS are now asking for this to be a separate form.
Also if you are a US based company and you are paying international contractors, you need to report the amount using forms:
- Form 1042 and Form 1042-S, foreign person's with US source income.
- Form W8-BEN is filed by the contractor themselves. It shows the IRS that the contractor is not a US based citizen and they don’t need to withhold tax. If the IRS doesn’t get this form they will deduct 30% of your income in tax withholding.
United Kingdom
In April 2020, much like the IRS in America, the law changed where contractors are concerned.
IR35 is a brand new tax rule that states contractors must be taxed as employees, even if the individual is working with an intermediary such as an umbrella company. This is to stop contractors forming a LTD company (LLC in the US) to save tax, but is effectively working as an employee for the end user through an umbrella company. Under these rules, a worker would most likely be seen as an employee.
Self-Assessment is where an individual simply works without forming an entity like a LTD company, and files their own tax every April. This worker would most likely be seen as a contractor.
Getting the correct guidance is really important at this stage, especially if you haven't processed payments before or hired contractors overseas before. Let’s assume you know how to hire them now you must pay them.
Some of the more common ways to pay contractors are:
- International wire transfer. Businesses can use their business bank accounts to transfer payments to foreign contractors via the global transfer network SWIFT. This network connects financial institutions across the globe.
- International money order. Basically a paper check, companies can also use this as a form of payment but it’s very old school and most modern companies wouldn't use this. The largest outlet for this type of money order payment system is Western Union. It's not used that often because of the major downside to it, the transaction is very slow.
- A regular bank check is also a possibility but again, it takes time to mail. They travel very slowly, and it takes 3 days to clear. You risk annoying your contractor's who just want to get paid quickly and efficiently.
- Online payment networks like Paypal or Revolut have become very popular in recent years. Many businesses are turning to the digital payment networks like Revolut/PayPal or Xoom when paying international contractors. The payment system is very intuitive and it’s instant unlike money orders or checks. The downside is that a lot of countries are banned from using them. Especially countries with high incidents of fraud.
- Through an Employer Of Record. This is the easiest option of all. One simple monthly payment to the EOR and they take care of your employees payroll, tax liability and wage payments.
This is where working with an Employer Of Record is a distinct advantage, because global employers of record make these payments on a daily basis. They reduce your risk to zero.
How Can An Employer Of Record Help?
You can mitigate most of these problems by working through an Employer of Record. They employ the contractor directly, and will shoulder all of the tax and payment liability.
You simply pay the Employer of Record a single monthly fee and they do the rest.
A good quality EOR like Emerald has worked with hundreds if not thousands of employees over the years, making payments in multiple currencies to multiple geographical locations.
All while staying tax compliant.
An Employer of Record is by far the simplest way to avoid tax and wage payment issues when hiring contractors. You’re tapping into a deep network of skilled EOR specialists who can find the talent you need, onboard them, sort out their tax liability and pay them every month without fail.
All you do is pay the Employer Or Record each month and they take care of the rest.
Talk to us today about how Emerald can help you navigate these issues and help you grow your business.
