3 Questions That Global Employers Should Ask to Avoid Misclassifying Employees

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Mar 5, 2020

Independent contractors and the companies that hire them are under more international scrutiny than ever before. In the last several years alone, there have been notable examples of governments levying severe punishments on corporations that misclassify workers. While there certainly are some companies knowingly disregarding these regulations, the majority simply don’t know how to navigate the subtle nuances that determine classification across countries properly.

The temptation for companies to classify employees as contractors poses a dangerous risk. The allure of substantial savings on benefits like vacation days and pension contributions by classifying employees as contractors might seem a massive opportunity, but in reality creates a substantial liability that, in the end, exposes a company to even more risk.

Most countries have regulations that favor the worker. The U.S. is perhaps the most notable exception, which makes it that much more important that U.S.-based employers operating internationally approach employee classification with diligence. Those found guilty of misclassification can be subject to significant penalties, which vary country by country but generally mandate that companies pay back wages, unpaid employment taxes, entitlements, compliance fees, and interest on incurred costs.

Employee vs. contractor

The definition of an independent contractor varies by country. Still, there is a universal tenet on which to base any assessment of a worker: Independent contractors are, by nature, separate from the traditional employer-employee relationship. To classify a worker as a contractor, an organization needs to demonstrate that it has afforded a worker the latitude to accomplish a task without specific instruction, unlike an employee, who is obliged to complete a task with more oversight from the employer. There are also relatively consistent criteria on the type of work a person is doing and whether a worker is free to perform other duties or work outside of what an employer has assigned them.

Common pitfalls

As companies evolve and strategic objectives transcend borders, the constant state of unpredictability associated with the global economy and entering foreign markets can easily ensnare those unable to adapt quickly and stay current. It’s a monumental task and often leads to several common compliance missteps. Let’s assume, then, that a U.S.-based company with no international expertise wants to expand its presence into just one foreign market. Here are a couple of the most common mistakes its executives might make:

  • The floating employee: Because the company isn’t aware of intricate foreign employment laws, it hires several overseas workers but keeps them on the books of its U.S.-based headquarters rather than registering a legal entity in the foreign country. As a U.S. company, it reports employee income to the IRS, makes Social Security contributions, and adheres to other U.S. regulations, and therefore assumes it is compliant. But since the company is employing people in a foreign country, it also has to comply with that country’s employment, tax, and payroll laws and has been exposed to potentially steep fines, tax penalties, and even criminal liability.
  • The quick fix: A company’s rapid growth can accelerate hiring decisions and increase the risk of noncompliance and worker misclassification. In scenarios such as these, developing fully vetted international expansion strategies is wishful thinking—there’s simply no time. Companies are moving into new markets faster than ever, making the need to hire independent contractors in those markets that much more necessary. But as the company hires independent contractors and continues to scale quickly in a new market, the scope and nature of the contractors’ work expands and drifts. Suddenly, they’re being paid by time worked, are working exclusively for the same company, and are being sent company laptops and tools to create new efficiencies in workflows. These are all hallmark signs that the nature of the relationship between the employer and the worker has fundamentally changed, and that a once-compliant relationship has now opened the employer to additional compliance risk.

Fortunately, there are a few simple steps companies operating in foreign markets can take to get a baseline assessment of how they classify workers. Every company should conduct regular self-assessments that can be simplified into three core areas: behavioral controls, financial controls, and an evaluation of the nature of the relationship between an individual worker and the employer. While this framework should never be the only tool by which companies conduct workforce assessments, it can answer basic questions about whether a company is compliant in its classification of workers.

This self-assessment can be answered with three easy questions:

  • Behavioral control: Is the worker given more independence to finish a project than you would normally afford a full-time employee?
  • Financial control: Is the employer paying a lump sum for a project?
  • Employer/employee relationship: Is the worker’s employment contingent on completion of a certain project?

If the answer to any of these questions is ‘yes,’ that worker is an independent contractor by most countries’ standards. For future process control when considering adding support from independent contractors, every company should take these additional steps to mitigate noncompliance:

  • Identify the full population of independent contractors within the organization, especially departments that span multiple countries. Assess the population using the above framework.
  • Engage with legal experts to assess the existing level of corporate risk and exposure as a result of potential misclassification. Determine if there are unique criteria for independent contractors across different countries in which you’re operating.
  • Create an inclusive process for ongoing reporting and classification for any new independent contractor request. Make ongoing training programs available and conduct internal self-assessments at least quarterly to ensure continued compliance.

With this basic framework and internal steps that formalize the process by which workers are classified, and their status monitored, companies can significantly reduce the risk of severe penalties.

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