Last month's Global HR Hot Topic drew the distinction between independent contractors and de facto employees overseas. Having made that distinction, there are a number of refinements, special issues, tips and pitfalls to address.
Challenge: Engaging an independent contractor abroad raises special problems and traps.
It is easy to engage a "one-off" overseas independent contractor for a discrete task like fixing a computer or a plumbing problem. The problems arise in the grey area between "contractor" and "employee" — such as where a multinational needs a long-term foreign contractor who can act as an agent, follow detailed instructions and refrain from competing. Avoid this grey area by taking three (often difficult) action steps:
1. Revisit the threshold decision to make a foreign services provider an independent contractor.
Consider hiring as an employee. Yes, hiring as an employee can cause administrative headaches, including payroll and "permanent establishment" tax problems in countries where a company has no other presence. But the strategic question is whether those headaches will hurt more than the pain when a foreign contractor later claims to have been a de facto employee.
2. Draft an independent contractor agreement that makes the case for real independence.
Loosen the reins. Resist the temptation to tie a contractor down with non-compete restrictions, to motivate with bonus pay, and to negotiate in vacation, work hours and other provisions that look like employment terms. Be sure the contract invokes the local rules (in Turkey, for example, refer to the "Code of Obligations").
3. Structure the day-to-day working relationship to buttress the contractor's independence.
Keep the contractor off organization charts. Do not provide an office or company business cards. Do not schedule hours.
Pointer: Take three action steps before engaging any overseas independent contractor, and use a checklist to spot other issues.
After taking these three steps, use a checklist to account for additional issues:
- Entering a new country: A widely held misperception is that a multinational entering a new country where it has no corporate presence (no local branch, subsidiary or license to transact business) cannot employ locals — and must engage any service provider as a contractor. In fact, though, few countries prohibit foreigners from employing locals. But consider the ramifications:
- Permanent establishment: A principal doing business in some new foreign country can be said to have a "permanent establishment" there, which raises a host of legal and tax implications. But either employing or contracting with a local could trigger a "permanent establishment."
- Contractor pay reporting: In the US, principals must notify the IRS of payments to American independent contractors using the 1099 form. Few other countries require reporting contractor pay, but check.
- Foreign payroll: Consider using a third-party payroll administrator to make withholdings and payroll taxes for employees.
- Visa: A foreign local employee paid through a US entity payroll will not likely be able to enter the US without a US work visa.
- Specific local laws: Some countries are enacting laws protecting contractors. Be sure to comply. On October 11, 2007, a new Spanish law gives "economically dependent independent contractors" (those whose chief client accounts for 75+ percent of their work) rights to vacation and severance pay. A new 2007 labor code in Peru imposes a presumption that full-time contractors are employees.
- Contractual backstops: In contracting with foreign contractors, consider negotiating in indemnities, set-asides, hold-harmless provisions and other remedies, in case contractors (or their employees) are ever held the principal's employees. Enforceability and collectibility aside, these provisions might be enough disincentive to keep a disgruntled ex-contractor from suing in labor court.
- Third-party staffing agency: A popular strategy for engaging overseas contractors is to enlist a local independent manpower or staffing agency to hire a service provider, and then to contract for the services through the agency. The agency will charge, but this fortifies the case for the contractor's independence (it is tough to argue an "employment" relationship between two corporations). See, e.g., James v. Greenwich Council  E.A.T. (UK temp agency employee held not employee of principal). However, in some countries a principal could be held a "dual employer" with the staffing company. And local restrictions against outsourcing (such as in Brazil) become more problematic when engaging a freestanding company.
- Sole proprietorship: One step short of the "third-party staffing agency" strategy is to have the contractor incorporate a closely held company and then to contract with it, instead of the contractor personally. The veil here can be pierced, of course, but this strategy can offer advantages. For example, in the Netherlands, it may be possible to sever a contract with a corporate entity without having to seek the government permission necessary to terminate a contractor.
- Embedded subcontractors: Foreign contractors sometimes engage their own employees or subcontractors who may be invisible to the overseas principal. This arrangement may buttress the argument that the contractor is not an employee, but unfortunately the "embedded" employees can always argue that the principal is their "dual employer." Develop a proactive strategy to contain exposure.
- Mid-term conversions: Nipping the independent contractor-vs.-de-facto-employee problem in the bud at the time of initial engagement is a best practice. Liability can soar after a mischaracterization lingers for years. Consider a global project, converting mischaracterized contractors to employees.
- Sales people: Where an independent contractor will sell product, a principal that sidesteps employment laws can walk right into regulations on sales agents. Independent contracts with sales people need to account for local laws that impose protections (especially regarding compensation and termination) on sales agencies (and, less commonly, on distributorships). In the European Union these laws fall under the too-often-ignored Directive 86/653. See O. Brettle, "Commercial Agents," 189 Personnel Management Newsletter (UK) 2006, at 6; O. Brettle, "The Commercial Agents Regulations — Ten Years On," Employment Law Journal (UK) 1/04, at 22.