Local host-country employment laws and payroll requirements restrict employers with no local registered employer entity.
The September issue introduced the challenge of employing a “floating” employee in a country where an employer has no local entity or infrastructure, but could be held a “permanent establishment.”
When an employer’s overseas presence triggers the local country’s threshold for commercial registration, the question becomes: What must the employer file? Registration requirements differ from country to country and the requirements differ depending on the corporate status selected (representative office, branch, subsidiary). Requirements for a branch or subsidiary can include:
- Providing a local address
- Naming a local-resident agent (and sometimes, such as for a branch in Malawi, even naming an entire board of directors—notwithstanding that a local branch technically is not a separate entity)
- Empowering the local authorized agent via an “apostiled” and translated power of attorney
- Registering with local tax, social security and other government authorities
- Opening a local bank account with a minimum required paid-in capital
- Issuing a bond locally in favor of third party claimants
- Making industry-specific filings (for example, special authorizations are required for engineering firms in Brazil, news organizations in Vietnam and retail sales operations in the Philippines)
This raises the question of compliance: What happens if an overseas-based employer violates these registration rules and operates an unregistered local permanent establishment? In countries such as Spain, corporate registrations may be seen as “mere” notarial acts and a failure to register may mean only civil, tax and employment exposure. But in other countries, local corporate registry officials have police power to investigate, charge and fine a foreign business that flouts local registration laws. The Democratic Republic of the Congo, for example, can seize assets and ban an unregistered business and its agents from operating in-country. The Philippines can sentence business people who sell products locally without registering under a local “retail trade” law to 6 – 8 years in prison.
Violations of corporate registration requirements are likely to come to light when a local employee quits or gets fired. Violations also get rooted out as advances in technology help enforcers scrutinize “floating” employee arrangements ever more closely. Noncompliance threatens financial costs that run higher than fines and lawsuits, in that failing to register impedes acts that require proof of commercial registrations—renting office space, opening a bank account, importing goods through customs, selling to a government entity. (In Norway, for example, a business is virtually paralyzed without a registration number from the Norwegian Register of Business Enterprises.) Further, an employer’s failure to get local commercial registrations can cascade into violations of other local laws, be they: corporate tax requirements, employment rules or immigration mandates (each discussed below).
Outside of the few jurisdictions such as Bahrain and U.A.E. that impose no corporate income tax, any enterprise operating somewhere through a “floating” employee—even an employer not generating profits from the local market and even an organization registered in its home country as a nonprofit—exposes itself to liability under local corporate tax laws. In short, a local “permanent establishment” will usually have to file a local corporate tax return. Whether any corporate tax payment is actually due locally will be a fairly straightforward analysis if the local host country and the multinational’s home country have executed a tax treaty for avoiding double taxation. Where there is no treaty, local income tax laws will apply, with their local definitions of taxable income and their domestic principles of tax liability.
When a local floating employee triggers a corporate tax-filing requirement, the unregistered employer may argue that its local representative plays a non-revenue-generating role and triggers no permanent establishment. Whether this argument prevails turns on the facts and definitions under local corporate tax law. That said, if local (in-country) customers buy products or services or pay bills through the floating employee, the employer may have a tough time arguing its in-country operations generate no taxable local revenue—especially, but not necessarily, if the local employee has agency authority to bind the employer.
Countries everywhere extensively regulate employment relationships, imposing rules on such topics as:
- Employment contracts/fixed-term agreements/probation periods
- Compensation (wages/overtime/bonuses/profit-sharing)
- Personal income tax withholdings/social security/social insurance contributions/other social funds
- Part-time/temporary work
- Caps on work hours/overtime pay/ wage-hour rules
- Vacation/public holidays
- Firings/severance pay
Local employment laws generally reach even a single-employee local start-up operation of a foreign-owned employer—a floating employee—even if employer and employee had agreed on a choice-of-law clause that purports to apply the law of the employer’s headquarters country. (Local employment protection laws almost invariably reach a multinational’s in-country employees by force of public policy regardless of employee citizenship and regardless of a choice-of-foreign-law clause in an employment agreement. See Global HR Hot Topic for July 2008.)
Local employers in an overseas market will be predisposed to comply with local employment laws. But an incoming overseas-based employer new-to-market with no local infrastructure will face employment law compliance challenges for two reasons: (1) Full compliance with local employment laws is difficult when the local rules are not readily available and are foreign to the employer’s institutional culture, and (2) keeping a local floating employee off-the-books prevents compliance with mandates like payroll withholdings/contributions.
Employment law liabilities arise when local labor law enforcers bring employment-related claims, or else when a floating employee sues in local labor courts (which will generally exercise some form of “long-arm” jurisdiction over nonresident employers, if they can serve process). Indeed, these employment liabilities can be contagious: In Brazil, for example, an employer entity that fails to contribute to mandatory local “social” (social security and unemployment) funds will expose sister entities to liability for affiliates’ debts to these funds.
Best Practice Tip:
When employing a “floating” employee (with no local-country employer entity) in a new country, implement a viable legal compliance strategy