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Independent Contractor or Employee: Issues to Consider Before Choosing an Independent-Contractor Engagement

In the last installment of the “Independent Contractor or Employee” series, we discussed what laws might apply and what problems you might encounter when using an independent-contractor engagement for your multinational organization. In this installment we pose questions to consider when determining whether an independent-contractor engagement is the best solution for your organization’s needs. 

Before Choosing an Independent-Contractor Engagement: A Questionnaire

Companies thinking about engaging an independent contractor in a foreign country are well served to conduct a risk analysis before entering into such arrangements. Of some comfort is that the principles underlying the misclassification inquiry are fairly similar from country to country—though some countries scrutinize independent-contractor relationships more than others, and different employment law and tax regimes prioritize different aspects of the relationship. The following questions will assist you in evaluating just how perilous the proposition of using contractors may be under the circumstances. 

Is the contractor an individual or a company? Contracting with a company is preferable to reduce the risk of employee misclassification, although courts will still look at the substantive terms of the relationship. Generally, it is recommended that independent contractors be required to set up a company as a precondition to entering into the relationship—but be careful, as certain countries have laws that make this more complicated. Note also that an entity that maintains a traditional office may receive more scrutiny than an individual with regard to whether the entity is considered the company’s “permanent establishment” in a country. 

Are the contractor’s services essential to the company? Though there are some exceptions, bona fide independent contractors do not usually perform functions that are central to the company’s administration or core product or service. For example, an independent contractor that provides marketing services for a package delivery company is less likely to be deemed a misclassified employee than a delivery worker for a package delivery company.

Will the contractor service other clients? An exclusive relationship is an extremely strong indicator that the contractor is really an employee. In a genuine contractor relationship, the contractor is permitted to market to and service other customers—including the company’s competitors. Even if the relationship is described as nonexclusive within the services agreement between the purported contractor and the company, a contractor who, in practice, provides services only to the company, and does so on a full-time basis, may be deemed an employee.

Must the contractor abide by company policies, procedures, rules, and/or regulations? Contractors generally should not be bound by internal company regulations—and in some jurisdictions this is an extremely important test. Even where there might be a legitimate reason to apply a company policy to a contractor—such as a confidentiality policy or a Foreign Corrupt Practices Act compliance protocol—consider whether these terms might be incorporated into the agreement instead. Alternatively, some organizations develop policies applicable to all third-party vendors that are separate and distinct from policies applicable to employees.

Will the contractor undergo mandatory training before or during the relationship? Contractors should be trained professionals who do not require additional training to perform the services—required training, especially on an ongoing basis, suggests an employment relationship.

Can the contractor delegate the services? A requirement that a particular individual personally perform the services (as opposed to subcontract or assign to the contractor’s employee) indicates an employment relationship.

Is the arrangement of a finite duration? Ideally, the relationship should be limited to a particular project to be completed by a certain deadline. If the relationship is ongoing, the contractor should have the right to accept or reject assignments. A long-term independent-contractor relationship between a company and a particular contract (over a year) can imply employment status. Keeping the term short confines the company’s legal exposure in the event of misclassification—many (but not all) courts will respect the contract’s fixed-term nature even after deeming it an employment contract, avoiding the possibility of reinstatement. (For this reason, the risk of a misclassification claim is reduced when the company does not terminate a services contract with an independent contractor prior to the expiration of its term as set forth in the agreement.) A finite term also decreases the likelihood that the contractor or contractors will constitute a “permanent establishment” of the company in the foreign jurisdiction. If the contractor is an expatriate, he or she should provide services for the company for a period of time short enough not to trigger host-country income taxes under the applicable bilateral tax treaty—usually 183 days in a year. 

How many contractors does the company plan to engage in the country? The greater the number of misclassified contractors, the higher the corresponding risk that one of them files a claim, or that the country’s authorities challenge and/or seek to declare the engagement a permanent establishment, thereby taxing company profits in the foreign country.

Will the contractor’s performance be observed, monitored, or supervised? A company should not dictate or control the means or methods of a contractor’s performance. Rather than giving specific direction as to how to perform, if the end result is that the services are not performed in accordance with the parties’ agreement, the company can exercise contractual remedies.  However, disciplinary action and/or performance evaluations should not be part of a true independent-contractor relationship. 

Is the contractor now, or was the contractor previously, a company employee? Changing a relationship from employee to contractor is considered a red flag for tax authorities. If the contractor’s duties are similar to his or her employment duties, this increases the likelihood of a misclassification finding once the relationship is terminated. Frequently, employees may claim that their prior service as a contractor should be included when calculating benefits entitlements based on length of service.

Will the contractor have the authority to conclude contracts? The ability to execute and/or materially negotiate a contract on behalf of the company indicates employment status and increases likelihood of permanent establishment status. 

Can the contractor choose the time and place of performance? Subject to contract deadlines, the contractor should generally be able to choose, how, when, and where to perform the services. Someone who is expected to show up at a specific time and place is more likely to be an employee.

Will the contractor provide his or her own supplies? Contractors typically provide their own supplies—for which they should not be reimbursed by the company (they usually take a tax deduction for these).

Alternatives

Before deciding on the independent-contractor approach, a company should also evaluate whether other options would accomplish its goals with less risk. Some of those options include:

  • Contract with a staffing agency or umbrella company to serve as the contractor’s employer. This option is often the most expensive, but also usually the least risky. The parties should enter into a contractual agreement that clearly sets forth their obligations with respect to the employee, allocating liability for all employment-related liabilities. In addition, the employee should know which entity is his or her legal employer. In some jurisdictions, staffing agencies are hesitant to contract with foreign companies that lack a corporate presence in the country, often because of the permanent establishment risk. Where the company needs a specialized industry license, it may have to work with a company that already has that license.
  • Enter into a direct employment relationship with the individual, utilizing a payroll provider. The company should comply with any regulatory requirements, such as registering for a permit to do business in the jurisdiction. In some countries, direct employment relationships are only permitted with local entities.
  • Consider various corporate options, including a joint venture, representative office, or subsidiary. Depending on the country, there may be a low-cost option available that would meet the company’s needs without too much investment of time or money.  Representative office structures usually have limitations on who can be employed and what the office can do.
  • Use fixed-term employment contracts and/or probationary periods. Whether through a payroll provider or otherwise, a fixed-term employment contract may be a viable low-risk option in some jurisdictions. Note, however, that some countries have time or subject-matter limits on fixed-term contracts, outside of which the relationship is automatically considered one of indefinite duration. In addition, some labor codes provide for statutory indemnities to fixed-term employees at termination. 

In the next installment of our four-part “Independent Contractor or Employee” series we will discuss key points for drafting an effective independent-contractor agreement for multinational organizations. 

Carson G. Burnham is a shareholder in the Boston office of Ogletree Deakins, and she chairs the firm’s International Practice Group. Bonnie Puckett is an associate in the Atlanta and Boston offices of Ogletree Deakins.

May 28, 2013 | TAGS: , , , , .