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In the last few years, companies have begun to source talent from outside of their home countries, looking for a diverse pool to tap into. This is our new normal, expedited by the pandemic and larger trends towards remote work and telecommuting. Despite these moves, companies hiring talent from foreign countries generally do not consider a cross-border work relationship’s legal ramifications. In this blog, we'll go through the legal and compliance issues that countries must consider before hiring a foreign independent contractor.
TABLE OF CONTENTS
Getting Started with Hiring Foreign Independent Contractors
- What defines an Independent contractor?
- Who is considered an employee?
- Where will the services be rendered?
Tax Considerations for Hiring a Foreign Independent Contractor
- Tax implications to consider for hiring remote employees
- Canadian Withholding Taxes
- Canadian Treaty Exemptions
- The cost of misclassifying a contractor who resides outside of the US
- How labor laws and employee definitions in the contractor's country
- Determining whether or not you must report
- Reporting contractor payments in Canada
- Reporting payments made to non-resident contractors living outside of your home country
- Reporting payments made to foreign independent contractors
Mitigating Risk When Hiring Foreign Contractors
- Hiring a domestic or foreign independent contractor: understanding the benefits and risks
- Establishing a contractor agreement
- How to avoid turning an independent contractor into an employee
Getting Started with Hiring Foreign Independent Contractors
The move to digital has allowed companies to move beyond geographical borders and hire talent from many different countries. Yet, few companies are prepared to deal with issues that may arise when hiring employees from foreign countries. When it comes to legal or labor disputes, the hiring company will often have to navigate a system they do not know, in a language they may not be familiar with in the country that the freelancer resides in.
In a cruel twist of fate, companies can sometimes find themselves in costly, avoidable legal nightmares in attempting to reduce costs by hiring foreign independent contractors. These legal mishaps implicate not only the employer but the employee as well.
When hiring remote foreign contractors without setting up a branch or headquarters in the remote country, companies rarely understand that they are now exposing themselves to a new set of legal and tax liabilities.
It's imperative that before jumping in and hiring a remote team, you understand the risks associated with hiring a foreign independent contractor and how you can reduce those risks effectively. Each country will have different laws, but we will attempt to give a complete picture of what is expected in this blog.
Did you know that you can be penalized if your foreign independent contractor is actually an employee? It all comes down to how you structure the working relationship. Here is a quick breakdown:
What defines an independent contractor?
Under US laws, the IRS defines an independent contractor as the following: "an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done."
Independent contractors are expected to file Self-Employment Tax, meaning that the companies that hire them do not need to withhold or remit income taxes or pay for social security, medicare, or unemployment tax on their behalf.
Similarly, Canada defines a self-employed contractor as someone who sets their terms and decides how and when to perform their work. When you are an independent contractor, no one is overseeing your activities, and you're free to work when and for whom you choose. You may provide your services to different payers at the same time.
The Canada Revenue Agency (CRA) defines an independent contractor as someone with the following:
- A self-employed individual usually works independently.
- The worker does not have anyone overseeing their activities.
- The worker is generally free to work when and for whom they choose and simultaneously provide their services to different payers.
- The worker can accept or refuse work from the payer.
- The working relationship between the payer and the worker does not present a degree of continuity, loyalty, security, subordination, or integration, all of which are generally associated with an employer-employee relationship.
Who is considered an employee?
In contrast to an independent contractor, an employee is a person whose performance of their services is controlled by the payor (the company).
Understanding the nature of the relationship between an employee and an employer is essential. To make it simple: determining between self-employed and full-time employees is ultimately determined by the amount of control and independence an employee has in their job.
The important facts for you, as an employer, to keep in mind are who provides tools and supplies, whether expenses are reimbursed, and whether the work being performed is a fundamental aspect of the business. Need more information? We dive deep into employee/employer relationship classification in this helpful blog from the Knit Payroll team.
In the US, if a court or the IRS recognizes a person you've hired as an independent contractor is an employee, you may face penalties for not meeting specific employment requirements.
This could include paying for the person's unpaid Social Security, worker compensation premiums, unemployment tax, and outstanding benefits, including any interest and penalties remaining on those payments.
Where Will the Services Be Rendered?
In Canada, the recent legislative changes (within the last three years) and new and burgeoning case law create more significant liability for the employer who misclassifies their employee as a contractor. Read more here.
If you are a Canadian business owner and consider hiring a foreign contractor to perform specific services for you, there are several tax implications involved.
Before you start hiring foreign independent contractors for your Canadian business, you have to determine where the foreign contractor will render their services. Will it be in Canada or elsewhere?
Generally, if the contractor is not a resident of Canada rendering services outside of Canada, there should be no tax obligations. This is true even if the person or company receiving the services is Canadian.
Canadian Withholding Taxes
The taxation of a Canadian resident is different from that of a non-resident. Residents file an annual income tax return with the Canadian Revenue Agency (CRA) and must include all of their global income and then calculate the government's tax payable.
If any amounts have been withheld at source, such as employment taxes withheld by an employer, they are credited, and the Canadian taxpayer pays the difference or could receive a refund.
In the case of a non-resident, any payment received is subject to withholding by the Canadian payer. Here, the withholding outlines the final tax for the non-resident, who may then, depending on their local laws, receive a foreign tax credit in their country of residence.
Regarding services rendered in Canada by non-residents, generally, the payer (employer) who makes a payment to a non-resident of Canada for any services rendered must withhold and remit 15% of the gross amount paid.
As a Canadian payer, if you overlook withholding this amount, you are liable for the non-resident's taxes. If you’re hiring from abroad, you've probably contended by now with how you will go about paying and managing payroll taxes for remote employees. But, there are still things that may be a bit of a mystery. That's why we decided to sift through the information available and put this guide together! Check it out here.
Don’t let complicated tax and labour laws prohibit your business from growing. Knit Payroll can help you simplify payroll, payments and streamline HR. Try our free 30-day trial out now!
Canadian Treaty Exemptions
There are exceptions to the rules laid out above, with most exceptions being found in Canada's tax treaties.
While they exist, these exemptions are not automatic, which means that you will not just receive them immediately. You must apply to them via the CRA. If you're a small business, you can use the Section 105 waiver, which can be granted to foreign contractors that live in a country with whom Canada has a tax treaty. They also must meet one of the following:
- The non-native is an individual who makes less than $5,000 for the current year.
- The non-resident's presence in Canada is recurring, but their cumulative presence is less than 240 days during a given period and less than 180 days under the existing contract.
- The non-resident's presence is not recurring, and the person performs services in Canada for less than 180 days under the current agreement.
Understanding the cost of misclassification if the worker is a US resident
In 2015, the US Labor Department held an investigation around the misclassification of employees as independent contractors. They collected a whopping $246 million in back wages for more than 240,000 misclassified workers.
In the case of the IRS or the US Labor Department finding employment violations, they will likely investigate all of a company's employees and contractors within three days. During that time, the company can face penalties, including fines and even potential imprisonment.
The cost of misclassifying a contractor who resides outside of the US
Believe it or not, there may be even more liability under local laws. When hiring a remote employee from an EU country, on top of paying wages, taxes, and benefits, you may need to pay a minimum of four weeks of vacation and holidays per year.
If an employer misclassifies an employee as self-employed in France, they can expect fines and up to three years of imprisonment. In South America, both Argentina and Peru have similar penalties as France does.
US and Canadian companies looking to hire foreign workers may face an increased amount of risks and liabilities in foreign courts in the case of their contractors being classified as employees.
Let's not forget termination. An employee is generally entitled to severance pay under the termination clauses, whereas an independent contractor can be terminated without compensation. Employers could face a situation where an unhappy contractor may look to pursue severance pay in a local court by saying that they were, in actuality, an employee.
Indeed, misclassification can come with high costs! The amount of effort and expense of navigating a dispute or resolutions in foreign courts could be a huge burden for companies of all sizes.
Learn how labor laws define 'contractors' and' employees' in the contractor's country
To mitigate the potential liability that can come from hiring a remote foreign worker, it's essential to understand the countries' classification structure.
In most places (including Canada and the US), it's not enough to just make a written note that a worker is a contractor. Countries will turn to the relationship’s facts when determining whether the said worker is a contractor or an employee of the company.
While each country has its standards and rubric for determining worker classification, they tend to look similar to examine how much control the company has over the individual. For example, many countries classify contractors who work full-time exclusively for one company as a de facto employee, whether their contract says the contractor or freelancer.
For example, according to some countries’ laws, if your employee signs a non-compete document, they are immediately considered an employee. This is because a non-solicitation/non-compete could be seen as evidence of the employer's control over the employee after termination.
Time is also a consideration: a long-term relationship can help define the classification of an employment relationship. It gets even more granular: a contractor that provides their own office and supplies is more likely viewed as an independent contractor. As more employees are working remotely, you'll need to be extra careful about navigating this space.
You mustn't make assumptions on what a country classifies as a contractor or not or assume that the same standards exist country by country. Make sure you do your due diligence and determine employee/employer relationship classification before hiring an independent contractor from abroad.
Determining whether or not you must report
Depending on where your company is headquartered, Canada or the US, you may have to report to the IRS or the CRA on an independent worker's pay.
In the US, if both your company and the contractor are US-based, you must report payment over the annual total of $600. To do this, you must fill out and file Form 1099-MISC at the end of the fiscal year.
This form must be filled out for each contractor a company hires, highlighting the sum of all payments made during the year. Form 1099 can only be filed on paper, but accounting services exist that will electronically deliver copies to contractors and mail them out to the IRS. From there, companies must also remember to file a Form 1096 to summarize all reported 1099's.
Further, when a US company hires independent contractors that are US residents, they should have contractors complete Form W-9. If they are foreign workers residing outside of the company, have them fill out FORM W-8BEN. Click here to download Form W-8BEN.
Reporting Contractor Payments in Canada
In Canada, employers must file a T4A slip to the CRA for any contractor they have paid more than $500 to in a given tax year.
The T4a slip is a Canada Revenue Agency (CRA) form that summarizes all compensation that your business has paid out to a contractor or non-employee worker. On the other end, independent contractors are expected to use these forms to file their year-end income taxes rather than a T4 slip that full-time employees file. Learn more about the difference between T4a and T4 slips in this handy resource.
Reporting payments made to non-resident contractors living outside of your home country
In the US:
When dealing with foreign contractors that do not have US residency that have made US source income must pay the same rates as US citizens, or 30%, depending on the type of income they have made. In the case of a tax treaty between the countries, you may receive a reduced rate or exemption.
A US company or person paying a non-US resident/citizen should look to facts around whether the payment is considered US source income and report accordingly. This can be done by reporting the amount to the IRS through filing out either Form 1042 or 1042-S (Foreign Persons' US Source Income Subject to Withholding).
If you've employed the services of a non-resident contractor living outside of Canada for your business, there are specific duties and responsibilities that you must adhere to under the CRA.
You must fill out and file a T4A-NR slip for each contractor you have employed not living in Canada. Use the T4A-NR slip to report all amounts you paid to non-resident individuals, partnerships, and corporations for services they performed in Canada that they did not perform in the ordinary course of an office or employment.
Read more about T4a-NR slips and how to navigate them on the CRA site.
Don’t leave yourself open to liability - connect with a Knit Expert today to learn how to navigate hiring a foreign independent contractor.
Do I need to report payments made to foreign independent contractors?
If you're looking to understand the reporting structure in the US, you must be aware of the requirements necessary to file either Form 1042 or 1042-S to the IRS. The most significant consideration to file is that a foreign person must have US source income.
Need more information? In this article, the IRS gives detailed information on how sources are determined for various types of income for foreign persons.
Foreign independent workers earn income by providing personal services of any nature. Under IRS guidance, the source of personal services income can be identified by where the services are performed. This means that even if a foreign person works for a US-based organization, their income is not considered US source income. This is as long as said service has been performed outside of the US.
Due to this law, a US company is not obligated to withhold or report taxes if the contractor completes their work outside the US. In the worker’s case completing a portion of their work or service within the US, specific conditions must be met to help avoid tax obligations.
Mitigating Risk When Hiring Foreign Contractors
We recommend learning the nuances of local tax laws associated with independent contractors to help you make the process easier.
Depending on the country, you will need to consider different labor laws to help identify contractors from employees. Beyond labor laws, this also applies to tax laws, as each country may have a different way of treating payments to contractors. For example, many countries’ tax agencies do not require the hiring company to report any contractors' payments. If the company is not headquartered or registered in the country where a foreign contractor is a resident, there often is no need to report or withhold taxes.
Despite this, the company must keep in mind several things that can trigger a permanent establishment in a company, including:
- signing a contract in a country
- having a regular place of business (even for a short period)
It's key that companies understand that local tax agencies could easily find grounds to impose taxes on foreign companies.
At the same time, a handful of countries have worked to increase rights for contractors. Some have brought forward laws to protect independent contractors, requiring the hiring company to provide benefits and payroll remittances despite not being full-time employees.
One such country is France. The country has enacted specific designations entitled portage salarial and auto-entrepreneur for any self-employed contractors or freelancers. The laws require the contractor's principals to make payroll contributions and withholdings similar to those of a regular employer.
In another European Union member country, Spain, there are similar laws enacted to protect independent contractors. The country has stated that an "economically dependent contractor" that dedicates more than 75% of their full-time effort is entitled to benefits. Benefits include 18 days of annual paid time off, severance pay and more.
A myriad of nuances in each jurisdiction must be considered by a company hiring foreign independent contractors. To avoid penalties and slaps on the wrist under local laws, a company must look to expert advice, finding someone who is well-versed in the foreign country's tax and labor laws for independent contractors in advance of hiring.
Another way to mitigate your risk is to specify the contractor's duty to comply with local tax laws and requirements within the contractor agreement and request proof of tax compliance before the start date.
Hiring a domestic or foreign independent contractor: understanding the benefits and risks
Hiring independent contractors locally or globally can be a good idea for companies looking to grow. Generally, these companies are motivated by financial reasons; hiring foreign contractors can be less expensive than hiring employees full time. When you know your obligations as an employer, hiring a contractor can be effective and save you the cost of employee benefits, severance, office space, and more.
Companies may get even more discounts if they employ contractors from other countries with better lower labor costs and exchange rates.
Here are three other key benefits of hiring independent foreign contractors.
- Increased productivity. Freelancers can bring specific, honed-in skills to a company to aid in accomplishing a particular goal. They generally do not need to be trained and do not require onboarding, meaning that they can be productive from the get-go.
- Increased talent pool. Going beyond your country's borders can help you source different, exciting talent. Bringing diverse voices to the table can help impact your business in a myriad of ways.
- More staffing flexibility. It is far simpler to employ contractors for shorter, specific tasks and projects. You can also quickly decide if they are a fit for your team or not and choose not to re-engage if they are not a good match. When they are not a fit, you don't need to worry about severance or face expenses or legal issues that come with firing a full-time employee.
There are definite positives to hiring contracts beyond what we have outlined above. But, as we know, taking on a foreign independent contractor comes with unique risks and a higher level of governmental scrutiny that a company must consider. Here are some risks to consider when hiring foreign independent employees.
- The company has less control over how and when the work is done. When you engage contractors, you can assume that you will have less control over them than your full-time employees. With contractors, you cannot closely supervise how they work and their overall workflows. And, according to specific laws, if you assert more control over their work, you could eventually push them into a full-time worker classification, leading to more legal implications for you.
- You might experience a lack of consistency. Many contractors are hired on a case-by-case basis, generally short-term. In any working relationship of this type, you can expect high turnovers.
Further, in a remote-first world, companies engaging foreign contractors can find it challenging to control work quality due to language differences and reduced face-to-face communication.
Avoid penalties by preparing an air-tight contractor agreement that meets every legal requirement of each country involved
As you can see, there are many things to consider when hiring foreign independent contractors. To ensure compliance, we recommend having a solid written agreement. This is above and beyond the essential step for hiring a foreign contractor.
An iron-clad written agreement will help you navigate any language barriers and cultural differences that can create miscommunication. This agreement should also include considerations around the local labor and tax laws to ensure that it is not invalidated by mistake sometime in the future.
Hiring foreign independent contractors without a written contract can leave room for error and costly, time-consuming disputes in foreign countries. To avoid this, ensure that the agreement clearly states the full scope of services, compensation and indicates the contractor's independence and the hiring company's lack of control around how the contractor performs said work.
Don't forget to include these contractor agreement mainstays as well:
- Confidentiality and/or non-disclosure clauses
- Indemnity clauses
- Intellectual Property Transfer clauses
- Notice or termination clause
- Dispute resolution clauses
It is essential to understand that any contract or agreement that you put together for parties residing/operating in different countries must meet the requirements of laws for the countries involved.
Remember: What may be true in one country is not always accurate in another. We urge you to contact Knit to get the expertise you need or visit our blog to learn more about how to administer payroll accurately to contractors abroad.
How to avoid turning an independent contractor into an employee
As we mentioned above, there can be a fine line between an employee and contractor, depending on local laws.
Did you know? While you may outline the working relationship between you and your foreign independent contractor accurately, it may not be considered in a legal dispute. Many courts worldwide will look beyond the contract terms to determine the actual relationship between you and your contractor.
To make sure that you avoid a misclassification, you must interact with your contractor as such. A contractor must be autonomous, without the employer controlling when and how the work is done. While each country will have its criteria to make an accurate determination, here are some ways to support a contractor's status:
- Do not set a work schedule that the contractor must adhere to;
- Avoid hiring a contractor to perform an essential aspect of your business.
- No exclusive relationships. Give the contractor freedom to have multiple clients other than your organization;
- Do not have a compulsory training system or supervision;
- Avoid requiring reporting on tasks or metrics;
- Allow contractors to provide their supplies and tools for the job and do not provide reimbursement for incurred costs;
- Do not provide any employment benefits (including insurance, a pension plan, and vacation pay, etc.) outside of agreed payments;
Be thoughtful in your approach when hiring foreign independent contractors. You may feel as though a written agreement will solve all your worries, but you may put yourself at risk for how you interact with your contractor beyond the scope of the contract. Many courts around the world weigh facts over the written agreement.
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Hiring foreign independent contractors can have its upsides and downsides for sure. Taking time to understand your duties and responsibilities can reduce and prevent costly legal troubles in the future.
As a best practice (for any business area), it is always an excellent idea to have contracts, agreements, payment and other work-related records signed and in writing. Suppose you have hired a foreign independent contractor that you want to engage full-time. In that case, it's in your best interest to consult local lawyers and tax professionals to understand labor and tax laws before extending any relationship.
There are inherent challenges to navigating cross-border contractor relationships, but Knit can help! Schedule a time to chat with us to learn how you can prevent risks and maximize growth, or onboard today in just a few clicks with a free 30-day trial of Knit Payroll.