In today’s global economy, it has become increasingly common for companies based in the United States to engage workers who live abroad for various purposes. U.S. companies often classify these workers as “independent contractors” to avoid having to navigate the employment landscape in other countries. However, U.S. companies should be aware of the potential pitfalls of misclassifying foreign workers, particularly in countries where employment laws tend to be more employee-friendly than U.S. law. Employers should consider the following factors when engaging foreign independent contractors to work abroad.
- Foreign Law: When engaging an independent contractor abroad, it is essential to understand the employment and tax laws in the country where the contractor will work, which may require engaging a foreign attorney or an American attorney well versed in international law.
- Classifying Workers: In general, the law of the country where the worker is based will govern the classification of a worker as an employee or an independent contractor – or other terms used in other countries – regardless of contractual choice-of-law provisions. Many countries apply factors similar to those applied in the U.S., such as the degree of control the company has over the worker and the worker’s level of independence. Overseas, this concept is often referred to as “subordination” – whether the worker is dependent on the company or autonomous. Broadly speaking, an independent contractor relationship normally exists if the worker can work for other companies, the relationship is short-term, the worker has control over how/when the work is performed, the worker assumes some business risk, and the worker pays his own taxes.
- Consequences of Improper Classification: In the U.S., a company that misclassifies a worker as an independent contractor may face liability in the form of back tax withholding (including social security and Medicare), overtime (for non-exempt workers), benefits, interest, and penalties. In foreign countries with more employee-friendly laws, an employer might also have to pay back vacation/holiday pay, mandatory benefits, severance/notice pay, and government fines, which can be quite expensive.
- Reporting: The U.S. Internal Revenue Service only requires companies to file 1099s for domestic workers. A U.S. company that engages an independent contractor overseas should ask that worker to complete IRS Form W-8BEN. In many foreign countries, independent contractors are solely responsible for reporting their compensation and paying taxes without any involvement by the company that compensates them. Again, it is vital that a company engaging contractors in another country fully understand its reporting and tax obligations vis-à-vis that country.
- Agreement: It is advisable to execute a formal independent contractor agreement defining the parties’ respective roles and tax obligations, although the terms of the agreement may not be binding if a worker’s independent contractor status is challenged.
- Establishing Corporate Presence: A U.S. company that engages independent contractors in a foreign country should be aware that the contractors’ activities in that country could result in the company being deemed to have permanently established a corporate presence in the country, which could implicate corporate and tax issues. Again, it is important to understand the laws of the country where contractors will be based in order to avoid unintended consequences like having to pay taxes to a foreign country.
- U.S. Citizens Working Abroad for U.S. Employer: U.S. citizens who are employed outside of the U.S. by a U.S. company (or a foreign company controlled by a U.S. company) are protected by various U.S. employment laws, including Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, and the Americans with Disabilities Act, except where compliance with U.S. law would violate the law of the country where the worker is physically located. Thus, it is essential that U.S. employers who employ U.S. citizens abroad be familiar with the employment laws of the United States and the countries where their workers are based.