Status Check

Know a country’s classification rules before hiring independent contractors.

By Eric Krell Nov 1, 2011
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November Cover

Andrew Slentz knows a thing or two about the administrative complexity of managing independent contractors abroad, including the risks of misclassification. That’s why the senior vice president of global human resources relies on a highly organized internal management approach as well as a global network of experts to ensure that St. Louis-based Peabody Energy Corp.complies with relevant overseas requirements.

"We’ve developed a matrix—an evergreen, constantly evolving document that identifies the legal, tax and HR, finance and banking implications of hiring and using independent contractors in each country" where the company operates, Slentz explains.

This matrix covers 25 to 30 contractorsin most of the10 countries where Peabody Energy does business, including Australia, China and India. In addition to identifying country-specific requirements, the document lists global and local advisors whom managers can turn to for employment law and related HR guidance in each country.

The approach reduces Peabody Energy’s risk of incurring significant penalties from overseas regulatory agencies or courts as a result of independent contractor misclassification.

While such misclassification has figured as a prominent domestic HR risk for some time, it qualifies as a "burgeoning issue" overseas for global U.S. companies, notes Alan Koral, a New York-based shareholder with Vedder Price PC and head of the firm’s Labor and Employment practice area.

But not all employers are aware of the different country requirements—or the stakes.

Monetary penalties can be greater than in domestic cases, which rarely require offending organizations to shell out for back vacation and severance pay. Donald Dowling, a New York-based international employment partner with White & Case LLP, reports that labor court judgments, even in developing countries, can require companies to award misclassified contractors "hundreds of thousands, sometimes millions of dollars."

More Penalties

If a U.S. court or the Internal Revenue Service (IRS) determines that a misclassified contractor worked as a de facto employee in the U.S., liability typically is limited to the following categories:

  • Back tax withholdings.
  • Back Social Security contributions.
  • Back state unemployment and workers’ compensation insurance.
  • Back overtime, if the employee is nonexempt.
  • Back health care benefits due under the terms of certain employers’ plans.
  • Interest and other types of penalties.

The same violation abroad can saddle U.S. companies with all those penalties as well as back vacation pay;back mandatory benefits such as payments to state housing funds and state-mandated unemployment funds; and severance pay, notice pay and liability for unfair dismissal.

Additional fines may be levied.Spanish law, for example, adds a penalty for "very severe violations."

Fools Rush In

The rules for independent contractor classification vary by country. When U.S. companies enter a new country, they often hire independent contractors for translation services, sales positions, consulting projects, company-specific expertise and so on. But because there is pressure to get up and running quickly, the rules may be neglected or ignored.

‘It would be a very risky move to take United States laws and think that they apply across the globe.’

Dowling says corporate leaders sometimes want to know why they can’t use a workforce made entirely of independent contractors in a particular country. His response: "I will ask why they don’t do the same thing for their entire U.S. workforce. They say, ‘That would never fly.’ Well, the same holds true for Thailand, France, Brazil or wherever you’re setting up shop."

Dowling recounts an instance where, after a string of claims and lawsuits, a U.S. company hired his firm to help convert existing overseas independent contractors to full-time employees.

The company had hired salespeople as independent contractors in several Latin American countries instead of opening offices in that region. The arrangement worked well for years—until the contractors were terminated.

The salespeople "ran to labor courts in these countries and argued that they were de facto employees," he recalls. "The company countered that it had a contract specifying that the salespeople were hired as independent contractors. But the contract does not preclude the legal analysis."

In that case, the actual working relationships between the company and the salespeople were subjected to tests and questions by the labor courtsto determine the proper classification in the eyes of a government agency.

Not in Kansas Anymore

A similar analysis takes place when independent contractor misclassification issues arise in the U.S. According to an American Bar Association report co-authored by Koral, this domestic analysis is generally based on the Fair Labor Standards Act. However, the IRS "applies a somewhat different but overlapping 20-factor test" if the issues arise out of an employment tax dispute, and the National Labor Relations Board applies yet another test for determining employee status for contractor issues that arise during its investigations of employment practices.

Rules and laws in other countries vary. France provides only vague criteria for classifying independent contractors. Spanish law does not provide a definition of employment. The U.K. has three categories of relationships—employees, contractors and workers. India has unique income-tax withholding requirements for companies hiring independent contractors.

"I have not yet found a single person who is well-versed in the local laws governing independent contractor classification in more than a few countries," says Jeannee Hoppe, global program manager of contingent workforce solutions for 3M. The science-based company, headquartered in St. Paul, Minn., conducts business in more than 65 countries.

The American Bar Association report includes a country-by-country overview of many independent contractor classification requirements. Roughly 23 million independent contractors are misclassified in Europe alone, according to the report.

Levels of liability and enforcement also vary. Dowling notes that a member of the Society for Human Resource Management recently asked peers on the organization’s HR Talk bulletin boardif the laws regarding independent contractor classification were as strict in Latin American countries as they are in the U.S. "The short answer is simple: ‘No, they are even stricter,’ " Dowling says.

Brazil poses some of the greatest risks in terms of costs and other liabilities to companies that misclassify independent contractors; several other Latin American countries also rigorously enforce classification rules.

Knowledge Is Power

According to HR executives familiar with the issue, awareness of overseas laws is key to avoiding potentially costly independent contractor misclassification violations.

"It would be a very risky move to take United States laws and think that they apply across the globe," Hoppe emphasizes. "The potential impact to your brand can be significant."

HR professionals should ensure that overseas contractors can answer affirmatively to the six questions in the sidebar. Then consider the following:

Find local employment law expertise. Before expanding abroad, findsomeone who is well-versed in the local laws, Hoppe advises.

Slentz frequently calls on his personal global network of employment law experts. HR professionals looking into independent contractor issues abroad for the first time should start by checking in with global consulting, accounting or relocation services companies, he suggests.

Peabody Energy’s local employment law, tax and HR expertise is "three-pronged," Slentz explains. Internal staff knowledge of independent contractor classification issues is complemented by expertise from global services firm partners and local expertise in a specific country or specific area of a country.

Understand the ins—and outs—of the contract. In the rush to establish a presence in a new country, managersoften overlook how independent contractor agreements can be terminated.

"There’s just so much pressure to get in," Slentz notes, "that you don’t often think about getting out."

That can create problems down the road because contractors who are unhappy with their termination can file misclassification claims with local regulators.

Think about leasing employees. Ask yourself whether a job need can be met by hiring a full-time employee or by using a local staffing agency.

The arrangements "will likely cause administrative headaches," Dowling says, "but those headaches hurt less than the pain a nominal foreign contractor inflicts after being deemed a de factoemployee."

Demonstrate independence, on paper and in practice. Dowling advises managers to draft independent contractor agreements that establish genuine independence by removing any language—scheduled work hours, paid vacations, noncompete clauses and the like—that treats the contractor like a subordinate.

Then structure a working relationship that reflects the terms of the contract. "In day-to-day practice, respect the contractor’s structural independence as spelled out in the contract," Dowling says. "Keep the contractor off organization charts. Let him compete. Refuse to provide a title, an office or company business cards. Do not schedule hours. Do not invite the contractor to training sessions or office parties."

Pay attention to related issues. Oversights in areas such as background checks and banking rules that govern how an employee can be paid may create an environment where independent contractors are more likely to run to local labor courts.

The author is a business writer based in Austin, Texas, who covers human resource, finance and social marketing issues.

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