Expanding Across Borders Comes with Hidden Workforce Costs

By Stuart Buglass Mar 19, 2014

Most growth companies aspire to expand into international markets and become global competitors. But for the uninitiated, doing so can be an expensive and complicated undertaking. Each country has its own labor laws and employment regulations, so there is no single formula for success.

Human resource professionals and finance executives should protect against the most obvious and costly pitfalls when moving into foreign territories. Armed with some insider advice about potential problems, you can avoid being caught off guard by the most egregious high-ticket items.

Taking Shortcuts May Prove Costly

The first thing to know is that taking shortcuts can often get you into trouble. For instance, many companies have adopted the practice of using business travelers as overseas employees, rather than hiring expatriates or local employees. After all, business visitors can spend a number of months in a country before breaching their visa limits, and that period can be refreshed simply by exiting and returning.

This approach appears to make bottom-line sense, but actually it can be a high-risk strategy because a sustained presence by a foreign visitor can lead to corporate tax liabilities, as well as personal tax liabilities for that employee.

Many HR managers automatically cite the “183-day rule,” which dictates that no local taxes apply if an employee stays in a foreign territory less than 183 days. However, this common rule is the result of tax treaties; if no treaty exists with the destination country, that threshold could be lowered to just 30 days.

In many cases, using business travelers as overseas employees can result in immigration violations, as well as tax and social security liabilities and penalties. A personal tax investigation can quickly lead to a costly defense of a permanent establishment enquiry.

Another questionable shortcut involves the use of contractor agreements in place of appointing local employees, which can negate the need for payroll administration, social security costs and local infrastructure. However, in countries such as Argentina and Brazil, local regulators require contractors to file the details of their engagements. Scrutiny of these details can cause local authorities to consider the overseas contractor to be a permanent establishment, resulting in greater tax liabilities than if the company had simply set up a local employee from the outset.

Mandatory Employer Costs Can Add Up Quickly

The general rule when budgeting to enter a new country is to include social security contributions—these can be upward of 45 percent of an employee’s salary in some countries. Yet other mandatory costs often go overlooked, such as the employer’s liability for workplace death or injury.

Most countries include liability coverage in their social security contributions. However, some countries require employers to take out separate private insurance policies from local carriers to cover death and injury. Australia goes further by mandating separate policies for each state in which employees are located.

Another hidden cost involves accounting for severance pay. In Italy, severance funds owed upon termination can be either remitted as regular contributions through payroll or accrued. You may get an unwelcome surprise when it comes time to pay an employee’s severance balance in Italy if you fail to accrue that full amount on the books.

There are several other potential snares to avoid. For instance, Mexico and Chile have mandatory requirements for employers to operate a profit sharing scheme for employees. In Belgium and Italy, employers must make mandatory percentage salary increases as determined by the state each year.

The biggest source of hidden mandatory costs will likely involve collective agreements. Beware in Spain, Italy and Scandinavia, because collective agreements there are directly enforceable in certain industry sectors, even if the employer is unaware of their existence. In Australia, an employer can classify its workforce under multiple collective agreements, due to the modern awards system developed along vocational lines there.

Low-Cost Labor Can Belie High Overall Costs

The BRIC (Brazil, Russia, India and China) countries are well-known for low-cost labor. Recently the destination du jour involves the so-called MINT (Mexico, Indonesia, Nigeria and Turkey) countries. But in all these countries, actual employment costs can run much higher than originally budgeted.

Savings from low hourly pay rates can also quickly be erased by rampant wage inflation, which recently topped 25 percent in Venezuela and Argentina. In another case, civil unrest in Oman following the Arab Spring revolts there resulted in sweeping changes that have increased the private-sector minimum wage by 60 percent, with guaranteed 3 percent salary increases year-over-year.

Finally, there is growing concern about an employee’s lack of English skills or related education in some low-wage countries. As a result, nearly 70 percent of employers in Brazil had difficulty filling jobs last year, according to a recent survey by ManpowerGroup.

Leave and Termination Costs May Come as a Surprise

Annual leave, sick pay and termination costs can fluctuate greatly between countries. In the Netherlands, employees get a vacation bonus of 8 percent of the annual base pay per leave year, in addition to the base salary when taking a day off. In Australia, local mandatory collective agreements require an increase of 17.5 percent on the basic wage for each day of leave. And in many countries, each day of leave must be compensated at the employee’s average earnings rate rather than basic pay, often calculated based on the previous six weeks’ pay.

Termination costs are another source of confusion. The costs of termination are not limited to the notice period specified in the employee’s contract—many countries recognize the employee’s right to not be unfairly dismissed.

In Japan, for instance, only the most extreme circumstances can justify a termination, such as a complete office closure. Therefore, a legitimate termination can be hard to substantiate, resulting in sizable payments for termination. And when a court finds in favor of an employee, the terminated employee can receive back pay for the full period between the judgment and the termination—which can take years in Japanese courts.

Stock Options, Benefits and Remote Employees Pose Challenges

Many HR executives assume that some standard employment practices, such as for employee stock options, are beyond foreign statutory influences. It is true that options trading in U.S. equity are subject to the rules stated by the U.S. agreement. However, local employees are also subject to local taxes that can apply to different events than in the U.S. Therefore, be sure to understand the local tax point for stock options, whether they fall on the grant, vesting, exercise, or sale of stock shares.

Employee benefits are another cost that can be greatly influenced up or down, depending on employee head count and length of trading history in the new territory.

Without a local bank account or trading history, companies may be unable to obtain vehicle leases or insurance policies for local employees. One common mistake is to contractually commit to providing a company car to an employee, only to find that a lease cannot be secured. As a result, the employer may have to absorb the cost of purchasing a car outright in order to comply with its contractual agreement.

Likewise, if the local head count falls below 20 employees, health insurance coverage may have to be provided on an individual basis, rather than through a group plan. This can greatly drive up coverage costs due to pre-existing health conditions.

Remote employees present another concern due to a lack of visibility around vacation accruals and attendance. If you are unable to closely monitor leave and office hours, then it is likely you will also struggle to monitor performance. By the time you identify underperforming employees, they may have already attained unfair-dismissal rights in some countries. Therefore, large cost savings can be achieved by actively monitoring the attendance, leave and performance of your remote employees.

No Magic Bullet for Avoiding Hidden Costs

When it comes to global employment, no single solution can be applied across-the-board for every nation. Each country must be assessed based on its own local tax codes and employment laws. The requirements for each country are unique and specialized.

That’s why when expanding into new territories, it’s important for HR managers and financial professionals to analyze not only the total cost of each new employee but also the average revenue expected per employee in that foreign country.

Such an analysis requires a full accounting of all hidden costs. Otherwise, there can be no way to determine if the foreign expansion makes financial sense.

Stuart Buglass is vice president of human capital consulting for Nair & Co., an international HR services firm that handles employment law, compensation and benefits, stock options, expatriate tax, and immigration-related issues.

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