Determining Independent Contractor Versus Employee Status
Hiring Foreign Independent Contractors: What US Companies Need to Know
From a legal perspective, an independent contractor is not an employee. If the person you’ve hired functions as an employee and you’re not treating that person as one, you and your foreign team could ultimately be on the hook for back taxes, penalties and benefits. From a tax perspective, the IRS has very specific criteria in its 20 questions you should be asking about whether a worker’s a contractor or an employee. The IRS and other federal and state authorities will impose substantial financial penalties , ongoing obligations and jump through lots of bureaucratic hoops if your company treats a foreign contractor as an independent contractor, when in fact you have an employee. The distinction also matters to U.S. companies because it is just so much simpler and easier to run your independent contractor program in terms of administration and compliance than it is to administer an employment relationship covering a large number of countries.
Legal Requirements for Hiring Overseas Contractors
The contract with the independent contractor (IC) is often the most important legal document in a company’s relationship with the independent contractor, as it controls the rights and liabilities between the contracting parties. The contract also becomes critical if the parties’ activities are challenged by a government authority. Therefore, it is important to address the following issues in any written contract with a foreign IC and which often cut across industry lines:
Choice of Law. Does the applicable law (i.e., the U.S. state law or the foreign country’s law) favor whether the contractor can be deemed an employee versus an independent contractor (i.e., through its employee benefits rules, overtime pay rules, or other employment-related rules)? Does the applicable law provide the worker with more rights that they would otherwise not have if they were employed in the U.S.? (e.g., social security or retirement benefits, vacation or sick leave, etc.)? This analysis must take into considerations that different countries have different legal requirements and rules for workers who are independent contractors versus employees.
Choice of Forum/Venue. Which court would the parties go to if there were a dispute? Likewise, what country would adjudicate the dispute? In what language and currency must it be adjudicated? From a practical perspective, if a dispute should arise, it is likely that the U.S. company would want to go to the U.S. courts. However, from a business point of view, an IC’s home country courts may be preferable.
Incorporation of the Contract Terms. Is the contract the parties’ entire agreement? Is the contract terminable by either party? Specific termination provisions should be included within the contract and include specific conditions under which either party may terminate without liability. However, the manner and circumstances in which either party can terminate may be limited by the particular state where the contractor resides to avoid a claim for wrongful termination. A non-disclosure agreement should also be included, as well as non-compete/non-solicitation clauses so that trade secrets, intellectual property, and confidential information are protected from disclosure or use by the foreign national.
Tax Considerations of Hiring International Contractors
Both the U.S. company and the foreign contractor may be required to make certain tax filings with the Internal Revenue Service (IRS) or the appropriate state revenue authority, even if no taxes are required to be paid. If a tax must be paid, then it may be reduced by the amount of a foreign tax credit, but that is a separate issue to be handled by a professional accountant.
If the U.S. company makes a payment to a foreign contractor for services performed or property delivered in the U.S., then the U.S. company would be required to withhold a 30 percent tax on the payment to it (unless reduced, as mentioned above). If the foreign contractor does not provide the required documents to the U.S. company (see below for more on this issue), then the U.S. company may also be required to withhold the 30 percent tax from any future payments pending receipt of the required documentation. In the case of payments to a foreign independent contractor based in a country with which the U.S. has a tax treaty, it is only the amount that the U.S. company is required to withhold, and not the amount that must actually be paid, that can be reduced by the foreign tax treaty. The treaty generally does not require the withholding. However, the withholding is sometimes required if the payment is in the form of royalties or is for personal services, such as consulting services. The IRS allows withholding to be reduced to 0 percent on payments to foreign independent contractors, even without a tax treaty, if the contractor provides one of the following: If the independent contractor is a non-U.S. resident alien, he or she should provide an IRS Form W-7 (Application for a Writ of Regularization) to the U.S. company, or file the form independently in order to obtain an Individual Taxpayer Identification number (ITIN) so that a Form W-8BEN can be submitted. For foreign contractors who are U.S. citizens, dual citizens or individuals who are resident aliens under the "substantial presence test," Form W-9 should be submitted.
Contractual Arrangements and Required Compliance
Foreign independent contractors must be protected by a solid contract that is completely enforceable under the laws of the respective country or countries where they physically work. If your foreign independent contractor works in two countries, it is best to have agreements with them under the laws of both countries. Most state bar associations sanction attorneys engaging in "multi-jurisdictional" work and these attorneys either obtain an opinion from a foreign attorney or pass on the opinion from local counsel, which must be respected by the "home country" attorney. The costs of the different reviews are typically low , ranging from a few hundred to less than a thousand dollars. Studies and experience show that a well-written contract and a few well-managed ground rules allow solid engagement of independent contractors that do not cross the legal lines into employee territory. Indeed, the greatest danger presented by utilizing independent contractors comes from failing to have optimal contractual provisions and fail to manage the relationship effectively. As with any good contract, your country of choice agreement should address the issue of ownership of intellectual property, trade secrets, confidential information, non competitive activity and non-solicitation. These terms should be defined and the provisions themselves should be appropriately narrow.
Handling Payments and Currency Conflicts
Something to consider when hiring foreign independent contractors is the challenge of paying the contractor because currency exchange rates can vary immensely from country to country and payment methods to foreign contractors can also vary. Here are some tips on how to manage payments to your foreign independent contractors:
PayPal. Many independent contractors overseas use PayPal to receive foreign payments but the high cost of inflation in some countries makes this too onerous. Moreover, PayPal charges a steep fee for receiving foreign currency — their average charge is $4.99 or 5%, whichever is greater.
Paypal is considered a foreign financial institution so it is subject to U.S. sanctions. That means the payment must originate from an account that has not been sanctioned for that country. SDNs (Specially designated nationals) can also not use it. Check out the lists and instructions here. Just be sure you clear this prior to sending payment.
In addition, when sending PayPal payments there can be multiple fees along the way. Take for example the fees charged from Mexico and the United States – the receiver pays 5% + $0.06 of the received payment, and the sender pays a fixed cost of $5.00. Additionally, the receiver may pay a fee for withdrawal of funds, starting at $0.45 USD.
Payoneer. This is a new option, and relatively global in nature. It’s also one of the fastest. Payoneer is best used for rapid and frequent global payouts, similar to PayPal, and is trusted and convenient for overseas contractors.
Transfer Wise. This is a newcomer which offers competitive money transfers in over 55 currencies. The transfer fees are often much less than that of traditional banks, depending on the currency. A bank transfer to England, for example, can cost up to $35, which is less than the $500 charge of Xe. One drawback is that the service typically takes 2-4 business days. The international conversion is at the interbank rate offered by the international market, plus a small fee.
TransferWise recently teamed up with Xero accounting software so that invoices can be quickly created and paid in more than 20 currencies. Making foreign currency invoice processing easier is a great advantage for any business.
Ria Financial. This method is great if your contractors work in the Middle East. Ria Financial service is similar to using a money transfer service and has low fees.
Veem (Fees are a little higher than TransferWise, and not necessarily a good fit for every country)
Landmark Bank. Canada The Landmark Bank announces the launch of its international money transfer services, called Low Cost Remittance. It even has an app to send funds for partners.
World First, CurrencyFair, Yes, Payoneer, TransferWise, and Payza have all been around for a while and have good reviews and some of the lowest fees on the market.
Best Practices When Using Foreign Workers
- Clearly outline expectations, deliverables, and timelines both in your contract and follow-up documentation. Keep all correspondence to a minimum and put everything in writing. The only exceptions to this are meetings or any other requests for hours worked, which really should be done in the native language. As well, communicate your requirements ahead of time and not when deadlines are quickly approaching.
- Work out your payment terms, as well as currency, money transfer, and money conversion issues at the very start of your relationship with your new worker. If you don’t, you could find him/her refusing to work until you pay them in a different currency and are forced to pay lots of extra transaction fees.
- Think carefully about where your Independent Contractor(s) is/are located. The fact is that there are some locations that can present more of a problem for you than others , in terms of cultural and societal norms that can impact how they get their work done. For instance, while getting a European contractor to sign a contract is relatively simple, getting a Chinese contractor to sign a contract is more complicated. The European ethos tends to be much more formal, and contracts are taken seriously and are given prominence in working relationships. The Chinese ethos, in contrast, may view agreements as being more informal, and may in fact only see them as a guideline for the working relationship. Alternatively, however, Chinese Independent Contractors come at a fraction of the price of their Western counterparts. So it is up to your company to decide where you want to base your people, what you want them to do, and how much you are willing to pay for them. You may have to make a trade off on one or more of these points in order to accomplish your goals.