International Hiring: Understanding the Basic Solutions

Recorded on 6th April 2021. (UnaTerra regularly hosts webinars on a range of international expansion topics – to sign up for the next one, visit our Webinar page.)

Contents

• Why expand abroad?
• Permanent Establishment Risk
• Mechanisms for hiring international employees
• Hiring international contractors
• International PEO/EOR
• Direct employment (No legal entity)
• Direct employment (With legal entity)
• Compliance exposure
• Things to think about when budgeting for international hires
• Q&A

Thank you for joining this webinar. We’re really excited to bring this information to you today. This is the first webinar of our 2021 programme about solving the mysteries of international HR, hiring internationally and different facets of doing business in other countries. My name is Andrew Laing and I’m a Business Manager with UnaTerra. We also have our Chief Revenue Officer, Julian Christmas, joining us. 

I will give you a little bit of background about UnaTerra before we get started. We help our clients expand into over 90 countries around the world. We provide advice on expansion, registration support and post registration support including HR, payroll, accounting and compliance. We help with everything that you need taken care of so that you can focus on your business and your people.

In this webinar, we’ll go over…

Today we will go over international hiring and the basic solutions that are available, when those solutions are applicable and a little bit of the reasoning behind why these solutions are in place. We’ll go over why companies hire internationally, how governments respond and what solutions there are in place in other countries. We do business in over 90 countries and there are differences in how hiring works between all of those. We will also go over some of the basic costs for hiring abroad, which varies country to country. 

We will be sharing some polls throughout the presentation. I’m going to put the first one up now, about which of these options best describes your company’s international presence. This is going to feed into our next slide, about why companies expand abroad. 

Why expand abroad?

For a lot of companies, the driver is your access to a new market, selling into a new market, or having a customer there that needs support. The other side of the coin that we see is access to talent. A lot of countries have highly skilled talent at less rates than somewhere like the US or the UK. A lot of companies are finding that this is a good reason to expand abroad, especially now with remote working being a much bigger thing.

Governments often offer tax incentives and other types of incentives to attract foreign businesses. An example of this would be an R&D tax credit. You can get a lot of your R&D expenses refunded at the end of the year when you’re filing taxes. It really depends on what a company’s workforce skills are and what they are trying to attract. This is something that we could help you understand as you look at designing your international strategy.

Some key considerations when you are building a global workforce and expanding abroad are not only whether it’s cheaper to hire somebody in another country, but also the cost of remaining compliant, establishing a solution that works and thinking about salaries. It can be difficult to maintain a cohesive corporate culture across a lot of different countries in a global workforce. This is something that we have experienced with me being based in California. We have got staff on the East Coast and in the UK, so remaining in compliance is important. 

Permanent establishment risk

We will go over some of the solutions that can help keep you in compliance. The key thing to consider when expanding abroad is permanent establishment (PE) risk, which is the driver behind a lot of compliance and the backbone of a lot of these solutions. I’ll go ahead and pass it over to Julian to explain PE risk.

Hi everybody. Thank you for joining the webinar today. Thanks, Andrew, for the introduction. Interesting, just looking at the poll results it is a relatively even split between each of the categories, with the biggest return being people looking to expand internationally. We obviously have some attendees who are here to understand a little bit more about what it means and what to consider when expanding internationally and hiring people internationally. 

This concept of permanent establishment risk is fundamental to a lot of the work that we do. At UnaTerra, we work with a lot of companies with their existing international operations, but also to create new international approaches and hire people in new countries. One of the first things we want to understand to help inform what the solution will be is whether the planned activity is going to create a permanent establishment. It’s always important to consider this, so I thought we’d do a couple of minutes on permanent establishment, what it means, and under what circumstances permanent establishment is triggered. 

Some of you may or may not have heard of this issue of permanent establishment. It’s a very tax risk focused concept. If you’re in HR or in a tax or finance department, for example, you may have come across it before. This is talking about your business activities in a new country or another country. A permanent establishment is a fixed place of business which gives rise to a certain type of tax liability in that country. It can be VAT or some form of sales tax exposure. The one that we advise on a lot, that our clients often need to consider, is corporate income or corporation tax and whether the activity that your company is planning or undertaking in a new country creates a nexus for income tax or corporation tax. 

There are different solutions out there, depending on what your plan is for a new country. In terms of informing your decision about that solution, we look at what is planned and assess the permanent establishment risk. How likely is it that your activity in that country is going to inadvertently trigger a risk to the local corporate tax landscape and environment? In making that determination, what do we look at and what are the key triggers for permanent establishment risk? What are the key activities that are going to trip that corporate tax exposure nexus in the country?

In terms of hiring people, it typically falls into two main categories. One is, are they engaging in commercial activity? Are they engaging in activity which directly generates revenue? The more senior the sales person, the greater the risk of triggering permanent establishment. If you have an individual selling in a country and generating revenue, that activity is a trigger for the local tax authorities to say that there is commercial activity which is generating sales and profits. The local tax authorities would like to have some element of tax earned off the profit that is generated by that local activity. If that selling activity was done from outside of that country, into that country, that doesn’t create the same tax situation as actually having somebody on the ground selling. Commercial activity is a very strong trigger for permanent establishment and therefore exposes the company to corporate tax in that country. 

Senior management or executive level management who are based or located in a country automatically create a permanent establishment. Senior decision-makers who are involved in the management decisions of the business are not directly generating revenue, but of course in making high-level decisions and steering the business they are almost at a higher level creating value. In a sense, they are responsible for generating revenue in all markets because they are involved in steering the whole business and strategy of the business. Senior managers, at an executive level, should always be accommodated. They will always create permanent establishment and we will talk further in a few slides time as to the difference in the solution if a permanent establishment is, or isn’t, created by certain activity. 

The last one is a fixed place of business. In having an office and a sign outside of your office that says your business is active in a country, it’s very difficult to argue that it isn’t a permanent establishment because it literally is an establishment. It doesn’t need to belong in a bricks and mortar sense to your business, as even working out of a WeWork or similar space can create that fixed place of business which triggers permanent establishment. The key thing to understand on this issue of permanent establishment is the sorts of activity that you are planning to engage in in a particular country. What is the impact in terms of planning the most appropriate solution and trying to hire and onboard new employees and individuals in that country? That is permanent establishment risk. 

Mechanisms for hiring international employees

When you’re looking to employ someone in another country, there are a lot of different options available. Starting at the top of this pyramid, a lot of businesses hire people internationally as contractors. This does not create an employment relationship. They are doing a specific function for your business. It’s important to assess whether an employment relationship does exist between your company and a contractor on a regular basis to ensure compliance, because contractors are receiving payments that aren’t through payroll and they are responsible for revenue taxes on their own. This could create some liability for your company if the government determines that there is an employer/employee relationship.

Moving down the pyramid, another one you might have heard of is Employer of Record. This is also called international PEO or EOR. This differs from PEO domestically here in the United States, where it is co-employment. Co-employment is sharing the legal employer responsibilities between two companies. Internationally, the PEO or EOR firm will hire the employee, meaning they have the legal responsibility. They take care of payroll, benefits and payroll compliance and they lease that employee out to your company, typically for a percentage of their compensation. This is a good way of entering into a market in a more compliant sense. It still exists in a grey area with regards to permanent establishment risk and that can become an issue. Putting sales people on an Employer of Record arrangement is not recommended as this triggers a permanent establishment risk. However, it is a good way of entering a country quickly and relatively compliantly.

At the bottom is direct employment, which is the least flexible but also has the least amount of risk. This is the most compliant solution. This involves making some kind of registration in the country, whether that be creating a legal entity or registering another legal entity to provide payroll in a country. These are both compliant solutions in different locations. This carries with it the biggest administrative burden and more costs but is going to keep you in compliance wherever you go. 

Again, moving from top to bottom, the top is the most flexible, contractors. It’s very easy to terminate that relationship or bring someone on as a contractor but you’re also most at risk for permanent establishment non-compliance or tax non-compliance. Then at the bottom, direct employment, is the least flexible. It takes a lot of time to set up an entity or make a registration in the country but also provides the least risk. You won’t have to worry about tax compliance as that would all be covered by whoever you get to help you.

Hiring international contractors

I wanted to introduce a second poll and ask whether people are using international contractors right now, or whether that’s something that companies are thinking of doing. If you do use contractors internationally, that would be helpful information for us to guide the presentation and we’ll go over some of the solutions in more depth.

Again, it’s interesting looking at the poll results coming in. It seems like everybody who has given an answer is using international contractors in some way, shape or form. In fact, the majority are confessing to having contractors who may actually be employees. The point of the poll was to look at how people are using contractors and how aware our audience is that in a lot of situations contractors are used domestically and internationally as a substitute for an employment relationship. There are all sorts of dangers and issues there. 

We are going to look at the four options and the pros and cons of each option. I will give a quick high-level view as to what the main risks are, if any. International contracting is an interesting area. The advantages are that you can hire international contractors immediately. Quick to hire is an understatement. They invoice and you pay the invoice, so there is no administration effort and no administration cost. The amount they invoice is the amount you pay and there’s nothing laid on top. It’s really straightforward. 

I’ll expand upon the disadvantages and the concept of limited application in a moment, but not every situation is appropriate for international or for the general concept of independent contracting. There is a high potential for liability and the general concept of risk attaching to this type of arrangement. It does also create permanent establishment risk. When it comes to talking about the risk associated with independent contractors, particularly those who are really employees, it’s a question of where do you start? 

One of the highest risks that you run with longer-term independent contracting is that a contractor could be considered a de facto employee. This is a determination that the employee can make, but it can also be a determination made by tax authorities or in court. Even though they’re not an employee, the courts or the tax authorities can interpret that the individual is, in fact, an employee on a substance over form basis. Therefore, they enjoy the protection of employment law in that country. However, as an employer without an employment contract, you certainly don’t enjoy any of the protection that you may otherwise get from employment law. You can end up with contractors who have full protection of employment law, but you as an employer have none. This can crystallise in a number of pretty nasty ways. One of them is that if you terminate a long-term contractor and they’re unhappy about it, they can bring about an employment related case against the company. The outcome can go either way and it can often depend on which country you’re talking about as to which way it does go.

Another risk is converting contractors to be employees. We work with companies who are trying to convert contractors who have been full-time engaged with the company for two, three or more years. With the best will in the world, they then seek to convert those contractors to be employees because it’s more compliant. However, if you are not able to convert them to terms that the contractor themselves are happy with, you can end up in a constructive dismissal situation. This is because they have the protection of a local employment law. You, as a company, don’t have a leg to stand on. I’ve worked with companies who have ended up keeping people as long-term independent contractors, because they consider the risk that has accumulated over time to be so great that they dare not risk crystallising it. So rather than head the risk off and try to mitigate ongoing risk, they actually end up running a much greater risk by essentially putting up with the status quo. 

Long-term independent contracting is fraught with risks. I would urge everybody to follow the rule book. If the arrangement looks like an independent contracting arrangement, if it feels and smells like an independent contracting arrangement, then by all means engage people as contractors. However, if it’s intended to be a long-term open-ended arrangement and you’re just trying to harness talent in as low cost a way as possible, it can very often backfire and what appears to be a low cost initially can sometimes unravel in the longer term. 

It has to be said that one of the situations which is most sensitive to this is due diligence. It often doesn’t unravel as a result of a legal case, or as a result of local tax authorities looking at the situation. However, if a company goes into due diligence and a whole raft of independent contractors, whether they be in your home country or abroad, are disclosed as part of due diligence, it can have an impact on valuation or appetite to invest. That is probably the situation when the risks are most likely to crystallise. That was a high level look at hiring international contractors. 

International PEO/EOR

We’re now going to graduate into more compliant territory. What are the options for hiring people, if you want to do it in a compliant way and most notably in compliance with HR law? There’s another poll going up. Does your company currently use PEO or Employer of Record services for international employees?

It looks like there’s a mix in answers. We will take a quick look at the advantages and disadvantages. I think those that use PEO or Employer of Record for international employees will understand the advantages. In terms of time and effort for your business, it’s very quick and it doesn’t cost much at the outset. It enables you to hire somebody in another country very quickly, very easily and there is very little upfront cost. If you identify somebody that you want to hire quickly in almost any country in the world, this is a solution which works well. It gives you total compliance in terms of local employment law. You can use PEO and Employer of Record services as a way of making sure that you’re engaging the employee locally, in full compliance with employment law.

In terms of disadvantages, there is still very much a grey area in terms of compliance. We have a compliance slide coming up which explains these different options that we’re presenting and to what extent are they compliant or not. For Employee of Record or PEO, there is very much a grey area on the international scene. It’s very different from the domestic PEO offering that’s available in the US. The benefits that you want to offer your employees tend to be limited in terms of what you’re able to offer and extend. If you want to replicate all the benefits that are available at HQ, sometimes that can be a bit difficult. 

Something we come up against a lot is corporate culture issues. The whole concept of Employer of Record is that you’re engaging with a third party to employ your local hire. Some employees don’t mind and some companies don’t mind, but there is a bit of a disconnect from a cultural perspective. Some are very sensitive to the fact that it’s very difficult to truly embrace a new hire and tell them that you’re fully extending your corporate culture to them if they’re engaged to a totally unconnected party. Enthusiasm for the model varies from candidate to candidate because your first hire in a country could be ok to be gauged through Employer of Record but the next one might refuse. We see plenty of situations where candidates are lost because prospective employers want to engage through Employer of Record.

It does also get expensive quickly, so there are no real economies of scale. If you want to hire one person, it will cost you X. If you want to have two or three people that would cost you two X or three X. You don’t get any sort of economies from increased head counts. Stock options is also a risk in a couple of ways. One is that if you are extending stock options to your employees, but they’re under an Employer of Record model, there is a compliance issue because technically they are options that are extended through their employment. However, if they are actually employed by a third party which isn’t in any way connected to your business it’s almost impossible to achieve compliance from a stock options perspective.

The second risk is that the PEO fee model is generally built on the basis of a percentage of your employee’s compensation. If your employee exercises stock options, in a lot of countries and a lot of situations, the gross value of the stock option exercise goes through payroll. As a payroll item, that counts as comp and the percentage that the PEO company applies will also apply to the stock option exercise. An employee might be on a 10,000 a month as a salary and your PEO fee might be 1,000, but if suddenly they exercise some stock options and their payroll for that month spikes to 100,000 or more, your PEO fee will ramp accordingly and can go from 1,000 to 10,000. That’s broadly how it works, so there is a risk from a cost perspective. 

At UnaTerra we don’t offer Employer of Record or PEO services. What we do recognise, having painted the advantages and disadvantages, is that it is a very good solution for certain situations. Although we don’t offer the service directly, we do fold it into our solutioning and if a client wants to hire one person in the UK and one person in Brazil, we have got some great solutions which are very cost-effective for hiring the one person in the UK. We don’t for Brazil because Brazil is a very complex place. From the point of view of employing even one person, you need to set up a legal entity. It takes months and it’s very expensive. In that situation we recognise that PEO or Employee of Record is the best solution for the one person in Brazil. 

Direct employment (No legal entity)

Moving on to direct employment. We have two options. One option is direct employment with no legal entity. In a fair number of situations, we talk to clients and prospects and they’re not aware that this is an option. In some countries you can employ somebody locally without the need to set up a legal entity. A lot of our prospects and clients have this general assumption that in order to employ somebody in a country, you have to have a legal entity in that country. Actually, that’s far from the truth. In lots of countries, it is possible to employ somebody locally without having a local legal entity. 

For example, if you want to hire one person in France, we need to take a non-French legal entity. It could be a UK legal entity or an American legal entity. We need to register that legal entity as an employer in France so that we create the necessary registrations and the necessary tax profile with the tax authorities. We can set up a payroll and create a French employment contract because in this situation, this is governed by French employment law. The employment contract can be between the French employee and the UK or the US legal entity. 

The advantage is that we don’t need to set up a legal entity and we just need to make some registrations. All we need to do is run a payroll and there’s no accounting requirements. Compliance requirements are very limited. It’s a really nice solution for hiring in certain countries. It gives you, as a business, full compliance with HR and employment law locally. We have an employment contract, which makes sure that the situation is compliant and ticks all the employment law boxes. You get a direct relationship with the employees, so they know that they are contracted to your business. It’s compliant from a benefits and stock options point of view, as long as you do it right, of course. You need to have the right support and the right advice. This is an area that we do a lot of work in. We put this solution forward in many cases as the best one from a cost/risk/benefit perspective. It’s quick and it’s low-cost, relative to the option which involves a legal entity.

In terms of disadvantages, it is not available in all countries. There are those that do and those that don’t allow this type of arrangement. It also doesn’t mitigate permanent establishment risk. Generally, the idea behind being able to employ people locally without a legal entity is that your business gets a chance to hire somebody who can investigate and consider the local market in a pre-commercial phase. In order to examine whether the French market is interesting to your business, you don’t want to have to set up an entity. You can make this simpler registration without a local legal entity that technically allows you to do non-commercial activity and in some situations that’s fine. You might just be hiring a software engineer or a customer support individual. We find that a lot of our clients do like to take something of a risk and have lower level of salespeople on this type of arrangement. Otherwise, you end up with a legal entity for every country where you have low-level sales representation. There is the ability to play in the margins with this particular solution.

In terms of suitability, it’s ideal for lower head counts (less than five). It’s better for non-commercial activity, but we do support plenty of these types of registrations with lower level sales and business development people. It’s just a question of understanding and accepting that there is a low permanent establishment risk. 

The good news is that you can hire people in a lot of countries, particularly in Europe, where you don’t need to go to the lengths of setting up a legal entity. You can go with this lighter touch solution. It’s quick to set up, it’s quick to close down and it’s relatively inexpensive. That’s the direct employment without a legal entity.

Direct employment (With legal entity)

The final one is direct employment through a legal entity. In terms of being a good corporate citizen and giving your business the best opportunity to be fully compliant, this is the all singing, all dancing solution. It’s the natural solution if you’re setting up a big operation. If you’re hiring teams of five or more, or if you have very senior people in a country, that should be culminated in a legal entity. It’s not unusual to find businesses setting up a legal entity in one country in Europe and conducting the majority of their bigger ticket sales through that legal entity, perhaps through a network of lower level salespeople who are employed in other countries without legal entities. It’s a bigger ticket solution and it’s a bigger commitment to a country, but in many situations it’s inevitable. 

In terms of the advantages, you get to be fully compliant with HR law, but you also get to be fully compliant from a corporate tax law perspective. A legal entity is what gives you full protection. In creating a legal entity, you are actually creating a permanent establishment. In fulfilling all of your obligations from a tax perspective, you can keep the company fully compliant, and you can take ownership of that permanent establishment situation rather than allowing the tax authorities to do so. You can only do that with a legal entity that has corporate tax registrations. It gives you the ability to be fully compliant from a corporate tax law point of view and still gives you the ability to have those direct relationships with your employees.

If you want to transfer employees between countries and they need visas, it’s almost impossible to do that without a legal entity. If you hire somebody in Australia and transfer somebody from HQ to join that person to set up the Australian part of the business, and that individual transferring needs a visa, it’s impossible to avoid the need for a legal entity. 

Legal entities also give you the option to take advantage of tax incentives. For example, if you’re trying to take advantage of the UK, Australian or Canadian R&D tax incentives. These three countries all have very strong R&D tax related incentives. It’s difficult to enjoy corporate tax related incentives without corporate tax registration. A legal entity is mandatory if you’re hoping to tap into those.

In terms of the disadvantages from a risk perspective, there aren’t any. A legal entity gives you the ability to control all of the risks. What are the disadvantages then? There is an admin burden. A legal entity needs accounting, not just payroll. It needs to be VAT registered or GST registered, and all of the compliance obligations need to be fulfilled. UnaTerra has a full package of services which delivers on all of that. A necessary part of that is higher upfront costs. A legal entity, with greater accounting and tax obligations, will result in higher costs but this is an inevitable part of doing business and setting up a more substantial operation.

Compliance exposure

What type of compliance does each of these options give you and deny you? Does the option that we’re looking at give you compliance with employment law? Does it enable you to give competitive benefits? Does it help you overcome permanent establishment risk? Does it give you what you need to sponsor visas? Does it enable you to compliantly extend stock options? 

Independent contracting is the easiest option to set up, but it doesn’t give you any of the above. You can’t be compliant with employment law if you’re a contractor. From a benefits perspective, it’s a real no-no to offer any benefits to independent contractors, even PTO. I often advise clients and prospects that it is a real mistake to offer contractors flat monthly amounts, regardless of whether they take paid time off or not. This is because PTO is one of the big bargaining chips you have when you’re trying to convert contractors to employees and it can be worth 10 or more percent of salary. If they’re moving to a situation where they enjoy PTO and if they already have that as an independent contractor, you’re not offering them anything extra. Independent contracting is super easy, somewhat risky and not compliant, unfortunately. 

PEO or Employer of Record does give you compliance with employment law. Your employee will get what they need and they won’t fall short on benefits or any of the locally mandated things they need to have. It is difficult to offer competitive benefits. Contrary to some opinion, if you employ somebody through PEO and they are a card carrying sales person for your business, that still creates a permanent establishment risk. In some situations, a PEO company will support visa sponsorship, although it is quite difficult to do. The grey area of stock options and PEO means that I can’t give a green tick to stock option compliance through the Employer of Record model. 

That leaves direct employment, either through a legal entity or not. Non-resident employer (employing without a legal entity) gives you full compliance with employment law. As an employer, it means you can offer whatever benefits you like, including medical cover. I’ve seen all sorts of unusual benefits offered. Whether you have a legal entity or not doesn’t impact your ability to offer that. However, it doesn’t give you protection from permanent establishment risk and it doesn’t give you the ability to apply for sponsors. In terms of visas, you can’t have employees switching between countries and moving to a country where there is no legal entity if they don’t have the right to work there. It does give you compliance from a stock option perspective. 

Finally, employing through a legal entity gets a tick in every box because the whole point of employing through a legal entity is that it gives you a vehicle through which you can be compliant from all perspectives. It allows you to go for visa sponsorships and you can apply from a stock options perspective. You have to do it right, obviously. Just because you’ve got a legal entity, it doesn’t make you compliant, but it means you can be compliant. 

Things to think about when budgeting for international hires

I want to talk about the costs and things to think about when you are budgeting for international hires and international expansion. Above and beyond the solutions and the costs of implementing those, some things that you might want to consider are payroll taxes. Some countries are significantly higher than others. Somewhere like France is about 45% and that includes social costs as well. The cost to employ them there is generally a percentage of an employee’s compensation. In Germany it’s 20 to 25%, whereas somewhere like Lithuania is closer to 2%. It’s good to get a sense of that before making your hires in those countries. 

Government mandated pension and government mandated healthcare exists in a lot of other places in the world. It can make it significantly more expensive than somewhere like the US where you’re paying for that through private insurance companies and can manage those costs a little better. 

You should also consider additional benefits such as healthcare vouchers, childcare vouchers, meal vouchers and car allowances. A lot of countries where there is government mandated healthcare or supplementary health insurance plans can help you be a top tier employer and attract better talent. You want to have a discussion with a provider like UnaTerra, or whoever you’re working with, to chat about what you want to scope in and what the costs of those might be. 

There is potential for litigation in some countries, such as France and the UK, which have employment law that heavily favours the employee. It doesn’t necessarily mean that your company is going to get into litigation, but somewhere like France where it’s really difficult to terminate someone has a high possibility for litigation and employees complaining about a dismissal or unfair dismissal. This can lead to legal fees. 

This is a high-level view on how to budget for international hires and international expansion. If you want a better idea, I’ll put my contact information at the end of the presentation. Feel free to get in touch. It’s highly dependent on which solution you’re going with, what country you’re entering and how many employees you have, but we can help walk you through that.

Q&A

That brings us to the Q&A. I know we have a couple of questions that came through. I wanted to mention that this is the first in a whole webinar series we’re doing this year. We’re doing these once every three weeks, but feel free to register for future ones. We’d love to see you. A few questions from the chat here…

UnaTerra’s 2021 webinar Series

If you’re interested in our future webinars, we’ll have more coming this year. We’ve got six in total and this is the first one. We’ll go over HR considerations, international compliance and the “unknown unknowns”.

A lot of people in HR or finance are told that you are expanding into China or Japan or France or Italy and to figure it out. This can mean a lot of research and groundwork and you still might not feel like you have everything covered. That’s what we’re here for, so feel free to start a conversation with us.

We look forward to seeing you on future webinars.