Defining the difference between an international contractor and employee is crucial for a number of reasons. But for many companies that are considering hiring an international contractor or full-time employee as part of their global expansion, this distinction can be a challenge—but it’s a distinction that can prevent costly fines, penalties, back pay, and other headaches. But by being mindful of the intricacies of hiring a foreign contractor, and performing a climate analysis in global markets, businesses can avoid these issues and continue operations unhindered.
Defining Contractors Vs. Employees
While some distinctions may be subtle, they are important distinctions nonetheless. It’s important to remember that an employee is someone hired under a contract of service to complete a number of recurring tasks while receiving pay on a regular basis for their work. An independent contractor, however, is someone who is employed under a contract. They are hired to perform a specified task and receive compensation as a fixed sum once the task has been completed. For example, a business that hires a worker to update its website: once the site is updated, that worker is compensated and their services are no longer needed. If the same company wanted routine, daily maintenance, updates, or other tasks to keep its site running smoothly and that worker receives a routine paycheck from the business, the person hired is most likely an employee.
How Other Countries Determine Classification
Even with these distinctions in mind, employers are still at risk for misclassifying their workers—whether contractor or employee. To ensure distinction between the two, the Irish Courts have developed a number of tests to determine a worker’s title. Though these tests can make these distinctions, a 2004 court case ruled that there is no single test and no complete list that can determine a worker’s classification. Therefore, each case will be judged based on its own criteria, and the Irish Court can use a number of tests to determine status. These tests include:
- The Control Test: this test weighs whether or not the employer has exercised control over the employee’s work
- The Integration Test: this test explores whether or not the worker is employed and part of the business, and if their work is essential to the business
- The Enterprise Test: this test determines how much entrepreneurship is exercised by the employee in an effort to evaluate if they have performed on their own account
Some of the main distinctions in Ireland’s classification include:
- Labor Law: employees are protected under the Unfair Dismissals Acts 1977 to 2007 while contractors are not protected under most laws
- Personal: the contract is unique to the employee and cannot be transferred while a contractor may be able to sub-contract their services
- Taxes: for an employee, the employer is responsible for taxes, while a contractor must report their own earnings, usually at a greater level of allowed tax deductions
- Social insurance: If the employee cannot work, s/he may receive welfare; contractors must insure they will not be able to earn an income
- Intellectual Property: rights developed by the employee are most often vested in the employer; the contractor and their employer must outline IP-specific provisions in the contract
- Trade Unions: employees in Ireland are entitled to participate in collective bargaining; contractors are not
- Data Protection: current data laws do not regulate employee-employer relationships; employers need to impose obligations on contractors to address data protection
Germany’s Distinction Between Contractors and Employees
No one specific regulation determines the distinction in Germany. Rather, it relies on a combination of German law and rulings from German labor courts to conduct a rigorous assessment based on specific criteria. However, Germany’s Commercial Code states that a contractor is identified by their ability to freely determine their performance and working time. Conversely, an employee is someone who may not determine their performance without instructions from the employer and works a fixed set of hours. This has huge implications for how the worker is taxed; in employee is taxed based on wage, which is a withholding tax and taken from the employee’s gross monthly pay by the employer. Contractors, by contrast, are usually subject to a VAT—unless they are involved in excluded professions or earn an annual revenue of up to EUR 17,500. The contractor must transfer VAT info and their personal income tax.
German employment laws are quite strict—especially by U.S. standards. Employment contracts must provide specific provisions of employment. Otherwise, employers may expect that employee-friendly statutory provisions will be enacted. This includes provisions such as paid vacation, paid sick leave, taxes, and health insurance.
Challenges of Hiring Independent Contractors in China
While Ireland and Germany allow for relatively easy contracting of freelancers, China—bluntly—does not. Chinese labor laws are designed to encourage direct employment from companies. These employment methods allow for (required) contributions to its social insurance program, making hiring an independent contractor virtually impossible without making undisclosed payments. Though Chinese law does have some form of independent contractor status, it is extremely rare for both legal and business reasons.
For businesses outside China wishing to do business in the PRC, hiring a contractor is essentially out of the question. Chinese law states that only Chinese-based companies or legal foreign entities can employ Chinese workers. Companies wishing to hire Chinese workers must setup a Chinese legal entity to do so; to hire a single worker, the employment contract must be in accordance with China’s Employment Contract Law. In recent years, the Chinese government has cracked down on companies with contractors operating as employees—meaning that it is extremely risky for a company to attempt to hire a Chinese contractor.
Expand Compliantly, Confidently
While some countries are friendlier to contractors and businesses, others come with huge risks and headaches. If you’re considering expanding and hiring a contractor or employee, reach out to Velocity Global today to learn how our International PEO, also known as Global Employer of Record, solution can help you expand quickly and compliantly. We can provide country-specific analyses of the climates for independent contractors, helping you determine the risks involved by hiring an independent contractor rather than an employee. Reach out to us today to learn more.