As your company evolves and you consider how to achieve your strategic objectives and meet growing customer demands, you may begin to see growing evidence of the need for international expansion.
“Companies are getting pulled into markets, regions and territories where they have no experience in operating, either because their existing client base pulls them there, or expansion goals do,” says Pete Tiliakos, a principal analyst with NelsonHall.
Are you ready to take this step?
In today’s ever-evolving global economy, entering new foreign markets means you’ll face unpredictability at every turn. Laws change. Currency valuations fluctuate wildly. Entire governments are replaced.
But despite all of this, there is much to be gained from global expansion.
Organizations that have already made the leap will tell you that, especially if you’re new to international expansion or want to test certain markets, perhaps the biggest lesson learned is that it is neither practical nor cost-efficient to take on employment challenges alone. There are just too many compliance nuances to keep up with, and time and resources are often better spent focusing on your organization’s strategic business objectives.
So, what are some common missteps that occur when launching new global initiatives? Let’s explore some examples of noncompliance—and how a partner with local expertise, can help prevent expansion complications or unwanted outcomes.
The ‘floating employee’ trap
Because they either don’t know the intricacies of employment laws in their target country—or they do, but they don’t want to deal with them—some companies will take the “floating employee” approach.
Let’s cross our fingers and hope this will work.
It may sound crazy, but for many organizations hiring in a new country, this is exactly the mindset.
This means they’ll hire workers in their new country, and instead of registering a legal entity in the country, will keep them “on the books” of the company headquarters, which in this case, we’ll assume is the U.S.
As a U.S.-based employer, the company reports employee income to the IRS, makes Social Security contributions, and follows other U.S. workforce-related regulations. But even if the company is complying with all U.S. laws, that doesn’t mean all its employees are compliant.
That’s because every country has its own regulations governing pay, benefits and taxes of people working in the country, as well as a variety of legal requirements for the entities that employ them. It’s a common misconception that someone working from an overseas home on tasks unrelated to the host-country market is outside the reach of host country payroll and employment law. If a U.S.-based company is employing people in a foreign country, the local laws must be followed.
A “floating employee,” particularly in the long term, almost always is a signal of noncompliance. And for companies just starting out with international expansion, noncompliance can be a backbreaker—resulting in steep fines, collection of lost tax revenues or even criminal liability.
The contractor ‘quick fix’
Sometimes a company’s rapid growth to keep up with market demands leads to quick hiring decisions. And sometimes this means that compliance falls through the cracks.
Take, for example, a company that encounters a once-in-a-lifetime sales opportunity that forces it to quickly enter a new international market. With little time to come up with a fully vetted expansion strategy, it begins employing independent contractors overseas.
The new independent contractors perform their projects accurately, and sales numbers climb every day. But as business picks up, the scope and nature of the contractors’ work begins to expand and drift into unlawful territory: Contractors are being paid for time worked rather than per project, are providing work exclusively for the company, and are using company tools and resources to complete the job.
Unfortunately, the company did not carefully consider how quickly business needs would change or how these changes would affect the independent contractors’ compliance—a common misstep during rapid international expansion.
Worker misclassification likely has become a common compliance mistake because independent contractors not only allow companies to hire quickly, but they are also less costly than traditional full-time employees.
In the U.S., employers who engage independent contractors are estimated to save 20% to 30% of the cost of hiring full-time employees. But oftentimes, the compliance risks of worker misclassification far outweigh any potential savings.
Here are a few examples of penalties that could be incurred by worker misclassification:
- In Canada, if a contractor is re-classified as an employee, the employer may need to pay the employee’s back income taxes, as well as pension and health contributions dated back to when the contractor work relationship began.
- In Germany, employer costs that are unpaid can result in penalties of up to 40% gross salary up to four years.
- In Australia, a penalty of $25,000 (USD) can be incurred per incident of misclassification, plus backdated pay and benefits.
- In Brazil, unpaid employer costs can be from 26.8% to 28.8% depending on the company’s core business.
As the examples show, penalties for worker misclassification can quickly and negatively affect the success of any international expansion.
A simple way to avoid noncompliance
In both examples, it would have been possible for the expanding company to employ people in new countries—and avoid the consequences of noncompliance— without having to register an entity.
Rather than risk floating employees or engaging misclassified independent contractors, the companies could have outsourced talent through an employer of record.
An employer of record acts as a partner to growing companies by providing HR and payroll management of local employees through established legal entities. The employer of record ensures that all employment, tax and benefits laws are followed, including payment in the home currency, then leases the employee back to the client company, which manages the employee’s day-to-day work.
By outsourcing HR and payroll to an employer of record, the company in effect also outsources the risk of noncompliance. That’s because the employer of record assumes responsibility for employment law compliance.
“Those companies that move to a single-source outsourced model have the distinct advantage of quickly attaining a complete, accurate process of hiring, paying and managing within each country, without ever losing sight of the larger, global picture,” NelsonHall’s Tiliakos says. “This is crucial knowledge if one wishes to solve the big problems and rethink the way they do business.”
Without having to take care of HR and payroll compliance issues, the company is free to focus on how its new employees in new international markets can contribute to the organization’s strategic business direction.