We recently addressed a colleague’s question that echoed one we hear fairly often. “We have an operation in Country A and want to hire our first employee in Country B. He is a national of Country B, will continue to live there while working for our company, essentially all his work activities will be conducted in Country B and he will not be an expat. Can’t we simply put him on a Country A contract, enroll him in Country A social insurance and our company benefits schemes, pay him through the Country A payroll and all will be well?”
Indeed, it is a true story (I am NOT making this up!) that a senior executive once told me that he intended to hire seven employees in France under UK contracts and payroll from the UK. His rationale?, “We don’t want to have the extra burden of setting up new administrative capacity in France and, besides, I don’t want to get tangled up in those restrictive French employment laws.”
While the desire to avoid the costs and efforts of establishing operations and additional administrative burden in “new” countries is understandable, it is not wise. Here’s why.
What are the key issues?
In most countries, a person resident in the country and performing services in the country is considered an employee in that country. It doesn’t matter where the payroll is paid, where the contract is issued, or what country the employing entity is located in.
In our example above, the likely circumstances would be:
- The government of Country B would assert that the employment relationship must be governed by Country B’s employment laws. This means that a local contract, and any additional “work rules” and requirements, must be executed in accordance with Country B’s rules. This also means that, on an ongoing basis, the employer is required to manage the employment relationship under the terms of Country B regulations.
- The employer and employee would be subject to Country B social insurance and, potentially, other mandatory program requirements, such as funded termination plans, 13th and 14th month payments and mandatory benefits. Social insurance and other contributions usually must be withheld from payroll and remitted in accordance with Country B regulations.
- The employee will be subject to income tax in Country B, not only on income generated related to his work in Country B but, potentially, on his worldwide income. Many countries require regular ongoing income tax remittances as income is being earned (so-called Pay-As-You-Earn or PAYE arrangements). In such cases, payroll once again is required to properly withhold, remit and report on income taxes in a manner akin to what must be done for social insurance.
- If based upon Country A parameters, the employee’s compensation and benefits package probably will not conform to Country B legal requirements and market practices. The employer could easily be paying too much or too little and if currencies are different, and there are exchange risks to consider. Each country has unique practices for mandatory and supplemental benefits, and the latter are usually integrated with local social plans in some manner. In the end, the inappropriately designed plans could be quite problematic and the employee would have the burden of dealing with them.
- Finally, although it is not a purely an “HR” issue, there is a significant corporate risk that HR professionals must be aware of when setting up employment in additional countries. Simply put, if an employee engages in business activities in a given country, especially if these activities produce revenue, the local authorities could rule that those activities create a “Permanent Establishment”, or PE. A PE is an ongoing business that is subject to local country corporate income taxes. If the company has not carefully established a local business entity that serves both as the employee’s “employer of record” and as a means for putting limitations around in-country business activities, then the authorities may assess corporate income taxes against the employer’s revenues both in-country and elsewhere. To illustrate a worst case scenario, if our example employee is on contract with the Country A entity and triggers a Permanent Establishment ruling in Country B, not only could the company’s Country B revenue be subject to Country B corporate income taxes, but Country B might also demand taxes on all of Country A’s company global revenues.
Is there a simple solution?
Yes. Local employees must be employed on local terms and conditions, in accordance with local market practice, by a local employer-entity, and paid via local payroll services that ensure compliance with employment, social insurance and income tax regulations. Oh, and by the way, if per chance the target employee doesn’t already have the appropriate immigration status, Work Permit and Residency Visa requirements come into play as well.
Exactly how the above can be accomplished is dependent upon what’s possible and appropriate in each country. It isn’t overly difficult or expensive to “do it right the first time” and it is much less expensive and disruptive to the business than not doing it correctly.
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