July 15, 2014 | 5-minute read (812 words)
Guest post contributed by Ben Wright of VelocityGlobal.
Using contractors to save on overseas employee costs can backfire, as this case study demonstrates.
Expanding your company into foreign markets can be daunting, and the prospect of hiring international staff is often the tip of the "fear" spear. Understanding the ever-changing domestic employment laws can be a real challenge. When venturing abroad we've seen countless situations of companies trying to avoid hiring employees altogether — often with disastrous consequences. Even a little bit of research can go a long way to keeping employees happy, regulators appeased, and your board of directors off your back.
Here's the story of a well-meaning client who needed to discreetly convert a contractor to an employee in Argentina.
We received a call from a distraught CFO. Her company had entered the Argentine market two years earlier, after researching several Latin American markets and concluding that it had a significant opportunity to sell its software in Argentina. The company was fairly confident about its prospects for success but wanted to stay flexible just in case things didn't work out. In speaking with her network, the CFO correctly recognized that setting up an Argentine subsidiary would be both expensive and time consuming. For all of these reasons — including the company's belief that if it classified this person as a "contractor" it could avoid the responsibility of a full employment relationship — our client decided to classify its Buenos Aires-based salesperson as a contractor.
At this point you may be thinking that things went awry due to an acrimonious separation ... not exactly. After two years, the relationship had never been stronger. Not once had the local authorities questioned the status of the employment relationship, which was by all accounts a success. So what did happen?
The employee decided to purchase a home. In Argentina, lenders require proof of full-time employment to qualify for a mortgage. Even with both sides keenly interested in maintaining the working relationship, this seemingly small change to the contractor's employment classification set in motion a landslide of time, money, and resources for our client.
In order to reclassify the employment status from contractor to employee, an employer first has to notify Argentina's Ministry of Labor of the change. Once our client provided the board with the details of its two year working relationship with the contractor, the Ministry made clear that it viewed the actual status as that of employee rather than contractor. It based its decision on the following, among other things:
- He worked exclusively for the client.
- He had business cards.
- He received variable compensation in the form of commission.
- The company provided him with a laptop.
- He was reimbursed for office expenditures.
The misclassification resulted in an official investigation.
11 months and $375,000 later, including the costs of counsel for both the "contractor" and our client, the case was resolved and our client hired its contractor as an employee in its newly-minted Argentina subsidiary. Ironically our client spent three times the amount it would have, had it simply set up a separate local entity from the beginning; and it spent six times the amount it would have cost to use an international PEO solution.
How could this have been avoided?
The situation could have been avoided had our client done one of two things: set up a subsidiary or utilized an outsourced employment model. Unfortunately it was unaware of an international professional employment organization (PEO) option at the time, so the decision to use the contractor classification seemed to be the lesser of two evils.
Savings on "contractors" often backfire for companies
The moral of the story is that classifying someone as a contractor most often ends up costing a company more than the alternatives would have. Yes, we know of stories where contractor relationships ended well, but those are by far the exception. As you can see from the above story, even when the relationship is strong, the slightest change in status quo can result in trouble as opposed to choosing one of the other employment options available. And this turn of events is not unique to Argentina.
You should view taking the time to correctly classify hires as a basic business best practice anywhere you plan to employ staff.
Ben Wright is CEO of Velocity Global, an international PEO service provider. A recognized thought leader on back office operations with more than a dozen years of experience helping companies expand overseas, Ben frequently speaks on international business panels and has presented on topics such as international employment, permanent establishment, global payroll, and expatriate assignments. For advice on expanding internationally or insight on your particular situation, contact him at email@example.com