CWS 3.0: September 12, 2012

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IC Compliance: Not Just a US Concern

As in the United States for the last decade, tax and social security authorities throughout Europe have realized they have been missing out on a large revenue stream due to workers being misclassified as independent contractors. As a result, they have been delving more deeply into the ways contractors relationships have been (or indeed have not been) structured. We have already seen audits of clients, agencies and contractors in the Netherlands, Germany, Norway, Switzerland, Belgium and France, resulting in heavy penalties where contractors have been deemed misclassified.

If misclassification is found, the employer faces a steep financial burden. It will have to pay its social contributions as well as the social contributions that should have been deducted by the employer from the employee. And social contributions in Europe are generally high. For example, the employer’s contribution is 50 percent of the worker’s base pay in France, 35 percent in Belgium and 30 percent in Sweden — and that doesn’t include the employee’s contributions, which range up to 22 percent of base pay.

And there’s more. There are other direct costs, which vary by country, which the company may need to make up for, such as vacation and holiday pay, severance pay, termination and notice costs and payment for a 13th month (holiday) payment. (In fact, Belgium has a 14th and, under certain circumstances, a 15th month holiday.) Interest charges for late payment, together with any fines levied, will then be added on top. These costs mount up quickly and will be applied to each misclassified worker.

The worker will also be entitled to claim any benefits that the client’s traditional workforce is entitled to. This may include bonuses, profit sharing, health insurances, education allowances, etc. If the contractor was supplied by a staffing firm, it may be on the hook for any financial losses. However, the staffing firm won’t be able to repair any damages made to the client’s image thanks to any negative press the client may suffer.

Further, the contractor will also face investigation and may, in order to avoid the consequences, elect to abandon the project, leaving the client without what has become an essential resource.

Varied Complexities
Work permits. Generally speaking, when working away from his/her home country, it is essential that the contractor has the right to live and work in that country. In some situations, when clients have identified a key contractor who is from overseas, he/she will need a work permit that must be obtained prior to the commencement of any work. As the application time for work permits can range from a few weeks up to several months, there are many instances where contractors are, in the worst possible scenario, going onto the client’s site whilst only being in possession of an entry visa to the country in question or at best, are in possession of a business visa that merely entitles the holder to attend business meetings and not work. This places a great deal of risk on both the contractor and the client, and there are severe penalties that both parties have to pay when detected.

Paying Taxes. Further, a contractor providing his/her service in another country is generally required to pay taxes and make social security contributions on their locally generated income in the country where the work is being performed. There are still many instances where contractors are not being correctly structured. In some cases they are being paid either all or part of the funds outside the country where the work is being performed. Thus, tax and social contributions are not being made in the correct place at the correct time and as a consequence, the authorities may immediately deem them, by default, to be employees of the client to whom they are providing services.

The IRS Test. Thus, it is essential that companies utilizing the services of contractors are certain that the contractors are either true independent contractors or are employed by another party. In order to determine if a contractor engaged internationally is truly independent, the basic principles as contained in the U.S. Internal Revenue Service’s three-factor test is an excellent guide. These same basic principles are used in most countries as the test of true independence. If challenged, the reality of the relationship will always be looked at and will override any written agreement.

Independent contractor evaluations can include the following questions:

  • Does the client direct when, where and how work is done?
  • Does the client request contractors to undergo any training?
  • Is the contractor free to use sub-contractors without requiring client approval?
  • Is the work of a full-time nature?
  • Is the contractor’s remuneration based on time as opposed to a project fee?
  • Does the contractor have responsibility for profit and loss on his activities?
  • Does the contractor provide his/her services to multiple clients?

It will often be the case that where the contractor is supplied via an agency, that the agency utilizes the services of a payroll company (often referred to in Europe as an “umbrella” or “management company”). It is essential that the agency checks that the contractor is fully and compliantly structured (which is certainly not always the case).

It is also essential to check that the contractor is correctly structured in the country where the services are being delivered and that all income generated is declared and is assessed for tax and/or social contributions. Failure to ensure that this is being done can lead to severe penalties.

The principles are similar in most countries, but there are many subtleties, nuances and interpretations possible, hence advice should always be taken before any engagements are undertaken. It will save a great deal of time and effort later on and may prevent serious penalties and costs from being incurred.

John Le Maire is an independent compliance consultant with John Le Maire Compliance Limited. He can be reached at john@jlmcompliance.com.

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