Are Employer of Record arrangements right for your business?

While the contractual arrangement with the EOR would suggest that the EOR is the employer, there is a significant risk that local law in the country of employment would find that the end-user client (you) engaging the EOR is in fact the employer due to your daily control over the allocation of work and annual leave etc. This would mean that you could be held directly responsible for certain employment rights and protections which you did not expect.

However, contrast this with the approach taken by your employee’s financial lenders who generally don’t see past the EOR and invariably view the relationship as precarious when reviewing home loan applications – one of the reasons why candidates favour direct employment is the stigma that is still attached to temporary employment, such as the EOR model.

One of the big issues driving the adoption of the EOR model is the potential to avoid creating ‘tax nexus’ or ‘permanent establishment’ thereby avoiding corporate tax in that country. It is highly likely that local authorities would take the view, based on a combination of headcount, roles, time in market and local customer base, that permanent establishment (nexus) exists regardless and as a result you will be responsible for whatever taxes and penalties are deemed to be due. EOR master services agreements do not indemnify their clients from these potential risks and as such we would advise that you seek independent legal or tax advice on this issue.

As you hire employees and make sales internationally, you will want to be sure to maintain confidential business information and will also want to protect your business from employees taking your trade secrets to a competitor. Typically, your employment contracts would contain post-termination restrictions covering the time period during which a former employee cannot use confidential information, share customer lists or details, poach staff etc. The contract the EOR will put in place with your employees will include similar restrictions, however it is unlikely to offer you effective protection as you are not a party to that contract. If you are concerned that the roles you are hiring could ultimately represent a competitive threat to your business if they were to leave, and you were unable to enforce these post-termination restrictive covenants, we would recommend that you do not use an EOR for these hires.

Your business's IP is likely its most valuable asset. In many countries, the IP that staff create in the course of their employment is automatically assigned to their employer. This means that in an EOR arrangement, the default position is that IP created by staff is assigned to the EOR rather than the company. The most common way to deal with this issue is to put an assignment of IP rights in place from the EOR to the end-user and it is important to ensure that a valid written assignment, which covers the breadth of IP rights, is in place.

If you need to terminate an employee or multiple employees hired through an EOR, for whatever reason, the EOR will need to carry this out on your behalf in line with local laws. Employment termination laws vary from country to country and employment protection is common in many countries. In the UK for example, if the employee has had more than two years of service, the EOR will need to ensure that they use one of the statutory ‘fair’ reasons for dismissal (such as redundancy or misconduct) and would need to follow a fair process. This process takes time and requires professional assistance in order to ensure there are no legal ramifications for you. Note that you will have most likely provided the EOR with full indemnity in the event of a termination ‘gone wrong’ so can you really ensure that the EOR doesn’t cut any corners during the termination process? We have seen EORs try to use severance agreements rather than following the strict legal termination process as they incur less costs for the EOR and can be brought about more quickly.

If an employee initiates a legal claim for unfair dismissal they would bring that claim against their ‘legal’ employer (the EOR) and they will most likely bring it against you as you were, in their opinion, their actual employer and because they would have known that the decision to terminate their employment came from you. As you have indemnified the EOR from these claims, it will be on you to defend the case and all damages will be on you. This is likely to incentivise the EOR to encourage you to take a settlement rather than defend the claim in the way that you would have done had you been clearly in control of the employment relationship and the resulting claim.

It is highly likely that if you are a US based technology company, you will offer stock or stock options to your international hires. Where stock is offered to employees, this has the potential to create a co-employment risk as well as employment tax implications for the end-user client, which should be considered carefully.

In countries with mandatory profit share (such as Mexico) or bonuses (such as India), the amount to be paid is generally linked to the revenue of the employer. This creates added issues for the EOR and is therefore generally ignored.

Despite many EORs claiming they can sponsor work visas for their client’s employees, this is rarely legal. Most countries demand that the applicant employer has daily control over the employee (EORs can’t satisfy this). Additionally, if you want to move your EOR employee to one of your existing territories, the easiest visa option in most cases would be to use an ‘intra-company transfer’ (ICT) visa. However, this obviously requires evidence of pre-existing employment within your organisation, and it therefore follows that time spent with a EOR won’t be considered.

Statutory employment rights are often enhanced with increasing headcount – for example protection against unfair dismissal in Germany is only available once an employer has 11 employees. Employees hired through an EOR will often have access to greater employment rights than had you hired the same employees directly.

Many countries supplement federal laws with mandatory collective bargaining agreements (CBA) that are specific to a trade sector. For start-up organisations CBAs can often be avoided or if they are applied they are generally employer friendly. For an EOR, it is usually the case that a more onerous CBA is applied, such as the CBA for temporary staffing agencies, requiring participation in contributory pension schemes, which otherwise could have been avoided. Your candidates will have operated within a specific CBA for your industry and to switch CBA part way through their career invariably leads to confusion, something that many candidates are not willing to accept.

Compliance with statutory and CBA rights invariably demands daily oversight to ensure the correct procedures are followed. For example, absent the required controls for working time an employee will have the right on termination to claim back-pay for unpaid overtime, as an example, which can lead to huge claims. Unless the EOR takes responsibility for this or proactively alerts you of the need for local processes, there won’t be the necessary records to defend a claim and the liabilities will pass to you.

It is important that you fully understand your contractual arrangement with the EOR. Particular attention should be paid to how the EOR addresses issues such as your liability for tax (both corporate and employment related) and litigation risk. Most often, these are addressed through indemnities. You should also fully understand the terms covering the termination of the master services agreement and how you can exit the arrangement with the EOR once you decide to establish your own local registration to hire and pay your local employees.

Are you planning to hire some initial employees to test the market, to gather local data and find potential customers? Or are you hiring engineers to work on your core technology? Or perhaps you are hiring technical support staff to provide 24/7 coverage to your global clients? 

Are you hiring one or two hires and that’s it for the foreseeable future? Or are you making a senior hire with a view to rapidly ramping headcount? Is this a short-term play or a long-term strategy?

This is a key question to ask to help understand the extent to which overseas tax authorities are likely to assess permanent establishment (nexus) for tax purposes. For example, a VP of sales for EMEA rapidly building out a sales team to generate revenue is more likely to point towards permanent establishment risk than a small team of software developers.

While there is no magic number there is no doubt that headcount growth over time is going to create a higher risk of permanent establishment than a single employee. You need to be aware of this permanent establishment or ‘nexus’ risk so that you can decide whether to use an EOR or set up your own presence. We believe that if you plan to quickly ramp up to three employees in any given country you would be better off registering either a branch or a subsidiary from the outset. Which option is ‘right’ is a conversation we would be happy to have with you.

The reality of the EOR model is that it hasn’t been tested in the courts in many international markets. One country that has looked at it closely is Germany, where EOR business falls under the same legislation as ‘employee leasing’, which stipulates that the maximum period of time an employee can be hired under a leasing agreement is 18 months. This means that after 18 months with the EOR you must switch to your own local business registration.

Many countries in Europe, in particular, have employee headcount thresholds beyond which there is a legal requirement for a works council. While your one or two employees are unlikely to trigger this, the EOR will almost certainly have sufficient employees on their books to make this a legal requirement and as such there will be more red tape that will govern your small headcount through the EOR than would govern them were you to set up your own local registration. 

Most employees care about the extent to which their new employer is committed to their employment, career prospects and growth. Do you feel you can show them this commitment by hiring them as contingent staff through an employee leasing company such as an EOR? 

If you can genuinely show that the individual you plan to engage meets the definition and requirements of the target country’s rules on independent contractors, this can be an extremely cost-effective way to bring on some initial talent in an overseas country for some short-term project work.

In reality, we tend to find companies do want to treat contractors as they would employees, providing vacation time, healthcare benefits, stock options etc and in return they expect the contractors to work as if they were an employees. As a result, it really is rare that a company makes their overseas hires as independent contractors.

This option really is the like-for-like alternative to the EOR in so far as it is relatively quick and low cost to set up and enables you to directly hire a small number of employees engaged in limited activities in the short to medium term. It is the traditional registration type for companies wishing to ‘test the market’ as it also brings with it very little compliance other than the need to comply with labour laws including payroll related legislation. There are typically no accounting, tax or financial reporting requirements associated with operating this model. 

A branch is simply an extension of its parent company into an overseas jurisdiction. As a result, it is fully able to carry out all manner of legal business activities but it does so in the name of its overseas parent company who takes full responsibility for all trading and employment liabilities arising from those operations.

Depending on where you operate your branch, you may be required to file financial statements that disclose the financial and business health of the parent company. These records are often made available to the public.

Unless there are specific tax reasons to operate via a branch, most of our clients elect to operate through a subsidiary.

Often, the most suitable alternative to using an EOR is the more traditional route of setting up an entity in the country you would like to employ talent or employing employees using another existing legal entity in the region to employ people.

In many countries, this is quicker and more straightforward than business leaders expect. For example, in the UK a subsidiary can be incorporated within 24 hours, in Ireland within a week and in mainland Europe, depending on the country, it can take two to six weeks.

Fees can range from a few hundred dollars to a few thousand dollars but it certainly does not cost $100,000 and take 12 months to incorporate as you may have been led to believe.

The subsidiary option will enable you to appropriately tax structure your overseas operations while at the same time offer you a liability shield from overseas trading and employment liabilities.