Independent contractors contribute to uber-profits. What about uber-compliance?

Since the end of the Great Recession, the market has witnessed a steady increase of independent contractors in the global workforce, who now make up more than seven percent of U.S. labor alone. Employers see the rising freelance economy as good for talent, who enjoy greater flexibility in scheduling and work processes. And employers reap tremendous benefits from the use of independent contractors through sizeable decreases in overhead, taxes and maintenance. Consider the operations at General Motors and Uber. Despite what you may think, these companies appear comparable on paper. Yet, one could easily argue that Uber seems the more profitable of the two enterprises.

GM is worth close to $60 billion and has over 200,000 employees. On average, GM workers earn between $19 and $28.50 per hour. Uber is valued at around $40 billion and has 163,000 drivers, whose average hourly wages range between $17 and $23 across the country. Here’s the big difference: Uber employs only 850 workers. The company classifies all of its drivers as independent contractors.

So where GM must front the costs of the equipment and facilities its employees use, along with the associated maintenance, Uber’s drivers are responsible for their own vehicles, including insurance, gas, oil changes, tires, cleaning and repairs. Uber is also exempt from the payroll taxes and benefits costs that a company like GM must bear. Yet, the issues of compliance that surround independent contractor utilization are far from black-and-white. The rise of independent contractors has become one of the most significant legal trends in the workforce today. Regulators say that misclassifying employees as ICs robs governments of crucial tax revenues and exploits workers, depriving them of healthcare and other benefits.

Most employers are aware by now that state and federal governments are cracking down on worker misclassification. Audits, enforcement actions and lawsuits focused on the misclassification of workers as independent contractors have become commonplace, and the potential costs of misclassification—back wages, tax liabilities, and retroactive exposure for employee benefits, unpaid unemployment insurance contributions, fines and penalties—can be steep.

The issue, however, has become a global one, and rectifying independent contractor misclassification problems can be substantially more expensive outside the United States where extra areas of exposure exist in countries that do not recognize the same employment-at-will statutes.

Independent contractor compliance is a global issue

Instead of hiring in-country employees, burgeoning multinationals often make their first forays into overseas markets by engaging local representatives as independent contractors -- sometimes called “consultants,” “freelancers” or “entrepreneurs.” The contractor approach offers an enticing shortcut around expensive local payroll obligations, benefits mandates, employment laws, corporate registration rules and tax requirements. This approach is especially attractive where a business has no local subsidiary or other corporate presence, and where local bureaucracy is slow.

Despite its appeal, the independent contractor alternative to traditional employment can be dangerous. The risks are real, not theoretical. Independent contractor status is fragile, with nominal “contractor” designations constantly falling under attack in courts around the globe. Although penalties for compliance failures and worker misclassification seem stiff here at home, they’re often much worse abroad where the rules are stricter. So let’s look at some of the top countries for outsourcing and their rules governing the validity of independent contracting relationships.

India

India remains the most popular destination for outsourcing. Workers there are industrious, intelligent and efficient. They also live in a country with complex and occasionally unstable political processes. Complying with labor regulations when engaging ICs is an absolute must. The Indian government forbids companies from controlling or supervising independent contractors, and it expects the agreements to be written as legally enforceable contracts that contain the consultant’s Permanent Account Number (PAN) to ensure that payments are tied to the taxes an IC must pay. Clients, too, must deduct taxes and pay the government when compensating the IC. The agreements are usually limited to 240 days.

China

China is the world’s most populous nation. And although it’s gaining traction as a formidable economic superpower, it’s still experiencing growing pains as it adjusts to the wider global marketplace. While the class action concept is not commonly recognized in the Asia Pacific region (or in fact, most places outside the United States, with the exception of Canada and a few other jurisdictions), individual wage and hour lawsuits are on the rise. Also, exemptions are typically narrower than in the United States -- many jurisdictions across Asia Pacific recognize employee groups that are exempt from wage and hour laws, which can result in misclassification exposure.

An independent contractor in China must function as an exclusive corporate entity. The government considers any worker who plays a contributing role in an organization’s business, or who operates under a company’s rules or policies, an employee. A compliant IC engagement requires the talent to execute two contracts with a client -- a services agreement and a legally recognized employment contract. A client that fails to undertake this employment arrangement properly may be forced to compensate the IC twice the negotiated pay.

Brazil

Brazil is regarded as the business hotspot of Latin America. It boasts a solid economic footprint and the largest domestic IT consumption in the region. It’s also one of the most “even-tempered” outsourcing locations for clients in North America and Europe. Financially, it’s very attractive. Yet it’s also achieved equilibrium with its balanced political environment, economic stability and skilled talent.

No specific legislation in the country regulates outsourcing, and the practice is growing as a result. It’s critical to understand, however, that all of Brazil’s labor laws are intended to protect the interests of its talent.

The complicated legislation known as CLT (Consolidação das Leis do Trabalho, or Consolidated Labor Laws) imposes on employers a series of obligations intended to protect workers. These laws range from the requirement that collective bargaining agreements be struck between employers and unions with respect to salaries, which are generally expressed monthly, to obligatory maternity and paternity leave, annual vacations, additional salaries in December and others. The state levies contributions on companies’ payrolls, and with these resources provides indemnity for employees in cases of unjustified dismissals.

The major difference in Brazil when compared to the United States is that all labor contracts are individual, despite the government imposition of collective bargaining agreements for each labor category. Terms are agreed to collectively and then expressed in the form of individual contracts between employers and workers. Currently, no alternative exists, though government and other interested entities are actively seeking changes in policy.

With that said, IC agreements in Brazil must be structured as project-based engagements for finite periods of time. The government mandates that particular functions of business always be carried out by statutory employees. Projects that endure long term, or seem indefinite, will automatically transition into formal employment relationships. ICs in Brazil, like those in China, are required to register themselves as autonomous corporate entities. To remain compliant, clients must document all services performed and payments issued, presenting a professional receipt. Clients must also apply the appropriate taxes.

Philippines

This Pacific Island nation is becoming a dominant player in talent outsourcing. The country offers foreign enterprises a highly skilled and multilingual workforce at enticingly low labor costs. Its current growth rate is 46 percent, and 80 percent of its call centers are administered to the United States. Yet like the other countries we’ve been examining, the Philippines’ regulatory structure is fairly rigid in ensuring the proper compensation of its talent and tax-based contributions to its government.

• The client maintains no control or supervision over the IC; the relationship can have no appearance of employee-employer. The contractor must be registered as a self-employed operator with the country’s Bureau of Internal Revenue (BIR) and be assigned a Taxpayer Identification Number (TIN).
• The self-employed talent pay their own statutory taxes and federal obligations: SSS, Philhealth and Pag-ibig contributions.
• The IC’s pay is negotiated and formalized in a professional services agreement, with remuneration generally predicated on an hourly, daily or project basis.
• Clients are required to withhold taxes from the fees paid to ICs. Those taxes must then be filed with the government (BIR Form 1601-E and 1604-E, for monthly and annual withholdings respectively).
• The IC needs to issue Official Receipts in order to comply with the mandated withholding process. This will be incredibly difficult if the individual does not have a TIN or BIR registration.
• Clients must declare fees paid to ICs in their income tax returns, reconciled with any “expanded withholding tax” declarations.

Canada

As in the United States, Canada continues to experience a boom in the presence of self-employed professionals. The supertemp phenomenon we’ve discussed in past articles -- where highly educated, skilled and seasoned talent strike out on their own -- is also a trend shared by our neighbor to the north.

As with each U.S. state, every Canadian province enforces unique legislation addressing labor laws. Three classifications of employment are recognized in Canada: independent contractors, dependent contractors and employees. The Canada Revenue Agency uses a “four-point test” to determine the type of relationship that exists. The document Employee or Self-Employed? (RC4110) “sets out a method that should, in most cases, allow payers and workers to determine the nature of their relationship.”

The method is based on these key points: control, ownership of tools, chance of profit/risk of loss and integration. Independent contractors do not receive benefits packages or pensions, and they must pay their CPP/QPP contributions. Employers are not required to withhold income tax or pay a share of CPP/QPP or EI.

• If contractors are found to be financially dependent on a single client, which cannot terminate the relationship at will, regulatory bodies will likely classify the talent as dependent workers.
• If clients provide ICs with job training, tools, equipment, facilities or a profit-loss structure that affects only the client company, those organizations run the risk of facing misclassification penalties. If the contractor is later deemed an employee, both parties become subject to unpaid taxes, penalties, interest and CPP and EI premiums.

Ask a professional

As labor boards, tax agencies and regulators around the world become more focused on identifying discrepancies with worker classifications, clients have an opportunity to avoid and substantially mitigate, if not prevent, the associated risks of misclassification audits -- along with the costs. Engaging MSPs and staffing professionals that specialize in IC compliance can provide you with the necessary research, due diligence, strategies and centralized management to bring conformity and risk reduction to your enterprise.