Unsure whether you’re getting it right with your international payroll and expansion strategy?
You’re in good company. Enterprises are increasingly looking abroad to find niche talent and expand their workforce, and yet according to Deloitte’s Global Payroll Management Report, top challenges are numerous – including legislative compliance, frequent changes in tax laws, and adhering to payroll processes. If you’re an organization looking to expand your workforce to a new location – what do you need to know?
This article is part of our guide on global payroll.
The complexities of international payroll taxes
Even within the US, tax and legal regulations change from state to state. As a general rule, your business needs to withhold taxes for employees in the state in which they work.
However, not all states have reciprocity agreements when it comes to taxes. If your business is based in New York, New Jersey, or Pennsylvania (as three examples), your employees may need to pay double income tax if they work full-time remotely from home, or are using an office out of state. Imagine how you’ll bring that one up in your perks at work conversation. “Company car, private medical, double the taxes… *cough*. Did we mention we host a hackathon each year?”
Nexus, the name for the laws that enforce a connection for tax purposes between states, also apply to employment taxes. That means in many cases your State Unemployment Tax Act taxes, your sales, and use taxes and any payroll taxes will all need to be paid from where your employee is working as well as your own business location. If you have multiple employees working across the US – this can add up fast.
Now broaden your view to think about international payroll laws. Hiring an employee who works outside of the US without a reciprocity agreement between the countries will trigger tax obligations for you as an employer in that country. Even if you do have a reciprocity agreement that alleviates the tax burden, you’ll need to set up a legal entity for your business in that location, which can take time and cost money, too. Not only that, but thanks to a little something called the Territoriality principle – the chances are that you’re bound by the common rules and laws of the country in which your employees are working, not the company processes you’re used to working within the US.
Let’s say you hire a new employee who is based in Mexico, they may legally expect you to participate in a food aid program aligned with the Law of Alimentary Assistance. In Poland, employers are obligated to provide Occupational Medicine examinations, and gym membership is a very common perk. At the very least, you’ll need to stay on top of laws such as vacation days, sick days, termination policies, and local holidays, all of which will be governed by where the employee works. Psst – if any US-based employees are reading this and wondering what country to skip to, it’s Spain, where you’ll be entitled to 30 paid vacation days plus 14 national holidays. Vamos!
Good to know: In some cases, the laws of the local country in which your employees are working will allow them to waive their rights to local employment protections, which may happen if the employees are working in the location for a short time, or if they feel that they are better protected by the laws of the home country. This is relevant for countries including Indonesia, China, and Cuba.
The benefits of local knowledge
No matter what, if you’re hiring employees internationally, brace yourself for some administrative headaches, as you’ll definitely need to register in the new location, and file your presence with agencies such as unemployment and tax. Setting up a legal entity abroad (foreign subsidiary or foreign branch) is the only compliant way to onboard overseas employees under your own company umbrella – and this can take months to set up, and be complex to tear down if and when that employee leaves the company.
You’ll want a local expert on hand (preferably one who speaks the language) who understands the laws and the culture, and who can handle the local authorities on your behalf. They will be invaluable in terms of finding candidates, offering competitive compensation, and understanding all the kinds of benefits we mentioned above. Think about seemingly small issues in the US, such as your employee’s work computer needing a hardware update, or a request for flexible working arrangements. When your trusty IT or HR team are US-based – how can you support their needs?
Don’t forget, you’ll also need to establish a global payroll strategy for making compliant and streamlined international payments to varied locations on an ongoing basis, including the right tax withholding and benefits applied.
Alternatives to setting up a legal entity for international payroll
If this all seems like too much hard work, especially if you’re talking about onboarding a single employee, or testing the waters in a new location, let’s look at two other options that you might consider for expanding abroad.
Leveraging Employer of Record (EOR) partners: Sometimes called Global PEO (Professional Employer Organizations), EoR is an innovative employment model where a local in-country partner takes on the employment of your candidates on your behalf in the host country. They will legally be the employer on paper, which means they usually handle taxes, compliance, and benefits, leaving you to focus on the employee’s day-to-day workload. As you do not have a legal entity in the location, you’re free from tax obligations, too. Remind your employees that they’ll see a different name at the top of their payslips, won’t you?
Independent contractor agreements: Ask yourself, do you need employees in these positions at all? Wages and participation in the gig economy have grown 33% since 2020, and what was accelerated by the pandemic isn’t going anywhere fast. Organizations are increasingly seeing the benefits of creating a global workforce of freelancers who can work on short-term projects and have very niche skills. This allows businesses to embrace an accordion model of working, whereby they expand and contract their teams as they need – in a similar way that they might right-size cloud resources, or utilize shared office space. As a bonus, your tax requirements will be pretty minimal.
If you do choose to go through this route, then make sure you are not violating any workforce classification rules.
Isolating the right choice for your business requirements
There is no perfect “one size fits all” when it comes to handling international payroll. If your plan is to expand to a new location, in the long run you will probably be looking to set up a legal entity in that region. For a small number of employees who you need full-time, EoR might be the right choice, while project-based talent can be most quickly and effortlessly onboarded using contractors. The choice, as they say, is yours!