A straightforward guide to employee misclassification for global companies

All you need to know about employee misclassification.

Independent contractors with arrows and question marks hovering around them.

The number of independent contractors is growing in many countries worldwide. In the U.S. and Europe alone, there are over 162 million people engaging in independent work, either full-time or part-time. While accessing this huge pool of global talent presents a fantastic opportunity for your company, it’s important that you understand the risks of welcoming independent contractors to your global team.

Global contractor compliance

When you hire contractors in a particular country, you need to comply with that country’s laws on employee misclassification. The rules vary, but breaking them can lead to a wide range of penalties and complications that you’ll want to avoid.

In this article, you will learn what employee misclassification is, the risks associated with misclassification globally, and how to stay compliant while hiring remote independent contractors in different countries.

What is employee misclassification?

Misclassification occurs when employers hire independent contractors but treat them like employees in all but name.

It can be easy to misclassify employees because countries are often not clear about the distinction between employees and contractors, increasing the risk to employers. For example, in Germany, laws regulating the distinction between employees and independent contractors are governed by German labor courts and German administrative courts. But in the U.K., the rules are governed by “off-payroll” or IR35 regulations set by HMRC, the country’s tax authority. 

Navigating the different criteria for each country can understandably cause confusion for foreign employers.

Worried you've misclassified a contractor? Get answers using Oyster's Contractor vs. Full-Time Analyzer.

What's the difference between a contractor and an employee?

Generally speaking, there are four main differences between a contractor and an employee:

1. Benefits

Employers don’t typically provide contractors with some benefits common to employees, like holiday or sick pay benefits—but bear in mind that they do have the option to do so. Employees, on the other hand, usually receive a more comprehensive range of benefits in their Total Rewards package. 

2. Expenses

Contractors often charge more for their services because they’re responsible for providing their own equipment. A contractor with the same skills as an employee will usually charge more for their services than an employee’s hourly wage, but that expense is usually offset by the fact that contractors are hired on an as-needed basis. 

3. Risk

There are many benefits of hiring contractors—including specialized help and flexibility regarding scope and schedule—but there’s also more risk. Misclassification between employees and contractors is the biggest risk because it can affect both the worker’s and company’s tax obligations.

4. Exclusivity

It’s common for a contractor to work for multiple companies at the same time because they’re leveraging specific skills or expertise. Conversely, employees are committed to working for your business and receive training on in-house procedures and preferences in addition to industry best practices.

To further illustrate the above, here are some typical persona characteristics of both independent contractors and employees:

Who classifies as an independent contractor?

There’s no universally accepted definition of an independent contractor. However, there are some common characteristics among these varying definitions. 

Generally, an independent contractor is a person to whom your company outsources projects. The contractor has control over their pay rates, workload, and how and where they do the work. The independent contractor can also work for multiple employers, and they pay their own taxes

While it sounds easy enough, it’s key to remember that, beyond the specifics of the arrangement itself, a contractor’s location affects their contractual relationship with your company and how regulators or other authorities may perceive that relationship. 

If a U.S.-based company hires a U.S.-based contractor, the contractor provides Form W-9. And your company will need to issue Form 1099-NEC by the end of January for the previous year. 

This is different for a non-U.S. contractor living in a foreign country. While a U.S. company does not need to report payments made to the foreign contractor, you need to collect Form W-8BEN to prove the contractor’s status. 

For example, if your foreign independent contractor is providing services from Poland, their work relationship with you is subject to Polish labor laws. This relationship might be examined by their National Labour Inspectorate as you work with said contractor. 

Who classifies as an employee?

As with independent contractors, there is also no universally adopted definition of an employee, and each jurisdiction will apply its own tests to determine whether an employee relationship exists. 

Generally speaking, an employer has control over many aspects of the employer-employee relationship. For example, the company lays out the work the employees do, how they do their work, where and when they do it, their salary, training, and acceptable performance. The company exercises a significant level of control over the employee’s performance and has the authority to impose consequences when that performance is inadequate.

As mentioned above, employees are entitled to paid time off, sick leave, and other benefits as laid out in the labor laws of their respective countries. For instance, if an employee is working in Greece, their country’s labor laws stipulate a 13th and 14th month salary.

With employees, the company also typically withholds taxes from salary or similar payments and is obligated to pay an employer’s contribution.

A checklist for determining employees vs. contractors

With the above definitions in mind, answering these quick questions will help you to determine whether you’re at risk of misclassifying employees:

1. Is the person's work an integral part of your company?

If so, it’s more likely that the person will be classified as an employee. They may have a range of duties that pertain to their role and will be trained and supervised to ensure the work is done to the company’s standard. An independent contractor provides a service to your company, but the scope is much narrower and focused on a single project. They also have a greater level of autonomy when working.

2. Does the work require a special skill set?

If the worker provides a special or unique skill set, it’s often easier to classify them as an independent contractor. If the necessary skills can or should be taught in-house, the worker is more likely to be classified as an employee because they’ll need access to company resources, like equipment and education programs.

3. What level of control do you have over where and when they work?

A worker is classified as a contractor if they can decide when they work, where they work, and how they work. If you’re okay with this, it’s possible to hire the person as a contractor. If the project requires more training and oversight, or if it needs to be done in a specific sequence and time frame, then you should plan to hire an employee.

4. Does the person work for anybody else?

An employee will work for your company and your company alone. A contractor can work for several clients at once. You may or may not be comfortable with this, depending on the sensitivity of information the contractor will have access to and your agreement on who owns the output.

For a quick and easy way of identifying workers at risk of misclassification, check out our free Worker Misclassification Analyzer.

Why misclassifying employees is a big risk for global employers

Because labor laws vary by country, there is a risk of misclassifying an employee on your distributed team if you misunderstand applicable labor laws. If you hire in multiple countries, this risk increases. It’s a good idea to have a local expert on your side who can mitigate any risks of misclassification.

At Oyster, we offer country-specific knowledge and legal expertise, so by partnering with us you’ll always know you’re bringing independent contractors onto your team in a compliant manner, avoiding any risk of misclassification. To learn more, check out Oyster for global contractors.

What are the penalties?

No matter the reason, employee misclassification can lead to a variety of negative (and potentially costly) consequences, including:

Back-taxes and Social Security

If employees are misclassified as contractors, tax and social security authorities may require retroactive payment of unpaid taxes and the social security contributions.   

Employees initiating litigation or administrative procedures

Misclassified workers may pursue legal recourse or file complaints with the labor authorities seeking compensation for unpaid wages, benefits, and any other entitlements they were deprived of due to the misclassification. In turn, such claims can lead to expenses for the company, including damages and attorney fees. 

Additionally, misclassification can potentially give rise to class action lawsuits, further increasing the company's legal and financial liabilities. Moreover, when a contractor files a complaint with the labor authority, it can trigger audits or investigations by labor authorities, leading to business disruptions, increased scrutiny of payroll and wage practices, and potential additional penalties

For example, drivers in California and Massachusetts who were misclassified as independent contractors sued Uber in 2016, and then won $100 million in damages and owed wages.

Financial penalties and criminal liability

A company found to have deliberately misclassified its workers as contractors may face increased financial penalties or fines imposed by tax authorities and local government regulators. The severity of penalties varies across jurisdictions and can include criminal liability. 

Loss of intellectual property

Misclassification can create uncertainty regarding the ownership of the work product produced during the contractor relationship. As a result, the company could find itself embroiled in a challenging legal dispute over intellectual property rights.

Tarnished reputation

Misclassification can harm a company's reputation, resulting in negative publicity and a loss of trust among employees, customers, and stakeholders.

How to stay compliant with employee classification rules globally

Here are some ideas for ensuring your company stays compliant when hiring contractors globally:

Conduct regular internal audits

To ensure compliance with employee misclassification rules globally, it’s crucial for HR and People Ops leaders to conduct regular internal audits. These audits should involve a thorough review of your company's current contractor relationships, including their contracts, work conditions, and payment structures. 

By regularly assessing these factors, you can identify potential areas of non-compliance and take corrective actions before they escalate into serious legal or financial consequences. Implementing a robust audit process will not only help maintain compliance, but also demonstrate your company's commitment to ethical and responsible hiring practices.

Stay up-to-date with the regulation in every relevant country

When you manage a global workforce, it’s essential to stay informed about the latest regulations related to employee misclassification in each country where your company hires contractors. Laws and regulations can change frequently, and it’s your responsibility to ensure that your company's practices align with the most current requirements. 

Using a global employment platform like Oyster to help you hire contractors is an easy and effective way to do this. Staying up-to-date with the latest regulations will not only protect your company from potential legal issues, but also establish your organization as a responsible and compliant employer.

Create guidelines for engaging contractors

Developing clear and comprehensive guidelines for engaging contractors is another effective strategy for staying compliant with employee misclassification rules globally. These guidelines should outline the roles and responsibilities of both parties, as well as the terms and conditions of the contractor relationship. 

Be sure to include specific criteria for determining whether a worker qualifies as an employee or a contractor, based on the laws and regulations in each country where you operate. This will help ensure consistency across your organization and reduce the risk of misclassification. Providing training and resources to your People Ops teams on these guidelines will further enhance their ability to effectively manage contractor relationships and maintain compliance.

Build a contractors team to mitigate risks and handle issues as they arise

You should also consider building a dedicated team within your People Ops team to focus exclusively on contractor management and compliance. This team should be responsible for monitoring contractor relationships, identifying potential risks, and addressing any issues that may arise. 

By having a dedicated group of experts who are well-versed in global employment laws and best practices, your company will be better equipped to navigate the complexities of hiring contractors worldwide. This proactive approach can help you mitigate risks, resolve issues quickly, and ultimately maintain compliance with employee misclassification rules on a global scale.

Use Oyster to convert contractors into employees

Oyster can help you to assess worker misclassification risks and compliantly convert contractors to full-time employees—all under one platform. Find out more about contractor conversion in Oyster.

About Oyster

Oyster is a global employment platform designed to enable visionary HR leaders to find, hire, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.

Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.

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