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Converting a Contractor to a Full-Time Employee: A Guide for Overseas Employers

In a recent trend, both companies and workers have begun to favor an independent contractor role over that of a formal employee, especially for a remote position abroad.  There are a number of reasons for this including more autonomy for the worker, and cost savings for the company.  It is well known that hiring a contractor has a lower overall cost than an employee, as well as more logistical ease and flexibility.

If your company currently hires overseas contractors for various roles and projects, at some point it may make sense to bring them on as a full-time employee.  This will depend on the worker’s preference and your business needs, but if those match up then an employee role could be better for both parties.

Aside from the motivations, this transition process can be bit more complex than simply hiring and onboarding a newly recruited employee.  This guide will outline some of the steps involved and challenges your company might encounter when transitioning a contractor to an employee role.

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Advantages for the Company in Transitioning the Contractor

In most cases, the overseas contractor will be a resident in the foreign country, initially engaged as a remote worker or for specific projects.  This can be a good arrangement to begin the work relationship and see how the contractor performs and interacts with your company, whether in a sales role, customer support or technical specialties.

The advantages for your company when you transition the contractor to an employee include:

  • Secures their skills long term
  • Gives them the benefits and compensation they need to stay committed
  • Avoids misclassification problems in the host country
  • Maintains status quo of projects and familiarity with your company

Despite these benefits, there are a few challenges to overcome in the transition from contractor to employee.

Problems and Challenges When Transitioning a Contractor to a Full-Time Employee

There are a number of steps that have to be followed to convert your contractor to an employee, most of which deal with new tax rules, structuring compensation and registration for benefits.

Verifying Your Worker’s Classification

The first thing to do is verify their new employee status.  As a contractor, they were essentially self-employed, so now they will give that up and switch to their status as your employee.  

This does add cost and complexity for you as the new employer to make sure that you are meeting local employment laws. However, you will no longer have to worry about the contractor being unexpectedly reclassified as an employee under local laws, along with fines and penalties

Every country has different tax forms for contractors and employees, for example in the US you would now need a W-2 form for the employee, and would no longer issue a 1099 form for contractors.  Other countries may have different tax id numbers or systems for employees vs contractors.

Changes in Payment and Taxation

Your previous contractor was simply paid according to your agreement with them, and once payment was remitted you had no further responsibility for tax withholding.  They would take care of their own tax situation as an independent business in their country.

Now, the new employee will be subject to normal tax withholding in payroll, and you will need to set up a local payroll in the foreign country if this is the first time you are employing there.  If you don’t want to set up an entity and incorporate locally, you can use a GEO service to run payroll for your employee through an employer of record.

Once payroll is set up, both tax and social contributions are withheld, and net salary is paid to the employee.  The worker may want to re-negotiate their compensation as an employee, since they will no longer have the ability to deduct work-related expenses from their income, as they did as a contractor.  However, they will have more benefits as an employee that may offset the increased taxes.

How Will Benefits and Entitlements Change for the New Full-Time Employee?

As an employee, your worker will now be entitled to a wider range of benefits and entitlements, as well as more job security through labor laws and protections.  The exact nature of benefits will depend on two factors, statutory entitlements in the host country and your own company’s policies.

Statutory entitlements must be followed as a minimum level, such as vacation leave, sick leave and pension contributions.  Other benefits may not be mandatory such as health insurance, but you should at least offer similar benefits to your other employees.

Following Local Labor and Employment Laws

You will also now be subject to the employment and labor laws of the host country.  When you hired the worker as a contractor, those did not apply, but now as an employee they have a whole new range of rights.  These include notice periods, justifiable termination, severance, and protection from unfair dismissal or discrimination.

For example, if you are in the US and accustomed to ‘at will’ employment with no required notice periods, you will discover that most countries require a 30-day notice with some cause for termination.  Many countries also require a written employment contract, and may specify some of the terms to be included.  Having in country experts and guidance will be necessary to make sure you get all of this right.

Creating an Employee Handbook

Because of all of these differences and changes, it is important to put together an employee handbook that outlines company policies and practices, as well as how benefits, entitlements and withholding will be handled in their country.  That way, the employee will understand the differences from their contractor role, and that would extend to expected work hours, communication and performance expectations.

How Shield Can Help with the Transition

As you can see, the transition from a contractor to an employee role is an involved process, placing you directly within the framework of employment and labor laws in a foreign country.  While you do gain a lot with a formal employee, there is an administrative and compliance burden that goes along with that.

We have a network of employers of record in all major markets, and can easily assist in bringing your new employee on to a local payroll, and making sure they understand how their compensation and benefits will be affected by the change.  We make international employment simple, in the areas of tax, payroll, and compliance for overseas employers.

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The information in this article is subject to changes in local legislation.

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