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Implications of Misclassification: A Country Focus

For companies that use contractors for overseas assignments, it is essential to understand the specific criteria used in each country for classification of workers.  Most jurisdictions will have laws that define the employee relationship and factors that may contribute to having independent contractors actually construed as employees.  This is important because there are major differences underlying a formal employment relationship that carry increased cost and legal obligations for the employer.

There can be significant penalties for misclassification, and a company needs to closely assess the specific country rules to avoid violating employment, tax and labor laws.  The employee classification laws apply to both domestic and foreign companies with local subsidiaries, although in some countries such as China and the United Kingdom, the burden of arriving at the correct classification will fall on the worker.

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Classification of Work Relationships

There is a general discussion of classifying contractors and employees in this article, and the main point to understand is that it often revolves around which party controls the work assignment and methods, including the freedom to organize work time and tasks. However, to limit the risk of misclassification, the laws of the host country should be thoroughly researched and understood since the elements used to determine ‘right of control’ can differ in each jurisdiction.

General Risks of Misclassification

Employer Risks

If an employer misclassifies a worker as a independent contractor rather than an employee, the risks in the home or host country might include:

  • Back wages and unpaid overtime, plus interest
  • Unemployment insurance and social security contributions
  • Unpaid employment taxes
  • Penalties for fraudulent actions

Nonetheless, many companies may continue to accept these risks due to the fact that using independent contractors is far more cost efficient than hiring employees for the same work assignment.

Worker Risks

Workers who are self-employed contractors usually will be responsible for making their own social security, tax and other statutory withholdings.  If the worker believes that there is actually an employee relationship, then these payments may go in arrears, since neither the company nor the worker is making the required contributions.  If the company can show that a contractor relationship exists, then the unpaid contributions would be the responsibility of the worker.

Country Examples of Classification Rules and Risks

1.  Australia

The Australian employment laws are designed to protect the rights of workers and their statutory entitlements.  There are two primary legal guidelines in Australia, the Fair Work Act, which governs worker rights and remedies in the event of misclassification; and the multi-factor test that is used to determine when an employee relationship is created.

In the event that an employer misclassifies a worker as a contractor, the consequences under the Fair Work Act will include:

  • Liability of up to $33,000 per violation
  • Establishing the worker’s entitlement to benefits and modern awards
  • Past due renumeration deductions and possible penalties
  • Damage to the employer’s reputation if they acted to avoid their obligations
  • Employee claims for back pay

2. Canada

Just as in Australia, misclassifying the work relationship will carry statutory liability for the employer in the following areas:

Income Tax

Employers are required to deduct income tax from an employee’s income, but not from independent contractors.  Thus, if a contractor relationship is re-classified as an employee, past tax withholding will be due and could be the total responsibility of the employer if the worker is unable to make the payment.

Pension and Insurance

Employers in Canada must contribute to the national pension plan and employment insurance for each employee, but the law does not apply to contractors.  If a work relationship is ruled as an employee rather than contractor, then the employer would be responsible for paying both their own share as well as the employee share of owed deductions, plus penalties and interest.

Wrongful Dismissal

Typically, wrongful dismissal or termination claims are limited to employees, and independent contractors do not have the same statutory or common law rights surrounding notice periods or severance pay.  However, a contractor with some length of service may attempt to receive severance pay by claiming formal employee status and the accompanying rights and benefits.

Employer Vicarious Liability

Vicarious liability for employers in Canada can arise when an employee’s acts or omissions create some type of harm to a third party.  This law does not apply to contractors, and in the event of re-classification as an employee, the employer may find itself exposed to unforeseen liability for past actions of the worker.

3.  Belgium

In Belgium there are a few distinct differences from other jurisdictions, and in some cases the worker will share liability in the case of misclassification.

Taxes

While employers are responsible for withholding income taxes, in the event of misclassification the employee could be liable for the past due taxes.  The company would have to pursue a claim against the worker, as employer would still have direct liability for payment to the tax authorities.  Liability for non-payment can be claimed by the tax office for up to three years preceding re-classification (5 years in the case of fraud).

Social Security

Past due social security contributions resulting from re-classification are the sole responsibility of the employer.  The company could face payment of both their own share as well as the employee share, plus penalties and interest.  Contrary to the rules governing owed tax payments, the company cannot attempt to recover social security contributions from the employee, even if the terms of the contract provide a basis for making a claim.

Employee Claims

If a work relationship in Belgium is re-classified as formal employment rather than as contractor, then the worker would have rights to make benefit claims from the start of the work relationship.

These benefits can include:

  • Holiday pay and end of year premiums
  • Statutory salary increases
  • Overtime pay (typically not extended to contractors)
  • Severance pay in the event of termination

Given the economic impact of these owed payments and benefits, it is crucial that foreign employers entering Belgium clarify work relationships when entering the labor market.

Summary

There are differences in the consequences and penalties for misclassification in each country, a company must research local rules prior to hiring workers for either short or long term assignments. There is an obvious appeal for a company to use independent contractors, given the ease of initiating work, avoiding onerous immigration and employment laws, and the related cost savings.  For short term or very specific assignments where the worker controls their own activities, a contractor relationship may be both suitable and legal.

However, if the company controls the work methods and time of the worker on assignment, then an employee relationship is probably in place.  In many countries the rules that protect worker’s rights may carry significant back payment obligations, as well as statutory penalties for employer misclassification.  The widespread use of contractors by companies has led to an increased scrutiny of work relationships by many countries across the globe.

One solution for companies entering a new jurisdiction is the use of a GEO service such as Shield GEO that can act as a local employer of record for the worker.  This can limit the company’s liability for misclassification, and gives the GEO the responsibility for correctly defining the work relationship and making the required deductions and statutory payments on behalf of the client and their employee.

Get in touch to find out more about how an Employer of Record solution can help your company

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