Worklife 2.0: Employers of record – the sky is the limit? Part 4 – Tax considerations

We are seeing an increasing number of companies partnering with “employers of record” (EoRs). As previously discussed (here, here and here), this arrangement is particularly popular amongst companies in rapid growth mode (including many in the tech sector). EoRs “employ” individuals in countries where the companies themselves do not have a formal corporate presence or branch. This allows them to access global talent and expand into new jurisdictions with relative ease and speed. EoRs are attractive partly because they handle the administrative aspects of the employment relationship, such as payroll, statutory benefits, immigration and tax reporting.

In this fourth blog post in a series exploring how to partner with EoRs and navigate the relevant legal landscape successfully, we focus on some of the tax considerations that need to be considered when entering into these sorts of arrangements.

Payroll taxes

One of the most attractive features of accessing talent via an EoR arrangement is that the EoR will take on responsibility for compliance with any local payroll tax obligations, such as registering for, calculating, deducting and paying local income tax and social security contributions. Any taxes paid by the EoR in this way are then charged back to the end user as part of the EoR’s fee.

While the EoRs will generally deal with any payroll taxes that arise in relation to the employee’s “home” jurisdiction, care should be taken if the employee may carry out aspects of their role somewhere else.

Consider, for example, an end user company in jurisdiction “A” which uses an EoR to access the services of an individual based in jurisdiction “B”. Although the EoR should generally ensure compliance with any payroll tax obligations in jurisdiction “B”, it is nonetheless possible that if the individual spends time working elsewhere (be that in jurisdiction “A” or a third jurisdiction) that this can trigger further payroll tax obligations which the EoR wouldn’t be expected to deal with. In some cases, this could even give rise to liabilities of the end user itself. End users who are looking to use an EoR to engage an individual who is expected to travel regularly for work should therefore consider obtaining local tax advice in the relevant jurisdictions to make sure they understand the local compliance implications.

Permanent establishment risk

While EoR arrangements can provide an effective way of outsourcing most if not all of the end user’s payroll tax compliance in the relevant local jurisdiction, end users should not assume that the EoR arrangement absolves them of all tax risk in relation to the local jurisdiction. In particular, careful thought should always be given to the question of whether the EoR arrangement is sufficient to trigger a taxable permanent establishment of the end user in the local jurisdiction. Failure to take care over these considerations can result in attribution of profits of the end user to the local jurisdiction for tax purposes, as well as penalties for non-compliance.

So, what is a permanent establishment? The relevant definition of permanent establishment will vary depending on the jurisdictions involved. However, it will normally involve looking to the double tax treaty in place between the end user and the jurisdiction where the EoR is being used. Since double tax treaties are generally based on the OECD’s model tax convention, the general principles will usually be the same (although there can be differences in both the language of the treaties and the way the definitions are interpreted by local tax authorities).

In broad terms, there are two categories of permanent establishment to watch out for: “fixed place of business” permanent establishments and “dependent agent” permanent establishments.

Fixed place of business permanent establishments

Typical examples of a fixed place of business permanent establishment are branches, offices, factories or places of management. Therefore, if the end user plans to open an office in the local jurisdiction where the individuals engaged through the EoR arrangement will work, this would expose the end user to a high risk of creating a permanent establishment.

Helpfully, the OECD’s commentary on its model treaty makes clear that an individual working from a home office will generally not give rise to a fixed place of business for these purposes, provided it is clear that the home office is not “at the disposal” of the end user. Points to be mindful of include ensuring the individual doesn’t host meetings at their home, doesn’t include their home address or telephone number on business stationery, and that the end user doesn’t contractually oblige the individual to work from the home office.

Dependent agent permanent establishments

Even if the end user doesn’t have a fixed place of business in the local jurisdiction, a permanent establishment can nonetheless be created if the individuals engaged through the EoR arrangement habitually conclude contracts in the local jurisdiction in the name of the end user. Many treaties now further specify that this can include a situation where the individuals play a key role in negotiating the contract in the local jurisdiction even where the contract is in fact concluded by the end user itself in its home state (i.e., “rubber-stamping”).

What this means is that an end user who wishes to engage the services of individuals who will play a senior role in their business, or who will in any event routinely negotiate contracts on behalf of the end user (e.g., a sales team), may find that their EoR arrangement risks creating a permanent establishment of the end user in the local jurisdiction.

Watch this space for future blog posts tackling other legal considerations relevant to EoR arrangements. For more information on EoRs and their utility for rapidly growing companies, please speak to the authors of this post or your usual Freshfields contact.