International expansion and growth

Distributed workforces: navigating the labor and compliance challenges

Published on 8th Sep 2020

Businesses are increasingly willing to take on workers wherever they are in the world, but with a variance in tax and labor laws, businesses need to consider the different models that are available.


We regularly advise businesses that have identified a new region or country with a talent pool or customer base they want to take advantage of. There are usually a number of ways for them to have people on the ground in that new region or country.  The current pandemic has not stopped that, but we’re increasingly being asked: I’m happy to have the right people working anywhere in the world, but how do I do that?

Labor and employment issues

Local employment laws will apply based on where the person is primarily located. These laws vary so will require localized contracts for each of the options outlined below; unfortunately, there is no European standard. Laws will also vary depending on the status of the relevant individuals:


Often companies think an easy solution is to on-board individuals as contractors and thereby not have to deal with payroll/benefits – as contractors will, on the face of it, be personally accountable for this.  However the use of contractors in Europe is coming under increased scrutiny from tax authorities. In a similar vein to the US 1099 position, authorities may look at whether the contractor has been misclassified from the start of the relationship or will later likely become a regular full-time position.  Mis-classification can give rise to tax penalties and interest – from both an employment and corporate perspective – together with claims for failed employer obligations.  One model that some US companies adopt is to engage contractors on a 'fixed price for defined deliverables' basis, often with licences of know-how and trading names etc. and a 'buy out' option if the arrangement works well. This can often avoid local employment and permanent establishment risk problems although the arrangements are not easy to operate, and need to be carefully constructed to avoid other local legal problems such as with the European Commercial Agents Directive.

Third party outsourced solution

Another option may be to use a third-party outsourced solution, such as an 'employer of record' (sometimes also called an international PEO). This may be a good short term solution as it can act as one point of contact for on-boarding, payroll and benefits purposes. However, its often an expensive option (particularly as headcount expands beyond a couple of “employees”) and results in lack of control over these “employees”. It also does not necessarily create a fully compliant solution from a corporate tax perspective, nor does it contractually protect the company from any failings on the part of the third party. Potential risk areas include tax liabilities or employee claims, where the liability is often passed back up the chain. These arrangements have also faced increased regulation and scrutiny in many countries, and extensive hiring periods should generally be avoided.

Direct employees of a local entity

A third option is direct employment via a local entity. Although this carries less compliance risk than the two options above, it entails ongoing obligations for corporate and tax filings, and compliance with local employment laws, which would fall solely to the local entity. Recognising that the future for businesses is likely to be very disbursed, for many, having multiple entitles across the world is impractical.

Direct Employees with a “hub” entity and payroll solution?

The final option, which we are seeing becoming increasingly popular, is to have a “hub” in one country (often the country with the highest headcount) where that local entity acts as the employer for all of the locally based staff, as well as other individuals based in different countries. This effectively creates your own employer of record model. It does not work in every country, as some will require a local hiring entity under local labor law, but would be appropriate across most of Europe.

With this “hub and spoke” model, businesses still need to think about many of the same issues, namely localizing employment contracts, the tax position from both an employment and tax perspective and working with an international accountant/payroll provider (or registering the entity for foreign payroll). However, in our experience this is a viable option that is often overlooked.  It mitigates risks to an extent, often costs the same (if not less) than a third party (depending on headcount), retains control and culture within the business and works as a flexible model where businesses start to expand further.

Immigration issues

Immigration rules cannot be forgotten in circumstances where individuals are relocating from the country where they were hired. This may be considered a permanent or semi-permanent relocation based on the local laws. In most places in Europe, whilst business visits are generally acceptable, visas are going to be required for lengthier work-related stays. We discuss the issues to consider in Germany in more detail in this Insight.

Tax and social security contributions

Employers in most countries are subject to income tax reporting, tax withholding and social security payments where they have local employees. This will require registration with the local tax and social security authorities. In most countries in Europe, there will also be minimum employment benefits that need to be borne in mind, including, for example, contributions toward employees' statutory health, pension and unemployment insurance. Non-compliance can often lead to penalties and is generally a bad way to start doing business in a new country.

Working together with a reputable international payroll provider/accountant is often a sensible first step as a company navigates these issues in a new country for the first time. A third party employer of record or international PEO can also help with this but, unlike international payroll provider/accountant, they are unlikely to take contractual liability for any mistakes/errors/fines and may cost about the same depending on headcount.

Engaging staff as contractors may be viewed as an easy way to side-step this, but runs the risk of future claims from the local tax authorities if they reclassify the relationship and request payment for all past unpaid tax and social security contributions, together with additional penalties or even claims for assisting in tax evasion.

Corporate permanent establishment risk

The tax position cannot be underestimated or overlooked, with corporate tax risks exceeding those from an employment tax perspective.

Engaging an individual, via any of the above mechanisms, in a country where you do not have a local corporate presence, can potentially pull the engaging entity into that country for corporate tax purposes. This is known as creating a taxable permanent establishment, which can result in local tax authorities seeking payment of taxes in that country.

Whether you are creating a taxable permanent establishment is unfortunately a rather grey area, and will turn on the specific facts including the role of the individual(s) and the company’s local activities, but anything that is sales or revenue generating is likely to tip the scale.  The specific facts should always be reviewed by corporate tax specialists to understand and minimize the permanent establishment risk.  The use of a third party, such as employer of record or international PEO does not reduce or minimise this risk and is often something that is specifically contracted out of, such that full liability for any taxable permanent establishment always remains with the business.

Where that permanent establishment risk is great, or even a certainty, there is often value in creating a local presence and entity in that country. It means that the tax position can be documented from the outset in the most tax efficient way (often on a cost-plus basis between the local and US entity) and the US entity is protected from both a legal liability perspective, via 'corporate veil', and a public information perspective – as filings do not need to be made about the US entity in the local country which would be publicly available to competitors.

Furthermore, in a similar manner, VAT issues may also arise from having a distributed workforce.  Such a workforce could change the place of supply of services for VAT purposes if such services are being supplied to a business but are treated as being received by, or used and enjoyed by, an individual in a different jurisdiction than that in which the employer company is based.

Employee Wellbeing and Corporate Culture

Putting the complicated legal issues aside, businesses should not forget the challenges of having a fully virtual distributed workforce in terms of maintaining company culture, staff engagement and wellbeing.

Whilst having staff that can work anywhere may make for happier employees as they can work near family, the challenge of different locations and timezones, together with the lack of face time can make for a disjointed team and result in the loss of company culture and engagement which can have a detrimental overall impact.  Maintaining this for a virtual distributed workforce will require a concerted effort.

What’s the answer?

For a business looking to have a distributed workforce, there is no one-size-fits-all solution. It’s a question of weighing up the pros, cons and risks in each area. Often the fully compliant, local corporate presence in every country is unwieldly and expensive, particularly where headcount is low. But simply not doing anything is too risky for a responsible business entering a new market. So the best solution is usually a risk-based one, with the spectrum, starting from most risky to least risky, often looking something like this:

  • A contractor (which all too often is misclassified, either because they have no contract, they have been misclassified from the start of the relationship or they will later likely become a regular full-time position).
  • Using a third party outsourced solution such as an employer of record, or international PEO.
  • Appoint local contractors on a 'fixed price for defined deliverables' basis, with licenses of know-how and trading names etc. and a 'buy out' option if the arrangement works well.
  • Setting up a “hub and spoke” model with localized employment contracts and using an international accountant/payroll provider/registering for foreign payroll.
  • Setting up and hiring through a local entity and using an international accountant/payroll provider/registering for foreign payroll.

As technology becomes increasingly important and companies seek to derive the benefits from access to a more diverse workforce and global talent, the trend towards a more decentralized workforce is set to continue. But for the benefits to outweigh the complications, as a business you must carefully plan a global talent strategy that works for you and take some steps to limit your risk while enabling you to recruit globally and support employees, wherever they sit around the world.

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* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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