How should you employ remote colleagues - Contractors, PEO, EOR, Owned Legal Entity, Friend's Legal Entity,...?

When you are hiring and employing remote workers or distributed teams, there is a lot of jargon that's thrown at you. For the record: contractors are 1099 folks, PEO is Professional Employment Organization, EOR is Employer of Record and your owned legal entity is well, your sister or subsidiary entity in the country where you'd like to employ people. The 3rd party entity (or the friend's entity) model is not a joke and I will share examples where this has really happened! I will try my best to de-clutter this massive choice-set, even at the risk of upsetting some of my lawyer and accounting friends :)

Let's get the basic objectives aligned: you are a company which has already decided to build distributed teams. You want to:

• stay compliant,
• spend as little as possible on any elements besides direct salary to your employees,
• spend least possible time managing legal/tax/administrative issues related to the remote employment, and
• most importantly, you want to make your distributed teams feel connected and integrated with your organization.

The default choices

Early Stage Companies: For startups, the temptation of the independent contractor route is understandable: on face value, its the fastest, cheapest, and least hassled.

Here's the kicker though:  the best talent would like sustainability of employment and integration into your team, possibly even with equity - all of which are hard to achieve in the contractor model. Additionally, there are enough cases where mis-classification of full-time-like employees as contractors has got companies in trouble - certainly not the kind of headache you need as a startup.

For the employee or contractor, the direct deposit of remuneration as contractor fees might seem lucrative given its lower taxes vis-a-vis salary income in most countries. However, the local tax authority views the individual as an independent proprietor or consultant running their own business, which at the salary levels for most mid-level roles, is not not enough to build a decent credit history over time.

Bottomline: The independent contractor model could be a stop gap but not your long-term sustainable modus operandi

Mid-to-Large Companies: The default choice here is to establish your own legal entity in the country where you want to employ folks.  It's your own entity so there is no question of sustainability concerns at the employee-end and you are also 100% compliant since you will engage a lawyer or a chartered accountant to manage all the setup and ongoing compliance.

Here's the kicker though: Don't be fooled into thinking this is easy and engaging a decent law firm or accounting consultant is all your job done. Starting an entity is the easy bit, but maintaining it with full compliance takes time, effort, and energy.

Ensure you account for factors like transfer pricing which could suck away as high as 20% on top of your total costs at the subsidiary entity. For those not familiar with the transfer pricing concept, the basic premise is that your subsidiary entity cannot charge you for its employment services at cost and must markup its services on an arms-length basis, ie how it would charge for these same services to a non-related or independent client, which obviously cannot be at cost. To avoid subjectivity, governments fix this 'markup percentage', typically between 10-20%. This transfer markup is essentially your profit at the subsidiary entity on which you will pay local taxes and the balance amount will sit in your retained earnings doing nothing!  This excess cash is very hard to repatriate and most countries have moratoriums or dividend distribution taxes when pulling this profit back to the owner entity. Although its technically cash sitting in your own entity, practically speaking, its cash blocked, at least for the near-medium term.

Another consideration to keep in mind is that if not structured correctly, cash being transferred into your newly formed entity is classified as an internal inter-company investment which means you cannot expense this amount on your P&L in the home country, thus increasing your tax payable amount.

Bottomline: Your own entity is a safe but expensive and time consuming route

The Alternatives

Because of the drawbacks in both the default choices of independent contractor and owned legal entity, ideas like PEO (Professional Employment Organization) and EOR (Employer of Record) have been marketing themselves aggressively as viable alternatives.

The definition-driven difference between both is quite clear:

• PEO: You are a co-employer with the PEO in the local country where your employees are located. As such, you need to have an owned legal entity and the PEO is more like your one-stop HR solutions provider. So, you do have a say in policies, benefits, and other factors given the co-employment arrangement but on the flip side, you still need to establish a legal entity
• EOR: No need to establish an entity and the EOR entity is the whole and sole legal employer of your employees. It manages payroll, benefits, and all other compliance matters for your employees for a fee. The good news here is that you don't need to establish your legal entity but by virtue of the engagement, you have little say in what benefits your employees will receive. Plus, your employees will certainly feel disconnected since their 'legal' employer is a completely independent 3rd party

Now, the lines between these are blurring and some providers also use them interchangeably - there are PEO models where you don't need an entity and there are EOR models where you can fully decide the benefits. Beyond a point, you might not even recall which model you started with and which model you actually end up engaging in!

I wasn't joking about the friend's entity model which I have seen be used for more than a stop-gap period as a EOR purely because the fees are much lower, maybe marginally over cost. But again, can you really convince serious employees to come and build a career with you when you take a such a deep short-cut on the foundational step of demonstrating your commitment?

In fact, I have personally witnessed a story where a Chicago-based company used a friend's legal entity in India to employ ~20 folks and one fine day when it was acquired, the 20 folks were let go without any severance or consideration - why? Because there was no legit connection between the Chicago-entity and the 3rd party Indian employer (the friend's entity) and the acquiring company did not feel the need to continue the operation - needless to say, those 20 employees will do their thorough homework before picking their next international employer!

What's the point?

Okay, longish article and why am I spinning a web with all these alternatives. The point I am trying to make is that there are too many options but none of them actually solve the problem. Recall our aligned objectives in the beginning:

• You want to stay compliant,
• spend as little as possible on any elements besides direct salary to your employees,
• spend least possible time on managing legal/tax/administrative issues related to the remote employment, and
• most importantly, you want to make your distributed teams feel connected and integrated with your organization.

With Employ Anywhere, we at kaamwork are building a simple solution that addresses these objectives - sometimes, too many alternatives are not a good thing - instead what you need is a fresh perspective and a de-cluttered approach...