Expanding your international workforce: which legal setup for hiring people in another country?
May 11, 2023
Starting up business in a new country, always an important milestone!
Starting up business in a new country is a very important milestone in a company's existence and thus needs to be given due attention and be very well prepared. This article is in no way a legal article, but rather a practical guide about the different set-up possibilities in a country, and a call to seek advice in determining the right set-up because there are many possibilities, but also many pitfalls.
Two important questions to answer
Let’s assume that your company is ready to expand its international footprint and start developing business in a new country where you also want to hire your first employee, but you don’t know exactly which preliminary steps to take. Then start by answering two important questions:
How committed is your company to starting up a certain country? Is there still a doubt whether the company should make the investment? Do you first want to “measure the temperature” and let the final decision depend on the outcome of this exercise?
Have you examined the tax regime of the new country and the differences with the one of your home country? Developing business in a new country will hopefully lead to profits and thus to paying taxes. Taxes are already high enough as they are, the last thing you want is a double taxation.
The first question to answer is how definitive the choice is to start up in a country. If you want to get your bearings first before really putting it on the ground properly, then you may want to foresee some flexibility in your country set-up and hold off heavy investments until you are 100% certain to stay. In this scenario, working with an “Employer of Record” (EOR) may be the safest and certainly the most flexible set-up. (Note: you can also work with a contractor, but we leave this possibility out of the scope of this article).
An EOR can recruit candidates for your company, put them on their payroll and send you a monthly invoice. There is no upfront investment needed, you pay your EOR on a monthly basis, and your company does not need to have a local legal entity at this stage. As flexibility comes with a price tag, expect a substantial mark-up though. It is important to mention that the EOR is the legal employer of the employee and as such is responsible for compliance aspects of the employment, including payroll, taxes, statutory benefits, insurances, etc. Please bear in mind that the benefits provided by the EOR to their employees are not necessarily aligned with the benefits of your reward policy.
You are there to stay
Once your decision to start up in a new country is more outspoken, you may want to consider other employment methods. This does not necessarily imply the creation of a local legal entity, as many European countries allow foreign companies to apply a direct employment method where the foreign company signs an employment contract with a local employee. To be allowed to do so however, the foreign employer must register with a number of local official bodies such as social security, tax, commercial register, insurances… The specific requirements vary from country to country as does the total lead time required for such a registration. Count on an average lead time of 6 to 8 weeks.
It is important to mention that in this stage, the potential profits of the new country are not taxed in that country, but only in the country of the parent company. The same applies for potential losses in the new country which can bededucted from the taxable revenue of the home country.
A local legal entity
Once your presence in a new country is “established”, it may be worthwhile to take a next step and create a legal entity in the new country. There are two possibilities: a branch or a subsidiary. For the choice between the two, it is best to seek advice. Here are some of the differences between the two:
A branch is a not an independent legal entity and should always be seen together with the parent company. A branch is completely controlled by the parent company who remains 100% liable for the branch office.
A subsidiary on the other hand, is a fully independent legal entity with a 51% to100% ownership stake for the parent company. It is owned by the parent company but operates as a separate entity. The parent organization has no liability for the subsidiary.
Both the branch and the subsidiary are subject to the local tax requirements. As soon as you have established a legal entity, you are supposed to pay taxes on the profits you make in the new country.
And what is a Permanent Establishment (Risk)?
Once your presence in a new country is“established”, the local authorities will start to gain more interest in the profits that you make and may probably start treating your company as a “Permanent Establishment” (PE). This a specific term in international Tax Law defined as a “legally dependent part of the company based in the domestic market. It is a fixed place of business which is used to fully or partly carry out the business operations of a company.” (OECD definition).
The reason for this is obvious: from the moment that you are a PE, your company is supposed to pay local taxes in the new country A branch, or a subsidiary is always a PE for local authorities since there is formal proof of a fixed place of business.
It is important to mention that a PE can also be created unintentionally as local authorities in the new country may see enough proof of a fixed place of business. Permanent establishment risk (or ‘PE risk’), is the risk that the presence of an enterprise in a foreign country has unintentionally created a‘ permanent establishment’ in that country. As this can lead to back taxes, penalties, and double taxation, it is crucial to seek advice and be guided by experts!
There are different options to hire people in another country. Before you decide to create a new legal entity, it is wise to check a lower-threshold alternative such as registering as a foreign employer. But, beware of the Permanent Establishment risk and ask for advice before your local activity is considered a fixed place of business.
Interested in how Paybix can support and unburden your organization in its journey to internationalization? Let's talk or check out our solutions.
About the author of this post
Hans Joris is a Co-founder and the CEO of PayBIX. PayBIX offers Integrated Payroll Solutions for 30 European countries by leveraging their next-generation, proprietary payroll platform EPIX and a network of in-country payroll providers.