When looking to close the talent gap, hiring international talent always comes to mind. Managers understand the advantages of employing people from a different country, as the benefits tend to be astonishing, especially in terms of diversity of backgrounds and different ways of thinking and approaching problems that need solving. Nevertheless, during Covid-19, relocating your international talent has become a difficult task. One of the options available to counter this situation is to set up an international entity in a new location in order to hire the employees locally.
When is setting up an international entity a good option?
When deciding whether setting up an international entity is a good option for your company’s hiring plans, you need to consider the alternatives. One alternative with increasing significance is the hiring of employees through a Professional Employer Organisation (PEO) or an Employer of Record (EOR). While the PEO/EOR models are good to start a business in a new country and to explore options and the market, once you start growing and expanding in a country and your number of employees increases, it might be recommendable to incorporate an entity as the costs of the PEO/EOR will exceed the costs for establishing a business.
One question we are often being asked is, up to how many employees you can have in a location without having a legal entity there? From a legal and compliance perspective, the answer is that there is no exact number of employees that would lead to the conclusion of a Permanent Establishment (PE) in a country and that the regulations in regard to a PE differ from country to country. Of course, you should always consult with local tax experts on each individual case.
Generally, in case of having several new hires in the same location that you intend on hiring on a full-time long-term basis, establishing a company in their home country might be one of the best options available, and actually the most compliant one.
Compliance requirements: What do you need to pay attention to?
Establishing an international entity is usually not the first option that comes to mind when considering hiring candidates from abroad. Using a PEO/EOR or even independent contractors and freelancers might be the first to come to mind. Nevertheless, there are specific conditions that need to be taken into consideration before choosing any of the available international hiring processes.
International regulations on subcontracting:
For instance, if you decide to hire candidates who are currently based in Brazil for what will be a full-time position, doing so through independent contracts will not be compliant with the labor and employment laws of most countries. If your headquarter is based in the EU, this risk will become even higher. Moreover, while you can hire these new recruits through a subcontracting agency, you may also find some trouble if you opt to keep them involved in long-term projects, as with each day that passes there are stricter regulations being set worldwide. Countries such as Belgium and Korea, for instance, have extremely explicit regulations on how long you can use a contractor for your projects.
Employment tax and social contributions:
Most jurisdictions require the employer to report the income tax of their employees, or to withhold part of their salary in form of State tax, which for example is the case in Portugal. Moreover, in most countries in Europe and Latin America, employers are also subject to social security contributions for each of their employees.
Complying with these obligations without a local presence in that market can be troublesome and, in case of non-compliance, the employer will face fines or might even be charged with tax fraud. Some of these contributions can, in some cases such as in Switzerland, be passed on to the employee, however, it will truly depend on how your employee is registered and his or her role in the company.
Even if you are establishing a foreign entity for hiring purposes only, it is crucial that you also consider the corporate tax implications that will follow. The best option for this is to contact local corporate tax specialists, that can guide you on how to establish the entity, but also that will help you to understand the risks that you might be facing when setting up your new company abroad.
The requirements for setting up an international entity
Although the regulations will vary from one jurisdiction to the other, there are certain steps that must be followed in order to establish an entity in a foreign country. As such, you will need to find a team of professionals that understand the corporate and employment legislation of your destination country, in order to ensure that your new business is compliant.
You will need to work with local governments and entities to open up your new business. The requirements to register a company will vary from one country to another, but usually you will have to prove that you have enough funds to establish this new company, register an address for your office, select the legal structure of your business, among others.
Payroll management also varies according to the jurisdiction of your new entity. For instance, in Germany, you will need to register with tax and social security authorities, and the employee wage will be subject to a withholding of 19.82% for social security, paid by both the employee and the employer, and a wage tax between 14% to 45%. In comparison, in Portugal, the employer is the sole responsible for withholding any contributions from the employee’s salary and ensuring that this percentage is delivered to the tax authority and social security. The percentages of each contribution are defined every fiscal year by the Portuguese government.
Regular accounting services
Considering the variation that happens in terms of tax, payroll, and other governmental contributions in different countries, you will ideally need to contract a local accountant that will help you ensure your bookkeeping is within the law and compliant with the local authorities.
Corporate annual compliance
Your new international entity will also be subject to yearly tax declarations, profit and loss reports, annual financial statements, as well as any other local documentation that is required. There might also be other local requirements that you need to comply with, such as yearly or quarterly auditing by a third-party organization.
Once your international entity is established and has its accounts set, you will be able to employ your new hires. It is advised that you contact a local employment lawyer, who can guide you on the local legislation in terms of working hours, benefits, employment requirements, paid vacation, and any other employment policies that are set in the destination country.
Establishing a foreign subsidiary: the pros and cons
Setting up an international entity for hiring globally is the best option for companies that strategically wish to develop their businesses abroad and that have a relatively high number of international employees in that specific location. This is also the international hiring option that presents the lowest risks in terms of labor laws and tax compliance, however, it is also relatively time-consuming and costly. Let’s see which are the pros and cons of establishing a foreign subsidiary.
PRO: Compliance with labor laws
The biggest positive point of establishing an international entity is that you will be compliant with any employment law of that location, as well as with the taxation required. The regulations for subcontracting employees vary widely from one jurisdiction to the other, and new legislation is being approved frequently in order to ensure that companies do not abuse these types of services. As such, having a legal entity in the host country will allow you to ensure that your employees are receiving all the benefits they are entitled to, as well as allowing you to make all the required tax and corporate withholding.
PRO: Improved visibility and business growth
Entering a new market will not only allow you to hire the employees that will help your business grow, but it will also give you the opportunity to expand your company's and brand’s visibility. Establishing an entity abroad will open new doors to increased sales and revenue, as well as setting a precedent for the discovery of new markets. The new-found location will also allow you to target your marketing campaigns to a new audience, and with the help of your local employees, you will be able to pass the language barrier. This can also allow you to develop your customer loyalty and foster better relationships with suppliers and clients.
Setting up an international entity can be expensive. The costs of establishing and maintaining a company in a foreign country will vary widely depending on the destination. For instance, it may cost on average €4.000 to set up an entity in the United Kingdom, while in Brazil you will be looking at expenses of almost €30.000. Moreover, after establishing your business you will also have to consider the expenses that are assigned to each employee. From income taxes to social security withholding, it is one of the most expensive international hiring options.
CON: Set up time
If you are looking for an immediate hire, establishing an international entity might not be the ideal option for you. Setting up a foreign subsidiary can take weeks and even months, depending on the destination country. The average waiting time to be able to finally hire your international employee is on average 4 months, however, it can actually be much longer than that depending on the jurisdiction. While some businesses will be able to wait a long period of time in order to bring the ideal candidate on board, others will not. This leads us to the next point to consider.
CON: Candidate loss
Job security is one of the main worries of candidates across the world, especially during Covid-19. Since you will not be able to hire a candidate until your entity is fully functional, this can lead to your candidate finding another opportunity during the waiting time. While you can try to find other employment options in the meantime, such as using an independent contractor, to keep your new employee engaged, you also need to take into consideration if it would be legal to recruit him or her as a full-time employee once the entity is set up.
In the end, there are many factors, pros and cons to consider when deciding on setting up an international entity in another location. Ultimately, it will be a strategic company decision comparing this option to the available alternatives.
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Please note that this blog article is based on our experience and does not constitute legal advice